The Arthur Computer Company Case Study Essay
Order ID 53563633773 Type Essay Writer Level Masters Style APA Sources/References 4 Perfect Number of Pages to Order 5-10 Pages
The Arthur Computer Company Case Study Essay
Arthur Computer Company, which has been a successful business, is now facing mounting losses, and some of its accounting choices have been called into question. Read the following case facts and determine if criticisms of the company’s accounting are justified. Does Shelly Sanders have reason to be concerned?
Randall French, the chief financial officer of Arthur Computer Company, swiveled his chair to look at the view from his 10th floor office at company headquarters. He had just received a call from Shelly Sanders, chair of the audit committee of the board of directors. Shelly had told Randall that she would like him to meet with the audit committee on Friday (today was Wednesday). The topics of concern were some accounting questions raised by Barker and Staples, LLP, the company’s independent auditors. The auditors wished to discuss some questions related to items on the 2005 financial statements that they had discovered in just completed audit fieldwork.
Arthur Computer had begun its operations in 1995 when Mark Arthur, the chief executive officer, had left a large personal computer Arthur and formed his own company to make and sell PCs. Because of Mark’s entrepreneurial and managing skills the company had grown rapidly.
The company had issued an initial public offering in 2000 and Randall had been hired that year as the company’s first CFO. Arthur’s revenue had risen to $1.926 billion by 2005 and the net income for 2005 was set currently at approximately $39 million. The audit for 2005 was in its final stages.
The return on net sales was just over a 2%. This return was less than the 3.5% return of 2004 and the 9.8% return, the highest ever, of 2003. During 2002, because of lagging sales, the company had created a new division, AirDiscount.com, which offered discounts on airfares to Internet shoppers. Arthur Computer had also purchased PAS Software, which installed software for accounting systems. These two moves had increased revenue and profits in 2003. In 2004 revenues increased, but the return on sales decreased. Randall French knew that the first quarter of 2006 would likely generate the first net loss from operations the company had suffered since the IPO. This loss was likely to exceed $30 million just for one quarter!
Randall was perplexed about Shelly’s call because he had met just last week with Ken Staples, the partner overseeing the Arthur audit. Ken and Randall had discussed some of the problems with financial statements. Although there was not complete agreement between the two, Randall felt that he had justified to Ken that the financial statements of the calendar year 2005 conformed to generally accepted accounting principles.
Ken Staples had contacted Shelly Sanders because of three different areas of concern on the 2005 financial statements. The first related to Arthur Computer’s practices of handling the sales of personal computers, while the second touched on revenue reporting by AirDiscount.com. The third the handling of software installation contracts by PAS software. After the CPA’s discussion with the audit committee, the committee decided it wanted to hear Randall French’s views on the questions raised.
Sales of Personal Computers
Arthur Computer Company’s normal practice was to record revenue on sale of PCs when they were shipped to the customer. All shipping terms were FOB shipping point. Over the years Arthur had developed some continuing relationships with various corporate buyers who regularly purchased large quantities of PCs. Usually; these corporations placed purchase orders followed by a written sales agreement signed by both seller and buyer.
In the last week of 2004 (Arthur’s fiscal year was the calendar year); Arthur had received purchase orders totaling $20 million. Arthur had signed the sales agreement, but the buyers had not signed them until January of 2005. Arthur recognized the sale of $20 million in December of 2004 and Barker and Staples had made no comment on this practice during its audit or 2004.
In the last week of 2005 Arthur received purchase orders of some $9.2 million on which sales agreements were not yet signed. Ken Staples now maintained that the sale was not complete until the agreements were signed. In both 2004 and 2005, the PCs had been shipped to the buyer in December, Randall French had noted the practice of recognizing the revenue from 2004 and thought that Ken Staples had agreed to it.
Another issue Ken raised centered on $5.6 million in sales related to purchase orders received from a company that had purchased large numbers of PCs in the past. The purchase order was received and filled in December 2005, but the PCs were not shipped because the buyer indicated that renovations were under way and space would not be available in their business location until April 2006. Arthur segregated the PCs in its warehouse and labeled them as sold.
Revenue was recognized in December 2005. The buyer had not entered into a written sales agreement in the past, but had taken delivery and subsequently paid upon the shipment and receipt of the PCs. Staples argued that revenue had not been earned and should not be recognized. French argued strenuously that based on past practice the sale was essentially complete.
When PC sales started lagging in late 2001 and 2002, Sue Liker, vice president of marketing, had an idea. Sue had joined Arthur from an e-commerce venture that had been successful in creating new types of sales. Sue went on to create an Arthur division called AirDiscount.com which would create online sales with a minimum cost. AirDiscount.com the seller booked airfares for customers at a discounted rate. Customers contacted Air Discount online with a request for travel by air to a specified location.
Air Discount searched for the lowest fare and offered it to the customer at a price slightly above Air Discounts cost. If the customer accepted, Air Discount completed the sale. In 2003 and 2004 this division was successful and generated over $200 million in total revenues. Direct costs in those two years were about $190 million. In 2005, the division revenues decreased to $50 million while costs totaled about $70 million.
AirDiscount.com recognized that amount of sale in revenues and the cost of the airfare to Air Discount in cost of goods sold. It purchased the airline ticket from the airline before it resold it to the seller. The airline ticket was purchased only when the seller acknowledged it would buy the ticket. Air Discount required a credit card number from the potential buyer before it searched for the airline ticket.
Ken Staples had proposed an adjustment reversing the revenues and related costs previously recognized in 2003 and 2004 ($190 million in revenues) and the $50 million revenues in 2005. Only the net amount of revenues and costs would then be shown on the financial statements. Randall French had vociferously protested this adjustment. Ken had said he would think about it. Randall had not heard from Ken so he assumed Ken had dropped his proposal for the adjustment.
The PAS Subsidiary
Still on Wednesday, Randall called Pamela Martinez, the controller for PAS Software Corp., the subsidiary purchased in 2002. Randall told her about the coming meeting with the audit committee and asked for information on revenue recognized in 2005 on a PAS software installation contract with Crain Aviation Co. The revenue recognized during 2005 on this contract had totaled $30 million. Randall had become very animated in the discussion. He was upset to learn only two days before the audit committee meeting that this amount of revenue was in question and he had not been informed.
Pam had definitely felt threatened by Randall’s tone. Her discussion with Rick Tanner, audit manager at Barker and Staples, had involved some questions about software installation accounting issues, but Pam felt she had answered them adequately.
The Crain Aviation contract, which had been signed early in 2005, was for $50 million, with a completion date sometime in early 2007. After requesting information on the progress of the software installation from the PAS software engineers, Pam had been told by one engineer that he estimated 60% of the contract would be complete at the end of 2005, while another had estimated only 35% of the contract complete. When Pam asked about the difference, each had stood by his estimate. Costs incurred in the contract at year end were about 40% of the total estimated costs while payment for about 20% of the contract had been received at the end of December 2005.
In conversations during the past year, Randall had often mentioned to Pam Arthur’s falling sales and the issue of developing a positive approach in finding ways to increase profits. As the year progressed, Pam had felt under a lot of pressure to show positive operating results from PAS. However, she felt very strongly that she not stooped to doing anything unethical.
A Final Resolution
Shelly Sanders sat in her office at Main National Bank on Thursday pondering the circumstances at Arthur Computer. As chief executive officer for a local bank in the city where Arthur computer was headquartered, Shelly felt a strong attachment to Arthur.
After Mark Arthur learned of the audit committee meeting on Friday, he told Shelly that she as chair could make any recommendations to the board that she wished. Mark had also mentioned that the audit results would be released shortly. He was very concerned that the prices for Arthur stock- which had fallen recently- would be further adversely affected if the return on sales for 2005 dropped below the already informally publicized 2%.
The auditor’s concerns left Shelly with an uneasy feeling. Were Arthur revenues and net income fairly stated? She had carefully studied the issues surrounding the concerns raised by Barker and Staples. She was considered to be the most knowledgeable audit committee member in the areas of finance and accounting. In her further discussion of the issues with Randall French and Ken Staples, both were adamant that their views were correct. What was Shelly Sanders to do?
The Arthur Computer Company
There are three major areas of concern discussed in the case that you should concentrate on. After you have read the Arthur Case please do the following:
Put yourself in Shelly’s shoes. What recommendations should she make to the board concerning each of the three issues? What is the proper accounting for the three items under consideration? Are any adjustments in order?
Using the indicators from Chapter 5 in the text, read through the facts below and determine whether Company A should report revenues gross or net. This is an actual case that came before the SEC.
Company A provided internet-based college application services to assist college applicants in applying for admission to colleges. Company A would enter into service contracts with various colleges who would place their college application forms electronically on Company A’s web site.
Additional services Company A would provide were to check the applicant’s credit and charge the applicant’s credit card as “merchant of record” for the tuition. The registrant was at risk if the credit card company denied that charge. Company A would receive a fee for the admission, which they withheld when remitting the tuition to the college.
Company A presented the entire tuition as revenue on its income statement under the theory that they were merchants of record.
What do you think after reviewing the criteria in your text? How did the SEC rule? Why?
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