REVENUE RECOGNITION CASE

Blender King

Question 1. What are the different steps involved in recognizing revenue under ASC 606?
Provide a detailed explanation of each of the steps as they relate to BK.

According to FASB’s codification on revenue recognition (ASC 606-10-05-4), an entity recognizes

revenue by applying a sequential five-step model. These five steps are delineated hereunder, with
respect to the Blender King case:

Step 1: To determine whether there is a valid contract:

As per ASC 606-10-25-1, an entity can account for revenue from customer only if valid contract
exists. The following criteria need to be met for a contract to be a valid contract:
a. The parties to the contract have approved the contract and they are committed towards their
obligations:
In the instant case, the transaction for sale and purchase of mixers between Blender King
(BK) and Chef Hardware (CH) is clearly approved by both parties, in which BK would
provide cordless mixers while CH would make payment, after accounting for warranty and
volume discounts etc. The contract need not necessarily be written, it can be oral or implied
by entity's customary business practices. Hence, this criterion is fulfilled.
b. Each party's rights and obligations relating to goods or services to be provided are properly
identified:
In this case, CH has the right to receive goods from BK, and also to receive warranty service
and volume discount in accordance with the customary practice of BK. On the other hand, BK
holds the right to receive payment i.e. each party's rights are duly identified.
c. The payment terms of the contract are identified:
BK would charge $50 per unit including warranty. We also know from the facts of the case
that the standalone price per unit is $40 (without warranty). Moreover, volume discounts are
also applicable depending upon the sales volume, which are also clearly defined and
identified. Thus, the payment terms are sufficiently clear and identified.
d. The contract has commercial substance:
The transaction is made by the manufacturer to its retail customer, in a B2B transaction, for
further sale to individual customers. Clearly, there would be a change in cash flows and assets
as a result of this transaction. Thus, this transaction has commercial substance.
e. Collection of payment is probable:
In this case, payment has already been made by CH. It means that there is no doubt over
collectability.
Since all conditions given in 606-10-25-01 are satisfied, we can say that there is a valid contract
between both entities.
Step 2: Identify the performance obligations in the contract:
FASB, in its Master Glossary, defines “performance obligation” as under:
A promise in a contract with a customer to transfer to the customer either:
a. A good or service (or a bundle of goods or services) that is distinct
b. A series of distinct goods or services that are substantially the same and that have
the same pattern of transfer to the customer.
According to ASC 606-10-25-19, the good or service can be said to be distinct if both of the
following criteria are met:
First criteria: The customer can benefit from goods or service either on its own or with other
resources readily available.
Second criteria: The entity's promise to transfer the good or service is separately identifiable.
Going by the above criteria, we have two performance obligations in the contract between BK and JK:
 Ist performance obligation: The first one is sale of mixers by BK to JK. It is a separate PO
because CH can benefit from this sale directly by reselling it to its individual customers, thus
satisfying the first criteria, as stated above.
 2nd performance obligation: The second performance obligation is the warranty contract for
which BK charges $10 extra (as per given facts of the case). Thus, the warranty contract
should be treated as a separate service for which an amount of $10 is charged. It is clearly
separately identifiable, thus satisfying the second criteria.

Step 3: Determining transaction price:

ASC 606-10-32-2 defines transaction price as under:
The transaction price is the amount of consideration to which an entity expects to be entitled
in exchange for transferring promised goods or services to a customer, excluding amounts
collected on behalf of third parties (for example, some sales taxes). The consideration
promised in a contract with a customer may include fixed amounts, variable amounts, or
both.
In the given case, CH pays $50 per unit for 100 cordless mixers on 1st Jan. Thus, the overall
transaction price is $5,000.
However, since there are two performance obligations i.e. sale of goods and warranty contract, the
transaction price shall be allocated to each PO.

Effect of volume discount on transaction price: It is important to note that contract between BK and
CH includes a provision for volume discount. The rate of this discount would depend on the aggregate
annual sales. Volume discounts are treated as variable consideration in accordance with ASC 606-10-
32-6.

In this case, we would use the methodology of “the expected value” for determining the volume
discount, in accordance with ASC 606-10-32-8, which defines the expected value as:
 The expected value is the sum of probability-weighted amounts in a range of possible
consideration amounts. An expected value may be an appropriate estimate of the amount of
variable consideration if an entity has a large number of contracts with similar
characteristics.

We cannot recognize the entire revenue of $5000 in this case, because variable consideration is
involved. Instead, we need to calculate the expected value of sales for the year, on the basis of given
probability for each sales bracket, and then give effect of discount on sales made in January:
Sales Bracket (as Average number of Sales as per weighted
Probability
given) mixers sold (units) probability (units)
Less than 1,000 500 35.00% 175

1,000 through 1,999 1500 40.00% 600

2,000 or more 1000 25.00% 250

Total 1025
After assigning the weights to each sales bracket, our annual expected sales come to 1025 units.
Therefore, discount for the expected sales of 1025 units should be taken at 3.75% (since number of
mixers expected to be sold during the year fall between 1,000 - 1,999). To further corroborate our
estimate, let us consider that if 1025 units is expected annual sale, then monthly sale should on
average be around 85 mixers. Since in Jan, the retailer has placed order of 100 units, the expected sale
that we calculated can be said to be a reasonable and achievable estimate.

Step 4: Allocating the transaction price to the performance obligations in the contract:
ASC 606-10-32-28 explains the objective of allocating the transaction price to the performance
obligations in the contract as:
The objective when allocating the transaction price is for an entity to allocate the transaction
price to each performance obligation (or distinct good or service) in an amount that depicts
the amount of consideration to which the entity expects to be entitled in exchange for
transferring the promised goods or services to the customer.
Since, we have two separate performance obligations, we will allocate the total transaction price
between both, i.e., the cordless mixer and the one-year warranty. The standalone allocated price for
the mixer is $50 ($50 sales price - $10 warranty cost), and $10 is allocated to the warranty.
Allocating transaction price to warranty contract
Total sale price per unit (inclusive of warranty) $50
Standalone sale price per unit (without warranty) $40
Standalone warranty contract price per unit (residual approach as per ASC 606-
$10
10-32-34)
Total number of units sold to CH 100
Total transaction price allocated to warranty $1000

Allocating transaction price to sale of goods

Sale price per unit (excluding warranty) $40
Number of units sold 100
Total sale price of goods (100 units) $4000
 Less: volume discount liability estimated [3.75% x $4,000] $150
Revenue from sale of mixers to be recognized $3850
Volume discount liability to be created $150

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation
Revenue from sale of goods: For performance obligation of sale of goods, revenue of $3,850 is
recognized immediately while $150 is provided for as liability (volume discount based on expected
value of sales). It is to be adjusted at end of year when volume discount can be ascertained. In case the
requirement for volume discount is not met at year end, then this liability will be reversed, and
additional revenue of $150 will be recognized.

Revenue from warranty: For performance obligation of warranty contract, revenue of $1000 should be
recognized over warranty period, which is one year in our case. Therefore, warranty liability will be
recognized/adjusted during one year, at the end of every month:

Warranty revenue per month = $1,000/12 = $83.33

Question 2. Record all journal entries for BK for the month of January based on ASC 606.
Include references to the guidance to support your proposed accounting. Show any calculations
you make to support your journal entries.

Journal Entries:

Date Account Dr. ($) Cr. ($) Explanatory Comments

Jan 1 Cash 5000 Total cash receipts are debited.
Standalone price per mixer is
$40, therefore $10 (residual
Warranty Liability 1000 value) is taken as standalone
price of warranty per unit. $10 x
100 units = 1000
Volume discount liability 150 =4000 x 3.75% = 150
Revenue from sale of
3850 =4000 – 150 = 3850
goods

The cost to manufacture each

Jan 1 Cost of goods sold 3200
mixer is $32.
Inventory 3200

One year warranty liability is

31st Jan Warranty Liability
Revenue from warranty
1000, which is reduced each
month by 83.33 (=1000/12).
83.33
This amount becomes part of
revenue from warranty liability
each month.
83.33 Revenue from warranty is
liability realized on monthly basis.