Chap 005

Chapter 5
Income Measurement and Profitabilit Anal sis
AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise, and problem in Intermediate Accounting, 7e, with the following AACSB learning s ills!
Questions
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Brief Exercises
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AACSB Tags
Analytic %eflective thin ing Analytic Analytic Analytic %eflective thin ing, Communications Analytic Analytic Analytic .iversity, Analytic Analytic %eflective thin ing, Analytic .iversity, %eflective thin ing, Analytic Analytic Analytic Analytic Analytic Analytic %eflective thin ing %eflective thin ing %eflective thin ing Analytic Analytic %eflective thin ing
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Analytic
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%eflective thin ing Analytic
CPA!CMA Exercises
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AACSB Tags
Analytic Analytic Analytic %eflective thin ing Analytic Analytic .iversity, %eflective thin ing .iversity, Analytic .iversity, %eflective thin ing .iversity, %eflective thin ing Analytic %eflective thin ing Analytic Analytic Analytic Analytic Analytic, Communications Analytic Analytic .iversity, Analytic Analytic Analytic, Communications Analytic, Communications Analytic Analytic, Communications Analytic Analytic, Communications Analytic %eflective thin ing, Analytic %eflective thin ing, Communications Analytic Analytic
AACSB Tags
%eflective thin ing, Analytic %eflective thin ing, Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic %eflective thin ing, Communications Analytic .iversity, Analytic Analytic Analytic Analytic Analytic %eflective thin ing, Communications Analytic Analytic .iversity, Analytic Analytic %eflective thin ing Analytic, Communications Analytic, Communications Analytic Analytic Analytic Analytic Analytic .iversity, Analytic %eflective thin ing, Analytic %eflective thin ing, Analytic %eflective thin ing %eflective thin ing, Analytic Analytic %eflective thin ing
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Problems
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Intermediate Accounting, 7'e
Q(ESTI)*S +), ,E-IE. )+ /E0 T)PICS

Question 5"#
The reali(ation principle requires that two criteria be satisfied before revenue can be recogni/ed! $. The earnings process is 0udged to be complete or virtually complete. &. There is reasonable certainty as to the collectibility of the asset to be received 1usually cash2.
Question 5"$
At the time production is completed, there usually exists significant uncertainty as to the collecti)ilit* o+ the asset to )e recei,ed. 3e don4t now if the product will be sold, nor the selling price, nor the buyer if eventually the product is sold. Because of these uncertainties, revenue recognition usually is delayed until the point of product delivery.
Question 5"%
A principal has primary responsibility for delivering a product or service, and recogni/es as revenue the gross amount received from a customer. An agent doesn4t primarily deliver goods or services, but acts as a facilitator that earns a commission for helping sellers to transact with buyers, and recogni/es as revenue only the commission it receives for facilitating the sale.
Question 5"&
5f the installment sale creates a situation where there is significant uncertainty concerning cash collection and it is not possible to ma e an accurate assessment of future bad debts, revenue and cost recognition should be delayed beyond the point of delivery.
Question 5"5
The installment sales method recogni/es gross profit by applying the gross profit percentage on the sale to the amount of cash actually received each period. The cost recovery method defers all gross profit recognition until cash has been received equal to the cost of the item sold.
Question 5"'
.eferred gross profit is a contra installment receivable account. The balance in this account is subtracted from gross installment receivables to arrive at installment receivables, net. The net amount of the receivables represents the portion of remaining payments that represent cost recovery.
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Question 5"1
Because the return of merchandise can retroactively negate the benefits of having made a sale, the seller must meet certain criteria before revenue is recogni/ed in situations when the right o+ return exists. The most critical of these criteria is that the seller must be able to ma e reliable estimates of future returns. 5n certain situations, these criteria are not satisfied at the point of delivery of the product.
Question 5"2
Sometimes a company arranges for another company to sell its product under consignment. The 6consignor7 physically transfers the goods to the other company 1the consignee2, but the consignor retains legal title. 5f the consignee can4t find a buyer within an agreed8upon time, the consignee returns the goods to the consignor. 9owever, if a buyer is found, the consignee remits the selling price 1less commission and approved expenses2 to the consignor. Because the consignor retains the ris s and rewards of ownership of the product and title does not pass to the consignee, the consignor does not record revenue 1and related costs2 until the consignee sells the goods and title passes to the eventual customer.
Question 5"3
:or service revenue, if there is one final service that is critical to the earnings process, revenues and costs are deferred and recogni/ed after this service has been performed. ;n the other hand, in many instances, service revenue activities occur over extended periods and recogni/ing revenue at any single date within that period would be inappropriate. 5nstead, it4s more meaningful to recogni/e revenue over time in proportion to the performance of the activity.
Question 5"#4
The completed contract method of recogni/ing revenues and costs on long8term construction contracts is equivalent to recogni/ing revenue at point of delivery, i.e., when the construction pro0ect is complete. The percentage8of8completion method assigns a fair share of the pro0ect4s expected revenues and costs to each period in which the earnings process ta es place, i.e., the construction period. The 6fair share7 typically is estimated as the pro0ect<s costs incurred each period as a percentage of the pro0ect<s total estimated costs. The completed contract method should only be used when the lac of dependable estimates or inherent ha/ards cause forecasts of future costs to be doubtful.
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Question 5"##
The completed contract method recogni/es revenue, cost of construction, and gross profit at the end of the contract, after the contract has been completed. The cost recovery method will recogni/e an amount of revenue equal to the amount of cost that can be recovered, which typically is an amount that exactly offsets costs until all costs have been recovered, and then will recogni/e the remaining revenue and gross profit. Therefore, revenue and cost are recogni/ed earlier under the cost recovery method than under the completed contract method, but gross profit recognition is delayed until late in the contract for both approaches. Assuming that the final costs are incurred 0ust prior to completion of the contract, both approaches should recogni/e gross profit at the same time.
Question 5"#$
The billings on construction contract account is a contra account to the construction in progress asset. At the end of each reporting period, the balances in these two accounts are compared. 5f the net amount is a debit, it is reported in the balance sheet as an asset. Conversely, if the net amount is a credit, it is reported as a liability.
Question 5"#%
An estimated loss on a long8term contract must be fully recogni/ed in the first period the loss is anticipated, regardless of the revenue recognition method used.
Question 5"#&
This guidance requires that if an arrangement includes multiple elements, the revenue from the arrangement should be allocated to the various elements based on the relative fair values of the individual elements. 5f part of an arrangement does not qualify for separate accounting, revenue recognition is delayed until revenue is recogni/ed for the other parts.
Question 5"#5
5:%S has less specific guidance for recogni/ing revenue for multiple8deliverable arrangements. IA# .o. !/ simply states that! 6=in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction7 and gives a couple of examples, whereas >.S. ?AA@ provides more restrictive guidance concerning how to allocate revenue to various components and when revenue from components can be recogni/ed.
Question 5"#'
Specific guidelines for revenue recognition of the initial franchise fee are provided by :ASB ASC ,"&#)-"#&"#$. A ey to these guidelines is the concept of su)stantial per+ormance. 5t requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recogni/ed as revenue. The term 6substantial7 requires professional 0udgment on the part of the accountant. 5n situations when the initial franchise fee is collectible in installments, even after substantial performance has occurred, the installment sales or cost recovery method should be used for profit recognition, if a reasonable estimate of uncollectibility cannot be made.
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Question 5"#1
%eceivables turnover ratio 5nventory turnover ratio Asset turnover ratio A A A Bet sales Average accounts receivable 1net2 Cost of goods sold Average inventory Bet sales Average total assets
Activity ratios are designed to provide information about a company4s effectiveness in managing assets. Activity or turnover of certain assets measures the frequency with which those assets are replaced. The greater the number of times an asset turns over, the less cash a company must devote to that asset, and the more cash it can commit to other purposes.
Question 5"#2
@rofit margin on sales %eturn on assets %eturn on shareholders< equity A A A Bet income Bet sales Bet income Average total assets Bet income Average shareholders< equity
A fundamental element of an analyst4s tas is to develop an understanding of a firm4s profitability. @rofitability ratios provide information about a company4s ability to earn an adequate return relative to sales or resources devoted to operations. %esources devoted to operations can be defined as total assets or only those assets provided by owners, depending on the evaluation ob0ective.
Question 5"#3
%eturn on equity Bet income Avg. total equity A A @rofit margin Bet income Total sales C C Asset turnover Total sales Avg. total assets C Dquity multiplier C Avg. total assets Avg. total equity
The .u@ont framewor shows return on equity as being driven by profit margin 1reflecting a company4s ability to earn income from sales2, asset turnover 1reflecting a company4s effectiveness in using assets to generate sales2, and the equity multiplier 1reflecting the extent to which a company has used debt to finance its assets2.
Question 5"$4
These perspectives are referred to as the discrete and integral part approaches. Current interim reporting requirements and existing practice generally view interim reports as integral parts of annual statements. 9owever, the discrete approach is applied to some items. Eost revenues and expenses are recogni/ed in interim periods as incurred. 9owever, if an expenditure clearly benefits more than 0ust the period in which it is incurred, the expense should be spread among the periods benefited. Dxamples include annual repair expenses, property tax expense, and advertising expenses incurred in one quarter that clearly benefit later quarters. These are assigned to each quarter through the use of accruals and deferrals. ;n the other hand, ma0or events such as discontinued operations, extraordinary items, and unusual or infrequent items should be reported separately in the interim period in which they occur.
Question 5"$#
>.S. ?AA@ views interim reports as an integral part of the annual report, so amounts that affect multiple interim periods are accrued or deferred and then charged to each of the periods they affect. 5:%S ta es much more of a discrete8period approach than does >.S. ?AA@, such that costs for repairs, property taxes, advertising, etc., that do not meet the definition of an asset at the end of an interim period are expensed entirely in the period in which they occur.
S(PP5EME*T Q(ESTI)*S +), ,E-IE. )+ /E0 T)PICS

Question 5"$$
The five ey steps in recogni/ing revenue under the new standard are! $. 5dentify a contract1s2 with a customer. &. 5dentify the separate performance obligation1s2 in the contract. '. .etermine the transaction price. (. Allocate the transaction price to the separate performance obligations. ". %ecogni/e revenue when 1or as2 the entity satisfies each performance obligation.
Question 5"$%
>nder the proposed AS>, a good or service is a separate performance obligation if it is distinct, which is the case if either! $. The seller regularly sells the good or service separately, or
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&. A buyer could use the good or service on its own or in combination with goods or services the buyer could obtain elsewhere.
Question 5"$&
>nder the proposed AS>, if an entity grants a customer the option to acquire additional goods or services, that promise gives rise to a separate performance obligation in the contract only if the option provides a material right to the customer that the customer would not receive without entering into the contract. 5f the option provides a material right, the customer in effect pays the entity in advance for future goods or services and the entity recogni/es revenue when those future goods or services are transferred or when the option expires.
Question 5"$5
>nder the proposed AS>, if an arrangement has multiple separate performance obligations, the seller allocates the transaction price to the separate performance obligations in proportion to the stand8alone selling prices of the goods or services underlying those performance obligations. 5f the seller can4t observe actual stand8alone selling prices, the seller should estimate them.
Question 5"$'
>nder the proposed AS>, a performance obligation for a good is satisfied when control of the good is transferred to the buyer. :our ey indicators that control of a good has passed from the seller to the buyer are! $. Buyer has an unconditional obligation to pay. &. Buyer has legal title. '. Buyer has physical possession. (. Buyer has the ris s and rewards of ownership.
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Question 5"$1
>nder the proposed AS>, if a seller provides the service of integrating products and services into one asset 1for example, as is done in the construction industry2, the ris s of providing the goods and services are not separable, so that arrangement is treated as a single service8related performance obligation. The performance obligation is viewed as satisfied over time if at least one of two criteria is met! $. The seller is creating or enhancing an asset that the buyer controls as the service is performed. &. The seller is not creating an asset that the buyer controls or that has alternative use to the seller, and at least one of the following conditions hold! a. The customer receives and consumes a benefit as the seller performs. b. Another seller would not need to reperform the tas s performed to date if that other seller were to fulfill the remaining obligation. c. The seller has the right to payment for performance even if the customer could cancel the contract at the customer4s discretion.
B,IE+ E8E,CISES
Brief Exercise 5"#
&-$' gross profit A F',---,--- # $,&--,--- A 6#72447444 &-$( gross profit A 4
Brief Exercise 5"$
5ndicators that the seller is a principal 1recogni/ing gross revenue2 as opposed to an agent 1recogni/ing net revenue2 include the following! The company is primarily responsible for providing the product or service to the customer. The company has general inventory ris , meaning that the company owns inventory prior to a customer ordering it and after a customer returns it. The company has discretion in setting prices and identifying suppliers. 5n this transaction, Ama/on never bears inventory ris , and is paid a fixed commission such that it has no discretion in setting prices. Therefore, Ama/on appears to be an agent, and would only recogni/e revenue on the transaction equal to the amount of the commission it receives.
Brief Exercise 5"%
&-$' Cost recovery G A Cost Sales! F$,&--,--A (-G 1implying a gross profit G A )-G2 F',---,-- The McGraw-Hill Companies, Inc., 2 !" %&1
&-$' gross profit A &-$' cash collection of F$"-,--- x )-G A 6347444 &-$( gross profit A &-$( cash collection of F$"-,--- x )-G A 6347444
Brief Exercise 5"&

Bo gross profit will be recogni/ed in either &-$' or &-$(. ?ross profit will not be recogni/ed until the entire F$,&--,--- cost of the land is recovered. 5n this case, it will ta e eight payments to recover the cost of the land 1F$,&--,--- F$"-,--- A +2, so gross profit recognition will equal $--G of the cash collected beginning with the ninth installment payment.
Brief Exercise 5"5

5nitial deferred gross profit 1F',---,--- # $,&--,---2 F$,+--,--Hess gross profit recogni/ed in &-$' 1F$"-,--- x )-G2 1,-,---2 Hess gross profit recogni/ed in &-$( 1F$"-,--- x )-G2 1,-,---2 .eferred gross profit at the end of &-$( 6#7'$47444 The seller must meet certain criteria before revenue can be recogni/ed in situations when the right of return exists. The most critical of these criteria is that the seller must be able to Brief Exercise 5"'ma e reliable estimates of future returns. 5f Eeyer4s management can ma e reliable estimates of the furniture that will be returned, revenue can be recogni/ed when the product is delivered, assuming the company has no additional obligations to the buyer. 5f reliable estimates cannot be made because of significant uncertainty, revenue and related cost recognition is delayed until the uncertainty is resolved.
Brief Exercise 5"1

Total estimated cost to complete A F) million I , million A F$" million G of completion A F) million F$" million A (-G Total estimated gross profit 1F&- million # $" million2 A multiplied by the G of completion ?ross profit recogni/ed the first year :irst year revenue A F&-,---,--- x (-G A 6274447444 F",---,--(-G 6$74447444
Brief Exercise 5"2

Assets!
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Accounts receivable 1F* million # " million2 Cost plus profit 1F) million I & millionJ2 in excess of billings 1F* million2 J Total estimated gross profit 1F&- million # $" million2 A multiplied by the G of completion ?ross profit recogni/ed in the first year
F&,---,--$,---,--F",---,--(-G F&,---,---
Brief Exercise 5"3

Kear $ A 4 Kear & A 6& million %evenue Hess! Costs in year $ Costs in year & Actual profit F&-,---,--1),---,---2 1$-,---,---2 F (,---,---
Brief Exercise 5"#4

Kear $! %evenue! Cost! ?ross profit! F) million F) million F-
Kear &! %evenue! F$( million 1F&- million total # ) million in year $2 Cost! F$- million ?ross profit! F ( million The anticipated loss of F' million 1F'- million contract Brief Exercise 5"##price less total estimated costs of F'' million2 must be recogni/ed in the first year applying either method. ;range has separate sales prices for the two parts of Hearn5t8@lus, so that vendor8specific ob0ective evidence 1LS;D2 allows them to allocate revenue to those parts Brief Exercise 5"#$according to their relative selling prices. Hearn5t will be allocated F&-- x MF$"- N 1F$"- I $--2O A F$&-, and that revenue will be recogni/ed upon delivery of the Hearn5t software. Hearn5t ;ffice 9ours will be allocated F&-- x MF$-- N 1F$"- I $--2O A F+-, and that revenue will be deferred and recogni/ed over the life of the one8year period in which the ;ffice 9ours are delivered. 5f Hearn5t were not sold separately, ;range would not have LS;D for all of the parts of the contract. 5n that case, revenue would be delayed until the later part was
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delivered. 5n this case, the F&-- would be deferred and recogni/ed over the life of the one8year period in which the ;ffice 9ours are delivered. ;range has separate sales prices for the two parts of Brief Exercise 5"#%Hearn5t8@lus, so the company can base its estimates of the fair value of those parts according to their relative selling prices. Hearn5t will be allocated F&-- x MF$"- N 1F$"- I $--2O A F$&-, and that revenue will be recogni/ed upon delivery of the Hearn5t software. Hearn5t ;ffice 9ours will be allocated F&-- x MF$-- N 1F$"- I $--2O A F+-, and that revenue will be deferred and recogni/ed over the life of the one8year period in which the ;ffice 9ours are delivered. 5f Hearn5t were not sold separately, the accounting would be the same. ;range would estimate the fair value of Hearn5t ;ffice 9ours to be F$-- and allocate revenue in the same fashion as it did when that product was sold separately. 1LS;D is not required under 5:%S2. Specific conditions for revenue recognition of the initial Brief Exercise 5"#&franchise fee are provided by :ASB ASC ,"&#)-"#&"#$. A ey to these conditions is the concept of substantial performance. 5t requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recogni/ed as revenue. The term 6substantial7 requires professional 0udgment on the part of the accountant. ;ften, substantial performance is considered to have occurred when the franchise opens for business. Continuing franchise fees are recogni/ed over time as the services are performed.
Brief Exercise 5"#5

%eceivables turnover ratio 1net2 %eceivables turnover ratio A A F)--,--MF$--,--- I $&-,---O N & 59&5 times A Bet sales Average accounts receivable
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5nventory turnover ratio 5nventory turnover ratio
A A A
Cost of goods sold Average inventory F(--,---J MF+-,--- I )-,---O N & 591# times
JF)--,--- # &--,---
Brief Exercise 5"#'

@rofit margin A A A %eturn on assets A A A %eturn on shareholders4 equity Bet income Sales F)",--F(&-,--#595: Bet income Average total assets F)",--F+--,--29#:
Bet income Average shareholders4 equity F)",--F"&&,"--J #$9&:
A A
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Shareholders4 equity, beginning of period Add! Bet income .educt! .ividends Shareholders4 equity, end of period
F"--,--)",--1&-,---2 F"(",---
JAverage shareholders4 equity A 1F"--,--- I "(",---2 & A F"&&,"--
Brief Exercise 5"#1

%eturn on equity A @rofit margin C C Asset turnover C Dquity multiplier
Bet income A Bet income Avg. total equity Total sales %eturn on shareholders4 equity A A A @rofit margin A A ;
Total sales C Avg. total assets Avg. total assets Avg. total equity
Bet income Average shareholders4 equity F)",--F"&&,"-#$9&: Bet income Sales F)",--F(&-,--#595: Asset turnover Sales Average total assets F(&-,--F+--,--A
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; Dquity multiplier A
95$5 times
Brief Exercise 517 (concluded)
Average total assets Average shareholders4 equity F+--,--F"&&,"-#95%
A A
Chec ! $&.(G %;D A $"."G profit margin x ."&" times asset turnover x $."' equity multiplier.
Brief Exercise 5"#2

5nventory turnover ratio A Cost of goods sold Average inventory ).A x F*",--Cost of goods sold A F*",--- x ).- A F("-,--Sales F)--,--Cost of goods sold A ?ross profit # ("-,--A 6#547444
#
S(PP5EME*T B,IE+ E8E,CISES

Brief Exercise 5"#3
An agreement needs to have the following five characteristics to qualify as a contract for revenue recognition purposes under the proposed AS>! $. Commercial substance. The contract is expected to affect the seller4s future cash flows. &. Approval. Dach party to the contract has approved the contract and is committed to satisfying their respective obligations.
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'. %ights. Dach party4s rights are specified with respect to the goods and services to be transferred. (. @ayment terms. The terms and manner of payment are specified. ". @erformance. A contract does not exist if either party can terminate a wholly unperformed contract without penalty. The %ichter agreement does not satisfy characteristic number (, and may not satisfy characteristics ' and " as well. Therefore, it does not qualify as a contract for purposes of recogni/ing revenue.
Brief Exercise 5"$4

Kes, these are separate performance obligations, because each good is sold separately to individual customers.
Brief Exercise 5"$#

Kes, they are separate. The renewal option is a material right because it allows the customer to renew at a better price than could be obtained without the right.
Brief Exercise 5"$$
Total estimated contract price A F&",--- I 1"-G x F$-,---2 A 6%47444 Based on relative stand8alone selling prices, the software Brief Exercise 5"$%comprises +-G of the total fair values 1F+-,--- N 1F&-,--- I +-,---22, and the technical support comprises &-G 1F&-,--- N 1F&-,--- I +-,---22. Therefore, the seller would recogni/e F*&,--- 1F,-,--- +-G2 in revenue up front when the software is delivered, and defer the remaining F$+,--- 1F,-,--- &-G2 and recogni/e it ratably over the next six months as the technical support service is provided, ma ing the following 0ournal entry! Cash ,-,--%evenue *&,-->nearned revenue $+,---
Brief Exercise 5"$&

A performance obligation is satisfied over time if at least one of two criteria is met! #9 The seller is creating or enhancing an asset that the buyer controls as the service is performed. $9 The seller is not creating an asset that the buyer controls or that has alternative use to the seller, and at least one of the following conditions hold! a. The customer receives and consumes a benefit as the seller performs the service.
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b. Another seller would not need to reperform the tas s performed to date if that other seller were to fulfill the remaining obligation. c. The seller has the right to payment for performance even if the customer could cancel the contract at the customer4s discretion. >nder Dstate4s construction agreement with CyberB, if for some reason Dstate could not complete construction, CyberB would own the partially completed building and could retain another construction company to complete the 0ob. A new construction contractor would not need to reperform Dstate4s wor if the new contractor completed the 0ob. Therefore, criterion &b is satisfied. @atterson initially would record the payment as Brief Exercise 5"$5 unearned revenue. Then @atterson would accrue interest expense of F$-,--- x "G A F"-- in year one of the contract, and interest expense of 1F$-,--- I "--2 x "G A F"&" in year two of the contract, in each case debiting interest expense and crediting unearned revenue. Therefore, at the point in time @atterson delivers the novel, it would have unearned revenue totaling F$-,--- I "-- I "&" A F$$,-&", and would recogni/e that amount as revenue.
E8E,CISES Exercise 5"#
,e<uirement # Alpine 3est should recogni/e revenue over the s i season on an anticipated usage basis, in this case equally throughout the season. The fact that the F("- price is nonrefundable is not relevant to the revenue recognition decision. %evenue should be recogni/ed as it is earned, in this case as the services are provided during the s i season. ,e<uirement $ *o=ember '7 $4#% Cash................................................................................ >nearned revenue........................................................ To record the cash collection
("("-
>ecember %#7 $4#% >nearned revenue 1F("- x $P"2......................................... ,%evenue....................................................................... To recogni?e re=enue earned in >ecember @no re=enue earned in *o=ember7 as season starts on >ecember #A9
,-
,e<uirement % F,- is included in revenue in the &-$' income statement. The F')- remaining balance in unearned revenue is included in the current liability section of the &-$' balance sheet. 3hen other parties are involved in providing goods or services to a seller4s customer, the seller has to determine whether its performance obligation is to provide the goods or services itself, ma ing the seller a principal, or the seller arranges for another party to provide those goods or services, ma ing the seller an agent. That determination affects whether the seller recogni/es revenue in the amount of consideration received in exchange for those goods or services 1if principal2 or in the amount of any fee or commission received in exchange for arranging for the other party to provide the goods or services 1if agent2.
Exercise 5"$
The McGraw-Hill Companies, Inc., 2 !" %&!/
,e<uirement # AuctionCo is a principal because it obtained control of the used bicycle before the bicycle was sold. Therefore, AuctionCo should recogni/e revenue of F'-. ,e<uirement $ AuctionCo is an agent because it never controlled the product before it was sold. Therefore, AuctionCo should recogni/e revenue for the commission fees of F$retained upon sending F&- to the original owner. ,e<uirement % 5n this case it appears that AuctionCo is acting as an agent, given that the bicycles are shipped directly from the owner to the customer. 9owever, additional aspects of the arrangement could ma e it more appropriate to treat AuctionCo as a principal. :or example, if AuctionCo must pay the bicycle owner the F&- wholesale price regardless of whether the bicycle is sold, then AuctionCo would appear to have purchased the bicycle and should be treated as a principal.Exercise 5"% ,e<uirement # $4#% cost reco=er :B F&'(,--A )"G 1gross profit G A '"G2 F')-,--$4#& cost reco=er :B F&(",--A *-G 1gross profit G A '-G2 F'"-,--$4#% gross profitB Cash collection from &-$' sales of F$"-,--- x '"G A $4#& gross profitB Cash collection from &-$' sales of F$--,--- x '"G A I Cash collection from &-$( sales of F$&-,--- x '-G A Total &-$( gross profit ,e<uirement $ $4#% deferred gross profit balanceB &-$' initial gross profit 1F')-,--- # &'(,---2 Hess! ?ross profit recogni/ed in &-$'
65$7544 F '",--'),--61#7444
F$&),--1"&,"--2
Balance in deferred gross profit account $4#& deferred gross profit balanceB &-$' initial gross profit 1F')-,--- # &'(,---2 Hess! ?ross profit recogni/ed in &-$' ?ross profit recogni/ed in &-$( &-$( initial gross profit 1F'"-,--- # &(",---2 Hess! ?ross profit recogni/ed in &-$( Balance in deferred gross profit account
61%7544 F $&),--1"&,"--2 1'",---2 $-",--1'),---2 6#417544
Exercise 5"&
$4#% 5nstallment receivables.................................................... ')-,--5nventory..................................................................... &'(,--.eferred gross profit................................................... $&),--To record installment sales $4#% Cash................................................................................ $"-,--5nstallment receivables................................................ $"-,--To record cash collections from installment sales $4#% .eferred gross profit....................................................... %eali/ed gross profit................................................... To recogni?e gross profit from installment sales "&,"-"&,"--
$4#& 5nstallment receivables.................................................... '"-,--5nventory..................................................................... &(",--.eferred gross profit................................................... $-",--To record installment sales $4#&
Cash................................................................................ &&-,--5nstallment receivables................................................ &&-,--To record cash collections from installment sales $4#& .eferred gross profit....................................................... %eali/ed gross profit................................................... To recogni?e gross profit from installment sales *$,--*$,---
Exercise 5"5
0ear &-$' &-$( &-$" &-$) Total
,e<uirement # Income recogni?ed F$+-,--- 1F'--,--- # $&-,---2 8-8 8-8 8-8 F$+-,---
,e<uirement $ Cost reco=er :B F$&-,--8888888888888 A (-G 1gross profit G A )-G2 F'--,--0ear &-$' &-$( &-$" &-$) Totals Cash Collected F *",--*",--*",--*",--F'--,--Cost ,eco=er @&4:A F '-,--'-,--'-,--'-,--F$&-,--Cross Profit@'4:A F (",--(",--(",--(",--F$+-,---
,e<uirement % 0ear &-$' Cash Collected F *",--Cost ,eco=er F *",--Cross Profit 8-8
The McGraw-Hill Companies, Inc., 2 !" %&2!
&-$( &-$" &-$) Totals
*",--*",--*",--F'--,--,e<uirement #
(",--8-8 8-8 F$&-,---
F '-,--*",--*",--F$+-,---
Exercise 5"'
Dul #7 $4#% 5nstallment receivables.................................................... '--,--Sales revenue............................................................... '--,--To record installment sale Cost of goods sold........................................................... $&-,--5nventory..................................................................... $&-,--To record cost of installment sale Cash................................................................................ 5nstallment receivables................................................ To record cash collection from installment sale Dul #7 $4#& Cash................................................................................ 5nstallment receivables................................................ To record cash collection from installment sale *",--*",---
*",--*",---
Exercise 56 (continued) ,e<uirement $ Dul #7 $4#% 5nstallment receivables.................................................... '--,--5nventory..................................................................... $&-,--.eferred gross profit................................................... $+-,--To record installment sale Cash................................................................................ 5nstallment receivables................................................ To record cash collection from installment sale .eferred gross profit....................................................... %eali/ed gross profit................................................... To recogni?e gross profit from installment sale Dul #7 $4#& Cash................................................................................ 5nstallment receivables................................................ To record cash collection from installment sale .eferred gross profit....................................................... %eali/ed gross profit................................................... To recogni?e gross profit from installment sale *",--*",--(",--(",---
*",--*",--(",--(",---
The McGraw-Hill Companies, Inc., 2 !" %&2"
Exercise 56 (concluded) ,e<uirement % Dul #7 $4#% 5nstallment receivables.................................................... '--,--5nventory..................................................................... $&-,--.eferred gross profit................................................... $+-,--To record installment sale Cash................................................................................ 5nstallment receivables................................................ To record cash collection from installment sale Dul #7 $4#& Cash................................................................................ 5nstallment receivables................................................ To record cash collection from installment sale .eferred gross profit....................................................... %eali/ed gross profit................................................... To recogni?e gross profit from installment sale *",--*",---
*",--*",--'-,--'-,---
Exercise 5"1
,e<uirement # F(--,--$--,--65447444
Cost of goods sold 1F$,---,--- # )--,---2 Add! ?ross profit if using cost recovery method Cash collected F )--,--?ross profit percentage A F$,---,--A )-G
,e<uirement $
Cash collected x ?ross profit percentage A ?ross profit recogni/ed F"--,--- x )-G A 6%447444 gross profit
Exercise 5"2
The McGraw-Hill Companies, Inc., 2 !" %&2Intermediate Accounting, 7'e
)ctober #7 $4#% 5nstallment receivable....................................................... (,---,--5nventory..................................................................... $,+--,--.eferred gross profit................................................... &,&--,--To record the installment sale Cash................................................................................ +--,--5nstallment receivable.................................................. +--,--To record the cash doEn pa ment from installment sale .eferred gross profit 1F+--,--- x ""GJ2........................ ((-,--%eali/ed gross profit................................................... ((-,--To recogni?e gross profit from installment sale )ctober #7 $4#& %epossessed inventory 1fair value2 .................................$,'--,--.eferred gross profit 1balance2........................................$,*)-,--Hoss on repossession 1difference2 .................................. $(-,--5nstallment receivable 1balance2.................................. ',&--,--To record the default and repossession.......................
JF&,&--,--- F(,---,--- A ""G gross profit percentage
Exercise 5"3
,e<uirement #
April #7 $4#% 5nstallment receivables.................................................... &,(--,--Hand............................................................................ (+-,--?ain on sale of land..................................................... $,,&-,--To record installment sale April #7 $4#% Cash................................................................................ $&-,---
The McGraw-Hill Companies, Inc., 2 !" %&2%
5nstallment receivables................................................ To record cash collection from installment sale April #7 $4#& Cash................................................................................ 5nstallment receivables................................................ To record cash collection from installment sale $&-,---
$&-,---
$&-,---
,e<uirement $ April #7 $4#% 5nstallment receivables.................................................... &,(--,--Hand............................................................................ (+-,--.eferred gain............................................................... $,,&-,--To record installment sale
Exercise 59 (concluded) 3hen payments are received, gain on sale of land is recogni/ed, calculated by applying the gross profit percentage 1F$,,&-,--- N F&,(--,--- A +-G2 to the cash collected 1+-G x F$&-,---2.
April #7 $4#% Cash................................................................................ 5nstallment receivables................................................ To record cash collection from installment sale .eferred gain................................................................... ?ain on sale of land 1+-G x F$&-,---2........................... To recogni?e profit from installment sale April #7 $4#& Cash................................................................................ 5nstallment receivables................................................ To record cash collection from installment sale .eferred gain................................................................... ?ain on sale of land 1+-G x F$&-,---2........................... To recogni?e profit from installment sale
$&-,--$&-,--,),--,),---
$&-,--$&-,--,),--,),---
Exercise 5"#4
The 2A#3 Accounting #tandards Codi+ication represents the single source of authoritative >.S. generally accepted accounting principles. The specific citation for each of the following items is! #9 .hen a pro=ision for loss is recogni?ed for a percentageFofFcompletion contractB :ASB ASC )-"#'"#&"#()! 6%evenue %ecognition#Construction#Type and @roduction#Type Contracts#%ecognition#@rovisions for Hosses on Contracts.7
$9
Circumstances indicating Ehen the installment method or cost reco=er method is appropriate for re=enue recognitionB :ASB ASC )-"#$-#&"#(! 6%evenue %ecognition#;verall#%ecognition# 5nstallment and Cost %ecovery Eethods of %evenue %ecognition.7 1Bote! ASC )-"#$-#&"#' also provides some guidance, as it indicates when installment method is not acceptable2. Criteria determining Ehen a seller can recogni?e re=enue at the time of sale from a sales transaction in Ehich the bu er has the right to return the productB :ASB ASC )-"#$"#&"#$! 6%evenue %ecognition#@roducts#%ecognition# ?eneral#Sales of @roduct when %ight of %eturn Dxists.7 ,e<uirement # $4#% F&,---,--'--,--$,&--,--$,"--,--F "--,--$4#& F&,---,--$,+*",--8-8 $,+*",--F $&",---
%9
Exercise 5"##
Contract price Actual costs to date Dstimated costs to complete Total estimated costs ?ross profit 1estimated in &-$'2
Cross profit recognitionB &-$'! F '--,--A &-G x F"--,--- A 6#447444 F$,"--,--&-$(! F$&",--- # $--,--- A 6$57444
,e<uirement $ &-$' &-$( ,e<uirement %
F 8-8 F$&",---
Balance Sheet At >ecember %#7 $4#%

The McGraw-Hill Companies, Inc., 2 !" %&2/ Intermediate Accounting, 7'e
Current assets4 Accounts receivable Costs and profit @6&447444GA in excess of billings @6%247444A J Costs 1F'--,---2 I profit 1F$--,---2
F $'-,--&-,---
Exercise 511 (concluded) ,e<uirement & Balance Sheet At >ecember %#7 $4#% Current assets4 Accounts receivable Current lia)ilities4 Billings @6%247444A in excess of costs @6%447444A ,e<uirement # F $'-,--F +-,---
Exercise 5"#$
1F in millions2
Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1actual in &-$"2 Cross profit @lossA recognitionB &-$'! F(-
$4#% F&&($&$)F )-
$4#& F&&$&)$+F (-
$4#5 F&&$*8-8 $*F "-
A &"G x F)- A 6#5 F$)&-$(! F$&A )).)*G x F(- A F&).)* # $" A 6##9'1 F$+&-$"! F&&- # $*- A F"- # 1$" I $$.)*2 A 6$%9%%
,e<uirement $ &-$'! F&&- x &"G A 655 &-$(! F&&- x )).)*G A F$().)* # "" A 63#9'1 &-$"! F&&- # $().)* A 61%9%%
The McGraw-Hill Companies, Inc., 2 !" %&" Intermediate Accounting, 7'e
,e<uirement % 0ear &-$' &-$( &-$" Total pro0ect income Cross profit @lossA recogni?ed 8-8 8-8 "F"-
The McGraw-Hill Companies, Inc., 2 !" %&"!
Exercise 512 (concluded) ,e<uirement & &-$'! %evenue! Cost! ?ross profit! &-$(! %evenue! Cost! ?ross profit! &-$"! %evenue! Cost! ?ross profit! ,e<uirement 5 &-$(! F$&A )-G x F&-J A F$& # $" A 6@%A loss F&-JF&&- # 1(- I +- I +-2 A F&,e<uirement # F$-- 1F&&- contract price # (- # +-2 "F "F++F F((F -
Exercise 5"#%
Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1loss2 1actual in &-$"2 $4#% F+,---,--&,---,--(,---,--),---,--F&,---,--$4#& F+,---,--(,"--,--',)--,--+,$--,--F 1$--,---2 $4#5 F+,---,--+,'--,--8-8 +,'--,--F 1'--,---2
Cross profit @lossA recognitionB &-$'! F&,---,-- The McGraw-Hill Companies, Inc., 2 !" %&"2 Intermediate Accounting, 7'e
A ''.''''G x F&,---,--- A 6'''7''1 F),---,--&-$(! F1$--,---2 # ))),))* A 6@1''7''1A
&-$"! F1'--,---2 # 1$--,---2 A 6@$447444A
The McGraw-Hill Companies, Inc., 2 !" %&""
Exercise 513 (continued) ,e<uirement $ Construction in progress Larious accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress
@gross profitA
$4#% $4#& &,---,--&,"--,--&,---,--&,"--,--&,"--,--&,*"-,--&,"--,--&,*"-,--&,&"-,--&,(*",--&,&"-,--&,(*",---
Cost of construction %evenue from long8term contracts

@%%9%%%%: x 6274447444A
))),))* &,---,--$7'''7''1 &,"((,--#71117%%% *)),))*
To record gross profit Cost of construction 1&2 %evenue from long8term contracts Construction in progress 1loss2 To record expected loss
1$2
1$2 and 1&2! @ercent complete A F(,"--,--- N F+,$--,--- A "".""G %evenue recogni/ed to date! "".""G x F+,---,--- A F(,(((,--Hess! %evenue recogni/ed in &-$' 1above2 1&,))),))*2 %evenue recogni/ed in &-$( $,***,''' 1$2 @lus! Hoss recogni/ed in &-$( 1prior page2 *)),))* Cost of construction, &-$( F&,"((,--- 1&2
The McGraw-Hill Companies, Inc., 2 !" %&"-
Exercise 513 (concluded) ,e<uirement % Balance Sheet Current assets4 Accounts receivable Costs and profit 1F&,))),))*J2 in excess of billings 1F&,"--,---2 Current lia)ilities4 Billings 1F",&"-,---2 in excess of costs less loss 1F(,(--,---JJ2 $4#% $4#&
F&"-,--- F"&",--$)),))*
F+"-,---
J Costs 1F&,---,---2 I profit 1F))),))*2 JJ Costs 1F&,---,--- I &,"--,---2 # loss 1F$--,--- A F*)),))* # ))),))*2
Exercise 5"#&
,e<uirement # Cross profit @lossA recogni?ed 8-8 F1$--,---2 1&--,---2 F1'--,---2
0ear &-$' &-$( &-$" Total pro0ect loss ,e<uirement $
Construction in progress Larious accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Hoss on long8term contract
$4#% $4#& &,---,--&,"--,--&,---,--&,"--,--&,"--,--&,*"-,--&,"--,--&,*"-,--&,&"-,--&,(*",--&,&"-,--&,(*",--$--,-- The McGraw-Hill Companies, Inc., 2 !" %&"%
Construction in progress To record expected loss
$--,---
The McGraw-Hill Companies, Inc., 2 !" %&"0
Exercise 514 (concluded) ,e<uirement % Balance Sheet Current assets4 Accounts receivable Current lia)ilities4 Billings 1F&,"--,---2 in excess of costs
1F&,---,---2
$4#% F&"-,---
$4#& F"&",---
F"--,--F+"-,---
Billings 1F",&"-,---2 in excess of costs less loss 1F(,(--,---J2

J Costs 1F&,---,--- I &,"--,---2 # loss 1F$--,---2
Exercise 5"#5
S(MMA,0
PercentageFofFCompletion Completed Contract Situation $4#% $4#& $4#5 $4#% $4#& $4#5 $ F$)),))* F&'',''' F$--,--- FFF"--,--& F$)),))* F1)),))*2 F$--,--- FFF&--,--' F$)),))* F1&)),))*2 F1$--,---2 FF1$--,---2 F1$--,---2 ( F$&",--- F'*",--- FFFF"--,--" F$&",--- F1$&",---2 F&--,--- FFF&--,--) F1$--,---2 F1$--,---2 F1$--,---2 F1$--,---2 F1$--,---2 F1$--,---2 Exercise 515 (continued) Situation # F PercentageFofFCompletion Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit
$4#% F",---,--$,"--,--',---,--(,"--,---
$4#& F",---,--',)--,--,--,--(,"--,---
$4#5 F",---,--(,"--,--8-8 (,"--,---
1actual in &-$"2
F "--,---
F "--,---
F "--,---
Cross profit @lossA recogni?edB &-$'! F$,"--,--A ''.''''G x F"--,--- A 6#''7''1 F(,"--,--&-$(! F',)--,--A +-.-G x F"--,--- A F(--,--- # $)),))* A 6$%%7%%% F(,"--,--&-$"! F"--,--- # (--,--- A 6#447444
Situation # F Completed Contract 0ear &-$' &-$( &-$" Total gross profit Cross profit recogni?ed 8-8 8-8 F"--,--F"--,---
The McGraw-Hill Companies, Inc., 2 !" %&"/
Exercise 515 (continued) Situation $ F PercentageFofFCompletion Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1actual in &-$"2 $4#% F",---,--$,"--,--',---,--(,"--,--F "--,--$4#& F",---,--&,(--,--&,(--,--(,+--,--F &--,--$4#5 F",---,--(,+--,--8-8 (,+--,--F &--,---
Cross profit @lossA recogni?edB &-$'! F$,"--,--A ''.''''G x F"--,--- A 6#''7''1 F(,"--,--&-$(! F&,(--,--A "-.-G x F&--,--- A F$--,--- # $)),))* A 6@''7''1A F(,+--,--&-$"! F&--,--- # $--,--- A 6#447444
Situation $ F Completed Contract 0ear &-$' &-$( &-$" Total gross profit Cross profit recogni?ed 8-8 8-8 F&--,--F&--,---
Exercise 515 (continued) Situation % F PercentageFofFCompletion Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1loss2 1actual in &-$"2 $4#% F",---,--$,"--,--',---,--(,"--,--F "--,--$4#& F",---,--',)--,--$,"--,--",$--,--F 1$--,---2 $4#5 F",---,--",&--,--8-8 ",&--,--F 1&--,---2
Cross profit @lossA recogni?edB &-$'! F$,"--,--A ''.''''G x F"--,--- A 6#''7''1 F(,"--,--&-$(! &-$"! F1$--,---2 # $)),))* A 6@$''7''12
F1&--,---2 # 1$--,---2 A 6@#447444A
Situation % F Completed Contract 0ear &-$' &-$( &-$" Total pro0ect loss Cross profit @lossA recogni?ed 8-8 F1$--,---2 1$--,---2 F1&--,---2
The McGraw-Hill Companies, Inc., 2 !" %&-
Exercise 515 (continued) Situation & F PercentageFofFCompletion Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1actual in &-$"2 $4#% F",---,--"--,--',"--,--(,---,--F$,---,--$4#& F",---,--',"--,--+*",--(,'*",--F )&",--$4#5 F",---,--(,"--,--8-8 (,"--,--F "--,---
Cross profit @lossA recogni?edB &-$'! F "--,--A $&."G x F$,---,--- A 6#$57444 F(,---,--&-$(! F',"--,--A +-.-G x F)&",--- A F"--,--- # $&",--- A 6%157444 F(,'*",--&-$"! F"--,--- # "--,--- A 6 F 4 F
Situation & F Completed Contract 0ear &-$' &-$( &-$" Total gross profit Cross profit recogni?ed 8-8 8-8 F"--,--F"--,---
The McGraw-Hill Companies, Inc., 2 !" %&-!
Exercise 515 (continued) Situation 5 F PercentageFofFCompletion Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1actual in &-$"2 $4#% F",---,--"--,--',"--,--(,---,--F$,---,--$4#& F",---,--',"--,--$,"--,--",---,--F 8-8 $4#5 F",---,--(,+--,--8-8 (,+--,--F &--,---
Cross profit @lossA recogni?edB &-$'! F "--,--A $&."G x F$,---,--- A 6#$57444 F(,---,--&-$(! &-$"! F- # $&",--- A 6@#$57444A F&--,--- # - A 6$447444
Situation 5 F Completed Contract 0ear &-$' &-$( &-$" Total gross profit Cross profit recogni?ed 8-8 8-8 F&--,--F&--,---
The McGraw-Hill Companies, Inc., 2 !" %&-2
Exercise 515 (concluded) Situation ' F PercentageFofFCompletion Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1loss2 1actual in &-$"2 $4#% F",---,--"--,--(,)--,--",$--,--F 1$--,---2 $4#& F",---,--',"--,--$,*--,--",&--,--F 1&--,---2 $4#5 F",---,--",'--,--8-8 ",'--,--F 1'--,---2
Cross profit @lossA recogni?edB &-$'! &-$(! &-$"! 6@#4474442 F1&--,---2 # 1$--,---2 A 6@#447444A F1'--,---2 # 1&--,---2 A 6@#447444A
Situation ' F Completed Contract 0ear &-$' &-$( &-$" Total pro0ect loss Cross profit @lossA recogni?ed F1$--,---2 1$--,---2 1$--,---2 F1'--,---2
Exercise 5"#'
,e<uirement #
Construction in progress A Costs incurred I @rofit recogni/ed F$--,--A H I F&-,---
Actual costs incurred in &-$' A 6247444 ,e<uirement $ Billings A Cash collections I Accounts receivable F,(,--- A
F'-,-- The McGraw-Hill Companies, Inc., 2 !" %&-"
Cash collections in &-$' A 6'&7444 ,e<uirement % Het A A Actual cost incurred I Dstimated cost to complete Actual cost incurred x 1Contract price # A2 A @rofit recogni/ed A F+-,--1F$,)--,--- # A2 A F&-,--A F$&+,---,---,--- # +-,---A A F&-,---A F$--,---A A F$&+,---,---,--A A F$,&+-,--Dstimated cost to complete A F$,&+-,--- # +-,--- A 6#7$447444 ,e<uirement & F+-,--A '9$5: F$,&+-,---
The McGraw-Hill Companies, Inc., 2 !" %&--
Exercise 517
,e<uirement # The specific citation that specifies the the circumstances and conditions under which it is appropriate to use the percentage8of8completion method is! :ASB ASC )-"#'"#&"# "*! 6%evenue %ecognition#Construction#Type and @roduction#Type Contracts# %ecognition#Circumstances Appropriate for >sing the @ercentage8of8Completion Eethod.7 ,e<uirement $ :ASB ASC )-"#'"#&"#"* reads as follows! 6The percentage8of8completion method is considered preferable as an accounting policy in circumstances in which reasonably dependable estimates can be made and in which all the following conditions exist! a. Contracts executed by the parties normally include provisions that clearly specify the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement. b. The buyer can be expected to satisfy all obligations under the contract. c. The contractor can be expected to perform all contractual obligations.7
Exercise 5"#2
As written, the question implies that there is no LS;D 1vendor specific sales price evidence2, because the question refers to the prices as estimated. >nder the assumption that there is no LS;D, the correct answer to this problem is as follows! ,e<uirement # %evenue should be recogni/ed at date of shipment of the upgrade, which occurs on Qanuary $, &-$(, because there does not exist vendor8specific evidence upon which to allocate transaction price to the various software deliverables. ,e<uirement $
The McGraw-Hill Companies, Inc., 2 !" %&-%
Dul #7 $4#%
Cash................................................................................ &(',-->nearned revenue........................................................ &(',--To record sale of softEare
5f instead the problem said that Dasywrite sold each of those components separately for the amounts listed, Dasywrite would have LS;D for each component, and the correct answer would be! ,e<uirement # %evenue should be recogni/ed as follows! Software # date of shipment, Quly $, &-$' Technical support # evenly over the $& months of the agreement >pgrade # date of shipment, Qanuary $, &-$( The amounts are determined by an allocation of total contract price in proportion to the individual fair values of the components if sold separately! Software Technical support >pgrade Total ,e<uirement $
Dul #7 $4#%
F&$-,--- N F&*-,--- x F&(',--- A 6#237444 F'-,--- N F&*-,--- x F&(',--- A $17444 F'-,--- N F&*-,--- x F&(',--A $17444 F&(',---
Cash................................................................................ &(',--%evenue....................................................................... $+,,-->nearned revenue 1F&*,--- I &*,---2............................ "(,--To record sale of softEare
Exercise 5"#3
,e<uirement #
Conveyer Habeler :iller Capper Total ,e<uirement $
1F&-,--- N F"-,---2 x F(",--- A F$+,--1F$-,--- N F"-,---2 x F(",--- A ,,--1F$",--- N F"-,---2 x F(",--- A $',"-1F",--- N F"-,---2 x F(",--- A (,"-F(",---
All F(",--- of revenue is delayed until installation of the conveyer, because the usefulness of the other elements of the multi8part arrangement is contingent on its delivery.
Exercise 5"$4
,e<uirement # 1F&-,--- N F"-,---2 x F(",--- A F$+,--1F$-,--- N F"-,---2 x F(",--- A ,,--1F$",--- N F"-,---2 x F(",--- A $',"-1F",--- N F"-,---2 x F(",--- A (,"-F(",---
Conveyer Habeler :iller Capper Total ,e<uirement $
>nder 5:%S, it is li ely that %ichardson would recogni/e revenue the same as in %equirement $, because 1a2 revenue for each part can be estimated reliably and 1b2 the receipt of economic benefits is probable.
Exercise 5"$#
)ctober #7 $4#%
Cash 1$-G x F'--,---2...................................................... '-,--Bote receivable............................................................... &*-,-->nearned franchise fee revenue.................................. '--,--To record franchise agreement and doEn pa ment
Danuar #57 $4#& >nearned franchise fee revenue...................................... '--,--:ranchise fee revenue.................................................. '--,--To recogni?e franchise fee re=enue
Exercise 5"$$
The McGraw-Hill Companies, Inc., 2 !" %&-/
5ist A
h d g a b i c $. 5nventory turnover &. %eturn on assets '. (. ".
5ist B
). *. +. l ,. m $-. f $$. 0 $&. e $'.
a. Bet income divided by net sales. b. .efers recognition until cash collected equals cost. %eturn on shareholders< equity c. .efers recognition until pro0ect is complete. @rofit margin on sales d. Bet income divided by assets. Cost recovery method e. %is s and rewards of ownership retained by seller. @ercentage8of8completion method f. Contra account to construction in progress. Completed contract method g. Bet income divided by shareholders< equity. Asset turnover h. Cost of goods sold divided by inventory. %eceivables turnover i. %ecognition is in proportion to wor completed. %ight of return 0. %ecognition is in proportion to cash received. Billings on construction contract . Bet sales divided by assets. 5nstallment sales method l. Bet sales divided by accounts receivable. Consignment sales m. Could cause the deferral of revenue recognition beyond delivery point.
Exercise 5"$%
,e<uirement # A A A Cost of goods sold Average inventory F$,+(-,--MF),-,--- I )'-,---O N & &.*, times
5nventory turnover ratio
,e<uirement $ By itself, this one ratio provides very little information. 5n general, the higher the inventory turnover, the lower the investment must be for a given level of sales. 5t indicates how well inventory levels are managed and the quality of inventory, including the existence of obsolete or overpriced inventory. 9owever, to evaluate the adequacy of this ratio it should be compared with some norm such as the industry average. That indicates whether inventory management practices are in line with the competition. 5t4s 0ust one piece in the pu//le, though. ;ther points of reference should be considered. :or instance, a high turnover can be achieved by maintaining too low inventory levels and restoc ing only when absolutely necessary. This can be costly in terms of stoc out costs.
The ratio also can be useful when assessing the current ratio. The more liquid inventory is, the lower the norm should be against which the current ratio should be compared.
Exercise 5"$&
Turnover ratios for Anderson Eedical Supply Company for &-$'! 5nventory turnover ratio A A A A A A A F(,+--,--MF,--,--- I *--,---O N & ' times F+,---,--MF*--,--- I "--,---O N & #%9%% times ')" $'.'' $19& da s F+,---,--MF(,'--,--- I ',*--,---O N
%eceivables turnover ratio
Average collection period
Asset turnover ratio &
A $ times The company turns its inventory over ) times per year compared to the industry average of " times per year. The asset turnover ratio also is slightly better than the industry average 1& times per year versus $.+ times2. These ratios indicate that Anderson is able to generate more sales per dollar invested in inventory and in total assets than the industry averages. 9owever, Anderson ta es slightly longer to collect its accounts receivable 1&*.( days compared to the industry average of &" days2.
Exercise 5"$5
,e<uirement # F$+- N F",&-- A '."G F$+- N M1F$,,-- I $,*--2 N &O A $-G F$+- N M1F""- I "--2 N &O A '(.'G
a. @rofit margin on sales b. %eturn on assets c. %eturn on shareholders4 equity
The McGraw-Hill Companies, Inc., 2 !" %&%
,e<uirement $ %etained earnings beginning of period Add! Bet income Hess! %etained earnings end of period .ividends paid
F$--,--$+-,--&+-,--$"-,--F$'-,---
Exercise 5"$',e<uirement #
a. @rofit margin on sales F$+- N F",&-- A '.()G b. Asset turnover F",&-- N M1F$,,-- I $,*--2 N &O A &.+, c. Dquity multiplier M1F$,,-- I $,*--2 N &O N M1F""- I "--2 N &O A '.(' d. %eturn on shareholders4 equity F$+- N M1F""- I "--2 N &O A '(.'G ,e<uirement $ @rofit margin x Asset turnover x Dquity multiplier A %;D '.()G x &.+, x '.(' A '(.'G Quarter
Exercise 5"$1
Exercise 5"$2
+irst Second Third Cumulative income before taxes F"-,--F,-,--- F$,-,--Dstimated annual effective tax rate '(G '-G ')G $*,--&*,--)+,(-Hess! 5ncome tax reported earlier 8-8 $*,--&*,--Tax expense to be reported F$*,--F$-,--F ($,(-5ncentive compensation F'-- million N ( A F*" million .epreciation expense ?ain on sale F)- million N ( A F$" million F&' million Quarters Ending
Exercise 5"$3
March %# Dune %4 Advertising F&--,--- F&--,--@roperty tax +*,"-+*,"-Dquipment repairs )",--)",--Dxtraordinary casualty loss 8 - 8 $+",--%esearch and development 8-8 ,),---
Sept9 %4 >ec9 %# F&--,--- F&--,--+*,"-+*,"-)",--)",--8-8 8-8 The McGraw-Hill Companies, Inc., 2 !" %&%!
Bote! this solution assumes that advertising, property tax, and equipment repairs are viewed as benefitting all periods following the one in which the expenditure is made, but that the extraordinary casualty loss and the %R. consulting fee only benefit the periods in which they occurred. Quarters Ending
Exercise 5"%4
March %# Advertising F+--,--@roperty tax '"-,--Dquipment repairs &)-,--Dxtraordinary casualty loss 8-8 %esearch and development 8-8 Dune %4 8-8 8-8 8-8 $+",--,),--Sept9 %4 8-8 8-8 8-8 8-8 8-8 >ec9 %# 8-8 8-8 8-8 8-8 8-8
S(PP5EME*T E8E,CISES
Exercise 5"%#,e<uirement #
The discount voucher provides a material right to the customer that the customer would not receive otherwise, because the customer can receive a '- percent discount with the voucher but only a $- percent discount without the voucher. That right to receive a discount could be sold separately. Therefore, the discount voucher given by Clar s is a separate performance obligation. ,e<uirement $ Cash *-,--%evenue 1to balance2 >nearned revenue 1discount option2 1$,--- pairs 1'-G # $-G discount2 &-G estimated to redeem coupon F$-- average purchase2
)),--(,---
Bote! the accompanying 0ournal entry to record cost of goods sold would be! Cost of goods sold (-,--5nventory (-,--To record cost of $,--- pairs of boots sold
The McGraw-Hill Companies, Inc., 2 !" %&%2
,e<uirement #
E x e r c i s e 5 " % $
Bo, Manhattan Toda* cannot recogni/e revenue upon receipt of the subscription fee. Dven though Manhattan Toda* received payments from customers for an annual subscription, the subscription activity does not transfer goods or services to customers. Therefore, the annual fee is viewed as a prepayment for future delivery of goods or services, and would be recogni/ed as unearned revenue when received. ,e<uirement $ %evenue for separate performance obligations will be recogni/ed when those performance obligations are satisfied. The total F$"- subscription price potentially must be allocated among two performance obligations! delivery of newspapers and coupon exercise 1or expiration2. ,e<uirement % The delivery of newspapers meets the criteria for a separate performance obligation, because it is regularly sold separately. The coupon for a (- percent discount on a carriage ride is a separate performance obligation. :irst, it is an option that conveys a material right to the recipient 1as opposed to 0ust a general mar eting offer2. Second, it meets the criteria for a separate performance obligation because the recipient could use it in combination with additional cash to en0oy a carriage ride.
The McGraw-Hill Companies, Inc., 2 !" %&%"
,e<uirement & The value of the coupon would be F$".)- 1(-G discount F$'- carriage fee '-G of customers redeeming coupon2. ;f the F$"- subscription fee, F$(.$' 1F$"- 1F$".)- 1F$".)- I $"-22 would be attributed to the coupon. >pon receiving the subscription fee, the 0ournal entry should be! Cash >nearned %evenue, subscription >nearned %evenue, coupon $"$'".+* $(.$'
The McGraw-Hill Companies, Inc., 2 !" %&%-
The McGraw-Hill Companies, Inc., 2 !" %&%%
Exercise 5"%%,e<uirement #
The license granted by @fi/er is not a separate performance obligation. The only way to exploit the license is via utili/ing ongoing %R. services from @fi/er. The license does not provide utility on its own or together with other goods or services that 9ealth@ro has received previously from @fi/er or that are available from other entities. %ather, the license requires @fi/er4s %R. services and proprietary expertise to be valuable. Therefore, @fi/er would combine the license with the %R. services to 9ealth@ro and account for them as a single performance obligation.
Exercise 5"%&
The McGraw-Hill Companies, Inc., 2 !" %&%0 Intermediate Accounting, 7'e
F"-,--- I 1F&-,--- x &-G2 A F"(,--,e<uirement $ The most li ely amount is F"-,---, because the probability of exceeding the performance threshold is less than "-G. ,e<uirement % ?iven that the outcome is binary 1Thomas either will receive the bonus or not2, the most li ely amount often would be preferred. 9owever, both amounts can be 0ustified theoretically. 1The probability8weighted amount is an expected value, and thus over all such contracts is the best estimate of the average amount that will be received.2 ,e<uirement & ?iven that aspects of receipt of the bonus are beyond Thomas4s control 1because Bran is responsible for implementation2, Thomas would view the bonus as not reasonably assured. Therefore, Thomas would recogni/e only F"-,--- upon delivery of the plan and wait until receipt of the bonus is reasonably assured 1li ely waiting until cost saving reaches the prespecified target2 before recogni/ing the bonus.
Exercise 5"%5
The transaction price should be limited to the fixed amount of consideration until the end of the year because the asset management company cannot predict the amount of value that the fund will provide by year8end. Dven if Seneca could predict that amount with some accuracy, it would not be able to recogni/e revenue associated with the bonus because that amount would not be reasonably assured until after year8end. $. %ecord the first quarterly payment. Cash or accounts receivable %evenue $--,--$--,---
&. %ecord the amount of additional revenue at the end of year. Cash or accounts receivable 1F+--,--- x $-G2 %evenue +-,--+-,---
Exercise 5"%'
.etermining whether Toys(> satisfies the performance obligation requires consideration of indicators that Ec.onald4s has obtained control of the dolls. Consider the following indicators!
$. The bu er has an unconditional obligation to pa . A customer is unconditionally obliged to pay for a good or service typically because the customer has obtained control of the good or service in exchange and the passage of time does not remove the obligation. 5n this case, Ec.onald4s does not pay Toys(> until the dolls are sold, so Ec.onald4s is conditionally 1not unconditionally2 obliged to pay for the toys. &. The bu er has the legal title. Hegal title often indicates which party has the ability to direct the use of, and receive the benefit from, a good or service. The facts do not state whether title transfers. '. The customer has ph sical possession and control of goods . 5n this case, Ec.onald4s has possession of the dolls.
The McGraw-Hill Companies, Inc., 2 !" %&%/
(. The bu er has the risIs and reEards of oEndership9 5n this case, given that Ec.onald4s returns unsold dolls to Toys(>, Ec.onald4s does not appear to be holding the ris s of ownership. 5t appears that Toys(> has not transferred control upon delivery because 1$2 Ec.onald4s has a conditional rather than unconditional obligation to pay, and 1&2 Toys(> appears to retain the ris of ownership. This is essentially a consignment arrangement, and Toys(> should not recogni/e sales until Ec.onald4s sells dolls to customers. 5n this example, Serry obtained the access code for Hevel 5 in the software on .ecember $, meaning that Serry has obtained the Exercise 5"%1control of the right to use the software for Hevel 5 on that date. Therefore, on that date Cutler should recogni/e F"- of revenue for Hevel 5. 3hen Tom passed the Hevel 5 test on .ecember '$, &-$&, and purchased access to Hevel 55, Cutler licensed Hevel 55 to Serry on the same day. 9owever, Serry received the access code for Hevel 55 on Qanuary $-, &-$', so control over Hevel 55 in the software was not transferred to Serry until Qanuary $-. Therefore, Cutler should recogni/e F$- of revenue for Hevel 55 on Qanuary $-, &-$', rather than .ecember '$, &-$&, because it did not satisfy a separate performance obligation until the access code was provided to its customer.
Exercise 5"%2
,e<uirement # %ecord unearned revenue upon receipt of initial payment! Cash >nearned revenue ,e<uirement $ $. %ecord interest expense at end of the first year of the contract! 5nterest expense 1F&-,--- x (G2 >nearned revenue +-+-&-,--&-,---
&. %ecord interest expense at end of the second year of the contract! 5nterest expense 1TF&-,--- I +--U x (G2 >nearned revenue +'& +'&
'. %ecord interest expense at end of the third year of the contract! 5nterest expense 1TF&-,--- I +-- I +'&U x (G2 >nearned revenue ,e<uirement % %ecord revenue upon Stewart4s satisfaction of his performance obligation! >nearned revenue 1F&-,--- I +-- I +'& I +)"2 %evenue &&,(,* &&,(,* +)" +)"
CPA ! CMA ,E-IE. Q(ESTI)*S

CPA Exam Questions
#9 b. The earnings process is completed upon delivery of the product. Therefore, in &-$(, revenue for "-,--- gallons at F' each is recogni/ed on Qanuary $". The payment terms do not affect revenue recognition.
The McGraw-Hill Companies, Inc., 2 !" %&0 Intermediate Accounting, 7'e
$9 d9 The deferred gross profit in the balance sheet at .ecember '$, &-$(, should be the balances in the accounts receivable accounts on that date for &-$' and &-$( sales multiplied by the appropriate gross profit percentage! Accounts receivable! sales in Total sales Hess! Collections to date Hess! 3rite8offs to date Accounts receivable balance x ?ross profit rate .eferred gross profit $&P'$P&-$( $4#% $4#& F )--,--- F ,--,--1'--,---2 1'--,---2 1&--,---2 1"-,---2 $--,--""-,--x '-G x (-G F '-,--- F &&-,---
The combined deferred gross profit in the balance sheet is F&"-,--1F'-,--- I &&-,---2.
CPA Re ie! "uestions (continued) %9 a. Kear of sale $4#% $4#& a. ?ross profit reali/ed F&(-,--F&--,--b. @ercentage '-G (-G c. Collections on sales 1aPb2 F+--,--F"--,--Sales $,---,--- &,---,--Balance uncollected at .ecember '$, &-$( F&--,--- F$,"--,--The total uncollected balance is F$,*--,--- 1F&--,--- I $,"--,---2. &9 d9 Construction8in8progress represents the costs incurred plus the cumulative pro8rata share of gross profit under the percentage8of8completion method of accounting. 59 c9 &-$' actual costs Total estimated costs %atio Contract price %evenue &-$' actual costs ?ross profit F&-,--N )-,--A $P' x $--,--'',''' #&-,--F$','''
'9 d9 Since the total cost of the contract, F',$--,--- 1F,'-,--- I &,$*-,---2, is pro0ected to exceed the contract price of F',---,---, the excess cost of F$--,--- must be recogni/ed as a loss in &-$'.
19 c9 6Cash collection is at least reasonably possible7 is not a requirement for revenue recognition under 5:%S.
CPA Re ie! "uestions (concluded) 29 a9 >nder the cost recovery approach, an amount of revenue is recogni/ed that is equal to cost incurred, so long as cost incurred is probable to be recovered. Since F$,---,--- of cost was incurred, F$,---,--- of revenue is recogni/ed. 39 a9 5:%S does not provide extensive guidance determining how contracts are to be separated into components for purposes of revenue recognition. #49 d9 5:%S recogni/es interim expenses more discretely than does >.S. ?AA@, such that the expense is recogni/ed in the period in which it occurs rather than being accrued as a prepaid expense asset when an amount is paid and then amorti/ed to expense over the year. Therefore, under 5:%S Barrett would recogni/e the entire F"-,--- as expense in the first period, and not accrue any prepaid expense asset. >nder >.S. ?AA@ Barrett would accrue an asset when it made the tax payment and then reduce the asset by F$&,"-each interim period while recogni/ing F$&,"-- of expense each interim period.
CMA Exam Questions

#9 c9 %evenue is recogni/ed when 1$2 reali/ed or reali/able and 1&2 earned. ;n Eay &+, F"--,--- of the sales price was reali/ed while the remaining F"--,--- was reali/able in the form of a receivable. The revenue was earned on Eay &+ when the title of the goods passed to the purchaser. The cost8 recovery method is not used because the receivable was not deemed uncollectible until Qune $-. $9 d9 %evenue is normally recorded at the time of the sale or, occasionally, at the time cash is collected. 9owever, sometimes neither the sales basis nor the cash basis is appropriate, such as when a construction contract extends over several accounting periods. As a result, contractors ordinarily recogni/e revenue using the percentage8of8completion method so that some revenue is recogni/ed each year over the life of the contract. 9ence, this method is an exception to the general practice of recogni/ing revenue at the point of sale, primarily because it better matches revenues and expenses. %9 b9 ?iven that one8third of all costs have already been incurred 1F),---,---2, the company should recogni/e revenue equal to one8third of the contract price, or F+,---,---. %evenues of F+,---,--- minus costs of F),---,--- equals a gross profit of F&,---,---.
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&0"
The McGraw-Hill Companies, Inc., 2 !" %&0-
Problem 5"# P,)B5EMS

,EACA* C),P),ATI)* 5ncome Statement :or the Kear Dnded .ecember '$, &-$' 5ncome before income taxes and extraordinary item ....................................... 5ncome tax expense ....................................... 5ncome before extraordinary item .................. Dxtraordinary item! ?ain from settlement of lawsuit @net of 6&447444 tax expenseA ................................. Bet income .................................................... 5ncome before extraordinary item .................. Dxtraordinary gain ......................................... Bet income ....................................................
J#K J#K F',)+-,---
$,(*&,--&,&-+,--)--,--F&,+-+,--&.&$ -.)F &.+$
Income from continuing operations before income taxesB >nad0usted F(,&--,--Add! ?ain from sale of equipment "-,--.educt! 5nventory write8off 1(--,---2 .epreciation expense 1&-$'2 1"-,---2 ;verstated profit on installment sale 1$&-,---2 J Ad0usted F',)+-,--F$)-,--1(-,---2 F$&-,---
J @rofit recogni/ed 1F(--,--- # &(-,---2 @rofit that should have been recogni/ed 1gross profit ratio of (-G x F$--,---2 ;verstated profit
Problem 5"$,e<uirement #
$4#% cost reco=er : B F$+-,--A )-G 1gross profit G A (-G2 F'--,--$4#& cost reco=er :B
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&0%
F&+-,--A *-G 1gross profit G A '-G2 F(--,--$4#% gross profitB Cash collection from &-$' sales A F$&-,--- x (-G A $4#& gross profitB Cash collection from &-$' sales A F$--,--- x (-G A I Cash collection from &-$( sales A F$"-,--- x '-G A Total &-$( gross profit ,e<uirement $ $4#% 5nstallment receivables.................................................... '--,--5nventory..................................................................... $+-,--.eferred gross profit................................................... $&-,--To record installment sales Cash ...................................................$&-,--5nstallment receivables................................................ To record cash collections from installment sales .eferred gross profit....................................................... %eali/ed gross profit................................................... To recogni?e gross profit from installment sales (+,--(+,--$&-,--F (-,--(",--6257444 6&27444
Pro#le$ 52 (continued) $4#& 5nstallment receivables.................................................... (--,--5nventory..................................................................... &+-,--.eferred gross profit................................................... $&-,--To record installment sales Cash................................................................................ &"-,--5nstallment receivables................................................ &"-,--To record cash collections from installment sales .eferred gross profit....................................................... %eali/ed gross profit................................................... To recogni?e gross profit from installment sales +",--+",---
,e<uirement % >ate $4#% &-$' sales $4#& &-$' sales &-$( sales &-$( totals Cash Collected F$&-,--F$--,--$"-,--F&"-,--Cost ,eco=er F$&-,--F )-,--$"-,--F&$-,--Cross Profit 8-8 F(-,--8-8 F(-,---
Pro#le$ 52 (concluded) $4#% 5nstallment receivables.................................................... '--,--5nventory..................................................................... $+-,--.eferred gross profit................................................... $&-,--To record installment sales Cash................................................................................ $&-,--5nstallment receivables................................................ $&-,--To record cash collection from installment sales $4#& 5nstallment receivables.................................................... (--,--5nventory..................................................................... &+-,--.eferred gross profit................................................... $&-,--To record installment sales Cash................................................................................ &"-,--5nstallment receivables................................................ &"-,--To record cash collection from installment sales .eferred gross profit....................................................... %eali/ed gross profit................................................... To recogni?e gross profit from installment sales (-,--(-,---
Problem 5"%
,e<uirement #
Total profit A F"--,--- # '--,--- A F&--,--5nstallment sales method! ?ross profit G A F&--,--- N F"--,--- A (-G
2!%#!#% Cash collections a9 Point of deli=er method
The McGraw-Hill Companies, Inc., 2 !" %&0/
2!%#!#&
2!%#!#5
2!%#!#'
2!%#!#1
F$--,--- F$--,--- F$--,--- F$--,--- F$--,--F&--,--8-8 8-8 8-8 8-8
b9 Installment sales method

1(-G x cash collected2
F (-,--- F (-,--- F (-,--- F (-,--8-8 8-8
F(-,---
c9 Cost reco=er method
8 - 8 F$--,--- F$--,---
Pro#le$ 53 (continued) ,e<uirement $

Point of >eli=er "--,--"--,--'--,--'--,--Installment Sales
Cost ,eco=er
5nstallment receivable Sales revenue Cost of goods sold 5nventory To record sale on 2!%#!#% 5nstallment receivable 5nventory .eferred gross profit To record sale on 2!%#!#% Cash 5nstallment receivable To record cash collections @Entr made each Aug9 %#A .eferred gross profit %eali/ed gross profit To record gross profit @Entr made each Aug9 %#A .eferred gross profit %eali/ed gross profit To record gross profit @Entr made 2!%#!#' L 2!%#!#1A
"--,--'--,--&--,--$--,--$--,--$--,--$--,---
"--,--'--,--&--,--$--,--$--,---
(-,--(-,---
$--,--$--,---
Pro#le$ 53 (concluded) ,e<uirement % Point of >eli=er >ecember %#7 $4#% Assets 5nstallment receivables Hess! .eferred gross profit 5nstallment receivables, net >ecember %#7 $4#& Assets 5nstallment receivables Hess! .eferred gross profit 5nstallment receivables, net (--,--Installment Sales (--,--1$)-,---2 &(-,--Cost ,eco=er (--,--1&--,---2 &--,---
'--,---
'--,--1$&-,---2 $+-,---
'--,--1&--,---2 $--,---
Problem 5"&,e<uirement #
All 0obs consist of four equal payments! one payment when the 0ob is completed and three payments over the next three years. BluebirdB Qob completed in &-$$, so down payment made in &-$$, another payment in &-$&, and two payments remain. F(--,--- gross receivable at $P$P&-$' implies payments of 1F(--,--- &2 A F&--,--- in &-$' and &-$(. :our payments of F&--,--- implies total revenue of ( x F&--,--- A F+--,--- on the 0ob. Twenty8five percent gross profit ratio implies cost of *"G x F+--,--- A F)--,---. Cost recovery method gross profit! @ayments in &-$$ and &-$& have already recovered F(--,--- of cost, so cost remaining to be recovered as of $P$P&-$' is F)--,--- total # F(--,--- already recovered A F&--,---. Therefore, the entire &-$' payment of F&--,--- will be applied to cost recovery, and no gross profit is recogni/ed in &-$'. 5nstallment sales method gross profit! F&--,--- payment x &"G gross profit ratio A F"-,--- of gross profit recogni/ed in &-$'. PitStopB Qob completed in &-$-, so down payment made in &-$-, another payment in &-$$, another in &-$&, and one payment remains. F$"-,--- gross receivable at $P$P&-$' implies a single payment of F$"-,--- in &-$'. :our payments of F$"-,--- implies total revenue of ( x F$"-,--- A F)--,--- on the 0ob. Thirty8five percent gross profit ratio implies cost of )"G x F)--,--- A F',-,---. Cost recovery method gross profit! @ayments in &-$-, &-$$, and &-$& of a total of F("-,--- have already recovered the entire F',-,--- of cost and allowed recognition of F)-,--- of gross profit. Therefore, the entire &-$' payment of F$"-,--- will be applied to gross profit. 5nstallment sales method gross profit! F$"-,--- payment x '"G gross profit ratio A F"&,"-- of gross profit recogni/ed in &-$'. Pro#le$ 54 (concluded) TotalsB Cost recovery method! F- 1Bluebird2 I $"-,--- 1@itStop2 A F$"-,---. 5nstallment sales method! F"-,--- 1Bluebird2 I "&,"-- 1@itStop2 A F$-&,"--.
,e<uirement $ 5f .an is focused on &-$', he would not be happy with a switch to the installment sales method, because that would produce gross profit of only F$-&,"--, which is F(*,"-less than he would show under the cost recovery method. 5t is true that the installment sales method recogni/es gross profit faster than does the cost recovery method, but the installment sales method also recogni/es gross profit more evenly than does the cost recovery method. The timing of these 0obs is such that &-$' is a year in which almost all of the gross profit associated with the @itStop 0ob gets recogni/ed, so &-$' loo s more profitable under the cost recovery method.
Problem 5"5
,e<uirement # $4#% F$-,---,--&,(--,--",)--,--+,---,--F &,---,--$4#& F$-,---,--),---,--&,---,--+,---,--F &,---,--$4#5 F$-,---,--+,&--,--8-8 +,&--,--F $,+--,---
Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1loss2 1actual in &-$"2
Cross profit @lossA recognitionB &-$'! F&,(--,--A '-.-G x F&,---,--- A 6'447444 F+,---,--&-$(! F),---,--A *".-G x F&,---,--- A F$,"--,--- # )--,--- A 63447444 F+,---,--&-$"! F$,+--,--- # $,"--,--- A 6%447444
Pro#le$ 55 (continued) ,e<uirement $ $4#% Construction in progress Larious accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress @gross profitA Cost of construction @cost incurredA %evenue from long8term contracts 1$2 To record gross profit $4#& $4#5
&,(--,--',)--,--&,&--,--&,(--,--',)--,--&,&--,--&,---,--(,---,--(,---,--&,---,--(,---,--(,---,---
$,+--,--',)--,--(,)--,--$,+--,--',)--,--(,)--,--)--,--&,(--,--',---,--,--,--',)--,--(,"--,--'--,--&,&--,--&,"--,---
1$2 %evenue recogni/ed! &-$'! '-G x F$-,---,--- A &-$(! *"G x F$-,---,--- A Hess! %evenue recogni/ed in &-$' %evenue recogni/ed in &-$( &-$"! $--G x F$-,---,--- A Hess! %evenue recogni/ed in &-$' R &-$( %evenue recogni/ed in &-$"
F',---,--F*,"--,--1',---,---2 F(,"--,--F$-,---,--1*,"--,---2 F&,"--,---
Pro#le$ 55 (continued) ,e<uirement % Balance Sheet Current assets4 Accounts receivable Construction in progress Hess! Billings Costs and profit in excess of billings $4#% F &--,--F',---,--1&,---,---2 $,---,--F*,"--,--1),---,---2 $,"--,--$4#& F)--,---
,e<uirement & Costs incurred during the year Dstimated costs to complete as of year8end Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1actual in &-$"2 $4#% F&,(--,--",)--,--$4#% F$-,---,--&,(--,--",)--,--+,---,--F &,---,--$4#& F',+--,--',$--,--$4#& F$-,---,--),&--,--',$--,--,,'--,--F *--,--$4#5 F',&--,--8 $4#5 F$-,---,--,,(--,--8-8 ,,(--,--F )--,---
Pro#le$ 55 (concluded) Cross profit @lossA recognitionB &-$'! F&,(--,--A '-.-G x F&,---,--- A 6'447444 F+,---,--&-$(! F),&--,--A )).)))*G x F*--,--- A F()),))* # )--,--- A 6@#%%7%%%A F,,'--,--&-$"! F)--,--- # ()),))* A 6#%%7%%%
,e<uirement 5 Costs incurred during the year Dstimated costs to complete as of year8end Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1loss2 1actual in &-$"2 $4#% F&,(--,--",)--,--$4#% F$-,---,--&,(--,--",)--,--+,---,--F &,---,--$4#& F',+--,--(,$--,--$4#& F$-,---,--),&--,--(,$--,--$-,'--,--F 1'--,---2 $4#5 F',,--,--8 $4#5 F$-,---,--$-,$--,--8-8 $-,$--,--F 1$--,---2
Cross profit @lossA recognitionB &-$'! F&,(--,--A '-.-G x F&,---,--- A 6'447444 F+,---,--&-$(! &-$"! F1'--,---2 # )--,--- A 6@3447444A F1$--,---2 # 1'--,---2 A 6$447444
Problem 5"',e<uirement #
0ear
Cross profit recogni?ed

&-$' &-$( &-$" Total gross profit ,e<uirement $
8-8 8-8 F$,+--,--F$,+--,---
Construction in progress Larious accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress 1gross profit2 Cost of construction 1costs incurred2 %evenue from long8term contracts 1contract price2 To record gross profit
$4#% $4#& $4#5 &,(--,--',)--,--&,&--,--&,(--,--',)--,--&,&--,--&,---,--(,---,--(,---,--&,---,--(,---,--(,---,---
$,+--,--',)--,--(,)--,--$,+--,--',)--,--(,)--,--$,+--,--+,&--,--$-,---,---
Pro#le$ 56 (concluded) ,e<uirement % Balance Sheet Current assets4 Accounts receivable Construction in progress Hess! Billings Costs in excess of billings $4#% F &--,--F&,(--,--1&,---,---2 (--,--F),---,--1),---,---2 8-8 $4#& F )--,---
,e<uirement & Costs incurred during the year Dstimated costs to complete as of year8end 0ear &-$' &-$( &-$" Total gross profit ,e<uirement 5 Costs incurred during the year Dstimated costs to complete as of year8end 0ear &-$' &-$( &-$" Total pro0ect loss $4#% F&,(--,--",)--,--$4#& F',+--,--(,$--,--$4#5 F',,--,--8 $4#% F&,(--,--",)--,--$4#& F',+--,--',$--,--$4#5 F',&--,--8
Cross profit recogni?ed 8-8 8-8 F)--,--F)--,---
Cross profit @lossA recogni?ed 8-8 F1'--,---2 &--,--F1$--,---2
Problem 5"1,e<uirement #
The McGraw-Hill Companies, Inc., 2 !" %&7/ Intermediate Accounting, 7'e
0ear &-$' &-$( &-$" Total gross profit ,e<uirement $
Cross profit recogni?ed 8-8 8-8 F$,+--,--F$,+--,---
Construction in progress Larious accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress 1gross profit2 Cost of construction 1costs incurred2 %evenue from long8term contracts 1contract price2 To record gross profit
$4#% $4#& $4#5 &,(--,--',)--,--&,&--,--&,(--,--',)--,--&,&--,--&,---,--(,---,--(,---,--&,---,--(,---,--(,---,---
$,+--,--',)--,--(,)--,--$,+--,--',)--,--(,)--,--$,+--,--&,(--,--&,(--,--',)--,--',)--,--&,&--,--(,---,---
Pro#le$ 57 (concluded) ,e<uirement % Balance Sheet Current assets4 Accounts receivable Construction in progress Hess! Billings Costs in excess of billings $4#% F &--,--F&,(--,--1&,---,---2 (--,--F),---,--1),---,---2 8-8 $4#& F )--,---
,e<uirement & Costs incurred during the year Dstimated costs to complete as of year8end 0ear &-$' &-$( &-$" Total gross profit ,e<uirement 5 Costs incurred during the year Dstimated costs to complete as of year8end 0ear &-$' &-$( &-$" Total pro0ect loss $4#% F&,(--,--",)--,--$4#& F',+--,--(,$--,--$4#5 F',,--,--8 $4#% F&,(--,--",)--,--$4#& F',+--,--',$--,--$4#5 F',&--,--8
Cross profit recogni?ed 8-8 8-8 F)--,--F)--,---
Cross profit @lossA recogni?ed 8-8 F1'--,---2 &--,--F1$--,---2
The McGraw-Hill Companies, Inc., 2 !" %&/
Problem 5"2,e<uirement #
Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit 1loss2 1actual in &-$"2 0ear &-$' &-$( &-$" Total pro0ect loss ,e<uirement $
Cross profit @lossA recognitionB
$4#% F(,---,--'"-,--',$"-,--',"--,--F "--,---
$4#& F(,---,--&,"--,--$,*--,--(,&--,--F 1&--,---2
$4#5 F(,---,--(,&"-,--8-8 (,&"-,--F 1&"-,---2
Cross profit @lossA recogni?ed 8-8 F1&--,---2 1"-,---2 F1&"-,---2
&-$'! &-$(! &-$"!
$-G x F"--,--- A 6547444 F1&--,---2 # "-,--- A 6@$547444A F1&"-,---2 # 1&--,---2 A 6@547444A
,e<uirement % Balance Sheet Current assets4 Costs less loss 1F&,'--,---J2 in excess of billings 1F&,$*-,---2 Current lia)ilities4 Billings 1F*&-,---2 in excess of costs and profit 1F(--,---2 $4#% $4#&
F $'-,---
F '&-,---
JCumulative costs 1F&,"--,---2 less cumulative loss recogni/ed 1F&--,---2 A F&,'--,---
Problem 5"3
,e<uirement #
The completed contract method of recogni/ing revenues and costs on long8term construction contracts is equivalent to recogni/ing revenue at the point of delivery, that
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&/!
is, when the construction pro0ect is complete. The percentage8of8completion method assigns a share of the pro0ect4s expected revenues and costs to each period in which the earnings process ta es place, that is, the construction period. The share is estimated based on the pro0ect<s costs incurred each period as a percentage of the pro0ect<s total estimated costs. The completed contract method should only be used when a lac of dependable estimates or inherent ha/ards ma e it difficult to forecast future costs and profits. ,e<uirement $ Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit a. $4#% F&-,---,--(,---,--$&,---,--$),---,--F (,---,--$4#& F&-,---,--$',"--,--(,"--,--$+,---,--F &,---,---
Cross profit recognitionB >nder the completed contract method Citation would not report gross profit until the pro0ect is competed. Citation would have to report an overall gross loss on the contract in whatever period it first revises the estimates to determine that an overall loss will eventually occur. Citation never estimates the Altamont contract will earn a gross loss, so never has to recogni/e one. >nder the completed contract method Citation would not report any revenue in the &-$' or &-$( income statements.
b9
The McGraw-Hill Companies, Inc., 2 !" %&/2
Pro#le$ 59 (continued) c9 Balance Sheet At >ecember %#7 $4#% Current assets4 Accounts receivable Costs @6&74447444GA in excess of billings @6$74447444A F &--,--&,---,---
J >nder the completed contract method, this account would only include costs of F(,---,--,e<uirement % Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit a. $4#% F&-,---,--(,---,--$&,---,--$),---,--F (,---,--$4#& F&-,---,--$',"--,--(,"--,--$+,---,--F &,---,---
Cross profit recognitionB &-$'! F (,---,--A &"G x F(,---,--- A 6#74447444 F$),---,--&-$(! F$',"--,--A *"G x F&,---,--- A F$,"--,--F$+,---,--Hess! &-$' gross profit $,---,--&-$( gross profit 6 5447444
b9
&-$'! F&-,---,--- x &"G A
6574447444
&-$(! F&-,---,--- x *"G A F$",---,--Hess! &-$' revenue 1",---,---2 6#474447444
The McGraw-Hill Companies, Inc., 2 !" %&/"
Pro#le$ 59 (continued) c9 Balance Sheet At >ecember %#7 $4#% Current assets4 Accounts receivable Costs and profit @6574447444GA in excess of billings @6$74447444A J Costs 1F(,---,---2 I profit 1F$,---,---2 ,e<uirement & Contract price Actual costs to date Dstimated costs to complete Total estimated costs Dstimated gross profit a9 Cross profit recognitionB &-$(! ;verall loss of 1F&,"--,---2 # previously recogni/ed gross profit of F$,---,--- A 6%754474449 b9 &-$(! Dasiest to solve using a 0ournal entry! Cost of construction 1to balance2 %evenue from long8term contractsJ Construction in progress 1loss2
J
F &--,--',---,---
$4#% F&-,---,--(,---,--$&,---,--$),---,--F (,---,---
$4#& F&-,---,--$',"--,--,,---,--&&,"--,--1F &,"--,---2
F$-,"--,--6174447444 F',"--,---
Total revenue recogni/ed to date A 1percentage complete21total revenue2 A 1F$',"--,--- N F&&,"--,---2 x 1F&-,---,---2 A 1)-G2 x 1F&-,---,---2 A F$&,---,--%evenue recogni/ed this period A total # revenue recogni/ed in prior periods A F$&,---,--- # ",---,--- A F*,---,---
The McGraw-Hill Companies, Inc., 2 !" %&/-
Pro#le$ 59 (continued) c9 Balance Sheet At >ecember %#7 $4#& Current assets4 Accounts receivable Current lia)ilities4 Billings @6#$74447444A in excess of costs and profit @6##74447444GA F $,)--,---
$,---,---
J &-$' costs 1F(,---,---2 I &-$' profit 1F$,---,---2 I &-$( costs 1F,,"--,---2 # &-$( loss 1F',"--,---2 ,e<uirement 5 Citation should recogni/e revenue at the point of delivery, when the homes are completed and title is transferred to the buyer. This is equivalent to the completed contract method for long8term contracts. The percentage8of8completion method is not appropriate in this case. There is no contract in place and until the completion of the home, the transfer of title, and the receipt of the full sales price, the earnings process is not virtually complete and there is still significant uncertainty as to cash collection. Also, the sales price is not fixed. ,e<uirement ' Income statementB Sales revenue 1' x F)--,---2 Cost of goods sold 1' x F("-,---2 ?ross profit
F$,+--,--$,'"-,--F ("-,---
Balance sheetB Current assets4 5nventory 1wor in process2 F&,*--,--Current lia)ilities4 Customer deposits 1or unearned revenue2 F'--,---J JF)--,--- x $-G A F)-,--- x " A F'--,---
Problem 5"#4
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&/%
,e<uirement # a9 Danuar %47 $4#%
Cash ............................................................................... &--,--Bote receivable .............................................................. $,---,-->nearned franchise fee revenue.................................. $,&--,---
b9
September #7 $4#%
>nearned franchise fee revenue...................................... $,&--,--:ranchise fee revenue ................................................. $,&--,---
c9
September %47 $4#% $,&-$,&--
Accounts receivable 1F(-,--- x 'G2 ................................. Service revenue ..........................................................
d9
Danuar %47 $4#& $--,--$--,---
Cash................................................................................ Bote receivable ..........................................................
Pro#le$ 51% (continued) ,e<uirement $ a9 Danuar %47 $4#% Cash ............................................................................... &--,--Bote receivable .............................................................. $,---,--.eferred franchise fee revenue.................................... $,&--,--Bote! Could also show as! Cash ............................................................................... &--,--Bote receivable .............................................................. $,---,--.eferred franchise fee revenue.................................... $,---,-->nearned franchise fee revenue.................................. &--,---
b9
September #7 $4#% &--,--&--,---
.eferred franchise fee revenue ....................................... :ranchise fee revenue 1cash collected2...........................
c9
September %47 $4#% $,&-$,&--
Accounts receivable 1F(-,--- x 'G2 ................................. Service revenue ..........................................................
d9
Danuar %47 $4#& $--,--$--,---
Cash................................................................................ Bote receivable ..........................................................
.eferred franchise fee revenue ....................................... :ranchise fee revenue .................................................
$--,--$--,---
The McGraw-Hill Companies, Inc., 2 !" %&//
Pro#le$ 51% (concluded) ,e<uirement %
Balance Sheet At >ecember %#7 $4#% Current assets4 5nstallment notes receivable 1F$,---,---2 less deferred franchise fee revenue 1F$,---,---2 Current lia)ilities4 >nearned franchise fee revenue F 8-8
F&--,---
Dxplanation! %evenue recognition on the entire note receivable is deferred. 5n addition, F&--,--- of unearned revenue must be shown as a liability.
Problem 5"##
$. &. '. (. ". ). *. 5nventory turnover ratio Average days in inventory %eceivables turnover ratio Average collection period Asset turnover ratio @rofit margin on sales %eturn on assets or! +. %eturn on shareholders4 equity ,. Dquity multiplier $-. .u@ont framewor F),'-- N M1F+-- I )--2 N &O A ,.')" N ,.- A (-.") days F,,--- N M1F)-- I (--2 N &O A $+.')" N $+.- A &-.&+ days F,,--- N M1F(,--- I ',)--2 N &O A &.'* F'-- N F,,--- A '.''G F'-- N M1F(,--- I ',)--2 N &O A *.+,G '.''G x &.'* times A *.+,G F'-- N M1F$,"-- I $,'"-2 N &O A &$.$G M1F(,--- I ',)--2 N &O N M1F$,"-- I $,'"-2 N &O A &.)* '.''G x &.'* x &.)* A &$.$G
Problem 5"#$,e<uirement #
%eceivables turnover DLD Pfi?er A A A Bet sales Accounts receivable F($,+)& F),"*( F(",$++ F+,**" A ).'* times A ".$" times
Average collection period A DLD Pfi?er A A
')" %eceivables turnover ')" ).'* A "* days
')" A *$ days ".$" ;n average, QRQ collects its receivables in $( days less than @fi/er. 5nventory turnover DLD Pfi?er A A A Cost of goods sold 5nventories F$&,$*) F',"++ F,,+'& F",+'* A '.', times A $.)+ times
Average days in inventory A DLD Pfi?er A A
')" 5nventory turnover ')" '.', A $-+ days
')" A &$* days $.)+ ;n average, QRQ sells its inventory twice as fast as @fi/er.
Pro#le$ 512 (continued) ,e<uirement $ %ate of return on assets DLD Pfi?er A A A Bet income Total assets F*,$,* F(+,&)' A $(.,G The return on assets indicates a company<s overall profitability, ignoring specific sources of financing. 5n this regard, QRQ4s
F$,)', $.(G A F$$),**" profitability is significantly higher than that of @fi/er. ,e<uirement %
@rofitability can be achieved by a high profit margin, high turnover, or a combination of the two. %ate of return on assets A DLD A A Pfi?er A A A @rofit margin on sales x x x x x x Asset turnover
Bet income Bet sales F *,$,* F($,+)& $*.$,G F $,)', F(",$++ '.)'G
Bet sales Total assets F($,+)& F(+,&)' .+)* times F(",$++ F$$),**" .'+* times A $.(G A $(.,G
Bo, the combinations of profit margin and asset turnover are not similar. QRQ4s profit margin is much higher than that of @fi/er, as is its asset turnover. These differences combine to produce a significantly higher return on assets for QRQ.
Pro#le$ 512 (concluded) ,e<uirement & %ate of return on A shareholders4 equity DLD Pfi?er A A Bet income Shareholders4 equity F*,$,* F&),+), F$,)', F)",'** A &).+G A &."G QRQ provided a much greater return to shareholders.
,e<uirement 5 Dquity multiplier A shareholders4 equity DLD Pfi?er A A Total Assets Shareholders4 equity F(+,&)' F&),+), A $.+A $.*, The two companies have virtually identical equity multipliers, indicating that they are using leverage to the same extent to earn a return on
F$$),**" F)",'** equity that is higher than their return on assets.
a. Times interest earned ratio A 1Bet income I 5nterest I Taxes2 N Problem 5"#% 5nterest A $* 1Bet income I F& I $&2 N F& A $* Bet income I F$( A $* x F& Bet income A F&b. %eturn on assets A Bet income N Total assets A $-G Total assets A F&- N $-G A F&-c. @rofit margin on sales A Bet income N Sales A "G Sales A F&- N "G A F(-d. ?ross profit margin A ?ross profit N Sales A (-G ?ross profit A F(-- x (-G A F$)Cost of goods sold A Sales # ?ross profit A F(-- # $)- A F&( The McGraw-Hill Companies, Inc., 2 !" %&12 Intermediate Accounting, 7'e
e. 5nventory turnover ratio A Cost of goods sold N 5nventory A + 5nventory A F&(- N + A F'f. %eceivables turnover ratio A Sales N Accounts receivable A &Accounts receivable A F(-- N &- A F&g. Current ratio A Current assets N Current liabilities A &.Acid8test ratio A Vuic assets N Current liabilities A $.Current assets N & A Current liabilities Vuic assets N $ A Current liabilities Current assets N & A Vuic assets N $ Current assets A & x Vuic assets Cash I Accts. rec. I 5nventory A & x 1Cash I Accounts receivable2 Cash I F&- I '- A 1& x Cash2 I 1& x F&-2 Cash I F"- A Cash I Cash I F(Cash A F$h. Acid8test ratio A 1Cash I Accounts receivable2 N Current liabilities A $.Current liabilities A 1F$- I &-2 N $.- A F'i. Boncurrent assets A Total assets # Current assets A F&-- # 1F$- I &- I '-2 A F$(0. %eturn on shareholders4 equity A Bet income N Shareholders4 equity A &-G Shareholders4 equity A F&- N &-G A F$--
Pro#le$ 513 (concluded) . .ebt to equity ratio A Total liabilities N Shareholders4 equity A $.Total liabilities A F$-- x $.- A F$-Hong8term liabilities A Total liabilities # Current liabilities A F$-- # '- A F*CA>(8 CA*>0 C)MPA*0 Balance Sheet At >ecember %#7 Assets Current assets! Cash Accounts receivable 1net2 5nventories Total current assets @roperty, plant, and equipment 1net2 Total assets 5iabilities and ShareholdersM E<uit Current liabilities Hong8term liabilities Shareholders4 equity Total liabilities and shareholders< equity F $&')$(F&-F '*$-F&--
$4#%
Problem 5"#&
,e<uirement # A A A Bet income Total assets F ",'.+ F(,-&$." A $(.+G
%ate of return on assets Metropolitan ,epublic
F (&(.) $-.)G A F(,--+.The return on assets indicates a company<s overall profitability, ignoring specific sources of financing. 5n this regard, Eetropolitan4s profitability exceeds that of %epublic.
,e<uirement $ @rofitability can be achieved by a high profit margin, high turnover, or a combination of the two. %ate of return on assets A Bet income Bet sales F ",'.+ F",),+.$-.(G F (&(.) F*,*)+.& A "."G x x x x A @rofit margin on sales x x Asset turnover
Bet sales Total assets
Metropolitan A A ,epublic A
F",),+.F(,-&$." $.(& times A F*,*)+.& F(,--+.$.,( times A $-.*G $(.+G
%epublic4s profit margin is much less than that of Eetropolitan, but partially ma es up for it with a higher turnover.
Pro#le$ 514 (continued) ,e<uirement % %ate of return on shareholders4 equity Metropolitan ,epublic A A A Bet income Shareholders4 equity F",'.+ F$((., I &,(*)., # ,-(.* F(&(.) F''".- I $,)-$., # ,)(.$ A '(.)G A ('.)G
%epublic provides a greater return to common shareholders. ,e<uirement & Dquity multiplier Metropolitan ,epublic A A A Total assets Shareholders4 equity F(,-&$." F$((., I &,(*)., # ,-(.* F(,--+.F''".- I $,)-$., # ,)(.$ A &.'( A (.$&
3hen the return on shareholders4 equity is greater than the return on assets, management is using debt funds to enhance the earnings for stoc holders. Both firms do this. %epublic4s higher leverage has been used to provide a higher return to shareholders than Eetropolitan, even though its return on assets is less. %epublic increased its return to shareholders (.-* times 1('.)G N $-.*G2 the return on assets. Eetropolitan increased its return to shareholders &.'( times 1'(.)G N $(.+G2 the return on assets.
Pro#le$ 514 (continued) ,e<uirement 5 Current ratio Metropolitan ,epublic Acid8test ratio Metropolitan ,epublic A A A A A A Current assets Current liabilities F$,&-'.F$,&+-.& F$,(*+.* F$,*+*.$ Vuic assets Current liabilities F$,&-'.- # ()).( # $'(.) F$,&+-.& F$,(*+.* # )'".& # (*).* F$,*+*.$ A A .(* .&$ A A .,( .+'
The current ratios of the two firms are comparable and within the range of the rule8of8thumb standard of $ to $. The more robust acid8test ratio reveals that Eetropolitan is more liquid than %epublic. ,e<uirement ' %eceivables turnover ratio Metropolitan ,epublic A A A Sales Accounts receivable F",),+.F(&&.* F*,*)+.& F'&".A $'." times A &'., times
Pro#le$ 514 (concluded) 5nventory turnover ratio Metropolitan ,epublic A A A Cost of goods sold 5nventory F&,,-,.F()).( F(,(+$.* F)'".& A ).& times A *.$ times
%epublic4s receivables turnover is more rapid than Eetropolitan4s, perhaps suggesting that its relative liquidity is not as bad as its acid8test ratio indicated. ,e<uirement 1 Times interest earned ratio Metropolitan ,epublic A A A Bet income plus interest plus taxes 5nterest F",'.+ I ").+ I ',(.* F").+ F(&(.) I ().) I &*).$ F().) A $+.( times A $).- times
Both firms provide an adequate margin of safety.
The McGraw-Hill Companies, Inc., 2 !" %&1/
Problem 5"#5
Branson Electronics Compan Income Statement
%evenues Cost of goods sold ?ross profit Advertising expense$ ;ther operating expenses& 5ncome before income taxes 5ncome tax expense' Bet income
$F"-,--&F(+,--'F*","--
F$+-,--'",--$(",--1$&,"--2 1"*,---2 *","-1&*,$+-2 F (+,'&-
N ( A F$&,"-I M",,--- # "-,---O x ')G
S(PP5EME*T P,)B5EMS
Problem 5"#',e<uirement #
a. The gym membership is one separate performance obligation. Since the discount voucher provides a material right to the customer that the customer would not receive otherwise 1a &" percent discount rather than a $- percent discount2, the discount voucher also is a separate performance obligation. To allocate the contract price to the performance obligation, we should first consider that :it R Slim would offer a $- percent discount on the yoga course to all customers as part of a seasonal promotion. So, a &" percent discount provides a customer with an incremental value of $" percent 1&"G # $-G2. Thus, the estimated standalone selling price of the course voucher provided by :it R Slim is F') 1F)-- initial price of the course $"G incremental discount (-G li elihood of exercising the option2. Since the standalone selling price of the annual membership fee is F+--, :it R Slim would allocate F'(.(" TF+-- M') N 1F') I +--2OU of the F+-- transaction price to the discount voucher on yoga course.
b.
c.
Since the discount voucher of the yoga course would be a separate performance obligation, :it R Slim would recogni/e revenue for the sale of annual membership fee and discount voucher. Cash >nearned revenue, membership fees >nearned revenue, yoga coupon +-*)"."" '(.("
The McGraw-Hill Companies, Inc., 2 !" %&!
Pro#le$ 516 (concluded) ,e<uirement $ a. The option to pay F$" for additional visits does not constitute a material right, because it is in the range 1F$& to F$+2 of normal fees paid by nonmembers. Therefore, it is not a separate performance obligation in the contract. Since the option to visit on additional days is not a separate performance obligation, :RS should not allocate any of the contract price to it. Therefore, the entire F"-- payment is allocated to the "- visits associated with the coupon boo . Cash >nearned revenue, coupon boo "-"--
b.
c.
:RS could recogni/e 1$P(-2 F"-- of revenue for each visit, since a coupon boo yields approximately (- visits. Alternatively, :RS could recogni/e revenue over the year following sale of the coupon boo .
Problem 5"#1
Scenario $! The terms of the contract and all the related facts and circumstances indicate that Star controls the room as it is built. Star has an unconditional obligation to pay throughout the contract as evidenced by the required progress payments 1with no refund of payment for any wor performed to date2 and by the requirement to pay for any partially completed wor in the event of contract termination. Although Star does not obtain legal title of the equipment until completion of the 0ob, Crown4s retention of title is a protective right, and not an indicator that it has retained control. Consequently, Crown4s performance obligation is to provide Star with construction services, and Crown would recogni/e revenue over time throughout the construction process. Scenario &! The terms of the contract and all the related facts and circumstances indicate that Star does not obtain control of the gym until it is delivered. Star does not obtain title to the equipment until the 0ob is completed, and if the contract is terminated prior to completion, Crown retains the equipment, suggesting that Crown retains control of the equipment throughout the 0ob. Consequently, Crown4s performance obligation is to provide Star with a completed gym, and Crown would defer revenue recognition until the end of the construction process.
The McGraw-Hill Companies, Inc., 2 !" %&! !
Scenario '! The terms of the contract and all the related facts and circumstances indicate that Coco has the ability to direct the use of, and receive the benefit from, the consulting services as they are performed. The restaurant has an unconditional obligation to pay throughout the contract as evidenced by the nonrefundable progress payments, and the right to a report regardless of contract termination. Also, the report is not of alternate use to Cost.river. Therefore, the Cost.river Company4s performance obligation is to provide the restaurant with services continuously during the three months of the contract, and Cost.river should recogni/e revenue over the life of the contract. Scenario (! The terms of the contract and all the related facts and circumstances indicate that Ddwards, the customer, obtains control of the apartment on completion of the contract. Ddwards obtains title and physical possession of the apartment only on completion of the contract. Consequently, the Tower4s performance obligation is to provide the customer with a completed apartment, and the Tower should not recogni/e revenue until delivery of the apartment.
Problem 5"#2
Bote! The contract requires ) payments of F&-,---, plus or minus F$-,--- at the end of the life of the contract. So the contract will provide either M1) F&-,---2 # F$-,---O A F$$-,---, or M1) F&-,---2 I F$-,---O A F$'-,---. a2 %evis would estimate the transaction price as follows! @ossible @rices F$'-,--- 1MF&-,--- )O I F$-,---2 F$$-,--- 1MF&-,--- )O # F$-,---2 Dxpected contract price at inception @robability +-G &-G Dxpected Consideration F$-(,--&&,--F$&),---
Dach month %evis would recogni/e F&$,--- 1F$&),--- )2 of revenue, using the following 0ournal entry! Cash Dxpected bonus receivable %evenue &-,--$,--&$,---
The McGraw-Hill Companies, Inc., 2 !" %&! 2
After six months the Dxpected bonus receivable will have accumulated to F),--- 1) F$,---2. b2 5f %evis receives the bonus, it will record the following entry! Cash Dxpected bonus receivable %evenue c2 $-,--),--(,---
5f %evis pays the penalty, it will record the following entry! %evenue Dxpected bonus receivable Cash $),--),--$-,---
Problem 5"#3,e<uirement #
At the contract4s inception, Lelocity would calculate the transaction price to be the probability8weighted average of the two possible eventual prices! Possible Prices Probabilities Expected Consideration F(--,--,&,--F(,&,---
F"--,--- 1MF)-,--- +O I F&-,---2 +-G F()-,--- 1MF)-,--- +O # F&-,---2 &-G Transaction price at contract inception!
Lelocity would allocate the transaction price, F(,&,---, to the performance obligation to provide consulting services. Because those services are provided evenly over the eight months, Lelocity would recogni/e revenue of F)$,"-1F(,&,--- + months A F)$,"--2. But Burger Boy is unconditionally obligated to pay only F)-,--- per month 1F$,"-less than the revenue recogni/ed2, so Lelocity would recogni/e an Dxpected bonus receivable of F$,"-- in the first month to reflect the most li ely bonus to be received at the end of the contract. This is the revenue recogni/ed in excess of its unconditional right to consideration. Therefore, the 0ournal entry to record the revenue that Lelocity would recogni/e each month for the first four months is as follows!
The McGraw-Hill Companies, Inc., 2 !" %&! "
Accounts receivable Dxpected bonus receivable %evenue
)-,--$,"-)$,"--
The McGraw-Hill Companies, Inc., 2 !" %&! -
Pro#le$ 519 (continued) ,e<uirement $ The expected bonus receivable would increase to F),--- 1( F$,"--2 by the end of the fourth month, equal to half of the total expected bonus of F$&,--- 1F(,&,--- # M+ F)-,---O2. After four months, the estimated li elihood of receiving the bonus is revised, so the estimated transaction price decreases to F(+(,---! Possible Prices Expected Probabilities Consideration F'--,--$+(,--F(+(,---
)-G F"--,--- 1MF)-,--- +O I F&-,---2 (-G F()-,--- 1MF)-,--- +O # F&-,---2 Transaction price after four months!
Therefore, as of that date the expected bonus receivable should equal F&,---, which is half of the new expected bonus of F(,--- 1F(+(,--- # M+ F)-,---O2. %ecording that ad0ustment requires a reduction of the expected bonus receivable from F),--- to F&,---! %evenue Dxpected bonus receivable (,--(,---
This entry reduces the expected bonus receivable to F&,---, with the offsetting debit a reduction in revenue. ;ver the remaining four months, expected bonus receivable will increase by F"-- each month, accumulating to F(,--- by the end of the contract. ,e<uirement % Because services are provided evenly over the eight months, Lelocity would recogni/e revenue of F)-,"-- 1F(+(,--- + months A F)-,"--2 in each of months five through eight. Because Burger Boy pays F)-,--- per month 1F"-- less than the revenue recogni/ed2, Lelocity would recogni/e an expected bonus receivable of F"-- each month to reflect the revenue recogni/ed in excess of its unconditional right to F)-,---. The 0ournal entry would be! Accounts receivable Dxpected bonus receivable %evenue )-,--"-)-,"--
The McGraw-Hill Companies, Inc., 2 !" %&! %
Pro#le$ 519 (concluded) ,e<uirement & At the end of contract, Lelocity learns that it will receive the bonus of F&-,---. 5t already has recogni/ed revenue of F(,--- associated with the bonus. Therefore, Lelocity recogni/es additional accounts receivable and additional revenue of F$),--- 1F&-,--- # (,---2. Dxpected bonus receivable %evenue Accounts receivable Dxpected bonus receivable ;% Accounts receivable Dxpected bonus receivable %evenue &-,--(,--$),--$),--$),--&-,--&-,---
CASES ,eal .orld Case 5"#
,e<uirement # A bill and hold strategy accelerates the recognition of revenue. 5n this case, sales that would normally have occurred in $,,+ were recorded in $,,*. Assuming a positive gross profit on these sales, earnings in $,,* is inflated. ,e<uirement $ A customer would probably not be expected to pay for goods purchased using this bill and hold strategy until the goods were actually received. %eceivables would therefore increase. ,e<uirement % Sales that would normally have been recorded in $,,+ were recorded in $,,*. This bill and hold strategy shifted sales revenue and therefore earnings from $,,+ to $,,*. ,e<uirement & Darnings quality refers to the ability of reported earnings 1income2 to predict a company4s future earnings. Sunbeam4s earnings management strategy produced a $,,* earnings figure that was not indicative of the company4s future profit8generating ability.
Dudgment Case 5"$
,e<uirement #
3hile revenue often is earned during a period of time, revenue usually is recogni/ed at a point in time when both revenue recognition criteria are satisfied. These criteria usually are satisfied at the point of delivery. The revenue has been earned and there is reasonable certainty as to the collectibility of the asset 1cash2 to be received. >sually, significant uncertainties exist at the time products are produced. At the point of delivery, the product has been sold and the price and buyer are nown. The only remaining uncertainty involves the ultimate cash collection, which can usually be accounted for by estimating and recording allowances for possible return of the product and for uncollectibility of the cash. ,e<uirement $ 5t would be useful to recogni/e revenue as the productive activity ta es place when the earnings process occurs over long periods of time. A good example is long8 term pro0ects in the construction industry. ,e<uirement % Some revenue8producing activities call for revenue recognition a+ter the product has been delivered. These situations involve significant uncertainty as to the collectibility of the cash to be received, caused either by the possibility of the product being returned or, with credit sales, the possibility of bad debts. >sually, these remaining uncertainties can be accounted for by estimating and recording allowances for anticipated returns and bad debts, thus allowing revenue and related costs to be recogni/ed at the point of delivery. But occasionally, an abnormal degree of uncertainty causes point of delivery revenue recognition not to be appropriate. %evenue recognition a+ter delivery sometimes is appropriate for installment sales and when a right of return exists. Eega should recogni/e revenue for the initial fee equally over the estimated average period members will continue to be members. Dven though the fee is nonrefundable, it is not 6earned7 until services are provided. Since there is no contractual period of service, it must be estimated. Eega would be 0ustified in recogni/ing only F' of the initial fee immediately to offset the cost of the membership card. The payment option chosen by members does not affect the revenue recognition policy. The monthly fee should be recogni/ed as revenue upon billing, as long as adequate provision is made for possible uncollectible amounts.
Dudgment Case 5"%
Dudgment Case
The revenue recognition policy is questionable. The trade8in policy causes gross profit to be overstated on 5"&liberal the original sale and understated on the trade8in sale. This
results from the granting of a trade8in allowance for the old computer that is greater than the old computer<s resale value. >sing the company<s recognition policy, gross profit recogni/ed on the two sales would be as follows! Sales price Cost of goods sold ?ross profit ?ross profit percentage )riginal sale F&,---,--$,&--,--F +--,--(-G TradeFin sale F&,'+-,--$,"--,--F ++-,--'*G
;f course, there is no guarantee that the customer will exercise the trade8in option. 5f, however, a large percentage of customers do exercise the option, and the distortion in gross profit is material, the company should adopt a revenue recognition policy that results in a more stable gross profit percentage for the two transactions. The critical question that student groups should Communication Case 5"5address is how to match revenues and expenses. There is no right or wrong answer. The process of developing the proposed solutions will li ely be more beneficial than the solutions themselves. Students should benefit from participating in the process, interacting first with other group members, then with the class as a whole. Solutions could ta e one of two directions! $. .eferral of revenue recognition. As each ice cream cone is sold, a portion of the sales price is deferred and a liability is recorded. This liability will then be reduced and revenue recogni/ed when the free ice cream cone is awarded. &. The accrual of estimated cost. This direction views the free ice cream cone as a promotional expense. The estimated cost of the free cone should be expensed as the $- required cones are sold. A corresponding liability is recorded which should increase to an amount equal to the cost of the free cone. 3hen the free cone is awarded, the liability and inventory are reduced. 5n either case, the accounting method must consider the fact that not all customers will ta e advantage of the free cone award. 5t is important that each student actively participate in the process. .omination by one or two individuals should be discouraged. Students should be encouraged to contribute to the group discussion by 1a2 offering information on relevant issues, and 1b2 clarifying or modifying ideas already expressed, or 1c2 suggesting alternative direction.
,esearch Case
@*oteB This case re<uires the student to reference a Nournal 5"'article9A

The McGraw-Hill Companies, Inc., 2 !" %&! /
$. &. '. (.
:ifty8five firms reported the use of one of the two long8term contract accounting methods. Twenty8seven of the firms are manufacturing companies. ;nly one company uses the completed contract method. That company reported using both methods. The most frequently used approach to estimating a percentage8of8completion is the cost8to8cost method.
@*oteB This case re<uires the student to reference a Nournal 5"1article9A
,esearch Case
$.
Abuse $. Cutoff manipulation
&. .eferring too much or too little revenue
'. Bill8and8hold sale (. %ight8of8return sale
Expanation The company either closes their boo s early 1so some current8year revenue is postponed until next year2 or leaves them open too long 1so some next8year revenue is included in the current year2. The company has an arrangement under which revenue should be deferred 1for example, it should be using the installment sales method2, but it doesn4t defer the revenue. ;r, a company could defer too much revenue to shift income into future periods. The company records sales even though it hasn4t yet delivered the goods to the customer. The company sells to distributors or other customers and can4t estimate returns with sufficient accuracy due to the nature of the selling relationship.
&. '. (.
Eanipulating estimates of percentage complete in order to manipulate gross profit recognition. These abuses tended to increase income 1*"G of the time2, consistent with management generally having an incentive to increase income. The auditors tended to require ad0ustment 1")G of the time2, consistent with auditors being concerned about income8increasing earnings management. .iscussion should include these elements.
Ethics Case 5"2

+actsB
9ori/on Corporation, a computer manufacturer, reported profits from &--+ through &-$$, but reported a F&- million loss in &-$& due to increased competition. The chief financial officer 1C:;2 circulated a memo suggesting the shipment of computers to Q.B. Sales, 5nc., in &-$' with a subsequent return of the merchandise to 9ori/on in &-$(. 9ori/on would record a sale for the computers in &-$' and avoid an inventory write8off that would place the company in a loss position for that year. The C:; is clearly as ing Qim :ielding to recogni/e revenue in &-$' that he nows will be reversed as a sales return in &-$(. Ethical >ilemmaB 5s Qim<s obligation to challenge the memo of the C:; and provide useful information to users of the financial statements greater than the obligation to prevent a company loss in &-$' that may lead to ban ruptcyW .ho is affectedH Qim :ielding C:; and other managers ;ther employees Shareholders @otential shareholders Creditors Auditors
Dudgment Case 5"3
,e<uirement #
The three methods that could be used to recogni/e revenue and costs for this situation are 1$2 point of delivery, 1&2 the installment sales method, and 1'2 the cost recovery method. $4#% gross profit under the three methodsB 1$2 point of delivery! F+-,--- # (-,--- A 6&47444 1&2 installment sales method! F(-,--A "-G A gross profit G F+-,-- The McGraw-Hill Companies, Inc., 2 !" %&!! Intermediate Accounting, 7'e
"-G x F'-,--- 1cash collected2 A 6#57444 1'2 cost recovery method! Bo gross profit recogni/ed since cost 1F(-,---2 exceeds cash collected 1F'-,---2. ,e<uirement $ Customers sometimes are allowed to pay for purchases in installments over long periods of time. >ncertainty about collection of a receivable normally increases with the length of time allowed for payment. 5n most situations, the increased uncertainty concerning the collection of cash from installment sales can be accommodated satisfactorily by estimating uncollectible amounts. 5n these situations, point of delivery revenue recognition should be used. 5f, however, the installment sale creates a situation where there is significant uncertainty concerning cash collection ma ing it impossible to ma e an accurate assessment of future bad debts, revenue and cost recognition should be delayed. The installment sales method and the cost recovery method are available to handle such situations. These methods should be used only in situations involving exceptional uncertainty. The cost recovery method is the more conservative of the two.
Dudgment Case 5"#4
Bote! the SDC guidance on these issues can be found in the :ASB4s codification at :ASB ASC )-"#$-#S,,! 6%evenue %ecognition#;verall#SDC Eaterials.7
Question # Bo. 5n the SDC<s view, it would be inappropriate for Company E to recogni/e the membership fees as earned revenue upon billing or receipt of the initial fee with a corresponding accrual for estimated costs to provide the membership services. This conclusion is based on Company E<s remaining and unfulfilled contractual obligation to perform services 1i.e., ma e available and offer products for sale at a discounted price2 throughout the membership period. Therefore, the earnings process, irrespective of whether a cancellation clause exists, is not complete. 5n addition, the ability of the member to receive a full refund of the membership fee up to the last day of the membership term raises an uncertainty as to whether the fee is fixed or determinable at any point before the end of the term. ?enerally, the SDC believes that a sales price is not fixed or determinable when a customer has the unilateral right to terminate or cancel the contract and receive a cash refund. MASC )-"#$-#S,,, SAB Topic $'.A.(, :ixed or .eterminable Sales @rice, a. %efundable fees for services.O
The McGraw-Hill Companies, Inc., 2 !" %&!!!
Question $ Bo. @roducts delivered to a consignee pursuant to a consignment arrangement are not sales and do not qualify for revenue recognition until a sale occurs. The SDC believes that revenue recognition is not appropriate because the seller retains the ris s and rewards of ownership of the product and title usually does not pass to the consignee. MASC )-"#$-#S,,, SAB Topic $'.A.&, @ersuasive Dvidence of an Arrangement.O
The McGraw-Hill Companies, Inc., 2 !" %&!!2
C&se 51% (concluded) Question % @rovided that the other criteria for revenue recognition are met, the SDC believes that Company % should recogni/e revenue from sales made under its layaway program upon delivery of the merchandise to the customer. >ntil then, the amount of cash received should be recogni/ed as a liability entitled such as Xdeposits received from customers for layaway salesX or a similarly descriptive caption. Because Company % retains the ris s of ownership of the merchandise, receives only a deposit from the customer, and does not have an enforceable right to the remainder of the purchase price, the SDC would ob0ect to Company % recogni/ing any revenue upon receipt of the cash deposit. This is consistent with item two 1&2 in the SDC<s criteria for bill8and8 hold transactions that states that Xthe customer must have made a fixed commitment to purchase the goods.X MASC )-"#$-#S,,, SAB Topic $'.A.', .elivery and @erformance, e. Hayaway sales arrangements.O
,esearch Case 5"##
,e<uirement #
The relevant literature can be found in the :ASB4s codification at :ASB ASC )-"#$"#&"#$! 6%evenue %ecognition#@roducts#%ecognition#?eneral#Sales of @roduct when %ight of %eturn Dxists.7 ,e<uirement $ ?AA@ lists the following factors that may impair the ability to ma e a reasonable estimate 1see ASC )-"#$"#&"#'2. a. The susceptibility of the product to significant external factors, such as technological obsolescence or changes in demand. b. %elatively long periods in which a particular product may be returned. c. Absence of historical experience with similar types of sales of similar products, or inability to apply such experience because of changing circumstances, for example, changes in the selling enterprise4s mar eting policies or relationships with its customers. d. Absence of a large volume of relatively homogeneous transactions. ,e<uirement % The six criteria are! a. The seller4s price to the buyer is substantially fixed or determinable at the date of sale. b. The buyer has paid the seller and the obligation is not contingent on resale of the product.
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&!!"
c. d. e. f.
The buyer4s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product. The buyer acquiring the product for resale has economic substance apart from that provided by the seller. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer. The amount of future returns can be reasonably estimated.
The McGraw-Hill Companies, Inc., 2 !" %&!!-
C&se 511 (concluded) ,e<uirement & Both companies recogni/e revenues from products sold when persuasive evidence of an arrangement exists, the price is fixed or determinable, shipment is made, and collectibility is reasonably assured. 9owever, for sales to distributors under terms allowing the distributors certain rights of return and price protection on unsold merchandise held by them, AE. defers recognition of revenue and related profits until the merchandise is resold by the distributors. ,e<uirement 5 The two revenue recognition policies differ with respect to AE.4s sales to distributors. %evenue for these sales is deferred until the merchandise is resold by the distributors. ;n the other hand, 9@ recogni/es all sales when products are shipped even though it offers price protection as well as the right of return to customers. Dstimates are recorded for customer returns, price protection, rebates, and other offerings. %easons for the difference in policies could relate to the types of products sold by the two companies, the distribution channels, and the actual agreements with customers. AE. sells semiconductors, a highly volatile industry. 5t may be more difficult for AE. to see through the distribution channels to reasonably estimate returns. Also, the agreements with distributors of AE.4s products may be more liberal than those of 9@ with respect to things li e price protection and returns. :or example, AE. might offer a longer time period for customers to return product than does 9@. Also, AE.4s sales to distributors might be contingent on resale of the product to end users, one of the six criteria that must be met before revenue can be recogni/ed when the right of return exists.
,esearch Case 5"#$
,e<uirement #
This topic is addressed in D5T: 5ssue Bo. ,,8$, The :ASB ASC cross8reference addresses this topic in paragraphs under :ASB ASC )-"#(". ,e<uirement $ The relevant literature can be found in the :ASB4s codification at :ASB ASC )-"#("#("#$ through )-"#("#("#$+! 6%evenue %ecognition#@rincipal Agent Considerations#;ther @resentation Eatters#;verall Considerations of %eporting %evenue ?ross as a @rincipal vs. Bet as an Agent.7 The Codification lists the following indicators for use of the gross method! $. The company is the primary obligor in the arrangement. &. The company has general inventory ris 1before customer order is placed or upon customer return2. '. The company has latitude in establishing price. (. The company changes the product or performs part of the service.
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&!!%
". The company has discretion in supplier selection. ). The company is involved in the determination of product or service specifications. *. The company has physical loss inventory ris 1after customer order or during shipping2. +. The company has credit ris . The indicators for the use of the net method are! $. The supplier 1not the company2 is the primary obligor in the arrangement. &. The amount the company earns is fixed. '. The supplier 1and not the company2 has credit ris . ,e<uirements % and & :or their AdSense program, ?oogle4s &-$- $-S states! 63e recogni/e as revenues the fees charged advertisers each time a user clic s on one of the text8based ads that are displayed next to the search results pages on our website or on the search results pages or content pages of our ?oogle Betwor members4 websites and, for those advertisers who use our cost8per impression pricing, the fees charged advertisers each time an ad is displayed on our members4 websites. 3e report our ?oogle AdSense revenues on a gross basis principally because we are the primary obligor to our advertisers.7 That is consistent with the first indicator for use of the gross method listed under %equirement &, so ?oogle4s reasoning appears appropriate. $. .elta should recogni/e the F(&" as revenue on Dudgment Case 5"#% Eay $", the date the flight commences. &. %evenue should be recogni/ed evenly over the period beginning after Than sgiving and ending April '-. '. The F",--- monthly charge is recogni/ed as revenue each month. The F$&,--- fee must be recogni/ed evenly over the ')8month lease period. (. Qanora 9aw ins should recogni/e the F)-,--- as revenue on August &+, the date the case is settled successfully. This assumes reasonable certainty as to the collection. Bill4s argument is that the completed contract method is preferable because it is analogous to point of delivery revenue recognition. That is, no revenue is recogni/ed until Dudgment Case 5"#&the completed product is delivered. Qohn4s argument is that the important factor is the earnings process and that revenue should be recogni/ed as the process ta es place. Qohn4s argument is correct. 5n situations when the earnings process ta es place over long periods of time, li e long8term construction contracts, it is preferable to recogni/e revenue during the earnings process, rather than to wait until the process is complete.
Communication Case 5"#5

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Suggested Crading Concepts and Crading SchemeB

5ncome differences. YYYYYYYY @ercentage8of8completion recogni/es gross profit during construction based on an estimate of percent complete. YYYYYYYY The completed contract method recogni/es no gross profit until pro0ect completion. YYYYYYYY :or both methods, estimated losses are fully recogni/ed in the first period the loss is anticipated. Balance sheet differences. The two methods are similar. 9owever, for profitable pro0ects, the construction in progress account during construction will have a higher balance when using the percentage8of8completion method due to the inclusion of gross profit. According to generally accepted accounting principles, the percentage8of8completion method should be used in most situations. The completed contract method distorts income when long8term pro0ects span more than one accounting period.
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YYYYYYY *- points Terminology and tone appropriate to the audience of a company controller. ;rgani/ation permits ease of understanding. YYYYYYY 5ntroduction that states purpose. YYYYYYY @aragraphs that separate main points. Dnglish YYYYYYY Sentences grammatically clear and well organi/ed, concise. YYYYYYY 3ord selection. YYYYYYY Spelling. YYYYYYY ?rammar and punctuation.
.riting 1'-G2 YYYYYYYYY ) YYYYYYYYY $&
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Lodafone4s revenue recognition policies for products and I+,S Case 5"#'services are similar to revenue recognition policies in the >.S. Sales of products are recorded when goods have been put at the disposal of the customers in accordance with agreed terms of delivery and when the ris s and rewards of ownership have been transferred to the buyer. Sales of services are recogni/ed as the services are provided. The terminology is somewhat different, but the end results, as compared to >.S. policies, should be similar in most cases.
I+,S Case 5"#1,e<uirement #

@er the revenue recognition section of ThyssenSrupp4s &-$- annual report, note $! Summary of Significant Accounting @olicies! The company4s normal method for accounting for long8term construction contracts is the percentage of completion method, used when it can ma e accurate estimates of contract income! 6= Construction contract revenue and expense are accounted for using the percentage8of8completion method, which recogni/es revenue as performance of the contract progresses. The contract progress is determined based on the percentage of costs incurred to date to total estimated cost for each contract after giving effect to the most recent estimates of total cost.7 3hen the company cannot ma e accurate estimates of contract income, it uses the cost recovery method! 6=3here the income of a construction contract cannot be estimated reliably, contract revenue that is probable to be recovered is recogni/ed to the extent of contract costs incurred. Contract costs are recogni/ed as expenses in the period in which they are incurred.7 @from $4#4 Annual reportA *ote #B Summar of significant accounting policies The consolidated financial statements have been prepared on a historical cost basis, except for certain financial instruments that are stated at fair value. The consolidated financial statements are presented in Duros since this is the currency in which the ma0ority of the ?roup4s transactions are denominated, with all amounts rounded to the nearest million except when otherwise indicatedZ this may result in differences compared to the unrounded figures.
,e<uirement $ The primary difference is that, under >.S. ?AA@, the company would use the completed contract method in circumstances in which it cannot ma e accurate estimates of contract income.
Trueblood Accounting Case Trueblood Accounting Case
A solution and extensive discussion 5"#2materials can be obtained from the .eloitte :oundation. A solution and extensive discussion 5"#3materials can be obtained from the .eloitte :oundation.
The McGraw-Hill Companies, Inc., 2 !" %&!!/
,eal .orld Case 5"$4
,e<uirement %
The following is from the &-$- $-S of Qac in the Box, 5nc. The responses to the question will vary if the company has since changed its revenue recognition policy. a9 These fees are recogni/ed as revenue when the company has substantially performed all of its contractual obligations. This policy agrees with ?AA@. b9 Continuing payments are based on a percentage of sales. ,e<uirement & Answers to this question will, of course, vary because students will research financial statements of different companies. Hi ely candidates for comparison include most of the fast8food chains such as Ec.onald4s, and 3endy4s, and Arby4s
,eal .orld Case 5"$#
,e<uirement $
Excerpt from )rbit?Ms $4#4 Annual ,eportB 5e,enue 5ecognition 3e recogni/e revenue when it is earned and reali/able, when persuasive evidence of an arrangement exists, services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. 3e have two primary types of contractual arrangements with our vendors, which we refer to herein as the XmerchantX and XretailX models. >nder both the merchant and retail models, we record revenue earned net of all amounts paid to our suppliers. >nder the merchant model, we generate revenue for our services based on the difference between the total amount the customer pays for the travel product and the negotiated net rate plus estimated taxes that the supplier charges us for that product. Customers generally pay us for reservations at the time of boo ing. 5nitially, we record these customer receipts as accrued merchant payables and either deferred income or net revenue, depending on the travel product. 5n the merchant model, we do not ta e on credit ris with the customer, however we are sub0ect to chargebac s and fraud ris which we monitor closelyZ we have the ability to determine the priceZ we are not responsible for the actual delivery of the flight, hotel room or car rentalZ we ta e no inventory ris Z we have no ability to determine or change the products or services deliveredZ and the customer chooses the supplier. 3e recogni/e net revenue under the merchant model when we have no further obligations to the customer. . . . >nder the retail model, we pass reservations boo ed by our customers to the travel supplier for a commission. 5n the retail model, we do not ta e on credit ris with the customerZ we are not the primary obligor with the customerZ we have no latitude in determining pricingZ we ta e no inventory ris Z we have no ability to determine or
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&!!1
change the products or services deliveredZ and the customer chooses the supplier. 3e recogni/e net revenue under the retail model when the reservation is made, secured by a customer with a credit card and we have no further obligations to the customer.
C&se 521 (continued) Excerpt from priceline9comMs $4#4 Annual ,eportB Merchant 5e,enues and Cost o+ Merchant 5e,enues Bame Kour ;wn @rice[ Services! Eerchant revenues for Bame Kour ;wn @rice[ services and related cost of revenues are derived from transactions where the Company is the merchant of record and, among other things, selects suppliers and determines the price it will accept from the customer. The Company recogni/es such revenues and costs if and when it fulfills the customer4s non8refundable offer. Eerchant revenues and cost of merchant revenues include the selling price and cost, respectively, of the travel services and are reported on a gross basis. . . . Eerchant @rice8.isclosed 9otel Service! Eerchant revenues for the Company4s merchant price8disclosed services are derived from transactions where its customers purchase hotel room reservations or rental car reservations from suppliers at disclosed rates which are sub0ect to contractual arrangements. The Company records the difference between the customer selling price and the supplier cost of its merchant price8disclosed reservation services on a net basis in merchant revenue. Agenc* 5e,enues Agency revenues are derived from travel related transactions where the Company is not the merchant of record and where the prices of the services sold are determined by third parties. Agency revenues include travel commissions, customer processing fees and global distribution system 16?.S72 reservation boo ing fees and are reported at the net amounts received, without any associated cost of revenue. Such revenues are generally recogni/ed by the Company when the customers complete their travel.
The McGraw-Hill Companies, Inc., 2 !" %&!2!
C&se 521 (concluded) ,e<uirement % a2 ;rbit/4s 6merchant model7 revenues This is reported net! 63e record revenue earned net of all amounts paid to our suppliers under both our merchant and retail models.7 b2 ;rbit/4s 6retail model7 revenues This is reported net! 63e record revenue earned net of all amounts paid to our suppliers under both our merchant and retail models.7 c2 priceline.com4s 6merchant revenues for \Bame Kour ;wn @rice[4 services7 This is reported gross! 6Eerchant revenues and cost of merchant revenues include the selling price and cost, respectively, of the travel services and are reported on a gross basis.7 d2 priceline.com4s 6merchant revenues for \@rice8.isclosed 9otel4 services7 This is reported net! 6The Company records the difference between the selling price and the cost of the hotel room reservation as merchant revenue.7 e2 priceline.com4s agency revenues! This is reported net! 6Agency revenues . . . are reported at the net amounts received, without any associated cost of revenue.7 ,e<uirement & Kes, it appears that relatively similar services can be accounted for as gross v. net depending on how they are structured. @riceline4s 6Bame your own @rice[7 service appears similar to services that ;rbit/ might offer under its merchant model, yet @riceline would recogni/e revenue gross and ;rbit/ would recogni/e revenue net. 5f similar things are treated differently, comparability is reduced.
Anal sis Case 5"$$familiarity with an actual annual report and library sources of
This case encourages students to obtain hands8on
industry data. They also must apply the techniques learned in the chapter. Kou may wish to provide students with multiple copies of the same annual
The McGraw-Hill Companies, Inc., 2 !" %&!22 Intermediate Accounting, 7'e
reports and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective. Apparently, a significant increase in assets occurred 5"$%during the last quarter. Total assets were F'&( million and now they total F("- million, as can be calculated as A Bet income N Shareholders4 equity A $(G A F&$ million N $(G A F$"- million A Total liabilities N Shareholders4 equity A & A F$"- million x & A F'-- million A Total liabilities I Shareholders4 equity A F'-- million I $"- million A F("- million
Dudgment Case
follows!
%eturn on shareholders4 equity Shareholders4 equity .ebt to equity ratio Total liabilities Total assets
The McGraw-Hill Companies, Inc., 2 !" %&!2"
Integrating Case 5"$&
Balance Sheet F $",--$&,--'-,--',--)-,--$(-,--F&--,--F &",--",--'-,--&-,--$"-,--F&--,--F'--,--1$+-,---2 $&-,--1,),---2 1&,---2 1*,---2 F $",--given 1e2 1d2 1i2 1h2 102 1b2 1g2 given 1f2 1l2 1 2 1b2 1a2 1c2 1c2 1o2 1m2 1n2 given
C&se 524
Assets Cash Accounts receivable 1net2 5nventory @repaid expenses and other current assets Current assets @roperty, plant, and equipment 1net2 5iabilities and ShareholdersM E<uit Accounts payable Short8term notes Current lia)ilities Bonds payable Shareholders4 equity Income Statement Sales Cost of goods sold ?ross profit ;perating expenses 5nterest expense Tax expense Bet income (concluded)
Calculations @6 in 444sAB a. @rofit margin on sales A Bet income N Sales A "G Sales A F$" N "G A F'-b. %eturn on assets A Bet income N Total assets A *."G Total assets A F$" N *."G A F&-c. ?ross profit margin A ?ross profit N Sales A (-G ?ross profit A F'-- x (-G A F$&Cost of goods sold A Sales # ?ross profit A F'-- # $&- A F$+d. 5nventory turnover ratio A Cost of goods sold N 5nventory A ) 5nventory A F$+- N ) A F'e. %eceivables turnover ratio A Sales N Accounts receivable A &" Accounts receivable A F'-- N &" A F$&
The McGraw-Hill Companies, Inc., 2 !" %&!2-
f. Acid8test ratio A Cash I A% I ST 5nvestments N Current liabilities A ., Current liabilities A 1F$" I $& I -2 N ., A F'g. Accounts payable A Current liabilities # Short8term notes A F'- # " A F&" h. Current ratio A Current assets N Current liabilities A & Current assets A F'- x & A F)i. @repaid expenses and other current assets A Current assets # 1Cash I A% I 5nventory2 A F)- # 1$" I $& I '-2 A F' 0. @roperty, plant, and equipment A Total assets # Current assets A F&-- # )- A F$(. %eturn on shareholders4 equity A Bet income N Shareholders4 equity A$-G Shareholders4 equity A F$" N $-G A F$"l. .ebt to equity ratio A Total liabilities N Shareholders4 equity A $P' Total liabilities A F$"- x $P' A F"Bonds payable A Total liabilities # Current liabilities A F"- # '- A F&m. 5nterest expense A +G x 1Short8term notes I Bonds 2 5nterest expense A +G x 1F" I &-2 A F& n Times interest earned ratio A 1Bet income I 5nterest ITaxes2 N 5nterest A $& Times interest earned ratio A 1F$" I & I Taxes2 N & A F$& Times interest earned ratio A 1F$" I & I Taxes2 A F&( Tax expense A F&( # 1$" I &2 A F* o. ;perating expenses A 1Sales # Cost of goods sold # 5nterest expense # Tax expense2 # Bet income A 1F'-- # $+- # & # *2 # $" A F,)
The McGraw-Hill Companies, Inc., 2 !" %&!2%
Air +rance"/5M Case

,e<uirement # a. A:4s balance sheet indicates current deferred revenue on tic et sales of ]&,((million as of Earch '$, &-$$. 3hile it is possible that A: has some noncurrent deferred revenue on tic et sales, none is indicated in note '$ 1other noncurrent liabilities2. b. The 0ournal entry would be! .eferred revenue on tic et sales Sales revenue &,((&,((-
c. This seems consistent with >.S. ?AA@. A liability for deferred revenue is recogni/ed when tic ets are purchased, and then the deferred revenue is reduced and revenue is recogni/ed when the transportation service is provided. ,e<uirement $ a. :rom note '.*! 65n accordance with the 5:%5C $', these \miles4 are considered distinct elements from a sale with multiple elements and one part of the price of the initial sale of the airfare is allocated to these \miles4 and deferred until the groups commitments relating to these \miles4 has been met. The deferred amount due in relation to the acquisition of miles by members is estimated! 8 According to the fair value of \miles,4 defined as the amount at which the benefits can be sold separately. 8 After ta ing into account the redemption rate, corresponding to the probability that the miles will be used by members, using statistical method.7
Air 'r&nce()*+ C&se (concluded) b. @er the balance sheet, A: has a liability for 6:requent flyer programs7 of ]+-) million. c. A:4s approach is consistent with >.S. ?AA@4s accounting for multiple8element contracts 1ASC )-"#&"#$"2, in that the revenue associated with A: miles is deferred and recogni/ed separately from the revenue associated with the flights that customers use to earn the miles. Bote! Accounting for customer loyalty programs is unresolved in >.S. ?AA@. Currently, this issue is not included in the scope of guidance about multiple8deliverable contracts 1see ASC )-"#&"#$"#&A2 or customer payments and incentives 1see )-"# "-#$"#'2. Airlines typically use the 6incremental cost7 method, which does not brea out the travel credits as a separate component of revenue and instead only accrues a liability for the estimated incremental cost of providing future travel services. Ket, if companies sell 6points7 in their customer loyalty programs to third parties, the portion of the sale that is for travel is estimated and recogni/ed as passenger revenue when the transportation is provided, similar to how it would be treated under normal accounting for multiple deliverables.

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Chapter 5

Income Measurement and Profitabilit Anal sis

#olutions Manual, $ol.!, Chapter %

%eflective thin ing Analytic

$ & ' ( " ) * + , $$ & '

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Intermediate Accounting, 7'e

Q(ESTI)*S +), ,E-IE. )+ /E0 T)PICS

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Intermediate Accounting, 7'e

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Intermediate Accounting, 7'e

S(PP5EME*T Q(ESTI)*S +), ,E-IE. )+ /E0 T)PICS

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Intermediate Accounting, 7'e

Brief Exercise 5"$

Brief Exercise 5"%

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Brief Exercise 5"&

Brief Exercise 5"5

Brief Exercise 5"1

Brief Exercise 5"2

Brief Exercise 5"3

Brief Exercise 5"#4

Brief Exercise 5"#5

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Intermediate Accounting, 7'e

5nventory turnover ratio 5nventory turnover ratio

Brief Exercise 5"#'

Bet income Average shareholders4 equity F)",--F"&&,"--J #$9&:

#olutions Manual, $ol.!, Chapter %

The McGraw-Hill Companies, Inc., 2 !" %&!"

JAverage shareholders4 equity A 1F"--,--- I "(",---2 & A F"&&,"--

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Intermediate Accounting, 7'e

Brief Exercise 517 (concluded)

Average total assets Average shareholders4 equity F+--,--F"&&,"-#95%

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Brief Exercise 5"$4

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#olutions Manual, $ol.!, Chapter %

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E8E,CISES Exercise 5"#

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Intermediate Accounting, 7'e

61%7544 F $&),--1"&,"--2 1'",---2 $-",--1'),---2 6#417544

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Intermediate Accounting, 7'e

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&-$( &-$" &-$) Totals

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Intermediate Accounting, 7'e

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