What are the accounting issue(s) and the relevant components of the authoritative literature?
The case focuses on a sales agreement with multiple deliverables. The critical issue is determining whether there are separate units of accounting in the sales agreement. In other words, should the multiple deliverables be accounted for as one unit of accounting or as two or more separate units of accounting? Guidelines that assist with evaluating sales transactions that involve multiple deliverables can be found in subtopic 605-25, ‘‘Revenue Recognition—Multiple-Element Arrangements,’’ in the Codification.
Requirement 2: What are the separate units of accounting in the sales agreement between AOI and CMI? Use the authoritative literature to explain your answer. As the explanation below illustrates, the multiple deliverables sold by AOI to CMI should be treated as two separate units of accounting (the assembly line system and its installation). FASB ASC 605-2525-5 presents specific criteria that must be met for the multiple deliverables in revenue-generating arrangements to be treated as separate units of accounting. The questions essentially posed by these criteria are the following:
1. Does the delivered item(s) have value to the customer on a standalone basis? 2. Does a general right of return exist for the delivered item(s) and, if so, is delivery or performance of the undelivered item(s) considered probable and substantially in the control of the vendor? Question 1 above, ‘‘Do the delivered item(s) have standalone value?’’ needs to be considered as each item is delivered to the customer (provided there are still items to be delivered). The first deliverable consists of the mixer segment and the molding segment (mixer/molding segment deliverable).
AOI must consider whether this deliverable has value to the customer on a standalone basis (absent the packaging segment and the installation services). As discussed in FASB ASC 605- 2525-5a, standalone value exists if the deliverable can be sold separately by any vendor or if the customer could resell the deliverable on its own. The case facts indicate that neither of these circumstances exists with respect to the mixer/molding segment deliverable. In other words, AOI does not sell the mixer/molding segment without also selling the packaging segment because all three components are needed for the assembly line system to function properly.
Are AOI’s assembly line components are compatible with any of AOI’s competitors’ assembly line systems. Given the facts in the case (i.e., the individual components do not function independently of one another), we assume that they are not. For these reasons, it is reasonable to assume that the customer cannot resell the mixer/molding segment on its own, so there is no resale market for these components. The mixer/molding segment deliverable does not represent a separate unit of accounting and must be bundled together with at least the packaging component deliverable. The next deliverable consists of the packaging component, which completes the assembly line system. AOI must consider whether the complete assembly line system has value to the customer on a standalone basis (absent the installation services). The case facts indicate that AOI sometimes sells the assembly line system without the installation services. For this reason, the complete assembly line system (the delivered item) has value to the customer on a standalone basis. As a result, it should be treated as a separate unit of accounting.
The final deliverable is the installation services. Because there are no remaining items to be delivered after the installation services, AOI does not need to consider whether the installation services have value to the customer on a standalone basis.
As a result of this portion of the analysis, AOI concludes that its agreement with CMI consists of two Alford, DiMattia, Hill, and Stevens 120113
RR Atletico Oaklawn Analysis 2
separate units of accounting: (1) assembly line system, and (2) installation services. Question 2, above, is not relevant and need not be considered because there is no general right of return provided by AOI in its agreement with CMI.
Requirement 3: How much of the arrangement consideration should be allocated to each unit of accounting? Be sure to identify any other issues that must be resolved to determine how revenue should be allocated.
AOI must now allocate the arrangement consideration between the two separate units of accounting. As discussed in FASB ASC 605-25-30-2, arrangement consideration should be allocated using the relative selling price method. The case asks to ‘‘identify any other issues that must be resolved to determine how revenue should be allocated.’’
To apply the relative selling price method, AOI must determine whether it has vendor-specific objective evidence (VSOE) of selling price (as defined below) for either or both of the separate units of accounting. If AOI has VSOE of selling price for a unit of accounting, it should use that selling price in the relative selling price method. If AOI does not have VSOE of selling price for a unit of accounting, it should determine whether it has third party evidence (TPE) of selling price (as defined below). If AOI does not have VSOE of selling price, but does have TPE of selling price for a unit of accounting, then AOI should use TPE of selling price in the relative selling price method. If AOI has neither VSOE of selling price nor TPE of selling price, then it must determine its best estimate of selling price (as defined in FASB ASC 605-25-30-6c) and use that price in the relative selling price method.
As discussed in FASB ASC 605-25-30-6a, VSOE of selling price exists if the vendor sells the unit of accounting separately and, thus, knows the price it charges for that unit on a standalone basis. The case facts indicate that AOI occasionally sells its assembly line system without installation for $95,000. If there is sufficient evidence to support selling the assembly line system without installation at that price, AOI should use a price of $95,000 for the assembly line system in the relative selling price method. Because AOI does not sell the installation services separately, it does not have VSOE of selling price for that unit of accounting.
Requirement 4: Now, assume that sufficient evidence exists to support the selling price of $95,000 for the assembly line system. However, there is some concern regarding the $12,000 charged for the installation services that AOI heard about from a prior customer.
What type of analy is must be done related to the $12,000 price for installation services to decide whether it should be used to allocate revenue to the components in the sales agreement? Explain your answer. As discussed in FASB ASC 605-25-30-6b, third-party evidence of selling price exists if the product or service is available to the customer from another vendor. The issue to consider is whether there is sufficient evidence to support the selling price for the installation services that AOI learned of from one of its customers as TPE. If so, AOI should use that price ($12,000) for the installation services in the relative selling price method. The following issues should be identified before deciding that the $12,000 sales price is TPE:
1. Are the outside technicians qualified to install the system? 2. Have customers who have used outside technicians been satisfied with the installation of the system, or has more work had to be done?
3. How many times have customers used outside technicians to provide installation services (i.e., there may not be sufficient evidence to support the selling prices of the installation services)? 4. Is there evidence other than ‘‘AOI has heard’’ (e.g., written contracts or binding quotes) that verify the price charged by other technicians?
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RR Atletico Oaklawn Analysis 3
Assuming that the outside technicians are qualified, that prior installations by outside technicians have been satisfactory, that it is not uncommon for customers to use outside technicians, that AOI has documentation for the price it has charged customers that have bought the assembly line system but not the installation, and that AOI has documentation that verifies the price charged by outside technicians to perform the installation, sufficient evidence does exist to support the selling prices for the assembly line system unit of accounting and the installation services unit of accounting. On the other hand, if it is concluded that there is not sufficient evidence to support the $12,000 figure as TPE, AOI’s only option, according to the literature, is to use its best estimate of selling price as a basis for allocating revenue. The entries below assume that $12,000 can be supported as TPE. Therefore, AOI should allocate the arrangement consideration included in its sales agreement with CMI as follows:
%of Total Allocated Arrangement
Selling price for assembly
Line system (VSOE)
Selling price of installation
Requirement 5: If there are no other issues that would affect the timing of revenue recognition, how much revenue should be recognized in the following periods? Include journal entries in your answer. (Assume that AOI has early adopted any pending guidance included in the relevant sections of the Codification.)
The journal entries that account for the revenue recognized by AOI in each of the quarters ending September 30, 20X9, December 31, 20X9, and March 31, 20Y0, are provided in the discussion that follows.
a. The quarter ending September 30, 20X9:
Inventory Held by Others
Explanation. AOI does not recognize any revenue in the quarter ending September 30, 20X9, because it cannot treat the mixer/molding segment deliverable as a separate unit of accounting. Because AOI has received cash for that deliverable by September 30, 20X9, it must reflect the receipt of that cash as unearned revenue. In addition, because AOI has delivered the mixer/molding segment by September 30, 20X9, it should consider reflecting the cost of this segment in a separate inventory account to highlight the fact that it is not inventory that AOI has on hand at the end of the period. b. The quarter ending December 31, 20X9:
Cost of Goods Sold
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RR Atletico Oaklawn Analysis 4
Assembly Line System Revenue
Inventory Held by Others
Explanation. An additional $20,000 is collected from CMI in the quarter ending December 31, 20X9, as the last component of the assembly line (the packaging segment) is delivered. As a result, AOI recognizes revenue allocated to the assembly line system ($88,800) in the quarter ending December 31, 20X9. Because $90,000 has been collected from the customer by the end of that quarter, the balance that remains in the unearned revenue account is $1,200 ($90,000 cash received less $88,800 revenue recognized). The amount of unearned revenue recognized in the quarter ending September 30, 20X9, was $70,000. The cost of the three components of the assembly line is recorded as cost of goods sold now that the related revenue has been recognized. The inventory held for others that was debited in the previous quarter is now removed from the accounts, as well as the $10,000 cost of the packaging segment.
c. The quarter ending March 31, 20Y0:
Cost of Services Provided
Installation Services Revenue
Cash-Installation Technician Wages
Explanation. AOI collects the remainder of the amount due from CMI in the sales arrangement. In addition, the remaining balance in unearned revenue is eliminated, as all revenue has now been earned; the amount of revenue allocated to the installation services ($11,200) is recognized in the quarter ending March 31, 20Y0. Last, the cost of the installation services to AOI is recorded. An additional question to discuss with the students in an open forum might include the following: Assume that the CPA review at your school offers students the right to retake the review for free if they attend a certain number of classes and get a certain score on the final exam. Does this arrangement raise any revenue recognition or other accounting concerns? This is an example of a multiple-element arrangement that accounting students in particular should appreciate.
The students are paying for the course itself and the right to retake the course. This raises two interesting accounting issues. First, the right to retake the CPA review course is, in effect, a ‘‘put’’ option embedded in the fee for the CPA review. If financial statements were prepared for the CPA review, the embedded derivative would likely have to be broken out and accounted for as a cash flow hedge. The second related issue is valuing the right to retake the review and determining the likely retake rate. Once the value and redemption rates are determined, calculating the appropriate amount of revenue to be deferred is possible.
Alford, DiMattia, Hill, and Stevens 120113
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