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Accounting For Free Equipment

Jill T's Profile

I have a multiple element question where our customers buy our service and we provide equipment at no additional cost. The agreement states that we have a right to the equipment if the contract is cancelled within 3 years of the signed date; after 3 years, the equipment becomes the property of the customer. I am thinking the equipment probably represents a lease until the 3 years is up. If so, the contract represents a multi-element arrangement. The equipment represents a large cost to us. Could we amortize the cost of the equipment over the 3 year period? If so, do you know what accounting standard would support that decision?

Answers

Anonymous
(consultant) |

Difficult to answer w/o knowing specific nature of equipment, but I think you are on right track. Under multi-element arrangement you allocate the contractual revenues in proportion to the relative fair values of the equipment and the service; treat the equipment as an instalment sale over 3 years and recognize service revenue over the service period (presumably more than 3 years).

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

Anonymous is on the right track.

Your Subject line "Free Equipment" is a non-sequitur, which is providing you with your conundrum. It is neither free to you the company or ultimately the customer, since they are paying for the equipment.

Sometimes it takes stepping away from the marketing tag lines and looking at circumstances from another perspective.

Jill T
Title: Controller
Company: UTA
(Controller, UTA) |

The customer is paying for the service not the equipment. I would like to justify amortizing the cost of the equipment over the life of the contract rather than taking the entire COGS at once.

Topic Expert
Keith Perry
Title: Consulting CFO and Business Operations A..
Company: Growth Accelerator
(Consulting CFO and Business Operations Advisor, Growth Accelerator) |

J,

You own the equipment; it has a three year life? Capitalize it and amortize it to COGS over the life.

On the surface it looks like COGS of the services up until 3 years. At three years you've technically sold the equipment...so it becomes COGS of equipment sold under the contract. However from a rev/cogs rec perspective, you should be breaking out the value of the equipment separately from the services, so the numbers end up in the right place from the start.

In any event, you shouldn't be taking the cogs up front as you don't exhaust the the value immediately (and it is still your property).

KP

(Agent, JKS Solutions, Inc.) |

The first question you need to answer is "What kind of agreement is it?" Most legal agreements will state on the face the nature of the agreement.

a. Installment sale
b. Lease
c. Purchase and sale
d. Services

If you have customers, this is probably a standard contract at your company. Since you may be new to this area of accounting or you may be new to the company, you, as the Assistant Controller probably need to meet with the Controller or the CFO that you report to get obtain the history in order to know how to record the transaction.

Multiple element contract: Yes

If the equipment transfers ownership to the customer at the end of the deal, then you have an equipment sale of some sort, probably an installment sale if there is not a lease.

There is plenty of GAAP guidance on these issues. If you do not have a CPA firm who can provide you with the text of the accounting standards, then you can pick up a Wiley US GAAP guide at www.amazon.com

Your facts are vague.

(Agent, JKS Solutions, Inc.) |

https://www.proformative.com/resources/webinar-video-understanding-lease-accounting

Lease accounting video. I do not endorse this but it is an immediate resource that you might find some answers within

Topic Expert
Bob Scarborough
Title: CEO
Company: Tensoft, Inc.
(CEO, Tensoft, Inc.) |

From the information given I would assume this is a multi-element arrangement (multiple related items). In a multi-element arrangement the sale to the customer (how it is presented to them) is not how revenue is recognized. The transaction process for a multi-element arrangement it to identify the fair value for each element in the transaction, allocate the sale to the elements of the transaction based on the appropriate model as required, and then to apply revenue rules to the resulting agreement.

The short version is - if there are two elements to the arrangement (service, hardware) you are probably within GAAP by amortizing the revenue and the fixed / set expense (equipment depreciation) over the term of the agreement. If there are additional elements (say a setup fee) or additional conditions (acceptance by the customer, milestone contract points) then you would have additional complexity.

The suggestion to discuss this internally is sound. To that suggestion I would add talking with your auditors, and possibly with a revenue recognition expert. Companies with more complex revenue would ideally have a written revenue policy (which internal and external stakeholders approve) to support the day to day. The effort to get a written policy in place is well worth it since it should communicate the impact of sales transaction impact on revenue. It is common to discover the structure of your sales efforts can be tweaked to optimize your revenue recognition opportunities.

Bob Scarborough
www.tensoft.com

Topic Expert
Barrett Peterson
Title: Manager, Accounting Standards,
Company: TTX
(Manager, Accounting Standards,, TTX) |

You have a multiple element agreement, requiring division of contract revenue between services and the associated equiment. The legal title of the agreement has little or no bearing on the accounting as many contracts are "compound" transactions. Some equipment leases contain lessee purchase options which, if exercised trigger installment sales paragraphs, converting a "lease" contract to an "installment purchase" agreement. You earn the equipment revenue over the three years to buyer ownership, and your cost of the equipment should be amortized over that period. Service revenue should br recognized as services are provided.

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