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Review case study 7-2, Solutions Network, Inc. Respond to Questions 3 and 4 in 175 to 350 words for each question. Case 7-2 Solutions Network, Inc. (a GVV case) “We can’t recognize revenue immediately, Paul, since we agreed to buy similar software from DSS,†Sarah Young stated. “That’s ridiculous,†Paul Henley replied. “Get your head out of the sand, Sarah, before it’s too late.†Sarah Young is the controller for Solutions Network, Inc., a publicly owned company headquartered in Sunnyvale, California.

Solutions Network has an audit committee with three members of the board of directors that are independent of management. Sarah is meeting with Paul Henley, the CFO of the company on January 7, 2016, to discuss the accounting for a software systems transaction with Data Systems Solutions (DSS) prior to the company’s audit for the year ended December 31, 2015. Both Young and Henley are CPAs. Young has excluded the amount in contention from revenue and net income for 2015, but Henley wants the amount to be included in the 2015 results. Without it, Solutions Network would not meet earnings expectations.

Henley tells Young that the order came from the top to record the revenue on December 28, 2015, the day the transaction with DSS was finalized. Young points out that Solutions Network ordered essentially the same software from DSS to be shipped and delivered early in 2016. Therefore, according to Young, Solutions Network should delay revenue recognition on this “swap†transaction until that time. Henley argues against Sarah’s position, stating that title had passed from the company to DSS on December 31, 2015, when the software product was shipped FOB shipping point. Background Solutions Network Network became a publicly owned company on March 15, 2011, following a successful initial public offering (IPO).

Solutions Network grew very rapidly during the past five years, although sales slowed down a bit in 2015. The revenue and earnings streams during those years are as follows: Year Revenue (millions) Net Income (millions) 2010 $148.0 $11.........3 Young prepared the following estimates for 2015: Year Revenues (millions) Net Income (millions) 2015 (projected) $262.5 $16.8

The Transaction On December 28, 2015, Solutions Network offered to sell its Internet infrastructure software to DSS for its internal use. In return, DSS agreed to ship similar software 30 days later to Solutions Network for that company’s internal use. The companies had conducted several transactions with each other during the previous five years, and while DSS initially balked at the transaction because it provided no value added to the company, it did not want to upset one of the fastest-growing software companies in the industry.

Moreover, Solutions Network might be able to help identify future customers for DSS’s IT service management products. The $15 million of revenue would increase net income by $1.0 million. For Solutions Network, the revenue from the transaction would be enough to enable the company to meet targeted goals, and the higher level of income would provide extra bonus money at year-end for Young, Henley, and Ed Fralen, the CEO. Accounting Considerations In her discussions with Henley, Young points out that the auditors will arrive on January 15, 2016; therefore, the company should be certain of the appropriateness of its accounting before that time. After all, says Sarah, “the auditors rely on us to record transactions properly as part of their audit expectations.†At this point Henley reacts angrily and tells Young she can pack her bags and go if she doesn’t support the company in its revenue recognition of the DSS transaction.

Over the weekend, Sarah calls her best friend, Shannon McCollough, for advice. Shannon is a controller at another company and Sarah would often commensurate with Shannon over their mutual experiences. Shannon suggests that Sarah should explain to Paul exactly what her ethical obligations are in the matter. Shannon thinks it might make a difference because Paul is a CPA as well. After the discussion with Shannon, Sarah considers whether she is being too firm in her position.

On the one hand, she knows that regardless of the passage of title to DSS on December 31, 2015, the transaction is linked to Solutions Network’s agreement to take the DSS product 30 days later. While she doesn’t anticipate any problems in that regard, Sarah is uncomfortable with the recording of revenue on December 31 because DSS did not complete its portion of the agreement by that date. She has her doubts whether the auditors would sanction the accounting treatment. On the other hand, Sarah is also concerned about the fact that another transaction occurred during the previous year that she questioned but, in the end, went along with Paul’s accounting for this transaction. On December 28, 2014, Solutions Network sold a major system for $20 million to Laramie Systems but executed a side agreement with Laramie on that date which gave Laramie the right to return the product for any reason for 30 days.

Even though Solutions Network recorded the revenue in 2014 and Sarah felt uneasy about it, she did not object because Laramie did not return the product; her acceptance was motivated by the delay in the external audit until after the 30-day period had expired. Now, however, Sarah is concerned that a pattern may be developing. Questions 1. What are the main arguments Sarah is trying to counter? That is, what are the reasons and rationalizations she needs to address in deciding how to handle the meeting with Paul? 2. What is at stake for the key parties in this case? What are Sarah’s ethical obligations to them? 3. Should Sarah follow Shannon’s advice? What if she does and Paul does not back off? What additional levers can she use to influence Paul and make her values understood? 4. What is the most powerful and persuasive response to the reasons and rationalizations Sarah needs to address? To whom should the argument be made? When and in what context?

Sample Paper For Above instruction

In the case of Solutions Network, Inc., the central ethical dilemma revolves around the recognition of revenue in accordance with generally accepted accounting principles (GAAP) versus management’s desire to meet earnings targets. Sarah Young, the company's controller, faces intense pressure from CFO Paul Henley to record revenue prematurely, especially considering the upcoming audit and performance expectations. The core arguments Sarah must counter include management’s rationalizations that recognizing revenue upon shipment, even with unresolved contractual obligations or pending deliveries, is acceptable under certain interpretations of revenue recognition standards. This perspective is often rooted in aggressive accounting practices aimed at portraying improved financial performance. Additionally, there is the argument that the passage of title on December 31, 2015, legally transfers risk and rewards to DSS, justifying revenue recognition at that point, despite contractual nuances such as shipment FOB shipping point. Sarah’s counterarguments emphasize the importance of adhering to the revenue recognition criteria outlined in authoritative standards like ASC 606, which stipulate that revenue should only be recognized when the company transfers control of goods to the customer and all performance obligations are fulfilled. Recognizing revenue prematurely risks misleading stakeholders, violating ethical standards, and potentially compromising the company’s reputation and the auditors’ trust.

The key parties at stake include Sarah Young, who maintains an ethical obligation to record financial information fairly and accurately; management, which is driven by pressure to meet financial targets; the shareholders, who rely on transparent and truthful reporting; and the auditors, tasked with verifying compliance with accounting standards. Sarah’s ethical obligations are grounded in the professional codes of conduct established by CPA organizations, emphasizing integrity, objectivity, and professional competence. Upholding these principles requires resisting undue pressure and ensuring financial statements faithfully represent the company’s economic reality. Furthermore, ethical decision-making involves balancing loyalty to her employer with her responsibility to the investing public and regulatory requirements. The dilemma is compounded by past instances where Sarah questioned transactions but acquiesced to management’s positions, raising concerns about her independence and consistency.

Shannon’s advice to articulate her ethical obligations offers a constructive approach, but following it may not guarantee management’s compliance if they are determined to press forward. If Paul refuses to back off, Sarah could leverage other mechanisms such as consulting with the audit committee, seeking advice from external auditors, or invoking the company’s ethical policies. It may also be effective for her to document her concerns formally and escalate the issue through appropriate channels to prevent future ethical breaches. Her influence can be strengthened through professional standards, her reputation, and her obligation to maintain independence. Ultimately, her response should be grounded in a compelling argument emphasizing the long-term risks of premature revenue recognition, including legal repercussions, loss of credibility, and damage to stakeholder trust.

The most persuasive response to management’s rationalizations involves presenting a factual, standards-based argument that underscores the importance of proper revenue recognition according to GAAP. This argument should be made directly to the executive team and board members, ideally in a formal or confidential setting where ethical considerations can be discussed without external pressures. Timing is critical; the discussion should occur before any financial statements are finalized and should be framed within the context of compliance, professional integrity, and safeguarding the company’s reputation. By aligning this response with the company’s long-term sustainable growth goals, Sarah can reinforce her commitment to ethical standards and demonstrate the risks of short-term gains achieved through questionable accounting practices.

References

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