stirling homex case study presentation

AÑORA . DELLAMAS . LAGUARDIA . PANCHO. REGIDOR . RICAFORT

CASE STUDY 1 STIRLING HOMEX


Obtain initial capital from an experienced construction investor

Start housing project in suburban Rochester

Develop a system of jacks, and transport units by train

1 year

Public issuance of stock

Certificate of Stock

Expansion in another lucrative market (financed by industrial revenue bonds)

Avon New York, 1967


1Broaden their customer spectrum

2Start doubling manufacturing facilities

3

Create U.S. Shelter Corporation, a completely owned subsidiary that provided financing for its customers.


1

Recorded sales of modules when units are manufactured andassigned to specific contracts

2

Recorded installation work which is documented on a percentageof completion method

Turnkey Program

Disclosed: Notes to

Consolidated Financial

Statements for July 31, 1971

Company registered for July 29, 1971 offering of preferred stock

Asked for clarification of the Company’s revenue recognition policy

COMPANY RESPONSE: They have set fiveconditions before sales were recognized

Securities and Exchange Commission


Monitors issues concerning the securities market

Evaluate Company’s Financial Statements adherence to IAS in terms of:

Timing of revenue recognition

Allocation of profit

Capitalization of expenses


What were the discrepancies (if any) in theStirling Homex’s financial statements thatmade SEC question the accuracy and fairnessof their financial position and performance?


2

Cite references from the International Accounting Standards that support possible claims of reporting irregularities

3

Pinpoint the effects of these irregularities, if any, on the FinancialStatements (overstatement / understatement)

1

Identify and analyze revenue recognition, expense capitalization, and profitallocation procedures of the Company

4

Suggest how it should be reported for a more accurate and fairpresentation of the Company’s financial position and performance.


Revenues come from:

manufacturing modules

installation of these modules

Sales of modules were recognizedwhen units are manufactured andassigned to specific contracts(treated documents from the local agencies asthe equivalent of a financing commitment)

Revenues from installation ofmodules: (a) recognized on % ofcompletion method and (b) billedon an estimated breakeven basis(bulk of profit margin: from the production ofmodules)

“Turnkey” program: Stirling Homexwas still the owner of the modulesat the time of their recognition ofrevenue(retained title and risk of loss until installation iscomplete and the new owner could claimpossession of the project)

2

The seller retains neither continuing managerial involvement to the degreeusually associated with ownership nor effective control over the goodssold

3The amount of revenue can be measured reliably

1

The seller has transferred to the buyer the significant risks and rewards ofownership

4

It is probable that the economic benefits associated with the transactionwill flow to the seller

5

The costs incurred or to be incurred in respect of the transaction can be measured reliably


IAS 18.14 Criteria in Recognizing Revenue from Sale of Goods

1

The seller has transferred to the buyer the significant risks and rewards ofownership



“Turnkey” program: Stirling Homex was still the owner of the modulesat the time of their recognition of revenue



2

The seller retains neither continuing managerial involvement to the degreeusually associated with ownership nor effective control over the goodssold

Sales of modules were recognized when units are manufactured andassigned to specific customer or project

Unbilled receivables: $24,633,799.00* recorded sales on “contracts in process”

(represent 70% of the total contract receivable)

*Refer to Note 3 of July 31, 1971 financial statements: Exhibit 1


• No mention of the contract of sale being countersigned by Housingand Urban Development

• No legally binding commitment of federal funds

• Substantially overstated revenue and receivable account, with acorresponding understatement of the yearend inventory

• Prematurely recognized revenue on contracts with housing agency customer (inclusive of manufactured modules and installation work) Revenue on installation work: overstated

Percentage completion method: applicable to installation work of Stirling Homex

Installation work falls under rendering of service, on which percentage of completion method of recording revenue is appropriate (IAS 11, Construction Contracts)


Sales contracts contains price for manufactured modules and charges for installation work.

Allocated revenue to installation work based on break-even basis(loosely based on costs incurred for the installation)

A need to divide the sales revenue to manufacturing and installation division


The Company’s method of allocating profit to Installation work is favorable to the Company.

Break even method of allocation profit results to:higher revenue from manufacturing which is recognized in

full upon signing of the agreement while installation is measured at percentage of completion method.


Cost: capitalized and included in the balance sheet when a future benefit for the expenditure exists

(Otherwise: cost will be expensed and reflected in the income statement)

Generally Accepted Accounting Principles (GAAP)

Stirling Homex Capitalized: Training and Professional DevelopmentResearch and Development

(Existence of future benefit is not certain)

Refer to Note 7: Deferred Charges of the company’s Financial Statement


Reasons for Uncertainty in Future Economic Benefits of Training and Professional Development

1

Different people have different learning capability.Increased work productivity and efficiency is not assured despite the training

2

Benefits from training are connected with the employee involvedEmployee can possibly: resign, retire or leave the companyFlow of benefits will discontinue unless there is a bond policy


Reasons for Uncertainty in Future Economic Benefits of Research and Development

1

Research and Development is an expense that may or may not lead to an asset and can only be capitalized if it meets the recognition criteria of IAS 38

IAS 38 Intangible Assets Criteria: • it is probable that the future economic benefits that are attributable to

the asset will flow to the entity• the cost of the asset can be measured reliably

IMPACT: $491,641.00 (from Training and Professional Development) $671,897.00 (from Research and Development)• Overstatement of Assets (July 31, 1971)• Understatement of Expense • Overstatement of Income


No Allowance for Doubtful Accounts despite sales increase of 78.76% and Gross Accounts Receivable increase of 144.38%

(due to 432.46% increase in Unbilled Contract Receivables)

No legally binding commitment of federal funds by HUD in Unbilled Contract Receivables

(Thus: More prudent to set up an Allowance for Doubtful Accounts)


2

An indication of the uncertainties relating to the amount or timing of anyoutflow

3The possibility of any reimbursement

1An estimate of its financial effect, measured under paragraphs 36-52

IAS 37 Paragraph 6: Unless possibility of any outflow in settlement is remote, an entity shall disclose

for each class of contingent liability at the end of the reporting period a brief description of the nature of the contingent liability and, where practicable:


Only disclosed the estimate of one contingent liability simply mentioned that the aggregate of the other disputes are

“insignificant” compared to the Company’s net worth

IMPACT:Hard for the users of the financial statements todetermine the amount of risk that they are takingwhen they decide to invest in Stirling Homex


2

Its debt or equity instruments are not traded in a public market

3

It did not, nor is in the process of filing, financial statements for the purpose of issuing instruments to the public

1

It is a subsidiary of another entity and all of its other owners, have been informed and do not object to the parent not presenting consolidated financial statements

4

Its ultimate or intermediate parent produces IFRS compliant consolidated financial statements available for public use

A parent is required to present consolidated financial statements except if:

A. It meets all of the ff. requirements:


C.It meets the criteria of an investment entity

B.

It is a post or long term-employment benefit plan to which IAS 19 Employee Benefits applies

A parent is required to present consolidated financial statements except if:


Did not include U.S. Shelter Corporation in its consolidation even though it is a wholly-owned financing subsidiary

As a result:Understated Unbilled Accounts ReceivableUnderstated Long term debt

IMPACT:Affect Debt-to-Equity ratio and Average Day’s Receivable (Could influence the decision of existing and would-be investors and creditors)


Stirling Homex financial statements: misrepresents the actual financial health of their company

2

Review of the Financial Statements revealed there are inconsistencies inthe accounting practice although information are disclosed in the Notes

3

The company’s auditor, Peat, Marwick, & Co., could be guilty of auditnegligence for not being to able to spot the inconsistencies and fraudulentreporting practices applied to the financial statements.

1Overstatement of the company’s revenues resulting to higher profits


Point of View: Securities and Exchange Commission (SEC)

2

SEC should report findings to the regulatory body responsible formonitoring companies from this industry

3

The Public Company Accounting Oversight Board (PCAOB) which overseesaudits of public companies should also be informed.

1

Implement stiff sanctions on the Company and the Auditor if substantiatedthat there was a financial reporting fraud committed in the preparation ofthe financial statements, specially the Company’s revenues.

4

Restated financial statements should be re-issued to users of these reports for proper decision making purposes.

5

SEC should issue an official statement of their investigation results and have it circulated publicly to inform the company’s current investors and to protect the interest of potential investors and creditors.

AÑORA . DELLAMAS . LAGUARDIA . PANCHO. REGIDOR . RICAFORT


Note 3 of July 31, 1971 financial statements


IAS 11 – Construction Contracts


Note 7 of July 31, 1971 financial statements


IAS 38 – Intangible Assets

Recognition Criteria

IAS 38 requires an entity to recognize an intangible asset, whether purchased or self-

created (at cost) if, and only if: (a) it is probable that the future economic benefits that are

attributable to the asset will flow to the entity; and (b) the cost of the asset can be measured

reliably (Refer to IAS 38.21).

This requirement applies whether an intangible asset is acquired externally or generated

internally. IAS 38 has additional recognition criteria for internally generated intangible

assets which includes the following:

(The probability of future economic benefits must be based on reasonable and

supportable assumptions about conditions that will exist over the life of the asset

(Refer to IAS 38.22)

( The probability recognition criterion is always considered to be satisfied for intangible

assets that are acquired separately or in a business combination (Refer to IAS 38.33)

Recognition Criteria Not Met

If an intangible item does not meet both the definition of and the criteria for recognition as

an intangible asset, IAS 38 requires the expenditure on this item to be recognized as an

expense when it is incurred. [IAS 38.68]


Calculations

A. Calculating for Sales Increase (1970 versus 1971)

(Based on Revenues from Manufacturing Division)

Figures based on the Financial Statements of Stirling Homex Corporation and Consolidated

Subsidiaries (Consolidated Statement of Income Year ended July 31, 1971 with comparative

figures for 1970): $29,482,271 (1971) and $16,492,770 (1970)

B. Calculating for Accounts Receivable Increase (1970 versus 1971)

Figures based on the Financial Statements of Stirling Homex Corporation and

Consolidated Subsidiaries (Consolidated Balance Sheets July 31, 1971 with comparative

figures for 1970): $37,845,572 (1971) and $15,846,119 (1970)


Calculations

C. Calculating for Unbilled Contract Receivables Increase (1970 versus 1971)

Figures based on Stirling Homex Corporation Notes to Consolidated Financial Statements

July 31, 1971 (Note 3 Receivables): $24,633,799 (1971) and $4,626,370 (1970)

D. Calculating for Percentage of Unbilled Contract Receivables

Figures based on Stirling Homex Corporation Notes to Consolidated Financial Statements

July 31, 1971 (Note 3 Receivables): $24,633,799 (Unbilled Contract Receivables) and

$35,016,425 (Total Contract Receivables)

stirling homex case study presentation

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