Reference no: EM13868256
Read each one and attempt to identify the key accounting issue or issues involved.
Part sharing transaction – A number of large utilities enter into an agreement to create an LLC to purchase a number of transformers to be stored in warehouses for national grid restoration following a potential natural disaster or terrorist attack. The transformers cost over $1 million each and have a production lead time of 18 months or more. Therefore, rather than have a utility purchase its own “emergency spares” that will likely be 1) too few in number to address a significant emergency and 2) would, based on probabilities for an individual utility, never be need, the LLC would allow utilities to share the costs of purchase, storage and transportation. While only eight utilities will own shares in the LLC, the LLC will enlist utility “subscribers” (as many as 50) that will pay an annual subscription fee to have access to the emergency transformers should there be an event. The subscribers’ fee is intended to cover the LLC’s ongoing operating cost and provide the eight investors with a reasonable return on their investment in transformers. If and when a subscriber needs to access the pool of transformers, the transformers are sold to the subscriber at the LLC’s depreciated book value.
Long-term service agreements – Power producers often enter into contracts with the manufacturer of the turbines used at a power plant to produce electricity to service the turbine and all of its related components based on the number of hours that the turbine runs (e.g., serviced every 25,000 hours) based on a fixed price contract. The power producer typically makes periodic advance payments prior to the time the turbine is serviced (the time period the plant is offline is known as an “outage”). A few months before the outage is scheduled to take place, the power producer makes the final payment that will fully cover all of the costs of the outage as the manufacturer uses those funds to purchase the parts that will replace the parts that are to be taken out. The accounting conclusion hinges on the fact that 90% of the cost of the outage relates to the value of the replacement parts (parts that would normally qualify for capitalization).
Emissions allowances – Utilities and other “polluters” receive emissions allowances from state environmental agencies which allow them to emit a specific amount of pollution (tons per year) in each calendar year. Unused allowances may be sold to other parties through a fairly liquid market that has developed over the years. Because a market has developed, there are entities that invest in emissions allowances for the sole purpose of buying and selling allowances for a profit. For utilities, the emissions allowances are either “used” or they are potentially traded for other emissions allowances in different future years.
Cell tower equipment – Cell Phone Company enters into a fixed price contract with manufacturer to provide equipment for enhancing the cell phone company’s entire network. While the expected quantity of equipment was 500 units, because of manufacturer’s overestimation of the equipment’s coverage, manufacturer had to provide an additional 200 units “for free” in order to meet the contract’s coverage requirement.
Antivirals – A manufacturer contracts to purchase 10,000 doses of antiviral medication to protect against a potential pandemic that could adversely affect the company’s workforce and its short-term profitability. The expected shelf life of the medication is three years and the medication will be stored at strategically located sites throughout the U.S. to allow for the most efficient distribution to employees. All services associated with the medication, including procurement, storage, employee medical history review, and writing of prescriptions, will be performed by a service company. These services are expected to equal the actual costs of the medication. While the current plan is to hold the medication until it is needed, the manufacturer is also considering distributing the medication directly to employees within the first six months of the program due to concerns that it might not be able to get the medication distributed to employees in a timely manner if a pandemic were to occur.
Charitable contributions – A company makes a promise to a charitable organization to contribute $1 million per year over the next five years. The initial contract does not have any requirements that the charity has to meet in order to receive its next annual contribution.