Question

I want to know specifically why we don't count the price of the phone in the below problem?

Problem: CellularCo runs a promotion in which new customers who sign a two-year contract receive a free phone. There is a one-time activation fee of $50 and a monthly fee of $40 for the ongoing service. The same monthly fee is charged by CellularCo regardless of whether a free phone is provided. The phone costs CellularCo $100. Further, assume that CellularCo frequently sells the phone separately for $120. CellularCo is not required to refund any portion of the fees paid for any reason.

Solution given by FASB: 605-25-55-12 The total arrangement consideration is $1,010.The selling price of the phone service is $960 ($40× 24 months), the price charged by CellularCo when sold separately. The selling price of the phone is $120, the price of the phone when sold separately by CellularCo. Without considering whether any portion of the amount allocable to the phone is contingent upon CellularCo's providing the phone service, CellularCo would allocate the arrangement consideration on a relative selling price basis as follows: $112.22 [$1,010 x ($120÷ [$120 + $960])] to the phone and $897.78 [$1,010× ($960÷ [$120 + $960])] to the phone service.However, because a free phone is provided in the arrangement and the customer has no obligation to CellularCo if phone service is not provided, $62.22 (assuming the customer has paid the nonrefundable activation fee) is contingent upon CellularCo's providing the phone service. Therefore, the amount allocable to the phone is limited to $50 ($112.22− $62.22), and the amount allocable to the phone service is increased to $960.

Answer 1

The example given is to illustrate the guidance when determining multiple revenue arrangements i.e. there is more than one accounting unit. In this case, the phone can be sold separately without a contract or the contract is sold by giving the phone free. The solution tries to explain the second option i.e. the contract is sold by giving the phone free. When the phone is free, the price of the same is not included in the revenue arrangement consideration. However since the contract contains both service and a tangible good, the revenue is allocated among both accounting units. If the phone were sold separately without the contract then the revenue is recognized based on the phone's sale price itself.

Any further clarification please comment, If it helped you, please give a thumbs up.