Recognizing Revenue
Response to the following problem:
Brad Company sells ships. Each ship sells for over $25 million. Brad never starts building a ship until it receives a specific order from a customer. Brad usually takes about four years to build a ship. After construction is completed and during the first three years the customer uses the ship, Brad agrees to repair anything on the ship free of charge. The customers pay for the ships over a period of 10 years after the date of delivery.
Brad Company is considering the following alternatives for recognizing revenue from its sale of ships:
a. Recognize revenue when Brad receives the order to do the job.
b. Recognize revenue when Brad begins the work.
c. Recognize revenue proportionately during the four-year construction period.
d. Recognize revenue immediately after the customer takes possession of the ship.
e. Wait until the three-year guarantee period is over before recognizing any revenue.
f. Wait until the 10-year payment period is over before recognizing any revenue.
Required:
1. Which of the methods, (a) through (f), should Brad use to recognize revenue? Support your answer
2. Interpretive Question: A member of Congress has introduced a bill that would require the SEC to crack down on lenient revenue recognition practices by shipbuilding companies. This bill would require Brad Company to use method (f) above. The "logic" behind the congressperson's bill is that no revenue should ever be recognized until the complete amount of cash is in hand. You have been hired as a lobbyist by Brad Company to speak against this bill. What arguments would you use on Capitol Hill to sway representatives to vote against this bill?