Applying FASB Concept Statements You Are Beginning

Applying Fasb Concept Statements You Are Beginning

Applying FASB Concept Statements You are beginning the 2015 annual audit of your client L&H Speech Products. This is your second year on the audit team. L&H is a software company that develops speech recognition software (think Apple Siri) and engages in complex software licensing and development arrangements. Their main business is developing speech recognition software applications and then licensing the software to their customers. You notice that they have recorded an asset of $1.5 million for a software license they acquired from a customer, Born Software.

You inquire about this asset and the CEO tells you that L&H will use the software in their own internal software development projects so they have capitalized the expense and will amortize it over its useful life of 7 years. You are also told that Born is a customer of L&H as they had purchased a software license from L&H for $1.5 million just over a year ago. You are told that Born intends to imbed speech recognition functionality into the software they are developing. As Born had not paid for the software license at the time they entered into the second arrangement, both parties agreed that they would swap checks to make it simple. Born would pay L&H $1.5 million for the L&H license and L&H would pay Born $1.5 million for the Born license, all at the same time.

The CEO tells you he will answer any questions you have and provide whatever documentation you would need in order to support the accounting for this transaction. He assures you that Born is an independent company and is not a related party to L&H. The following is a summary of the accounting by L&H: Entry in 2014 to record sale of license: Accounts receivable $1.5m Revenue $1.5m Entry in 2015 to record purchase of license and swap of checks: Asset – software license $1.5m Cash $1.5m Accounts receivable $1.5m Cash $1.5m

You have never seen a transaction like this so you decide to first consider the FASB Concept Statements as you try to figure out how to approach researching this. Using the definition of assets and revenue recognition. This is where you will start. Please document the following: 1) Your initial thought process as you evaluate L&H’s accounting for these two transactions from the perspective of the FASB concept statements 2) After completing step 1, what accounting guidance would you consider next? 3) Submit your analysis as your journal entry in Blackboard. I encourage you to work in groups to discuss the issues and possible answers, however I would like you to prepare your journal entry individually. SFAC Definition of Asset Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Assets have 3 characteristics: • Probable future benefit that can contribute to cash flows • Entity can obtain benefit and control other’s access to it • Transaction giving rise to benefit has already occurred. SFAC Revenue Recognition Revenue recognition involves consideration of two factors, (a) being realized or realizable and (b) being earned, with sometimes one and sometimes the other being the more important consideration.

Paper For Above instruction

The evaluation of L&H Speech Products’ accounting treatment for the transaction involving the $1.5 million software license from Born Software requires a careful application of the Financial Accounting Standards Board (FASB) Concept Statements, primarily focusing on the definitions of an asset and revenue recognition criteria. This analysis begins by examining whether the transaction aligns with these core principles and continuing with considerations of subsequent accounting guidance.

Initial Thought Process from the FASB Concept Statements Perspective

According to the SFAC (Statement of Financial Accounting Concepts), an asset is defined as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events" (FASB, 2010). For an asset to be recognized, the benefit must be probable, and the entity must have control over it. In this scenario, L&H has recorded an asset of $1.5 million for a software license acquired from Born Software. The critical question pertains to whether this transaction meets the asset recognition criteria.

From the initial disclosures, L&H intends to use the software in its own development projects, suggesting they now control the software. The control is implied through their capitalization of the license as an asset. However, the nature of the transaction—specifically, the swap of checks and exchange of licenses between an independent party—raises questions about the economic substance versus the legal form. The fact that both companies are independent suggests the transaction could be at arm’s length, but the swap of checks may be a formalistic mechanism rather than genuine exchange of value.

Furthermore, the transaction's recording in 2014 as a sale (accounts receivable and revenue) and then in 2015 as an asset (software license) indicates an inconsistency with standard revenue recognition principles. Typically, under the FASB ASC 606, revenue is recognized when control of the license transfers to the customer, which depends on the contractual rights and obligations. The subsequent capitalization suggests L&H views possession and control of the license as acquired, but whether the initial sale was genuine and whether it reflects a sale or an exchange with little economic benefit exchange remains uncertain.

Additionally, the transaction’s structure—an immediate swap of checks—could be viewed as a barter transaction, which traditionally does not generate revenue but rather an asset exchange. This interpretation aligns with the FASB ASC 845, which addresses revenue from barter transactions, requiring that revenue be recognized at fair value if the transaction is at arm’s length and involves an exchange of dissimilar goods or services.

Next Steps in Accounting Guidance

After this initial assessment, the subsequent step would be to consider the relevant accounting guidance on revenue recognition and asset measurement. Specifically, I would look to ASC 606, "Revenue from Contracts with Customers," to determine whether the initial sale qualifies as revenue and if so, at what point control transfers. This guidance emphasizes that revenue should not be recognized until the entity has satisfied performance obligations and control has transferred to the customer.

Furthermore, guidance in ASC 845, "Nonmonetary Transactions," would be examined to assess whether the exchange qualifies as a barter transaction. The key considerations include whether the transaction is at arm’s length and whether both parties intend to exchange dissimilar goods or services at fair value. If the exchange is deemed at fair value, revenue recognition principles would apply accordingly.

In addition, given the complexity involving licensed software and the possibility of multiple performance obligations, I would review the guidance at ASC 605 and ASC 606 to determine how to recognize revenue and whether the software license should be capitalized or expensed at initial acquisition. The concept of control transfer, measurement of consideration exchanged, and the characterization of the asset acquired are critical considerations.

Finally, the audit evidence provided by the client—such as contracts, correspondence, and documentation of the transaction's nature—is essential for confirming whether the recognized assets and revenue are appropriate under U.S. GAAP.

Conclusion

In conclusion, from the perspective of the FASB Concept Statements, the core issue revolves around whether L&H’s accounting adequately reflects the economic substance of the transaction and complies with the recognition criteria in ASC 606, ASC 845, and related guidance. The initial interpretation suggests the transaction may be a barter that does not generate revenue unless recognized at fair value. The decision on whether to recognize the software license as an asset and revenue depends on detailed documentation and further analysis of control transfer and transaction substance.

References

• Financial Accounting Standards Board. (2010). Statement of Financial Accounting Concepts No. 8: Conceptual Framework for Financial Reporting. FASB.
• Financial Accounting Standards Board. (2014). Accounting Standards Codification (ASC) 606: Revenue from Contracts with Customers.
• Financial Accounting Standards Board. (2014). ASC 845: Nonmonetary Transactions.
• Warren, C. S., Reeve, J. M., & Duchac, J. (2019). Financial & Managerial Accounting (14th ed.). Cengage Learning.
• Securities and Exchange Commission. (2018). Staff Accounting Bulletin No. 104: Revenue Recognition.
• Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). Intermediate Accounting (16th ed.). Wiley.
• Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial Accounting: Theory & Practice. Wiley.
• Henderson, S. (2014). Accounting for Barter Transactions: Barter and Nonmonetary Transactions. Journal of Accounting & Economics.
• Rappaport, A. (2014). Corporate Financial Management. Irwin.
• Kothari, S. P. (2005). Effect of the Sarbanes-Oxley Act on Financial Reporting and Corporate Governance. Journal of Accounting Research.