Lighthouse Case Anal
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Lighthouse is a provider of a ship tracking service that allows shipping companies to identify the location of their ships while at sea. Lighthouse and its customers enter into two contracts. The first contract is for the delivery and installation of the physical device and the second contract is for the tracking service. The price for the device and installation is a single nonrefundable amount of $10,000. The service contract which is generally for one year calls for fixed monthly payments of $300 per month. Customers may cancel the service contract at anytime.
Prior to the issuance of EITF 00-21 revenue recognition in accordance with GAAP was generally limited to a single deliverable. In most cases, firms were limited to recognizing revenue on arrangements with multiple deliveries on a straight line basis over the term of the contract (Sondhi pg 5). Contracts that were entered into near or at the same time were presumed to be have been negotiated as a package. They should be evaluated as a single arrangement when considering whether there are one or more accounting units (EITF 00-21 para. 2). However, when analyzing a Lighthouse arrangement with one of its customers, it appears that the portion of the agreement for delivery and installation of the physical device meets all the criteria for revenue recognition set for the in SAB 104. The contract is evidence of an agreement. Delivery and installation of the device has occurred. The $10,000 price is fixed. Although customers can cancel their contracts at anytime, it is unlikely that they will do so. The device is built to work exclusively with the Lighthouse service and there doesnt appear to be many competitors offering better deals.
Since the contract for delivery and installation appears to be earned under SEC criteria, the proceeds from that contract should be recognized as earned at the completion of installation and customer acceptance. The proceeds from the sale of the service should be recognized on a monthly basis over the one year contract period.
However, SAB 104 also requires an analysis of EITF 00-21 to determine the units of accounting involved in an arrangement with multiple deliveries prior to application of the guidance in SAB 104.
Lighthouse must evaluate all deliverables in the arrangement to determine whether they represent separate units of accounting (EITF 00-21 para. 8). In an agreement with multiple deliverables, the delivered items should be considered a separate unit of accounting if all of the following criteria are met: The delivered item has value to the buyer on a standalone basis, there is objective evidence of the fair value of undelivered items; If the arrangement includes a general right of return relative to the delivered item; and delivery or performance of the undelivered item is considered probable and substantially in control of the vendor (EITF 00-21 para. 9).
The physical delivery and installation of the hardware does not meet the first EITF 00-21 criteria as having standalone value to the buyer. The device was built to work exclusively with the Lighthouse service. If the customer were to cancel the service the device would be useless. Even if the original customer were able to find a buyer for the device it would likely be at a price drastically below the cost to the original