(Allocate Transaction Price) Crankshaft Company manufactures equipment. Crankshaft’s products range from simple automated machinery to complex systems containing numerous components. Unit selling prices range from \(200,000 to \)1,500,000 and are quoted inclusive of installation. The installation process does not involve changes to the features of the equipment and does not require proprietary information about the equipment in order for the installed equipment to perform to specifications. Crankshaft has the following arrangement with Winkerbean Inc.

• Winkerbean purchases equipment from Crankshaft for a price of \(1,000,000 and contracts with Crankshaft to install the equipment. Crankshaft charges the same price for the equipment irrespective of whether it does the installation or not. Using market data, Crankshaft determines installation service is estimated to have a standalone selling price of \)50,000. The cost of the equipment is \(600,000.

• Winkerbean is obligated to pay Crankshaft the \)1,000,000 upon the delivery and installation of the equipment.

Crankshaft delivers the equipment on June 1, 2017, and completes the installation of the equipment on September 30, 2017. The equipment has a useful life of 10 years. Assume that the equipment and the installation are two distinct performance obligations which should be accounted for separately.

Instructions

(a) How should the transaction price of $1,000,000 be allocated among the service obligations?

(b) Prepare the journal entries for Crankshaft for this revenue arrangement on June 1, 2017 and September 30, 2017, assuming Crankshaft receives payment when installation is completed.

Step by step solution

01

Meaning of Service Obligation

A service obligation is a contractual commitmentmade by a supplier to its customers to provide the service at the specified timeand at aspecified price or perform according to the contract.

02

Transaction price be allocated among service obligations and Journal entries for Crankshaft.

a. Transaction priceof $1,000,000 be allocated among service obligations:

Based on their respective standalone selling prices, thetotal income of $1,000,000 should be distributed to the two performance commitments (using relative fair values.) The fair valueof the equipment should be $1,000,000, and the fair value of the installation charge should be $50,000 in this scenario. The total fair value will be:

$$\begin{gathered} \mathrm{Tot}\mathrm{al}\mathrm{fair}\mathrm{value}=\mathrm{Value}\mathrm{of}\mathrm{Equipment}+\mathrm{Installation}\mathrm{Charges} \\ =\$1,000,000+\$50,000 \\ =\$1,050,000 \end{gathered}$$

s

$$\begin{gathered} \mathrm{Equipment}=\frac{\mathrm{Value}\mathrm{of}\mathrm{Equipment}}{\mathrm{Total}\mathrm{fair}\mathrm{value}}\times \mathrm{Transaction}\mathrm{Price} \\ =\frac{\$1,000,000}{\$1,050,000}\times \$1,000,000 \\ =\$952,381 \end{gathered}$$

$$\begin{gathered} \mathrm{Installation}=\frac{\mathrm{Installation}\mathrm{charges}}{\mathrm{Total}\mathrm{fair}\mathrm{value}}\times \mathrm{Transactipn}\mathrm{Price} \\ =\frac{\$50,000}{\$1,050,000}\times \$1,000,000 \\ =\$47,619 \end{gathered}$$

b. Journal entries:

Date	Particular	Debit ($)	Credit ($)
June 1, 2017	Cash a/c	1,000,000
	To Unearned service revenue a/c		47,619
	To Sales revenue (equipment) a/c		952,381
June 1, 2017	Cost of goods sold a/c	600,000
	To Inventory a/c		600,000
September 30, 2017	Unearned service revenue a/c	47,619
	To Service revenue a/c		47,619

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