South City Electronics is involved in printed circuit board assembly (PCBA), dealing with the assembly of complex

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Question:

South City Electronics is involved in printed circuit board assembly (PCBA), dealing with the assembly of complex electronic system processes. The equipment is sold to a variety of customers throughout the United States and abroad. The electronics company, based in the city of South San Francisco, is publicly owned. Josh Goldberg is the chief executive officer of the company. David Levin is the chief financial officer.

It's March 30, 2019, and Kiley Nolan, controller for South City Electronics, has just gotten off the phone with her supervisor, South City's CFO David Levin, who reiterated the points he made in a face-to-face meeting with her earlier that day—that the company would be in default on a $10 million loan if its cash flow and earnings for the quarter ended March 31, 2019, did not meet set goals in the loan agreement.

At that date, the company's cash flow was $920,000 and the earnings were $460,000. This is $380,000 and $240,000, respectively, below prescribed levels. Kiley knew her boss wanted her to agree to immediate revenue treatment for the transaction described below.

The Transaction

South City transferred title to equipment sold to Victor Systems on March 29, 2019, the date of delivery on a $1.6 million sale. The arrangement allowed for the transfer of title upon delivery to Victor's site, as had occurred. However, customer-specific acceptance provisions permit the customer to return the equipment unless the equipment satisfies certain performance tests. South City cannot demonstrate that, at the time of delivery, the equipment already met all the criteria and specifications in the customer-specific acceptance provisions. The arrangement also called for the vendor to perform the installation. South City also provides technical support for the installation and use of the equipment going forward.

Kiley is agonizing about what she should do. She believes it would be wrong to record the transaction as revenue in the first quarter of 2019 under GAAP and the recently adopted FASB revenue recognition standard, Revenue from Contracts with Customers. However, she is under a great deal of pressure to do so. Levin, her boss, took the position that the conditions under which the customer intends to operate the equipment were replicated in pre-shipment testing. Kiley knew, however, that the performance of the equipment, once installed and operated at the customer's facility, may reasonably be different from that tested prior to shipment.

Meeting between Kiley and Levin

Kiley and Levin's face-to-face meeting earlier in the day featured an acrimonious dispute over whether to record the $1.6 million as revenue.

"Kiley, we have fallen below debt covenant requirements," Levin said. "The only option is to record the sale to Victor Systems. Besides, revenue recognition rules allow us to do so."

"The accounting rules are quite clear on this matter," Kiley said. "We can't recognize the revenue, given the terms of the sale, because the performance of tests at our end may result in a different outcome once it is installed by Victor Systems and it does independent testing."

"I understand your concerns, Kiley. But you're relying on a new accounting standard that just went into effect. I disagree with how you have defined the performance obligations and responsibilities we have and that of Victor Systems under the contract."

"You're using an aggressive accounting interpretation that may have passed muster before the new standard but doesn't anymore," Kiley responded.

"You're being hyper-technical," Levin responded. "We can't afford such a luxury given our precarious position."

"You and I both know," said Kiley, "that we can't just pick and choose how to apply accounting standards. As CPAs, we need to follow both the letter of the new standard and the spirit of it."

Levin became visibly upset. "Now wait a minute. This is an operating decision made by me, not an accounting decision. The accounting should reflect my operating decision. You'd better get on board."

Kiley hesitated to answer. She wasn't sure what to say next. She decided to buy some time to develop a game plan to counter Levin's position. Levin and Kiley decided to meet the next day to put this matter to bed.

Questions

1. Review the requirements of Revenue from Contracts with Customers as discussed in Chapter 7. Do you believe Kiley interpreted the new rules correctly? Be specific.

There are 5 steps that Kiley needs to follow:

1. Identify the contract with a customer

2. Identify all the individual performance obligations within the contract

3. Determine the transaction price

4. Allocate the price to the performance obligations - assign a value to each part of the obligation

5. Recognize revenue as the performance obligations are fulfilled- Date that the transfer of control occurred

2. Explain the role of behavioral ethics and cognitive thinking in Kiley's decision to ask Levin for a one-day delay to rethink her position. What are the challenges facing her from these perspectives and the actions she might take?

3. Use ethical reasoning to evaluate the appropriateness of Levin's position.

4. Assume you are in Kiley Nolan's position. Answer the following questions as you prepare for the meeting with Levin tomorrow.

What are the main arguments you are trying to counter?
What is at stake for the key parties?
What levers can you use to influence Levin?
What is your most powerful and persuasive response to the reasons and rationalizations you need to address?

5. Assume the meeting concludes and Kiley has failed to change Levin's mind. In fact, he insists Kiley get on board. What should Kiley do next and why?

South City Electronics is involved in printed circuit board assembly (PCBA), dealing with the assembly of complex electronic system processes. The equipment is sold to a variety of customers throughout the United States and abroad. The electronics company, based in the city of South San Francisco, is publicly owned. Josh Goldberg is the chief executive officer of the company. David Levin is the chief financial officer.

It's March 30, 2019, and Kiley Nolan, controller for South City Electronics, has just gotten off the phone with her supervisor, South City’s CFO David Levin, who reiterated the points he made in a face-to-face meeting with her earlier that day—that the company would be in default on a $10 million loan if its cash flow and earnings for the quarter ended March 31, 2019, did not meet set goals in the loan agreement.

At that date, the company’s cash flow was $920,000 and the earnings were $460,000. This is $380,000 and $240,000, respectively, below prescribed levels. Kiley knew her boss wanted her to agree to immediate revenue treatment for the transaction described below.

The Transaction

South City transferred title to equipment sold to Victor Systems on March 29, 2019, the date of delivery on a $1.6 million sale. The arrangement allowed for the transfer of title upon delivery to Victor's site, as had occurred. However, customer-specific acceptance provisions permit the customer to return the equipment unless the equipment satisfies certain performance tests. South City cannot demonstrate that, at the time of delivery, the equipment already met all the criteria and specifications in the customer-specific acceptance provisions. The arrangement also called for the vendor to perform the installation. South City also provides support for the installation and use of the equipment going forward.

Meeting between Kiley and Levin

Kiley and Levin's face-to-face meeting earlier in the day featured an acrimonious dispute over whether to record the $1.6 million as revenue.

“Kiley, we have fallen below debt covenant requirements,” Levin said. “The only option is to record the sale to Victor Systems. Besides, revenue recognition rules allow us to do so.”

“The accounting rules are quite clear on this matter,” Kiley said. "We can't recognize the revenue, given the terms of the sale, because the performance of tests at our end may result in a different outcome once it is installed by Victor Systems and it does independent testing.”

“I understand your concerns, Kiley. But you’re relying on a new accounting standard that just went into effect. I disagree with how you have defined the performance obligations and responsibilities we have and that of Victor Systems under the contract.”

“You're using an aggressive accounting interpretation that may have passed muster before the new standard but doesn’t anymore,” Kiley responded.

“You're being hyper-technical,” Levin responded. “We can't afford such a luxury given our precarious position.”

“You and I both know,” said Kiley, “that we can't just pick and choose how to apply accounting standards. As CPAs, we need to follow both the letter of the new standard and the spirit of it.”

Levin became visibly upset. “Now wait a minute. This is an operating decision made by me, not an accounting decision. The accounting should reflect my operating decision. You'd better get on board.”

Kiley hesitated to answer. She wasn’t sure what to say next. She decided to buy some time to develop a game plan to counter Levin's position. Levin and Kiley decided to meet the next day to put this matter to bed.

Assume you are in Kiley Nolan's position. Answer the following questions as you prepare for the meeting with Levin tomorrow.
- a. What are the main arguments you are trying to counter?
- b. What is at stake for the key parties?
- c. What levers can you use to influence Levin?

d. What is your most powerful and persuasive response to the reasons and rationalizations you need to address?