Hasenpflug Industries, Inc. (HII) is a privately held company located in Atlanta, GA. HII is in its 2nd generation of ownership. HII has two main sources of revenue, each are distinct and separate from the other.

First, HII manufactures and sells racing go-karts for distribution in the U.S. This revenue stream represents approximately 70% of HII’s total net sales. Initially, HII’s business model was to manufacture their karts with no options or upgrades for the consumer market. However, over the course of time, their customer base, which expanded to include racing enthusiasts, racing clubs and weekend racers alike, demanded the ability to customize their orders and karts. Some of the options that HII now offers to its customers include the following upgrades:

1. 2 styles of tires – one for traction/grip and another for speed
2. 2 types of engines – electric or gasoline
3. Various options for aerodynamics, including front and rear diffusers
4. Various options for weight reduction, including aluminum or steel frame castings
5. Customized paint colors and graphics

In the early years, HII’s average sales price for one kart was approximately $1,500. Today, HII’s kart prices can range from $2,000 to $4,000 per kart, depending on the options and upgrades chosen by the customer.

On average, for a basic kart with no options or upgrades, and selling at $2,000 per kart, HII realizes a gross profit percentage of approximately 23%. On the high end, for a kart selling at approximately $4,000, HII typically realizes a gross profit percentage of approximately 32%.

HII manufactures and stocks in inventory its basic line of karts. This business model offers HII the ability to meet customer orders for basic karts when needed, but also gives flexibility to HII to modify/upgrade this basic kart for customer requested modifications when requested. The building of the customized karts is done consistently from the first day manufacturing begins until the karts are shipped to the end customer.

Secondly, HII, through its deep contacts and connections in the kart-racing network, generates revenue through conducting employment searches for kart racing and related businesses, some of whom are already customers through the purchase of karts. Through these connections, HII mainly secures retained search contracts for its customers interested in finding general manager and related types of positions. HII fees for these searches are generated by charging its customers 30% of the estimated annual compensation of the positions wished to be filled. On the onset of a search contract, HII and the customer estimate the annual compensation package needed for the desired position and then bills the customer in three equal installments, over the life of the contract. The three installments are billed at the following dates:

1. Signing of the engagement letter, which is meant to represent the start of the work
2. At the time candidates are presented to the customer for review
3. Upon successful acceptance of employment by the candidate

In many situations, there is a fourth invoice sent to the customer related to the search contract. This fourth and final invoice would represent the additional amount owed to HII based on the actual compensation of the candidate placed so that total billings are equal to 30% of the placed candidate’s annual compensation. Hll has analyzed how often a fourth invoice is generated and has concluded that 60% of the time a fourth invoice is required and the initial estimate of the annual compensation in the engagement letter is lower than actual by 20%.

HII has a December31financial reporting year-end and conducts an audit each year under U.S. GAAP.

Sales Example #1

HII sells 50 karts to Chicagoland Raceway, LLC on December 15, 2018. These karts are not customized and are simply the basic model of kart offered by HII. The total sales value of this order is $105,000, pre sales tax. Sales tax is to be applied to this order at 9%. The expected gross margin on this sale is 22%. Shipping terms offered by HII for this sales transaction are FOB Shipping Point and HII uses a 3^rd party carrier to ship these 50 karts to this customer on December 31, 2018.

Sales Example #2

HII sells 25 karts to Phoenix Racing, LLC on November 2018. These karts are slightly modified from the basic model of kart offered by HII and HII believes these carts could be sold to another customer with some or little effort. The total sales value of this order is $74,000, pre sales tax. Sales tax is to be applied to this order at 8%. The expected gross margin on this sale is 27%. Shipping terms offered by HII for this sales transaction are FOB Shipping Point and HII uses a 3^rd party carrier to ship these 25 karts, when fully completed. The karts were shipped to this customer on December 28, 2018.

Included in the sales contract with Phoenix are terms that provide for HII to be compensated for costs incurred to date should Phoenix Racing, LLC cancel the order before delivery.

Sales Example #3

HII sells 25 karts to Los Angeles Motor Speedway, Inc. on September 1, 2018. These karts are significantly modified from the basic model of kart offered by HII. HII believes that due to the significant modifications on these carts, it would be very difficult to find another buyer for these highly customized carts. The total sales value of this order is $97,500, pre sales tax. Sales tax is to be applied to this order at 10%.The expected gross margin on this sale is 33%. Shipping terms offered by HII for this sales transaction are FOB Shipping Point and HII uses a 3^rd party carrier to ship these 25 karts, when fully completed, to this customer on December 29, 2018.

Included in this sales contract with this customer are the terms that require the customer to reimburse Hll for costs incurred to date along with a normal profit margin should they cancel before these units are finished and shipped.

Sales Example #4

The terms of this sale are identical to Sales Example #1 except that HII is responsible for insuring the karts and other in transit risks during shipment from HII to the end customer.

Sales Example #5

On September 27, 2018, a customer engaged HII for a retained search related to their facilities manager position that has been open for 6 weeks. The candidates that have applied directly to the customer have been less experienced than desired, and thus, the customer has engaged HII to conduct the professional search. The position’s compensation package was estimated at $90,000, including benefits. HII estimated that the contract period would last no more than 90 days.

After 100 days, HII’s has fulfilled all of its obligations under this search contract. In addition, the final compensation package as negotiated by the accepted candidate totaled $120,000.

Students’ Requirements

1. Please compare and contrast the similarities or differences for each of the five sales examples between ASC 605 and ASC 606.

2. Please conclude on when revenue should be recognized for each of the five sales examples under both ASC 605 and ASC 606.