BKAL3063 INTEGRATED CASE STUDY

Contents
1.0

EXECUTIVE SUMMARY..................................................................................................1

2.0

STATEMENT OF THE PROBLEM.....................................................................................2

3.0

CAUSES OF THE PROBLEM............................................................................................4

4.0

DECISION CRITERIA AND ALTERNATIVE SOLUTIONS............................................7

5.0

RECOMMENDED SOLUTION, IMPLEMENTATION AND JUSTIFICATION..............9

References

BKAL3063 INTEGRATED CASE STUDY

1.0 EXECUTIVE SUMMARY

Biovail Corporation was a Canadian pharmaceutical company. On the last day of the end of the
third quarter, a truck accident happened. This truck accident caused several issues regarding
accounting policy based on the revenue recognition to arise: how Biovail Corporation should
account the sales based on two different Freight On Board (FOB) point which are FOB
shipping point and FOB destination point and what the effects of the Biovails revenue for both
FOB contract structures. In addition, whether it is ethical and relevant for Biovail Corporation to
estimate the revenue of the product that involved in the truck accident due to Biovail failed to
meet its third quarter 2003 earnings guidance.
Based on this case, the corporation was facing problems in recognizingtheir corporation revenue
whether they should realize on the third quarter financial statement or not. There are a few
solutions to overcome the problems. First, Biovail Corporation can enhance the management
authority. Second, BiovailCorporation can strengthen its internal control systems. Third, Biovail
Corporation can practice an ethical principle in managing their business. We recommend the best
alternative to solve the problem arisen in Biovail Corporation is to strengthen the internal control
in many aspects. The corporation should recruit independent external auditor to review the
financial reporting. Besides, the corporation needs to ensure that the finance department is really
understand about FOB concept and whatthe effects and also needs to hire external expertise to
obtain legal advice about FOB concept.

BKAL3063 INTEGRATED CASE STUDY

2.0 STATEMENT OF THE PROBLEM

Based on the case study of Biovail Corporation: Revenue Recognition and FOB Sales
Accounting, the main issue involvedBiovail Corporation should recognize revenue sales based
on which accounting policy that involved two different Freight On Board (FOB) point either
FOB shipping point or FOB destination point. BiovailCorporation decided and announced that
the product in the truck still might be sold in future, filing with US SEC that they disclose those
product as sales revenue once it was shipped to customer and they will not be related with any
future obligations on this product respectively. However, conflict occurred when Brain Crombie,
Biovails chief financial officer (CFO) informed the analyst that the contract between Biovails
and Distributor had little change in Manitabo when it left the shipping dock (FOB shipping
point). However, the Vice President of Biovails received an email from Distributor employee in
order to correct agreement statement on title to. The agreement between Biovail and the
Distributor provided that title to and risk of loss with respect to the product would not have
passed to the Distributor until the product was delivered to the Distributors facility U.S.A. (FOB
Destination). As Biovails is one of the listed corporations in New York Stock Exchange, the
corporation is subjected to fill its annual financial statement in accordance with U.S GAAP.
Furthermore, there is still another issue faced by the corporation due to the accident truck that
happened. Biovail Corporation had estimated that the range of loss due to the accident was $10
million to $20 million. However, during, the truck accident happened, the stock of product was
not filled completely full as according to the agreement. This had been estimated out by Tropper
that the truck was just about one-quarter full which means that there are still 25 pallets of the
product was not been filled up in the truck. Thus, it can prove that BiovailCorporation has
significantly overestimated the stock in the truck accident for almost 25 pallets where the actual

BKAL3063 INTEGRATED CASE STUDY

real value estimated was around $5 million (Scoot Anderson, 2009). The corporation was facing
the problem in recognizing their corporation revenue whether they should realize the corporation
revenue on the third quarter financial statement or not. Based on the case time line, the truck
carrying the shipment of Wellbutrin XL to North Carolina which also one of Biovails
Distributor had been involved in the multi-vehicle accident on the last day of the quarter 30
September 2003. This accident might influence the third quarter revenue if it was reported in the
financial statement due to the shortfall of revenue. This can be proof when the revenue range is
between $215 million to $235 million with an earnings per share of $0.35 to $0.45 is below
compared with the previous guidance $0.58 to $0.68 (Biovail Provides 2003 Guidance). Thus,
the corporation might have a poor review on their financial statement and affected their earnings
per share and revenue. Due to these reasons, the corporation had a loss in the guidelines in
disclose in the quarterly financial statement.

BKAL3063 INTEGRATED CASE STUDY

3.0 CAUSES OF THE PROBLEM

Based on this case, we had identified two main problems faced by Biovail Corporation which is
whether they should recognize the revenue on the third quarter of the financial statement or not.
According to the case, on September 30, 2003 which is the last day of the quarter, there was a
truck carrying a shipment from Biovails manufacturing facility in Manitoba to Biovails
Distributor, North Carolina and that truck was involved in a multi-vehicle traffic accident near
Chicago. Accordance with it, the main causes of this problem is that the corporation upper
management chief financial officer was not alert with his roles of responsibility. Based on this
case, the chief financial officer of the company did not alert on the term of agreement that had
been signed with their distributor. Biovails Chief Financial Officer, Brian Crombie told the
analyst that Biovails contract with the distributor had a title change in Manitoba when it left the
shipping dock (FOB shipping point), but the agreement between Biovail and the distributor
provided that the title to, risk of loss with respect to, the product would not pass to the distributor
until the product was delivered to the distributors facility (FOB destination). These two FOB
indicate different moments of revenue recognition and determine when corporation will
recognize the loss that happened in their corporation quarterly financial statement.
Besides that, the independency of audit committee in oversight all the corporation procedure and
process in accordance with the U.S GAAP in the financial statement caused the problems to
arise. Securities Exchange Commission (SEC), SAB 101 spells out the criteria for revenue
recognition based on existing accounting rules, which state that the companies should not
recognize revenue until it is realized or realizable and earned. Specifically, SAB 101 says
transactions must meet these four criteria (Thomas J. Phillips, 2001):

BKAL3063 INTEGRATED CASE STUDY

1.

There is persuasive evidence of an arrangement. Even though in this case, it does not
mention any information on this thing, it seems that there is an ongoing relationship
between Biovail and the Distributor and that certainly there was a bill, purchase order and
invoice in order to support this sale.

2.

The sellers price to the buyer is fixed or determinable. In this case we can clearly see the
evidence in this aspect.

3.

Collectability is reasonably assured. The evidence is the ongoing relationship between

Biovail and the distributor.

4.

Delivery has occurred or services have been rendered. This aspect leads to the main
problem of the Biovail Corporation.

Besides, the problem arose due to the audit committee lack of knowledge of Biovail Corporation.
This actually can be avoided if the members of audit committee aware and know their exact roles
and responsibilities. Generally, the main purpose of an audit committee in a company is to
provide an independent oversight of the financial reporting process, the audit process, the system
of internal controls and compliance with laws and regulations. They are also responsible to
ensure that the management clearly communicates to all employees that financial reporting is
absolutely acceptable and reliable. In addition to being independent to the company, audit
committee members are expected to conduct their work in a diligent and professional manner.
They are prohibited to do any unethical action. In contrast with this, it can be seen that the audit
committee are not independent which had caused the upper management to overestimate the
stock in the accident truck. The upper management did so because they were trying to maintain
the review on their corporation performance financial statement. The corporation had eventually

BKAL3063 INTEGRATED CASE STUDY

estimated out that the truck stock was around $10million to $20 million. However, the actual
amount was just around $5million. At the same time, the investors in the corporation should not
fully depend on the audit committee to the reporting and trust fully on them to manage all the
earnings between investors and corporation without having any aware of conflict of interest. The
investors must also take part in all the activities that happen during the period so that any
decision that made can be fully trusted and be reviewed.

BKAL3063 INTEGRATED CASE STUDY

4.0 DECISION CRITERIA AND ALTERNATIVE SOLUTIONS

In this case, the Biovails chief financial officer did not realized that there were some changes in
the content of agreement with the Distributor. This is a very serious matter and will have a huge
impact on the performance of Biovail Corporation. In order to prevent this incident from
happening in the future, Biovail Corporation should enhance their management authority. The
duties of each committee should be segregated clearly and they should always be informed and
updated with the latest work information especially if there are changes in the roles and
responsibilities of the committee. As an example for this case, a position should be assigned to
responsible for dealing and authorizing any changes in the content of agreement with the
Distributor. The particular position should inform the changes in the content of the agreement in
the board meeting as the board members have the right to obtain the latest information of the
company and at the same time can prevent miscommunication and misunderstanding between
each other.
In order to overcome earning management, BiovailCorporation should strengthen its internal
control system. COSO defined internal control as a process, affected by an entitys board of
directors, management and other personnel, designed to provide reasonable assurance to ensure
the effectiveness and efficiency of operations, reliability of financial reporting and compliance
with applicable laws and regulations. Having a strong internal control can prevent fraudulent act
and provide more reliable information for investors to make a better decision. For instance,
Biovail can establish a specific committee for revenue recognition to review and ensure that the
revenue recognition policies and procedures of the company are complied with GAAP. As a
result, a company with strong internal control will ensure the business is manage well and always
on the correct path.

BKAL3063 INTEGRATED CASE STUDY

To prevent fraud in misleading the financial statement and earning of the company, Biovail
Corporation should practice an ethical principle in managing their business. As one of the listed
companies on New York Stock Exchanges, Biovail Corporation is supposed not having any
problem regarding to the calculation revenue loss because they are able to hire a professional in
accounting department to follow the accounting standard with its strong financial resources. The
audit committee should have a clear understanding on their responsibility which is to oversee a
company system of financial reporting. If Biovail Corporation hire independent parties to
manage their earning management, the problem regarding the overstating revenue will not occur
(Gaa, J. (2007). To avoid unethical earning management activity, Biovail Corporation should
establish code of ethics in the company. The finance department employees should have a deep
understanding in the FOB structure of the product to avoid material mistakes in the calculation of
revenue. This is due to the overestimated of the loss will caused the reputation of Biovail
Corporation to be damaged. The overestimated of the Welbutrin XL will give a view to the
public that Biovail Corporation is poor in management and lying on the insurance claims.

BKAL3063 INTEGRATED CASE STUDY

5.0 RECOMMENDED SOLUTION, IMPLEMENTATION AND JUSTIFICATION

For Biovail Corporation case, we recommend Biovail Corporation to enhance the internal
controlas the best alternative to solve the issues arising in the company.
For the first issue which is the earning management, to prevent any fraud in the presentation of
the financial reports, the company should recruit independent external auditor to review the
financial reporting to minimize the risk of ambiguity in the application of the accounting
methods. Since Biovail Corporation knew that their practice in revenue recognition is incorrect
and not following the U.S GAAP, they should adjust its revenue before the financial reports are
audited by the external auditor to avoid any legal action is taken towards Biovail Corporation.
Furthermore,the second issue is the uncertainty of the shipping term used in the shipment of the
products. To tighten the internal control of Biovail Corporations, the employees especially for
those who are related to finance department should have a clear understanding about the FOB
shipping point and FOB destination point to avoid misstatement in financial reporting. We
recommend Davis Maris to pay more attention to the content of the agreement by examining the
sales documents to assist him in determining which party should bear the loss caused.The staffs
especially He also can obtain more information and assistance from external parties such as
lawyers to obtain legal advices on these matters. From these, David Maris can decide whether
FOB shipping point or FOB destination point should be followed.

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BKAL3063 INTEGRATED CASE STUDY

REFERENCES
Biovail Provides 2003 Guidance. (n.d). Retrieved September 17, 2016, from
COSO Definition of Internal Controls. (n.d.). Retrieved September 18, 2016, from Minnesota
Management & Budget: http://www.beta.mmb.state.mn.us/coso-definitions
Gaa, J. (2007). The Ethics of Earnings Management. The Case of Income Smoothing,
University of Alberta.
http://www.evaluategroup.com/Universal/View.aspx?type=Story&id=36988
PHILLIPS, T. J. (2001). The Right Wayto Recognize Revenue. Journal of accountancy.
Retrieved

September

17,

2016,

from

http://www.journalofaccountancy.com/issues/2001/jun/therightwaytorecognizerevenue.ht
ml
S.A. (2009, April 06). Biovail Founder Defends Decision on 2003 Accident. Retrieved
September

17,

2016

from

http://www.reuters.com/article/sa-biovail-melnyk-

idUSN0635387120090406

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