Question

On January 2, 2019, Royal Class Air Conditioning and Heating sold and installed an HVAC system to Peak Co. for $2,750. The selling price is allocated as follows: (1) 90% for the HVAC unit and (2) 10% for an ongoing 4-year service contract for the HVAC unit.

a. Determine each of the following related to this sale:

1. Identify the contract between the company and the customer.

2. Identify the performance obligations of Royal Class.

3. Determine the transaction price.

4. Allocate the transaction price to the performance obligations.

b. What amount of revenue should Royal Class recognize for the year ended December 31, 2019?

Answer 1

Answer to part a

Requirement 1. Identify the contract between the company and the customer:

As per IFRS 15/ASC 606 an entity accounts for revenue from customer only if valid contract is identified. The contract can be written, oral or implied by entity's customary business practices.

In instant case Royal Class Air Conditioning and Heating sold and installed an HVAC system to Peak Co. and also agreed to provide 4 year service contract. Thus there is an express contract of sale (with service) between company and customer.

Requirement 2. Identify the performance obligations of Royal Class

Step 1: Understanding how performance obligation is identified

As per IFRS 15/ ASC 606 a performance obligation is promise in contract to transfer a distinct good or service to a customer.

The good or service can be said to be distinct if

• Criteria No 1: The customer can benefit from goods or service either on its own or with other resources
• Criteria No 2: The entity's promise to transfer the good or service is separately identifiable

Step 2: Determining performance obligation in current contract

In instant case there are two performance obligation. The first one is sale of goods by Royal Class Air Conditioning and Heating to Peak Co , this is considered as performance obligation because Peak Co can benefit from this sale directly by using the product and thus satisfying the criteria 1 as stated above

The second performance obligation being service contract which is due for period of 4 years after sale of goods. Thus the service contract can be treated to be a separate service thus satisfying criteria 2 as stated above.

Requirement 3: Determine the transaction price

As per IFRS 15/ASC 606 the transaction price is consideration which entity expects in exchange of goods/services rendered or performance obligation performed. In instant case since $2,750 is received as consideration and so the transaction price is $2,750

Requirement 4: Allocate the transaction price to the performance obligations.

Allocation of transaction price towards sale (i.e. HVAC unit)------------------------> $2,475

[90% of transaction price i.e. 90% of $2,750]

Allocation of transaction price towards service contract------------------------------> $275

[10% of transaction price i.e. 10% of $2,750]

Answer to part b

For performance obligation of sale of goods revenue of $2,475 is recognized immediately in current year.However for performance obligation of service contract revenue is to be recognized/ adjusted over service period i.e. 4 years

Revenue from service contract for current year will be $275/4 = $68.75

Total revenue to be recognized for year ended December 31,2019 = $2,475 + $68.75 = $2543.75