Accounting Case Study: Pledge Transactions And Revenue Focus ✓ Solved

Accounting Case Study: Pledge Transactions and Revenue Focus

Assignment: Explain the accounting treatment of pledge transactions between Miller Corporation and Valerie Company as described. On January 1, Year 1, Miller records a pledge payable of $100,000 secured by a building appraised at $300,000, while Valerie records an accounts receivable of $100,000 with the same building. On January 1, Year 2, a new pledge occurs: Valerie records an account receivable of $250,000 and Miller records an account payable for a boat. When a pledge is fulfilled, the recipient recognizes revenue for the pledged amount and the fulfiller records an expenditure. A pledge is fulfilled when title transfers. By December 31, Year 2, only the boat title has transferred; the building transfer has not. State the revenue and expenditure recognized by Valerie and Miller for the relevant pledges and the status of any remaining pledge balances. Use the references provided and discuss relevant concepts under FASB ASC.

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Pledges, as described in this case, are promises to transfer assets to another party and are treated differently from completed conveyances. Under fundamental accounting principles, a pledge is established when one party commits to a transfer, creating a future economic benefit for the recipient and a liability for the pledging party, even before the asset changes hands. This distinction is consistent with foundational guidance on pledge and contribution-type transactions (Wild, Shaw, & Chiappetta, 2015). In practice, the pledge does not immediately generate revenue for the recipient nor a reduction of an expense for the pledgor; rather, it creates an asset or receivable on the recipient’s books and a corresponding payable on the pledgor’s books, reflecting the conditional promise to transfer a future asset (Wild, Shaw, & Chiappetta, 2015). The case explicitly presents two pledge events: the initial pledge on January 1, Year 1 and a second pledge on January 1, Year 2, each linked to different promised assets (a building and a boat) and different counterparty accounts (accounts receivable vs. accounts payable). These mechanics align with traditional interpretations of pledged assets and conditional transfers (Kumar & Sharma, 2015).

First, at the January 1, Year 1 pledge, Miller records an accounts payable for $100,000, with the building appraised at $300,000, while Valerie records an accounts receivable for $100,000 with the same asset. In this moment, no revenue is recognized by Valerie because the pledge has not been fulfilled; instead, Valerie recognizes a receivable reflecting the promise to deliver the asset or its value. Miller records a payable representing the obligation to convey the asset in the future. This treatment is consistent with the notion that a pledge creates a liability for the pledgor and a receivable or revenue for the recipient only upon the transfer of control or title (Wild et al., 2015). From a revenue recognition perspective, ASC 606 (and its predecessors) emphasizes recognizing revenue when performance obligations are satisfied, which in this pledge context occurs at transfer of title, not at the pledge date; as such, neither party records revenue or expense at the initial pledge date (Kieso, Weygandt, & Warfield, 2019).

Second, the January 1, Year 2 pledge introduces a second transaction: Valerie records an accounts receivable of $250,000 and Miller records an accounts payable of $250,000 for a boat. The same principles apply: the pledge creates a liability for Miller and a receivable for Valerie; no revenue for Valerie and no expense for Miller are recognized at the moment of the pledge because ownership and control have not yet transferred. It is important to note that the asset-specific context (boat vs. building) matters because the title transfer will determine the timing of revenue recognition for the recipient and the timing of expense recognition for the giver (Wild et al., 2015). In this scenario, Valerie’s AR reflects the promised boat transfer; Miller’s AP reflects the obligation to deliver the boat in the future, and the corresponding assets or wherewithal (in this case, the boat) are not yet transferred (Kumar & Sharma, 2015).

Fulfillment occurs when title transfers. On December 31, Year 2, only the boat title has transferred, so Valerie recognizes revenue for the boat pledged amount, and Miller recognizes an expenditure equal to the boat’s pledged value. This aligns with the general rule that revenue is recognized by the recipient when control of the promised asset is transferred, and the transfer is complete for the asset involved (Kieso et al., 2019). Thus, Valerie would record revenue of $250,000 related to the boat transfer, and Miller would record an expenditure of $250,000 corresponding to the delivery of the boat. At the same time, the pledge related to the building remains incomplete; the building transfer has not occurred, so the related payable (Miller) and receivable (Valerie) remain on the books, indicating continuing obligations and unfulfilled performance obligations tied to the building (Wild et al., 2015).

From a conceptual standpoint, two critical elements shape these outcomes: (1) the distinction between a pledge (a promise to transfer) and an actual transfer of asset, and (2) the timing of revenue recognition under ASC guidance. Pledges are promises that create future economic benefits but do not themselves generate revenue until the transfer of control occurs (Wild et al., 2015). In non-cash pledge contexts, this approach ensures that recognition aligns with the transfer of title rather than with the mere promise. In the boat scenario, the title transfer completes the performance obligation for Valerie, triggering revenue recognition. For Miller, the corresponding expenditure is recognized when the asset leaves the control of the pledgor, meeting the condition of fulfilling the pledge (Kieso et al., 2019). The building pledge remains open, leaving the related accounts payable/receivable in place until a transfer occurs, at which point the status would be updated accordingly (Kieso et al., 2019).

Beyond the mechanics of this case, several broader implications merit attention. First, the accounting for pledges emphasizes that transfer of title is the decisive event for revenue recognition by the recipient and for expense recognition by the donor or pledgor; until that moment, the transaction is recorded as a liability and an asset, not as revenue or expense (Wild et al., 2015). Second, the asset valuations (building at $300,000; boat at pledged value) influence the initial recognition of the payable/receivable and can have further implications for impairment and disclosure if the pledged asset’s value should change before transfer (Kieso et al., 2019). Third, in practice, organizations must disclose pledged transactions and related risks in their financial statements, including contingent liabilities and the status of unfulfilled pledges, to provide a faithful representation of financial position (Schroeder, Clark, & Cathey, 2019).

Thus, the focal points of the analysis—timing of recognition, the balance between liabilities and receivables, and the effects of transfer of title—are consistent with standard accounting practice for pledge-like arrangements. The Year 1 entries establish the initial liability and receivable without revenue impact; the Year 2 pledges create new promises; and the Year 2 fulfillment of the boat transfer completes revenue for Valerie and expenditure for Miller, with the building pledge continuing to be outstanding until its transfer occurs. This interpretation aligns with the framework described in standard accounting texts and codification, which emphasize that revenue recognition and expense recognition hinge on the concrete transfer of control rather than on pledge promises alone (Wild et al., 2015; Kieso et al., 2019).

In sum, Valerie recognizes revenue of $250,000 for the boat upon completion of the title transfer, Miller records an expenditure of $250,000 for the same event, and the building-related pledge remains unsettled, continuing to appear as an accounts receivable by Valerie and accounts payable by Miller until transfer occurs. The case demonstrates the importance of transfer-based timing in pledge arrangements and illustrates the alignment with ASC guidance on revenue recognition and asset transfer (Wild et al., 2015; Kumar & Sharma, 2015; Kieso et al., 2019).

References

  • Wild, J. J., Shaw, K. W., & Chiappetta, B. (2015). Fundamental accounting principles. McGraw-Hill Education.
  • Kumar, R., & Sharma, V. (2015). Auditing: Principles and practice. PHI Learning Pvt. Ltd.
  • Kieso, D. E., Weygandt, J. J., & Warfield, D. (2019). Intermediate Accounting (16th ed.). Wiley.
  • Libby, R., Libby, P. A., & Short, D. G. (2016). Financial Accounting (4th ed.). McGraw-Hill Education.
  • Warren, C. S., Reeve, J. M., & Duchac, J. (2018). Financial & managerial accounting. Cengage Learning.
  • Wahlen, J. M., Jones, J. P., & Pagano, M. (2016). Financial Reporting. South-Western/Cengage.
  • FASB. (n.d.). Revenue recognition: ASC 605/606. Retrieved from https://asc.fasb.org
  • Deloitte. (2020). Revenue recognition under ASC 606: A guide. Retrieved from https://www2.deloitte.com
  • PwC. (2020). Revenue recognition: ASC 606 guide. Retrieved from https://www.pwc.com

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