Carve In/Carve Out Adjustment Example With Kit Items

Sales Order and Revenue Arrangement

The parent Consulting Kit represents the total package sold for $800, while the fair value of the child elements total $1000. Revenue is allocated based on the fair value of each component: Strategic Planning is allocated 90% of the total revenue and Market Research is allocated 10%.

The revenue element for the parent Consulting Kit item has a sales amount but no fair value amount. The revenue elements for the kit components, Strategic Planning and Market Research, have fair value amounts but no sales amounts.

Revenue Plan

Insight Partners updates their revenue plans. Revenue will be recognized in October.

Partial Invoice 1

On October 15, Insight Partners bills $600 of the $800 sales order.

The general ledger impact of the invoice is as follows:

Revenue Recognition Journal

On October 30, after completing the consulting services, Insight Partners recognizes all the revenue for the provided services.

The general ledger impact of the revenue recognition journal is as follows:

Carve In/Carve Out Adjustment 1

On October 30, Insight Partners runs reclassification. Since the discounted sales amount is not equal to the revenue amount, a carve in/carve out adjustment is posted to accurately allocate the revenue to each element.

The carve-in and carve-out ratios are used to allocate the billing amount to the revenue elements. The carve-out for the Consulting Kit is $600 because it has zero fair value, resulting in a 100% carve out. Consequently, deferred revenue for the Consulting Kit is debited, reducing its deferred revenue balance by the carve-out amount of $600. The $600 is reallocated to its kit components using the carve-in amount.

The carve-in allocations for the kit components are 90% and 10% of $600, respectively. Consequently, the deferred revenue for Strategic Planning and Market Research is credited, increasing their deferred revenue balances by the carve-in amounts of $540 and $60. Since 75% of the sales order is billed, only 75% the revenue amount is allocated.

For more information, see Fair Value and Allocation.

The general ledger impact of carve-in/carve-out adjustment 1 is as follows:

Unbilled Receivable Adjustment

An unbilled receivable adjustment is posted in October because cumulative billing is less than cumulative revenue recognition.

The unbilled calculations are as follows:

• For Strategic Planning, the billed amount is $540 and the recognized amount is $720, leaving an unbilled amount of $180.

• For Market Research, the billed amount is $60 and the recognized amount is $80, leaving an unbilled amount of $20.

The general ledger impact of the unbilled receivable adjustment is as follows:

Invoice 2

On October 31, Insight Partners bills the rest of the sales order. The sales order is now fully billed.

The general ledger impact is as follows:

Carve In Carve Out Adjustment 2

On October 31, after billing the rest of the sales order, Insight Partners runs reclassification again.

The carve-in and carve-out ratios are used to allocate the billing amount to the revenue elements. The carve-out for the Consulting Kit is $200 because it has zero fair value, resulting in a 100% carve out. Consequently, deferred revenue for the Consulting Kit is debited, reducing its deferred revenue balance by the carve-out amount of $200. The $200 is reallocated to its kit components using the carve-in amount.

The carve-in allocations for the kit components are 90% and 10% of $200, respectively. Consequently, the deferred revenue for Strategic Planning and Market Research is credited, increasing their deferred revenue balances by the carve-in amounts of $180 and $20. The full revenue amount is now allocated.

For more information about carving ratios, see Fair Value and Allocation.

The general ledger impact of carve-in/carve-out adjustment 2 is as follows:

The summarized calculations of the carve-in/carve-out adjustments show that the carve amounts are the difference between the discounted sales amount and revenue amount for each element:

Consulting Kit:

• Discounted sales amount: $800

• Revenue amount: $0

• Total carve-out amount: $800

Strategic Planning:

• Discounted sales amount: $0

• Revenue Amount: $720

• Total carve-in amount: $720

Market Research:

• Discounted sales amount: $0

• Revenue amount: $80

• Total carve-in amount: $80

Reversal of Prior Unbilled Receivable

A reversal of the prior unbilled receivable adjustment is created because the sales order is now fully billed.

The general ledger impact of the reversal unbilled receivable adjustment is as follows:

T Accounts

The following T accounts show the balances, transactions, and dates for accounts receivable, unbilled receivable, deferred revenue, and income accounts during the revenue recognition process for Insight Partners.

The accounts receivable account has total debits of $800 from two invoices, resulting in an ending balance of $800.

The unbilled receivable account for Strategic Planning has equal total debits and credits of $180, resulting in an ending balance of $0 after billing is completed.

The unbilled receivable account for Market Research has equal total debits and credits of $20, resulting in an ending balance of $0 after billing is completed.

The deferred revenue account for the Consulting Kit has equal total debits and credits of $800, resulting in an ending balance of $0.

The deferred revenue account for Strategic Planning has equal total debits and credits of $900, resulting in an ending balance of $0.

The deferred revenue account for Market Research has equal total debits and credits of $100, resulting in an ending balance of $0.

The income account for the Strategic Planning has total credits of $720, resulting in an ending balance of $720.

The income account for Market Research has total credits of $80, resulting in an ending balance of $80.

At the end of October, the revenue arrangement has been full recognized and reclassified. The deferred revenue balance is $0.

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