Metropolitan Environmental Services, Inc. A Case Study in Revenue Recognition Policy

BUSINESS MEMORANDUM
Metropolitan Environmental Services, Inc. A Case Study in Revenue
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Metropolitan Environmental Services, Inc. A Case Study in Revenue
A converged standard on recognition of revenue has been provided recently by the International Accounting Standards Board which worked in collaboration with the Financial Accounting Standards Board. Revenue is basically recognized whenever a client obtains control of a service or a good (Financial Accounting Standards Board, 2012). The new revenue recognition standard developed by IASB and FASB replaces almost all U.S Generally Accepted Accounting Principles revenue guidance with one model. The standard is codified within a new Topic 606 in the Financial Accounting Standards Board Accounting Standards Codification (ASC). It is based upon the following five-step model: Step i: Identifying a contract with a client. Step ii: identifying performance obligations. Step iii: Determining the price of the transaction. Step IV: Allocating the price of the transaction to the performance obligations. Step v: Recognizing revenue as/when performance obligations are met (GrantThornton, 2014). The FASB Accounting Standards Codification 606 necessitates that revenue has to be recognized as the work is carried out if, and only if, control over the promised services/goods to the client over time (GrantThornton, 2014).
Customers obtain control when they have the ability of directing the utilization of and obtaining the benefits from the service/good. In essence, revenue is recognized whenever an organization fulfills its performance obligation by simply transferring a promised service/good to a client. After an entity has established what actually makes up the performance obligation, it would be essential, under the new guidance, to find out whether or not revenue has to be recognized at a particular point in time or over time (Lamoreaux, 2012).
Performance obligations satisfied at a specific point in time
A performance obligation is typically satisfied at a specific point in time incase the performance cannot be satisfied over time. This type of revenue recognition will take place at the point that control of a given asset is moved to the client. In determining the specific point in time at which a client gets control of a promised asset and that entity satisfies a performance obligation, that entity needs to consider the guidance on control FASB ASC 606-10-25-25 to 25-26 (American Institute of CPA, 2014).
Performance obligations satisfied over time
Conversely, revenue recognized over time necessitates that there be continuous transfer. Simply put, according to the Financial Accounting Standards Board (2012), revenue recognition over time would be apt in situations when: (i) the client gets and consumes a benefit as the contractor performs. This is described in FASB ASC 606-10-55-5 up to 55-6. (ii) Another entity will not have to re-do the task done to date if they were to take over from the contractor. The performance of the entity enhances or creates an asset, which the client controls as the asset is enhanced or created – this is described in FASB ASC 606-10-55-7. (iii) The contractor will have the right of receiving payment for the task completed to date even though the client terminates that contract for convenience. In essence, the performance of the entity does not create an asset with a different utilization to the entity, and the organization has an enforceable right to payment for the performance done thus far (Financial Accounting Standards Board, 2014).
A performance obligation is understood as a promise in a contract with a client to transfer a service/good which is distinct. A promised service/good is distinct if the following criteria are both met: (i) the service/good is separable from other promises in the contract; and (ii) the client could benefit from the service/good either on its own or with other services which are readily available to the client (Lamoreaux, 2012).
Scenario 1
In this scenario, Metropolitan signs a contract with Customer A for the collection, transport and disposal of the hazardous material. Revenue in this scenario should be recognized over time. This type of revenue recognition is apt in this scenario since the contractor – Metropolitan – would have the right to get payment for the task finished to date even if the client – Customer A – terminates the contract for convenience.
In the contract between Metropolitan and Customer A, the 2 parties are both committed to complete their respective obligations. The distinct performance obligation in this scenario is for Metropolitan to collect, transport, and dispose of the hazardous material from Customer A. Metropolitan signed a contract with the client to provide these 3 services for Customer A for a payment of $350,000. The performance obligation in this scenario affects revenue recognition in that revenue should be recognized over time as the client obtains a benefit as the contractor performs, and the contractor will have the right of getting payment for the tasks carried out to date even though the client terminates for convenience. For collection, decontamination, transportation and disposal services, revenue should be recognized over a period of time given that there is continuous transfer.
For all the three services, Customer A pays a combined price of $350,000. Customer A makes a deposit of $200,000 on the date the contract is signed. Metropolitan may keep this deposit incase the client cancels the contract at any time before the disposal process is initiated. In this scenario, the total revenue is the combined price the Customer A pays for the three services, which is $350,000. According to the Financial Accounting Standards Board (2014), service revenue is usually recognized over time, but in proportion to the amount of service carried out. Incase there is one last service that is crucial to the earnings process, costs and revenues are recognized and deferred as soon as the service has been carried out. As such, in this scenario, revenue will not be recognized until Metropolitan performs the final service, which is to incinerate the hazardous material.
Scenario 1 Journal Entry
October 5, 2012: Revenue is recognized
Journal Entry on October 1, 2012DebitCreditCash$350,000 Revenue$350,000
Scenario 2
In this scenario, Metropolitan is working on site to help with the collection and the decontamination of sites, waste removal and transportation, as well as disposal efforts. The contract is divided into 3 phases: (i) collection and decontamination, which will cost 12,000,000; (ii) transportation fees are estimated to be $500,000; and (iii) disposal and waste burial fees are estimated to be $5,000,000.
Generally, revenue is recognized at a point in time usually for transferred goods, or is recognized as over time for transferred services (Lamoreaux, 2012). In this scenario, the distinct performance obligation of the contractor, Metropolitan, is to perform the following services: collection and decontamination of sites; waste removal and transportation; and waste disposal.
It is of note that the Accounting Standards Codification 606 necessitates that performance obligations should be accounted for separate...