Question

Ocean Ltd (Ocean) enters into a contract with a customer to deliver a phone package to the customer in return for an upfront payment of $1500. Under the terms of the contract the customer will receive a 'free' phone upon signing the contract, and phone service for two years. Ocean also sells phones and phone services separately.

Which of the following statements is correct?
A. At the inception of the contract, Ocean recognises revenue of $1500.
B. At the inception of the contract, Ocean recognises a contract liability of $1500.
C. Ocean identifies one performance obligation in the phone package.
D. Ocean identifies two performance obligations in the phone package.

Answer 1

The correct statements are B and D. At the inception of the contract, Ocean recognizes a contract liability of $1500 rather than immediate revenue, and there are two performance obligations identified: the phone and the two-year service.

Step-by-step explanation:

When Ocean Ltd enters into a contract with a customer that provides a phone and a two-year phone service for an upfront payment of $1500, this involves accounting for revenue recognition, with guidance from standards such as the International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP), depending on the jurisdiction. Based on revenue recognition principles, companies should recognize revenue when the performance obligations are satisfied.

Statement B is correct: At the inception of the contract, Ocean recognises a contract liability of $1500. This is because the payment is received in advance of fulfilling the performance obligations. The revenue associated with the phone and the service will be recognized as the company satisfies these obligations over the two-year period.

Statement D is correct: Ocean identifies two performance obligations in the phone package. One performance obligation is the delivery of the 'free' phone, and the other is the provision of the phone service for two years. This is consistent with revenue recognition principles that require entities to account for individual promised goods or services distinctly.