Revenue recognition steps
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Revenue recognition steps
Identify contract
The contract is straightforward for Mirabella, Inc. since there is a written agreement that specifies the Mirabella who is the franchisor and Jemison Brothers who is the franchisee. The agreement specifies the rights, obligations and payment terms of both parties as follows. Jemison Brothers have contracted the sales manager for Mirabella for the later to provide and perform computer integration services for security equipment for $10.1 million and have everything operational within one year. According to Financial Accounting Standards Board (FASB) (2017), the contract also has commercial substance, which implies the expected changes in the cash flows for both Mirabella and Jemison Brothers based on the contract. For instance, only after everything is operational within one year will the full payment be due.
Identify performance obligation in the contract
Mirabella sales manager must determine if some of its services are distinct. According to the Financial Accounting Standards Board (FASB) (2017), distinct services would not be part of the intellectual property that Jemison Brothers, which is the franchisee, has licensed. Such activities may include but not limited to pre-opening activities, training of the staff at Jemison Brothers on how to operate the equipment as well as site selection. In this regard, the contract states that Jemison will not get control of the equipment until the integration is completed. That implies that all the pre-opening activities that will be in operation before the integration is complete are distinct. However, the contract has not specified in detail the breakdown of such activities alongside the integration processes. Such activities will not be part of the intellectual property that Jemison Brothers is licensing.
Determine the transaction price
For Mirabella Inc. determining the transaction price will involve listing the entire revenue streams. According to Financial Accounting Standards Board (FASB) (2017) that would include revenues that Mirabella Inc. will receive upfront, as well as the revenue it will receive over time from the Jemison Brothers such as the initial fee, maintenance fee, and transfer fees. Precisely, Mirabella received upfront revenue of $9.5 million two days after the signing of the contract. That implied that Jemison Brothers are entitled to a discount of $0.5 million entitled to payment made within three days of the date the parties sign the contract. Out of the initial $10.1 million of the security equipment price, Jemison Brothers was to pay as part, in exchange of $0.1 million credit worth of its old security equipment but only after the integration is complete. However, based on its extensive experience, Mirabella believes the old equipment at the contract inception date was $0.115 million, which implies that Mirabella would gain extra revenue of $0.015 million if the contract were completed as agreed. However, Mirabella will have its revenue reduce through a free 5-year maintenance service worth $0.3 million offered to Jemison Brothers. There are projections on bonuses and penalties based on punctuality in completing the contract. However, in this case, I assume that from the significant historical experience with similar integration jobs, Mirabella will not pay any bonus or incur any penalty because it has the highest probability of 46% of completing the contract within 12 months.
Allocate the transaction to each performance obligation
In this step, Mirabella must assign a transaction price to each distinct service in step two at the inception of the contract. According to Financial Accounting Standards Board (FASB) (2017), this will be done using the adjusted market assessment approach, which is an approved method of making the determination. Mirabella has considered the market in which security equipment sells and estimated the price that a client in that market would be willing to pay before signing the contract. The method is suitable for Mirabella because there are other competitors in the area offering similar goods and services and therefore forming a basis in the analysis. For the case of Mirabella Inc., it has considered offering a distinct service in the maintenance of the equipment free of charge for 5 years, which is worth $0.3.
In general, the prices include
Provision and performance of computer integration services for security equipment= $10 million
Credit worth of old security equipment to be received as part-payment =$0.1 million
Distinct service in the maintenance of the equipment offered free =$0.3 million
Bonus earned upon completing the contract in time =$0.0 million
Penalty incurred on late completion of contract =$0.0 million
Discount offered to Jemison Brothers =$0.5 million
Estimated excess value on old equipment =$0.015million
Recognize revenue when each performance obligation is satisfied
For Mirabella to recognize the revenue in the particular provision and performance of computer integration services for the security equipment it must transfer the goods and services within 12 months according to the contract. According to Financial Accounting Standards Board (FASB) (2017), any royalty Mirabella earns during the contract has a carve-out exception as sale-based. That means Mirabella must continually recognize such royalties as the underlying integration occur even if not yet received as long as it is accrued. In this particular case, Mirabella Inc. will not earn or incur other loyalties outside the ones stated above, as the assumption is that it will complete the contract within 12 months.
In summary
Provision and performance of computer integration services for security equipment= $10 million
Credit worth of old security equipment to be received as part-payment =$0.1 million
Bonus earned upon completing the contract in time =$0.0 million
Estimated excess value received on old equipment =$0.015 million
Total revenue incurred =$10.115 million
Less
Distinct service in the maintenance of the equipment offered free =$0.3 million
Penalty incurred on late completion of contract =$0.0 million
Discount offered to Jemison Brothers =$0.5 million
Net revenue received by Mirabella Inc. =$9.315 million
I used ASC 606-10-25 FASB codifications. This was mainly the revenue principle (Financial Accounting Standards Board (FASB), 2017). Conclusions were reached on the projection basis and assumptions that Mirabella Inc. was able to complete integration as stipulated in the contract and within 12 months.