Revenue Recognition in the Telecommunications Industry

PIRATE Wireless: Revenue Recognition in the Telecommunications Industry PIRATE Wireless is an international telecommunications company headquartered in the United States where it opened its first store in New York in 2003. PIRATE Wireless began offering smartphones to its customers in 2010 and due to great demand, was soon opening stores throughout the country, and then the world. PIRATE Wireless offers its customers voice and data services as well as other smartphone related software and accessories. Their marketing approach is to develop and advertise enticing packages that combine their various customer offerings into one transaction. Customers are drawn to the clever pirate themed graphic design of their advertisements as well as the savings provided by the discounted packages. Jim Bayley is one such customer. Jim is in the market for a new smartphone but does not have the time to research and shop for this purchase. He has an extremely demanding career and his time is severely limited. One afternoon, during a very short lunch break, Jim walked by a PIRATE Wireless store in lower Manhattan. The pirate, wearing blue garb and holding a smartphone, caught his eye as did the following advertisement on the window: Smartphone FREE 2-year Unlimited Voice and Data $75 per month FREE sounded good to Jim and he was ready to make a purchase. His current phone couldn’t hold its charge and Jim needed access to his client contacts at all times. He could not afford to be without a highly functioning smartphone. Jim desperately wanted to get back to the office but figured he would pop into the store and see if he could conduct this transaction quickly. In Jim’s line of work, he not only needs a smartphone, but encryption software for added protection. There were no signs for encryption software pricing so Jim approached Eliza, a PIRATE Sales Associate, and asked, “Excuse me, do you have encryption software for smartphones?” “Yes, we do,” she responds. “We have Cryptonite encryption software, but we sell it only as an add-on to a smartphone purchase,” she explained. “Were you planning to purchase a smartphone today?” 2 “Yes, I am interested in purchasing that bundle you have advertised over there,” Jim points to the giant sign. Eliza’s eyes lit up, “That is an amazing offer! I’m thinking of getting it myself. That purchase definitely qualifies for the Cryptonite add-on. The add-on normally sells for $100, but I think it might be free with this particular purchase. I can check that in the system if you’d like.” “No need, I’ll take it,” he responds. “Great! What color would you li….” she begins. “Black,” Jim interrupts. Noticing that he appears to be in a rush, Eliza hands Jim a purchase agreement to sign for the phone services and makes her way to the storage room in the back of the store to get his phone. She comes back with the device and places it in front of Jim who immediately opens the box, assembles his phone and turns it on. Eliza begins to process the payment, “Yes, that encryption software is free with this purchase.” “Great,” Jim responds. “How do I install the software?” “Oh, here is your PIN number” Eliza replies and hands Jim a card that looks similar to a calling card with a scratch off. “You go to the website on the back of the card and enter the PIN number. It will start to download automatically,” she continues to explain. Jim scratches the card with a quarter he pulls out of his pocket and opens his web browser. “Whoa now, hold your horses; the phone service won’t be activated until I finish ringing you up,” Eliza explains. “Sorry, I’m in a bit of a rush. I thought I could kill two birds with one stone,” Jim apologizes. Eliza smiles and continues ringing up the purchase. “I forgot to mention, you can use that encryption software on 2 additional devices. You can just go to the website from each device and enter the PIN. So, if you have a laptop or tablet, for instance, you can encrypt them too.” “Great!” 3 “Alright” Eliza replied. “You have a smartphone that normally sells for $600 and a $100 Cryptonite add-on, all for the low cost of $0 dollars.” “One more thing, is an extended warranty available?” Jim asks. Jim’s current smartphone was just eighteen months old and was no longer covered under the 1 year warranty that came with that purchase. The smartphone started giving Jim problems just after the 1 year mark. He was not going to let that happen again. “Yes. It’s $100 for 2 years of coverage. The device itself has a 1 year warranty, the extended warranty would cover years 2 and 3.” “Let’s add that.” “Ok,” Eliza says while she begins to add the warranty to the purchase. “Now for the service, you have the Unlimited Voice and Data Bundle for 2 years. Normally, the Voice is $45 and the Data is $40, but when we sell the services with a smartphone, which is 99% of the time, they are discounted to the $75 package price as posted on the sign.” “Ok.” Eliza prints a few sheets of paper and hands them to Jim. “Keep this paperwork. The first page is your account information including your phone number; the second is a breakout of the charges; and the third is the proof of purchase for your warranty,” Eliza explained while Jim flipped through the pages. “You’ll notice the total charges for today are $100. Will that be cash or credit?” “Cash,” Jim responds while pulling a $100 bill out of his wallet. “Is my phone activated?” he asked. “Yes it is. You are good to go.” Jim immediately opens the web browser and installs the encryption software. He then hastily grabs the charger, PIN card, and the paperwork Eliza left him, and hurriedly walks out of the store. Eliza places the $100 bill in the cash register, thankful for another completed transaction. 4 Several days later: You walk into the PIRATE Wireless store where Jim Bayley purchased his phone. You have just been hired as Assistant Controller by PIRATE Wireless Corp. and your chief task is to help your company implement Revenue from Contracts with Customers, the jointly converged standard issued by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). The Controller asked you to make site visits to various stores to get a sense for the types of transactions customers engage in. As part of your site visit, you review Jim Bayley’s sales transaction which his Sales Associate, Eliza, vouched was a fairly typical transaction for the store. She also provides some additional information which may assist you in determining the appropriate accounting treatment. Grateful for her assistance, you head back to corporate to determine the proper revenue recognition. Additional Information:  The Cryptonite PIN gives Jim access to software version 3.0 only. It does not provide Jim to access to any future updates or enhancements.  Jim does not use the Cryptonite PIN again until August 1, Year 1, when he purchases a tablet. He never uses the PIN on a 3rd device.  Jim is not required to make any payment to PIRATE Wireless Corp. until March 31, Year 1 when the first month's service bill is sent. Each month of service will be billed at the end of each month. Jim always pays his bills two days after the invoice date.  Claims on extended warranties provided by PIRATE Wireless generally occur evenly over years two and three. Case Requirements 1. As the new Assistant Controller of PIRATE Wireless Corp., use the Five-Step Revenue Recognition model below, describe the key points PIRATE Wireless should consider when recording the necessary journal entries for this transaction. Be sure to discuss each step, using the authoritative literature for support, as it applies to this case. The Controller of PIRATE Wireless 5 Corp. has provided you with suggested resources and an outline of steps to follow to facilitate your determination of the proper revenue recognition for this transaction and other scenarios. Use the FASB CRS (Codification Research System) or the IASB eIFRS (International Financial Reporting Standards) as your sources of authoritative literature. Other authoritative sources may be used to supplement the online resources. a. Step #1: Identify the contract with a customer. b. Step #2: Identify the separate performance obligations in the contract. c. Step #3: Determine the transaction price. d. Step #4: Allocate the transaction price to the separate performance obligations in the contract. e. Step #5: Recognize revenue when (or as) the entity satisfies a performance obligation. 2. Prepare the journal entries PIRATE Wireless will record over the life of the contract: a. Point of Sale on March 1, Year 1. (Only the Revenue side of the transaction is required, ignore Cost of Goods Sold recognition for purposes of this case.) b. Monthly provision of Voice and Data Service in Years 1 and 2. Note that the journal entry for each month of the 24 month period will be identical so only provide the entry for Month 1. c. Monthly collection of cash from Jim in Years 1 and 2. Note that the journal entry for each month of the 24 month period will be identical so only provide the entry for Month 1. d. Monthly provision of warranty in Years 2 and 3. Note that the journal entry for each month of the 24 month period will be identical so only provide the entry for Month 1. 3. PIRATE Wireless estimates that 2% of its service contracts are cancelled. In this event, the company is not paid the revenues associated with such contracts. Assuming that PIRATE uses the portfolio method of accounting for contracts, how will this affect the journal entries above? 4. How will the journal entries in Requirement 2 differ if the voice and data services are regularly sold for $45 and $30 respectively (i.e. Jim does not receive a discount on the services)?                                                                                                                                                                                                                                      

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