Lighthouse Lighthouse is a provider of locating services to the shipping industr

Question

Lighthouse
Lighthouse is a provider of locating services to the shipping industry. Lighthouse’s Ship Finder service is a one-way messaging service that routes messages from the ships at sea to the shipping company’s offices. These messages provide the shipping company with detailed information related to ship location, speed, and current local weather. In order to utilize the Ship Finder service, Lighthouse must install a dedicated hardware unit or device on the ship. Customers generally sign two separate contracts, one governing the sale of the devices and the other governing the provision of the service.
Once the devices are installed (one per ship), Lighthouse will connect the device to its service. Service contracts generally are for 12 months and are billed on a monthly basis. The services are priced at standard rates, although discounts are offered depending on the number of devices sold. The devices also have been sold at a discount. However, the discount is based on the number of units purchased (or to be purchased) and does not appear to be unreasonable.
Standard pricing for the devices and service are as follows:
Product or Service Price
Ship Finder Device $10,000 per unit, MSRP
Ship Finder Service $300 per month, per unit
The Lighthouse devices are made to be used exclusively with the Lighthouse services and, currently, there are no other competitors making devices that work with the Lighthouse services. Customers may cancel the service at any time. However, amounts paid related to the devices are non-refundable. Payments for the devices are due upon completion of the installation and final acceptance by the customer.
Required:
• How should revenue be recognized for sales of both the Ship Finder devices and service?

Explanation / Answer

Under the accrual basis of accounting ,revenues are reported in the income statement in the period in which they are earned. For example, revenue is reported when the services are provided do customers. Cash may or may not be received from customers during this period. The accounting concept supporting this reporting of revenues is called the revenue recognition concept.               The revenue recognition principle provides that companies should recognize revenue (1) when it is realized or realizable and (2) when it is earned. Therefore, proper revenue recognition revolves aroung the three terms: Revenues are realized when a company exchanges goods and services for cash or claims tro cash (receivables) Revenues are realizable when assefts a company receives in exchange are readily convertible to known amounts of cash or claims to cash. Revenues are earned when a company has substantially accomplished what it must do to be entitled to the benefits represented by the revenues- that is, when the earnings process is complete or virtually complete. Four revenue transactions are recognized in accordance with this principle. 1. Companies recognize revenue from selling products at the date of sale. This date is usually interpreted to mean the date of delivery to customers. 2. Companies recognize revenue from services provided, when services have been performed and are billable. 3.Companies recognize revenue from permitting others to use enterprise assets, such as interest, rent,and royalties, as time passes or as the assets are used. 4. Companies recognize revenue from disposing of assets other than products at the date of sale.             Three alternative revenue recognition methods are available when the right or return exposes the seller to continued risks of ownership. These are 1. not recording a sale until all return privileges have expired; 2. recording the sale, but reducing sales bny an estimate of future returns; and 3. recording the sale and accounting for the returns as they occur. The FASB concluded that if a company sells its product but gives the buyer the right to return it, the company should recognize revenuje from the sales transactions at the time of sale only if all of the following six conditions have been met. 1. The seller's price to the buyer is substantially fixed or determinable at the date of sale. 2. The buyer has paid the seller, or the buyer is obligated to pay the seller, and the obligation is not contingent on resale of the product. 3. The buyer's obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product. 4. The buyer acquiring the product for resale has economic substance apart from that provided by the seller. 5. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer. 6, The seller can reasonably estimate the amount of future returns. If the above six conditions are may not ,in that case, the company must recognize sales revenue and cost of sales either when the return privilege has substantially expired or when those six conditions subsequentlyl are met, whichever occurs first. In the income statement, the company must reduce sales revenue and cost of sales by the amount of the estimated returns.

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