Page 72 - Finance for Non-Financial Managers

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The Income Statement: The Flow of Progress
The Widget Isn’t Sold—or Recorded—
Until It Works
Imagine the new salesperson on the staff of Wonder Widget 53
selling an advanced version of the Wonder Widget, the Enterprise
Widget.The salesperson does a great job of selling the product’s bene-
fits and tells the customer the price includes full installation and train-
ing, with no commitment to pay until it works. So, the customer signs
the order.The paperwork goes into Wonder Widget’s sales office for
processing and the salesperson enthusiastically goes on to the next
deal, hoping for a commission check before sunset. Meanwhile, the
process of setting up the customer begins, including credit application,
credit checking, shipping instructions, etc.Then the product finally
ships to the customer. Done, right? Nope.Actually, it’s just beginning.
This Enterprise Widget isn’t “plug and play” like its predecessors; it
requires installation, setup, debugging, and finally training, all of which are
part of the product package. By the time all that is completed, months
have passed and the salesperson still has that sale on an open item list—
“I sold it but they haven’t yet paid me for it.” Yet the company can’t hold
the customer to the sale until the installed product is accepted. Under
the rules of accounting, when the customer is irrevocably committed and
the company has delivered on its promises, the transaction can be
recorded. Under Wonder Widget’s commission plan, the commission is
payable under the same circumstances. So, no sale, no commission.

Expenses do not get recorded when they are committed,
when the order is called in, when a purchase order is issued, or
even when the supplier agrees to supply the goods or services
ordered. All those things are simply requests or promises, all of
which can be rescinded without penalty. So they’re not the
irrevocable transactions that we can record. When the supplier
acts on that promise to deliver, then we have an accounting
event that should be recorded and the money is really spent.
Why would the sales manager even care about such refine-
ments of accounting? Well, first, he was being evaluated on his
performance against budget, of course, always a good tool for
instilling budget consciousness. But mostly he wanted to be
relieved of the need to keep track of money he had committed
and (in his mind) spent. It’s easy to understand his desire,
since keeping track of such details is time-consuming. If the