Revenue Recognition and US GAAP Harvard Case Solution & Analysis

Case Number 02

Q1: What are the accounting issue(s) and the relevant components of the authoritative literature?

Accounting issues in recognizing the revenue from sale agreement transactions those such as entered into by AL, involves the timing and division of components for the revenue recognition purposes, in addition to this, the recognition of revenues is subject to number of factors as described by generally accepted accounting practice (GAAP) such as the delays in delivery might result in decline by the customer for acceptance of partial performance of ALI part and customer acceptance issue will make the recognition of revenues more difficult, meanwhile, the un deliverance of the complete agreement is led by the fact that the installation of components is being delayed by ALI. Therefore, the revenue is recognized for completion of the delivery of whole components and the completion of installation of client site. Furthermore, the revenues can be recorded on a deferral basis where the recording of revenues is based on the deferral requirements as suggested by the customer, meanwhile, the inventory will continue to be shown in ALI records until the final recognition of revenue on complete installation, meanwhile, the return of the component product will be accepted with reference to the delivery of per components at client site.

Q2: 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.

Generally accepted accounting practice requires that arrangement consideration should be allocated on the basis Vendor-Specific Objective Evidence of Selling Price, (ASC 605-25-30-6A) Third-Party Evidence of Selling Price (ASC 605-25-30-6B) and Best Estimate of Selling Price (ASC 605-25-30-6C). However, in case of ALI, the VSOE fair value of individual element is $95,000/- for the assembly line and the fair value of another accounting element which is the installation element can be determined on the basis of third party evidence of selling price which is $12,000/-. Furthermore, the allocation of arrangement consideration should be done using the fair value of individual element as established above, which allocates the arrangement consideration in accordance with the established fair value of individual element.

However, the additional factors that need to be considered in the process of allocation of arrangement consideration is the allocation of arrangement consideration must be made at the time when the agreement to sell the assembly is being initiated. Meanwhile, the selling price of each of the accounting unit should be established using the Vendor-Specific Objective Evidence, however, if the Vendor-Specific Objective Evidence is not available than the selling price should be established using the third party evidence. In addition to this the when deciding upon the Vendor-Specific Objective Evidence, Third-Party Evidence, the vendor should consider the cost benefit analysis of establishing the fair selling price.

Q3: 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 ALI heard about from a prior customer. What type of analysis 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.

However, in case if the there are some concerns over the third party evidence for the fair value of installation which is $12,000/- than the ALI should use the best estimate of selling price in order to establish the fair selling price of installation element. (ASC 605-25-30-6C) However, in determining the best selling price ALI should consider the characteristics that are specific to the installation element. Additionally, ALI can use the cost of installation in order to determine the best selling price in this case ALI should apply their required gross profit margin on the installation element and thus the cost of installation which is $5,000/- plus the gross profit margin. (ASC 605-25-55-43) However, in case if the establishment of bestselling price is complex and the cost plus gross margin would not be reasonable estimate, then various other factors should be considered in estimating the best selling price and the these factors would market specific as well as company specific. (ASC 605-25-55-82)

Q4: 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 ALI has early adopted any pending guidance included in the relevant sections of the Codification.)

a.      The quarter ending September 30, 20X9?

No revenue would be recognized at during this quarter.

b.      The quarter ending December 31, 20X9?

No revenue would be recognized at during this quarter.

c.       The quarter ending March 31, 20Y0?

Considering the requirement of generally accepted accounting practices GAAP, the revenue should be recognized when each component is delivered at client site, however, in this case the value of individual component is nil for the customer. Therefore, the revenue should be recognized when the third equipment is delivered at client site. Meanwhile, the revenue relating to the installation would be deferred until the installation is completed. Therefore, the resulting Journal entries have been prepared in an appendix at the end of this memo................................

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