Harvard Case - EOS Imaging: Revenue Recognition
"EOS Imaging: Revenue Recognition" Harvard business case study is written by Kun Huo, Matthew Sooy, Zoe Zhou. It deals with the challenges in the field of Accounting. The case study is 14 page(s) long and it was first published on : Aug 26, 2021
At Fern Fort University, we recommend that EOS Imaging implement a comprehensive revenue recognition policy that aligns with the International Financial Reporting Standards (IFRS) 15, specifically focusing on the five-step model for revenue recognition. This policy should be clearly communicated to all relevant personnel, including sales, marketing, finance, and accounting departments, to ensure consistent application and accurate financial reporting.
2. Background
EOS Imaging is a French medical device company specializing in 3D imaging systems for orthopedic and spine applications. The case study focuses on the company's revenue recognition practices, specifically the challenges arising from the implementation of IFRS 15, which replaced the previous revenue recognition standard, IAS 18.
The main protagonist is the company's CFO, who is tasked with ensuring the company's financial reporting complies with IFRS 15 and addresses the concerns raised by the auditors.
3. Analysis of the Case Study
The case study highlights several key issues related to EOS Imaging's revenue recognition:
- Lack of a clear and consistent policy: The company lacked a documented revenue recognition policy aligned with IFRS 15. This resulted in inconsistent application of the standard across different departments and transactions.
- Complex revenue streams: EOS Imaging's revenue model involved multiple components, including sales of imaging systems, software licenses, and service contracts, making it challenging to determine the appropriate revenue recognition timing.
- Uncertainty regarding performance obligations: The company struggled to identify and allocate revenue to specific performance obligations within its contracts, leading to potential misstatements in financial reporting.
- Lack of proper documentation: EOS Imaging lacked sufficient documentation to support its revenue recognition decisions, making it difficult to justify the accounting treatment to auditors.
Framework: To analyze the situation, we can utilize the five-step model outlined in IFRS 15:
- Identify the contract with the customer: This step involves determining if a valid contract exists and identifying the specific goods or services covered by the contract.
- Identify the performance obligations in the contract: This involves identifying the distinct goods or services that the customer is entitled to receive.
- Determine the transaction price: This involves determining the amount of consideration the company expects to receive from the customer in exchange for the goods or services.
- Allocate the transaction price to the performance obligations: This involves allocating the transaction price to the different performance obligations identified in the contract.
- Recognize revenue when (or as) the entity satisfies a performance obligation: This involves recognizing revenue as the company satisfies the performance obligations in the contract.
4. Recommendations
To address the revenue recognition challenges, EOS Imaging should implement the following recommendations:
- Develop a comprehensive revenue recognition policy: This policy should clearly define the company's approach to revenue recognition, outlining the specific steps involved in applying IFRS 15. The policy should be aligned with the five-step model and address the specific challenges outlined in the case study.
- Implement a robust process for identifying and allocating performance obligations: EOS Imaging should establish a clear process for identifying and allocating performance obligations within its contracts. This process should involve input from relevant departments, such as sales, marketing, and finance, to ensure accurate and consistent application.
- Develop a system for tracking and documenting revenue recognition decisions: The company should implement a system for tracking and documenting all revenue recognition decisions. This documentation should be detailed enough to support the company's accounting treatment and provide evidence for auditors.
- Provide training to relevant personnel: EOS Imaging should provide training to all relevant personnel, including sales, marketing, finance, and accounting staff, on the new revenue recognition policy and the application of IFRS 15. This training should be ongoing to ensure that employees remain up-to-date on the latest guidance and best practices.
- Engage with external experts: The company should consider engaging with external experts, such as accounting consultants or auditors, to provide guidance and support in implementing the new revenue recognition policy and ensuring compliance with IFRS 15.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core competencies and consistency with mission: Implementing a comprehensive revenue recognition policy aligned with IFRS 15 is essential for EOS Imaging to maintain its financial reporting integrity and build trust with investors.
- External customers and internal clients: The new policy will ensure that revenue is recognized accurately and consistently, providing transparency and clarity for customers and internal stakeholders.
- Competitors: By complying with IFRS 15, EOS Imaging will be in line with industry best practices and maintain its competitive advantage in the medical device market.
- Attractiveness ' quantitative measures: Implementing a robust revenue recognition system will improve the accuracy and reliability of the company's financial statements, enhancing its attractiveness to investors and potential acquirers.
6. Conclusion
EOS Imaging faces significant challenges in implementing IFRS 15, but by taking a proactive approach and implementing the recommendations outlined above, the company can ensure accurate and compliant revenue recognition. This will enhance the company's financial reporting quality, build trust with stakeholders, and support its long-term growth strategy.
7. Discussion
Other alternatives include continuing with the existing revenue recognition practices, which could lead to significant financial reporting errors and potential penalties. However, this option poses a significant risk to the company's reputation and financial stability. Another alternative is to adopt a simplified revenue recognition model, but this may not be appropriate for EOS Imaging's complex revenue streams and performance obligations.
The key assumptions underlying these recommendations include the company's commitment to implementing the new policy, the availability of resources to support the necessary changes, and the willingness of employees to adapt to the new procedures.
8. Next Steps
EOS Imaging should implement the recommendations outlined above within the next six months. The following timeline outlines the key milestones:
- Month 1: Form a task force to develop a comprehensive revenue recognition policy aligned with IFRS 15.
- Month 2: Develop a process for identifying and allocating performance obligations.
- Month 3: Implement a system for tracking and documenting revenue recognition decisions.
- Month 4: Provide training to relevant personnel on the new policy and IFRS 15.
- Month 5: Conduct a pilot implementation of the new policy on a sample of contracts.
- Month 6: Full implementation of the new revenue recognition policy across all contracts.
By following these steps, EOS Imaging can effectively address its revenue recognition challenges and ensure compliance with IFRS 15.
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Case Description
Jane Zhou, an equity analyst at a large asset management firm, was preparing a report on EOS Imaging (EOS), a French medical device company that her firm had invested in. EOS's drastic fall in First Quarter (Q1) 2019 revenue caught Zhou's attention, as the company had maintained a continuous growth record up until 2018. In Q1 2019, EOS only achieved 1 per cent of its Q1 2019 equipment sales revenue. Also, during Q1, EOS made a significant change to its general sales agreement, leading to a corresponding change in revenue recognition timing. Zhou wondered if the revenue slowdown could be mainly attributed to the accounting method change rather than to weakening demand. It was crucial for Zhou to understand the impact of this change and to decide whether she should recommend her portfolio manager to liquidate the firm's position in EOS or not.
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