Posted: May 24th, 2022
Trans-Share Case Study: An Analysis of Accounting Practices Before the Company Goes Public
It is an exciting day for Trans-Share. The opportunity to finally go public has come, but with it are a number of very important decisions the organization must make about its operational procedures. It is important for companies to work out the kinks of its financial reporting before the organization goes public, which makes the accounting situation much more complicated. As such, it is recommended that Trans-Share review its current financial reporting methods in order to determine if they are the most efficient.
After reviewing the case study, it can be assumed that it is best that the fractional interest program be accounted for immediately as a sale, and not a lease. The processes for accounting leases simply do not fit the needs of the organization best. Some adjustments are needed, but an entire overhaul of the accounting policy is not necessary. The case study suggests that “typically the company will realize a profit on the initial sale of the fractional interest because the sales price provided in the contract for the fractional interest would exceed the cost of that proportion of the aircraft” (Hawkins, 2001, p 3). As such, fractional interest should be accounted for as a sale, and not a lease, in the journal entries of the financial ledger. Moreover, the customer is not leasing a single individual aircraft, but rather access to aircraft services. As such, it is not a typical lease, where customer would be fleecing a single product. Instead, “for approximately every four aircraft sold, a fit aircraft is kept available to be able to meet customer demand (that is, so that there will be an aircraft available when different customers require transportation services at the same time)” (Hawkins, 2001, p 3). If the client was working with a very particular airplane, and no others, it could be reassessed as a potential lease. However, the fact is Trans-Share provides services, rather than leasing individual aircraft units. These services include the right to use aircraft of particular size based on the elements within the contract written at the beginning of the business relationship. As such, it is best for the company to go with the first option, with “revenue attributable to the initial sale of the fractional interest” being “recognized at the time of sale” (Hawkins, 2000, p 3). Accounting for the fractional interest of the lease would only complicate accounting procedures, and require a complete overhaul of the accounting system, which in this case is not necessary.
Next, the concept of using multiple deliverables needs to be evaluated in order to provide for the best way to account for revenue streams. It is clear that there are multiple deliverables present within the operations of Trans-Share. It is important to deal with each individual deliverable sufficiently and in a way that does not underestimated by putting in a category with other deliverables that are not under the same financial recording processes. The company should continue to hold its fractional interest program in cohesion with the Financial Accounting Standards Emerging Issues Task Force (EITF) No. 00-21, which deals with accounting arrangements with multiple deliverables. Under this guideline, revenue streams within a foundation that deals with multiple deliverables should focus on accounting for each stream individually, and separate from other related transactions (FASB ASC 840-10-25-35). Working with this as the primary foundation for reporting practices in the accounting policies would also help streamline all changes being made to the reporting process. Completely reworking the accounting practices would be a nightmare for the company, complicating issues way too much before it goes public. However, slightly adjusting revenue arrangements under the guidance of the EITF regulation can help minimize the amount of change necessary, while still optimizing the efficiency of that change. It helps provide a strong foundation with the uniform set of practices that will streamline the accounting process when the company goes public. As such, the fractional interest program should be considered as “a multiple deliverable arrangement that should be accounted for in accordance with Securities and Exchange Commission staff” because revenue from three separate revenue models is immediately being recognized (Hawkins, 2001, p 3). Essentially, there are three separate transactions that take place during one client interaction within the revenue model that the organization should set up. First, there is the initial sale of the interest related to the particular aircraft in question. Then there is also a maintenance and handling costs that Trans-Share must account for properly based on the fact that the customer is not paying out-of-pocket for these expenses on their own. Finally, there is the potential to market aircraft for resale after the initial agreement with the customer has ended. These three types of transactions need to be accounted for in a multiple deliverables accounting method. Each one requires its own unique revenue model, where accounting for transactions occurs separately from one another and often at different times.
The next major conclusion needed here is when monthly fees and airplane usage are to be recognized. According to the regulations set out in the U.S. GAAP, FASB Concepts Statement No. 5, it is important to measure revenue as it occurs. Paragraph 83(a) suggests that “revenues and gains generally are not recognized until realized realizable,” under the notion that reporting of such realized revenues and gains should be reported immediately (Financial Accounting Standards Board, 2008, p 22). With this in mind, it is important that all goods and services, including the fractional interest and maintenance, should be recognized as they are realized. This means as the products and services are delivered to the customer. Once the customer agrees with Trans-Share and enters into a contract stating the terms of that agreement, the fractional interest of the aircraft should be rendered. Additionally, it is important to once again bring up the EITF, which deals with accounting and environment working with multiple deliverables (FASB 605). The EITF Issue No. 00-21 suggests that each one of the multiple deliverables may need differing accounting methods, all of which recognize the revenue once the service or good has been delivered to client. Essentially, this means that all revenue should be recognized in the quarter in which the service was conducted and according to the transaction date. In regards to the fractional interest, it is also important to record this level in fair market value (Financial Accounting Standards Board, 2008).
In correlation with monthly fees being recorded at the time the services were rendered, revenue and profit from the sale of fractional interest should be recognized immediately. When a contract is signed between Trans-Share and to client, the stipulations of the fractional interest are set out for the contract term, which is typically around five years. These sets out the exact payment per month and year the client will be sending Trans-Share for that fractional interest. Typically, the client pays about 1/8 of the interest and directly when payments are received is when they should be accounted for. An example is provided in the Journal entries below, with a contract worth fractional interest amount of $100,000 for a period of five years. The client ends up paying about $20,000 a year in fractional interest. This fractional interest must be recorded at the time the client is billed. It is necessary to immediately report income in this manner.
Overall, there are some clear adjustments needed within the accounting practices of Trans-Share before the company goes public. However, these changes are not overwhelming, and can be conducted with minimum cost to the organization. It is important to make sure that all three revenue streams are accounted for immediately, and separately as separate entities under the notion of a multiple deliverables strategy. Using this financial foundation, Trans-Share will definitely look better to public buyers.
On June 1, 2013, a new client was added to the roster. It is a medium-sized advertising firm that works in an international context. The contract itself covers a five-year period, with the interest being around $100,000. This seeks payback of $20,000 a year required by the client as part of the contract foundation. On June 2, 2013 a cash payment of $6,000 was received for the total flying hours and maintenance for a client for the month of May, 2013. Once that transaction was completed, the pilots who flew those hours were paid a total of $3,200 on June 3. Payment for the maintenance on that plane used was also paid out on June 3 for a total of $1,800. These transactions are recorded in the following journal entries.
Fractional Interest Payment for first year
Monthly Payment for Flight Hours and Maintenance
Payment for Pilots working on previous account
Financial Accounting Standards Board. (2008). Statement of Financial; Accounting Concepts No. 5. Web. http://www.fasb.org/cs/BlobServer?blobkey=id&blobnocache=true&blobwhere=1175820900391&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs
Hawkins, David F. (2001). Trans-Share Inc. Harvard Business Review.
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