Question

Question: Wal-Mart Stores, Inc.

Wal-Mart Stores, Inc. provided the following disclosure in a recent annual report.

New accounting pronouncement (partial) . . . the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101—“Revenue Recognition in Financial Statements” (SAB 101). This SAB deals with various revenue recognition issues, several of which are common within the retail industry. As a result of the issuance of this SAB . . . the Company is currently evaluating the effects of the SAB on its method of recognizing revenues related to layaway sales and will make any accounting method changes necessary during the first quarter of [next year].

In response to SAB 101, Wal-Mart changed its revenue recognition policy for layaway transactions, in which Wal-Mart sets aside merchandise for customers who make partial payment. Before the change, Wal-Mart recognized all revenue on the sale at the time of the layaway. After the change, Wal-Mart does not recognize revenue until customers satisfy all payment obligations and take possession of the merchandise.

Instructions

(a) Discuss the expected effect on income (1) in the year that Wal-Mart makes the changes in its revenue recognition policy, and (2) in the years following the change.

(b) Evaluate the extent to which Wal-Mart’s previous revenue policy was consistent with the revenue recognition principle.

(c) If all retailers had used a revenue recognition policy similar to Wal-Mart’s before the change, are there any concerns with respect to the qualitative characteristic of comparability? Explain.

Short answer

Answer

1. Change in recognition principle will only change the time of revenue recognition; it will not change the overall amount.
2. Revenue policy of Walmart was inconsistent with the realization criteria.
3. It isn’t easy to compare layaway transactions even if the revenue recognition principle is the same.

Step-by-step solution

Definition of Net Income

The net benefit earned by the business entity after deducting all expenses, including interest and tax expenses, is known as net income.

Effect on the income

1. The revenue recognition principle will be reversed by Walmart in the year of change for all the incomplete sales of the Layaway in prior periods. This procedure will reduce the income of Walmart in the year of change.
2. In the succeeding years, after making the adjustments in the year of change, the income level will come to the prior level as long as the level of layaway sales remains the same. It concludes that the change in accounting method only changes the time of revenue recognition but does not change the overall amount.

Consistency in the revenue policy

Walmart recognizes the revenue before the delivery of the product. It means that revenue is recognized before the completion of earning process. In such a case, if the customer does not pay the outstanding amount, the realization criteria are not met.

Qualitative characteristics of comparability

Even if each retailer uses the same revenue recognition criteria, it won’t be easy to compare the layaway transactions.

For example: If different retailers use different policies to determine the number of customers to be put down to set aside the merchandise.