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308 SECTION 1 The Role of Accounting as an Information System Concept Review Exercise INSTALLMENT SALES Boatwright Implements, Inc., manufactures and sells farm machinery. For most of its sales, revenue and cost of sales are recognized at the delivery date. In 2016 Boatwright sold a cotton baler to a new customer for $100,000. The cost of the baler was $60,000. Payment will be made in five annual installments of $20,000 each, with the first payment due in 2016. Boatwright usually does not allow its customers to pay in installments. Due to the unusual nature of the payment terms and the uncertainty of collection of the installment payments, Boatwright is considering alternative methods of recognizing profit on this sale. Required: Ignoring interest charges, prepare a table showing the gross profit to be recognized from 2016 through 2020 on the cotton baler sale using the following three methods: 1. Revenue recognition upon delivery. 2. The installment sales method. 3. The cost recovery method. Solution: At Delivery Installment Sales Method (40%  3  cash collection) Cost Recovery Method 2016 $40,000 $ 8,000 $ -0- 2017 -0- 8,000 -0- 2018 -0- 8,000 -0- 2019 -0- 8,000 20,000 2020 -0- 8,000 20,000 Totals $40,000 $40,000 $40,000 Industry-Specific Revenue Issues SOFTWARE AND OTHER MULTIPLE-ELEMENT ARRANGEMENTS The software industry is a key economic component of our economy. Microsoft alone reported revenues of almost $78 billion for its 2013 fiscal year. Yet, the recognition of software revenues has been a controversial accounting issue because of the way software vendors typically package their products. It is not unusual for these companies to sell multiple software elements in a bundle for a lump-sum contract price. The bundle often includes product, upgrades, post-contract customer support, and other services. The critical accounting question concerns the timing of revenue recognition. Prior to ASU No. 2014-09, GAAP required that the revenue associated with a software contract that included multiple elements be allocated to the elements based on “vendorspecific objective evidence” (“VSOE”) of fair values of the individual elements. The VSOE of fair values are the sales prices of the elements when sold separately by that vendor. If VSOE didn’t exist, revenue recognition was deferred until VSOE became available or until all elements of the contract had been delivered. 38 For example, suppose that a vendor sold software to a customer for $90,000. As part of the contract, the vendor promises to provide “free” technical support over the next six months. However, the vendor sells the same software without technical support for $80,000, and the vendor sells a stand-alone six-month technical support contract for $20,000, so those products would sell for $100,000 if sold separately. Based on that VSOE, the software comprises 80% of the total fair values, and the technical support 20%. Therefore, the seller would recognize $72,000 ($90,000  3  80%) in revenue up front when the software is delivered, and defer the remaining $18,000 ($90,000  3  20%) and recognize it ratably over Revenue for bundled software contracts was allocated based on vendor-specific objective evidence (VSOE). 38 FASB ASC 985–605–25: Software–Revenue Recognition–Recognition (previously “Software Revenue Recognition,” Statement of Position 97-2 (New York: AICPA, 1997), p. 14).


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