Mr Hans Christian, a senior partner at Harmony Accountancy, has asked an intern to review the issues and the positions the firm should adopt concerning specific rules of revenue recognition adopted by some of the firm’s clients.
Required
For the various types of businesses or activities of Harmony Accountancy clients listed below, identify when revenues and costs might be recognized and what issues might arise (if any) in applying the matching principle.
(a) A young adults’ apparel retail store (such as ‘The Gap’ or ‘Abercrombie and Fitch’ in the US, or Zara, H&M or Celio in Europe).
(b) A shipbuilding firm holds a fixed-price long-term contract to build seven identical navy ships for a Defense Ministry. The firm uses subcontractors extensively. Each ship requires six months of work in dry-dock plus four months of finishing, fitting and testing before being released to the client. As soon as a dry dock is freed, a new ship is started.
(c) An apple and peach grower in Agen, in South West France. After the harvest, the fruit are stored in cool airtight warehouses, in an oxygen poor and humidity regulated atmosphere, until shipment is required. Apples can be stored for up to ten months with no ill effects on taste or appearance. Peaches can be stored at most a week before shipment. The fruits are shipped by the grower, using independent truckers, to the distribution platforms of large supermarket chains on the basis of preset contracts at preset prices for each period of production or consumption. Payment is due 30 days after delivery to the supermarket wholesale platform. All excess production is sold directly to ‘farmers’ markets’ retailers.
(d) An oil and gas company that does exploration, drilling and extraction but does not handle transport, refining or distributing.
(e) A movie (or TV) studio produces films and TV programs. It expects that domestic sales will cover only part of the costs of production, editing, promotion and distribution, and that foreign sales (which can happen after, before or at the same times as domestic release) and DVD sales revenue will provide additional revenue equivalent to 80 percent to 120 percent of domestic sales. DVD sales are, on the average, delayed by six months from the date of the initial release of the film or program.
(f) A real estate developer builds and markets turnkey new residential townships: retail facilities, community buildings (such as church, temple or mosque, or schools, hospital and satellite medical centers, sports center(s) and swimming pools, and live or movie theaters), apartments and individual houses. While marketing and sale of the real estate begins before ground is broken, the developer’s policy is to allow occupancy of housing only once most community and retail facilities have been constructed and leased (or sold) and half the housing development has been physically completed. Customers (residents or businesses) must put down 10 percent of the value of their purchase to make the reservation and freeze the price until availability for occupancy is declared, at which time full payment of the rest of the purchase price is expected.
(g) The mortgage-loan department of a bank or financial institution.
(h) A producer of olive oil (the production is entirely sold in the 12 months after pressing, i.e., before the next harvest) and olive-based prepared foods (some of which require aging beyond 12 months before reaching a sellable state). This producer buys the ripe olives from farmers.
(i) The firm ‘Meals Inc.’ is a provider of prepaid ‘meal checks’ sold to business clients. These checks allow the primary customers to subsidize employee meals by giving (or selling at a large discount) these ‘checks’ to their personnel to use as they please in a large network of approved meal and food providers. The restaurants or food stores that accept these checks as form of payment submit their ‘checks’ to ‘Meals Inc.’ and are paid on the last day of the month for all checks received by ‘Meals Inc.’ since the previous submission and before the 25th of the month.
(j) A livestock rancher (raises free-range cattle for meat consumption) who must buy half the feed for his livestock due to having insufficient acreage for the number of heads of cattle herded. This rancher buys young steers right after they are weaned, and raises them for 14 to 18 months before selling them on the hoof.
(k) A milk farmer (raises cattle in closed stables for milk production and calves) who buys threequarters of the grain required to feed the cows and calves. The rest of the food is grown on the farm. The farmer owns three bulls and, in addition, buys, when needed, artificial insemination services from a local veterinary clinic offering such service.
(l) An express courier closes its books on 31 December. It receives, at the last working day of the year, a package, and full payment for shipment. It knows the package cannot be delivered before the next accounting period. Same situation if the package is postage due (i.e., the recipient pays postage or shipping expenses once they have received the package, in the next accounting period).
(m) Pear Corporation sells, among other products, iPhones. These are assembled in China from parts coming essentially from China, South Korea and the US. The software development cost (allocated over an expected eight million sets sold) represents half the manufacturing end-cost of the jPhone (for up to eight million units). Pear Corp. provides its end-customers with software upgrades, free of charge for up to two years (when the model will, in all likelihood, be made obsolete by a newer model – the older model software is still supported with upgrades, if needed to fix bugs, but not for enhancements, for another two years).
(n) An oil and gas refinery and distribution company that buys its oil through long-term contracts from producers. It refines the oil, including oil-based fine chemistry applications, transports and distributes its products under its own name.
(o) A business whose main activity is to operate safely and effectively its sole asset, which is a 2,300 km dual pipeline connecting the oil fields of the Baku and Caspian Sea Coast region in Azerbaijan, with the Mediterranean port of Antalya in Turkey. The pipeline is available, on a first come first served basis, for any user willing to pay the price of transport. The installation can transport crude oil as well as any refined product. The pipeline requires an interruption of only three hours between different products to adapt to the new product (crude oil versus refined oil, for example).
(p) A firm that provides on-demand support services to offshore oil explorers and operators. These services include creating and operating living-bases, barge transport for delivery of parts, supplies and pipes, specialized divers and diving equipment, oilspill containment equipment, etc.
(q) A web-based search-engine operator sells advertising to businesses. It guarantees a certain number of ‘hits’ for the ads it will place prominently on-screen during a search by a user. The customer pays the operator a fixed fee upfront for being present on its website when certain keywords are introduced by the ‘search user’. If the number of hits is not reached over the agreedupon period, part of the fee paid will be refunded on a prorated basis. If a larger number of hits is obtained beyond the threshold, the customer must pay an additional fee per hit, calculated on the basis of the overage over a three-month period.
(r) Firm G sells businesses the opportunity to promote their product or services by offering, for a short period of time, deep discounted coupons for the business’ products to firm G’s ‘customers’.
These are mainly people who have agreed to share their e-mail address with Firm G and have expressed an interest in receiving such coupons. For example, a vendor, to get new customers to try its products or services, may offer through Firm G, for 50 CU, a coupon worth 100 CU towards the purchase of that vendor’s merchandise or service; the offer is valid only up until a preset date printed on the coupon. The customer pays up-front for the 50 CU coupon, and Firm G transfers 60 percent of that amount to the merchant eight weeks after the promotion started and keeps the other 40 percent. What is the revenue firm G can legitimately recognize and when?
(s) Telephone operator Z subsidizes the mobile phone sets it sells to its customers. A Smart Phone, such as the jPhone, for example, costs Z about 650 CU per set. It is sold to Z’s customers for 200 CU, as long as they agree to commit to a two-year service contract. Should the customer cancel his or her contract before the two-year delay has elapsed, the customer would have to pay a cancellation penalty of 480 CU. The penalty is, however, reduced by 20 CU each month during which the contract is in effect.
(t) Laurelhurst Gymnasium (LG) in Seattle, Washington, is a sports club offering access to all sorts of fitness equipment to its members. The membership fee is paid upfront for six months and renews automatically, every semester, unless the customer requests a cancellation, by registered letter, received by LG one month before the termination date of the previous semester. The customers who cancel receive a refund of the unused funds, except for the current month. All classes or personal training require the customers to pay additional specific fees to LG.