Objectives
To expose you to current issues facing the profession in relation to revenue recognition.
To learn to research current accounting issues.
To provide you an opportunity to demonstrate and improve your communication skills.
Expectation and Evaluation:
The project is conducted in a group of no more than 4 members. The group is assigned randomly.
Group members are required to participate in the project with equal efforts. Each member will turn in an anonymous form evaluating each member's participation in the project. The participation evaluation will determine whether any downward adjustments to the project grade for specific individuals in the group are necessary. The maximum downward adjustment is the earned project grade.
Project Requirements:
In completing your project, please show clearly related references to the guidance to each question. For example, if your group answer is based on guidance from ASC 605-10-1, then you need to state clearly in the project that "based on ASC 605-10-1, revenue is ..." 4. Your group's submitted project MUST be typewritten using a word processing software and handwritten submissions are not acceptable.
FASB codification website: https://aaahq.org/FASB-GASB. The username is AAA51352, and the Password is 6U8XutW
General background:
EYE SPY sells sophisticated video surveillance equipment. EYE SPY sells the equipment and computer integration services together. It does not sell these separately. The equipment cannot operate without being fully integrated with a computer system. Significant customization is required during this integration. Other competitors could theoretically provide computer integration services. Historically, EYE SPY has not sold maintenance services.
The sales manager for EYE SPY has just obtained a signed contract from Secret Manufacturing (SM) to provide and perform computer integration services for surveillance equipment at a cost of $10 million, and have everything operational within one year, at which time full payment is due. SM will not get control of the video surveillance equipment until the integration is completed and EYE SPY turns control of the system over to SM. Management expects to be able to have the system fully operational and available for use by SM in the 12th month of the contract.
EYE SPY believes this system would also be valuable to SM's competitors. The contract price of $10 million includes a five-year maintenance agreement that will commence after the installation is completed. SM has a great credit rating and always pays its bills. EYE SPY's sales manager is very pleased because he will receive a 2% bonus based on the gross sales contract price, and it is payable upon receipt of a signed contract.
EYE SPY maintains a marketing group to work on contract proposals. The total annual salaries for the marketing group are $400,000. On average, the marketing group works on 20 proposals each year. This contract is expected to have a 15% to 20% margin.
Part I:
Requirement:
Read ASC 606, Perform the following tasks:
1.1 Perform step one of the revenue recognition model and identify the contract(s) with the customer. By reference to the applicable accounting literature, provide a detailed analysis to support your conclusion.
1.2 Perform step two of the revenue recognition model and identify the performance obligation(s) in the contract(s). By reference to the applicable accounting literature, provide a detailed analysis to support your conclusion.
1.3 Review ASC 340-40-25-1 through 3 on deferring costs. Record any required journal entries as of the date of receiving the signed contract.
Part II: Background:
In the initial contract negotiation stage, the contract price with SM was $10.1 million in cash. However, as part of the final contract negotiations, SM agreed to give EYE SPY its old surveillance equipment in exchange for a credit of $100,000. It is expected that this old surveillance equipment will not be decommissioned until the new equipment is operational. Based on its extensive experience, EYE SPY's management believes it is probable that the estimated fair value of the old equipment at the contract inception date is $115,000.
There was also a provision in the contract that SM would receive a discount (similar to that which, would be reflected in a separate financing transaction between EYE SPY and SM) from the contract price of $10 million if they paid within three days of when the contract was signed. EYE SPY determined a discount of $500,000 for this financing based on applying the typical credit rate for the equipment and integration services to be delivered at the end of year one and the monthly delivery of maintenance services in year two through six of the contract. SM wired $9.5 million to EYE SPY two days after the contract was signed. In the interest of full and expanded disclosure, EYE SPY has decided not to apply the practical expedient in ASC 606-1032-18.
Due to deep security concerns and recent losses of proprietary information, SM also offered a bonus to EYE SPY if the integration was completed early and EYE SPY agreed to pay a penalty if the integration was completed late. EYE SPY has a large number of contracts with bonus characteristics similar to the contract with SM. The following is the schedule of the potential bonus or penalty. While no specific outcome is probable, EYE SPY's management assessment of the likelihood of completing the integration in the specified time frame is based on significant historical experience with similar integration jobs.
|
Completed
|
|
Bonus
|
|
Penalty
|
|
Percentage
|
|
10 months
|
|
$100,000
|
|
|
|
17%
|
|
11 months
|
|
50,000
|
|
|
|
27%
|
|
12 months
|
|
0
|
|
$ 0
|
|
46%
|
|
13 months
|
|
|
|
(50,000)
|
|
7%
|
|
14 months
|
|
|
|
(100,000)
|
|
3%
|
|
15 months plus
|
|
|
|
(500,000)
|
|
0%
|
|
|
|
|
|
|
Total 100%
|
Requirement:
2.1 Perform step three of the revenue recognition model and determine the transaction price. By reference to the applicable accounting literature, provide a detailed analysis to support your conclusion.
2.2 Record any required journal entries for the first two days of the contract beyond what was recorded in Part I.
Part III: Background:
As stated in Part I, EYE SPY sells the video surveillance equipment and computer integration services together. It does not sell these separately. EYE SPY typically sells this type of video surveillance equipment and integration services with a forecasted cost of $8.136 million for $9.85 million. EYE SPY has just begun selling maintenance services and has forecasted the cost of these services at $164,000.
In the initial contract negotiations, EYE SPY told SM they would be asking for $300,000 related to the five-year maintenance contract. SM informed EYE SPY that several competitors were offering attractive pricing to obtain this maintenance work. In order get the maintenance work, the draft contract was revised to reflect that the maintenance services would be offered at a cost of $200,000.
Requirement:
3.1 Perform step four of the revenue recognition model and allocate the transaction price to each separate performance obligation. By reference to the applicable accounting literature, provide a detailed analysis to support your conclusion.
Part IV: Background
At the end of 11 months, the system is fully operational. The system has been tested and accepted by SM. The old surveillance equipment was decommissioned when the new system was installed. The old equipment was shipped to EYE SPY in month 11. The old surveillance equipment was sold the next month for $120,000. For the sake of simplicity, no financing component needs to be allocated to the maintenance contract.
Requirement:
4.1 Perform step five of the revenue recognition model and recognize revenue as performance obligations are satisfied. By reference to the applicable accounting literature, provide a detailed analysis to support your conclusion.
4.2 Record any required journal entries for revenue, deferred costs, etc., through the 11th and 12th months of the contract (Note: While some journal entries may have been recorded monthly, for purposes of this case, show the cumulative journal entry recorded through the 11th and 12th months).