Question

Clayton engineering Incorporated (CEI) is a public company with a calendar year-end. In its current fiscal quarter, ending December 31, 2017, it entered into a sales agreement with Beverage World Limited (BWL). Under the sales agreement, CEI is selling an assembly line system to

BWL that consists of the following four components:

_ Conveyor

_ Filler

_Capper

_Labeler

BWL will use the assembly line to manufacture bottled beverage. The total contract price is $75,000. Under the agreement, CEI is also responsible for installing the assembly line system at BWL’s Newark manufacturing facility and removing BWL’s old assembly line from its manufacturing facility. Both installation and removal services are offered as “free of charge” when BWL purchases the assembly line system from CEI.

The sales agreement between CEI and BWL provides the following details regarding cash payment upon delivery.

Conveyor                                                                       $ 21,500

Filler                                                                               21,500

Capper                                                                             21,500

Labeler                                                                            10,500

Installation                                                                         FREE

Removal of old system                                                        FREE

Total                                                                               $75,000

The sales agreement is dated December 15, 2017. Customers rarely purchase the Conveyor, the Filler and the Capper separately because the three segments cannot be used in production without each other. If any of the three segments breaks down, most companies would choose to replace all three segments together.

CEI delivers the first two components of the assembly system on March 29, 2018, and agrees to deliver the Capper by the end of May. The capper normally should be delivered together with the Conveyor and the Filler because without the capper, the customers cannot use the conveyor and the filler in their manufacturing process. However, the delivery date for the Capper is delayed because CEI does not have that component of the assembly line system on hand at the time the sales agreement is entered into. As such, CEI has to manufacture that component of the line. Because of the backlog of orders CEI has in its manufacturing department at the time it enters into the sales agreement with BWL, it cannot commit to delivering the Capper segment to BWL until the end of May. CEI actually delivers the capper segment on May 10, 2018. CEI installed the three components on the same day. The installation service requires some modification of the assembly line and is essential for the three components to function as desired by BWL.

CEI removed the old assembly line system from BWL’s manufacturing facility on May 15, 2018.

The last component of the assembly system (i.e., labeler) is custom-designed for BWL to make special labels for BWL’s products. BWL has an old labeler that is still in good condition but they decide to order a new one from CEI to meet the need of their new marketing strategy. The new labeler can be used independently in production without the rest of the assembly line; it is also compatible with the company’s old assembly line. The going market price for custom-made labeler is $8,000. Both CEI and a few of its competitors sell labelers to their customers at around this price level. CEI starts to work on the labeler shortly after the sales agreement is signed. The labeler is half-done by the end of December 2017 but is actually delivered to BWL on January 18, 2018. The installation of the labeler requires minimal effort.

CEI and its main competitors do not sell installation services without the first three parts of the assembly line system. Almost all companies in the area provide installation services when selling new assembly line systems. A few independent contractors in the area provide installation services for a fee when someone needs to install used assembly lines. CEI has heard from a prior customer who hired a contractor to install a used assembly line system that the contractor charged $2,000. The condition under which this fee was charged is unknown to CEI.

CEI has provided removal service for a fee in the past. They typically hire outside technicians and charge their customers a markup on cost of 25%.

CEI requires cash upon delivery according to the sales agreement, so BWL pays the amounts listed in the sales arrangement as the items are delivered on January 18, 2018, March 29, 2018, and May 10, 2018.

CEI sells the assembly line system with removal service but has in the past sold the assembly line without removal service for $74,000. CEI currently also sells the conveyor, the filler and the capper without the labeler or removal service for $66,500.

In addition to the above information, CEI also provided their inventory and service costs associated with fulfilling the arrangement with BWL:

                                                                           Cost

Conveyor                                                          $20,000

Filler                                                                10,000

Capper                                                               8,000

Labeler                                                                 5,000

Removal                                                               1,500

Installation                                                             800

Total:                                                                $45,300

1.     How many performance obligations can you identify in the sales agreement between CEI and BWL? Use the authoritative literature and cite the Accounting Standard Codification (ASC) number(s) to explain your answer.

2.     Please be specific when answering the next two questions. Explain your answer and cite the appropriate ASC numbers to back up your discussion.

a.      Discuss if installation service should be treated as a distinct performance obligation.

b.     ASSUME installation is a performance obligation and you need to determine the standalone selling price for installation service. What would be your plan? What kind of investigation, analysis or adjustment you would need to do in order to get this job done? (Note: There isn’t just one correct answer. Be thoughtful in addressing this question. Logic and common sense matter. The codification system provides the basic guidelines and some ideas)

3.     Based on your answer to Question 1, allocate the total contract price charged by CEI to each performance obligations. Explain the methods you used and cite the ASC numbers.

4.     For each performance obligation you have identified in Question 1, specify whether you are able to recognize revenue at a point in time or over a period of time. Explain your answer and cite the ASC numbers. If you believe certain performance obligation(s) are satisfied over time, help CEI determine the approach (es) it can use to allocate revenue over time. Explain your answer and cite the ASC numbers.

5.     Based on your answers to Question 1, Question 3 and Question 4, how much revenues (if any) and expenses (if any) should CEI recognize in the following periods? Write all journal entries CEI needs on each important date in the following quarters.

a. The quarter ending December 31, 2017?

b. The quarter ending March 30, 2018?

c. The quarter ending June 30, 2018?

Answer 1

(1) The performance obligations are listed below by CEI:

• Delivery of Conveyor and filler on 29th march,2018
• Delivery of Capper on May 10,2018
• Delivery of labeller on january 18,2018

Performance obligations is the promise to transfer goods or services. Performance obligation is either stated or implied. According to ASC 606, when the goods or services are transferred to customer then it is believed that performance obligation if fulfilled. So, here in this case, in every case performance obligation is deemed to be fulfilled when goods are transferred to customer i.e BWL and when the payment is done by the BWL then that date will be considered as the fulfilment of performance obligation.

(2) (a) According to ASC 606, the installatiion service cannot be treated as distinct performance obligation because installation service cannot be seperated from product and this service does not get sold out(not seperately sold out)therefore it is not considered as seperate performance obligation.

(b) If installation is considered as performance obligation then to determine the standalone selling price for installation service, i am going to study market propely. For determining the selling price for installation service its is needed to check the selling price of the components with the installation service and then check the selling price of the components without installation service in the market. And then check out te difference, the difference will be the selling price for installation service.

Selling price of components with installation service (-) Selling price of components without installation service = Selling price of Installation service.

(3) Total Contract Price= $75000

Allocation of this contract price to the below componments:

• Conveyor and filler= $43000
• Capper = $21500
• Labeller = $10500

*The price were already decided in the sales agreement

(4) Yes, we are able to recognize the revenue. This is as shown below:

• Conveyor and filler= No revenue
• Capper = No revenue
• Labeller = $10500(-) 8000= $2500

In labeller, we are able to recognize revenue of $2500 because $10500 is the chargeable amount to customer i.e BWL for labeller but the market price was $8000 only. So, this results in revenue over a period of time and this revenue is recognised according to ASC 606.

(5) Journal entries for Revenue :

(a.) The quarter ending December 31, 2017

No Revenue

(b)  The quarter ending March 30, 2018

No Revenue

(c) The quarter ending June 30, 2018

Date	Particulars	Amount Dr(in $)	Amount Cr(in $)
May 10, 2018	Labeller A/c Dr To Profir/ Loss A/c (Being Revenue earned on labeller)	2500	2500