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Revenue Recognition

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Submitted By joshteh
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Discussion Question 1:

A. Merchant, Inc should not recognize revenue for the membership fees and accrue the costs to provide membership services at the outset of the arrangement. According to Staff Accounting Bulletin No. 101, one of the realization principles is “delivery has occurred or services have been rendered”. After customers paid for the membership fees, Merchant Inc still has unfulfilled obligations to perform services promised to its customers throughout the entire membership period. Therefore, the earning process is judged to the incomplete. Another realization principal according to Staff Accounting Bulletin No.1 101 is “The seller’s price to the buyer is fixed or determinable.” In this case, since “the customer has the unilateral right to cancel the arrangement at any time during its term and receive a full refund of the initial fee”, the fees collected are “neither fixed nor determinable until the cancellation privileges lapse” (ASC 985-605-25). In conclusion, Merchant Inc should not recognize membership fees as earned revenues until the contracts between Merchant Inc and its members end (or until the refund privileges expire). B. Zampiello Company should not recognize revenue upon delivery of its product to Spartans. Since “Spartans is a consignee, and title to the products does not pass from Zampiello Company to Spartans until Spartans consumes the products in its operation”, Zampiello Company still retains the risk of ownership of the product upon delivery to Spartans. According to ASC-605-10-S99 SEC materials, “products delivered to a consignee pursuant to a consignment arrangement are not sales and do not qualify for revenue recognition until a sale occurs”. C. Robinson Corporation should recognize revenue upon the delivery of the merchandise to its customers. Robinson should not record revenue when it receives cash deposit because the company still retains the risk of ownership of the merchandise. The cash deposits should be treated as a liability to Robinson until the delivery of the merchandise to its customers.

Discussion Question 2:
Pit Shop Service & Tire Centers operations should be reported as a discontinued operation in Auto World Inc.’s second quarter financial statements. First, Auto World determined that Pit Stop Centers meet the definition of a “component of an entity” as defined in ASC 205-20-20. In order to be reported as a discontinued operation in Auto World Inc.’s financial statements, Pit Shop Centers and Auto World must meet both conditions stated in ASC 250-45-1: a. The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction. b. The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.
Auto World must pass two tests (two requirements stated above) in order to report Pit Stop Centers as a discontinued operation. Let’s examine each of the tests below:
Test 1: Evaluate whether operations and cash flows of a disposed component are eliminated from the ongoing operations of the entity as a result of the disposal transaction.
According to ASC 205-55-4 “The evaluation of whether the operations and cash flows of a disposed component have been or will be eliminated from the ongoing operations of the entity depends on whether continuing cash flows have been or are expected to be generated and, if so, whether those continuing cash flows are direct or indirect.” Therefore, we have to determine if the continuing cash flows generated by Pit Stop are direct or indirect to Auto World.
From the case, we know that Auto World and Giant entered into a six-year royalty agreement that provides Auto World the right to receive a royalty fee equal to 12% of future revenues of the Pit Stop Centers. According to ASC 205-55-13, “passive royalty interests in the disposed component’s operations” is one example of continuing cash flows that would likely not be direct.
According to ASC 205-55-5 “if all continuing cash flows are indirect (that is, not direct), the cash flows are considered to be eliminated and the disposed component meets the paragraph 205-20-45-1(a) criterion to be considered a discontinued operation.”
Therefore, the operations and cash flows of Pit Stop Centers have been eliminated from the ongoing operations of Auto World as a result of the disposal transaction.
Test 2: Whether or not Auto World has significant involvement with Pit Stop Centers after the disposal transaction.
According to the case, the terms of the royalty agreement do not provide Auto World with the ability to be involved in the operations of Pit Stop Centers. We can safely predict that the ongoing entity, Auto World, will not “influence the operating or financial policies” (ASC 205-55-15) of Pit Stop Centers. Therefore, Auto World doesn’t have significant involvement with Pit Stop Centers after the disposal transaction.
In conclusion, Auto World can record Pit Stop Centers as a discontinued operation under its financial statements because the operations and cash flows of Pit Stop Centers have been eliminated from the ongoing operations of Auto World, and Auto World doesn’t have significant involvement with Pit Stop Centers after the disposal transaction.

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