Which Method Is Appropriate?
Green Brothers Furniture sells discount furniture and offers easy credit terms. Its margins are not large, but it deals in heavy volume. Its customers are often low income individuals who cannot obtain credit elsewhere. Green Brothers retains the title to the furniture until full payment is received, and it is not uncommon to have 20% of sales be uncollectible. Green Brothers is considering expansion and has hired an independent auditor to review its financial statements prior to obtaining outside funding. The auditor questions the use of accrual accounting as a method for recognizing revenue and suggests that Green Brothers use the installment sales method. The auditor justifies this by stating that because of the high rate of uncollectible, the earnings process is not substantially complete at the point of sale. Financial statements adjusted to the installment sales method result in a 17% decrease in net income for the fiscal year just ended. The chief financial officer for Green Brothers counters that if uncollectible can be estimated, even if that estimate is high, the use of the accrual method is appropriate. The accountant also notes that restated financial statements showing the lower net income figure will make obtaining external funding much more difficult. Which method of revenue recognition would you argue that Green Brothers should use? Why? Remember that your decision could affect this company’s ability to obtain favorable external financing.