Biovail Corporation Revenue Recognition and FOB Sales Accounting Case Solution

1. How many truckloads of product are actually required to carry $10 million of product? Show your calculations.

The medicines are stored in a drum, which is in turn put into the truck container. The number of drums that can be stored in the truck can be calculated by dividing the volume occupied by each drum with the total volume of the truck. Similarly, the quantity of medicines in each drum can be calculated by the volume of each tablet by the total volume of the drum. These calculations will give us the total number of tablets that can be sold in the truck. The total number of tablets can be multiplied by the selling price charged to calculate the total revenue of the medicines that can be carried in each truck. These calculations are illustrated as follows.

Volume of truck container = 1700 x 450 x 250 = 191,250,000 cm³

Volume of drum = 64 x 3.7854 x 1000 = 242,265.60 cm³

Max number of drums in the truck (truncated to the nearest hundredth*) = 191,250,000 / 242,265.60
= 700 drums

*the number of drums is truncated to account for the fact that the drums will not fit perfectly within the truck. There will be some extra space between the drums and the walls of the container.

Volume of each tablet (including packing) = 1.5 cm³

Number of Tablets in each drum (truncated to the nearest thousandth*) = 242,265.60 / 1.5

= 161,000 tablets

*the number of tablets is truncated to account for the fact that the tablet will not fit perfectly within the drum.

Max number of tablets in each truck = 161,000 x 700 = 112,700,000

Price of each tablet = wholesale acquisition price – wholesaler margin – distributor mark-up

Wholesaler margin = 35% x 2.83 = $ 0.99

Distributor mark-up = (2.83 – 0.99) x 400% / (1 + 400%) = $ 1.47

Price of each tablet = 2.83 – 0.99 – 1.47 = $ 0.37

Maximum Revenue from each truck = 112,700,000 x 0.37 = $ 41,462,330

Since the truck can carry about $40 million worth of tablets at full capacity, $10 million worth of the product can be carried in a single truck at approximately twenty-five percent capacity.

2. How should the company recognize revenue based upon the two possible FOB contract structures mentioned in the case?

One possible FOB (freight on board) is FOB shipping. This type of contact between the buyer (distributor) and the seller (Biovail) implies that the responsibility of the goods transfers from the seller to the buyer at the time when the goods are dispatched for shipment. This is the point where the responsibility for goods shifts to the seller. At this point, the company is stripped of any accountability with respect to the sale. The four conditions listed under US GAAP can be argued to have met at this point. Therefore, Biovail can realize revenue as soon as the goods are shipped.

Another possible FOB in this case is FOB destination. Under this type of FOB, the seller continues to assume responsibility (and hence risk) for the goods even after they have been shipped for delivery. The responsibility transfers to the buyer of the goods only when the goods reach their desired destination. Since, the delivery of the goods is not complete until the goods reach their destination, the revenue can only be recognized when the goods are received at their destination.

3. How does the accident affect stated revenues under different FOB contract structures?

There is a fundamental difference between the two types of FOBs discussed before. The buyer bears the risk during transportation of the product under FOB shipping. On the other hand, the seller bears the risk of transportation Under FOB destination. If the FOB shipping was under effect, the revenues from the product would have been recorded when the shipment was dispatched. The distributor would have been responsible for any accidents during shipments, and would have to bear the resulting loss. On the contrary, Biovail could not realize revenue under FOB destination because the goods never reached their destination. Instead, they would need to write-off the manufacturing costs of the medicine in their income statement or record an insurance claim against the manufacturing costs.