Mesmerizing Marketers Revenue Recognition Case Study

MEMO

Mesmerizing Marketers

Date: July 20, 2020

Prepared By: XYZ

Re: Mesmerizing Marketers Revenue Recognition Case

BRIEF BACKGROUND OF THE COMPANY

MM – Mesmerizing Marketers is a marketing company that endeavors a wide range of marketing offering to its customers. Specifically:

• MM is in the process of creating a TV commercial which will worth $1M, an app worth $500K and a Facebook page worth $250K. The amounts indicated for each of the function represents the charges imposed by MM for such items when sold to customers individually. The activities indicated are not inter-related to each other i.e., each function is an independent offering of MM.
• If the customer agrees to purchase a TV commercial, an app and the Facebook page altogether, the price will be $1.5M. The payments terms are 50 percent consideration due at the time of signing the contract while the other 50% will be due over the rest of the development period. The bifurcation of which is – 25% at mid-point and remaining 25% at the time of completion.
• If the app is downloaded 500K times or more in the first month, there is a one-time bonus of 250K payable to MM.

Stone – the customer, approached MM to expand its customer base. MM and stone entered into a verbal contract on November 30, 20x5 for one TV commercial, one app and a Facebook page. MM had done a credit check on stone to check its capability to pay for the ordered items. Stone turned out to be sound and is capable of paying to MM. If, in case, Stone cancel the order other than the fact that MM could not comprehend the contract as promised, Stone will be at a liability to pay MM.

Stone made the promised payment of 50% at the time of the initiation of the contract i.e., Stone paid $750K to MM on November 30, 20x5. It took MM six months to complete the TV commercial, two weeks to complete the Facebook page and three months to complete the app. It was predicted by MM that the customer base of Stone will not adapt new technology as soon as it comes out. So, it will take almost three months for the customers of Stone to start using the app due to which the condition of the app being downloaded for 500K times in the first month will not be possible.

KEY CONSIDERATION INVOLVED IN THE ACCOUNTING QUESTIONS

MM’s CFO is trying to understand the new revenue recognition model and has asked to explain how MM would account for the scenario under the new standard.

1. How should MM account for the above offering with Stone under the new revenue recognition model?
2. How would your conclusions change if:

1. The app sold to Stone is actually downloaded more than 500K times in the first month?
2. MM believes at the outset that there is about a 75 percent chance that the app will be downloaded more than 500K times and it is probable that there will not be a significant reversal of revenue?

SUMMARY CONCLUSIONS OF ACCOUNTING QUESTIONS

1. MM should account for the offerings on the basis of the percentage of contract completion method and based on the percentage of service completed. As of November 30, 20x5, MM recognized 50% of the revenue at the time of the inception of the contract as stated in the case.

1. In this case, MM is entitled to recognize the one-time bonus of $250K on March 31, 20x6.
2. Here, MM would we recognizing the revenue on the basis of the % of each performance obligation.

                                                                                                                       BONUS

AUTHORITATIVE AND INTERPRETIVE GUIDANCE

1. Refer to ASC 606-10-05-4 (Five-step revenue recognition process)
2. Refer to ASC 606-10-32-8 (Estimating Variable Consideration)
3. Refer to ASC 606-10-55-16 (Methods for measuring progress toward complete satisfaction of performance obligation).
4. Refer to ASC 606-10-32-28 (Allocating the Transaction Price to the Performance Obligation)
5. Refer to ASC 606-10-32-40 (Allocation of Variable Consideration).

DETAILED DISCUSSION, ANALYSIS, EVALUATION OF ALTERNATIVES AND REASONS FOR CONCLUSIONS

Here, it is important to understand the five-step process set forth in ASC 606-10-05-4, in order to understand the new revenue recognition standard and in order to answer the above-mentioned questions.

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According to ASC 606-10-05-04, “An entity recognizes revenue in accordance with the core principle by applying the following steps:

• Step 1: Identify the contract(s) with a customer – A contract is an agreement between two or more parties that creates enforceable rights and obligations. The guidance in this Topic applies to each contract that has been agreed upon with a customer and meets specified criteria.

• There is clearly a verbal contract between MM and stone. All the criterias of the contract are in compliance with the case. Thus, it would be fair to say that a contract exists.

• Step 2: Identify the Performance Obligations in the Contract -  A contract includes promises to transfer goods or services to a customer. If those goods or services are distinct, the promises are performance obligations and are accounted for separately. A good or service on its own or together with other resources that are readily available to the customer and the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.

• If all the goods are identified separately, they have the tendency to generate economic benefits independently. It has been vividly shown in the case that the TV commercial, an app and the Facebook page are not inter-related. They all have their different prices and can be sold individually or together as well. Also, Stone had the option to decide what to buy and what not to and it would not affect the other items. Clearly, there are three performance obligations to be fulfilled. The creation and deliverance of:

• Facebook Page
• TV Commercial
• App

• Step 3: Determine the Transaction Price – The transaction price is the amount of consideration in a contract to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. The transaction price can be a fixed amount of customer consideration, but it may sometimes include variable consideration or consideration in a form other than cash.

• MM can expect the following sale consideration as Transaction price:

• $1.5 M for marketing the products as per agreement
• If the app is downloaded 500K times in the first month, $250K would be payable to MM as a one-time bonus.

ASC 606-10-32-8 states that MM should use any method which predicts more accurately the amount of consideration to be received. Since, MM predicted as per the customer base of Stone that the additional one-time bonus will not be received, it should use the most likely amount method and recognize zero bonus revenue.