Ch. 6.2 Handout SLN

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College of Southern Nevada *

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401

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Accounting

Date

Apr 3, 2024

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ACC 401 – Financial Reporting I Dr. Scott C. Jackson, PhD Ch. 6 – Revenue Recognition (Part II) 1. Ski West, Incorporated, operates a downhill ski area near Lake Tahoe, California. An all-day adult lift ticket can be purchased for $85. Adult customers also can purchase a season pass that entitles the pass holder to ski any day during the season, which typically runs from December 1 through April 30. Ski West expects its season pass holders to use their passes equally throughout the season. The company’s fiscal year ends on December 31. On November 6, 2024, Jake Lawson purchased a season pass for $450. a. When should Ski West recognize revenue from the sale of its season passes? Ski West should recognize revenue equally over the ski season. Ski West fulfills its performance obligation over time as it delivers the service to its pass holders by providing access to its ski lifts. b. Prepare the appropriate journal entries that Ski West would record on November 6 and December 31. November 06, 2024 Cash 450 Deferred revenue 450 December 31, 2024 Deferred revenue 90 Service revenue 90 ($450 × 1/5 = $90) c. What will be included in the Ski West 2024 income statement and balance sheet related to the sale of the season pass to Jake Lawson? $90 is included in revenue in Ski West’s 2024 income statement. The $360 remaining balance in deferred revenue is included in the current liability section of Ski West’s 2024 balance sheet. 2. On March 1, 2024, Gold Examiner receives $147,000 from a local bank and promises to deliver 100 units of certified 1-ounce gold bars on a future date. The contract states that ownership passes to the bank when Gold Examiner delivers the products to Brink’s, a third-party carrier. In addition, Gold Examiner has agreed to provide a replacement shipment at no additional cost if the product is lost in transit. The stand-alone price of a gold bar is $1,440 per unit, and Gold Examiner estimates the stand-alone price of the replacement insurance service to be $60 per unit. Brink’s picked up the gold bars from Gold Examiner on March 30, and delivery to the bank occurred on April 1. a. How many performance obligations are in this contract? Delivery of gold is one performance obligation. The additional insurance for replacement of gold bars is a second performance obligation. 1 b. Prepare the journal entry Gold Examiner would record on March 1, March 30, and April 1. March 01, 2024 Cash 147,000 Deferred revenue - gold bars 141,120 Deferred revenue - insurance 5,880 March 30, 2024 Deferred revenue - gold bars 141,120 Sales revenue 141,120 April 01, 2024 Deferred revenue - insurance 5,880 Service revenue 5,880 1 The insurance service is capable of being distinct because the bank could choose to receive similar services from another insurance provider, and it is separately identifiable, as it is not highly interrelated with the other performance obligation of delivering gold, and the seller's role is not to integrate and customize them to create one service or product. So, the insurance qualifies as a performance obligation. The receipt of cash prior to delivery is not a performance obligation, but rather gives rise to deferred revenue associated with performance obligations to be satisfied in the future.

Explanation: Value of the gold bars: $1,440 per unit × 100 units = $ 144,000 Stand-alone selling price of the insurance: $60 × 100 units = 6,000 Total of stand-alone prices $ 150,000 Gold Examiner first identifies each performance obligation’s share of the sum of the stand-alone selling prices of all deliverables: Gold bars delivered: $144,000 ÷ ($144,000 + 6,000) = 96% Insurance: $6,000 ÷ ($144,000 + 6,000) = 4% 100% Gold Examiner then allocates the total selling price based on stand-alone selling prices, as follows: $147,000 Transaction price × 96% = $141,120 Gold bars delivered $147,000 Transaction price × 4% = $5,880 Insurance for replacement of gold bars Gold Examiner recognizes only the portion of revenue associated with passing of the legal title. The revenue associated with insurance coverage will be earned only when that performance obligation is satisfied. 3. Clarks Incorporated, a shoe retailer, sells boots in different styles. In early November, the company starts selling “SunBoots” to customers for $70 per pair. When a customer purchases a pair of SunBoots, Clarks also gives the customer a 30% discount coupon for any additional future purchases made in the next 30 days. Customers can’t obtain the discount coupon otherwise. Clarks anticipates that approximately 20% of customers will utilize the coupon, and that on average those customers will purchase additional goods that normally sell for $100. Required: a. How many performance obligations are in a contract to buy a pair of SunBoots? 2. The delivery of SunBoots is one performance obligation. The option for discount on additional future purchases is a second performance obligation because it provides a material right to the customer that the customer would not receive without the purchase of SunBoots. 2 b. Assume Clarks cannot estimate the stand-alone selling price of a pair of SunBoots sold without a coupon. Prepare a journal entry to record revenue for the sale of 1,000 pairs of SunBoots, assuming that Clarks uses the residual method to estimate the stand-alone selling price of SunBoots sold without the discount coupon. Cash 70,000 Sales revenue 64,000 Deferred revenue - coupons 6,000 If Clarks can’t estimate the stand-alone selling price of SunBoots, it will use the residual method to calculate that price as the amount of the total transaction price minus the value of the discount. Cash (1,000 × $70) = $70,000 Sales revenue (to balance) = $64,000 Deferred revenue − coupons (discount option) = 1,000 pairs × $100 average purchase price × 30% discount × 20% of customers estimated to redeem coupon. 2 That material right to receive a discount is both capable of being distinct, as it could be sold or provided separately, and it is separately identifiable, as it is not highly interrelated with the other performance obligation of delivering SunBoots, and the seller’s role is not to integrate and customize them to create one product. So, the discount option represented by the coupon is distinct and qualifies as a performance obligation.

4. On May 1, 2024, Meta Computer, Incorporated, enters into a contract to sell 5,000 units of Comfort Office Keyboard to one of its clients, Bionics, Incorporated, at a fixed price of $95,000, to be settled by a cash payment on May 1. Delivery is scheduled for June 1, 2024. As part of the contract, the seller offers a 25% discount coupon to Bionics for any purchases in the next six months. The seller will continue to offer a 5% discount on all sales during the same time period, which will be available to all customers. Based on experience, Meta Computer estimates a 50% probability that Bionics will redeem the 25% discount voucher and that the coupon will be applied to $20,000 of purchases. The stand-alone selling price for the Comfort Office Keyboard is $19.60 per unit. a. How many performance obligations are in this contract? 2. Delivery of keyboards is one performance obligation. The option to receive a special discount is a second performance obligation, as it provides a material right that the customer would not receive had it not bought the keyboards. 3 b. Prepare the journal entry that Meta would record on May 1, 2024. May 1, 2024 Cash 95,000 Deferred revenue - keyboards 93,100 Deferred revenue - coupons 1,900 Explanation: When two or more performance obligations are associated with a single transaction price, the transaction price must be allocated to the performance obligations on the basis of respective stand- alone selling prices (estimated if not directly available). Meta’s estimated stand-alone selling price of the discount option is: Value of the discount coupon: (25% discount − 5% normal discount) × $20,000 = $ 4,000 Estimated redemption × 50% Stand-alone selling price of discount coupon: $ 2,000 Stand-alone selling price of the keyboards: $19.60 × 5,000 keyboards = 98,000 Total of stand-alone prices $ 100,000 Meta first must identify each performance obligation’s share of the sum of the stand-alone selling prices of all deliverables: Discount: $2,000 ÷ ($2,000 + $98,000) = 2% Keyboards: $98,000 ÷ ($2,000 + $98,000) = 98% 100% Meta then allocates the total selling price based on stand-alone selling prices, as follows: $95,000 Transaction price × 98% = $93,100 Delivery of keyboards $95,000 Transaction price × 2% = $1,900 Discount on future purchases The deferred revenue for the keyboards will become recognized as revenue on June 1st. The deferred revenue for the option to exercise the discount coupon is recognized when the coupon either is exercised or expires in six months. 3 In this particular instance, the customer has the right to receive a 25% discount for any purchases in the next six months, which is a 20% discount in addition to the normal 5% discount offered to other customers. The option to receive the discount, represented by the coupon, is both capable of being distinct, as it could be sold or provided separately, and it is separately identifiable, as it is not highly interrelated with the other performance obligation of delivering keyboards, and the seller’s role is not to integrate and customize them to create one product. So, it is distinct and qualifies as a performance obligation.

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c. Assume the same facts and circumstances as above, except that Meta gives a 5% discount option to Bionics instead of 25%. In this case, what journal entry would Meta record on May 1, 2024? May 1, 2024 Cash 95,000 Deferred revenue - keyboards 95,000 All customers are eligible for a 5% discount on all sales. Therefore, the 5% discount option issued to Bionics, Incorporated does not give any material right to the customer, so it is not a performance obligation in the contract, and Meta would account for both (a) the delivery of keyboards and (b) the 5% coupon as a single performance obligation. 5. Thomas Consultants provided Bran Construction with assistance in implementing various cost-savings initiatives. Thomas’s contract specifies that it will receive a flat fee of $50,000 and an additional $20,000 if Bran reaches a prespecified target amount of cost savings. Thomas estimates that there is a 20% chance that Bran will achieve the cost-savings target. a. Assuming Thomas uses the expected value as its estimate of variable consideration, calculate the transaction price. The expected value would be calculated as follows: Possible Amounts Probabilities Expected Amounts $70,000 ($50,000 fixed fee + $20,000 bonus)× 20% = $ 14,000 $50,000 ($50,000 fixed fee + $0 bonus) × 80% = 40,000 Expected contract price at inception $ 54,000 Or, alternatively: $50,000 + ($20,000 × 20%) = $54,000 b. Assuming Thomas uses the most likely value as its estimate of variable consideration, calculate the transaction price. The most likely amount is the flat fee of $50,000, because there is a greater chance of not qualifying for the bonus than of qualifying for the bonus, so that is the transaction price. c. Assume Thomas uses the expected value as its estimate of variable consideration, but is very uncertain of that estimate due to a lack of experience with similar consulting arrangements. Calculate the transaction price. Because Thomas is very uncertain of its estimate, Thomas can’t argue that it is probable that it won’t have to reverse (adjust downward) a significant amount of revenue in the future because of a change in returns. Therefore, Thomas would not include the bonus estimate in the transaction price, and the transaction price would be the flat fee of $50,000.