Engineering World Inc.

Revenue Recognition Memo for Candy Rocks Ltd. Agreement

Mar, 2016

Introduction
Engineering World Inc. is a manufacturer of a three-component assembly line system. The system is sold for
$285,000 without installation services, and with installation services for a total of $300,000. Currently,
installation services are not available to be purchased separately. On March 15th, 2016, EWI entered into a sales
agreement with Candy Rocks Ltd. (CRL) for the sale of the assembly line system. EWI has also agreed to
install the system once the segments are delivered to CRL. Examined in this memo is how EWI will be
recognizing revenue from the Candy Rocks Ltd. sales agreement as well as briefly noting another method for
recognizing revenue if a different amount of performance obligations are determined.

Performance Obligations
EWI has determined one performance obligation in the agreement with CRL: to deliver and install the assembly
line system. According to ASC 606-10-25-14, a performance obligation must be capable of being distinct and
distinct within the context of the contract. Although there are three segments to the assembly line, one cannot
function without the others. The installation is also considered part of the same obligation because without EWI
installing the assembly line system, CRL cannot receive benefit from the system alone. This is supported under
ASC 606-10-25-21, which states the factors indicating when two or more goods or services are not separately
identifiable. Per the guidance, the installation service provided is not separately identifiable from the assembly
line segments because they are highly interdependent; EWI would not be able to fulfill its promise of
transferring each the assembly line system and the installation service independently.

Measurement
At present, EWI does not offer installation services without the purchase of the assembly line. The following
methods to determine an estimate of the stand-alone price of installation can be found in ASC 606-10-32-34.
The residual approach is shown below, and can only be used because EWI has not yet established a price for
installation services if sold separately.
Total price of assembly line with installation
Stand-alone price of assembly line
Estimated stand-alone price of installation

300,000
-285,000
15,000

The residual method results in the selling price being the same as the cost of installation, which does not
consider room for markup.
An additional method would be to use an expected cost plus a margin approach. The expected cost of
installation is $15,000. The average percent price markup for the three segments of the assembly line is 67
percent; therefore, to keep the margin consistent, the estimated selling price for installation services would be
approximately $25,000 ($15,000 x 1.67).
EWI can also estimate the installation price using the adjusted market assessment approach. It is understood that
a customer is willing to pay $36,000 for installation services based on the price an outside technician charged to
install the same assembly line. Because the installation process does not involve any modifications to the

Engineering World Inc.

Revenue Recognition Memo for Candy Rocks Ltd. Agreement
Mar, 2016
system, the $36,000 estimate from an outside technician may be an accurate estimation. However, this is
information on one customer, and the conditions of the customer are not known; for instance the customer may
have needed the system installed as soon as possible and was willing to pay more at the time. Other factors that
should also be taken into consideration include if the product was sold with right of return, if the installation
price is considered variable based on customer warehousing circumstances, and other current market conditions.
Based on the information above and all other observable inputs, EWI determines $36,000 as an appropriate
standalone selling price for installation services. However, because there is only one performance obligation and
the given prices will be used for revenue recognition, the standalone selling price of installation services does
not affect the allocation of the transaction price to the performance obligation.
Yet in order to see the affect of the standalone selling price, a situation with multiple performance obligations
will be briefly examined. In the event that EWI recognizes the delivery of the assembly line system and
installation service as two distinct performance obligations, the allocation of the transaction price would be
different. In this case, the transaction price, $300,000, should be allocated in proportion to the standalone selling
prices of the assembly line and installation service (ASC 606-10-32-31). The standalone price for the assembly
line is $285,000 and the standalone price of installation is $36,000, making up 89% and 11% of the total,
respectively. Using those percentages, EWI would allocate the $300,000 transaction price specified in the
contract as $267,000 for the assembly line system, and $33,000 for the installation service.

Revenue Recognition
EWI recognizes one performance obligation to deliver and install the assembly line system. EWI will recognize
revenue over time because the customer controls the asset for a period of time before it is installed. The
assembly line performance obligation satisfies the second requirement of ASC 606-10-25-27 to recognize
revenue over time: the customer controls the asset as it is being created. According to ASC 606-10-25-34, when
recognizing revenue over time EWI needs to include in the measure of progress any good or service for which
control is transferred to CRL while the performance obligation is being satisfied. CRL is determined to have
control of the asset because EWI has a present right to payment as the segments of the assembly line are
delivered and CRL has physical possession of the assets.
Using paragraphs of ASC 606-10-55-17 through 55-19 as a guideline, EWI has determined sufficient reliable
information required to apply a method of measuring progress. An output method of measuring progress will be
used, as it is straightforward to use milestones when the segments of the assembly line system are delivered to
CRL. The information required to apply an output method is readily available and directly observable: the
amount to be recognized is the selling price of each segment and will be recognized when each segment is
delivered.

Engineering World Inc.

Revenue Recognition Memo for Candy Rocks Ltd. Agreement
Mar, 2016
For the quarter ending March 31, 2016
The total amount of revenue that should be recognized is $210,000. This is calculated by adding the selling
price of the mixing segment and the molding segment (120,000 + 90,000), as those were the two segments
delivered to CRL on March 20, 2016.
Cash
Sales Revenue

210,000
210,000

For the quarter ending June 30, 2016

The total amount of revenue that should be recognized is the selling price of the packaging segment, which is
$60,000. The packaging segment was delivered on May 26, 2016.
Cash .
Sales Revenue .

60,000
60,000

For the quarter ended September 30, 2016

The total amount of revenue that should be recognized is $30,000 for the installation services provided on July
1, 2016.
Cash .
Sales Revenue .

30,000
30,000

If EWI assumes there is no evidence to support the use of the $36,000 estimate of the standalone selling price
for installation service, there will be no affect on the amount of revenue recognized. This is because revenue is
being recognized over a period of time, using amount of units delivered and services performed. The pricing of
each segment in the sales agreement is used when revenue is recognized, which means the standalone prices are
not utilized.
As mentioned earlier, there is a case in which the standalone selling estimates would have an affect on the
revenue recognition. In the event that EWI recognizes two performance obligations and allocates the transaction
price based on the standalone selling prices of the assembly line system and the installation service, the revenue
recognized for the quarters ended June 30, 2016 and September 30, 2016 would be affected. The three methods
for determining the standalone selling price of the installation service in accordance with ASC 606-10-32-34
were examined above. The most directly observable method for EWI is the expected cost plus a margin
approach, which estimates the selling price of installation services at $25,000. This is because it maintains a
percent margin and is more substantial evidence than a market estimate used by one customer in the past. If this
method were used instead, the following would be the amount of revenue recognized for each quarter.

Engineering World Inc.

Revenue Recognition Memo for Candy Rocks Ltd. Agreement
Mar, 2016
Quarter ended March 31, 2016: No revenue recognized
No performance obligation satisfied
Quarter ended June 30, 2016: $276,000
Performance obligation of delivery of all segments satisfied
(285,000=92% of 310,000; 300,000 x 92%)
Quarter ended September 30, 2016: $24,000
Performance obligation of installation services satisfied
(25,000=8% of 310,000; 300,000 x 8%)

Implementation Summary
In the sales agreement with Candy Rocks Ltd., Engineering World Inc. determined one performance obligation
to be recognized over time on an output basis of units delivered. Although there is another method in which
multiple performance obligations are present, EWI determined it to be more directly observable with one
performance obligation as the assembly line segments and the installation services are interdependent.
Throughout the course of the contract agreement, EWI will reassess the progress and market conditions to
ensure the most accurate method of revenue recognition.