In: Accounting
a) Referring to Case Requirement 3 ai, allocate the contract price of $245,000 to each performance obligation. Explain in your own words and provide citation from ASC 606.
b) For each performance obligation in Case Requirement 3ai, should TSA recognize revenue at a point in time or over time? Explain in your own words and provide citation from ASC 606.
Requirement 3
Assume that TSA, Inc. entered into a contract with client Anon for $230,000 on January 1, Year 1, to transfer a software license and an additional $15,000 for installation of the software. The license entitles Anon to use the software in its current form over an unlimited period and does not include updates. Two years of customer support come free with the license. In recent stand-alone contracts with other customers for the same software, TSA has charged $200,000 for the software license,
$40,000 for two-year customer support, and $20,000 for installation. The software is usable without customer support from TSA and it can be installed by other vendors. The installation is expected to take 250 hours, of which 150 hours will be required in Year 1 and the remainder in Year 2. The entire fee of $245,000 is collected on the contract date. Base your answers on the current ASC 606.
Before start explaining the above question , Let me explain about New method of Revenue recognition . While studying CPA , We used to follow below formula for easy recognition : ISTAR
1) I - identify the contract with Customer
2) s- Identify Separate Performance Obligation
3) T - Determine the Transaction price
4) A - Allocation of Transaction price among Performance Obligation based on Standalone Selling price ( Fair Value basis )
5) R- Recognition of revenue
New Recognition of revenue and Impact on Software Industry . Major impact on recognition of License revenue . Whether License revenue we will recognised at the point or Over the period of time .
License revenue divided into Two part - Right to use and Right to access . This scenario normally appear when License are distinct in nature .
Normally as per New Standard everything based on Contractual Obligation . Right to access based License would be recognised over the period of time . Other side, Right to use base license software recognised at the time .
ASC 606 , also talk in line with IFRS 15 with different terms . 1) Functional 2) Symbolic . By name, we can understand that Symbolic mean brand , logo which all are not relates to Functional , So we can recognised revenue over the period basis and other case mean functional , we can recognised at the point basis .
Another important point to note that specially in case of Software company , we can recognised revenue under different head
1) Fixed Bid basis - This is basically POCM (% of completion method)
2) Fixed price, T& M basis - Flat base rate and recognised over the period of time
3) Annual Support /Maintenance service - recognised revenue over the period of time .
4) license fees revenue as discussed above
So breakdown of $ 245000 between $ 15000 installation and Software $ 2,30,000. Installation of the system we can recognised revenue on % of completion basis ( POCM) and License revenue $ 2,30,000 we can recognised as mentioned above base .
Installation Revenue recognised as below :
Expected hr | 250 |
Yr1 | 150 |
% coverage | 0.6 |
Installation | 20,000 |
Yr1 Revenue Recognised | 12,000 |
Yr2 | 100 |
% coverage | 40% |
Installation | 20,000 |
Yr2 Revenue Recognised | 8,000 |
Journal Entries :
Flow of JE while recognising revenue on POCM basis :
Year 1 - Unbilled Contract receivable A/C Debit- $ 12000
Contract Revenue Earned A/C - credit - $ 12,000
Year 2 - Unbilled Contract receivable A/C Debit- $ 8,000
Contract Revenue Earned A/C - credit - $ 8,000
General Knowledge - While raising Invoice : Account Receivable A/c - Debit
Unbilled Contract Receivable -A/C credit
While collection of cash --- Cash A/c - Debit
Account Receivable A/C - credit