Louis Manufacturing Inc. (LMI) purchased some telecommunications equipment in January of the current year. The equipment normally sells for $2,300. In order to entice LMI to close the deal, the salesperson offered LMI related services that normally sell for $1,000. The services allow LMI to access the Internet for the next year. The equipment and services were bundled together and LMI was charged $2,700 for the whole thing-a great deal. There is a general right of return but LMI has already taken delivery of the equipment and has started using it. All is working well and LMI is very happy with the service.
Instructions
(a) Explain how bundled sales are accounted for under the earnings approach.
(b) Calculate how revenue would be allocated to the separate units in the transaction under the relative fair value method.
(c) Calculate how revenue would be allocated to the separate units in the transaction under the residual value method, assuming:
1. The value of the equipment is known but the value of the Internet service is unknown.
2. The value of the Internet service is known but the value of the equipment is unknown.