Question

How will the reservation, purchase agreement, and the delivery of a Model 3 impact Tesla’s financial statements?

Since 2016, Tesla has been accepting reservations for its Model 3 car, which is a mid-size all electric four-door sedan. The long-range battery Model 3 (310 miles on a single charge) starts at $50,000, while the standard range battery Model 3 (220 miles) starts at $35,000. Production cannot keep up with demand for this model. Tesla produced and delivered 1,772 units during 2017. Tesla has said it plans to produce 5,000 units per week in the latter half of 2018. Currently there are more than 400,000 reservations for the Model 3, with 1,800 reservations being added per day. If a customer wants to purchase a Tesla Model 3, the customer will first make a reservation for a Model 3 which puts the customer in line. A reservation requires a $1,000 reservation payment. When the production of that customer’s Tesla would be scheduled within the next 1 – 3 months, Tesla invites the customer to place an actual order. The $1,000 reservation payment is applied to the customer’s purchase agreement. If the customer changes their mind at any point before making the purchase agreement, the $1,000 reservation payment is refundable to the customer. Full payment for the Model 3 (less the $1,000 reservation payment) is collected at the time of delivery to the customer.

Questions:

1. When Tesla receives a $1,000 reservation payment from a customer, what Tesla general ledger accounts does this $1,000 impact? Explain.

2. Now assume that a customer orders a Model 3 by completing the purchase agreement. Will this purchase agreement directly impact Tesla’s balance sheet or income statement at the date of the purchase agreement?

3. When the Model 3 is delivered to the customer and payment is received, how will Tesla’s balance sheet and income statement be impacted at the point of delivery?

Answer 1

Solution to Question 1:  IND AS -18 "Revenue" prescribes that revenue from the sale of goods should be recognized when all the following criteria are satisfied:

• The Significant risks and rewards of ownership of the goods have been transferred to the buyer.
• The seller retains neither continuing managerial involvement to the degree usually associated with the ownership nor effective control over the goods sold.
• The amount of the revenue can be reliably measured.
• It is probable that economic benefits associated with the transaction will flow to the seller.
• The cost incurred or to be incurred in respect of the transaction can be measured reliably. In such circumstances, any consideration already received received for the sale of goods is recognized as a liability.

So therefore, receipt of $1000 received by Tesla as a reservation payment from a customer is recorded as short term liability in its books.

Entry shall be as follows:-

Bank/Cash A/c Dr. $1000

To Advances from Customers $1000

Solution to Question 2 As explained above, the transfer of "Significant risks and rewards" is essential. For example, if goods are sold but the receivable will be collected only if the buyer is able to sell, then "significant" risk of ownership are retained by the original seller and no sale is recognized. Also "Agreement to sale is not actual sale."

Given in the question Tesla invites the customer to place an actual order prior to production of Model 3. That is orders when partial payment is received in advance of delivery of goods not presently held in inventory, that is goods are still to be manufactured, in such case Revenue is recognized when the goods are delivered to the buyer.

So, purchase agreement will not directly impact Tesla’s balance sheet or income statement at the date of the purchase agreement. Entry for Purchase agreement shall be as follows:-

Legal Charges Dr. $ 1000

To Bank/Cash $1000

Solution to Question 3: In this case, as explained in Solution to Question 2, Revenue is exercised when delivery takes place. So entry of sale for long-range battery Model 3 shall be as follows:-

Bank/Cash A/c Dr. $ 49000

Advances to Customers Dr. $ 1000

To Revenue from Operations $ 50000

Extract of Income Statement (taking example of sale of long-range battery Model 3)

Revenue from Operations

Sale of Model 3 $50000

Administrative Expenses

Legal Expenses $1000

Extract of Balance Sheet (taking example of sale of long-range battery Model 3)

Equity & Liabilities

Reserves & Surplus

Profit as of Current year (ignoring costs other then legal charges) $49000

Current Assets

Cash at Bank $49000