Oracle Systems Corporation

Résumé du document

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.

Extraits

[...] Estimate Oracle's 1990 sales if revenue is recognized at delivery rather than when the contract is signed. Hint : use the estimate, provided by the controller, of the effect of recognizing revenue at delivery on day's receivable. Adopting the more conservative revenue-recognition policy delivery and not at the signature of the agreement-, the controller estimates that the day's receivable would fall from 160 days to 120 days. Then, the period between agreement and shipment is equal to 40 days, i.e. [...]

[...] 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. How might the company respond to restore its credibility? to recover the investor's confidence and its financial credibility, the company should stabilize its financial situation by announcing financial and operational restructurings: Generate cash -improve the financing period -launch a Cash Collection Program to collect old receivables -encourage customers to pay quickly thanks to discounts -encourage sales force not to extend payment-terms any more Save money -freeze capital expenditures and hiring -lay-off a part of its work force -stop supplying consultants to large customers Signal restructuring and profitability -replace a part of top executives (and particularly the CFO by a conservative respected specialist) -announce changes in commercial policy and elaborate a financial board chart -announce regular and growth results Pay down its debt -reimburse debt -replace its costly short-term bank debt by convertible bonds Bibliography Cholthicha Srivisal & Paul M. [...]

[...] a decrease of 25%. Thus, with the first hypothesis (revenue-recognition at the signature of the agreement), we have the following equation [Average accounts receivable / Net sales] * 365 = 160 at the end of FY 1990 ( Amount of net sales = 690 and amount of receivables (related to licenses) = 302 Regarding the second method of revenue-recognition, the estimations of the controller, and considering x the fraction of revenue with an agreement but not delivered, the equation would become the following [(Average accounts receivable / (Net sales-x)] * 365 = 120 ( x = 113 Thus, with this method of revenue-recognition based on the delivery, we would obtain net sales of licenses equal to 690 113 = 577, i.e. [...]

[...] A change in revenue recognition affects the firm's lending contracts and management compensation too. As we can see above, the financial situation of the firm has been damaged between the end of FY 1989 and the end of FY 1990. If we add a change in the revenue-recognition method, this damage will be stronger and the credibility of the firm will be affected. However, we can see that the net debt ratio of the firm remains correct and in spite of a change in net income, the equity remains sufficient to cover the total of fixed assets. [...]

[...] 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. Do you recommend that Oracle make the accounting change? Why ? If Oracle makes the accounting change, its financial credibility will be damaged. [...]