In 1990, the CEO of Oracle Systems Corporation is facing increasing pressure from analysts about the aggressive revenue-recognition policy. As a result, the stock price is plumbed and the CEO is worried about the cost of new equity capital to finance future growth and the firm may become a takeover candidate. We answer to several questions in order to understand the revenue-recognition method and the consequences of change. Oracle underlies aggressive revenue-recognition policy for licence fees: the firm recognizes revenue when the contract has been signed and not when the shipment of the product has been occurred. The accounting treatment for the revenue recognition of a product should be at the delivery and not at the agreement. Moreover, the collectibility of licence fees is questionable because the day's receivable substantially exceeds the average of the sector (160 days against 62 days). The reasonable amount of day's receivables should be at or slightly over the industry's average because a lower day's receivable decreases the default payment of customer, reduces the working capital but improves the company's financing cost and increases the value of operating cash flow.
[...] How do you expect investors to respond if Oracle decides to recognize revenue at delivery rather than when the contract is signed? If Oracle decides to recognize revenue at delivery rather than when the contract is signed, we can expect that the investors will respond negatively. Indeed, a change to the more conservative method engenders the decrease of the net income and consequently of the earning per share and of the stock price. As a result, the change in revenue recognition affects the financial credibility of Oracle. [...]
[...] Using the 1990 cost of sales ratio and the average tax rate, the size of the retained earnings write-off required if Oracle adopts the new revenue recognition method retroactively is (82 + 43 65 25) = 35. Method At agreement At shipment revenues) EBT) Licences at shipment FY89 = licences at agreement FY 89 * + licences at agreement FY 88 licences at shipment FY 88 How would a change in revenue recognition affect the firm's lending contracts and management compensation? [...]
[...] Why did Oracle experience such a dramatic stock price decline when it announced the accounting change? Oracle experiences such a dramatic stock price decline when it announced the accounting change because it reflects to financial difficulties. The net income was overstated by the less conservative method (M$84 against M$117). In addition to that, it announces a loss (27M$ + M$12) and reserve for uncollectible receivables (M$42). As a result, the company becomes a target for short sellers and speculation. The series of bad news announcements that Oracle made from late August to September 1990 appear to have further shaken investors' confidence in the firm. [...]
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