 and welcome to this session in which we'll discuss contract modification. First of all, what is a contract modification? Well, contract modification occurs when you have a change in the terms of the contract and the contract is an ongoing contract. Well, the simplest example I can give you is when you have a cell phone plan with AT&T, Verizon, T-Mobile, what's gonna happen sometime you might add a data plan, you might increase your data plan, you may add a new line, you may reduce the features on your line. Well, what's happening here is you are modifying your contract with that service provider, that service phone providers. So how do companies treat contract modification? Well, companies first, they need to determine whether this modification constitute a new contract, do they have a new service, a separate obligation, that's the first thing they have to do, or is the modification of the existing contract. So simply put, do we have a new contract as a result of this modification or this is just the modification and the existing contract still valid, that's what they have to determine. Now, how do we determine whether we have a new contract or this is a modification? Well, to determine whether we have a new contract or not, we must satisfy two, not one, two conditions. The first one is this, the product or the service offered in the new contract are distinct and not interdependent or interrelated with goods with other goods and services. So simply put, we are offering a product that's unique, that's distinct. Now, if you don't know what distinct is, what's interdependent, what's not interdependent or interrelated, please go to the prior session where we talked about the contract. So here we're looking, we're selling a product that it's unique in a sense that we can sell it, it's can be sold separately. For example, a first selling cup of coffee, the cup of coffee is the product, not the coffee and the sugar. If we have coffee and sugar, those are two product, but the cup of coffee is the distinct product. This is what we're selling. Okay, it's not interdependent with anything else. Coffee is not interdependent with anything else. A first selling cup of coffee, it's its own distinct product. We cannot separate the sugar and the coffee separately. We cannot say we're selling coffee and we're selling sugar, we're selling a cup of coffee. Now, that's the first condition. The second condition is the product or services must have a standalone price. So simply put, we can charge for this product separately and there's a separate price for this product as it stands by itself. If those two conditions are met, so standalone price being charged to the customer as if you are buying the product separately. If those two conditions exist, then we meet the conditions that we have a new contract, not the modification of the existing one, a new one. How do we know if we have a modification of an existing contract? Well, guess what? We fail the condition of the new contract. We fail those conditions. If we fail any of those conditions, we trade the change prospectively. What does prospectively means? It means we're gonna look at the present and look forward and make all the adjustments. So we treat it prospectively. Now, obviously, the best way to illustrate this concept is to actually look at an example with journal entries to determine how we determine how we book those journal entries when we have whether a new contract or an existing contract. Before we look at the example, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course. I don't replace your accounting course. I can help you understand the material better by providing new lectures, multiple choice, true, false resources for your accounting courses, as well as your CPA review course. My resources are aligned with your Becker, Roger, Wiley, Gleam, whether miles, whatever CPA review course you are taking, I give you access to 1500 previously released AI CPA questions with detailed solution. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other connect with me on Instagram, Facebook, Twitter, and Reddit. And if you are a CPA candidate, I have a CPA group called CPA exam support group. Please join us so we can have a discussion about the CPA exam with other CPA candidate as well. So let's take a look at this example. Adam has a contract to sell 1000 iPhone covers to best buy electronics over a six month period for a price of $10. That's the contract. After 600 covers have been delivered, Adam modifies the contract by promising to deliver an additional 200 covers for 1600. In other words, they're going to sell each new additional cover for $200. And that's really the $8 as the standalone price of the product at the time the contract modification. What happened is those iPhone covers, there is not a lot of demand on them. Therefore, what we do we promise to deliver an additional 200, but we're going to lower the price because they're not as popular. Adam sells the iPhone covers separately. So those so the cover is obviously it should be sold separately. It can be sold separately. And the cost per cover for Adam is $6. So Adam buys them for six, initially was selling them at 10. Then then Adam promises to sell an additional 200 for $8. Now how do we book those journal entries? So let's just start with the first 600 covers debit cash $6,000, which is 600 times 10 credit sales 6,000. Now we're going to assume it's cash. It doesn't matter whether it's cash or a count receivable. The concept is the same. Then we have to book our cost of goods sold. Our cost of goods sold is 3600, which is 600 phones, iPhone covers times $6 our cost per cover that's debit cost of goods sold credit inventory. Now what we in addition to those 600 we sold an additional 100 covers after the contract modification. So after we modified the contract we sell we sold 100 cover. Now we're going to assume that the price of the additional covers reflect stand alone price. So the $8 here is the stand alone price and the cover as distinct from the original product and Adam can sell them separately. Obviously, as then again, the stand alone. Those products are separate because the iPhone cover is one unit, nothing is complicated there. Okay, what does that mean? It means we modified the contract, but it looks like this is a new contract. So the additional 200 unit because they have a stand alone price and they can be sold separately. It's a new contract. So how do we account for this? You know, after you remember the contract for 1000 unit, we are 1000 covers we sold 600. So we still have 400 to sell 400. And now we're going to account for this 100 100 additional. In other words, how do we account for this 100 because it occurred after the contract modification. Since we assume it's a new contract, the 200 units are a new contract. So pretty straightforward, we're going to debit cash $1000 for $1000 100 unit times 10 credit sales 1000 debit cost of goods sold 100 units time six credit inventory 100 unit times six. So it's pretty straightforward. If it's a new contract, we don't have to do basically anything if the new information is based is for a new contract. Now let's assume the additional 100 the additional 100 covers assuming that the price of the additional cover does not reflect a stand alone selling price here. We're going to be assuming after we did the modification, we're going to assume that this is not a new contract. This is a modification of an of an existing contract. We're going to assume those 200 new units. It's a modification of the new contract, which is going to have to make this assumption to see how it works. So if that's the case, here's what's gonna happen. We don't go back and change anything from the past. So simply put the 600 unit here, the 600 covers that we sold, we don't change any of that it's treated prospectively. It means what's gonna happen next here's what's gonna happen next. So now we're gonna do we're gonna blend the old contract with the new contract. How do we do so? Well, we still have 400 iPhone cover not yet delivered. It's supposed to be delivered at $10. That's true. That's 4000 not yet delivered. Then we have an additional 200 iPhone covers will be delivered at eight. That's 1600. Now we're gonna blend the two. What does blending mean? It means we still have to deliver five thousand six. We expect to deliver $5600 of iPhone covers for 600. Therefore, the new blended price is $9 and 33 cent. Well, it means now we're gonna be selling each unit for $9 and 33 cent. So how much do we sell? If we sold the additional 100 unit? Well, it's gonna be 100 times $9 and 33 cent debit cash credit sales for the same amount debit cost of goods sold credit inventory. So this is basically how it works. Assuming this is the modification of the existing contract. So what does what does that mean? It means you're gonna blend the old contract what remain in the old contract with a new contract figure out the new price and book the journal entry. Don't go back. It's not retrospectively. It's treated prospectively prospective method. We don't go back and change any prior sales because those occur occurred before the contract modification. What should you do now? 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