Ics-case-4-biovail-1-1.doc 1p5l6v

BKAL 3063: BIOVAIL CORPORATION

Table of Contents 1.0

Abstract........................................................................................................................... 2

2.0

Introduction..................................................................................................................... 2

3.0

Questions and answer....................................................................................................4

4.0

Recommendations........................................................................................................14

5.0

References..................................................................................................................... 15

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BKAL 3063: BIOVAIL CORPORATION 1.0

Abstract

Biovail Corporation, a large pharmaceutical company and had applied advanced drug-delivery technologies to improve the clinical effectiveness of medicines. It is recently had its stock downgraded by a well-known pharmaceutical analyst and a number of other analysts were also scrutinizing the company. The outcome was not favorable, as Biovail's acquisition methods were labeled as unethical and their ing practices were questioned. An investor with the company must decide if she will continue to invest in a company that has been identified with low ethical standards.

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Introduction

Biovail Corporation was one of Canada’s largest publicly traded pharmaceutical companies. Its products

commercialized

both

directly

in

Canada

and

through

strategic

partners

(internationally). The company was very expert in the development and large scale of manufacturing of pharmaceutical products. Besides that, Biovail’s stock had listed on both the Toronto and New York stock exchanges. Biovail filed annual reports to the U.S. SEC and prepared financial statements in accordance with both U.S. and Canadian generally accepted ing principles (GAAP). Biovail Company engaged activities on enhance formulate of the existing drugs, clinical testing, manufacture and commercial pharmaceutical products and utilized advanced drug delivery technologies. On 30 September 2003, there was a truck carrying a shipment of Wellbutrin® XL from Biovail’s manufacturing facility in Manitabo to Biovail’s Distributor, North Carolina was involved in a multi-vehicle traffic accident near Chicago. The company announced that the loss of the quarterly earnings which target by $260 million is because of the truck accident happened. It contributed a significant unfavorable variance where the company estimated that revenue of the truck that involved in accident was in the range of 2

BKAL 3063: BIOVAIL CORPORATION $10 million to $20 million. There are several issues in this case which included ing policy based on the revenue recognition; how Biovail Corporation should the sales based on two different “Freight On Board” (FOB) point which are FOB Shipping point and FOB Destination point, and ethic of earning management where Biovail is suspected might significantly overestimate the value of the product that involved in the truck accident due to Biovail fail to meet its third quarter 2003 earnings guidance.

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BKAL 3063: BIOVAIL CORPORATION 3.0

Questions and answer

1)

How many truckloads of product are actually required to carry $10 million of product? Show your calculations.

Step 1 Based on paragraph 3, page 3,it stated that1 Wellbutrin XL tablet is estimated to be 1.5 cm3 which is including the packing space. While for interior dimensions of a typical 18-wheeler trailer is 17m x 4.5m x 2.5m Step 2 To make the calculation easier, we need to convert the trailer dimensions to centimetres before calculate the volumes. To convert meters into centimetres the ratio is: 1meter = 100 centimetres(End note 11) 17m= 1,700 centimetres 4.5m = 450 centimetres 2.5m = 250 centimetres Step 3 The next step calculates the volume of wheeler trailer. Volume of a rectangular prism = a x b x c Volume= 1,700 x 450 x 250 Volume of 18 wheeler trailer = 191,250,000 cm3 Step 4 4

BKAL 3063: BIOVAIL CORPORATION To find out how many Wellbutrin XL tablets fit into a trailer 1.5x=191,250,000X = 127,500,000 (Answer) Step 5 How much revenue (missing revenue) does Biovail get from a single pill? Biovail + 400% (Distributor mark up) + 35% (wholesaler margin) = $2.83 (Refer page 3, paragraph 3) Supply chain: Biovail →Distributor →Wholesaler→ Retailer 2.83 / 135%

= 2.10

135 % (35% + 100%)

2.10 / 500%

= 0.42

500% (400% + 100%)

The total value of tablet in one fully loaded trailer 127,500,000 x 0.42= $53,550,000 One truck can carry $10 million worth of Wellbutrin XL tablet product.

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BKAL 3063: BIOVAIL CORPORATION

2)

How should the company recognize revenue based upon the two possible FOB contract structures mentioned in the case? Why?

According to GAAP, four conditions must be met in order to recognize revenue: 1. Persuasive evidence of an arrangement exists: Although the case does not provide extra information on this aspect, it seems clear that there is an ongoing relationship between Biovail and the Distributor and that certainly there was a bill, purchase order and/or invoice in order to this sale. 2. Seller’s price to the buyer is fixed or determinable: The case provides clear evidence in this aspect. 3. Collection is reasonably assured: given the ongoing relationship between Biovail and the Distributor, it appears evident that this aspect was probably covered as well. 4. Delivery has occurred or services have been rendered: this is the key point of conflict in the Biovail’s case.

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BKAL 3063: BIOVAIL CORPORATION

There are basically two different moments of revenue recognition according to the FOB condition: a. FOB Shipping: The company should recognize revenue at the moment/in the period in which product leaves Biovail shipping dock at the warehouse since in that precise moment both ownership and responsibility over the goods is transferred from Biovail to the client. b. FOB Destination: The Company should recognize revenue at the moment/in the period in which product is delivered to the Distributor’s facility since in that precise moment both ownership and responsibility over the goods is transferred from Biovail to the client. So Biovail should recognize the revenue based on the four condition that been stated.

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BKAL 3063: BIOVAIL CORPORATION

3)

How does the accident affect the stated revenues under the different FOB contract structures? Explain your reasoning.

Step 1 To calculate volume of ¼ full of trailer: Interior dimensions of a typical wheeler trailer: 17m x 4.5m x 2.5m Volume of a rectangular prism = a x b x c Volume= (1,700 x 450 x 250 x ¼) cm3 Thus, volume of ¼ full of wheeler trailer = 47,812,500 cm3 Step 2 Calculate volume of a Wellbutrin® XL tablet which was 0.5cm 3 and 1.00cm3as packing space for each tablet : Length x Width x Height = (1.5 x 1.5 x 1.5) cm3 = 3.375 cm3 Step 3 Calculate total tablets in the ¼ full of trailer: 47,812,500 cm3 ÷ 3.375 cm3 =14,166,667 tablets Step 4 Extract 400% mark up for Distributor and 35% wholesaler margin from the wholesale acquisition price to arrive at the original price charged by Biovail which is $ 0.42 per tablet.

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BKAL 3063: BIOVAIL CORPORATION

Step 5 Calculate the actual revenue: 14,166,667 tablets x $ 0.42 per tablet = $5,950,000 (estimated revenue) Step 6 Additional information: 1liters = 1,000 cm3 1 U.S gallon = 3.7854 liters Volume of ¼ full of wheeler trailer = 47,812,500 cm3 ÷ 3785.4 cm3 = 12,630 gallons 12,630 gallons / 64 gallons drums = 197 drums Therefore each 64-gallon drum consisted of 14,166,667 tablets ÷ 197 drums = 71,912 tablets

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BKAL 3063: BIOVAIL CORPORATION

Reasoning: An accident occurred on September 30, 2003 creates anin transit shipment loss of Wellbutrin® XL an antidepressant tablets causing Biovail to released guidance for the third quarter revenue would be decrease as well as pushing down earning per share. There are two types of FOB contract structure which is FOB shipping and FOB destination. Biovail recognize revenue in third quarter that ends on September 30,2003 using the FOB shipping method which the risk and benefit of ownership has transfer to distributor when the trailer left Biovail facility. However, later on Kenneth Howling, vice president of Finance receive an email and told Crombie to correct the statement because the agreement between Biovail and distributor was FOB destination. Thus, FOB destination risk and benefit of ownership transfer to distributor is recognizing only when the product has reach the distributor. However the product did not receive by distributor because of the accident. Hence, the risk and benefit during the accident is still under Biovail and has not yet transfer to the distributor. Following the criteria of FOB destination, revenue should record the day on receive product by distributor that will happen after September 30,2003 and the beginning of fourth quarter. However, Biovail knowingly recognize revenue overstating third quarter result which ends on September 30, 2003. In addition, Biovail has claimed that the company estimate the lost revenue of shipment during the accident occurred was range of $10 million to $20 million which was overstated revenue and it is not legitimate. As per Melnyk stated “This accident will have a negative financial impact on Biovail’s third quarter revenues”. Yet the estimated revenue from the accident is $5,950,000 which reflects a red flag.

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BKAL 3063: BIOVAIL CORPORATION Initially, there are no specific benefits to recognize revenue in FOB shipping or FOB destination. However, Biovail have recognize revenue for third quarter which was overstated revenue by using FOB shipping because Biovail do not want to bare the risk and benefit of the tablets which transfer it to distributor and to deceive investors to create the appearance of achieving the earning goals. Biovail intentionally misstated both the effect of the accident on third quarter earnings as well as the value of the product involve in the accident. In fact, the accident had no effect on third quarter earnings. Therefore the accident was just a cover face of Biovail financial report problem. The accident was not the main reason of Biovailcondition. The accident was giving Biovail opportunity to provide the marketplace with a partial explanation for the missed earnings because Biovail has doing misleading of report in previous years and Biovailface manufacturing problems. Related to the accident, the products that are involved are still salable and the manufacturing cost value is fully insured. Therefore, we believe that the revenue is not a lost yet and should not recognize it.

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BKAL 3063: BIOVAIL CORPORATION

4)

Are you concerned about the company’s treatment of analysts who cover the stock? Would you want to be the analyst covering this company?

Yes, we are concerned about the company’s treatment of analyst who covers the stock. Treatment of analyst can see through case of Jerry Treppel, Jerry Treppel had reported that Biovail’s revenue and earnings performance had not been high quality. He also highlighted that sales of Cardizem® CD represented 40% of product sales at Biovail and its reported sales has increased at least 10 million more than previous quarter. Jerry Treppel also issue a report that contained a sell recommendations, this come immediately with Biovail response, releasing a number of public statements regarding Treppel’s report coverage, caused Jerry Treppel lastly resigned his position. From this, could see that company had act tough in dealing this ‘sell’ recommendation report, taking no compromise, attack the report issuer, try many ways to invalidate the report. This increase suspicion that Biovail presented misleading information and try to cover it from discovered. This situation could come with 2 perspectives, one from the perspective of future career and another from the ethical perspective. From the future career perspective, be an analyst covering Biovail’s stock could be a challenging job, challenged individual’s ethical whether to reveal the truth to public or silent it to get further job promotion. As see from the past result, become a whistle-blower in analyst industry will unemployed at the end, because almost all the companies afraid any minor financial report mis-present will reported once discovered. Silent the truth will benefit by getting future job promotion, but it involved deceive investment clients, disregard right of clients to know the truth to get promotion or high pay. If we act as an analyst for Biovail, we will try our best to analyse the situation and come out with a good solution without putting a ‘Sell’ recommendation as first and last solution. Biovail is 12

BKAL 3063: BIOVAIL CORPORATION having a big loss for the quarter ended September 30, 2003, which means it is not a one year loss. It is not easy to sell the company because as a big company for sure it has a quite number of shareholders and in our perspective, Biovail still have a big market in Canada. Although they have a substantial loss but they can get improve in their profit if they make a plan on recovering the loss. May be Biovail can have a short-term agreement with the other pharmaceutical companies to get co-operation from them in distributing Biovail’s products or any other business activities.

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BKAL 3063: BIOVAIL CORPORATION

4.0

Recommendations

Based on this case, we came out with some recommendations. First, Biovail Corporation should be more alert on the recognition term; especially for the revenue recognition because it can be a misstatement of revenue and it leads the ant to commits the fraud. As a big company, suppose that Biovail Corporation should not have a problem regarding the recognition of revenue because they are able to hire a professional in ing department as well as to follow the ing standard and practice. Second, Biovail Corporation should pay attention to the content of the agreement between company and distributor in order to avoid miscommunication. There is a conflict between them for the term of FOB. The conflict is about the of ‘FOB shipping point’ and ‘FOB Destination’. These are very important because it is relate to the recognition. Having an agreement is a key to have a good business relationship because distributor is an important part for Biovail Corporation. Third, must avoid any fraud in presenting its financial reports. Biovail Corporation should make an adjustment for its revenue since they already know that their practice in revenue recognition is wrong and did not follow the U.S GAAP.

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BKAL 3063: BIOVAIL CORPORATION

5.0

References 1) Carton, B. (2010, September). Flashback: ing for Biovail's Truck Accident. Compliance Week . 2) Anderson, J. (2006, February).Claiming Stock Manipulation, Biovail Sues Hedge Fund.The New York Times. Retrieved from http://www.nytimes.com 3) Barr, A. (2006, February). Biovail sues SAC Capital, 21 others. Market Watch. Retrieve from http://www.marketwatch.com 4) Acharya, M. (2014, April). Biovail, CEO mislead investors, OSC says. The Star. Retrieve from http://www.thestar.com

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