A parent company produces an energy-saving product and sells it to its 60%-owned subsidiary at cost-plus price. The subsidiary then installs and places the product at customer sites free of charge, but ownership of the product remains with the subsidiary. The subsidiary bills customers only based on an agreed percentage of actual monthly energy savings.

Professional advice is now sought on how to record such business transactions in the subsidiary's books, particularly in the following aspects:

1. Should the product be classified as inventory or non-current assets (if non-current, which specific category)?

The product is inventory before installation, but after installation, if its useful life exceeds one accounting year and it is used to earn revenue (rather than for sale), it may meet the definition of fixed assets (such as 'right-of-use assets' or 'leased assets'). Since ownership remains with the subsidiary and the product is used to generate ongoing energy-saving sharing income, it should generally be capitalized as a non-current asset (e.g., 'fixed assets - energy-saving equipment') and depreciated over its useful life.

2. For sales revenue being the amount collected based on the agreed energy-saving percentage, should corresponding cost of sales (COS) be recognized?

If the product is recognized as a fixed asset, cost of sales should not be recognized in full at installation, but should be allocated over the service period through depreciation expense. If the product remains as inventory (e.g., if it is expected to be sold in the future), the corresponding inventory cost should be recognized when revenue is recognized. However, given that ownership does not transfer and revenue is based on energy-saving performance, it is more appropriate to treat it as service revenue, with costs reflected through depreciation and operating expenses.

3. Should depreciation expense be recognized for products installed at customer sites?

Yes, if the product is capitalized as a fixed asset, it should be depreciated over its estimated useful life (e.g., the contract period or the equipment's economic life). Depreciation expense should be recognized in profit or loss and may be presented as cost of sales or administrative expenses, depending on the business model.

4. How should installation costs (and dismantling costs) be accounted for?

Installation costs (including direct labor, materials, etc.) that enable the fixed asset to reach its intended usable condition should be capitalized into the initial cost of the fixed asset. If dismantling costs are expected to occur and can be reliably estimated, a provision should be recognized at installation, with a corresponding increase in the fixed asset cost (or as a long-term deferred expense). For example: Debit: Fixed assets - energy-saving equipment (including installation fees); Credit: Bank deposits/Accounts payable. For an estimated dismantling obligation: Debit: Fixed assets; Credit: Provision.

5. Are there any other necessary journal entries?

Yes. The following entries are recommended for consideration:

  • Monthly recognition of energy-saving sharing revenue: Debit: Accounts receivable (or bank deposits); Credit: Main business revenue (or service revenue).
  • Depreciation accrual: Debit: Main business cost (or administrative expenses); Credit: Accumulated depreciation.
  • If maintenance or operating costs are incurred, they should be expensed in the current period.
  • If ownership of the product may ultimately transfer to the customer, it is necessary to assess whether lease standards (IFRS 16 or ASC 842) apply and adjust accounting treatment accordingly.
  • At the end of the period, an impairment test should be performed; if the recoverable amount of the product is lower than its carrying amount, an impairment provision should be recognized.

In summary, it is recommended that the subsidiary exercise professional judgment based on specific contract terms and accounting standards (such as 'Accounting Standards for Business Enterprises No. 4 - Fixed Assets' or International Financial Reporting Standards), and consult certified public accountants when necessary.