You did such a great job on Project I that Rosalie Gerst, your immediate supervisor (the professor) now feels confident you can conduct professional accounting research using the FASB Accounting Standards Codification (ASC). She called an impromptu meeting Wednesday morning to discuss one of the firms largest clients, Larson Industries; a manufacturer of carpentry and other premium handheld and mechanical tools. Rosalie asks, could you prepare a report that addresses multiple complex revenue recognition issues facing Larson Industries new contract with Dynamic Wholesale, Inc.? Further, Rosalie agrees to provide the details of the contract between Larson and Dynamic in a separate document (case study file). Using ACS 606 and IFSR 15.

The Contract:

Agreement between Larson and Dynamic The purchase order from Dynamic called for 1 million standard AM300s priced at $152 each to be shipped on May 15, terms n/90, so that Dynamic had the opportunity to accept the shipment and place the goods on warehouse floors by May 31. The agreement transfers legal title of the goods to Dynamic at the point of delivery at the warehouses. Dynamic will price the goods at $249.99, the same price offered at Larsons stores and website. The company also indicated interest in purchasing 1 million more products from Larson within the next year. However, the company currently did not have the warehouse capacity to house the products and company managers were not certain as to when inventory would need to be reordered. Larson offered to reserve the additional products for Dynamic and instructed inventory personnel to set the inventory aside on separate 66 McNellis, Barone, and Herbold Issues in Accounting Education Volume 35, Number 2, 2020 pallets at the shipping locations, and told the accounts receivable department to send an invoice immediately to confirm Dynamics interest in the additional goods. The transaction, while mutually beneficial for both companies, came with certain risks that Dynamic and Larson addressed in the initial purchase contract. Because the agreement represented a new venture into the wholesale space, one of Larsons concerns was that the AM300 would not sell efficiently at the $249.99 price point. Such a situation could halt any future orders from Dynamic, potentially taking away Larsons momentum in this part of the supply chain. Accordingly, Larson included in the agreement a volume discount to Dynamic in a two-tiered plan. First, if Dynamic purchases a total of 1.5 million products within six months (i.e., an additional 500,000 goods beyond the initial 1 million products ordered), Larson will provide a 10 percent retroactive discount on all 1.5 million products. Second, for any purchases beyond the 1.5 million products within the six months, Larson will offer a 12 percent discount to the additional purchases. In accordance with the risk of idle warehouse inventory, Larson was also worried that Dynamic may be prompted to offer significant store discounts to free up warehouse space. The volume discounts would certainly allow Dynamic to do so without sacrificing its expected profit margin for the AM300. Store discounts, however, could send a negative signal to the consumer market about the relative quality of the AM300. To alleviate these concerns, Larson offered price protections to Dynamic, stipulating that Dynamic would not offer any trade discounts to customers, aside from the standard 5 percent discount provided to consumers using the Dynamic store credit card, and that any unsold items could be returned to Larson within the first 60 days after May 31. Larson includes this price protection clause in its agreements with all business customers. This part of the agreement was viewed favorably by Dynamic, whose chief concern was the inventory risk it was undertaking. While Larson was interested in protecting the perception of its flagship product, it was also intently focused upon increasing sales volume of the AM300 through a targeted plan. At the time of the agreement, Larson was developing a manufacturers coupon, entitling customers to $50 off the AM300, with a 60-day expiration date. The coupon would allow customers to redeem it on purchases from Larsons website and factory outlets or at any retailer that accepts manufacturer coupons. Retailers that accept the coupon could present any coupons received from customers to Larson for reimbursement of the $50. Larson felt as though such a coupon gave the company control over the perception of product quality more effectively than if the retailers/wholesalers had license to discount the product at differing price points. When Dynamic learned of Larsons plans, however, they became concerned that this coupon could drive sales away from its warehouses, especially with the price protection agreement in place and Dynamics general policy with regard to manufacturer coupons. To counter, Dynamic offered to accept Larsons coupon as long as Larson did not honor coupon reimbursement requests from any other retailers, thereby removing other retailers incentive to accept the coupon. Accordingly, the final coupon, limit one per customer, was to be included in major newspapers across the country on May 31, explicitly redeemable only at Larson and at the point-of-sale at Dynamic. In order to promote the success of the agreement, Dynamic arranged product demonstrations of the AM300 at all of its warehouses on the first weekend of each month from JuneAugust 2019. The demonstration will be by Jackson Marketing Services. With regard to the aforementioned perceptions of quality, though, Larson was skeptical about the nature of the product demonstrations, as ineffective promotion could result in slow-moving inventory and perhaps greater returns from Dynamic. As such, Larson demanded partial responsibility in creating the demonstration script and thus agreed to split the cost of the product demonstrations with Dynamic. Dynamic, however, was adamant that (1) the ultimate presentation still follow Dynamics typical style seen for all products and (2) the demonstration only promote the accessories included in the AM300. Larson ultimately agreed to Dynamics points. Because Jackson and Dynamic have an ongoing relationship with regard to product demonstrations taking place at the warehouses, Jackson billed Dynamic for the costs associated with the demonstration services prior to each event. In turn, Dynamic gave Larson the option to pay its share of the costs by remitting payment to Dynamic or by directly paying Jackson. Larson indicated that the first payment would be made directly to Jackson. The sale of the AM300 to Dynamic has the potential to significantly increase Larsons volume, yet the company also understands the importance of the accessories sales to its business model. Given the nature of the product demonstrations to take place, Larson is concerned that Dynamic customers will focus extensively on the accessories included with the AM300 product and will be unaware of or will ignore the other accessories available at the companys website and stores. To address this issue, Dynamic agreed to sell the companys gift cards in addition to other retailers gift cards offered in the kiosks at Dynamic. In turn, though, Dynamic was worried that the gift cards would lead customers to forgo purchases of the AM300 at Dynamic warehouses, opting in favor of buying the gift cards and ultimately purchasing the product directly from Larson. As such, Larson agreed to pay a 3 percent commission to Dynamic on the value of gift cards sold at Dynamic. The industry standard, and the commission rate used by both Dynamic and Larson, is typically 2 percent. Finally, with the agreement in place and with the increase in volume of sales occurring outside of Larsons stores and website, the company focused on the risk of a deterioration in customer service. Larson is very popular within the industry for its service to customers experiencing issues with its products and accessories. As such, Larson asked Dynamic to accept all warranty claims for the AM300 at its warehouses within the first year of sale to its customers, thus providing a convenient Larson Industries: A Case on Identifying and Researching Revenue Recognition Issues 67 Issues in Accounting Education Volume 35, Number 2, 2020 option for customers experiencing problems with the product. For claims on the main product, Larson has instructed Dynamic to provide customers the option of a refund or an exchange for a new AM300. Dynamic will send these products back to Larson, and Larson will reimburse Dynamic for the refund or exchange amount and shipping costs. After the first year, all warranty claims must be made directly to Larson.