Background on Stella Co. and its sales transaction

Stella Co., a wholly-owned subsidiary of a U.S. listed company-Alpha Inc., is a manufacturer of active and passive communications equipment located in Shenzhen, China. It sells its products to Chinese Communication Carrier (CCC) that is partially owned and operated by the Chinese government. About half of Stella’s revenues are generated through sales to the CCC.

Due to the significant size and market share of the CCC, it dictates all aspects of its relationship with Stella. The CCC does not place formal purchase orders or provide signed contracts prior to initiating an order with Stella. Instead, it has in place with Stella an approved and enforceable frame agreement that identifies the rights and obligations of the parties. Although the frame agreement does not specify fixed prices, they specify general payment terms that include probable discount on quoted price and a payment period of up to six months from product delivery.

The CCC will place an order for product by calling in a verbal order, sending a text message, or sending an e-mail to Stella sales representative. A price is quoted by Stella when the order is placed. The actual price will be negotiated and specified in the final contract. The actual price has historically been four to six percent less than the price quoted when the order was initially placed. Stella’s record indicates an equal probability of price discount anywhere between four and six percent. It may take up to three months for an agreement with a fixed sales price to be signed (“chopped” is the term used in China) by both parties.

Stella just introduced a new communication equipment that is of high interest to the CCC. A stand-alone price of this new equipment is $450,000. A customer can also purchase a three-year maintenance/software-upgrade agreement for this new equipment at a price of $50,000. Because the CCC is such an important customer, Stella quoted the CCC a bundled price of $480,000 that includes the new equipment and the three-year maintenance/software-upgrade agreement. The maintenance/software-upgrade agreement will start upon customer receipt of the equipment. The CCC recently called and placed a purchase order for the new equipment, and the maintenance agreement that includes software upgrades. The quoted prices of $480,000 in this purchase order is subject to negotiation and discount as indicated in the prior paragraph.

The CCC often demands shipment from Stella within three to 10 days after placing an order. Stella often ships products before an agreement is chopped. The products are shipped to the customer’s warehouse. Stella requests a signed delivery confirmation document and also requests that the agreement is chopped when product is received. However, the customers tend to ignore Stella’s requests about signed delivery confirmation, and defer chopping the agreement for up to three months. The CCC has a history of paying for all purchases about two months after the agreement is chopped. Thus, payment is received by Stella an average of five months after shipments are received by the CCC. The standard customer-payment period for Alpha, Stella’s parent, is only one to two months after shipments. Stella’s other customers also follow this standard payment period. The CCC rarely returns products and the return rate is negligible.

Questions:

1. Identify the number of performance obligations in the contract and describe what they are along with why they are separate performance obligations.

2. Specify (1) how Stella should recognize revenue for each performance obligation, i.e., at a point in time (when exactly?), or over a time period (which time period?), and (2) how much of revenue should be recognized for each one.

Answer rating: 100% (QA)

1 There are two performance obligations in the contract The first is the ... View the full answer