Question

The Company assists clients by designing and implementingsolutions that reduce the overall costs of its customers’ supplychains. The Company provides Just-In-Time (JIT) inventorymanagement of spare parts used in its customers’ manufacturingprocesses to reduce cycle times and lower inventory-related costs.The Company entered into a supply management contract (the“Agreement”) with the Customer, an unrelated third party, toprovide spare parts ,

management services,(including sourcing, procurement, repair,transport and delivery), and warehouse management.

?The key terms of the agreement between the company andcustomer are as follows:

I. Purchase Process•

A Customer provides the Company with a plan at the beginningof the year with a forecast of spare parts that it needs as part ofits manufacturing process. On the basis of this plan, the Companypurchases spare parts from third-party vendors and ships the spareparts directly to the Customer’s location. The Agreement statesthat the Customer determines the product and service specificationsand that no changes or modifications can occur without theCustomer’s consent. The Company purchases spare parts directly fromvendors. Note that although the Company purchased the spare partsaccording to the plan, the Customer is not obligated or committedto purchase these spare parts. •

The Company directly purchases from third-party vendors; theCustomer, is not involved in the purchasing process. Vendors namethe Company in their invoices; the Customer is not named in theinvoice. The Company is responsible for all payments to its vendorsin purchasing the spare parts. •

When spare parts are purchased by the Company , the vendorships the spare parts directly to the Customer’s warehouse;however, the Customer does not purchase and obtain title to thespare parts in its warehouse until it issues a purchase order(P.O.) to the Company. At this point, the title of the inventoryfor which a P.O. has been authorized transfers from the Company tothe Customer

.

The Company is responsible for the quality of the product soldto the Customer, who has the right to return any defective productto the Company.

•Purchase of spare parts by the Company is generally made inadvance of receiving a P.O. from the Customer,and the Company isobligated to pay the vendors within the agreed-upon payment termsirrespective of whether the spare parts are sold to the Customer orpayment is collected from the Customer •

The Company has latitude in vendor selection and negotiatespricing with its vendors. The Company sets the price it charges theCustomer on the basis of the Company’s cost plus a predeterminedmark-up. If the Company is able to achieve certain cost savings forthe Customer (on the basis of its ability to negotiate pricing withits vendors), it is entitled to bonus payments that are based on apercentage of such savings. Therefore, the better the Company doesin negotiating savings for the Customer, the greater the margin itearns on each sale.

Spare parts inventory, that is not purchased by the Customeras part of the P.O. process ( because parts are obsolete orrequirements have changed) remain the property of the Company Ifthe Company is not able to sell the inventory to other parties, theCustomer will reimburse the Company for 50 percent of the cost ofthe unsold parts

.

II. Warehouse Operations

•

The spare parts are held in the Customer’s (Tara) warehouse,allowing immediate access to the spare parts, which avoids the costof storage for the Company.• Although inventory is held in theCustomer’s warehouse, risk of loss or damage remains with theCompany, and insurance is paid for by the Company. The Company hasdedicated employees stationed at each Customer’s warehouse. Theseemployees handle the day-to-day issues with spare parts receivedinto the warehouse.• The Company’s and Customer’s inventory systemsare interfaced, allowing the Company to monitor stock levels.

III. Shipping Terms

As noted above, the spare parts are shipped directly from thevendors to the

Customer’s warehouse. The Company retains title and risk ofloss during shipping and at the Customer’s warehouse until a P.O.is issued by the Customer to purchase the spare parts. After theCustomer issues the P.O., the title transfers, and the Companyrecognizes revenue

.

IIII. Company Fee•

The Company receives 5.5percent as a “consumption fee” forspare parts that are consumed (i.e., purchased) by the Customerfrom the warehouse. In addition, as noted above, the Company earnsother fees according to its ability to negotiate favorable pricingon the spare parts.

Required

:

•

a. How should the Company report revenue related to thisarrangement?

b. When should it be reported by the Company?

c. When is the Revenue Earned by The company for Reportingpurposes? For Tax Purposes?