Question

Case 19-3 Yeah, Science! Pinkman Inc. (“Pinkman”) is a wholly owned subsidiary of an SEC registrant. Pinkman has a contract (the “Contract”) with the Heisenberg Institute (“Heisenberg”), which is a privately funded research institute with the stated mission of developing a cure for narcolepsy and other wide-spread sleep disorders. Under the Contract (which has a term of ten years), Pinkman serves as the administrator of the “Lab,” which is a multiple-unit campus consisting of recreational vehicles that Heisenberg uses to conduct research. As administrator of the Lab, Pinkman provides Heisenberg a single, distinct combined bundle of services (the “Lab Administration”) that comprises all the activities necessary to administer the Lab and conduct research therein. To provide the Lab Administration, Pinkman employs approximately 15,000 personnel (including administrators, scientists, researchers, technicians, etc.) that administer and maintain the Lab infrastructure and conduct the research performed therein. Research is conducted via multiple individual “Research Programs.” Pinkman is compensated by Heisenberg under the Contract on a cost-plus-fixed-fee basis. In accordance with this payment structure, Heisenberg reimburses Pinkman (via a prefunded bank account) for all expenses incurred by Pinkman in its provision of the Lab Administration (including all labor-related costs associated with Pinkman’s employees, such as salaries, benefits, and severance, etc.), and Heinsenberg additionally pays Pinkman a predetermined annual fixed fee (as established within the Contract terms). The annual fixed fee does not fluctuate with changes in the costs incurred by Pinkman. In other words, regardless of the costs incurred by Pinkman in its provision of the Lab Administration (all of which are reimbursed by Heisenberg), the fixed fee that Pinkman receives does not change. Additional information related to Pinkman’s operations and the Contract is as follows: • Pinkman is the legal employer of all the personnel that it employs. In its role as employer, Pinkman is responsible for all activities normally associated with a legal employer, including (but not limited to) the following: o Pinkman is responsible for hiring all employees, and it is the legal counterparty to the employee in each individual’s employment contract. o Pinkman is responsible for evaluating employee performance, and it has the discretion to terminate employees who are not performing well. o Pinkman is responsible for handling and resolving employee complaints, including any potential lawsuits that may arise during the course of employment. o Pinkman is legally obligated to pay its employees, even if it does not receive reimbursement from Heisenberg. (However, Pinkman has never Case 07c: Yeah, Science! Page 2 Copyright © 2019 Deloitte Development LLC All Rights Reserved. failed to receive adequate prefunded reimbursement from Heisenberg for all of its allowable expenses.) Pinkman also manages employee compensation, including decisions regarding salary, benefits, and merit/equity adjustments. However, because the Contract involves the use of personnel for the benefit of a private entity, the Contract sets certain restrictions and minimum requirements regarding the manner in which Pinkman must manage its employee workforce, including the following relevant terms: o Heisenberg determines a maximum employee salary, which is commensurate with certain established rates Heisenberg offers its employees. Although Pinkman has the ability to pay its employees more than this established rate, any salary in excess of this established rate is not reimbursable by Heisenberg. In practice, Pinkman does not employ any personnel to which it pays more than the maximum rate established by Heisenberg. o Heisenberg determines the minimum level of annual paid vacation days and annual paid holidays that must be provided to Pinkman’s employees. o Heisenberg must approve all changes in the fringe benefits offered to Pinkman’s employees, such as new types of insurance coverage, changes in premium levels and eligibility for coverage, revisions to retirement plans, and bonus programs. • Pinkman cannot use its employees for any tasks other than the Lab Administration and cannot transfer its employees to other of its corporate parent’s subsidiaries. In addition, Pinkman does not employ any personnel other than those who perform the Lab Administration under the Contract. • The Contract specifies the overall number of employees that Pinkman must employ each year during the Contract’s term. Pinkman must employ between 85 percent and 115 percent of this number to be contractually compliant. • Heisenberg establishes specific job skill requirements that it requires Pinkman’s employees to have, but Heisenberg does not review and approve the individual employees hired by Pinkman. • In the event that the Contract is terminated and Heisenberg appoints a new vendor to administer the Lab, the employees of Pinkman must be transferred to employment with the new vendor. The validity of this transfer provision is demonstrated by the fact that Pinkman inherited its employees from Heisenberg’s previous vendor when Pinkman initially secured the Contract to be the administrator for the Lab. Case 07c: Yeah, Science! Page 3 Copyright © 2019 Deloitte Development LLC All Rights Reserved. • The Contract contains a detailed statement of work (SOW) that lists and describes all the activities that are required to be performed by Pinkman’s employees. Heisenberg must approve all changes, additions, or deletions to the SOW. o The SOW includes detailed descriptions of each of the specific Research Programs that are to be undertaken at the Lab by Pinkman’s employees. The Research Programs have been developed, planned, and approved by Heisenberg. o The SOW also describes the administrative tasks (e.g., janitorial, maintenance) to be performed by Pinkman’s employees to maintain the Lab infrastructure. • All costs incurred by Pinkman must be in accordance with an established “Budget.” The Budget contains detailed funding information for all of the individual Research Programs and administrative tasks at the Lab. • The Budget is formally updated and approved by Heisenberg annually, but it is a fluid document that is continuously reviewed and updated by Heisenberg throughout the year to respond to its shifting priorities. For example, if Heisenberg believes that “Research Program X” has a need for a specific employee skill set that is currently working on “Research Program Y,” Heisenberg can adjust the Budget to move that employee skill set and the related labor costs from “Research Program Y” to “Research Program X.” • Heisenberg has the sole and unilateral ability to adjust the Budget as it deems necessary. • The work of Pinkman’s employees is overseen by Heisenberg Representatives (HRs). The HRs are Heisenberg employees that work at the Lab, and they are responsible for ensuring that the work of Pinkman’s employees (including the Research Programs) is in accordance with the SOW and the Budget. • Heisenberg holds title to all resources, systems, furniture, etc. used by Pinkman to deliver the Lab Administration.

Required: Using the guidance in ASC 606, Revenue From Contracts With Customers, determine whether Pinkman is a principal or an agent in the Contract to provide Lab Administration to Heisenberg, and therefore whether Pinkman should recognize revenue on a gross or net basis.

Complete the requirements for the enclosed case on revenue recognition 2 -3 page report and should cite the specific parts of ASC 606 that you are using to justify your answers.

can you please solve this case as soon as possible this all the information that i have. thank you

Answer 1

Solution:

Principal versus Agent Considerations (Section 606-10-55)

606-10-55-36 When another party is involved in providing goods or services to a customer, the entity should determine whether the nature of its promise is a performance obligation to provide the specified goods or services itself (that is, the entity is a principal) or to arrange for those goods or services to be provided by the other party.

606-10-55-36A To determine the nature of its promise (as described in paragraph 606-10-55-36), the entity should:

a. Identify the specified goods or services to be provided to the customer (which, for example, could be a right to a good or service to be provided by another party [see paragraph 606-10-25-18])

b. Assess whether it controls (as described in paragraph 606-10-25-25) each specified good or service before that good or service is transferred to the customer.

606-10-55-37A When another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of any one of the following:

a. A good or another asset from the other party that it then transfers to the customer.

b. A right to a service to be performed by the other party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf.

c. A good or service from the other party that it then combines with other goods or services in providing the specified good or service to the customer

606-10-55-38 An entity is an agent if the entity’s performance obligation is to arrange for the provision of the specified good goods or service services by another party. An entity that is an agent does not control the specified good or service provided by another party before that good or service is transferred to the customer.

606-10-55-39 Indicators that an entity controls the specified good or service before it is transferred to the customer ) (and is therefore a principal [see paragraph 606-10-55-37]) include, but are not limited to, the following:

a. The entity is primarily responsible for fulfilling the contract promise to provide the specified good or service. This typically includes responsibility for the acceptability of the specified good or service (for example, primary responsibility for the good or service meeting customer specifications). If the entity is primarily responsible for fulfilling the promise to provide the specified good or service, this may indicate that the other party involved in providing the specified good or service is acting on the entity’s behalf.

b. The entity has inventory risk before or after the specified good or service have has been transferred to a customer, after transfer of control to the customer (for example, if the customer has a right of return). For example, if the entity obtains, or commits to obtain, the specified good or service before obtaining a contract with a customer, that may indicate that the entity has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the good or service before it is transferred to the customer.

c. The entity has discretion in establishing the price for the specified good or service which may indicate that the entity has the ability to direct the use of that good or service and obtain substantially all of the remaining benefits. However, an agent can have discretion in establishing prices in some cases. For example, an agent may have some flexibility in setting prices in order to generate additional revenue from its service of arranging for goods or services to be provided by other parties to customers.

Interpretation

• In the given case, Pinkman has employed its own personnel to provide the identified distinct combined bundle of services being Lab Administration services, that administer and maintain the Lab infrastructure and conduct the research performed therein. All of whom are paid by Pinkman and Pinkman is reimbursed by Heisenberg
• Heisenberg determines a maximum employee salary, which is commensurate with certain established rates Heisenberg offers its employees.
• Pinkman cannot use its employees for any tasks other than the Lab Administration and cannot transfer its employees to other of its corporate parent’s subsidiaries. In addition, Pinkman does not employ any personnel other than those who perform the Lab Administration under the Contract.
• If Heisenberg believes that “Research Program X” has a need for a specific employee skill set that is currently working on “Research Program Y,” Heisenberg can adjust the Budget to move that employee skill set and the related labor costs from “Research Program Y” to “Research Program X.”
• The work of Pinkman’s employees is overseen by Heisenberg Representatives (HRs). The HRs are Heisenberg employees that work at the Lab, and they are responsible for ensuring that the work of Pinkman’s employees (including the Research Programs) is in accordance with the SOW and the Budget

• All of the above points indicate that

1. Pinkman does not have control over the service of lab administration before providing it tot the customer Heisenberg
2. Does not have the ability to direct the use of specified service being lab administration services. For example it cannot cannot transfer its employees to other of its corporate parent’s subsidiaries.
3. Pinkman does not set the price since Heisenberg determines a maximum employee salary, which is commensurate with certain established rates Heisenberg offers its employees.

• Based on above citations and its interpretations, Pinkman is an agent in the Contract to provide Lab Administration to Heisenberg, and therefore should recognize revenue on a net basis.