Accounting Case Study- Robbin Inc.

15/3/2010
Eunice Yau (210907855), Janice Tang (210907707)
To: Robbin Inc.
From: Accounting Advisor

Re: Revenue Recognition policy that should be adopted after accepting full responsibility for
service
1. Proposed change in accounting policy that would have on Robbin’s assets, liabilities,
revenues, and expenses
Robbin Inc. follows the accounting policy proposed by the auditors, there will be changes in all
of the four main accounts, including assets, liabilities, revenues, and expenses. If Robbin follows
the policy, it will not recognize revenue until the end of the warranty period when the warranty
service is completely performed and the amount of warranty expense is known.

When the purchase is made by the customer, the transaction will result in,
Accounts receivable/Cash (asset increases)
Deferred gross margin (liabilities increases)
Inventory (asset decreases)

Depending on whether the purchase is made in cash or on account, assets will increase since the
company will collect their payment from customers. The inventory decreases since the
electronics are given to the customers. The deferred gross margin will be credited to represent
the difference between the cost value and the market value. This is a contra asset to record the
delivery of goods to customers without recognize revenue.

When the company receives payment from customers on account, the company collects the cash
and credits the account receivables

Cash (asset increases)

Accounts Receivable (asset decreases)

During the period when Robbin Inc. provides warranty service to their customers, they will
record costs for servicing the new product. However the expense will be deferred until the end of
the warranty, so they can match expense at the same time as the revenue it helped to earn.

As warranty service is performed at a monthly basis, the following transaction will occur,
 Accounting Case Study- Robbin Inc.
15/3/2010
Eunice Yau (210907855), Janice Tang (210907707)
Deferred warranty expense (expenses increases, owner equity decreases)
Cash (asset decreases)

At the end of the warranty period, Robbin Inc. can record revenue since warranty expense is
known and the entire warranty service is performed, They can recognize revenue and expense at
the same time to meet the IFRS requirements,

Deferred gross margin (liabilities decreases)

Cost of sales (expenses increases, owner’s equity decreases)
Warranty expense (expense increases, owner’s equity decreases)
Revenue (revenue increases, owner equity increases)
Deferred expense (asset decreases)

Based on the facts provided from the case, the auditors propose to record revenue at the end of
the warranty period. Such changes will have an overall impact on revenue and expenses.
However, assets and liabilities will remain the same. Since Robbin Inc. has taken full
responsibility of the warranty service, more expenses will increases due to the costs of providing
warranty for the electronics. Hence, the customers have the right to return electronics anytime
until the warranty ends. The additional expenses will cost a decrease in revenue. However, other
transaction will stay the same as if revenue is recognized at the point of sale.

The balance sheet will not be affected because assets and liabilities will remain the same since
Robbin Inc. will still collect cash from customers while inventories will decrease through sale.
There will be no changes in liabilities.
 Accounting Case Study- Robbin Inc.
15/3/2010
Eunice Yau (210907855), Janice Tang (210907707)
2. Options for accounting for Robbin’s extended service transactions and
recommendation
User and Objectives
Robbin's management; who are responsible and managing Robbin Inc. are interested in
maximizing profit under the assumption that their bonus payment is based on the company's net
income. They wish to continue with existing accounting policy which recognizes service revenue
earned immediately when the product is sold. One of the management’s main objectives are
performance evaluation. Since the company is taking charge of the full responsibility, it is very
important for management to be able to see whether it is cost-efficient, profitable for Robbin Inc.
to provide in-house extended service plan. Management wants to reflect to the shareholders that
despite of the change of the company’s policy, the performance is still very stable, or even
perform better, possibly by maximizing the revenue, so that it can attract potential investors, and
retain existing investors. Another objective is tax minimization. Management may want to
minimize tax so that the business has more cash on hand to support its day-to-day operation. Last
but not least, they need to make sure that the financial statement follows IFRS, since Robbin Inc
is a public company.
The next user of the financial statement is existing shareholders of Robbin Inc. since they are a
public company. Their main interest is to evaluate management, observe stewardship and
maximize profit. By profit maximization, the price of their shares would increase thus receiving
desired amount of dividends. Given the purpose of stewardship, they want to make sure that an
appropriate amount of bonus is given according to management's contributions. Furthermore,
they would like to see if the managers are allocating and using the resources effectively to
maximize the company's profit. More importantly, they want to know the performance of the
company after the new policy has been implemented, which can determine whether they still
want to continue to invest in the company.
Another users are the potential shareholders. Based on the financial statements, they want to
predict the future earnings of the company to see whether or not it is worth investing in.
Auditor also plays a vital role because it is within auditor's profession to ensure that Robbin
conducts appropriate and accurate accounting information and follows all of the IFRS principles.
CRA, competitors, and customers are additional users who might want to know Robbin's
financial statements. CRA would like to make sure that the company complies with Income Tax
Law. Competitors might want to set a benchmark and compare their financial performance with
Robbin. Customers might be interested in whether the company operates ethically and profitably.
Robbin's management is the main user of the objective since they need the financial information
to determine whether they need to make changes in their revenue recognition. Their main
objective will be performance evaluation to make sure that their revenue recognition truly
reflects the company's overall financial performance. Managers may attempt to maximize profits
in order to gain more bonuses, and reduce tax paid by the company. However, the performance
of the company should not be overstated since this is the first year implementing in house
extended service. Only in this way the management will be able to know whether or not the
service is worth carrying out in the long run. All financial transactions are recorded accurately
under the IFRS principles.
 Accounting Case Study- Robbin Inc.
15/3/2010
Eunice Yau (210907855), Janice Tang (210907707)
Constraints and facts
Robbin Inc. must prepare their financial information by inhering all of the IFRS principles.
Since the company is a public company, they must recognize revenue by meeting all the five
criteria listed on the IFRS. First, the performance has occurred given the ownership is transferred
and the buyer obtain full control of the product or service. Secondly, the revenue is reasonably
measureable. Also, the expense and cost is reasonably measureable. Lastly, the collection of
revenue is reasonably assured. Given a public corporation, we are assuming that annual
dividends will be given out to shareholders and that managers' bonuses are based on the
company's performance.
Given the proposed change in accounting policy, by recognizing revenue at the end of the
warranty period will lead to several changes in income statements.
Issues
The main issue in this case is when to recognize revenue for Robbin Inc. There are three possible
revenue recognition periods; record product once it is sold, gradually over the warranty period,
or at the end of the warranty period.
Alternative 1: Once the product is sold
Although Robbin Inc. is accessible to the data of warranty service used from the third party, cost
is still not easily measurable since cost differ from companies to companies, especially when
Robbin Inc. has not provided warranty service before, the cost may not be comparable to the
third-party vendor who has provided the services for years. At point of sales, revenue is known
and collection is assured; ownership and rewards have been transferred. However, risks are not
transferred from seller to buyers since Robbin Inc. is still obligated to provide warranty service
on the products sold. As Robbin Inc. is a public company which makes it compulsory to follow
the IFRS, this alternative may not be feasible as it does not meet all the criteria stated. The
management may want to recognize at this point to maximize revenue, however, as the auditor
points out, it does not reflect the substance of the transaction stream. Adopting this revenue
recognition method will make no difference than company’s previous policy of outsourcing to a
third-party vendor. This alternative fails to reveal this information for better performance
evaluation.
Alternative 2: Gradual Method
Under this alternative, revenue can be spread over the warranty period; expenses incurred are
matched each month. Cost and revenue are known. One can argue that risks, measured in a
monthly basis, have been transferred from buyers to sellers. Rewards, ownerships have been
transferred. Performance has occurred. This alternative fulfills all the five criteria. By
recognizing revenue in this way, companies may not minimize the tax by deferring the entire
revenue, and management may not be able to obtain as much bonus when they maximize the
company. However, this method enables revenue to be recorded every month; consistent revenue
shown on the financial statements convinces investors that it is a very stable business. More
importantly, this alternative can capture the economic activities in providing the service
throughout the months; so that it reflects true performance of the company. In this way,
management can formulate strategies and policies that help improve company’s performance,
and evaluate whether the in-house extended service plan is going on well. Also, it also helps
 Accounting Case Study- Robbin Inc.
15/3/2010
Eunice Yau (210907855), Janice Tang (210907707)
shareholders to have a better understanding on the operation of the company, so that they can
better evaluate whether or not to invest in the company. This alternative resolves auditor’s
worries of not truly reflecting the substance of the transaction system.
Alternative 3: At the end of the warranty period
At the end of the warranty period, cost and revenue and known. Collection is assured. Risks,
rewards, ownerships have been completely transferred from buyer to sellers. All the criteria in
IFRS are met. This helps the company to minimize tax by deferring revenue so that the company
has more cash on hand to support its day-to-day operation. However, by recognizing revenue in
this way, products sold and warranty services provided throughout the warranty period are not
reflected in the financial statement. As a result, management cannot evaluate accurately whether
taking full responsibility for service is good for Robbin Inc. in the long run. Since it is the first
time of the company performing warranty service, it would be better if management can evaluate
performance of the policy throughout the period so that possible amendment and improvement in
the in-house extended service can be made. This alternative does not meet management’s main
objective of performance evaluation. Although this alternative addresses auditor’s concern that
the statement reflects the substance of the transaction stream, it may consider to be too
conservative. With this alternative, the financial statements produced would show fluctuating
earnings. Since revenue can only be recognized at the end of the warranty period, the company
cannot record any operating revenue throughout the warranty period. As a result, a great loss will
be shown in the statements. Fluctuating revenue discourage shareholders to invest in the
company as they may consider the business too risky.
Recommendation
Recognizing revenue in gradual method is more appropriate than other two alternatives.
Recognizing revenue at the point of sales, which does not meet the criteria on IFRS, is not
feasible as Robbin Inc, as a public company has to follow IFRS. The gradual method meets the
criteria in the IFRS; performance has occurred, collection is assured, costs and revenue also are
measurable. This alternative also meets management’s main objective, performance evaluation.
Although this may not help achieve tax minimization that allows the company to hold more cash
flow like the third alternative, recognizing revenue at the end of the warranty period does, it
helps to minimize more tax by deferring part of the revenue to the next month than the first
alternative, recognizing revenue once the product is sold. As this is Robbin Inc’s first year to
take full responsibility for the service, it is very important for them not to produce a too
“healthy” financial statement that may overstate the company’s performance. Gradual method
reflects the true performance of the company so that management and shareholders can evaluate
the impact of the changes made in the company more accurately. Last but not least, gradual
method reflects the substance of the transaction stream which addresses to auditor’s concerns.