(1) The consideration from the original contract that has not yet been recognized as revenue and — JCR Jets calendar- year company accepts with major airline build January 2015

JCR Jets, a calendar- year company, accepts a contract with a major airline to build 4 jets on January 2, 2015. JCR accepts a fixed fee of $ 300 million and must complete the project within three years. JCR Jets uses the percentage- of- completion method of accounting. It determines percent complete using the percentage of labor hours incurred relative to expected total labor hours. Management expects that it will take 2 million labor hours to build the three jets. During 2015, JCR incurs actual costs of $ 112 million and estimates it will cost an additional $ 160 million to complete the jets. It incurred 800,000 labor hours during 2015. On January 3, 2016, JCR Jet agrees with its customer to upgrade the jets. The parties agree that the fixed fee for the four jets will now be $ 350 million. JCR estimates that this upgrade will require an additional 400,000 labor hours and additional costs of $ 40 million. Provide a written analysis and your conclusions of how JCR should account for this contract upgrade, using the Codification for support. Provide any necessary computations.

SOLUTION

This transaction is a contract modification as discussed in paragraphs 10 through 13 of ASC 606-10-25.ASC 606-10-25-10 defines a contract modification as a change in the scope and/or price of an existing contract that is approved by both parties to the contract.

ASC 606-10-25-11 discusses the situation when the parties to the contract modification are involved in a dispute over the modification, or just haven’t set the new price yet. This does not apply to the contract modification that JCR Jets has agreed to.

Paragraphs 12 and 13 of ASC 606-10-25 lay out the accounting treatment for contract modifications. Modifications may be treated as a separate contract, but they may not.ASC 606-10-25-12 presents the criteria that must be present in order for the modification to be treated as a separate contract. For separate contract treatment the scope of the contract must have increased because of additional, distinct goods or services and the price of the contract must increase by an amount that reflects the standalone selling prices of the additional goods or services. The increase in price can be the standalone selling price adjusted for circumstances specific to that contract. The example provided by the Codification is that the customer may receive a discount because the seller does not have to incur selling-related costs.

ASC 606-10-25-13 provides a discussion of the accounting treatment if the modification does not meet the conditions to be treated as a separate contract. In this case, the seller should treat it in one of three ways, as appropriate.

1. If the goods/services that are remaining to be transferred are distinct from the goods/services that have been transferred as of the date of the contract modification, then the seller should treat the modification as if it were a termination of the existing contract and a creation of a new contract. The amount of consideration that should be allocated to the remaining goods/services should be the summation of

(1) The consideration from the original contract that has not yet been recognized as revenue and

(2) The incremental consideration promised in the contract modification.

🔒

Unlock the complete assignment

You are viewing the free preview. Purchase this assignment once to reveal the complete resource.

$9.99 USD

Secure checkout is completed by Stripe.

2. If the goods/services that are remaining to be transferred are not distinct from the goods/services that have been transferred as of the date of the contract modification, then the seller should make an adjustment to revenue as of the date of the contract modification. This adjustment is made on a cumulative catch-up basis and should be measured as the effect that the contract modification has on the transaction price and on the entity’s measure of progress towards completion.

3. If the contract modification is a combination of (1. and (2., the seller should adjust revenue for the goods/services that are not distinct and treat the goods/services that are distinct as a new contract, terminating the old one.

Conclusions:

In the case of this transaction, the contract modification should not be treated as a separate contract per ASC 606-10-25-12 because it does not meet the two criteria. Specifically, the scope has not increased because of distinct goods/services. The upgrade to the jets is not distinct from the rest of the work. Thus, JCR will use the treatment discussed in ASC 606-10-25-13 to account for this modification.

Because the goods that remain to be transferred to the customer are not distinct from the goods that have already been transferred, JCR cannot account for this as a termination of the existing contract and creation of a new one. Instead, it must treat the contract modification as an adjustment to revenue. Thus, on January 3, 2016, JCR should adjust revenue to a new measurement based on a new transaction price and a new measure of progress towards completion.

As of December 31, 2015, JCR Jets recognized revenue of $120 million computed as follows:

Actual labor hours	800,000
Estimate total labor hours as of 12/31/2015	2,000,000
Percent complete	40%
Estimated total revenue	$300 million
Percent complete	40%
Revenue recognized in 2015	$120 million

On January 3, 2016, JCR computes the revenue that should be recognized to date as follows:

Actual labor hours	800,000
Estimate total labor hours updated for contract modification	2,400,000
Percent complete	33%
Estimated total revenue updated for contract modification	$350 million
Percent complete	33%
Adjusted revenue to date	$115.5 million

Thus, JCR Jets will need to make an adjustment on January 3, 2016 that decreases revenue by $4.5 million, which is the $120 million already recognized less the $115.5 million that should be recognized.