Question

EZ Clean-Up Inc. (EZ Clean-Up or the “Company”) provides various set-up, tear-down, and clean-up services to party-planning businesses as well as various third-party customers.

The Company entered into a contract with The Function Junction LLC to be the sole provider of its services for all its events for a period of three years. The Function Junction holds weekly events, with EZ Clean-Up providing its services for every event. After the initial three-year period, the contract is renewable in one-year increments. The average customer relationship period typically lasts five years (the initial three-year term plus two one-year renewals). The Company accounts for the arrangement as a contract with a customer within the scope of ASC 606.

As an incentive to execute new customer contracts, the Company offers its sales representative a one-time $5,000 commission, which is earned and payable to the sales representative as soon as the contract is executed with the customer. No additional commission is paid to the sales representative upon renewal of the contract by the customer.

Before winning the contract, the sales representative incurred $500 in travel costs to travel to The Function Junction’s headquarters to perform a demonstration.

EZ Clean-Up incurred approximately $2,000 in external legal costs to draft the contract executed between the Company and The Function Junction.

Required:

1. Under US GAAP, how should EZ Clean-Up treat incremental costs of obtaining a contract? Please answer the same question under IFRS/IAS.

2. According to US GAAP, which costs in this case are incremental costs of obtaining the contract, and therefore are required to be capitalized?

3. According to US GAAP, how should EZ Clean-Up determine the appropriate amortization method, and over what period should the Company amortize any capitalized costs?

4. According to US GAAP, what disclosures should EZ Clean-Up provide in its financial statements?

Answer 1

Answer:-Generally accepted accounting principles (GAAP) refer to a common set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies in the United States must follow GAAP when their accountants compile their financial statements. GAAP is a combination of authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting accounting information. GAAP aims to improve the clarity, consistency, and comparability of the communication of financial information.

Generally Accepted Accounting Principles is the accounting standard adopted by the U.S. Securities and Exchange Commission (SEC). While the SEC previously stated that it intends to move from U.S. GAAP to the International Financial Reporting Standards (IFRS), the latter differ considerably from GAAP, and progress has been slow and uncertain. More recently, the SEC has acknowledged that there is no longer a push to move more U.S companies to IFRS so the two sets of standards will "continue to coexist" for the foreseeable future.

1. Under GAAP, incremental costs of obtaining the contract should be capitalized if they are recoverable and amortized during the contract period or average customer relationship period unless a commensurate expense ( eg. commission) is incurred for the renewals. As per IFRS 15 Incremental costs of obtaining a contract should be recognized as an asset unless entities do not expect to recover them.

2. The commission of 5,000 dollars is the incremental cost of obtaining the contract.

3. As per GAAP, the amortization of incremental costs should be done on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. Since the payment of commission is a one-time contract expense and another commensurate payment is not expected to be made in the future, the expense will be amortized over 5 years which is the average customer relationship period.

4. EZ clean should be Providing an explanation of the significant changes in the contract asset balances during the reporting period. EZ should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flow arising from contracts with customers. Entities should also present contract assets as current and non-current in a classified statement of financial position.