(17, 10, 2013)
The management of Trans-Share Inc should not account the fractional interest program as financial or operating lease because it does not meet the provisions of FAS 13 and IAS 18 accounting standards. Moreover, it does not meet the revenue recognition criteria because entity still enjoys effective control over aircrafts after the sale. The contract of lease often allows the customer to extend the contract for a longer period or second term. Under lease arrangements, the legal title is transferred to the buyer at the end of the period but this is not the case with Trans-Share services. The lessee also has the option to purchase the assets at a price which is below the market price but again this is not the case with Trans-Share. One of the most significant features of the lease is that any gains or losses arising from the fluctuation in the market value of scrap value of the asset fall to the lessee. It can be clearly said that major risks and rewards associated with the owning of the assets remain with the company and minimum are transferred to the buyer. This arrangement should therefore be classified as Multi Deliverables arrangements (Accountingresearchmanager.com.mimas.calstatela.edu, 2013).
At the time of services, the company has the right to facilitate customer from the aircraft for which the payment was made or the management has the right to facilitate the customer by offering any other aircraft of same standards for which any other party has paid to enjoy same level of services. This sale arrangement seems to be hybrid in nature and it shall be regarded as multiple deliverables. The amount earned by Trans-Share Inc at the time of sale is actually a membership fee of the company to avail air transport or cargo facilities. The management of the company is obliged to provide services once the customer has become part of their client list. For the company, there are various service and maintenance costs associated with the aircrafts in order to ensure high quality and uninterrupted services. Although the customer would have to pay for running and operating expenses to the company in the form of monthly and hourly rent which must be in excess of the cost incurred by the company. The company’s actual revenue is the money that inflows from its customers in the form of rent and fixed charges and this amount should be recognized as revenue because it is nonrefundable in any circumstances. However, the funds received when selling the aircrafts have several options attached to it. All these options are favorable to the company in one form or the other so the gain or loss on reacquisition or sale of the assets should be recognized in the financial statements (Robertson, 2009).
The company enjoys a maximum control on the funds it receives at the point of sale must also increase its interest income or other income if the amount is invested appropriately. There is also a cash back incentive to customer by putting its interest back to the company at 95% of fair market value. The customer in empowered to sale its stakes to third party if and only if the company refuses to reacquire it. If the customer is unable to find a buyer at prevailing market prices within 180 days then the company is obliged to reacquire the asset. This is again a condition which prevents the management to recognize revenue from sale.
The business services of Trans-Share Inc are in accordance with the guidelines of ASC 605-25 multiple-element arrangements that obligates a supplier to provide more than one product or service and that are not in conformance of any other accounting standards or principles. Trans-Share business services are not lease but contractually binding agreements. It provides that for multiple deliverables revenue should be recognized for as separate accounting units. The purchase and management agreement between Trans-Share Inc and its customers meet both the outlines necessary for a deliverable to be classified as separate unit of accounting. Usually deliverables are all performance obligations on the company or supplier by virtue of an agreement. Trans-Share Inc at the time of rendering services has an obligation to facilitate customers from the aircraft for which the payment was made or the management has the right to facilitate the customer by offering any other aircraft of same standards for which any other party has paid to enjoy same level of services. To fulfill their clients demand, the management of Trans-Share provides diversified or various kinds of products and services, or rights to use airplanes for transportation purposes. The management transfers the service units or deliverables to the customer over a different period of time. The contract also provides the buyer with an option to acquire additional deliverables in subsequent periods at predetermined prices (Accountingresearchmanager.com.mimas.calstatela.edu, 2013). The purchase and management agreement between the management of Trans-Share and its customers entitles its customers to procure additional services for an amount below prevailing market prices in addition to existing products in possession of parties to the contract. Trans-Share must also offer trade-in rights to its customers by means of which they acquire a product having right to return that product at any stage in the coming years. The exercise of options may be contingent upon the customer but in monetary terms for instance, service charges of 5% to 8 % or price 5% less fair market value.
In such situations, the vendor would recognize the revenue from the sale of the product subject to the fulfillment of the guidelines contained by the relevant accounting standard. The revenue from monthly fees should be recognized to the extent of the completion stage of the services at the yearend date but the revenue from the usage of airplane should be recognized at expiration of the contract which is usually five years in this case. The revenue from monthly fees meets all the recognition criteria as laid down in FAS 13 and IAS 18. All the economic benefits are flowing to the entity from the transaction and the costs associated is likely to be measured with full accuracy. The revenue from services rendered is required to be recognized keeping in view the substance of the transaction and by not only considering its legal form. In case of airplane usage there are certain prerequisites that are not meeting to be recognized as revenue (Sec.gov, 2013).
The company enjoys a significant degree of influence to the inventory sold and this kind of involvement may change the status of the sale in the future periods because company has so many obligations on the options agreed in the deal. Only the title of the assets sold is transferred to the customer but the risk and rewards of the ownership still lies with the company which can be converted into liability at any stage or might result in the outflow of large funds for the purpose of reacquisition so therefore the sale cannot be recognized during the life cycle of the contract. The ASC 605-25 does not provide help regarding when the substance of the transaction be recognized as revenue. In this case, the recognition may affect the timing of revenue recognition by demanding deliverables in a multiple-element arrangement to be accounted for as a single unit of accounting (Accountingresearchmanager.com.mimas.calstatela.edu, 2013).
The company earns fixed rent from the customers. The estimated length of the contract or lease is for five years. Rentals earned under operating lease are charged to the income statement of the period. Specified upgrade rights or substitute rights are also a part of purchase and management agreement between the customers and management of Trans-Share Inc. The company has promised to provide a customer future enhancements to an existing product if there is any technological advancement and version improvement. There is one condition which seems to be partially in contradiction to the condition of multi deliverables framework that includes the sale of products or services may contain exclusivity clauses whereby the supplier confirms that it will not supply products and services to others except limited support. Trans-Share Inc has mentioned that it would facilitate its customers not only by the products they have purchased but also by the airplanes of same quality purchased any other customer. The journal entries for the recognition of revenues, expenses and profits are as follows;
Debit: Expenses $000
Credit: Bank/Cash $000
Debit: Bank $000
Credit: Rent Income $000
Debit: Bank $000
Credit: Unrecognized Revenue $ 000
Debit: Unrecognized Revenue $ 000
Credit: Recognized revenue $000
Accountingresearchmanager.com.mimas.calstatela.edu (2013). Login - EZ Proxy Server - Primary. [online] Retrieved from: http://www.accountingresearchmanager.com.mimas.calstatela.edu/wk/rm.nsf/arm.html?Open&rnm=039520&try=2 [Accessed: 17 Oct 2013].
Robertson, L. (2009). Financial management. Oxford: CIMA Pub..
Sec.gov (2013). SEC Staff Accounting Bulletin No. 101. [online] Retrieved from: http://www.sec.gov/interps/account/sab101.htm [Accessed: 17 Oct 2013].