A company wishes to acquire the use of equipment for five years.It also wishes to acquire maintenance services on the equipment, from the provider of the equipment, for the same period of time.Both the acquirer and provider of the equipment agree that the service represents 20% of the overall value of the transaction.Three options are available for the exchange of goods and services: (1) A payment of $1 million at the beginning of each contract year; (2) a lump sum pre-payment of $4.545 million; or (3) a lump sum pre-payment of $1.5 million at the beginning of the contract, and a lump sum payment of $3.888 million at the end of the contract.Except for the payment schedule, both the acquirer and the provider are completely open to structuring the transaction in any manner permitted by U.S. GAAP, including transfer of ownership at any point during the contract, or no transfer of ownership at all.The equipment being acquired typically is considered to have a 5 year useful life.
Required, Part I:
A) Design a transaction structure so that it falls under Topic 606 (Revenues from Contracts with Customers), and has the following characteristics:Two performance obligations, where the equipment sale is recognized at the point of sale, and the service revenue is recognized over a five year period.
B) Design a transaction structure so that it falls under Topic 606 (Revenue from Contracts with Customers), and has the following characteristics:One performance obligation, where the entire revenue is recognized at the point of sale.
C) Design a transaction structure so that the equipment falls under Topic 842 (Leases), the maintenance falls under Topic 606 (Revenues from Contracts with Customers), and has the following characteristics: The equipment is a financing lease to the lessee, a sales-type lease to the lessor, and the maintenance is a service contract with revenue recognized on a straight line basis over 5 years.
D) Design a transaction structure so that both the equipment and the maintenance are accounted for as a service contract, recognized equally over the five year life of the contract (i.e., there is no asset or liability recorded by the acquirer).
[note: you don’t need to implement each of the three payment options for each of the transaction designs listed above.Just choose whichever one of the payment options works best for your design.]
Required, Part II: For each of the four scenarios above, identify a type of company that would likely benefit more from that transaction structure than from any of the other three transaction structures you designed.Briefly describe why you think this would be the most beneficial transaction structure for the company.You may define “type†of company however you wish, although it’s probably easiest to think in terms of financial statement needs (i.e., companies with a lot of debt; or companies with tight debt covenants; or growth companies; or companies with declining revenues; or companies with unstable earnings patterns; etc.).
