Question

C3-3

The meaning of control (LO 3-1)

Wilson Corporation repairs rail cars for its clients, a process that often takes several months. As a result, the work on some contracts is done over two accounting periods. Wilson is determining whether it will be able to recognize revenue on such contracts over time and therefore record a portion of the revenue on such contracts before returning the rail cars to the clients.

Wilson’s controller has determined that its repairs enhance an asset the customer controls, and therefore Wilson may recognize revenue over time. Wilson’s auditor disagrees with Wilson’s interpretation, arguing that the customer does not control the asset until Wilson returns it. After all, the auditor says, “the customer cannot use or derive any benefit from a rail car that is not in its possession.” The auditor suggests that Wilson re-read ASC paragraph 606-20-25-25, which states

page 162

Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. The benefits of an asset are the potential cash flows (inflows or savings in outflows) that can be obtained directly or indirectly in many ways, such as by:

1. Using the asset to produce goods or provide services (including public services)
2. Using the asset to enhance the value of other assets
3. Using the asset to settle liabilities or reduce expenses
4. Selling or exchanging the asset
5. Pledging the asset to secure a loan
6. Holding the asset.

In addition to his argument that the customer does not control the asset, the auditor notes that Wilson has the ability to prevent others, including the customer, from directing the use of the asset until the repairs are completed and paid for. “The customer does not control the rail car while it is being repaired, Wilson Corporation does.”

Required:

Draft a memo describing which of the interpretations is correct and why.

Answer 1

Date: October 23^rd 2019

To: CEO of Wilson Corporation

Cc: Controller

Subject: Recording revenue on contracts for repair of rail cars.

The objective of this memo is to help explain how revenue should be recognized with regards the contracts that we have for repair of rail cars.

We will have to consider the following points laid out by IFRS with regards to revenue recognition:

• Risks and rewards of ownership have been transferred to the owners of the rail cars.
• Wilson Corporation does not have control any longer over the rail cars repaired.
• The collection of payment from these contracts is reasonably assured.
• The revenue amount can be reasonably measured.
• Cost of servicing and other costs can be reasonably measured.

Secondly the provisions of ASC 606 of FASB and IASB will also be considered. The provisions of ASC 606 state that revenue has to be recognized when the entity satisfies a performance obligation. Performance obligation is satisfied when the promised good or service is transferred to the customer. It only when the promised good or service is transferred to the customer that the customer obtains control of those goods. Here the performance obligation is being satisfied over time and not at a point.

As such we can recognize revenue over time and we will have to select an appropriate method for measuring our progress towards completing our service obligation. Thus according to provisions of 606-10-25-23 through 25-30 we can recognize revenue on such contracts over time and therefore record a portion of the revenue on such contracts before returning the rail cars to the clients.