SOLUTION: ACT 430 SU Accounting Practices Issues in Vaccine Corporations Internal Memorandum

Vol. 28, No. 3
pp. 691–703
American Accounting Association
DOI: 10.2308/iace-50463
Accounting for the Public Interest: A Revenue
Recognition Dilemma
Arline Savage, Douglas C. Cerf, and Roberta A. Barra
ABSTRACT: This case illustrates how accounting rules impact the public interest and
vice versa. The setting is a gray area of accounting in which management, the external
auditors, the SEC, and international accounting standard setters may have differing
opinions about the accounting treatment. Students consider the situation in which an
accounting rule leads to a business and societal problem. They gain an understanding of
how this happens and how such problems can be addressed. The context for this case is
a revenue recognition issue for bill-and-hold sales. It also provides students with the
opportunity to consider the real-world implications of accrual- versus cash-based
accounting. This case is useful for intermediate- to graduate-level financial accounting
classes or an accounting capstone class.
Keywords: revenue recognition; bill-and-hold sales; public interest; international
accounting standards; cash versus accrual.
ou are a newly promoted audit manager at a national CPA firm with international
affiliates, and you are very excited about being part of the audit team of a major client of
the firm: a large pharmaceutical corporation that participates in the U.S. government’s
Vaccine for Children Program (VCP). The VCP purchases its federal stockpile of pediatric vaccines
from only a small, select group of major pharmaceutical companies deemed eligible to participate in
this program. This vaccine stockpile is a strategic reserve in which vaccine makers maintain a sixmonth supply. Your appointment to this audit team bodes well for your long-term goal of becoming
a partner at the firm. Your first task is to educate yourself about the vaccine industry, in compliance
with AU 210.04. You prepare a brief overview of the industry (see Appendix A) to discuss with the
audit team.
Your personal interest in the vaccine case extends beyond that of an auditor. You remember
only too well the following newspaper report: ‘‘Pediatric vaccine stockpile drops: The stockpile
Arline Savage is a Professor at The University of Alabama at Birmingham; Douglas C. Cerf is a Professor at
California Polytechnic State University, San Luis Obispo; and Roberta A. Barra is an Associate Professor at
the University of Hawaii at Hilo.
The authors thank Paul Munter (KPMG Partner in the Department of Professional Practice, lead technical partner for
international accounting and IFRS activities, and member of KPMG’s IFRS Panel) for his insightful comments, which
significantly improved this case.
Published Online: March 2013
Savage, Cerf, and Barra
apparently has become a victim of a U.S. campaign against deceptive accounting practices’’ (Brown
2005a). Your appointment as a member of the audit team for one of the pharmaceutical firms
involved in the controversy brings to mind the extreme anxiety experienced by your sister and her
husband when their baby could not get a vaccine that she needed because of the vaccine shortage,
which had resulted from an accounting dispute between the SEC and the vaccine makers and their
As you sit at your desk, you ask yourself the following questions:

Could a similar situation happen on my watch as an audit manager?
What should an auditor do when accounting policy has significant adverse impacts on
society or on some groups in a particular society?
What takes precedence: accounting for economic substance or the public interest?
Isn’t accounting supposed to be in the public interest?
Now that you think about it, one of your colleagues recently mentioned that the International
Federation of Accountants (IFAC 2012) had recently finalized a Policy Position on A Definition of
the Public Interest and that IFAC’s concept of the public interest addresses a broader set of
stakeholders than does the AICPA’s Public Interest principle. IFAC defines the public interest as
‘‘the net benefits derived for, and procedural rigor employed on behalf of, all society in relation to
any action, decision, or policy’’ (IFAC 2012; emphasis added). You decide that conducting an
investigation and analysis of this topical issue, even if it includes use of your rather scarce personal
time, provides you with an opportunity to become a better auditor who considers all aspects of an
accounting issue.
As part of your audit planning, you begin by reviewing U.S. generally accepted accounting
principles (GAAP) revenue recognition concepts and criteria, followed by transaction-specific
guidance that directly relates to pharmaceutical companies’ vaccine stockpiles, which are classified
as bill-and-hold sales. You know that a bill-and-hold sale is a sale in which the buyer purchases
products and requests that the seller hold the product to be delivered upon request at a future time.
The seller can charge the buyer an inventory carrying cost. Sometimes, the buyer pays for the
product before it is shipped, such as the VCP in which your client participates. The government
prepays for the stockpiled vaccines, which are stored by the vaccine companies in their warehouses
and are not delivered until the government—in this case, the Centers for Disease Control (CDC)—
request delivery. The vaccine makers are also required to rotate the inventory as the vaccines expire.
After preparing a synopsis of U.S. GAAP revenue recognition concepts and criteria in general, you
follow up with further research on the accounting treatment of bill-and-hold sales using the GAAP
codification, as well as International Financial Reporting Standards (IFRS) relating to these issues.
A few days later, you meet with your client’s CFO. During lunch, the conversation casually
evolves into a discussion of the vaccine shortage controversy that occurred some years ago. The
CFO tells you that he was, in fact, CFO at that time. He explains to you the issue within the context
of your client, and he also discusses the ensuing controversy. After lunch, you do some research on
the vaccine industry (Appendix A; Prifti 2010) and document the issue from the vaccine maker’s
perspective, and you also summarize the consequences of the controversy.
The Vaccine Makers’ Perspective
The development of a single vaccine by a pharmaceutical company can take 12 to 15 years and
between $500 million and $1 billion in funding (Sloan et al. 2004). In late 1999, the SEC issued
guidance in ASC 605-15-S99-1. Prior to the issuance of ASC 605-15-S99-1, vaccine makers
recognized revenue once the government made the agreement to stockpile the vaccine and the
vaccine company received payment and stockpiled the inventory. But because of ASC 605-15-S99Issues in Accounting Education
Volume 28, No. 3, 2013
Accounting for the Public Interest: A Revenue Recognition Dilemma
1, stockpiled inventories of vaccines held in the companies’ warehouses were officially considered
unsold by the external auditors, stockholders, and Wall Street. Despite the significant amount of
cash that the vaccine makers received up-front from the federal government stockpile program, they
could no longer recognize revenue at the time the vaccines were placed in the stockpile, but had to
wait until the vaccines were shipped upon government request. The vaccine makers’ reactions to
ASC 605-15-S99-1 were generally negative.
Although ultimately responsible for GAAP, the SEC does not set GAAP (having delegated that
authority to the FASB). SEC guidance is authoritative in that it prescribes financial statement
presentation formats and disclosures and accounting recognition and measurement principles that
public companies are obligated to follow (Deloitte Global Services Limited 2012). So whereas the
SEC did not ‘‘technically’’ create a new accounting standard with ASC 605-15-S99-1, an external
auditor for the vaccine makers correctly opines that ‘‘we expect the implementation [of ASC 60515-S99-1] . . . to have a significant impact on the revenue reporting practices of a number of
[companies]’’ (Brown 2005a).
The vaccine makers’ perspective was that they should be allowed to recognize the revenue
when the vaccines are inventoried and stockpiled instead of when the vaccines are delivered. By
delaying the point at which vaccine makers could recognize revenue for these vaccines, the new
accounting standard had created a disincentive to participate in the government program.
The Consequences of ASC 605-15-S99-1
The vaccine situation came to a head in the summer of 2004, when the CDC asked the vaccine
makers to make additions to the stockpile. Three said no. Only one vaccine maker said yes. One
vaccine maker’s response was: ‘‘Almost 2 years ago, [we] raised the ‘revenue recognition’ issue
with CDC. . . . We understood from our conversations that we were the first manufacturer to do so.
. . . We stated then that short of SEC changes in the interpretation of Staff Accounting Bulletin
#101, and/or changes to the stockpile terms, [we] would be out of the stockpile business’’ (Brown
2005b). All the pharmaceutical firms involved said they supported the idea of a stockpile and
termed its diminished state ‘‘really a threat to public health’’ (Brown 2005b).
By 2005 the stockpile of eight vaccines that provided protection against 11 childhood diseases
had fallen to less than a third of the required level, at 13.2 million doses of vaccine instead of 41
million doses. For two vaccines, including one that protected children against diphtheria, pertussis,
and tetanus, the stockpile was empty. This situation posed an enormous threat to the health of
children in the United States and put the nation in a vulnerable position in the event of an
emergency situation. The fallout was that parents were shocked and incredulous that their children’s
lives were being put at risk because of an accounting rule, and so they took their infuriation to
Congress, where a congressional representative succinctly expressed parents’ sentiments: ‘‘I don’t
care how they solve it; they should just solve it’’ (Brown 2005b).
1. Appendix B provides a synopsis from four sources of revenue recognition rules: (1) General
U.S. GAAP Revenue Recognition Concepts and Criteria, (2) General IFRS Revenue
Recognition Concepts and Criteria, (3) Accounting Treatment for Bill-and-Hold Sales
Using the GAAP Codification, and (4) Accounting Treatment for Bill-and-Hold Sales
Using IFRS. Answer the questions below. Base your analyses on the literature from
Appendix B and use this literature to support your conclusions.
(a) Associate IFRS revenue recognition concepts and criteria to those of U.S. GAAP,
using only Appendix B, Parts 1 and 2, by building a table with two columns. Label
Issues in Accounting Education
Volume 28, No. 3, 2013
Savage, Cerf, and Barra
one column ‘‘IFRS’’ and the other column ‘‘U.S. GAAP.’’ In each row of the first
column of your table, list an IFRS criterion or concept and then draw arrows from each
of these to the U.S. GAAP criteria or concepts listed in the second column.
(b) Explain how revenue recognition for bill-and-hold sales under IFRS (Appendix B,
Part 4) differs from the GAAP Codification (Appendix B, Part 3).
(c) Would the bill-and-hold sales of stockpiled vaccines, as described in this case,
constitute a revenue transaction under IFRS? Why or why not?
2. Go back to the time of this case, when the government made the agreement to purchase the
vaccine and the vaccine company received payment and stockpiled the inventory.
According to U.S. GAAP revenue recognition concepts and criteria at that time (i.e.,
Appendix B, Part 1), did the management of the vaccine companies and their external
auditors have authoritative accounting justification for recognizing revenue on the
stockpiled vaccines? Support your answer by referring only to the relevant revenue
recognition concepts and criteria in Appendix B, Part 1.
3. Operating cash flow is often referred to as the lifeblood of a firm. The vaccine makers
received cash up-front from the government for the stockpiled vaccines. Such cash would
be reported to stakeholders (financial analysts, stockholders, lenders, etc.) in the operating
cash flow section of the Statement of Cash Flows in the fiscal period of receipt. Given this,
why would these pharmaceutical companies be so concerned about when the revenue
related to this cash is recognized for income statement purposes? In your response, consider
how recognized revenues are used by firm stakeholders. Use your library databases to
provide at least two references to support your answer.
4. Do you agree or disagree with the position taken by the vaccine companies? Should they be
allowed to recognize revenue for stockpiled vaccines? Why or why not?
5. After careful consideration of the public interest consequences of ASC 605-15-S99-1,
would it be appropriate for the SEC to modify its revenue recognition position exclusively
for pharmaceutical companies stockpiling vaccines for the federal government by allowing
them to recognize revenue on stockpiled vaccines? Why or why not?
6. Use the SEC website to determine whether the SEC subsequently modified its revenue
recognition position for these vaccine makers by amending its authoritative guidance, given
the public outcry about the vaccine shortage. Provide information that supports your
Brown, D. 2005a. Pediatric vaccine stockpile drops. The Tribune (April 17): A1, A13.
Brown, D. 2005b. Pediatric vaccine stockpile at risk; makers hesitate to supply government. The
Washington Post (April 17): A01.
Deloitte Global Services Limited. 2012. U.S. Securities and Exchange Commission (SEC). Available at:
Economist, The. 2007. Beyond the egg. (March 10): 65.
International Federation of Accountants (IFAC). 2012. A Definition of the Public Interest. Policy Position
No. 5. New York, NY: IFAC. Available at:
Lancet Infectious Diseases, The. 2004. Where have all the vaccines gone? 4 (4): 187.
National Network for Immunization Information. 2006. Vaccine Supply and Shortages. Available at: http://
Prifti, C. 2010. The Vaccine Industry: An Overview. Available at: http://www.
Issues in Accounting Education
Volume 28, No. 3, 2013
Accounting for the Public Interest: A Revenue Recognition Dilemma
Salinsky, E., and C. Warble. 2006. The vaccine industry: Does it need a shot in the arm? National Health
Policy Forum 25 (January): 14.
Sloan, F. A., S. Berman, S. Rosenbaum, R. A. Chalk, and R. B. Giffin. 2004. The fragility of the U.S.
vaccine supply. The New England Journal of Medicine 351 (23): 2443.
Overview of the Vaccine Industry
Vaccine makers are pharmaceutical companies that make vaccine production decisions based
on profitability (National Network for Immunization Information 2006). Virtually all licensed
vaccines in the U.S. are produced by five companies, including our client. Thirty years ago, the
vaccine industry included many more firms, with 35 companies producing vaccines for the U.S.
Vaccine shortages are not confined to the U.S. Between 1988 and 2001, 10 of 14 global vaccine
manufacturers partially or completely stopped production of traditional childhood vaccines (The
Lancet Infectious Diseases 2004). This trend is primarily attributed to low profitability, costly R&D
and production, and liability issues. Analysts expect vaccine profit margins to remain below the
profit margins of branded pharmaceuticals (The Economist 2007).
Demand for pediatric vaccines is directly related to the size of the birth cohort in a given year
and is consequently not difficult for manufacturers to predict. Governments are the largest single
purchasers of vaccines. U.S. federal and state government purchases of pediatric vaccines account
for almost 60 percent of total pediatric vaccines purchased in the country. Many factors discourage
vaccine research and development, including limited demand, liability issues, and bulk purchasing
discounts. By comparison to the demand by the government, the demand for vaccines by others is
in small quantities and widely distributed. This leads to significant sales transaction costs. Many
organizations believe that the revenue received from administering vaccines does not warrant the
assumed liability. Because the government purchases large quantities, they are able to obtain bulk
purchase discounts. These factors all lead to lower motivation to perform research and development
on vaccines. Additionally, the production of an approved vaccine requires approximately 12 to 15
years of research and costs $500 million to $1 billion (Sloan et al. 2004). Fixed costs of vaccine
production are estimated at approximately 60 percent, requiring substantial sales to exceed fixed
costs (Salinsky and Warble 2006). Given that vaccines are only administered a few times per
individual, markets and profitability are limited.
Synopsis of Revenue Recognition Rules Applicable At Time of Vaccine Case
Part 1. General U.S. GAAP Revenue Recognition Concepts and Criteria
Revenue recognition under U.S. GAAP is heavily prescriptive and requires that two conditions
be met: the revenue must be both earned and realized or realizable. To meet the first condition, the
Financial Accounting Standards Board (FASB) Concepts Statement No. 5, paragraph 83 (b), issued
December 1984, states that ‘‘an entity’s revenue-earning activities involve delivering or producing
goods, rendering services, or other activities that constitute its ongoing major or central operations,
and revenues are considered to be earned when the entity has substantially accomplished what it
must do to be entitled to the benefits represented by the revenues.’’ More specificity is provided by
the SEC, which gives additional authoritative guidance for companies registered with the SEC. The
Accounting Standards Codification (ASC) incorporates some SEC guidance. With respect to
revenue recognition, the SEC guidance can be found in Staff Accounting Bulletin (SAB) Topic 13
Issues in Accounting Education
Volume 28, No. 3, 2013
Savage, Cerf, and Barra
(included in the Codification as ASC 605-10-S99-1), which states that for revenue to be ‘‘earned’’
from the sale of goods, two criteria must be met: (1) persuasive evidence of an arrangement must
exist (in other words, the final agreement between the parties must specify the nature and terms of
the transaction and must consequently be in writing), and (2) delivery of the goods must have
occurred (i.e., the risks and rewards of ownership have been transferred).
ASC 605-10-25-1, derived from FASB Concepts Statement No. 5, paragraphs 83(a) and (b),
states that ‘‘the two conditions (being realized or realizable and being earned) are usually met by the
time the product or merchandise is delivered . . . to customers, and revenues from manufacturing
and selling activities . . . are commonly recognized at the time of sale (usually meaning delivery).’’
Specifically, with respect to ‘‘realized or realizable,’’ ASC 605-10-S99-1 also requires that (1) the
seller’s price to the buyer must be fixed or determinable, and (2) collectability must be reasonably
Part 2. General IFRS Revenue Recognition Concepts and Criteria
While U.S. GAAP revenue recognition guidance is heavily prescriptive and comprises more
than a hundred standards (pre-codification), many of which are industry-specific and can produce
confli …
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