JJ Ltd: Revenue recognition and non‐GAAP Earnings
Background on Company:
The following information relates to various transactions that have occurred during JJ Ltd’s
fiscal year ending 30 June, 2021. Assume that as an ASX‐listed company, JJ Ltd complies with
the requirements of AASB 15 Revenue.
Transaction with Customers (Mosh Ltd):
JJ Ltd holds a batch of modems that are ready to ship to customers before 30 June, 2021.
Mosh Ltd places an order for 20 modems on 25 June, 2021 that it intends to use throughout
its various offices and JJ Ltd delivers the product on 29 June, 2021. JJ Ltd generally enters into
written sales agreements with this class of customer and it requires the signatures of the
authorised representatives of both parties. As a result, JJ Ltd prepares a written sales
agreement and Ms Jones, the authorised representative of JJ Ltd, signs the agreement on 21
June, 2021. Mosh Ltd does not sign the agreement before 20 June because its authorised
representative Mr Beedle is on holidays. However, its purchasing department orally agreesto
the purchase and states that it is highly likely that the contract will be signed in the first week
of JJ Ltd’s next fiscal year when Mr Beedle returns from vacation. Mosh Ltd is a long‐standing
customer with JJ Ltd with an excellent credit rating.
The CEO of Mosh Ltd has a long‐standing business relationship with the CEO of JJ Ltd and as
a result will often receive a discount on bulk acquisitions of equipment from JJ Ltd. Although
the total amount due for the purchase of the 20 modems is $7,000, an extensive history of
similar transactions between JJ Ltd and Mosh Ltd suggests the following outcomes are
Discount offered on purchase of 20 modems: Probability
Transaction with Customers (Mel Ltd):
On 1 April, 2021 a second customer Mel Ltd enters into a two‐year contract for internet
services provided by JJ Ltd. Mel Ltd has a choice of: (a) a superior internet package that
includes basic access plus access to Wi‐Fi hotspots for $1,800; or (b) a basic internet package
at a cost of $1,300 which has the option of gaining access to the same Wi‐Fi hotspots for an
additional fee of $500. Mel Ltd purchases the superior internet package.
At the same time of entering into the two‐year contract for the superior internet package,
Mel Ltd buys a modem from JJ Ltd, obtaining title to the equipment at the time of purchase.
JJ Ltd offers Mel Ltd a discount of $30 on the purchase of the modem and superior internet
package and so Mel Ltd pays a total of $2,120. The modems retail for $350 if purchased
separately. Mel Ltd decides to buy the modems from JJ Ltd because there is an active
secondary market for them. JJ Ltd provides internet services to customers who purchase its
modems as well as to customers who do not purchase its modems. As a result, JJ Ltd ensures
that most other equipment is compatible with its network.
Mel Ltd experiencestwo weeks ofservice quality issuesin May 2021. When the invoice of $75
for the month of May arrives for Mel Ltd, the manager calls JJ Ltd and requests a credit for
the service outage. The invoice totals $75 and Mel Ltd is granted a credit of $37.50. Mel Ltd
pays the invoice on 16 June, 2021.
Additional Events and the Disclosure of Non‐GAAP Profit Before Tax:
During the year, to combat the economic downturn due to the impact of Covid‐19, the
government grants JJ Ltd regulatory credits totalling $2.3 million. The regulatory credits are
granted free of charge and so are recorded as revenue with no corresponding costs under
generally accepted accounting practice (GAAP).
The management of JJ Ltd announces a restructuring of their manufacturing business on 1
May 2021. This is the third restructuring of this business segment within the last five years,
which reflects the increased competition and rapid pace of technological change faced by JJ
Ltd. The estimated costs of the latest restructuring total $18 million and include items such
as ‘non‐cash write‐downs of inventory and equipment’, and the ‘estimated costs of staff
In January 2021, a piece of land was sold for $15 million. The land was originally purchased
for $17 million and is measured using the cost model.
The management of JJ Ltd prepares non‐GAAP financial statements for the year ended 30
June, 2021 because they argue that the GAAP‐compliant profit does not adequately capture
JJ Ltd’s financial performance. The resulting non‐GAAP profit is described as the ‘core
operating profit before tax’.
In preparing the non‐GAAP ‘core operating profit before tax’, the management of JJ Ltd
makes the following adjustments to the profit before tax of $1 million that is reported in
compliance with GAAP.
(i) In the GAAP‐compliant financial statements, the regulatory credit revenue of
$2.3 million is disclosed as part of ‘other income’. However, management
believes that since the regulatory credit was used to support the manufacturing
of modems, which are sold as part of the core business of JJ Ltd, the regulatory
credit revenue should be disclosed as part of the revenue from the sale of
modems. As a result, the non‐GAAP financial statements disclose the regulatory
revenue as part of modem sales revenue.
(ii) In the GAAP‐compliant financial statements, the estimated costs of restructuring
are shown as a cost in the calculation of profit before tax. In the non‐GAAP
financial statements, the restructuring costs are not shown as a cost because
managers argue that they are an accrual item that includes ‘non‐cash’
impairments of inventory and equipment’ as well as other non‐cash, accrual
(iii) In the GAAP‐compliant financial statements, the sale of the land is included in
the calculation of profit before tax. In the non‐GAAP financial statements, the
sale of the land is not included because managers argue that selling property is
outside the ordinary course of business for JJ Ltd.
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