Question

1. determine when the seller should recognize revenue.

2.  Explain your answer using GAAP revenue recognition guidelines.

3. Explain how each transaction would appear on the income statement and balance sheet for 2017.

Case 3-Your company sells a product bundle of software that includes a 3 year service contract for $100,000, Your company installed the software on July 1, 2018, and the client paid $50,000 cash. Thebalance is due on December 31, 2018. Identify the performance obligations and the revenue in 2018, assuming: (a) the performance obligations are interdependent (b) the performance obligations are not interdependent ( the service contract is sold separately for $25,000 and the software for $100,000.)

Answer 1

You should record revenue when it has been earned. The revenue recognition principal says that revenue must be recognize and recorded when it is earned means business should not wait for actual collection of revenue. Revenue become realizable when business sale goods or services. So the seller should recognize the revenue at the time he transfer the titles in goods to purchaser without doing wait for actual realization of payment.

In the given case when the company sells software and service contract in bundled format i.e. performance obligation are interdependent. The company installed the software in client premises at July 1 2018 and receives payment of $ 50000 on said date and the balance is due on 12-31-2018. In this case company transfers the ownership of software on the date it installed in client premises i.e. July 1, 2018. So company should recognize the revenue of $100000 in its income statement for year 2018 and should record $50000 due on clients in balance sheet as an assets (account receivable) for the year 2018.

Service to be rendered in contract is of a type which cannot be billed on any periodical basis in future, it is a contingency type liability which can emerge or cannot emerge in future so the whole amount of bundled contract of $ 100000 will be recognized in year 2018 although the service contract for three years. company should make a provision for expenses to be occurred in future for service contract in balance sheet.

And in second given scenario where the software is sold separately for $ 100000 and service contract is sold separately for $25000. Again here the title of software is transferred in year 2018 to the client so the revenue of $100000 should be recorded in income statement as revenue for year 2018.

Service associated in service contract sold in second scenario is a type which cannot be billed in future on any periodical manner there are contingency in service event may occur or may not be occur so in this case the revenue from service contract is also be recognized in year of sale i.e. year 2018.

But company should make a provision for contingency of service may occur in future in reference of service contract and this provision should be reflected in balance sheet of company.

If the service contract will have a nature that a revenue could be recognized over period of three years than we have to take approach of differed revenue and account the revenue on that concept for example subscription for three years is paid in advance by client, but in given scenario nature of service contract is not like this, so company should recognize the revenue from sale of service contract in year of sale in given case.