The Association to Advance Collegiate Schools of Business (AACSB) states in Standard 40

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1 ISSUES IN ACCOUNTING EDUCATION - TEACHING NOTES Vol. 26, No pp American Accounting Association TEACHING NOTES A Series of Revenue Recognition Research Cases Using the Codification R. Mark Alford, Teresa M. DiMattia, Nancy T. Hill, and Kevin T. Stevens INSTRUCTOR NOTES AND SUGGESTED SOLUTIONS The Association to Advance Collegiate Schools of Business (AACSB) states in Standard 40 that essential capacities [of accounting graduates] should include communication, ability to deal with diversity and critical thinking (AACSB 2009). The American Institute of Certified Public Accountants (AICPA) notes that students hone critical communications skills when they work in teams and make class presentations (AICPA 2009). Springer and Borthwith (2004, 277) state that there is a long-standing need for learning experiences that create opportunities for students to work on developing the higher-order thinking skills required for success in business and the accounting profession. As Burns (2006, 127) notes, it is important to provide accounting students with the opportunity to research issues in ambiguous situations, especially given that accounting alumni working in public accounting tell us that they spend significant time researching topics in specialized industries. The four cases provide an opportunity for students to practice and improve upon their critical thinking skills. They also provide students the opportunity to hone their research skills. Case One: Suggested Answers Requirement 1: What are the accounting issue(s) and the relevant components of the authoritative literature? This case is concerned with how a vendor should account for a sales incentive. More specifically, this case addresses how a detergent manufacturer (CCPC) should account for a coupon drop it makes for its Fresh & Bright detergent. Subtopic , Customer Payments and Incentives, of the Codification is used to address the facts in this case. Requirement 2: When should CCPC recognize the effects of the Fresh & Bright coupon drop in its financial statements? Following the guidance in FASB ASC , such cost should be recognized at the later of the following two points in time: (1) when the vendor recognizes revenue for the product on R. Mark Alford is an Associate Professor, Teresa M. DiMattia is an Instructor, Nancy T. Hill is a Professor, and Kevin T. Stevens is a Professor, all at DePaul University. Please do not make the Teaching Notes available to students or post them on websites. Published Online: August

2 A Series of Revenue Recognition Research Cases Using the Codification 65 which the sales incentive is offered, and (2) the offer date for the sales incentive. CCPC recognizes revenue on its Fresh & Bright detergent when it sells the detergent to the wholesaler. The case facts indicate that CCPC sold over $2 million of Fresh & Bright detergent into the supply chain by September 30, The offer date for the sales incentive is the coupon drop date of October 1, Comparing this date to the date of September 30, 2009 (by when $2 million of revenue has been recognized by CCPC), it is clear that the later of the two dates is the offer date of the coupon. As such, the cost of the sales incentive should be accrued by CCPC on October 1, Requirement 3: What is the dollar amount of the effect of the Fresh & Bright coupon drop on CCPC s financial statements? CCPC must also concern itself with the amount of the sales incentive that should be accrued. CCPC drops 500,000 coupons that give customers a $2 discount on the purchase of Fresh & Bright detergent. As such, the maximum total discount that could be provided by CCPC is $1 million. However, FASB ASC indicates that the accrual for a sales incentive should take expected redemption rates into consideration, provided that the vendor can make reasonable and reliable estimates of these redemption rates. CCPC has not issued coupons for detergents in the past. However, CCPC has offered coupons on other products with a six-month redemption period, where the redemption rate was 1.5 percent. If sufficient evidence exists to support the 2 percent expected redemption rate for the detergent coupons with a one-year redemption period, then it follows that CCPC expects only 10,000 coupons to be redeemed, which would result in a total discount of $20,000. If sufficient evidence does not exist to support CCPC s redemption rate estimate of 2 percent, then it should recognize the maximum potential cost of the incentive, or $1 million. Requirement 4: What would constitute sufficient evidence of CCPC s expected redemption rate of 2 percent? FASB ASC indicates that a vendor s ability to make a reasonable and reliable estimate of the amount of coupons that will be redeemed can be impaired by several factors. The first of these factors is a relatively long period over which the incentive can be redeemed. The next factor addresses the absence of historical experience with similar types of sales incentive programs with similar products. As the case points out, any historical coupon redemption data related to new detergents are unavailable, yet ample information is available regarding the past redemption rates on coupons for other products offered by CCPC. Finally, the absence of a large volume of relatively homogenous transactions is identified as a factor that might impair efforts to make a reasonable and reliable estimate of the redemption rate of the new coupons. It is difficult to predict how students will apply the factors mentioned above. The important point is that they consider them carefully, rather than blindly applying the expected redemption rate of 2 percent without a conscientious review of the data above. Students who conduct an Internet search on coupon redemption rates may discover that freestanding inserts on consumer products have an average redemption rate (in 2009) of 1.05 percent, so the 2 percent estimate appears reasonable (Santella and Associates 2011). Students should intuitively realize that the longer redemption period leads to a higher redemption rate. Indeed, the length of the redemption period matters, and redemption rates, in general, increase as the redemption period expands beyond six months (Watershed Publishing 2011). Requirement 5: What are the accounting implications if CCPC s estimated redemption rate changes to 2.5 percent at a later point in time? If students cannot justify the use of a 2 percent estimated redemption rate for the coupons, the question regarding the change in estimate to 2.5 percent is moot. If 2 percent is not considered a

3 66 Alford, DiMattia, Hill, and Stevens reasonable and reliable estimate of future redemptions, then CCPC must record the maximum cost of the coupons ($1 million) on October 1, On the other hand, if the 2 percent can be supported as a reasonable and reliable estimate, only $20,000 is initially accrued. If the 2.5 percent change in estimate is made with sufficient evidence to support it, CCPC would treat the increase in the expected redemption rate as a change in accounting estimate. A change of this type is accounted for currently and prospectively. As a result, CCPC would increase the recorded cost of the incentive by $5,000. Requirement 6: How should the effects of the Fresh & Bright coupon drop be reflected in the income statement? FASB ASC indicates that sales incentives in the form of cash consideration or, in this case, cash discounts should be reflected as a reduction of revenue unless two conditions are met. One of these conditions deals with whether the vendor (CCPC, in this case) receives a separate, identifiable benefit in the form of goods or services in return for the cash consideration. CCPC receives neither a good nor a service in exchange for the consideration it pays as a result of the consumer redeeming the coupon. As such, CCPC is not able to overcome the presumption that the cost of its sales incentive should be reflected as a reduction of revenue. Requirement 7: What are the necessary journal entries? If sufficient evidence exists to support CCPC s estimated redemption rate of 2 percent, CCPC would record the following journal entry on October 1, 2009: Revenue 20,000 Coupon Redemption Accrual 20,000 If sufficient evidence does not exist to support CCPC s redemption rate of 2 percent, CCPC would record the following journal entry on October 1, 2009: Revenue 1,000,000 Coupon Redemption Accrual 1,000,000 When CCPC reimburses the retailers for the coupons that have been redeemed, CCPC would make the following journal entry: Coupon Redemption Accrual Cash Amount Redeemed Amount Redeemed Case Two: Suggested Answers Requirement 1: What are the accounting issue(s) and the relevant components of the authoritative literature? Assume, for purposes of interpreting the Codification, that Landline is the entity. Case Two considers revenue recognition for a telecommunications company, Landline Corporation, which provides a line to Psychics R Us (PRU) and other providers of psychic services, whereby callers request and receive these services. The issue in the case is whether Landline (the entity) is a principal in the transactions involving PRU and the callers or whether it is an agent for PRU in these transactions. The distinction is important because if Landline is a principal, it is required to record revenue on a gross basis, meaning that revenue

4 A Series of Revenue Recognition Research Cases Using the Codification 67 should be recorded at $5 per minute and a related expense at $4 per minute should be recorded. Alternatively, if Landline is an agent for PRU, then revenue of $1 per minute should be recorded on a net basis ($5 per minute charged to the customer less $4 per minute that Landline must remit to PRU). FASB ASC through 18 provide a list of indicators to determine whether the gross or net method of recording revenue is appropriate. Requirement 2: Should Landline recognize revenue gross (i.e., as a principal) for the total amount billed to the customer for their time spent using the number, or net (i.e., as an agent) for the net amount retained by Landline? FASB ASC through 18 include eight indicators that support reporting gross revenue and three indicators that support reporting net revenue. Two indicators appear in both lists, where the reporting method depends on the guidance in the Codification. Because some case facts provide support for the gross method, while others support the net method, a benefit of this case is that the identification of the appropriate method for recognizing revenue is not straightforward. Rather, a careful weighing of the case facts, coupled with an analysis of the authoritative literature, is necessary. As Table 1 indicates, the strong indicator, primary obligor, suggests that the net method should be used. In addition, one other indicator, earn a fixed amount, also suggests that the net method should be used. On the other hand, there are three indicators, price establishment, discretion in supplier selection, and credit risk (a weak indicator), where the gross method is suggested. If students rely solely on the strong indicator related to the primary obligor, then Landline should use the net method to record revenue, since PRU is the primary obligor. On the other hand, students may argue that the gross method should be followed, since three factors (including one weak indicator) signal that the gross method is more appropriate than the net method. Requirement 3: What journal entries are necessary to appropriately account for each minute a customer spends using PRU s number? If students argue that Landline should use the net method to record revenue (in Requirement 2), the journal entry below follows the net method to record each minute a caller uses the number: Accounts Receivable from Customers 5 Revenue 1 Payable to PRU 4 If students argue that Landline should use the gross method to record revenue (in Requirement 2), the journal entry below records each minute a caller uses the number: Accounts Receivable from Customers 5 Cost of Services Provided 4 Revenue 5 Payable to PRU 4 It may also be instructional to discuss the analysis that PRU would go through in determining how much revenue it should recognize for each minute a caller uses the number. Three indicators support the gross method: primary obligor (a strong indicator) performs part of the service and determines service specifications. In contrast, only one indicator earns a fixed amount is a net indicator. Thus, PRU should record the gross amount charged to the customer for

5 68 Alford, DiMattia, Hill, and Stevens Indicator TABLE 1 Analysis of Gross and Net Method Indicators Indicator of Gross or Net Method from the Codification Analysis for Landline (the entity) Supportive Case Facts Primary Obligor Gross if the entity is the primary obligor (responsible for fulfillment) Net if the supplier is the primary obligor (responsible for fulfillment) Net Users of the number do not know that Landline is involved in the transaction until they see their bills (i.e., the identity of the telecommunications company is likely of no significance to the customer). Landline may wish to consult with its legal counsel to confirm that Landline is not responsible to the customers for the psychic services provided over the number. Inventory Risk Gross Not Applicable These two indicators are not Physical Loss Inventory Risk Gross Not Applicable relevant in this transaction, after Order or Shipment as there is no inventory. Price Establishment Gross Gross Landline (not PRU) establishes the amount charged to the customer for all psychic services ($5 per minute). Changes the Product or Performs Part of the Service Determination of Product or Service Specifications Discretion in Supplier Selection Gross Gross Not Applicable Not Applicable These two indicators are not relevant, since Landline plays no part in providing the psychic advice or determining the service specifications. Landline is only responsible for providing the telecommunications services and routing calls. PRU is solely responsible for providing the psychic advice (i.e., service) sought by the customer. Gross Gross Landline ultimately chooses which psychic service provider will take calls from customers, depending on the availability of PRU and non-pru psychics. (continued on next page)

6 A Series of Revenue Recognition Research Cases Using the Codification 69 Indicator TABLE 1 (continued) Indicator of Gross or Net Method from the Codification Analysis for Landline (the entity) Supportive Case Facts Credit Risk Gross if the entity assumes the credit risk Net if the supplier assumes the credit risk Gross Landline assumes credit risk associated with the transactions with PRU because Landline is obligated to pay PRU $4 per minute when the customer uses the number, regardless of whether the customer pays the $5 per minute they are charged for the psychic services. Earn a Fixed Amount Net Net Landline earns $1 per minute when the number is used. use of the number as revenue. PRU would also recognize an expense for the telecommunications service it is purchasing from Landline. Thus, PRU would record the following journal entry for each minute a caller uses the number: Accounts Receivable from Landline 4 Cost of Service Provided 1 Revenue 5 Case Three: Suggested Answers Requirement 1: What are the accounting issue(s) and the relevant components of the authoritative literature? Case Three focuses on a sales agreement with multiple deliverables. The critical issue is determining whether there are separate units of accounting in the sales agreement. In other words, should the multiple deliverables be accounted for as one unit of accounting or as two or more separate units of accounting? Guidelines that assist with evaluating sales transactions that involve multiple deliverables can be found in subtopic , Revenue Recognition Multiple-Element Arrangements, in the Codification. Requirement 2: What are the separate units of accounting in the sales agreement between ALI and CMI? Use the authoritative literature to explain your answer. As the explanation below illustrates, the multiple deliverables sold by ALI to CMI should be treated as two separate units of accounting (the assembly line system and its installation). FASB ASC presents specific criteria that must be met for the multiple deliverables in revenue-generating arrangements to be treated as separate units of accounting. The questions essentially posed by these criteria are the following: 1. Does the delivered item(s) have value to the customer on a standalone basis?

7 70 Alford, DiMattia, Hill, and Stevens 2. Does a general right of return exist for the delivered item(s) and, if so, is delivery or performance of the undelivered item(s) considered probable and substantially in the control of the vendor? Question 1 above, Do the delivered item(s) have standalone value? needs to be considered as each item is delivered to the customer (provided there are still items to be delivered). The first deliverable consists of the mixer segment and the molding segment (mixer/molding segment deliverable). ALI must consider whether this deliverable has value to the customer on a standalone basis (absent the packaging segment and the installation services). As discussed in FASB ASC a, standalone value exists if the deliverable can be sold separately by any vendor or if the customer could resell the deliverable on its own. The case facts indicate that neither of these circumstances exists with respect to the mixer/molding segment deliverable. In other words, ALI does not sell the mixer/molding segment without also selling the packaging segment because all three components are needed for the assembly line system to function properly. Students should ask if ALI s assembly line components are compatible with any of ALI s competitors assembly line systems. Given the facts in the case (i.e., the individual components do not function independently of one another), we assume that they are not. For these reasons, it is reasonable to assume that the customer cannot resell the mixer/molding segment on its own, so there is no resale market for these components. The mixer/molding segment deliverable does not represent a separate unit of accounting and must be bundled together with at least the packaging component deliverable. The next deliverable consists of the packaging component, which completes the assembly line system. ALI must consider whether the complete assembly line system has value to the customer on a standalone basis (absent the installation services). The case facts indicate that ALI sometimes sells the assembly line system without the installation services. For this reason, the complete assembly line system (the delivered item) has value to the customer on a standalone basis. As a result, it should be treated as a separate unit of accounting. The final deliverable is the installation services. Because there are no remaining items to be delivered after the installation services, ALI does not need to consider whether the installation services have value to the customer on a standalone basis. As a result of this portion of the analysis, ALI concludes that its agreement with CMI consists of two separate units of accounting: (1) assembly line system, and (2) installation services. Question 2, above, is not relevant and need not be considered because there is no general right of return provided by ALI in its agreement with CMI. Requirement 3: How much of the arrangement consideration should be allocated to each unit of accounting? Be sure to identify any other issues that must be resolved to determine how revenue should be allocated. ALI must now allocate the arrangement consideration between the two separate units of accounting. As discussed in FASB ASC , arrangement consideration should be allocated using the relative selling price method. The case requirements ask students to identify any other issues that must be resolved to determine how revenue should be allocated. To apply the relative selling price method, ALI must determine whether it has vendor-specific objective evidence (VSOE) of selling price (as defined below) for either or both of the separate units of accounting. If ALI has VSOE of selling price for a unit of accounting, it should use that selling price in the relative selling price method. If ALI does not have VSOE of selling price for a unit of accounting, it should determine whether it has thirdparty evidence (TPE) of selling price (as defined below). If ALI does not have VSOE of selling price, but does have TPE of selling price for a unit of accounting, then ALI should use TPE of selling price in the relative selling price method. If ALI has neither VSOE of selling price nor TPE

8 A Series of Revenue Recognition Research Cases Using the Codification 71 of selling price, then it must determine its best estimate of selling price (as defined in FASB ASC c) and use that price in the relative selling price method. As discussed in FASB ASC a, VSOE of selling price exists if the vendor sells the unit of accounting separately and, thus, knows the price it charges for that unit on a standalone basis. The case facts indicate that ALI occasionally sells its assembly line system without installation for $95,000. If there is sufficient evidence to support selling the assembly line system without installation at that price, ALI should use a price of $95,000 for the assembly line system in the relative selling price method. Because ALI does not sell the installation services separately, it does not have VSOE of selling price for that unit of accounting. Requirement 4: Now, assume that sufficient evidence exists to support the selling price of $95,000 for the assembly line system. However, there is some concern regarding the $12,000 charged for the installation services that ALI heard about from a prior customer. What type of analysis must be done related to the $12,000 price for installation services to decide whether it should be used to allocate revenue to the components in the sales agreement? Explain your answer. As discussed in FASB ASC b, third-party evidence of selling price exists if the product or service is available to the customer from another vendor. The issue that the students must consider is whether there is sufficient evidence to support the selling price for the installation services that ALI learned of from one of its customers as TPE. If so, ALI should use that price ($12,000) for the installation services in the relative selling price method. Students should identify the following issues before deciding that the $12,000 sales price is TPE: 1. Are the outside technicians qualified to install the system? 2. Have customers who have used outside technicians been satisfied with the installation of the system, or has more work had to be done? 3. How many times have customers used outside technicians to provide installation services (i.e., there may not be sufficient evidence to support the selling prices of the installation services)? 4. Is there evidence other than ALI has heard (e.g., written contracts or binding quotes) that verify the price charged by other technicians? Assuming that the outside technicians are qualified, that prior installations by outside technicians have been satisfactory, that it is not uncommon for customers to use outside technicians, that ALI has documentation for the price it has charged customers that have bought the assembly line system but not the installation, and that ALI has documentation that verifies the price charged by outside technicians to perform the installation, sufficient evidence does exist to support the selling prices for the assembly line system unit of accounting and the installation services unit of accounting. On the other hand, if it is concluded that there is not sufficient evidence to support the $12,000 figure as TPE, ALI s only option, according to the literature, is to use its best estimate of selling price as a basis for allocating revenue. The entries below assume that $12,000 can be supported as TPE. Therefore, ALI should allocate the arrangement consideration included in its sales agreement with CMI as follows: Selling Percentage Allocated Arrangement Price of Total Consideration Selling price for assembly $95, % $88,800 line system (VSOE) Selling price of installation 12, % 11,200 service (TPE) Total $107, % $100,000

9 72 Alford, DiMattia, Hill, and Stevens Requirement 5: If there are no other issues that would affect the timing of revenue recognition, how much revenue should be recognized in the following periods? Include journal entries in your answer. (Assume that ALI has early adopted any pending guidance included in the relevant sections of the Codification.) The journal entries that account for the revenue recognized by ALI in each of the quarters ending September 30, 20X9, December 31, 20X9, and March 31, 20Y0, are provided in the discussion that follows. a. The quarter ending September 30, 20X9: Cash 70,000 Inventory Held by Others 45,000 Unearned Revenue 70,000 Inventory 45,000 Explanation. ALI does not recognize any revenue in the quarter ending September 30, 20X9, because it cannot treat the mixer/molding segment deliverable as a separate unit of accounting. Because ALI has received cash for that deliverable by September 30, 20X9, it must reflect the receipt of that cash as unearned revenue. In addition, because ALI has delivered the mixer/molding segment by September 30, 20X9, it should consider reflecting the cost of this segment in a separate inventory account to highlight the fact that it is not inventory that ALI has on hand at the end of the period. b. The quarter ending December 31, 20X9: Cash 20,000 Unearned Revenue 68,800 Cost of Goods Sold 55,000 Assembly Line System Revenue 88,800 Inventory Held by Others 45,000 Inventory 10,000 Explanation. An additional $20,000 is collected from CMI in the quarter ending December 31, 20X9, as the last component of the assembly line (the packaging segment) is delivered. As a result, ALI recognizes revenue allocated to the assembly line system ($88,800) in the quarter ending December 31, 20X9. Because $90,000 has been collected from the customer by the end of that quarter, the balance that remains in the unearned revenue account is $1,200 ($90,000 cash received less $88,800 revenue recognized). The amount of unearned revenue recognized in the quarter ending September 30, 20X9, was $70,000. The cost of the three components of the assembly line is recorded as cost of goods sold now that the related revenue has been recognized. The inventory held for others that was debited in the previous quarter is now removed from the accounts, as well as the $10,000 cost of the packaging segment. c. The quarter ending March 31, 20Y0: Cash 10,000 Unearned Revenue 1,200 Cost of Services Provided 5,000 Installation Services Revenue 11,200 Cash-Installation Technician Wages 5,000

10 A Series of Revenue Recognition Research Cases Using the Codification 73 Explanation. ALI collects the remainder of the amount due from CMI in the sales arrangement. In addition, the remaining balance in unearned revenue is eliminated, as all revenue has now been earned; the amount of revenue allocated to the installation services ($11,200) is recognized in the quarter ending March 31, 20Y0. Last, the cost of the installation services to ALI is recorded. An additional question to discuss with the students in an open forum might include the following: Assume that the CPA review at your school offers students the right to retake the review for free if they attend a certain number of classes and get a certain score on the final exam. Does this arrangement raise any revenue recognition or other accounting concerns? This is an example of a multiple-element arrangement that accounting students in particular should appreciate. The students are paying for the course itself and the right to retake the course. This raises two interesting accounting issues. First, the right to retake the CPA review course is, in effect, a put option embedded in the fee for the CPA review. If financial statements were prepared for the CPA review, the embedded derivative would likely have to be broken out and accounted for as a cash flow hedge. The second related issue is valuing the right to retake the review and determining the likely retake rate. Once the value and redemption rates are determined, calculating the appropriate amount of revenue to be deferred is possible. Case Four: Suggested Answers Requirement 1: What are the accounting issue(s) and the relevant components of the authoritative literature? This case addresses a bill-and-hold sales arrangement between Chemicals Inc. (ChemInc) and Bond Pharmaceuticals (Bond). In an arrangement of this type, the product has not been delivered to the customer, yet it is still possible that revenue can be recognized. This case can be particularly significant if it follows a classroom discussion that focuses on the fact that revenue generally is not recognized until delivery has occurred. In paragraph 84a of Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises, the FASB indicates that, The two conditions [for revenue recognition] (being realized or realizable and being earned) are usually met by the time product or merchandise is delivered...to customers, and revenues from manufacturing...are commonly recognized at the time of sale (usually meaning delivery) (FASB 1984). In the interpretive response in SAB Topic 13.A.3a (as captured in FASB ASC S99-1), the Securities and Exchange Commission (SEC) staff indicates that delivery is normally the point in time when the customer has taken title and assumed the risks and rewards of ownership of the products (SEC 2003). The fact that the goods are not physically delivered by year-end is central to the questions in this case. Requirement 2: How does the fact that ChemInc has not shipped the MCA to Bond by the end of the year affect the recognition of revenue by ChemInc in 20X9? What other issues must be considered before deciding when ChemInc can recognize revenue? Explain your answer and include journal entries. The essence of the case is that there is no doubt that the delivery of the product, Medical Compound A (MCA), to Bond has not occurred by the end of 20X9; yet, a careful analysis of the literature is necessary to determine if ChemInc can appropriately recognize revenue in 20X9 nonetheless. The analysis focuses on the characteristics of a bill-and-hold transaction. In SAB Topic 13.A.3a, the SEC staff provides a list of seven criteria that must be met before revenue can be recognized in a bill-and-hold transaction. The best way to approach this case is to consider each of the criteria individually. This analysis is presented in Table 2.

11 74 Alford, DiMattia, Hill, and Stevens TABLE 2 Analysis of Criteria Related to a Bill-and-Hold Sales Arrangement Criteria Met? Facts to Support/Issues to Raise Transfer of ownership risks Fixed commitment in writing Requested by customer and substantial business purpose Did not retain any specific performance obligations Segregated the inventory and will not use it to fill other orders Complete and ready for shipment Fixed schedule of delivery No Yes Yes Yes No Yes No Title to the purchased MCA must pass to Bond upon segregation of the inventory. Students should ask whether Bond assumes the physical risks of loss associated with the purchased MCA as of December 20, 20X9. Bond s commitment to purchase the MCA is noncancelable. Bond and ChemInc executed and appropriately approved the sales agreement by December 20, 20X9. Bond initiated the transaction with ChemInc by issuing a written order on December 20, 20X9. Bond needs the MCA by the beginning of the second quarter of 20Y0, and the quantity it needs may not be available if it waits to place the order later, given ChemInc s production scheduling and inventory policies. Bond can avoid the costs associated with a potential special production run of MCA by purchasing it on a bill-and-hold basis. Bond explicitly acknowledges in the sales agreement executed on December 20, 20X9, that ChemInc has no further performance obligations once the MCA has been segregated from ChemInc s other inventory. ChemInc must explicitly agree not to use the segregated MCA to fill other customer orders. ChemInc attests to the fact that the MCA is complete and ready for shipment upon its segregation. There is not a fixed schedule to deliver the MCA to Bond because a date-certain has not been provided. The CFO s belief that the special storage chamber will be complete by February 1, 20Y0, is not objective evidence of a date-certain. There is a stipulation that the MCA will be delivered at the earlier of when the storage chamber is complete or March 31, 20Y0. This is more specific than the CFO s prediction, but lacks specificity. Because the sale does not meet all seven of the criteria that must be met before ChemInc could consider recognizing revenue prior to delivery in a bill-and-hold agreement, no revenue may be recognized in 20X9 for the transaction with Bond. It should be noted that the literature in SAB Topic 13.A.3a indicates that even if the seven criteria above have been met, it is still possible that revenue recognition is not appropriate, as the listing is not intended as a checklist. In SAB Topic 13.A.3a, the SEC staff provides additional factors that an entity should consider prior to concluding that it is appropriate to recognize revenue before delivery occurs in a bill-and-hold transaction. While consideration of these factors is not necessary for ChemInc s situation because the transaction with Bond does not meet all seven of the required criteria, it may be useful to require students to at least identify the additional factors and comment on why they are important in making a final determination as to whether ChemInc should recognize revenue in 20X9.

12 A Series of Revenue Recognition Research Cases Using the Codification 75 Students should point out that in order for revenue to be recognized prior to delivery in this case, Bond must have attained the risks of ownership to the MCA. Typically, this would occur when title to the MCA passes to Bond. More subtle points are that (1) Bond should insure its inventory once purchased if this is its customary business practice for inventory, (2) the agreement should explicitly stipulate that ChemInc will not use the inventory to fill other customers orders, and (3) because the delivery date for the order of MCA is contingent upon completion of its special storage chamber, no date-certain is provided, even though the CFO believes it will be completed by February 1, 20Y0. With regard to this last issue, if all other criteria were met, an argument that the delivery date is fixed within the first quarter of 20Y0 may be advanced to support revenue recognition in the quarter ended December 31, 20X9. Requirement 3: What are the necessary journal entries for the quarters ending December 31, 20X9, and March 31, 20Y0? The journal entries and revenue recognized by ChemInc in each of the quarters ending December 31, 20X9, and March 31, 20Y0, are provided in the discussion that follows. Quarter Ending December 31, 20X9: Cash 1,000,000 Unearned Revenue 1,000,000 Inventory Subject to Bill-and-Hold Transaction 150,000 Inventory 150,000 Explanation. While ChemInc cannot recognize any revenue related to the bill-and-hold transaction in the quarter ending December 31, 20X9, the journal entries recorded by ChemInc must take into consideration that the $1,000,000 sales price for the MCA has already been received and the fact that the MCA was segregated from ChemInc s other inventory. Quarter ending March 31, 20Y0: Unearned Revenue 1,000,000 Cost of Goods Sold 150,000 Revenue 1,000,000 Inventory Subject to Bill-and-Hold Transaction 150,000 Explanation. Given that the contract indicated that the MCA would be delivered at the latest by March 31, 20Y0, all of the revenue from the transaction should be recognized by that date. Also, the unearned revenue is removed from the accounts. Finally, the cost of the sale is recorded as inventory is removed from the Subject to Bill-and-Hold account. REFERENCES American Institute of Certified Public Accountants (AICPA) New AICPA Start Here, Go Places website debuts. Available at: Association to Advance Collegiate Schools of Business (AACSB) Eligibility Procedures and Accreditation Standards for Accounting Accreditation. Available at: accreditation/accounting/standards/aacsb_accounting_standards.pdf Burns, C. S The evolution of a graduate capstone accounting course. Journal of Accounting Education 24:

13 76 Alford, DiMattia, Hill, and Stevens Santella and Associates Coupon trends. Available at: Springer, C., and A. F. Borthwith Business simulation to stage critical thinking in introductory accounting: Rationale, design, and implementation. Issues in Accounting Education 19 (3): Watershed Publishing Coupon-redemption conventional wisdom sometimes foolish. Available at: /