Question

Canucks Inc., a software company sells new accounting software and user support bundled together. The fair value of the software is $1,500 and the fair value of the user support is $500. The user support is valid for a period of 12 months from the date of software purchase. To be able to compete with a competitor's offering, Loon decided to sell the bundle at a discount for $1,800. During its first month of sales, 100 units of this software bundle were sold at the discounted price, and expenses were $50,000. Instructions a) Calculate the sale price that should be allocated to each component of the bundle using the adjusted market assessment approach. b) Calculate the sale price that should be allocated to each component of the bundle using the residual approach. c) Assuming that the relative fair value method is used and income tax rate is 30%, calculate the net income applicable to Loon's first month of sales.

Answer 1

The adjusted market assessment approach allocates $1,350 to software and $450 to user support. The residual approach assigns the full fair value to software and allocates the remaining $300 to user support. Using the relative fair value method, after deducting expenses and taxes, the net income for the first month is $91,000.

Step-by-step explanation:

Allocation of Sale Price Using Different Approaches

To answer the student’s question, we need to calculate how the sales price of $1,800 for the software bundle should be allocated between the software and user support using different methods.

a) Adjusted Market Assessment Approach

The total fair value of the bundle is $1,500 (software) + $500 (user support) = $2,000. The sale price of $1,800 represents a $200 discount on the total fair value. The sale price should be allocated based on the ratio of each component’s fair value to the total fair value:

b) Residual Approach

Under the residual approach, we assign the fair value to one component first (typically the one with the determinable fair value), and the remainder goes to the other component. If we assign the software its full fair value of $1,500, the residual amount for user support is the bundle price minus software’s fair value:

User Support: $1,800 - $1,500 = $300

c) Relative Fair Value Method and Net Income Calculation

Using the relative fair value method, the allocation would be the same as in part a). To find the net income, subtract expenses ($50,000) from the total revenue ($1,800 × 100 = $180,000), and then calculate the after-tax income by applying the 30% tax rate:

Revenue minus Expenses: $180,000 - $50,000 = $130,000

Net Income before taxes: $130,000

Income Tax (30% of $130,000): $130,000 × 0.30 = $39,000

Net Income after taxes: $130,000 - $39,000 = $91,000