Question

Existence of a contract (LO 3-2)

The time frame in each of these scenarios is after the effective date of the new revenue recognition rules in ASC Topic 606.

Required:

For each of the following independent situations, determine the point at which a contract exists and is subject to application of the 5-step revenue recognition model by Amiel Corporation.

1. A regular customer of Amiel’s always places an order on the last day of the month, but did not do so in December. Amiel is certain it is because the customer’s purchasing manager was ill and that the order will be received when she returns. In fact, the order is received by fax in early January, with an apology from the customer’s purchasing manager and a note requesting that Amiel “expedite shipment of this December order.”
2. One of Amiel’s customers calls and gives Amiel a list of goods it intends to buy, but with the caveat that the order is subject to the approval of the purchasing manager, who will not be in for several days. In fact, the order is received by fax several days later when the purchasing manager returns.
3. One of Amiel’s customers calls and gives Amiel an order. Amiel typically receives orders by fax and asks the customer to confirm the order by fax, which it does several days later.
4. Amiel and one of its customers agree that Amiel will sell it certain goods, but that the price will depend on the price of oil two weeks later. Amiel and the customer have agreed on a formula that will determine the price of the goods based on the price of oil. Amiel makes this arrangement because oil is a key component of the goods Amiel sells.

Answer 1

The five steps to revenue recognition are identify contract, identify performance obligations, determine transaction price, allocate the transaction price to the performance obligation, recognise revenue when the performance obligations are satisfied.

In the first case, there is no contract that is enforceable and so revenue will be recognised only on transfer of title in goods to the customer in January of the following year or thereafter.

In the second case, the purchase manager is authorised to raise PO on behalf of customer. In his absence, there cannot be a contract between Amiel and customer. The other employees cannot bind the customer. So the revenue should be recognised on receipt of Purchasing manager approval and transfer of title in goods to customer.

In the third case also, an oral call cannot bind the customer. A legal obligation gets created only on written fax. Also Amiel has not acted on the customer order by telephone, so order by fax should be taken for revenue recognition. So oral talk by any employee of customer should not be taken for revenue recognition. Amiel should also start work only after fax is received, thus there is no reason to book the revenue on oral talk but wait till fax is received. Unless an authorised person from the customer has called and the call has been recorded for future reproduction in court of law, the oral recorded call can clearly recognise the authorised person, work should not be started on oral calls and the company should wait for fax to start work and recognise revenue. Only dispatch of goods can be later disputed by customer that the goods are not needed etc. and so revenue is recognised only on legal evidence that can be reproduced to the customer binding the customer. Oral calls that is not recorded is not legal evidence. The normal practice is fax and so Amiel should wait for fax to even start work. Oral calls only if properly recorded and where the voice of the authorised purchase manager is clearly recognisable and can be shown as evidence to the customer should be entertained.  

The last example can be recognised as revenue on transfer of goods to the customer even if the transfer of goods is before the determination of price of oil two weeks later. The determination of price is in immediate future and not distant future. The determination of price is as per contract, the order is received as per contract and the transfer of goods to the customer can be treated as revenue in books. The fourth case fulfils all the steps involved in revenue recognition if the transfer of title in goods is made to the customer for consideration to be determined on price of oil two weeks later from the date of order receipt.. The revenue can be recognised on transfer of title in goods to the customer.