Avian flu revenue recognition

International Journal of Case Method Research & Application (2009) XXI, 2 2009 WACRA®. All rights reserved ISSN 1554-7752 ACCOUNTING IN THE DEFENSE OF THE NATION
Heidemarie Lundblad
California State University, Northridge
Janice Bell
Babson College
This paper contains an instructional case that addresses revenue recognition in a special “Bill and Hold” situation. It requires research that goes beyond basic Financial Accounting Standards Board (FASB) rules and introduces students to the fact that accounting rulemaking takes place in a socio-political environment. The case is suitable for either an Intermediate Accounting course or a Masters’ level accounting course. It is followed by an abbreviated teaching note. A detailed, annotated Teaching Note is available from the author upon request. On a brisk day in January 2006, a jubilant Gerald Clury (CEO of Cylan Laboratories, a U.S. generic drug manufacturer) announced to senior managers a major development: “We’ve got the contract with HHS to make Tamiflu! Schumer and the FDA used some muscle and got those Swiss to roll over! Roche is granting us a license to make Tamiflu! Since the media has gotten everybody panicked by talking of a potential bird flu pandemic because of those deaths in Asia and Turkey, the feds are going to build up stockpiles of anything that may help against it, and we are in the catbird seat! Jack, didn’t you tell me that we can easily produce 15 million doses in a couple of months, once we get going?” Jack Straw, VP of Production, grinning from ear to ear enthusiastically replied, “You betcha, we’ve got capacity. Ever since Pfutzer grabbed that contract for the Anthrax drug from the DOD, we’ve got nothing but capacity! We’re ready to roll. Just get me the specs!” “No problem,” Clury confidently replied, “Roche is sending us the final technical details. You should have them by the end of the week. HHS wants a minimum of 20 million doses of Tamiflu and – icing on the cake! – they also want to get us a license to produce that experimental vaccine against the H5N1 strain of avian flu, you know, the one that Chiron is working on. They are demanding the same deal from Chiron that they got from Roche and - I don’t want to brag - but let’s face it, we are best positioned to produce the quantities that HHS needs for its stockpile. I don’t want to raise your hopes too high, but I see bonuses in your future!” Ellis Myles, head of public relations, bobbed up and down with excitement: “Did you see the ticker? Our stock went up to a 52 week high as soon as the announcement of the Roche deal came out! When can I issue the press release on the Chiron deal? Man, this is big! We are going to be profitable and get credit for doing a good deed for the nation as well!” “Let’s slow down a little, before we count those chickens – sorry, bad pun,” interjects June Weaver, the controller. “I’m as excited as you are about the chance for solid profits while we do something good International Journal of Case Method Research & Application (2009) XXI, 2 for the country. But I am a little concerned about the details. Looking at the contract, I see that we get 30% of the contract price as soon as we accept the order. The rest will be paid when the doses are put in the stockpile. That’s okay. But, and I’m sorry, this is a big but – I see in ‘item 3’ of the contract that we won’t actually deliver the doses to the feds unless there is an outbreak of the bird flu. In the meantime we must maintain the stockpile and – I quote – ‘be ready to deliver at a moment’s notice’. Additionally, we have to ensure that there is always a fresh supply of Tamiflu available. There goes our lean just in time inventory system! ‘Item 5’ does say that we can sell the drugs (or the vaccine) to another party, as long as we ensure there will be sufficient quantities in case of need. That will help, as far as the need to rotate the stuff is concerned. But, I don’t know how we can recognize revenue from the deal until we actually deliver the doses - I mean, we obviously won’t even segregate them! This sure looks like the kind of thing the SEC objected to in the Parness case, you know, the infamous ‘Bill and Hold’ trick. “Shoot, June,” Clury grouses, “are you telling me that we can’t recognize revenue until we deliver? That doesn’t make any sense. What if there is no pandemic? The contract is for three years, and we get to keep the money, so when do we get to show the revenue? You better get on this right away and get me an answer by tomorrow! I sure want to be a good corporate citizen, but, dang, we can’t afford to do this if there is nothing to show on the income statement except expenses! Alright, meeting’s over. And June, you get me a detailed report on this revenue recognition stuff by tomorrow – no later than three. I’m booked on an interview show with CNBC about this avian flu pandemic and if those bean counters try to sandbag me, I want ammunition, because I’m gonna’ let ‘em have it.” TEACHING NOTE
This case was prepared on the basis of publicly available documents; it addresses an unusual, specific issue (revenue recognition prior to delivery of a drug or vaccine designed to prevent a possible pandemic) and is loosely based on a real company that had to address the issues discussed in the case. However, since the dialogue is purely fictitious, all names (including the company name) are also invented. The case is suitable for and has been used successfully in several sections of Intermediate Accounting. It would also be suitable for an MBA level course on financial reporting. The case itself is quite short; however, a fairly significant amount of research is required to successfully complete the assignment. In addition to the case itself, this abbreviated teaching note includes a suggested “writing prompt” and a copy of a generic critical thinking grading rubric is included. A detailed, annotated grading (solution) matrix is available upon request. The case can be used as part of classroom discussion or as (as the author has done) it is suitable to teach students how to prepare a memo or short report. If the case is used for a written assignment a suggested “writing prompt” as follows is included. The author believes that students need to learn to be concise. The writing prompt requires a memo not to exceed one page (plus references). Obviously, a more extensive research report could easily be required. As the brief discussion above indicates, although the case is short, it addresses an important accounting issue and it forces the instructor and students to reconcile accounting theory as defined in the Financial Accounting Concepts with political, social policy reality. This provides an opportunity for interesting discussions regarding the social, political environment in which accounting policy must be made. SUGGESTED WRITING PROMPT
• Research the appropriate accounting literature on revenue recognition. • Analyze, interpret, and synthesize the technical material. • Effectively communicate the information in a memo using direct organization, mostly active voice, • Present a logical explanation demonstrating that you have related the information to the International Journal of Case Method Research & Application (2009) XXI, 2 WRITING TASK
After researching the appropriate authoritative accounting literature, prepare a one-page memo addressed to Mr. Clury. Communicate your findings using direct organization. List your references on the second page. As can be seen from the writing prompt, the accounting issues are not specifically identified in the question. The case contains sufficient information to allow students to identify the accounting issues and to engage in the appropriate research to complete the assignment. Students receive a generic “evaluation rubric” (included in the appendix) that show how the assignment will be evaluated. (A detailed, annotated evaluation rubric and comprehensive Teaching Note is available to instructors upon request). APPENDIX

This is the generic critical thinking grading rubric. Students download and attach it to their assignments.
For grading purposes a detailed annotated grading rubric is used. It is available to instructors upon
Research the relevant authoritative literature Interpret and Apply the Accounting Literature to the Issue(s). 1. Identify and State Solution(s) Select and Support a Solution: Discussion supports the selected solution using reasons based on logical interpretation of the relevant literature. 2. If appropriate supply schedules or journal entries 1) Determine and State Relevant Facts: (Critical Thinking-reason) a) Student sorts relevant material from irrelevant materials b) Student separates opinions from facts c) Student identifies need to collect data 2) Identify and State Accounting Issues (Critical Thinking-reason & understanding Conceptual Material) a) Student understands the transaction or events b) Student recognizes items not stated: unperformed duties, hidden contingencies c) Student classifies the issue into a broad category: revenue recognition, matching, etc. 3) Research the Relevant Authoritative Literature (Research & Critical thinking -reasoning) a) Student researches GAAP and doesn’t discuss tax requirements b) Student researches the issue identified in item 2 c) Student seems to understand the standards researched 4) Interpret and Apply the Accounting Literature to the Issue(s) (Critical Thinking-understands multiple perspectives & applies conceptual understanding) a) Identify and state the solution: States a clear solution that a client can understand; or b) Identifies alternative ways to treat if appropriate. c) Defends solution and /or plausible alternatives clearly with judgment that is based on accounting literature/concepts. (Analyzes deeply enough that each portion of the research is tested, e.g. if extraordinary event needs to be material, unusual, and infrequent, student tests items against all three.) International Journal of Case Method Research & Application (2009) XXI, 2 d) Uses material (facts) from case and compares to the accounting literature e) Develops necessary supporting schedules, recommends correct journal entry as appropriate. f) Organizes thoughts in a logical order demonstrating deductive or inductive reasoning. ENDNOTES
1 The author gratefully acknowledges the assistance of Janice Bell for drawing attention to a SEC press release and suggesting to develop a case on this issue. Thanks are also due to two anonymous reviewers who made helpful suggestions. 2 Cylan is a fictional company. However, the issues addressed in this case are based on actual events 3 Senator Charles Schumer (D-NY) issued public demands that Roche Holdings sublicense its patent for Tamiflu to U.S. generic drug makers: “Right now, Roche a giant Swiss company has the patent for Tamiflu, but they, unfortunately, are putting profits before rural health safety. . and so we have asked Roche what we asked Bayer to do, when the country needed Cipro, to sublicense its patent … so we could quickly produce enough Tamiflu.” (Schumer 2005) 4 FDA: Food and Drug Administration (The federal agency overseeing drug manufacturing in the U.S.) 5 Roche Holding A.G. is the Swiss pharmaceutical company that owns the Tamiflu license patent. 6 DoD: Department of Defense 7 HHS: Department of Health and Human Services. It is the federal agency that has the legal authority to order measures to combat a pandemic and stockpile medications, etc. 8 Chiron, Inc. (now majority owned by Novartis of Switzerland) is the pharmaceutical company that produces a majority of the flu vaccine used in the U.S. The company is currently testing a vaccine against avian flu for humans. 9 The shelf life for Tamiflu is about ten years. For the vaccine it is probably no longer than two years. 10 See Securities Exchange Act Release No. 23507 and Accounting and Auditing Enforcement Release No. 108, In the Matter of Stewart Parness (AAER 108) (August 5, 1986). REFERENCES
American Institute of Certified Public Accountants: SOP 97-2 Software Revenue Recognition. Anon: “U.S. Senator Schumer Holds a News Conference on Avian Flu”. 20 _____: “Chiron to Supply United States with Pandemic Influenza Vaccine for Stockpile; Contract with U.S. Department of Health & Human Services for H5N1 Stockpile”. Business Wire, October 27th, 2005. Accessed online January 7, 200 International Journal of Case Method Research & Application (2009) XXI, 2 Financial Accounting Standards Board: Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises. Financial Accounting Standards Board, Norwalk, Conn., December, 1984 Godfrey, John: “Avian Flu: Preventing A Pandemic Dow Jones Newswires, December 9, 2005. Insana, Ron: “Drug company takes flu threat seriously” USA TODAY, November 5, 2005, p.5B Securities and Exchange Commission: Accounting and Audition Enforcement Release No.
s and Exchange Commission, August 5, 1986. 17 CFR Parts 231, 241, and 271 [Release Nos. 33-8642; 34-52885; IC-27178] _____: “Staff Accounting Bulletin 101: Revenue Recognition In Financial Statements. Securities and _____: “Staff Accounting Bulletin 104 Topic 13: Revenue Recognition, A. Selected Revenue Recognition Issues 3: “Delivery and Performance” (Bill and Hold Sales)”: Securities and Exchange Commission, Dec. 17, 2003 17 CFR Part 211: _____: “Commission Guidance Regarding Accounting for Sales of Vaccines and Bioterror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile.” Securities and Exchange Commission, December 5, 2005. 17 CFR Parts 231, 241, and 271 [Release Nos. 33-8642; 34-52885; IC-27178]

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