Case Study: Velocity Cellular

Case Study: Velocity Cellular
Revenue Recognition in a Multiple-Element Arrangement Velocity Cellular Services is planning the rollout of a new prepaid phone service called Power Starterpack. Using the current, relevant accounting guidance, determine and support the appropriate method for recognizing revenue for this new product.
Power Starterpack Details Velocity Cellular sells the Power Starterpack for $200. The Power Starterpack consists of two elements: a new activation card and a prepaid voucher for $50 worth of airtime. The new activation card allows the subscriber’s cellular phone to function and gives the subscriber additional features not available with the old activation card. Activation cards can be purchased separately from Velocity. Identical activation cards can be purchased from other vendors. The $50 prepaid airtime voucher must be used within 360 days or the remaining value is forfeited. If there is no activity for seven consecutive months, the subscriber’s account is closed and the phone number is deactivated. No refunds are given and the subscriber has no general rights of return for the Power Starterpack.
Are the Deliverables Considered Separate Units of Accounting? Velocity Cellular adopted ASU 2009-13, “Revenue Arrangements with Multiple Deliverables” in the current fiscal year. The Update amends the criteria in Subtopic 605-25 for separating revenue in multiple-deliverable arrangements. The amendments replace the use of the fair value of deliverables with the selling price of the deliverables. This change allows the financial statements to more accurately affect the nature of multiple-element arrangements [ (FASB Emerging Issues Task Force, 2009) ]. The first question to address is whether the multiple deliverables in the Power Starterpack are to be considered separate units of accounting. To determine whether the arrangement’s deliverables are separate units of accounting, ASC 605-25-25-5 states the following two criteria must be met: a) the delivered item or items must have value to the customer on a standalone basis, and b) if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item or items is considered probable and substantially in the control of the vendor [ (FASB, 2011b) ]. Both the activation card and the prepaid airtime voucher have standalone value to the customer, so the first condition is met. There is no general right of return in this case, so the second condition does not apply. This arrangement meets the criteria for treatment as separate units of accounting.
How Should the Arrangement Consideration be Measured and Allocated? The second question is how the revenue should be measured and allocated among the separate units of accounting. The selling price for each deliverable is to be determined using vendor-specific objective evidence of the selling price, if it exists. ASC 605-25-30-6A limits vendor-specific objective evidence to either the price charged for the deliverable when it is sold separately or the price established by management having the relevant authority if the deliverable is not yet being sold separately [ (FASB, 2011a) ]. In the case of the Power Starterpack, both deliverables are sold separately by Velocity Cellular, so the selling price is known. ASC 605-25-30-2 requires that revenue be allocated at the beginning of the arrangement to all deliverables on the basis of their selling price, with few exceptions. One exception applies in this case. ASC 605-25-30-5 limits the amount of revenue allocable to the delivered item to the amount that is not contingent upon meeting other specified performance conditions [ (FASB, 2011a) ]. The prepaid voucher is contingent upon the company providing specific performance, or airtime usage, to the subscriber. This limits the amount of revenue allocable to the activation card to $150 ($200 package price minus $50 prepaid voucher), regardless of the actual individual selling price of the activation card. $50 would be allocated to the prepaid voucher.
How Should the Revenue be Recognized? ASC 605-10-25-1 calls for revenue to be recognized when it is a) realized or realizable, and b) earned. Revenue is realized when goods or services are exchanged for cash or claims to cash. Revenue is earned when the seller has substantially accomplished what it must do to be entitled to the revenues [ (FASB, 2011c) ]. The SEC provides further guidance in SAB 104. For revenue to be both realized or realizable and earned, the following four conditions must be met: * There must be persuasive evidence of an arrangement. * Delivery has occurred or services have been rendered. * The seller’s price to the buyer is fixed or determinable. * Collectability is reasonably assured [ (SEC, 2003) ]. The Power Starterpack activation card meets these four conditions. When purchasing the Power Starterpack, the subscriber must return the old activation card to Velocity and install the new activation card. This activity fulfills the first two criteria. The Power Starterpack is paid for at the time of sale and there are no additional costs to the buyer. This satisfies the final two criteria. Revenue can be recognized for the activation card at the time of purchase. The revenue from the prepaid voucher for $50 worth of airtime cannot be recognized at the time of sale because the services have not been rendered and therefore, have not been earned. The prepaid voucher is analogous to a gift card with an expiration date. There is very little GAAP guidance to address how to account for gift cards. Industry practice varies, but the recommended approach is to recognize revenue as the card is presented to the issuer in exchange for goods or services [ (Marden & Forsyth, 2007) ]. In the case of the $50 prepaid airtime voucher in the Power Starterpack, revenue should be recognized as airtime is used. If a balance remains at the expiration date, the revenue for the remaining balance should be recognized on the expiration date. If the subscriber’s account terminates due to inactivity, the remaining balance on the card can be recognized at that time. In a speech before the 2005 AICPA National Conference on Current SEC and PCAOB Developments, Pamela R. Schlosser, Professional Accounting Fellow with the SEC’s Office of the Chief Accountant, presented this approach as acceptable to the SEC [ (Schlosser, 2005) ].
Conclusion
The deliverables in Velocity Cellular’s Power Starterpack qualify as separate units of accounting. Revenue of $150 should be allocated to the activation card and recognized at the time of purchase. Revenue of $50 should be allocated to the prepaid voucher, but cannot be recognized until the airtime is used. In the event the prepaid voucher expires before it is fully used, revenue should be recognized in the amount of the remaining balance on the expiration date. If the subscriber’s account terminates due to seven months of continuous inactivity, revenue should be recognized in the amount of the remaining voucher balance at the time of account termination.

References
FASB Emerging Issues Task Force. (2009, October). Accounting Standards Update No. 2009- 13. Retrieved February 14, 2011, from FASB: http://asc.fasb.org/imageRoot /62/6844362.pdf
FASB. (2011a). Revenue Recognition, Multiple-Element Arrangements, Initial Measurement (605-25-30-2 through 605-25-30-6A). Retrieved February 15, 2011, from FASB: http://asc.fasb.org/viewpage?nav_type=goto&ovcmd=goto&codification_text=605-25-30
FASB. (2011b). Revenue Recognition, Multiple-Element Arrangements, Recognition, General Units of Accounting (605-25-25-5). Retrieved February 15, 2011, from FASB : http://asc.fasb.org/section&trid=2197284%26analyticsAssetName=subtopic_page_sectio n%26nav_type=subtopic_page#2197284
FASB. (2011c). Revenue Recognition, Overall, Recognition, General, Revenue and Gains (605- 10-25-1). Retrieved February 14, 2011, from FASB: http://asc.fasb.org/ viewpage?nav_type=goto&ovcmd=goto&codification_text=605-10-25
Marden, R. E., & Forsyth, T. B. (2007, November). Giftcards and financial reporting: unwrapping the uncertainties of revenue-recognition and other issues. Retrieved February 15, 2011, from The CPA Journal Online: http://www.nysscpa.org/cpajournal /2007/1107/essentials/p28.htm
Schlosser, P. R. (2005, December 5). Statement by SEC staff: remarks before the 2005 AICPA National Conference on Current SEC and PCAOB Developments. Retrieved February 14, 2011, from SEC: http://www.sec.gov/news/speech/spch120505ps.htm
SEC. (2003, December 17). Staff Accounting Bulletin No. 104. Retrieved February 10, 2011, from SEC: http://www.sec.gov/interps/account/sab104rev.pdf