How should the company recognize revenue based upon the two possible FOB structures mentioned in the case? According to GAAP, four conditions must be met in order to recognize revenue: 1. Persuasive evidence of an arrangement exists: although the case does not provide extra information on this aspect, it seems clear that there is an ongoing relationship between Biovail and the Distributor and that certainly there was a bill, purchase order and/or invoice in order to support this sale. 2. Seller’s price to the buyer is fixed or determinable: the case provides clear evidence in this aspect. 3.
Collection is reasonably assured: given the ongoing relationship between Biovail and the Distributor, it appears evident that this aspect was probably covered as well. 4. Delivery has occurred or services have been rendered: this is the key point of conflict in the Biovail’s case. There are basically two different moments of revenue recognition according to the FOB condition: a. FOB Shipping: The company should recognize revenue at the moment/in the period in which product leaves Biovail shipping dock at the warehouse since in that precise moment both ownership and responsibility over the goods is transferred from Biovail to the client. . FOB Destination: The company should recognize revenue at the moment/in the period in which product is delivered to the Distributor’s facility since in that precise moment both ownership and responsibility over the goods is transferred from Biovail to the client. Given the facts and information presented in the case, Biovail should have recognized revenue following the FOB Destination structure. However, Biovail recognized revenue as if it was operating under FOB Shipping, probably in an attempt to boast revenue for the period.
Additional comments – Only big distributors would be willing to run the risk associated with FOB shipping; smaller distributors would likely prefer FOB destination. Given the high cost of pharma products, insurance associated with it is probably very expensive as well. – If working under FOB Destination, the producer must make sure that the Distributor is fully insured for his PO. As clearly depicted in the case, the high cost of pharma products can put a company in trouble if it cannot cash a sale of this magnitude.