Reference no: EM132486644

Background

Point 1: Solutions Network, Inc., became a publicly owned company on March 15, 2011, following a successful initial public offering (IPO). Solutions Network built up a loyal clientele in the three years prior to the IPO by establishing close working relationships with technology leaders, including IBM, Apple, and Dell Computer. The company designs and engineers systems software to function seamlessly with minimal user interface. There are several companies that provide similar products and consulting services, and DSS is one. However, DSS operates in a larger market providing IT services management products that coordinate the entire business infrastructure into a single system.

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                  Revenues (millions)                  Net Income (millions)

2010                        $148.0                                 $11.9

2011                           175.8                                13.2

2012                              202.2                             15.0

2013                                 229.8                              16.1

2014                                    267.5                           17.3

Young prepared the following estimates for 2015:

Year                  Revenues (millions)                   Net Income (millions)

2015 (projected)            $262.5                            $16.8

The Transaction

Point 1: 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.

Point 2: 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

Point 1: 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. Young is taken aback. Henley seems unusually agitated. Perhaps he was under a lot more pressure to "meet the numbers" than she anticipated. To defuse the matter, Sarah makes an excuse to end the meeting prematurely and asks if they could meet on Monday morning, after the weekend. Henley agrees.

Point 2: 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.

Point 3: 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.

Point 4: 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

Question 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?

Question 2: What is at stake for the key parties in this case? What are Sarah's ethical obligations to them?

Question 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?

Question 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?