Financial Accounting Case Study: Biovail Corporation Analysis

This case study analyzes Biovail Corporation's revenue recognition policies and their implications. It examines the conditions for revenue recognition, specifically focusing on FOB sales accounting and the disagreement between Biovail and its distributor regarding the Wellbutrin shipment. The report discusses managerial motivations behind accounting practices, the impact of these practices on earnings quality, and the ethical considerations involved, particularly concerning potential conflicts of interest for analysts. The analysis includes an assessment of how different Free on Board (FOB) terms affect revenue recognition, the impact of a truck accident on revenue, and the implications of aggressive accounting techniques. The case study references academic research to support its findings and concludes with an overview of the financial and ethical ramifications of Biovail's accounting decisions.

Financial Accounting
Assignment

1
By student name
Professor
University
Date: 25 April 2018.
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Contents
Background and Abstract............................................................................................................................3
Introduction.................................................................................................................................................3
Question 1: Revenue Recognition, Managerial Motivation and Research Component...............................3
Question 2: Earnings Quality and Research Component.............................................................................5
Question 3: Ethical Component...................................................................................................................6
Conclusion...................................................................................................................................................6
References...................................................................................................................................................7
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Background and Abstract
A report has been prepared on the case study of Biovial Corporation and its revenue recognition
policies. The different revenue recognition policies has been discussed in the report and how the FOB
sales accounting is being effected based on different criteria and circumstances. The report also
highlights the reasons as to why the disagreement took place between the company and the distributor
with respect to the delivery of the goods (Wellbutrin) through shipment. All this has been discussed
using the academic research articles (Alexander, 2016). Question 2 on the case study discusses on the
comments given by J.P. Morgan on the egregious accounting techniques being used by the company and
how it affects the financials and estimations of the company. Part 3 of the case study discusses on the
scenario that how would J.P. Morgan and Banc of America would react to if Biovail considers to issue
shares in future and how it would influence Mr. Maris’ analysis on stock recommendation.
Introduction
The company Biovail Corporation is a Canadian Pharmaceutical Firm, which is publicly listed, and it has
been operating since many years. Its expertise is to apply advanced drug delivery technologies and the
improve the effectiveness of the medicines. It is involved in development and manufacturing of the
various pharmaceutical products. It has commercialised the product in Canada as well as internationally
through strategic partners (Bailey, Collins, & Abbott, 2017). The company also distributes its products in
United States but one of its recent in-transit shipments which it claims to be carrying a huge inventory
ranging between $10-$20 Mn has met with an accident and it is going to have a serious impact on the
overall revenue as well as earnings per share estimates for quarter ended 20th September 2003.
Question 1: Revenue Recognition, Managerial Motivation and Research
Component
a. For the revenue to be recognised in the books of accounts of the company, the following
conditions should be met:
i. There should be a persuasive evidence that the arrangement exists between the parties
ii. The delivery of the goods and services in question must be completed
iii. The associated risk and reward with respect to the ownership in the goods have also
been transferred to the buyer (Dichev, 2017)
iv. The price at which the seller sells to the buyer is determinable or fixed
v. There is a certainty in the collection and it can be reasonably assured.
For the given 6 cases of revenue recognition, the following is the justification of the case if the company
Biovail implemented Free on board Biovail or Free on Board destination.
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Type Particulars Description Remarks
FOB Biovail
Ownership
transfers:
Upon shipment
from
Biovail facility in
Manitoba, Canada
In case FOB Biovail is selected as incoterms, then the
risk and reward to the buyer would pass at
Manitoba, Canada and therefore the revenue can be
recognised if collection certainty is there.
Revenue is earned:
Upon shipment
from
Biovail
No, for the recognition of revenue, further
conditions needs to be satisfied like the amount
should be fixed and the collectability of the same
should be certain, only then can be revenue be
recognised in the books.
Assuming that
there
was no accident,
the
associated revenue
would be earned:
30 September
when the
truck left Biovail’s
facility
in Manitoba
Yes, in case there was no accident and the significant
risks and rewards would have been transferred on
delivery and the amount was certain then the
revenue could have been earned and realised in
books on 30th September itself (Dumay & Baard,
2017).
FOB
Destination
Ownership
transfers:
Upon delivery to
North
Carolina facility of
Distributor
In case FOB Destination is selected as incoterms,
then the risk and reward to the buyer would pass at
North Caroline (at the distributor’s facility) and
therefore the revenue can be recognised once it
reaches there only and collection is certain.
Revenue is earned:
Upon delivery to
North
Carolina facility of
Distributor
No, just on delivery the revenue cannot be earned in
books. For the recognition of revenue, further
conditions needs to be satisfied like the amount
should be fixed and the collectability of the same
should be certain, only then can be revenue be
recognised in the books (Linden & Freeman, 2017).
Assuming that
there
was no accident,
the
associated revenue
would be earned:
Either very late on
1 October,
or more likely 2
October given
that North
Carolina is more
than 8 hours’
drive away
Yes, in case there was no accident and the significant
risks and rewards would have been transferred on
delivery and the amount was certain then the
revenue could have been earned and realised in
books on 1st or 2nd October as soon as it reaches to
North Caroline. But then this would not qualify as
avenue for period ended 30th September 2003.
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b. There was a disagreement between the distributor and the company Biovail over the timing of
transfer of title of the shipment of Wellbutrin, which was transported. It is due to this reason
that the employee of the distributor directly called the Vice President of Finance, Biovail, Mr.
Kenneth Howling to correct the statement on revenue recognition given by CEO of BIovail, Mr.
Brain Crombie in the conference call in Earnings guidance and informed that as per the
agreement between Biovail and the Distributor, the title, risk and reward with respect to the
goods delivered would pass on to the distributor once it reaches the Distributor’s Facility (FOB
destination). Whereas the CEO of the company assumed that, the terms of delivery were FOB
Biovail and title on the goods would change in Manitoba at shipping point. This was the main
reason of disagreement as in case of FOB destination the company would have borne the loss, if
any during the transit of the goods and the insurance and transit charges would have been
borne by Biovail depending on the terms of the contract but in case the incoterms is FOB
shipping point, then the risk of transit loss post Manitoba would be on distributor (Du, 2018). As
the academic article, “An experimental investigation of dimensional precision in uncertainty
disclosures related to revenue recognition”, it all depend on the terms of the contract between
the parties as to when the revenue should be recognised in the books and the same should be
clearly specified in the disclosures and studied at the time of revenue recognition. One another
research article is “An examination of SEC revenue recognition comments and IPO earnings
management”, which explains on how the revenue and the earning per share as well as the
share prices of the company gets impacted through revenue recognition criteria’s (Schuldt,
2018). The last academic research article that has been referred to as “ASC 606: Challenges in
understanding and applying revenue recognition”, which explains what are different criteria’s to
be observed while revenue recognition and what are the general challenges in this case (Hepp,
2018).
Question 2: Earnings Quality and Research Component
In the given case, the analysts from J.P. Morgan Securities Inc. was upbeat and mentioned that the
rating of Biovail was “overweight” on the truck accident incident and reiterated that they have never
argued that the accounting policies of the company was aggressive instead it claimed that the
company’s current accounting policies were not overtly egregious and that the earnings impact of the
Wellbutrin XL was truly shown and disclosed by the company. The comment was given in line of the
poor earnings performance of the company over the past periods and continuous downgrading of the
earning guidance. The analysts has shown though the company had been using good and correct
accounting policies, but it was inflating its income and showing the same aspirationally to the investors
in order to attract them and later on restating the same downwards. It was also enquired and studied as
to how much of the truck would need to be filled in order to prove the missing revenue claim by Biovail
due to truck accident and it was established that the truck was only one quarter full instead of the
nearly full truck which suggested that the company has overestimated the loss and thus deceiving the
investors (Van Rinsum, 2018). It had a serious impact on the third quarter revenues of the company and
thus it can be said that Treppel’s remarks on aggressive accounting techniques being used by Biovail was
completely true and justified. As per the MD&A disclosure which is required by Financial Reporting
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Release 36, a company should be disclosing both the historical as well as prospective trend of financial
condition and that would help the investor in understanding the results of the operation and factors
which are contributing to increase or decrease in revenue. Many companies have resorted to techniques
like channel stuffing which means artificially inflating the revenue by deliberately sending more goods to
the retailers and these results in bringing down the sales for the future period. All this has also been
stated in the research journal articles “Disclosure Checklists and Auditors’ Judgments of Aggressive
Accounting” and “The Modern Corporation and the Public Interest” (Bogle, 2018). Both the articles
suggest that the accounting needs to comply with the standards and requisite disclosures should be
made in this regard to meet the users’ need of correct information.
Question 3: Ethical Component
In the given case, if Biovail plans to issue the shares in the future and if the company considers Banc of
America or J.P. Morgan to handle and coordinate for this lucrative transaction, then it would certainly
influence Mr. Maris’ analysis of the company and its accounting techniques and the findings on the truck
accident and thereby the stock recommendation. This is because Biovail is the account, which is in the
hands of Mr. Maris, the successor of Jerry Treppel and the company has already had a more than 20%
decline in the value of the shares (Fay & Negangard, 2017). Mr. Treppel was placed on leave during 2002
by BAS when he had issued a true report on the Biovail and had issued a sell recommendation based on
his studies that the revenue and the earning quality of the company has not been of highest quality in
the past few years and that the company’s growth in the sales was not sustainable considering the over
reliance on one of the product sales named Cardizem which accounted for 40% of the revenue. It is
because of the this true analysis and sell recommendation given by him that the investigation on him by
New York State Attorney General’s Office and the Securities Exchange Commission and the National
Association of Securities Dealer and ultimately he had to resign from the position. If Maris would have
done the same, he also might have landed in the same circumstance and above all if Maris would give
true report, it would have affected revenue and earnings of BAS and JP Morgan, whatsoever may be the
case (Kachelmeier, Schmidt, & Valentine, 2018). This is an ethical issue as per APES 110, which states
that the true and fair view of affairs should be reflected to the investors for correct decision-making or
else the decision would be biased.
Conclusion
From the above discussion and analysis, we see that the unfavourable variance has caused a huge
fluctuation in the share prices and though the company had insurance for the goods lost in transit but it
was still facing losses in quarterly revenue. The analysts from Banc of America and J.P.Morgan has cut
down on the rating of the company and have instigated an investigation into the issue following the
continuous decrease in the performance of the company. All the given questions have been answered
based on the circumstances of the case.
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References
Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 411-
431.
Bailey, C., Collins, D., & Abbott, L. (2017). The Impact of Enterprise Risk Management on the Audit
Process: Evidence from Audit Fees and Audit Delay. Auditing: A Journal of Practice & Theory,
37(3), 25-46.
Bogle, J. C. (2018). The Modern Corporation and the Public Interest. Financial Analysts Journal, 74(3), 1-
10.
Dichev, I. (2017). On the conceptual foundations of financial reporting. Accounting and Business
Research, 47(6), 617-632. doi:https://doi.org/10.1080/00014788.2017.1299620
Du, N. &. (2018). An experimental investigation of dimensional precision in uncertainty disclosures
related to revenue recognition. Accounting Research Journal, 31(1), 90-101.
Dumay, J., & Baard, V. (2017). An introduction to interventionist research in accounting. The Routledge
Companion to Qualitative Accounting Research Methods, 265. Retrieved from
https://books.google.co.in/books?
hl=en&lr=&id=PzQlDwAAQBAJ&oi=fnd&pg=PA265&dq=Dumay,+J.,+%26+Baard,+V.+(2017).
+An+introduction+to+interventionist+research+in+accounting.
+The+Routledge+Companion+to+Qualitative+Accounting+Research+Methods,
+265.&ots=ta1isTHB
Fay, R., & Negangard, E. (2017). Manual journal entry testing : Data analytics and the risk of fraud.
Journal of Accounting Education, 38, 37-49.
Hepp, J. (2018). ASC 606: Challenges in understanding and applying revenue recognition. Journal of
Accounting Education, 42(1), 49-51.
Kachelmeier, S., Schmidt, J., & Valentine, K. (2018). The disclaimer effect of disclosing critical audit
matters in the auditor’s report. SSRN, 2(1), 1-39.
Linden, B., & Freeman, R. (2017). Profit and Other Values: Thick Evaluation in Decision Making. Business
Ethics Quarterly, 27(3), 353-379. Retrieved from https://doi.org/10.1017/beq.2017.1
Schuldt, M. &. (2018). An examination of SEC revenue recognition comments and IPO earnings
management. Accounting Research Journal, 1-15.
Van Rinsum, M. M. (2018). Disclosure Checklists and Auditors’ Judgments of Aggressive Accounting.
European Accounting Review, 27(2), 383-399.
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