I need help with part 2. I have included the entire case so you can see all of the information. I am working on a case study. I have copied and pasted the full case study and my response so far. I have a question about the calculation using the expected cost plus margin approach. I do not know which numbers to use to get the percentages of the obligations. I know there are 2 performance obligations, the first one is the equipment and integration service and the second one is the service maintenance part. Do I use 10 million, 9.5 million? Also, once I have the percentage do I multiply it by the 9.5 million? I am only working on part two. Revenue recognition steps 4 and 5.

I am only working on part 2. Here is the case study below:

The Case, Part 1:

EYE SPY sells sophisticated video surveillance equipment. EYE SPY sells the equipment and computer integration services together.It does not sell these separately. The equipment cannot operate without being fully integrated with a computer system. Significant customization is required during this integration. Other competitors could theoretically provide computer integration services. Historically, EYE SPY has not sold maintenance services.

The sales manager for EYE SPY anticipates receiving a signed contract from Secret Manufacturing (SM) to provide equipment and to perform computer integration services for that surveillance equipment. EYE SPY expects to have everything operational within one year, at which time full payment is due. SM will not get control of the video surveillance equipment until the integration is completed and EYE SPY turns control of the system over to SM. EYE SPY management expects to be able to have the system fully operational and available for use by SM in the 12^th month of the contract.

In the initial contract negotiation stage, the contract price with SM was $10.1 million in cash.However, as part of the final contract negotiations, SM agreed to give EYE SPY its old surveillance equipment in exchange for a credit of $100,000. It is expected that this old surveillance equipment will not be decommissioned until the new equipment is operational. Based on its extensive experience, EYE SPY's management believes it is probable that the estimated fair value of the old equipment at the contract inception date is $115,000.

For this contract, EYE SPY decided to offer maintenance services. As part of the initial contract negotiations, EYE SPY told SM they would be asking for $300,000 related to the five-year maintenance contract. SM informed EYE SPY that several competitors were offering attractive pricing to obtain this maintenance work. In order get the maintenance work, EYE SPY agreed to offer the maintenance services for $200,000. The contract price of $10.1 million includes this five-year maintenance agreement that will commence after the installation is completed.

There is also a provision in the contract that SM would receive a discount (similar to that which would be reflected in a separate financing transaction between EYE SPY and SM) from the contract price of $10.1 million if they pay the cash component within three days of when the contract is signed. EYE SPY determined a discount of $500,000 for this financing based on applying the typical credit rate for the equipment and integration services to be delivered at the end of year one and the monthly delivery of maintenance services in year two through six of the contract.

Due to deep security concerns and recent losses of proprietary information, SM also is offering a bonus to EYE SPY if the integration is completed early and EYE SPY has agreed to pay a penalty if the integration is completed late. EYE SPY has a large number of contracts with bonus characteristics similar to this proposed contract with SM. The following is the schedule of the potential bonus or penalty. While no specific outcome is probable, EYE SPY's management assessment of the likelihood of completing the integration in the specified time frame is based on significant historical experience with similar integration jobs.

Completed

10 months bonus $100,000 percentage 17%

11 months bonus $50,000 percentage 27%

12 months bonus 0 $percentage 46%

13 months penalty (50,000) percentage 7%

14 month penalty (100,000) percentage 3%

15 months plus penalty (500,000) percentage 0%

Total percentage 100%

SM has a great credit rating and always pays its bills.

EYE SPY's sales manager is very pleased because he is supposed to receive a 2% bonus based on the $10 million (after credit for equipment) contract price, payable upon receipt of a signed contract. Additional costs related to acquiring the contract include the costs of the marketing group which supports the sale manager. The total annual salaries for the marketing group are $400,000. On average, the marketing group works on 20 proposals each year. This contract is expected to have a 15% to 20% margin.

Scenario, Part 2

On July 1, 2020, EYE SPY received a signed contract for $10 million (after the $100,000 credit for the old equipment) with all negotiated terms, as described in part 1. Taking the discount, SM wired $9.5 million to EYE SPY two days after the contract was signed. In the interest of full and expanded disclosure, EYE SPY has decided not to apply the practical expedient in ASC 606-10-32-18.

On May 31, 2021, the system became fully operational. The system was tested and accepted by SM. The old surveillance equipment was decommissioned when the new system was installed. The old equipment was shipped to EYE SPY by June 1. The old surveillance equipment was sold during June for $120,000. For the sake of simplicity, no financing component needs to be allocated to the maintenance contract.

EYE SPY has forecasted a cost of $8.136 million for the equipment and integration required by the contract. It has forecasted the cost of the maintenance services at $164,000.

INSTRUCTIONS for PART 2: write a second Accounting Issues Memo addressing the concerns of EYE SPY with respect to the last 2 steps of revenue recognition.

The client is uncertain about the allocation of the transaction price, if more than 1 performance obligation was identified in part 1.

The client is uncertain when revenue may be recognized during the time of the contract.

The client wants guidance as to the implications for its financial statements as of the May 31 and June 30, 2021. (Note: Even if you conclude that some journal entries should be recorded monthly, for purposes of this case, show the cumulative journal entry recorded for the months of May and June.Show all calculations.)

Here is what I have so far:

To: Eye Spy,Accounting Files

From: Accounting

Date: 7/01/2021

RE: Accounting for Revenue by apply the last 2 steps of the Revenue Recognition guidance (Topic 606) to contract revenue from Secret Manufacturing (SM)

Facts

July 1, 2020, SM delivered the sign contract for $10 million (after the $100,000 credit for the old equipment) with all previously negotiated terms. SM elected to take the $500,000 discount and paid $9.5 million two days after delivering the signed the contract. In the interest of full and expanded disclosure Eye Spy, has elected to not apply the practical expedient in ASC 606-10-32-18.

The system was fully functional on May 31, 2021. SM tested and accepted the system.The old equipment was decommissioned and shipped to Eye Spy by June 1. The old equipment was sold in June for $120,000. No financing component will be allocated to the maintenance contract.

The forecasted cost for the equipment and integration required in the contract is $8.136 million. The forecasted cost of the maintenance service is $164,000.

Issues

1. How should the transaction price be allocated to the 2 identified performance obligations?

2. When should the revenue be recognized during the time of the contract?

3. What are the implications for the financial statements?

Analysis-Issue 1: How should the transaction price be allocated to the 2 identified performance obligations?

FASB Accounting Standards Codification (ASC) 606-10 (Revenue from Contracts with customers) provides the following guidance for:

32-33

If a standalone selling price is not directly observable, an entity shall estimate the standalone selling price at an amount that would result in the allocation of the transaction price meeting the allocation objective in paragraph606-10-32-28. When estimating a standalone selling price, an entity shall consider all information (including market conditions, entity-specific factors, and information about the customer or class of customer) that is reasonably available to the entity. In doing so, an entity shall maximize the use of observable inputs and apply estimation methods consistently in similar circumstances.

32-34 Suitable methods for estimating the standalone selling price of a good or service include, but are not limited to, the following:

a.Adjusted market assessment approachAn entity could evaluate the market in which it sells goods or services and estimate the price that a customer in that market would be willing to pay for those goods or services. That approach also might include referring to prices from the entity's competitors for similar goods or services and adjusting those prices as necessary to reflect the entity's costs and margins.

b.Expected cost plus a margin approachAn entity could forecast its expected costs of satisfying a performance obligation and then add an appropriate margin for that good or service.

c.Residual approachAn entity may estimate the standalone selling price by reference to the total transaction price less the sum of the observable standalone selling prices of other goods or services promised in the contract. However, an entity may use a residual approach to estimate, in accordance with paragraph606-10-32-33, the standalone selling price of a good or service only if one of the following criteria is met:

1.The entity sells the same good or service to different customers (at or near the same time) for a broad range of amounts (that is, the selling price is highly variable because a representative standalone selling price is not discernible from past transactions or other observable evidence).

2.The entity has not yet established a price for that good or service, and the good or service has not previously been sold on a standalone basis (that is, the selling price is uncertain).

In this instance the expected cost plus a margin approach should be used. There are two performance obligations which need to have costs allocated to them. In order to calculate the cost. We start with.

Analysis-Issue 2: When should the revenue be recognized during the time of the contract?

FASB ASC 606-10 provides the following guidance for recognizing revenue as follows:

25-23Satisfaction of Performance Obligations

An entity shall recognizerevenuewhen (or as) the entity satisfies aperformance obligationby transferring a promised good or service (that is, an asset) to acustomer. An asset is transferred when (or as) the customer obtains control of that asset.

25-24 For each performance obligation identified in accordance with paragraphs606-10-25-14 through 25-22, an entity shall determine at contract inception whether it satisfies the performance obligation over time (in accordance with paragraphs606-10-25-27 through 25-29) or satisfies the performance obligation at a point in time (in accordance with paragraph606-10-25-30). If an entity does not satisfy a performance obligation over time, the performance obligation is satisfied at a point in time.

Measuring Progress toward Complete Satisfaction of a Performance Obligation

25-31For eachperformance obligationsatisfied over time in accordance with paragraphs606-10-25-27 through 25-29, an entity shall recognizerevenueover time by measuring the progress toward complete satisfaction of that performance obligation. The objective when measuring progress is to depict an entity's performance in transferring control of goods or services promised to acustomer(that is, the satisfaction of an entity's performance obligation).

25-32An entity shall apply a single method of measuring progress for each performance obligation satisfied over time, and the entity shall apply that method consistently to similar performance obligations and in similar circumstances. At the end of each reporting period, an entity shall remeasure its progress toward complete satisfaction of a performance obligation satisfied over time.

Methods for Measuring Progress

25-33Appropriate methods of measuring progress include output methods and input methods. Paragraphs606-10-55-16 through 55-21provide guidance for using output methods and input methods to measure an entity's progress toward complete satisfaction of a performance obligation. In determining the appropriate method for measuring progress, an entity shall consider the nature of the good or service that the entity promised to transfer to the customer.

25-34When applying a method for measuring progress, an entity shall exclude from the measure of progress any goods or services for which the entity does not transfer control to a customer. Conversely, an entity shall include in the measure of progress any goods or services for which the entity does transfer control to a customer when satisfying that performance obligation.

Based on the guidance from the FASB codification, revenue for each performance obligation should be recognized as the obligation is satisfied. For the equipment and integration services the revenue will be recognized once the equipment and integration is completed and SM takes control of the equipment and services.

The maintenance service will be recognized over the time of the service agreement. The total cost of the service, $200,000 should be recognized as unearned revenue. The $200,000 should be allocated to the 5 years of required service and each year the portion of the payment corresponding to that year will be recognized.

$200,000 (cost of maintenance service)/ 5 (years)= 40,000 per year.

Analysis-Issue 3: What are the implications for the financial statements?

ASC 340-40 (Other Assets and Deferred Costs -Contracts with Customers) provides the following information regarding incremental costs of

Conclusion

Issue 1: I How should the transaction price be allocated to the 2 identified performance obligations?

In order to allocate the transaction price to the performance obligation, the expectant cost plus margin method is used. We first find the percentage of the transaction price that is representative of the amount of each cost. Multiple the percentage times the total contract price to find the amount allocated to each performance obligation.

Issue 2: When should the revenue be recognized during the time of the contract?

Revenue should be recognized as each performance obligation is fulfilled. The first obligation was fulfilled when the equipment was installed, integration was complete and SM took ownership of the fully integrated equipment.

The performance obligation of the maintenance will be performed over a five year period. Each year the revenue earned for the service maintenance will be recognized. We calculate that amount as the full price of the service, $200,000 divided by the number of years of the agreement, in this case 5 years. Each year revenue of $40,000. Will be recognized.

Issue 3: What are the implications for the financial statements?

Dislosure