Question

Sandhill Company manufactures equipment. Sandhill’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. Sandhill has the following arrangement with Winkerbean Inc.

A. Winkerbean purchases equipment from Sandhill for a price of $940,000 and contracts with Sandhill to install the equipment. Sandhill charges the same price for the equipment irrespective of whether it does the installation or not. Using market data, Sandhill determines installation service is estimated to have a standalone selling price of $55,000. The cost of the equipment is $630,000.
B. Winkerbean is obligated to pay Sandhill the $940,000 upon the delivery and installation of the equipment.

Sandhill 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.

How should the transaction price of $940,000 be allocated among the service obligations?

Answer 1

The transaction price of $940,000 should be allocated with $885,000 recognized for the equipment and $55,000 for the installation service, based on their standalone selling prices.

Step-by-step explanation:

The transaction price of $940,000 between Sandhill Company and Winkerbean Inc. for the purchase and installation of equipment should be allocated based on the standalone selling prices of each performance obligation. Sandhill has determined the standalone selling price of the installation service to be $55,000.

Since the equipment is sold for the same price regardless of who installs it, the standalone selling price for the equipment can be assumed to be the difference between the total transaction price and the installation service price, which is $940,000 - $55,000 = $885,000. Therefore, the revenue recognized for the equipment should be $885,000 and for the installation service should be $55,000.

The relative standalone selling price of the equipment is $885,000 ($940,000 - $55,000) and the relative standalone selling price of the installation service is $55,000. Therefore, the transaction price of $940,000 should be allocated $885,000 to the equipment and $55,000 to the installation service.

This allocation reflects the fair value of each performance obligation and ensures that revenue is recognized appropriately for each obligation.