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How should the truncation price be allocated

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Reference no: EM132235001

Question - Pharoah Company manufactures equipment. Pharoah's products range from simple automated machinery to complex systems containing numerous components. Unit selling price range from $200,000 to $1,500,000, and are quoted inclusive of installation. The installation process does not involve changes to the features of the equipment to perform to specifications. Pharoah has the following arrangement with Winkerbean Inc.

  • Winkerbean purchases equipment from Pharoah for a price of $1,100,000 and contracts with Pharoah to install the equipment. Pharoah charges the same price for the equipment irrespective of whether it does the installation or not. The cost of the equipment is $700,000.
  • Winkerbean is obligated to pay Pharoah the $1,100,000 upon delivery and installation of the equipment.

Pharoah delivers the equipment and completes the installation of the equipment on September 30, 2017. The equipment has a useful life of 10 years. Assume that the equipment and the installation are two distinct performance obligations that should be accounted for separately. Pharoach does not have market data with which to determine the standalone selling price of the installation services. As a result, an expected cost plus margin approach is used. The cost of  installation is $52,000; Pharoach prices these services with a 25% margin relative to cost.

Required -

How should the truncation price of $1,100,000 be allocated among the service obligations?

Prepare the journal entries for Pharoah for this revenue arrangement in 2017, assuming Pharoah receives payment when installation is completed.

Reference no: EM132235001

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