Case Overview

Learning Objectives
Case Intended Usage
Case Numerical Analysis

Biovail Corporation announces it will miss its

quarterly earnings target by $25 million to $45
million, blaming $10 million to $15 million of the
shortfall on a truck accident involving a shipment
that left its facility on the last day of the quarter.
The accident occurred after the quarter end, thus
should not have affected reported revenues.
US SEC lodged a complain against Biovail Corp.
The case centered on the question of revenue
recognition and how Biovail should have accounted
for the sales (FOB company or FOB destination).

The broad objective is to explore the

concepts of revenue recognition.
Other specific objectives include
ethics of earnings management:
information flows to the capital
market, ethics, relationships with
analysts and the enforcement role of
the SEC.

The case can be used to explore concepts of

revenue recognition and the consequences of
management erroneous/misleading statements
concerning the reasons for missing earning targets.
Can be used to consider the relationship between
firms, analysts, and the regulatory SEC.
As a new stock analyst, what action would you take
to investigate the accident and the appropriate
treatment of the shipment for revenue purposes?
Does the truck accident has any impact on Biovails
3rd quarter revenue/earnings?
Can be used to assess the effect of accident on the
2 contract structures (FOB Biovail, FOB Destination).

Declining prescription volumes due to increased

availability of competitive unbranded products.
US SEC litigation against Biovail and its former
CEO could affect its stock value and reputations.
Biovail earnings guidance: its good, bad and ugly
consequences - too optimistic or too low for
Analysts and Investors?
Analysts downgrade of stock rating on Biovail
Determine ownership title change: Freight On
Board Shipping Point or Freight On Board
Destination.
Lack of co-ordination create communication gap
(FOB Destination)

Revenue is a key metric subject to considerable

scrutiny by Investors, Analysts and other
Stakeholders. The timing and recognition of revenue
is one of the top accounting areas of risk, with a
high complex endeavor.
According to the accrual principle, revenues are
recognized when they are realized, and are earned
(usually when goods are transferred or services
rendered), no matter when cash is received.
In contrast to cash accounting, revenues are
recognized when cash is received no matter when
goods or services are sold.
In case the event triggering revenue recognition
occurs before payment is received, the debit goes to
accounts receivable and credit to revenue.

Biovails CFO announced FOB shipping point to

analysts in a conference call.
Agreement provides that title to, and risk of loss
of products passed after delivery, i.e. FOB
Destination prevails.
Who should take the blames?
In your opinion, how should the company
recognize revenue based upon the two possible
FOB contract structures
How does the accident affect the stated revenues
under the different FOB contract structures?

What had Maris and his analysts team gone

through to obtain information? Why had been
so thorough?
Let us revisit the original announcement of
the accident from the company.
What do you think Maris expected the
company to do if he published a Sell
recommendation? Is this a legitimate behavior
for the firm?

Maris and his team watched the report on the

TV stations web site and spoke with many
people including: the state trooper handling
the crash investigation to get a copy of the
accident report; someone at the impound lot
where the truck was towed; the towing
company; and a local TV reporter/camera
person whod shot the scene.
Why was Maris expending this amount of
effort for the investigation?
How do you consider the fate of Treppel and
the relationship between Biovail and BAS

Treppel had a close relationship with a

different pharmaceutical firm which might
have been considered a competitor of Biovail.
Do you think there is a conflict of interest?
For Maris to be precise in his actions, he has
to estimate how much of a truck would be
needed to carry $10m of Wellbutrin product.
How about the state troopers estimate of the
25% (1/4th) loading in the truck.

In the management accounting issue: How

much of a truck $10million worth of product
would fill.
Does it suggest that $10million to $20million
might be a reasonable value for the truck
contents?

Wholesale Acquisition Cost per pill = $2.83

Revenue per pill = wholesale cost/wholesaler
selling price: $2.83/(1+35%) = $2.10
Manufacturer Revenue per pill = Revenue per
pill/distributor selling price: $2.10/(1+400%) =
$0.42
Lost Revenue = $10,000,000
Number of pills = $10,000,000/$0.42 = 23.8
million pills
Volume per pill (including package) = 0.5cm +
1.00cm = 1.5cm
Volume of 23.8 million pills = 23.8 million*1.5cm
= 35.7 million cm
Volume of Truck = (17meters x 4.5meters x
2.5meters) = 191.25million cm
Therefore, 23.8million pills represent 35.7/191.25
= 19% of a truck

Were the goods in transit insured? Should this

eliminate concerns about losses?
What are the two delivery contracts
mentioned in the case? How do they differ?
There has to be appropriate and clear
accounting rules for recognition of revenue.
Do you think the firm failed in its obligation
to give investors an opportunity to look at the
registrants financial

FOB Biovail

FOB Destination

Ownership Transfers

Upon shipment from

Biovail facility

Upon delivery to North

Carolina facility

Revenue is Earned

Upon Shipment from

Biovail

Upon Delivery to North

Carolina

Assuming that there was September 30

no accident, which date
would this occur?

What was the status

when the truck accident
occurred?

Either very late on

October 1, or more
likely October 2 given
that North Carolina is
more than 8 hours drive
from Chicago

Ownership had already

Ownership had not yet
passed to the distributor passed to the distributor

What was the effect of

Nothing, since revenue
the truck accident on Q3 had already been
revenue?
recognized before the
accident occurred.

Nothing, since the

accident actually
happened after the end
of Q3, and no revenue
should have been
recognized for the
shipment in Q3.

What behavior do you predict from Biovail

and its executives considering: the size of
Melnyks personal investment in the firm; the
decision of CIBC to drop coverage of Biovail
at the same time the analyst firm downgraded
Biovail; the litigation against Treppel and the
possibility that Biovail may seek to prosecute
Maris if any of the facts in the
recommendation were inaccurate

As at November 2008, the lawsuit between BAS

analyst Mr. Treppel and Biovail was still
proceeding through the courts.
Maris published a sell recommendation on Biovail
stock. The price of Biovail stock dropped from
$29.05 to $25.20 per share a day before, which
reduced Melnyks personal net worth by
$100million.
Maris became embroiled in litigation with Biovail.
BAS discontinued coverage on Biovail in March
2006.
The case against Maris was settled for a reported
$2million to pay off Maris Lawyers in 2007.

Nov 2003: Biovail received notification from SEC that it had

initiated informal inquiry pertaining to Biovails accounting
and financial reporting practices for the fiscal year
May 2007: Biovail confirmed notice from SEC alleging
violations of federal securities Laws. These issues included
whether the company improperly recognized revenue and
expenses for accounting purposes in relation to its published
financial statements in certain periods, and misleading
disclosure concerning forecast of a revenue shortfall in
respect to the 3-month period ending Sept 30, 2003.
Melnyk announce his retirement from the position of Biovail
Chairman and CEO on the day following his receipt of the
Wells notice.
March 2008: The SEC charged Biovail, its former CEO, its
former CFO, and 2 other senior executives. Without admitting
or denying, Biovail settled for $10million. However, the 4
executives will still face SEC charges.

Although the complaint overall alleges multiple

fraudulent accounting schemes used to manage
earnings, the removal of R&D from Biovail
financial statements to a Special Purpose Entity
and the understatement of foreign exchange
losses, the most relevant pieces of the complaint
to this case relate to the mis-reporting of the
effects of the truck accident.
The complaint states that the truck contained only
about $5m of product (not the $10m to $20m
stated at the time of the accident). More
significant is the fact that the truck accident had
NO EFFECT on Biovails 3rd-quarter revenues, and
that explaining the revenue shortfall in this
manner was misleading

If FOB company applied, then the shipment

occurred in Q3. as such, the accident would have
no effect on revenue for the quarter, since
delivery to the customer had already occurred at
the time of the accident. If FOB destination
applied, then the delivery could not have
occurred by the end of September 2003
(regardless of the accident). As such, the accident
again had no effect on the quarterly earnings.
The SEC complaint doesnt just criticize the error
in initial reporting but focuses on the continual
reiteration of the erroneous reporting and failure
of the executives to fully correct the errors.

The effect on stock prices of missing

earnings target/restating earnings. See 1)
Skinner and Sloan (2002). 2) Richardson and
AND Scholz (2004).
The accuracy and bias of analyst forecasts.
See 1) Cowen, Groysberg and Healy (2006);
and same authors, but in (2008).
Earnings Management. See Graham, Harvey
and Rajgopal (2005).

How many truckloads of product are actually

required to carry $10million of product? Show
your calculations.
How should the company recognize revenue
based upon the two FOB contract structures
mentioned in the case? Why?
How does the accident affect the stated revenues
under the different FOB contract structures?
Explain your reasoning.
Are you concerned about the companys
treatment of analysts who cover the stock? Would
you want to be an analyst covering this company?
What do you think management should have
done differently and speculate the possible
consequences?