Larson Industries

Case Study on Larson Industries
Larson Industries Research Revenue Recognition Issues
Introduction
Larson Industries is one of the firm's biggest clients. The company partakes in the manufacturing of carpentry and other premium handheld and mechanical tools. Larson Industries has entered into an agreement with Dynamic Wholesale, Inc. regarding the sale of AM300, which is Larson's leading product in the industry. Multiple complex revenue recognition problems face this new Contract (McNellis, Barone, and Herbold, 2020).
The purpose of this report is to present to Rosalie Grant the identified and analyzed for accounting issues in the Larson-Dynamic Contract about revenue recognition and the recommended appropriate accounting treatment. The report capitalizes on the most current execution of the updated revenue recognition guidance as per Topic 606 derived from the Financial Accounting Standards Board's Accounting Standards Codification, together with IFRS 15 from the International Accounting Standards Board.
Larson-Dynamic contract Accounting Issues
This section of the report examines four different accounting issues about revenue recognition in the Contract between Larson and Dynamic. Specifically, the report will consider the pertinent facts of the case, the particular accounting issue, the identification of suitable authoritative guidance from the accounting and analysis of the issue.
Accounting Issue 1: Principal vs. Agent Considerations
As indicated by ASC 606-10-25-2, a contract is described as an agreement or covenant between two or more parties that generate rights and obligations that are enforceable. One of the critical elements that should be considered within a contract is the principal and agent's specificity and how any amounting revenue should be considered. For promoting the success of the agreement, Dynamic organized product demonstrations of the AM300. Jackson Marketing Services will carry this out.
Considering that Dynamic and Jackson have a continuing association concerning product demonstrations occurring at the warehouse, Jackson billed Dynamic for the costs linked with the demonstration services in advance of each event. Consequently, Dynamic provided Larson the choice to pay its share of the costs by remitting payment to Dynamic or by directly paying Jackson. Larson designated that the initial payment would be made directly to Jackson (McNellis, Barone, and Herbold, 2020).
In this regard, Jackson, a third party, is involved in rendering product demonstration services to consumers (McNellis, Barone, and Herbold, 2020). Consequently, Larson needs to determine whether the firm is acting as a principal or agent. This assessment is imperative to examine the performance obligations within the contract effectively. The fundamental difference amid an agent and a principal considers the nature of the performance obligation being met. In particular, the principal has a performance obligation to render the specified goods or services to the end consumer.
On the other hand, the agent organizes for the principal to render the specified good or service (ACS 606-10-55-36). Based on the assessment, it is conceivable that the principal is Dynamic. Following ASC 606, it is ascertained that that "an entity is a principal if it controls the specified good or service before that good or service is transferred to a customer" (ASC 606-10-55-37).
Jackson is an agent in the transaction as determined by an examination of the three factors outlined by the ASC:
1. The entity is fundamentally responsible for fulfilling the promise to provide the specified good or services. In this regard, Jackson is not accountable for providing AM300. Rather, it facilitates the product's demonstration to aid with the sale of AM300 to end consumers.
2. The second element to consider is whether the entity has inventory risk before or after the specified goods or services are transferred to a customer. In this case, it is perceptible that Jackson does not have any control over the inventory before or after the transaction, and does not face any financial loss on any unsold units of AM300.
3. The third element to consider is if the entity had discretion in setting prices. Jackson agrees to make demonstrations of AM300 and does not have any part to play in selling the product directly or indirectly to set the prices and not change that price (McNellis, Barone, and Herbold, 2020).
After determining the agent and the principal in the transaction, it becomes possible to ascertain the financial statement reporting effect. The transaction principal should report revenue based on the gross amount that is billed to a customer. On the other hand, the agent is expected to report the revenue based on the net amount retained—for instance, the amount paid to a consumer minus the amount paid to a subcontractor.
Accounting Issue 2: Performance Obligation in the Contract
A second problem in the Contract between Larson and Dynamic is the identification of performance obligations. The first step takes into account pinpointing distinct goods and services promised. Specifically, a contract comprises of promises for the transference of goods or services to a consumer.
If such goods or services are deemed distinct, the promises are considered performance obligations and are therefore accounted for separately (606-10-05-4). Concerning the case study, it is perceptible that there is a promise made by Larson in shipping 1 million standard AM300s. The Contract facilitates the transference of the goods' legal title to Dynamic, specifically when they are delivered to the warehouse.
To ascertain performance obligations and proper accounting for the revenue, the accounting standard indicates a need to pinpoint whether the goods in question are distinct. In delineation, a good or service is deemed to be distinct if the consumer can benefit from the service or good on its own or in tandem with other resources that are freely available to the consumer. The entity's promise in the transference of the good or service to the consumer is separately recognizable from other promises within the Contract (606-10-25-14).
In the case of the Contract, it is perceptible that the AM300 as a product satisfies the criteria for being distinct (McNellis, Barone, and Herbold, 2020). To be distinct, two things have to be taken into consideration. First of all, there is the capability of being distinct. Significantly, the consumer can benefit from AM300 on their own. The second criteria are the aspect of being distinct within the Contract. A note within the case study, Larson's promise to transfer the 1 million pieces of AM300 is separately identifiable from other promises contained within the Contract (606-10-25-18).
Accounting Issue 3: Transaction Price
Another perceptible accounting issue in the Contract between Larson and Dynamic is determining the transaction price. ASC 606-10-32-2 indicates that a business entity is obligated to consider the terms of the Contract, together with its conventional business processes, to ascertain the transaction price. Nature and timing influence the approximation of the transaction price, and the amount of consideration promised by a consumer.
Following ASC 606-10-32-2, the transaction price is delineated as the amount of consideration to which a business entity anticipates to be entitled to interchange for the transference of promised goods or services to a consumer, with the exclusion of amounts gathered on behalf of third parties. What is more, the consideration that is promised within a contract with a consumer may comprise of either variable amounts or fixed amounts or both of them.
In the Contract, Larson has to consider the effects of the following to determine the transaction price:
1. Variable consideration
In essence, variable consideration alludes to consideration within a contract that can differ and is not fixed based on incentives, discounts, credits, and performance bonuses. Consideration has a contingency on whether a future event occurs or does not occur (Du and Whittington, 2017).
In the case study, it is perceptible that there is variable consideration in quantity discounts rendered to the consumer on bulk purchases. Specifically, Larson incorporated in the Contract a bulk discount to Dynamic in a two-tiered plan. To begin with, if Dynamic makes a purchase of a total of 1.5 million products within six months, Larson will be obligated to provide a 10 percent retroactive discount on all 1.5 million products. The second aspect of the agreement is for any purchase orders surpassing 1.5 million products within the six months; then, it implies that Larson will be obligated to render a 12 percent discount to the extra purchases (McNellis, Barone, and Herbold, 2020).
ASC 606-10-32-12 provides appropriate authoritative guidance on this accounting issue. Specifically, the codification points out the factors that Larson needs to consider when evaluating the probability of substantial reversal in the amount of accumulative revenue acknowledged will not take place once the uncertainty is associated with the variable consideration. The elements to be considered include the following:
i. The consideration amount is largely vulnerable to factors external to the influence of the company. Some of these aspects comprise of volatility within the market for AM300s, the judgment or actions undertaken by third parties, in addition to a significant risk of the massive bulk of the products becoming obsolete.
ii. The uncertainty regarding the consideration amount is not anticipated to be resolved for a lengthy period.
iii. Larson has experience with the same type of contract agreement it has with Dynamic is limited, or that such experience has restricted predictive values (McNellis, Barone, and Herbold, 2020).
iv. Consideration into whether Larson has the practice of either offering a wide variety of price concessions or altering the terms and conditions of payment of the same contracts in the same set of circumstances
v. The Contract in question has a significant number and a wide range of conceivable consideration amounts (FASB, 2020).
In line with ASC-606-10-32-8, Larson should consider two different methods for the approximation of variable consideration. These approaches include the following:
1. The Expected Value method
This is the summation of the probability-weighted amounts in a variety of conceivable consideration amounts. Imperatively, an expected value may be a suitable approximate of the amounts of variable considerations if the company has a massive number of contracts with the same characteristics (Rampulla, 2019).
2. The Most Likely Amount method
This alludes to the single most likely amount in a variety of conceivable consideration amounts. The most likely amount may be a suitable approximation of the amount of variable consideration of the Contract has only two conceivable results (Rampulla, 2019).
2. Significant Financing Component within the Contract
Concerning ASC 606-10-32-17, a contract with a customer would not have a signi?cant ?nancing component if any of the following factors are existent:
i. The consumer makes payment of the goods or services in advance. Secondly, the timing of the transference of such goods or services is carried out at the discretion of the consumer
ii. A significant amount of the consideration promised by the consumer is not fixed but rather variable. Also, there is variability in the amount or timing of the consideration based on a future event taking place or not taking place, especially when it is not significant under the control of the business entity
iii. The variance between the promised consideration and the cash selling price of the product or service emanates for the basis except for the provision of finance to either the business entity or the customer. Secondly, the variance between such amounts is in proportion to the basis of the variance.
As Larson determines the transaction price, the company should adjust the amount of consideration concerning the time value of money. This is because the timing of the payment to be made by Dynamic concerning the future bulk of the AM300s is abound to render substantial benefit of financing to the company for making the transference of the products (McNellis, Barone, and Herbold, 2020).
As a result, the notion of the significant financing component is that Larson ought to take into consideration the revenue based on the price that Dynamic will pay at the time that Larson will make the transference of the additional 1 million bulk amount of AM300s in the future (McNellis, Barone, and Herbold, 2020).
Accounting Issue 4: Consideration Payable to Customer
ASC 606-10-32-25 points out that consideration payable to a consumer comprises cash amounts that a business entity makes a payment, or anticipates making a payment, either to the consumer or additional parties that purchase the business entity's goods or services from the consumer. It is imperative to note that consideration that is payable to a consumer can also consider credit that is applicable against amounts owed to the business entity (FASB, 2020).
Based on the case's facts, there are several considerations payable to consumers. To increase the sales volume of the AM300, Larson came up with a coupon, which entitles the customers to have $50 off of the product, with the offer having an expiration date of 60 days. Retailers that agree to take the coupon could present any coupons received from customers to Larson for reimbursement of the $50.
However, Dynamic had an issue with this consideration. The significant fear that this coupon could result in diminishing sales from its warehouses, particularly with the price protection agreement in place. As a counter to the deal in place, Dynamic offered to consent to the coupon set by Larson on condition that Larson failed to implement coupon reimbursement demands from any other retailers, in this manner eliminating other retailers' incentive to accept the coupon. Because of that, the concluding coupon, limit one per customer, was to be incorporated in major newspapers across the country on May 31, unequivocally redeemable simply at Larson and at the point-of-sale at Dynamic (McNellis, Barone, and Herbold, 2020).
ASC 606-10-32-25 indicates that when the consideration payable to a consumer is considered to be a reduction of the transaction price, then there is recognition of the reduction of revenue if these aspects take place:
1. The vendor recognizes the revenue for the transfer of the associated goods or services to the customer.
2. The vendor makes payment or promises to make payment of the consideration, regardless of whether the payment is contingent on a future event. This sort of promise may be implied by the conventional business practices of the vendor.
As per ASC 606-10-32-25 and consideration of the relevant facts of the case, Larson is expected to account for consideration payable to the customer as a reduction of the transaction price in question and as a result of the revenue to be generated (Rampulla, 2019). Bearing in mind that the consideration payable to the customers does not encompass a variable amount. Larson should not estimate the transaction price concerning the guidelines given on variable consideration. In the case in question, the consumer's payment is in exchange for a distinct good, the AM300, that transfers to the customer (McNellis, Barone, and Herbold, 2020).
This is because once the consideration is made, the consumer obtains control of the rights of the product. As a result, Larson should determine that the payment is a reduction of the transaction price. Therefore, in this particular case, Larson can consider the nonrefundable payment as consideration payable to customers and regulate the amount against the transaction price as a deduction (Rampulla, 2019).
Recommendation and Conclusion
This report takes into account a summary of pertinent case facts, ascertainment of the suitable authoritative guidance in the form of accounting standards, analyses of the issues pinpointed, and a consideration of the alternative accounting treatments. Larson Industries has entered into an agreement with Dynamic Wholesale, Inc. regarding the sale of AM300, which is Larson's leading product in the industry. ASC 606 provides guidance that helps both of these business entities to recognize revenue accruement by properly explaining the principles to pinpoint revenue contracts. In analyzing several accounting issues pinpointed from the case, it is recommended that Larson should take into consideration several five phases in the Contract.
The first step is for Larson to pinpoint the contracts with Dynamic as a customer. The initial step in revenue recognition is the identification of contracts with a customer. As indicated by ASC 606-10-25-2, a contract is described as an agreement or covenant between two or more parties that generate rights and obligations that are enforceable. Both the parties should approve the agreement either in written or oral form.
Also, Larson and Dynamic should be devoted to fulfilling their obligations. The rights of every party should be identifiable. By acknowledging the transfer of control, this will aid in recognition of revenue. The Contract should not encompass any social contract but rather should have commercial substance. The second step is identifying performance obligations in a contract. Bearing in mind that the goods are distinct, the promises are considered performance obligations and are therefore accounted for separately.
The third step takes into account the determination of the transaction price. This will include the need to incorporate both cash consideration and non-cash considerations. The fourth step takes into account allocating the transaction price to the performance obligation within the Contract. The final step is recognizing revenue when Dynamic satisfies its performance obligation.




References
McNellis, C. J., Barone, G. J., Herbold, J. (2020). Larson Industries: A Case on Identifying and Researching Revenue Recognition Issues. Issues in Accounting Education 35(2): pp. 65 – 75.
Financial Accounting Standards Board (FASB). (2016). Revenue from Contracts with Customers (Topic 606). Financial Accounting Series. Retrieved from: https://asc.fasb.org/imageRoot/32/79982032.pdf
Du, N., Whittington, R. (2017). Implementing Variable Considerations in Revenue Recognition. The CPA Journal. Retrieved from: https://www.cpajournal.com/2017/12/04/implementing-variable-considerations-revenue-recognition/
Rampulla, R. (2019). Revenue Recognition: Mastering the New FASB Requirements. Association of International Certified Professional Accountants, Inc.