252 SECTION 1 The Role of Accounting as an Information System BILL-AND-HOLD ARRANGEMENTS. A bill-and-hold arrangement exists when a customer purchases goods but requests that the seller not ship the product until a later date. For example, a customer might buy equipment and ask the seller to store the equipment until an installation site has been prepared. For bill-and-hold arrangements, the key issue is that the customer doesn’t have physical possession of the asset until the seller has delivered it. Remember, physical possession is one of the indicators that control may have been transferred as listed in Illustration 5–3 . Bill-and-hold arrangements might arise normally in the course of business, but they also have been abused by some companies in the past. Managers at companies like Sunbeam , NutraCea , and Nortel Networks are alleged to have overstated revenue by falsely claiming that unsold inventory has been sold under a bill-and-hold arrangement. The physical possession indicator normally overshadows other control indicators in a bill-and-hold arrangement, so sellers usually conclude that control has not been transferred and revenue should not be recognized until actual delivery to the customer occurs. Revenue recognition usually occurs at delivery for a bill-and-hold arrangement. Assume that TrueTech starts selling TechStop franchises. TrueTech charges franchisees an initial fee in exchange for (a) the exclusive right to operate the only TechStop in a particular area for a five-year period, (b) the equipment necessary to distribute and repair TrueTech products, and (c) training services to be provided over a two-year period. Similar equipment and training can be purchased elsewhere. What are the performance obligations in this arrangement, and when would TrueTech recognize revenue for each of them? 1. The exclusive five-year right to operate the only TechStop in a particular area is distinct because it can be used with other goods or services (furnishings, equipment, products) that the customer could obtain elsewhere. 2. The equipment is distinct because similar equipment is sold separately. 3. The training is distinct because similar training could be acquired elsewhere. TrueTech would allocate the initial franchise fee to three separate performance obligations based on their relative stand-alone prices: (1) the right to operate a TechStop, (2) equipment, and (3) training. TrueTech would recognize revenue for the right to operate a TechStop over the five-year license period, because TrueTech’s ongoing activities over the license period affect the value of the right to run a TechStop. TrueTech would recognize revenue for the equipment at the time the equipment is delivered to the franchisee, and would recognize revenue for the training over the two-year period that the training is provided. What if TrueTech also charges franchisees an additional fee for ongoing services provided by TrueTech? In that case, TrueTech would recognize revenue associated with that fee over time as it provides the ongoing services. Illustration 5–20 Franchise Arrangements FRANCHISES. Many retail outlets for fast food, restaurants, hotels, and auto rental agencies are operated as franchises. In franchise arrangements, the franchisor , such as Subway, grants to the franchisee , quite often an individual, a right to sell the franchisor’s products and use its name for a specified period of time. The franchisor also typically provides initial start-up services (such as identifying locations, remodeling or constructing facilities, selling equipment, and providing training to the franchisee) as well as providing ongoing products and services (such as franchise-branded products and advertising and administrative services). So, a franchise involves a license to use the franchisor’s intellectual property, but also involves initial sales of products and services as well as ongoing sales of products and services. The franchisor must evaluate each part of the franchise arrangement to identify the performance obligations. Illustration 5–20 gives an example. In a franchise arrangement, a franchisor grants to the franchisee the right to sell the franchisor’s products and use its name.
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