The attached case asks you to use the codification as well as your understanding of financial reporting to address issues related to a company’s revenue recognition. The process you use to develop an answer for the case will likely be similar to that used for group projects. All parts of the case and your logic should be discussed.
Specifically, your response to requirements 2 and 3 should include a list of the authoritative pronouncements (ASC topic-subtopic-section-paragraphs) that are relevant to answering the case. Your list should include all of the citations that helped you form an answer, but the list should not be so broad that it includes a lot of irrelevant paragraphs.
You can research the issues via the web, textbooks, journals, etc., but if your answer is clearly and closely related to any of the sources you research, you must provide a citation/reference to the source
CASE
Moto Knappy is a manufacturer of automobile motors. The manufacturing process takes a couple of months. The company produces several standard and custom models. To simplify this case, assume the motors are sold without a right of return or any warranty of any kind. Moto Knappy is a publicly traded company headquartered in Lindsey.
Transaction(s)1)
Jensen Jalopies assembles cars using many parts that it purchases from suppliers plus some additional parts it manufactures itself. On August 10, 2012, Jensen Jalopies signs a contract to buy 100 model 357 motors from Moto Knappy. The contract specifies the following:
• The motors will be ready for delivery on December 20, 2012. However, Jensen Jalopies has informed Moto Knappy that because its assembly process follows just-in-time practices, Jensen Jalopies may delay delivery until it is ready to use the motors. However, the customer must take delivery of all 100 motors no later than March 5, 2013.
• The purchase price is $900 per motor. The contract requires a 10% down payment at signing. The remainder of the price is due on December 20, 2012, provided that the 100 motors are ready to deliver.
• Any motors not delivered on December 20 will be stored in Moto Knappy’s warehouse. One of its employees, Tom Wayne, is assigned to go to the warehouse once every two weeks and spin the crankshafts on all motors in storage to ensure they are properly lubricated and the internal parts do not seize. The contract does not reimburse Moto Knappy for any of the cost of storage or Mr. Wayne’s maintenance of the motors.
• If Moto Knappy fails to deliver some of the motors, the purchase price for those motors will be refunded.
As of December 15, 2012, Moto Knappy has 100 model 357 motors in inventory. Jensen Jalopies takes delivery of 40 motors on December 20, 2012, 30 motors on January 20, 2013, and the final 30 motors on February 20, 2013. As per the contract, Moto Knappy collects the remainder of the purchase price on December 20, 2012. The model 357 is used by several customers of Moto Knappy; any additional orders for that model are expected to be supplied by making new motors, but if a rush order is received, Moto Knappy could use some of its existing inventory to meet the rush order and then build new motors to replenish its inventory.
Transaction(s)2)
Moto Knappy enters a contract on September 10, 2012, to sell 50 model 440 motors to Ayres Autos. The contract specifies the following:
• The motors will be shipped to Ayres Autos on December 15, 2012.
• The purchase price is $1,100 per motor. The contract requires a 10% down payment at signing. The remainder of the price is due on delivery. The deposit is refundable if Moto Knappy fails to deliver the motors.
As of December 13, 2012, Moto Knappy has 60 model 440 motors in inventory. Ayres Autos contacts Moto Knappy with the following information:
“We experienced a fire in our warehouse on December 10. As a result, we can only take delivery of 10 motors at a time until the warehouse is repaired.”
Moto Knappy enters discussions with Ayres Autos, and as a result, the contract is modified (in writing) as follows:
• Ten motors will be shipped to Ayres Autos on December 15, 2012. Ayres Autos will take delivery of the remaining 40 motors when it has room or has repaired its warehouse or March 2, 2013, whichever is earlier.
• In the meantime, the remaining 40 motors are sent to Cuccia’s Closet, a local storage facility. The contract with Cuccia’s Closet lists Ayres Autos as the lessee. It allows access by Tom Wayne to spin the crankshafts; Ayres Autos will pay Moto Knappy $50 for each hour that Mr. Wayne spends spinning motors at Cuccia’s Closet. The motors can only be removed from the premises by Ayres Autos employees.
• An insurance contract exists covering the motors at Cuccia’s Closet against risk of loss due to fire, theft, or flood. Ayres Autos bought the contract and is the sole beneficiary.
• Moto Knappy collects the remainder of the purchase price for all 50 motors on December 15. The initial deposit becomes nonrefundable upon shipment of the first 10 motors.
• The revised agreement cannot be unilaterally cancelled by either party.
Required
1) Before diving into the codification, explain in basic terms the main concern to be addressed in determining the appropriate revenue recognition pattern for transactions 1 and 2. Use terms that a sophomore in Principles could understand. You are not expected to cite the ASC in answering this part, but if you find a passage that is clearly on point, you can.
2) For the transfers to Jensen Jalopies, what is the appropriate revenue recognition? Incorporate ASC citations in your discussion. Also, provide the journal entries related to revenue or deferred revenue (if any) at August 10, December 15, December 20, January 20, and February 20. You do not need to worry about journal entries related to the cost of manufacturing the motors or inventory and cost of goods sold.
3) For the transfers to Ayres Autos, what is the appropriate revenue recognition? Incorporate ASC citations in your discussion. Also, provide the journal entries related to revenue or deferred revenue (if any) at September 10 and December 15. Also, assuming Ayres Autos took delivery of the remaining 40 motors on January 15, what is the entry for that day? You do not need to worry about journal entries related to the cost of manufacturing the motors or inventory and cost of goods sold.