Question

Assume it is February of 2018:

How will the reservation, purchase agreement, and the delivery of a Model 3 impact Tesla’s financial statements?

Since 2016, Tesla has been accepting reservations for its Model 3 car, which is a mid-size all-electric four-door sedan. The long-range battery Model 3 (310 miles on a single charge) starts at $50,000 while the standard range battery Model 3 (220 miles) starts at $35,000.

Production cannot keep up with the demand for this model. Tesla produced and delivered 1,772 units during 2017. Tesla has said it plans to produce 5,000 units per week in the latter half of 2018. Currently, there are more than 400,000 reservations for the Model 3, with 1,800 reservations being added per day.

If a customer wants to purchase a Tesla Model 3, the customer will first make a reservation for a Model 3 which puts the customer in line. A reservation requires a $1,000 reservation payment. When the production of that customer’s Tesla would be scheduled within the next 1 – 3 months, Tesla invites the customer to place an actual order. The $1,000 reservation payment is applied to the customer’s purchase agreement. If the customer changes their mind at any point before making the purchase agreement, the $1,000 reservation payment is refundable to the customer. Full payment for the Model 3 (less the $1,000 reservation payment) is collected at the time of delivery to the customer.

Questions

1. When Tesla receives a $1,000 reservation payment from a customer, what Tesla general ledger accounts does this $1,000 impact? Explain.
2. Now assume that a customer orders a Model 3 by completing the purchase agreement. Will this purchase agreement directly impact Tesla’s balance sheet or income statement at the date of the purchase agreement?
3. When the Model 3 is delivered to the customer and payment is received, how will Tesla’s balance sheet and income statement be impacted at the point of delivery?

Answer 1

When Tesla receives $ 1,000 reservation payment, journal entry would be as follows:

Dr. Cash a/c $ 1000

Cr. To Unearned Revenue $ 1000

(To record reservation payment for model 3 from customer)

Cash is debited because, cash received from customer and the same form part of asset side of balance sheet. Unearned Revenue is a liability account and form part of balance sheet. Liability account is credited because, if customer cancels the order before entering into purchase agreement, Tesla has to refund this amount and thus this is considered as liability of Tesla. At this point in time, no entry gets accounted under income statement, because actual service has not been rendered or goods has not been delivered. Only balance sheet reflects this transaction.

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While entering purchase agreement:

Dr. Unearned Revenue $ 1000

Cr Accounts Receivable - customer name $ 1000

(To record advance received from customer against purchase agreement)

Entering purchase agreement denotes customer has confirmed the order and this reservation payment gets treated as advance from customer. Only when this advance amount reflects under accounts receivable, the net amount to be collected from customer after delivery of the product reflects accurately. For example, once actual sale or delivery of product occurs, entry will be Debit to Accounts Receivable (Balance sheet) and Credit to Revenue (Income statement). Generally Accounts Receivable will have "debit" balance, which denotes the amount to be collected from customer; Thus, the above entry (i.e.) Credit in Accounts Receivable denotes the amount already collected from customer.

Even at this point in time, only balance sheet accounts will have impact and no entry occurs in income statement. Income statement gets affect only when the actual service / goods has been rendered / delivered.

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Model 3 delivered to customer and payment received:

let's assume price of Standard range battery model 3

Dr. Accounts Receivable-customer $ 35,000

Cr. Sales Revenue $ 35,000

(To record revenue generated from delivery of product to customer)

Dr. Cash $34,000

Cr. Accounts Receivable - customer $ 34,000

(To record payment received from customer after adjusting advance payment of $ 1000)

Based on above entry, Revenue gets accounted and form part of income statement, because goods has been delivered. Accounts receivable gets accounted for full value of the product (i.e.) $ 35,000 while delivery, but already there exists credit balance of $ 1,000 in balance sheet. Thus, net amount of $ 34,000 gets accounted, while customer making payment and accounts receivable balance becomes "0"; cash received reflects in Balance sheet. Net effect of above entries - revenue generated from sale gets accounted in income statement and cash generated from sale gets accounted in balance sheet.

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PS: As part of sale transaction, Dr. Cost of Goods Sold and Cr. Inventory will also be accounted, in order to account for related expense and reduction in inventory pertains to this sale transaction, which is out of purview of this question.

In all the above transactions, until actual sale occurs, entries will be posted only under balance sheet accounts, because balance exists under balance sheet accounts only gets carried forward and not the income statement accounts. Thus even if the actual sale occurs in following year, advance cash received still reflects in accounts receivable account. Moreover income statement denotes actual profit or loss made during the year, which decides various other factors like turnover of the company, tax payments, dividend payments etc. so balances exists under income statement accounts cannot be carried forward to next year; the same gets closed and balance transferred to retained earnings account.

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