Revenue Recognition Harvard Case Solution & Analysis

Example:-

We take example of Telecommunication Company in order to understand this further. For example if there is contract taking place between customers and a telecommunication company. According to contract there is no any charge for mobile phone however $100 will be charged per month from customer. This is 4 year mobile phone plan. According to last revenue recognition approach while issuing free phone to the customer, there is no revenue recognition. However it can be easily understood that customer is not given mobile phone free. It is given for subsequently monthly payments. According to contract, customer is bound to use services of that particular network for two years. Customer will be penalized if he breaks or breaches the contract.

According to new revenue recognition approach i.e. IFRS 15, the company needs to determine transaction cost for each item i.e. mobile phone and network services. Let’s take example step by step.

Step 1: Identify Customer Contract

There is formal contract between customer and Telecommunication Company. The contract includes 4 year mobile plan with $100 per month. There will also be other terms and conditions available in the contract like customer will use that particular telecom services.

Step 2: Identify Performance Obligations of Contract

In this contract there are two performance obligations of Telecom Company. One is to give free mobile phone to customer and other is to provide mobile plan based on 4 year.

Step 3: Determine Transaction Price

As discussed above customer would be paying $100 for 48 months (4 year). So the transaction price will be $4800 (48*100).

Step 4: Allocate Transaction Price

For example if the phone issued to customer is worth $2000 and the services that customer use are worth $3840 (80*48)i.e. $80 per month.

Prices Ratio of Allocation (A) Transaction price (B) Allocation of Transaction Price (A)*(B)
Mobile Worth $2000 50% $2400
4 Year Mobile Plan $3840 50% $2400
Total $5840 100% $4800 $4800

It is noted that customers get mobile free of charge but according to new revenue recognition approach $2400 revenue is allocated to mobile phone. However according to last approach there will be no revenue recognition as mobile is given free of charge to the customers.

Step 5: Recognize Revenue

When phone is transferred to customers, $2400 will be recognized as shown in above table. The books entry will be:

DR un billed revenue (liability)            $2400

CR revenue                              $2400

Effectively the un billed revenue will be amortized over the life of contract i.e. 4-year.

Conclusion

To conclude, the new model that includes 5 steps is more complicated as compared to the previous model but it also has more advantages. In previous model; revenue of mobile phone was not recognized as it was given free to the customers, although full control and underlying benefits of mobile are transferred to the customers. Under IFRS 15 which is a new method; gives fair allocation of revenue recognition.......

 

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