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Chapter 5 Revenue Recognition and Profitability Analysis

Questions for Review of Key Topics


Question 51
The five key steps in applying the core revenue recognition principle are:
Identify the contract with a customer.
Identify the performance obligation(s) in the contract.
Determine the transaction price.
Allocate the transaction price to the performance obligations.
Recognize revenue when (or as) each performance obligation is satisfied.
Question 52
A performance obligation is satisfied at a single point in time when control is transferred to the
buyer at a single point in time. This often occurs at delivery. Five key indicators are used to
decide whether control of a good or service has passed from the seller to the buyer. The
customer is more likely to control a good or service if the customer has:
An obligation to pay the seller.
Legal title to the asset.
Physical possession of the asset.
Assumed the risks and rewards of ownership.
Accepted the asset.
Management should evaluate these indicators individually and in combination to decide whether
control has been transferred.
Question 53
A performance obligation is satisfied over time if at least one of the following three criteria is
met:
The customer consumes the benefit of the sellers work as it is performed,
The customer controls the asset as it is created, or
The seller is creating an asset that has no alternative use to the seller, and the seller can
receive payment for its progress even if the customer cancels the contract.
Answers to Questions (continued)
Question 54
Services typically qualify for revenue recognition over time because the customer consumes the
benefit of the sellers work as it is performed. However, for convenience, even if the service
qualifies for recognition of revenue over time, the seller might wait to recognize revenue until the
service has been completed because it is more convenient to account for it that way. For
example, if a service is delivered over days or even weeks, the seller might just wait to
recognize revenue until delivery is complete rather than bothering with a more precise
recognition of revenue over time. This departure from GAAP is appropriate only if the amount of
revenue recognized under the departure is not materially different from the amount of revenue
that would be recognized if revenue was recognized over time.

Question 55
Sellers account for a promise to provide a good or service as a performance obligation if the
good or service is distinct from other goods and services in the contract. The idea is to separate
contracts into parts that can be viewed on a stand-alone basis. That way the financial
statements can better reflect the timing of the transfer of separate goods and services and the
profit earned on each one. Performance obligations that are not distinct are combined and
treated as a single performance obligation.
A performance obligation is distinct if it is both:
Capable of being distinct. The customer could use the good or service on its own or in
combination with other goods and services it could obtain elsewhere, and
Separately identifiable

from other goods or services in the contract. The good or service


is not highly interrelated with other goods and services in the contract.

Answers to Questions (continued)


Question 56
If an arrangement has multiple performance obligations, the seller allocates the
transaction price in proportion to the stand-alone selling prices of the goods or services
underlying those performance obligations. If the seller cant observe actual stand-alone selling
prices, the seller should estimate them.
Question 57
A contract specifies the legal rights and obligations of the seller and the customer. For a
contract to exist for purposes of revenue recognition, it must:
Have commercial substance, affecting the risk, timing or amount of the sellers
future cash flows,
Be approved by both the seller and the customer, indicating commitment to
fulfilling their obligations,
Specify the seller and customers rights regarding the goods or services to be
transferred, and
Specify payment terms.
Be probable that the seller will collect the amount it is entitled to receive.
We normally think of a contract as being specified in a written document, but contracts can be
oral rather than written. Contracts also can be implicit based on the typical business practices
that a company follows. The key is that, implicitly or explicitly, the arrangement be substantive
and specify the legal rights and obligations of a seller and a customer.
Question 58
If a seller grants a customer the option to acquire additional goods or services, that option gives
rise to a performance obligation only if the option provides a material right to the customer that
the customer would not receive without entering into the contract. If the option provides a
material right, the customer in effect pays the seller in advance for future goods or services, and

the seller recognizes revenue when those future goods or services are transferred or when the
option expires.
Answers to Questions (continued)
Question 59
Variable consideration is included in the contracts transaction price when the seller believes it is
probable that it wont have to reverse (adjust downward) a significant amount of revenue in the
future because of a change in that variable consideration. The seller estimates the variable
consideration as either the expected value or the most likely amount to be received, and
includes that amount in the contracts transaction price.
Question 510
A seller is constrained to recognize only the amount of revenue for which the seller believes it is
probable that a significant amount of revenue wont have to be reversed (adjusted downward) in
the future because of a change in that variable consideration. Indicators that variable
consideration should be constrained include limited other evidence on which to base an
estimate, dependence of the variable consideration on factors outside the sellers control, and a
long delay between when the estimate must be made and when the uncertainty is resolved.
Question 511
A right to return unsatisfactory merchandise is not a performance obligation. Rather, it
represents a potential inability to satisfy the original performance obligation to provide
satisfactory goods. We view a right of return as a particular type of variable consideration. A
seller usually can estimate the returns that will result for a given volume of sales based on past
experience. Accordingly, the seller usually recognizes revenue upon delivery, but then reduces
revenue and accounts receivable to reflect the estimated returns. However, if a seller cant
estimate returns with reasonable accuracy, the constraint on variable consideration applies, and
the seller must postpone recognizing any revenue until returns can be estimated.
Answers to Questions (continued)
Question 512
A principal has primary responsibility for delivering a product or service and obtains
control of the goods or services before they are transferred to the customer. A principal
recognizes as revenue the amount received from a customer. An agent doesnt primarily
deliver goods or services, but acts as a facilitator that earns a commission for helping
sellers to transact with buyers, and recognizes as revenue only the c
ommission it
receives for facilitating the sale.
Question 513
In general, the time value of money refers to the fact that money to be received in the future is
less valuable than the same amount of money received now. If you have the money now, you
can invest it to earn a return so the money can grow to a larger amount in the future.
If payment occurs either before or after delivery, conceptually the arrangement includes a
financing component. However, when delivery and payment occur relatively near each other,
the financing component is not significant and can be ignored. As a practical matter, sellers can
assume the financing component is not significant if the period between delivery and payment is
less than a year. However, if the financing component is significant, sellers must take it into

account, both when a prepayment occurs and when an account receivable occurs. We discuss
accounting for the time value of money in Chapter 6, and apply it to many future chapters.
Question 514
If a seller purchases distinct goods or services from their customer and pays more than fair
value for those goods or services, the excess payments are viewed as a refund of part of the
price of the goods and services that the customer purchased from the seller. The excess
payments are subtracted from the amount the seller is entitled to receive from the customer
when calculating the transaction price of the sale to the customer.
Answers to Questions (continued)
Question 515
Adjusted market assessment approach: Under this approach, the seller estimates
what it could sell the product or services for in the market in which it normally sells
products. The seller likely would consider prices charged by competitors for similar
products.
Expected cost plus margin approach: Under this approach, the seller estimates its
costs of satisfying the performance obligation and then adds an appropriate profit margin
to determine the revenue it would anticipate receiving for satisfying the performance
obligation.
Residual approach: U
nder this approach, the seller subtracts from the total transaction
price the sum of the known or estimated stand-alone selling prices of the other
performance obligations that are included in the contract to arrive at an estimate of an
unknown or highly uncertain stand-alone selling price.
Question 516
Some licenses transfer a right to use the sellers intellectual property as it exists when the
license is granted. For these licenses, subsequent activity by the seller doesnt affect the
benefit that the customer receives. If a license transfers such a right of use, revenue is
recognized at the point in time the right is transferred.
Other licenses provide the customer with access to the sellers intellectual property with the
understanding that the seller will undertake ongoing activities during the license period that
affect the benefit the customer receives. If a license provides such a right of access to the
sellers intellectual property, the seller satisfies its performance obligation over time as the
customer receives benefits of the sellers ongoing activities, so revenue is recognized over the
period of time for which access is provided.
Answers to Questions (continued)
Question 517
In franchise arrangements, the franchisor typically has multiple performance obligations. The
franchisor grants to the franchisee a right to sell the franchisors products and services and use
its name for a specified period of time. The franchisor also usually provides initial start-up
services (such as identifying locations, remodeling or constructing facilities, and selling
equipment and training to the franchisee). The franchisor also may provide ongoing products
and services (such as franchise-branded products and advertising and administrative services).
So, a franchise involves a license to use the franchisors intellectual property, but also involves
initial sales of products and services as well as ongoing sales of products and services.

Question 518
A bill-and-hold arrangement exists when a customer purchases goods but requests that the
seller not ship the product until a later date. The key indicator of whether control has passed
from the seller to the customer for bill-and-hold arrangements is whether the customer has
physical possession of the asset. Since the customer doesnt have physical possession of the
goods in a bill-and-hold arrangement, the customer isnt viewed as controlling the goods. That
indicator normally overshadows other control indicators in a bill-and-hold arrangement.
Therefore, sellers usually conclude that control has not been transferred and revenue is not
recognized until actual delivery to the customer occurs.
Answers to Questions (continued)
Question 519
Sometimes a company arranges for another company to sell its product under consignment.
The consignor physically transfers the goods to the other company (the consignee), but the
consignor retains legal title. If the consignee cant find a buyer within an agreed-upon time, the
consignee returns the goods to the consignor. However, if a buyer is found, the consignee
remits the selling price (less commission and approved expenses) to the consignor.
Because the consignor retains the risks and rewards of ownership of the product and title does
not pass to the consignee, the consignor does not record revenue (and related costs) until the
consignee sells the goods and title passes to the eventual customer.
Question 520
Sometimes companies receive non-refundable prepayments from customers for some future
good or service. That is what occurs when a company sells a gift card. The seller does not
recognize revenue at the time the gift card is sold to the customer. Instead, the seller records a
deferred revenue liability in anticipation of recording revenue when the gift card is redeemed. If
the gift card isnt redeemed, the seller recognizes revenue when it expires or when, based on
past experience, the seller has concluded that customers will not redeem it.
Question 521
Bad debt expense must be reported clearly either on its own line in the income statement or in
the notes to the financial statements.
Question 522
If the customer makes payment to the seller before the seller has satisfied performance
obligations, the seller records a contract liability. If the seller satisfies a performance obligation
before the customer has paid for it, the seller records either a contract asset or a receivable.
The seller recognizes an accounts receivable if the seller has an unconditional right to receive
payment, which is the case if only the passage of time is required before the payment is due. If
instead the seller satisfies a performance obligation but its right to payment depends on
something other than the passage of time (for example, the seller satisfying other performance
obligations), the seller recognizes a contract asset.
Answers to Questions (continued)
Question 523
If a long-term contract qualifies for revenue recognition over time, the seller recognizes a portion
of the projects expected revenues and costs to each period in which construction occurs,
according to the percentage of the project completed to date. If the contract does not qualify for

revenue recognition over time, the seller recognizes revenue and costs when the construction
project is complete.
Question 524
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. If
the net amount is a debit, it is reported in the balance sheet as a contract asset. Conversely, if
the net amount is a credit, it is reported as a contract liability.
Question 525
An estimated loss on a long-term contract must be fully recognized in the first period the loss
becomes evident, regardless of the revenue recognition method used.
Question 526

Receivables turnover ratio =


Net sales
Average accounts receivable (net)
Inventory turnover ratio
=
Average inventory
Asset turnover ratio =
Average total assets

Cost of goods sold

Net sales

Activity ratios are designed to provide information about a companys 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.
Answers to Questions (continued)
Question 527

Profit margin on sales =


Net sales

Net income

Return on assets
=
Net income
Average total assets
Return on shareholders'
=
Net income
equity
Average shareholders' equity

A fundamental element of an analysts task is to develop an understanding of a firms


profitability. Profitability ratios provide information about a companys ability to earn an adequate

return relative to sales or resources devoted to operations. Resources devoted to operations


can be defined as total assets or only those assets provided by owners, depending on the
evaluation objective.
Question 528
Return on
equity

Net income
Avg. total equity

Profit margin

Net
income
Total sales

Asset
turnover

Total sales
Avg. total
assets

Equity multiplier

Avg. total
assets
Avg. total equity

The DuPont framework shows return on equity as being driven by profit margin (reflecting a
companys ability to earn income from sales), asset turnover (reflecting a companys
effectiveness in using assets to generate sales), and the equity multiplier (reflecting the extent
to which a company has used debt to finance its assets).

Appendix Questions for Review of Key Topics


Question 529
The realization principle requires that two criteria be satisfied before revenue can be
recognized:
1.
The earnings process is judged to be complete or virtually complete.
2.
There is reasonable certainty as to the collectibility of the asset to be received (usually
cash).
Question 530
At the time production is completed, there usually exists significant uncertainty as to the
collectibility of the asset to be received. We dont know 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 531
If the installment sale creates a situation where there is significant uncertainty concerning cash
collection and it is not possible to make an accurate assessment of future bad debts, revenue
and cost recognition should be delayed beyond the point of delivery.
Question 532
The installment sales method recognizes 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 533

Deferred 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.
Answers to Questions (continued)
Question 534
The completed contract method recognizes revenue, cost of construction, and gross profit at the
end of the contract, after the contract has been completed. The cost recovery method will
recognize 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
recognize the remaining revenue and gross profit. Therefore, revenue and cost are recognized
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 just prior to completion of the contract, both approaches should
recognize gross profit at the same time.
Question 535
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. If part of an arrangement does not qualify for separate accounting, revenue
recognition is delayed until revenue is recognized for the other parts.
Question 536
IFRS has less specific guidance for recognizing revenue for multiple-deliverable arrangements.
IAS No. 18 simply states that: 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 transaction and gives a couple of examples, whereas U.S. GAAP
provides more restrictive guidance concerning how to allocate revenue to various components
and when revenue from components can be recognized.
Answers to Questions (concluded)
Question 537
Specific guidelines for revenue recognition of the initial franchise fee are provided by FASB ASC
952605251. A key to these guidelines is the concept of s ubstantial performance. It 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 recognized as revenue. The term
substantial requires professional judgment on the part of the accountant. In 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.
BRIEF exercises
Brief Exercise 51

In 2016 Apache has transferred the land, and the construction company has an obligation to
pay Apache. Apaches performance obligation has been satisfied, and revenue and a related
accounts receivable of $3,000,000 can be recognized
Under accrual accounting, revenue is recorded when goods and services are transferred
to customers (2016), not necessarily when cash changes hands in future periods.
Brief Exercise 52
A performance obligation is satisfied over time if a
t least one of the following three criteria is
met:
The customer consumes the benefit of the sellers work as it is performed,
The customer controls the asset as it is created, or
The seller is creating an asset that has no alternative use to the seller, and the seller can
receive payment for its progress even if the customer cancels the contract.
Under Estates construction agreement with CyberB, if for any reason
Estate cant complete construction, CyberB would own the partially completed building.
Therefore, criterion 2 is satisfied, and revenue should be recognized as the building is being
constructed.
Brief Exercise 53
This contract qualifies for revenue recognition over time, because the performance obligation (to
provide technology consulting services upon request) is consumed by the customer as the
sellers work is performed. Therefore, Varga should recognize revenue of $4,000 ($6,000
8/12 months) in 2016.
Journal entries (not required):
May 1, 2016
Cash
Deferred revenue
December 31, 2016 adjusting entry
Deferred revenue
4,000
Service revenue ($6,000 x 8/12)

6,000
6,000

4,000

Brief Exercise 54
Based on relative stand-alone selling prices, the software comprises 70% of the total fair values
($70,000 [$30,000 + 70,000]), and the technical support comprises 3
0% ($30,000 [$30,000
+ 70,000]). Therefore, Sarjit would recognize $56,000 ($80,000 70%) in revenue when the

software is delivered and defer the remaining $24,000 ($80,000 30%) to be recognized evenly
over the next six months as the technical support service is provided.
$80,000
Transaction Price
$80,000
Transaction Price

70%
70%
30%
30%

$24,000
Technical Support Service
$24,000
Technical Support Service
$56,000
Software
$56,000
Software

The journal entry is recorded as follows:


Cash

80,000
Sales revenue (for software)
Deferred revenue (for tech support)

56,000
24,000

Brief Exercise 55
Number of performance obligations in the contract: 1
.
Access to eLean services is one performance obligation. Registration on the website is not a
performance obligation, but rather is part of the activity eLean must provide to satisfy its
performance obligation of providing access to eLeans on-line services. The $50 payment is an
upfront payment that is part of the total transaction price associated with the service, and the
monthly payments are the other component.

Brief Exercise 56
Number of performance obligations in the contract: 1
.
We need to consider three aspects of the vacuum contract: delivery of the vacuum, the
one-year quality-assurance warranty, and the option to purchase the three-year extended
warranty. Delivery of the vacuum cleaner is a performance obligation. The one-year warranty
that is included as part of the purchase (the quality-assurance warranty) is not a performance
obligation, but rather is part of the obligation to deliver a vacuum of appropriate quality. The
option to purchase a three-year extended warranty is not a performance obligation within the
contract to purchase a vacuum, because customers can purchase that warranty for the same
amount at other times, so the opportunity to buy it at the same time that they buy the vacuum
does not present a material right.
Brief Exercise 57
Number of performance obligations in the contract: 2
.
We need to consider three aspects of the vacuum contract: delivery of the vacuum, the
one-year quality-assurance warranty, and the option to purchase the three-year extended
warranty. Delivery of the vacuum cleaner is a performance obligation. The one-year warranty
that is included as part of the purchase (the quality-assurance warranty) is not a performance
obligation, but rather it is part of the obligation to deliver a vacuum of appropriate quality. The
option to purchase the extended warranty, though, is a performance obligation within the
contract to purchase a vacuum. Customers can purchase that warranty at a 20% discount if
they do so when they buy the vacuum, so the opportunity to buy the extended warranty
constitutes a material right. Also, the option is capable of being distinct, as it could be sold or
provided separately, and it is separately identifiable, as the vacuum could be sold without the
option to purchase an extended warranty, so the option is distinct, and qualifies as a
performance obligation.

Brief Exercise 58
Number of performance obligations in the contract: 2
.
In addition to the subscription, the renewal option is a performance obligation because it
provides a material right that allows the customer to renew at a better price than could be
obtained without the right. The renewed protection is capable of being distinct, as it could be
sold or provided separately, and it is separately identifiable, as the customer can use the

renewed protection on its own. Therefore, the renewed protection is distinct, and qualifies as a
performance obligation.
Brief Exercise 5-9
Number of performance obligations in the contract: 1
.
The separate goods and services that Precision Equipment has agreed to provide (equipment,
customized software package, and consulting services) might be c apable of being distinct, but
they are not separately identifiable. In the context of the contract, the goods and services are
highly dependent on and interrelated with each other. The contractors role is to integrate and
customize them to create one automated assembly line.
Brief Exercise 5-10
Number of performance obligations in the contract: 1
.
Lego enters into a contract to design and construct a specific building. Each smaller component
of the construction contract, though capable of being distinct, is not separately identifiable
because each component is highly interrelated with each other, and providing them to the
customer requires the seller to integrate the components into a combined item (garage).
Brief Exercise 5-11
Number of performance obligations in the contract: 1
.
A right of return is not a performance obligation. Instead, the right of return represents a
potential failure to satisfy the original performance obligation to deliver goods to the customer.
Because the total amount of cash received from the customer depends on the amount of
returns, a right of return is a type of variable consideration.
Aria should estimate sales returns and reduce revenue by that amount in order to arrive at net
revenue, which would be the transaction price (the amount to be recorded as revenue on the
sellers books). The total net revenue in this situation is $280,233:
Revenue
$288,900
($90 3,210 units)
Sales returns 8,667
($288,900 3%)
Net revenue $280,233
Brief Exercise 512
The expected value would be calculated as follows:
Possible Amounts Probabilities Expected Amounts
$35,000 ($25,000 fixed fee + 10,000 bonus) 50% =
$17,500
$25,000 ($25,000 fixed fee + 0 bonus)
50% =
12,500

Expected contract price at inception

$30,000

Or, alternatively:
$25,000 + ($10,000 50%) = $30,000
Brief Exercise 5-13
When a contract includes variable consideration, sellers are constrained to recognize only the
amount of revenue they believe is probable that they wont have to reverse (adjust downward) in
the future if the variable consideration changes. In this case, factors outside the sellers control
(stock market volatility) make the sellers estimate of variable consideration very uncertain, so
the amount of revenue that Continental will recognize during the year is limited to the fixed
annual management fee, which is $1.5 million (1% of the clients $150 million total assets under
management). Therefore, Continental would use $
1.5 million as its estimate of the transaction
price. Any performance bonus earned by Continental will be recognized as revenue if and when
it is earned.

Brief Exercise 514


Finerly should recognize $0 of revenue upon delivery to distributors. Given the uncertainty
about estimated returns, Finerly cant argue that it is probable that it wont have to reverse
(adjust downward) a significant amount of revenue in the future because of a change in returns.
Therefore, Finerly wont recognize revenue until it either can better estimate returns or sales to
end consumers occur. Essentially, because Finerly cant estimate returns, it treats this
transaction as if it is placing those goods on consignment with independent distributors.
Brief Exercise 515
Amazon will recognize revenue of $150, its commission on the sale. In this transaction,
Amazon never has primary responsibility for delivering a product or service, and it is not
vulnerable to risks associated with holding inventory or delivering the product or service.
Therefore, Amazon serves as an agent, and will only recognize revenue on the transaction
equal to the amount of the commission it receives.
Brief Exercise 516
If a seller is purchasing distinct goods or services from a customer at the fair value of those
goods or services, we account for that purchase as a separate transaction. Otherwise, excess
payments by the seller are treated as a refund of the customers purchase. If the payments are
made (or are expected to be made) at the time of the original sale, the transaction price of the
customers purchase is reduced immediately by the refund. If payment is not expected at the

time of the sale, revenue is recorded based on the full transaction price, and any subsequent
payment by the seller above fair value results in a reduction of the transaction price at that time.
There is no indication that Lewis payment to AdCo for $10,000, which is $2,500 more than the
fair value of those services ($7,500), was expected at the time of the original sale. Therefore,
the original sale would be recorded based on the full transaction price of $60,000. The
overpayment of $2,500 reduces the $60,000 transaction price of the goods sold by Lewis to
AdCo at the time the $10,000 is paid, resulting in a downward adjustment of revenue of $2,500
at that time and net revenue over the period of $60,000 2,500 = $57,500.
Brief Exercise 517
Under the adjusted market assessment approach, OHara would base its estimate of the
stand-alone selling price of the club-fitting services on the prices charged by other vendors for
those services, adjusted as necessary. Because OHara typically charges 10% more than what
other vendors charge, OHara would estimate the stand-alone selling price of the club-fitting
service to be $110 110% = $121.
Brief Exercise 518
Under the expected cost plus margin approach, OHara would base its estimate of the
stand-alone selling price of the club-fitting service on the $60 cost it incurs to provide the
services, plus its normal margin of $60 30% = $18. Therefore, OHara would estimate the
stand-alone selling price of the club-fitting services to be $60 + 18 = $
78.
Brief Exercise 519
Under the residual approach, OHara would base its estimate of the stand-alone selling price of
the club-fitting services on the total selling price of the contract ($1,500) minus the observable
stand-alone selling price of clubs ($1,400). Therefore, OHara would estimate the stand-alone
selling price of the club-fitting services to be $1,500 1,400 = $100.
Brief Exercise 520
The software license is a right of use, since Saars activities during the license period (which for
this software does not have an end date) will not affect the value of the software to Kim.
Therefore, Saar can recognize the entire $100,000 upon transfer of the right. However, the
license to use the Saar name is an access right, with Saars ongoing activity affecting the
benefit that Kim receives, so Saar should recognize revenue as that access is consumed over
36 months. Since Kim uses the Saar name for four months in 2016 (September through
December), Saar should recognize revenue of 4 36 = 1/9 of $90,000, or $10,000, for that
access right in 2016. In total, Saar recognizes revenue of $100,000 + 10,000 = $110,000 in
2016.

Brief Exercise 521


Because Carlos had completed training and was open for business on August 1, 2016,
TopChop apparently has satisfied its performance obligation with respect to the initial training,
equipment and furnishings, so it would recognize $50,000 of revenue in 2016. In addition, since
Carlos was a franchisee for the last six months of 2016, TopChop should recognize 6 12 =
50% of a yearly fee of $30,000, or $15,000. In total, TopChop recognizes revenue from Carlos
of $50,000 + 15,000 = $65,000 in 2016.
Brief Exercise 522
$0. Prior to delivery, Dowell maintains c ontrol of the inventory and should not recognize
revenue.
Brief Exercise 523
$250, equal to revenue for the sale of one painting. Kerianne has a consignment arrangement
with Holmstrom, so should not recognize transfer of paintings to Holmstrom as sales. Kerianne
would recognize Holmstroms commission of $250 20% = $50 as an expense.
Brief Exercise 524
GoodBuy should not recognize revenue when it sells the $1,000,000 of gift cards, because it
has not yet satisfied its performance obligation to deliver goods upon redemption of the cards.
GoodBuy should recognize revenue of $840,000 for redemptions, as well as $30,000 for gift
cards that it estimates will never be redeemed, totaling $
870,000.
Brief Exercise 525
Contract asset: $0.
Contract liability: $2,000.
Accounts receivable: $0.
Holt has a contract liability, deferred revenue, of $
2,000. It never has a contract asset because
it hasnt satisfied a performance obligation for which payment depends on something other than
the passage of time. It does not have an accounts receivable for the $3,000 until it delivers the
furniture to Ramirez.

Brief Exercise 526


For long-term contracts, we view a company as having a contract asset if CIP > Billings, so
Cady has a contract asset for the first construction job of $6,000 ($20,000 CIP less $14,000
billings). For long-term contracts, we view a company as having a contract liability if Billings >
CIP, so Cady has a contract liability for the second construction job of $2,000 ($5,000 billings
less $3,000 CIP).
Brief Exercise 527
Total estimated cost to complete = $6 million + 9 million = $15 million
% of completion = $6 million $15 million = 40%
First year revenue = $20,000,000 x 40% = $8,000,000
First year gross profit = $8,000,000 $6,000,000 = $
2,000,000
Note: We can also determine first year gross profit as follows:
Total estimated gross profit ($20 million 15 million) =
$5,000,000
multiplied by the % of completion
40%
Gross profit recognized the first year $2,000,000
Brief Exercise 528
Assets:
Accounts receivable ($7 million 5 million) $2,000,000
Cost plus profit ($6 million + 2 million*)
in excess of billings ($7 million) 1,000,000
* First year gross profit = $8,000,000 6,000,000 = $2,000,000

Brief Exercise 529


No revenue or gross profit recognized until project completed in year 2.
Year 2 revenue
$20,000,000
Less: Costs in year 1
(6,000,000)
Costs in year 2 (10,000,000)
Year 2 gross profit
$ 4,000,000
Brief Exercise 530
The anticipated loss of $3 million ($30 million contract price less total estimated costs of $33
million) must be recognized in the first year applying either method.

Brief Exercise 531


Receivables turnover ratio =
Net sales
Average accounts receivable (net)
Receivables turnover ratio =
$600,000
[$100,000 + 120,000] 2
=

5.45 times

Inventory turnover ratio


=
Average inventory

Cost of goods sold

Inventory turnover ratio


=
$400,000*
[$80,000 + 60,000] 2
=

5.71 times

*$600,000 200,000
Brief Exercise 532
Profit margin =
Sales
=

Net income

$65,000
$420,000

=
15.48%
Return on assets
=
Net income
Average total assets
=

equity

$65,000
$800,000

=
8.13%
Return on shareholders
=
Net income
Average shareholders equity
=

$65,000

$522,500*
=

12.44%

Shareholders equity, beginning of period $500,000


Add: Net income
65,000
Deduct: Dividends (20,000)
Shareholders equity, end of period $545,000
*Average shareholders equity = ($500,000 + 545,000) 2 = $522,500

Brief Exercise 533


Return on
equity

Net income
Avg. total equity

Profit margin

Net
income
Total sales

Return on shareholders
equity
=

Asset
turnover

Total sales
Avg. total
assets

$65,000
$522,500

12.44%
Net income
Sales

=
Asset turnover=

Equity multiplier

Avg. total
assets
Avg. total equity

Net income
Average shareholders equity

Profit margin =

$65,000
$420,000
15.48%
Sales
Average total assets

Equity multiplier

$420,000
$800,000

=
=

0.525 times
Average total assets
Average shareholders equity

$800,000
$522,500
=

1.53

Check: ROE = 15.48% profit margin 0.525 times asset turnover 1.53 equity multiplier =
12.43 (difference due to rounding)
Brief Exercise 534
Inventory turnover ratio = Cost of goods sold Average inventory
6.0
=
x
$75,000
Cost of goods sold
Sales
$600,000

= $75,000 6.0 = $450,000

Cost of goods sold = Gross profit

450,000
= $150,000

Appendix BRIEF exercises


Brief Exercise 535
2016 Gross profit = $3,000,000 $1,200,000 = $1,800,000
2016 Gross profit percentage = Gross profit Sales:
$1,800,000
= 60%
$3,000,000
2016 gross profit = 2016 cash collection of $150,000 x 60% = $
90,000
2017 gross profit = 2017 cash collection of $150,000 x 60% = $
90,000
Brief Exercise 536
Initial deferred gross profit ($3,000,000 1,200,000)
Less gross profit recognized in 2016 ($150,000 x 60%)

$1,800,000
(90,000)

Less gross profit recognized in 2017 ($150,000 x 60%)


Deferred gross profit at the end of 2017
$1,620,000

(90,000)

Brief Exercise 537


No gross profit will be recognized in either 2016 or 2017. Gross profit will not be recognized until
the entire $1,200,000 cost of the land is recovered. In this case, it will take eight payments to
recover the cost of the land ($1,200,000 $150,000 = 8), so gross profit recognition will equal
100% of the cash collected beginning with the ninth installment payment.

Brief Exercise 538


Year 1:
Revenue:
Cost:
Gross profit:
Year 2:
Revenue:
Cost:
Gross profit:

$6 million
6 million
$0

$14 million ($20 million total 6 million in year 1)


10 million
$ 4 million

Brief Exercise 539


Orange has separate sales prices for the two parts of LearnIt-Plus, so that vendor-specific
objective evidence (VSOE) allows them to allocate revenue to those parts according to their
relative selling prices. LearnIt will be allocated $200 x [$150 ($150 + 100)] = $120, and that
revenue will be recognized upon delivery of the LearnIt software. LearnIt Office Hours will be
allocated $200 x [$100 ($150 + 100)] = $80, and that revenue will be deferred and recognized
over the life of the one-year period in which the Office Hours are delivered.
If LearnIt were not sold separately, Orange would not have VSOE for all of the parts of the
contract. In that case, revenue would be delayed until the later part was delivered. In this case,
the $200 would be deferred and recognized over the life of the one-year period in which the
Office Hours are delivered.
Brief Exercise 540
Orange has separate sales prices for the two parts of LearnIt-Plus, so the company can base its
estimates of the fair value of those parts according to their relative selling prices. LearnIt will be
allocated $200 x [$150 ($150 + 100)] = $120, and that revenue will be recognized upon
delivery of the LearnIt software. LearnIt Office Hours will be allocated $200 x [$100 ($150 +
100)] = $80, and that revenue will be deferred and recognized over the life of the one-year
period in which the Office Hours are delivered.

If LearnIt were not sold separately, the accounting would be the same. Orange would estimate
the fair value of LearnIt Office Hours to be $100 and allocate revenue in the same fashion as it
did when that product was sold separately. (VSOE is not required under IFRS).
Brief Exercise 541
Specific conditions for revenue recognition of the initial franchise fee are provided by FASB ASC
952605251. A key to these conditions is the concept of substantial performance. It 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 recognized as revenue. The term
substantial requires professional judgment on the part of the accountant. Often, substantial
performance is considered to have occurred when the franchise opens for business.
Continuing franchise fees are recognized over time as the services are performed.
exercises
Exercise 51
The FASB Accounting Standards Codification represents the single source of authoritative U.S.
generally accepted accounting principles.
Requirement 1
Regarding the five steps used to apply the revenue recognition principle, the appropriate citation
is:
FASB ASC 60610054: Revenue from Contracts with CustomersOverallOverview and
BackgroundGeneral.
Requirement 2
Regarding indicators that control has passed from the seller to the buyer, such that it is
appropriate to recognize revenue at a point in time, the appropriate citation is:
FASB ASC 606102530: Revenue from Contracts with
CustomersOverallRecognitionPerformance Obligations Satisfied at a Point in Time.
Requirement 3
Regarding circumstances under which sellers can recognize revenue over time, the appropriate
citation is:
FASB ASC 606102527: Revenue from Contracts with
CustomersOverallRecognitionPerformance Obligations Satisfied Over Time.
Exercise 52
Requirement 1
Ski West should recognize revenue over the ski season. Ski West fulfills its performance
obligation over time as it delivers the service to its pass holders by providing access to its ski
lifts.

Requirement 2
November 6, 2016 To record the cash collection.
Cash
450
Deferred revenue
450

December 31, 2016 To recognize revenue earned in December (no revenue earned in
November, as season starts on December 1).
Deferred revenue ($450 x 1 /5)
90
Service revenue
90
equirement 3
R
$90 is included in revenue in Ski Wests 2016 income statement. The $360 remaining balance
in deferred revenue is included in the current liability section of Ski Wests 2016 balance sheet.
Exercise 53
VP first must identify each performance obligations share of the sum of the stand-alone selling
prices of all performance obligations:
TV:

$1,700

= 85%

$1,700 + 100 +
200
Remote:

$100

= 5%

$1,700 + 100 +
200
Installation:

$200

= 10%

$1,700 + 100 +
200
100%
VP would allocate the total selling price of the package ($1,900) based on stand-alone selling
prices, as follows:
TV:

$1,90
0

85
%

$1,61
5

Remote:

$1,90

5%

95

0
Installation:

$1,90
0

10
%

190
$1,90
0

$1,900
Transaction Price
$1,900
Transaction Price

85%
85%
10%
10%
5%
5%

$95
Remote
$95
Remote
$1,615
TV
$1,615
TV
$190
Installation
$190
Installation

Exercise 54
The FASB Accounting Standards Codification represents the single source of authoritative U.S.
generally accepted accounting principles.
Requirement 1

Regarding the basis upon which a contracts transaction price allocated to its performance
obligations, the appropriate citation is:
FASB ASC 606103229: Revenue from Contracts with
CustomersOverallMeasurementAllocating the Transaction Price to Performance
Obligations.
Requirement 2
Regarding indicators that a promised good or service is separately identifiable, the appropriate
citation is:
FASB ASC 606102521: Revenue from Contracts with
CustomersOverallRecognitionIdentifying Performance ObligationsDistinct Goods or
Services.
Requirement 3
Regarding circumstances under which an option is viewed as a performance obligation, the
appropriate citation is:
FASB ASC 606105542: Revenue from Contracts with CustomersOverallImplementation
Guidance and IllustrationsCustomer Options for Additional Goods or Services.
Exercise 5-5
Requirement 1
Number of performance obligations in the contract: 2
.
Delivery of gold is one performance obligation. The additional insurance is a second
performance obligation. The insurance service is capable of being distinct because the bank
could choose to receive similar services from another insurance provider, and it is separately
identifiable, as it is not highly interrelated with the other performance obligation of delivering
gold, and the sellers role is not to integrate and customize them to create one service or
product. So, the insurance qualifies as a performance obligation. The receipt of cash prior to
delivery is not a performance obligation, but rather gives rise to deferred revenue associated
with performance obligations to be satisfied in the future.
Requirement 2
Value of the gold bars:
$1,440/unit 100 units =
$ 144,000
Stand-alone selling price of the insurance:
$60 100 units =
6,000
Total of stand-alone prices $150,000
Gold Examiner first identifies each performance obligations share of the sum of the stand-alone
selling prices of all deliverables:
Gold bars:

$144,000
$144,000 +

= 96%

6,000
Insurance:

$6,000

= 4%

$144,000 +
6,000
100%
Exercise 5-5 (concluded)
Gold Examiner then allocates the total selling price based on stand-alone selling prices, as
follows:
$147,000
Transaction Price
$147,000
Transaction Price

96%
96%
4%
4%

$5,880
Insurance
$5,880
Insurance
$141,120
Gold
$141,120
Gold

Entry on March 1, 2016:

Cash
Deferred revenuegold bars

147,00
0
141,12

0
Deferred
revenueinsurance

5,880

Requirement 3
Entry on March 30, 2016:
Deferred revenuegold
bars

141,120

Sales revenue

141,120

Gold Examiner recognizes only the portion of revenue associated with passing of the legal title.
The revenue associated with insurance coverage will be earned only when that performance
obligation is satisfied.
Requirement 4
Entry on April 1, 2016:
Deferred
revenueinsurance
Service revenue

5,88
0
5,88
0

Exercise 56
Requirement 1
Number of performance obligations in the contract: 2
.
The delivery of SunBoots is one performance obligation. The discount coupon for additional
future purchases is a second performance obligation because it provides a material right to the
customer that the customer would not receive otherwise. That right to receive a discount is both
capable of being distinct, as it could be could be sold or provided separately, and it is s eparately
identifiable, as it is not highly interrelated with the other performance obligation of delivering
SunBoots, and the sellers role is not to integrate and customize them to create one product.
So, the discount coupon is distinct and qualifies as a performance obligation.
Requirement 2
If Clarks cant estimate the stand-alone selling price of SunBoots, it will use the residual method
to calculate that price as the amount of the total transaction price minus the value of the
discount.

Cash (1,000 x $70)


Sales revenue (to balance)
Deferred revenue (discount option)

70,000
64,000
6,000*

*(1,000 pairs $100 average purchase price 30% discount 20% of customers estimated to
redeem coupon)

Exercise 57
Requirement 1
The amount of revenue Manhattan Today should recognize upon receipt of the subscription fee:
$0.
Even though Manhattan Today received payments from customers for an annual subscription,
payment of 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 recognized as deferred revenue subscription (a liability) when received. Later, when
newspapers are delivered, deferred revenue subscription will be reduced and revenue
recognized.
Requirement 2
Number of performance obligations in the contract: 2
.
Delivering newspapers is one performance obligation. The coupon for a 40% discount on a
carriage ride qualifies as a second performance obligation. First, it is an option that conveys a
material right to the recipient (as opposed to just a general marketing offer). Second, it is both
capable of being distinct, as it could be sold or provided separately, and it is s eparately
identifiable, as it is not highly interrelated with the other performance obligation of delivering
newspapers, so it is distinct and qualifies as a performance obligation. The sellers role is not to
integrate and customize them to create one product. The seller will record deferred revenue
coupon for that performance obligation and recognize revenue when either the coupons are
exercised or Manhattan Today estimates that they will not be redeemed.
Exercise 57 (concluded)
Requirement 3
Value of the coupon: 40% discount $125 carriage fee =
$ 50
Estimated redemption 30%
Stand-alone selling price of coupon $ 15
Stand-alone selling price of a normal subscription
135
Total of stand-alone prices $150
Manhattan Today must identify each performance obligations share of the sum of the
stand-alone selling prices of all deliverables:
Coupon:

$15

= 10%

$15 +
135
Subscription:

$135

= 90%

$15 +
135
100%
Manhattan Today allocates the total selling price based on stand-alone selling prices, as
follows:
$130
Transaction Price
$130
Transaction Price

90%
90%
10%
10%

$13
Coupon
$13
Coupon
$117
Subscription
$117
Subscription

Upon receiving the fee for 10 subscriptions, the journal entry should be:
Cash ($130 10)
Deferred revenue subscription ($117 10)
Deferred revenue coupon ($13 10)

1,300
130

Exercise 5-8
Requirement 1
Number of performance obligations in the contract: 2
.

1,170

Delivery of keyboards is one performance obligation. The special discount coupon is a second
performance obligation, as it provides a material right that the customer would not receive
otherwise. In this particular instance, the customer has the right to receive a 25% discount,
which is a 20% discount in addition to the normal 5% discount offered to other customers. The
coupon is both capable of being distinct, as it could be sold or provided separately, and it is
separately identifiable, as it is not highly interrelated with the other performance obligation of
delivering keyboards, and the sellers role is not to integrate and customize them to create one
product. So, it is distinct and qualifies as a performance obligation.
Requirement 2
When two or more performance obligations are associated with a single transaction price, the
transaction price must be allocated to the performance obligations on the basis of respective
stand-alone selling prices (estimated if not directly available).
Metas estimated stand-alone selling price of the discount option is:
Value of the discount:
(25% discount 5% normal discount) $20,000 = $ 4,000
Estimated redemption 50%
Stand-alone selling price of discount:$ 2,000
Stand-alone selling price of the keyboards:
$19.6 5,000 keyboards =
98,000
Total of stand-alone prices $100,000
Meta first must identify each performance obligations share of the sum of the stand-alone
selling prices of all deliverables:
Discount:

$2,000

= 2%

$2,000 +
98,000
Keyboards:

$98,000

= 98%

$2,000 +
98,000
100%
Exercise 5-8 (concluded)
Meta then allocates the total selling price based on stand-alone selling prices, as follows:
$95,000
Transaction Price
$95,000
Transaction Price

98%
98%
2%
2%

$1,900
Discount
$1,900
Discount
$93,100
Keyboards
$93,100
Keyboards

The journal entry to record the sale is:

Cash

95,00
0
93,10
0

Deferred revenuekeyboards
Deferred revenuediscount
option

1,900

The deferred revenue for the keyboards will become earned June 1st.
The deferred revenue for the option to exercise the discount coupon is earned when the coupon
either is exercised or expires in six months.
Requirement 3
All customers are eligible for a 5% discount on all sales. Therefore, the 5% discount option
issued to Bionics, Inc. does not give any material right to the customer, so it is not a
performance obligation in the contract, and Meta would account for both (a) the delivery of
keyboards and (b) the 5% coupon as a single performance obligation.

Cash
Deferred
revenuekeyboards

95,00
0
95,00
0

Exercise 59
Requirement 1
The expected value would be calculated as follows:
Possible Amounts Probabilities Expected Amounts
$70,000 ($50,000 fixed fee + 20,000 bonus) 20% =
$14,000
$50,000 ($50,000 fixed fee + 0 bonus)
80% =
40,000
Expected contract price at inception
$54,000
Or, alternatively: $50,000 + ($20,000 20%) = $54,000
Requirement 2
The most likely amount is the flat fee of $50,000, because there is a greater chance of not
qualifying for the bonus than of qualifying for the bonus, so that is the transaction price.
Requirement 3
Because Thomas is very uncertain of its estimate, Thomas cant argue that it is probable that it
wont have to reverse (adjust downward) a significant amount of revenue in the future because
of a change in returns. Therefore, Thomas would not include the bonus estimate in the
transaction price, and the transaction price would be the flat fee of $50,000.
Exercise 5-10
Requirement 1
During the July 1 July 15 period, Rocky estimates a less than 50% chance it will earn the
bonus, so using the most likely amount approach, it assumes no bonus, and estimates its
revenue as $1,000 per day 10 days = $10,000
Accounts receivable

10,00
0

Service revenue ($1,000 10


days)

10,00
0

Requirement 2
During the July 16 July 31 period, Rocky earns guide revenue of another 15 days $1,000
per day = $15,000. In addition, because Rocky estimates a greater than 50% chance it will earn
the bonus, using the most likely amount approach, it estimates a bonus receivable of $100 per
day (10 days + 15 days) = $2,500.
Accounts receivable ($1,000 15
days)

15,00
0

2,500

Bonus receivable ($100 25 days)

17,50
0

Service revenue (to balance)

Requirement 3
On August 5, Rocky learns that it wont receive a bonus, and receives only the $25,000 balance
in accounts receivable. Rocky must reduce its bonus receivable to zero and record the
offsetting adjustment in revenue.
Cash ($1,000 25
days)

25,00
0

Accounts receivable

Service revenue ($100 25


days)

25,00
0

2,500

Bonus receivable

2,500

Exercise 5-11
Requirement 1
Rockys normal guide revenue is 10 days $1,000 per day = $10,000. Rocky also estimates
that there is a 30% chance it will earn the bonus, so its estimate of the expected value of the
bonus revenue earned to date is:
Possible Amounts Probabilities Expected Amounts
$1,000 ($100 bonus 10 days)
30% =
$300
$0 ($0 bonus 10 days)
70% =
-0Expected bonus as of July 15
$300
Or, alternatively: $100 10 days 30% = $300.
Rockys July 15 journal entry would be:
Accounts receivable ($1,000 10 days)

10,00

0
Bonus receivable ($100 30% 10
days)

300
10,30
0

Service revenue

Requirement 2
During the July 16 July 31 period, Rocky earns another 15 days $1,000/day = $15,000 of its
normal guiding revenue. In addition, because Rocky now believes there is an 80% chance it will
earn the bonus, its estimate of the expected value of the bonus revenue earned to date (based
on all 25 days guided during July) is:
Possible Amounts Probabilities Expected Amounts
$2,500 ($100 bonus 25 days)
80% =
$2,000
$0 ($0 bonus 25 days)
20% =
-0Expected bonus as of July 31
$2,000
Or, alternatively: $100 25 days 80% = $2,000.
Exercise 5-11 (concluded)
With $300 of bonus receivable and revenue already recognized, Rocky must recognize an
additional $2,000 $300 = $1,700 of bonus receivable and bonus revenue. Rockys July 31
journal entry would be:

Accounts receivable ($1,000 15 days)

15,00
0

Bonus receivable ([$100 80% 25 days]


$300)

1,700

Service revenue (to balance)

16,70
0

Requirement 3
On August 5, Rocky learns that it wont receive a bonus, and receives only the $25,000 balance
in accounts receivable. Rocky also must reduce its bonus receivable to zero and record the
offsetting adjustment in revenue.

Cash ($1,000 25)

25,00
0

Accounts
receivable

25,00
0

Service revenue ($100 80% 25


days)
Bonus receivable

2,000

2,000

Exercise 512
Requirement 1
Record revenue upon sale:
Accounts receivable
Sales revenue

150,000
150,000

Requirement 2
Because the advertising services have a fair value ($5,000) that is less than the amount paid by
Furtastic to Willett ($12,000), the remaining amount ($7,000) is viewed as a refund, reducing
revenue by that amount.
Advertising expense
Sales revenue
Cash

5,000
7,000
12,000

Requirement 3
Record receipt of cash:
Cash
Accounts receivable

150,000
150,000

Requirement 4
It is probable that Willett will pay by Furtastic, so the relatively low likelihood of bad debts does
not affect Furtastics recognition of revenue on the Willet sale. If Furtastic had considered it less
than probable that it would collect its receivable from Willet, it would not have a contract on June
1 for purposes of revenue recognition, and would not recognize revenue until payment actually
occurred on June 30.
Exercise 513
Requirement 1

Under the adjusted market assessment approach, VP would base its estimate of the
stand-alone selling price of the installation service on the prices charged by other vendors for
that service, adjusted as necessary. Given that the other vendors are similar to VP, no
adjustment is necessary. Therefore, VP would estimate the stand-alone selling price of the
installation service to be $150, the amount charged by competitors for that service.
Requirement 2
Under the expected cost plus margin approach, VP would base its estimate of the stand-alone
selling price of the installation service on the $100 cost it incurs to provide the service, plus its
normal margin of 40% $100 = $40. Therefore, VP would estimate the stand-alone selling
price of the installation service to be $100 + 40 = $
140.
Requirement 3
Under the residual approach, VP would base its estimate of the stand-alone selling price of the
installation service on the total selling price of the package ($1,900) less the observable
stand-alone selling prices of the TV ($1,750) and universal remote ($100). Therefore, VP would
estimate the stand-alone selling price of the installation service to be $1,900 ($1,750 + 100) =
$50.
Exercise 514
The FASB Accounting Standards Codification represents the single source of authoritative U.S.
generally accepted accounting principles.
Requirement 1
Regarding the alternative approaches that can be used to estimate variable consideration, the
appropriate citation is:
FASB ASC 60610328: Revenue from Contracts with
CustomersOverallMeasurementVariable Consideration.
Requirement 2
Regarding the alternative approaches that can be used to estimate the stand-alone selling price
of performance obligations that are not sold separately, the appropriate citation is:
FASB ASC 606103234: Revenue from Contracts with
CustomersOverallMeasurementAllocation Based on Standalone Selling Prices.
Requirement 3
Regarding the timing of revenue recognition with respect to licenses, the appropriate citation is:
FASB ASC 606105558-60: Revenue from Contracts with
CustomersOverallImplementation Guidance and IllustrationsDetermining the Nature of the
Entitys Promise.
Exercise 515
Requirement 1
Total amount of franchise agreement$ 600,000

Less: stand-alone selling price of training


(15,000)
Less: stand-alone selling price of building and equip.
Stand-alone selling price of five-year right
135,000

(450,000)

Requirement 2
As of July 1, 2016, Monitor has not fulfilled any of its performance obligations, so the entire
$600,000 franchise fee is recorded as deferred revenue.
Cash
Notes receivable
Deferred revenue

75,000
525,000
600,000

Requirement 3
On September 1, 2016, Monitor has satisfied its performance obligations with respect to training
and certifying Perkins and delivering an equipped Monitor Muffler building. Therefore, Monitor
should recognize revenue of $15,000 + 450,000 = $465,000 on that date. In addition, by
December 31, 2016, Monitor has earned 4 months of revenue (September December)
associated with the five-year right it granted to Perkins, so Monitor should recognize revenue of
$135,000 (4 (5 12)) = $9,000 associated with that right. Total revenue recognized for the
year ended December 31, 2016, is $465,000 + 9,000 = $
474,000.
Exercise 516
The FASB Accounting Standards Codification represents the single source of authoritative U.S.
generally accepted accounting principles.
Requirement 1
Regarding disclosures that are required with respect to performance obligations that the seller is
committed to satisfying but that are not yet satisfied, the appropriate citation is:
FASB ASC 606105012: Revenue from Contracts with
CustomersOverallDisclosurePerformance Obligations.
Requirement 2
Regarding disclosures that are required with respect to uncollectible accounts receivable, also
called impairment losses on receivables, the appropriate citation is:
FASB ASC 60610504b: Revenue from Contracts with
CustomersOverallDisclosureContracts with Customers.
Requirement 3
Regarding disclosures that are required with respect to contract assets and contract liabilities,
the appropriate citation is:
FASB ASC 606105010: Revenue from Contracts with
CustomersOverallDisclosureContract Balances.

Exercise 517
Requirement 1
2016 2017
Contract price $2,000,000
$2,000,000
Actual costs to date
300,000
1,875,000
Estimated costs to complete 1,200,000
Total estimated costs 1,500,000
1,875,000
Gross profit (estimated in 2016)
$ 500,000

-0$ 125,000

Revenue recognition:
2016: $ 300,000
= 20% $2,000,000 = $400,000
$1,500,000
2017: $2,000,000 400,000 = $1,600,000
Gross profit recognition:
2016: $400,000 300,000 = $100,000
2017: $1,600,000 1,575,000 = $25,000
Note: We also can calculate gross profit directly using the percentage of completion:
2016: $ 300,000
= 20% $500,000 = $100,000
$1,500,000
2017: $125,000 100,000 = $25,000
Requirement 2
2016: $0 (contract not yet completed)
2017: $2,000,000 1,875,000 = $125,000
Exercise 517 (concluded)
Requirement 3

Balance Sheet
At December 31, 2016
Current assets:
Accounts receivable

$
130,000

Costs and profit ($400,000*) in


excess
of billings ($380,000)

20,000

* Costs ($300,000) + profit ($100,000)


Requirement 4

Balance Sheet
At December 31, 2016
Current assets:
Accounts receivable

$
130,000

Current liabilities:
Billings ($380,000) in excess of costs
($300,000)

Exercise 518
Requirement 1
($ in millions) 2016 2017 2018
Contract price $220 $220 $220
Actual costs to date 40
120
170
Estimated costs to complete 120
60
Total estimated costs 160 180
170
Estimated gross profit (actual in 2018)

$ 80,000

-0$ 60

$ 40

$ 50

Revenue recognition:
2016: $40
$160

= 25% $220 = $55

2017: $120
$180
2018:

= (66.67% $220) $55 = $91.67

$220 ($55 + $91.67) = $73.33


Gross profit (loss) recognition:
2016: $55 40 = $15
2017: $91.67 80 = $11.67
2018: $73.33 50 = $23.33

Note: We also can calculate gross profit directly using the percentage of completion:
2016: $40
$160

= 25% $60 = $15

2017: $120
$180
2018:

= 66.67% $40 = $26.67 15 = $11.67

$220 170 = $50 (15 + 11.67) = $


23.33

Exercise 518 (concluded)


Requirement 2
Yea
r

Revenue
recognized

Gross profit (loss)


recognized

201
6

-0-

-0-

201
7

-0-

-0-

201
8

$220

$50

Requirement 3
2017 Revenue recognition:
$120
$200

= (60% $220) $55 = $77

2017 Gross profit (loss) recognition:


$77 80 = $(3)
Note: Also can calculate gross profit directly using the percentage of completion:
$120
$200

= 60% $20* = $12 15 = $(3) loss

*$220 ($40 + 80 + 80) = $20

Exercise 519
Requirement 1
2016 2017 2018
Contract price $8,000,000
$8,000,000
$8,000,000
Actual costs to date 2,000,000
4,500,000
8,300,000
Estimated costs to complete 4,000,000
3,600,000
-0Total estimated costs 6,000,000
8,100,000
8,300,000
Estimated gross profit (loss)
(actual in 2018)
$2,000,000
$ (100,000) $ (300,000)
Revenue recognition:
2016: $2,000,000
= 33.3333% $8,000,000 = $
2,666,667

$6,000,000
2017: $4,500,000
= (55.5556% $8,000,000) $2,666,667 = $
1,777,778
$8,100,000
2018: $8,000,000 ($2,666,667 + 1,777,778) = $
3,555,555
Gross profit (loss) recognition:
2016: $2,666,667 2,000,000 = $666,667
2017: $(100,000) 666,667 = $(766,667)
2018: $(300,000) (100,000) = $(200,000)
Exercise 519 (continued)
Requirement 2

Construction in progress

Various accounts

2016

2017

2,000,00
0

2,500,00
0

2,000,00
0

2,500,00
0

2,500,00
0

2,750,00
0

2,500,00
0

2,750,00
0

2,250,00
0

2,475,00
0

To record construction costs

Accounts receivable

Billings on construction contract


To record progress billings

Cash

Accounts receivable

2,250,00
0

2,475,00
0

To record cash collections

Construction in progress

666,667

Cost of construction

2,000,00
0

Revenue from long-term


contracts

2,666,66
7

To record gross profit

Cost of construction (1)

2,544,44
5

Revenue from long-term


contracts

1,777,77
8

Construction in progress

766,667

To record expected loss

(1)

Revenue recognized in 2017 $1,777,778


Plus: Loss recognized in 2017 (prior page)
Cost of construction, 2017 $2,544,445
Requirement 3
Balance Sheet

766,667

2016

2017

$250,00
0

$525,00
0

Current assets:
Accounts receivable
Costs and profit ($2,666,667*) in

excess of billings ($2,500,000)

166,667

Current liabilities:
Billings ($5,250,000) in excess
of costs less loss
($4,400,000**)

$850,00
0

* Costs ($2,000,000) + profit ($666,667)


** Costs ($2,000,000 + 2,500,000) loss ($100,000 = $766,667 666,667)
Exercise 520
Requirement 1
Year

Revenue
recognized

Gross profit (loss)


recognized

2016

-0-

-0-

2017

-0-

$(100,000)

2018

$8,000,000

(200,000)

Total

$8,000,000

$(300,000)

Requirement 2

Construction in progress

Various accounts

2016

2017

2,000,00
0

2,500,000

2,000,00
0

2,500,000

2,500,00

2,750,000

To record construction
costs

Accounts receivable

0
Billings

2,500,00
0

2,750,000

2,250,00
0

2,475,000

2,250,00
0

2,475,000

To record progress billings

Cash

Accounts receivable
To record cash collections

Loss on long-term contract


Construction in progress

100,000

100,000

To record expected loss

Exercise 520 (concluded)


Requirement 3

Balance Sheet

2016

2017

$250,00
0

$525,00
0

Current assets:
Accounts receivable

Current liabilities:
Billings ($2,500,000) in excess of costs
($2,000,000)

$500,00
0

Billings ($5,250,000) in excess of costs less


loss ($4,400,000*)

$850,00
0

* Costs ($2,000,000 + 2,500,000) loss ($100,000)


Note: Billings in excess of costs is a contract liability, similar to deferred profit.

Exercise 521
SUMMARY
Revenue Recognized
Over Time

Revenue Recognized Upon Completion

Situatio
n

2016

2017

2018

2016

2017

2018

$166,667

$233,333

$100,000

$0

$0

$500,000

$166,667

$(66,667) $100,000

$0

$0

$200,000

$166,667

$(266,66
7)

$(100,00
0)

$0

$(100,00
0)

$(100,00
0)

$125,000

$375,000

$0

$0

$0

$500,000

$125,000

$(125,00
0)

$200,000

$0

$0

$200,000

$(100,000)

$(100,00
0)

$(100,00
0)

$(100,00
0)

$(100,00
0)

$(100,00
0)

Situation 1 - Revenue Recognized Over Time


2016 2017 2018
Contract price $5,000,000
$5,000,000
$5,000,000
Actual costs to date 1,500,000
3,600,000
4,500,000
Estimated costs to complete 3,000,000
900,000
-0-

Total estimated costs 4,500,000


Estimated gross profit
(actual in 2018)
$ 500,000

4,500,000

4,500,000

$ 500,000

$ 500,000

Gross profit (loss) recognized:


2016:
Revenue =

$1,500,000
= 33.3333% $5,000,000 = $1,666,667
$4,500,000

Gross Profit = 1,666,667 1,500,000 = $166,667


Note: We can calculate gross profit directly as
$1,500,000
= 33.3333% $500,000 = $
166,667
$4,500,000
2017:
Revenue =

$3,600,000
= 80.0% $5,000,000 = $4,000,000 1,666,667
$4,500,000
= $2,333,333

Gross Profit = 2,333,333 2,100,000 = $233,333


Exercise 521 (continued)
Note: We can calculate gross profit directly as:
$3,600,000
= 80.0% $500,000 = $400,000 166,667 = $233,333
$4,500,000
2018:
Revenue = $5,000,000 4,000,000 = $1,000,000
Gross Profit = $1,000,000 900,000 = $100,000
Situation 1 - Revenue Recognized Upon Completion

Year

Gross profit
recognized

2016

-0-

2017

-0-

2018

$500,000

Total gross
profit

$500,000

Situation 2 - Revenue Recognized Over Time


2016 2017 2018
Contract price $5,000,000
$5,000,000
$5,000,000
Actual costs to date 1,500,000
2,400,000
4,800,000
Estimated costs to complete 3,000,000
2,400,000
-0Total estimated costs 4,500,000
4,800,000
4,800,000
Estimated gross profit
(actual in 2018)
$ 500,000
$ 200,000
$ 200,000

Exercise 521 (continued)


Gross profit (loss) recognized:
2016:
Revenue =

$1,500,000
= 33.3333% $5,000,000 = $1,666,667
$4,500,000

Gross Profit = $1,666,667 1,500,000 = $166,667


Note: We can calculate gross profit directly as
$1,500,000
= 33.3333% $500,000 = $
166,667
$4,500,000

2017:
Revenue =

$2,400,000
= 50.0% $5,000,000 = $2,500,000 1,666,667
$4,800,000
= $833,333

Gross Profit = 833,333 900,000 = $(66,667)


Note: We can calculate gross profit directly as:
$2,400,000
= 50.0% $200,000 = $100,000 166,667 = $(66,667)
$4,800,000
2018:
Revenue = $5,000,000 $2,500,000 = $2,500,000
Gross Profit = $2,500,000 $2,400,000 = $100,000
Situation 2 - Revenue Recognized Upon Completion

Year

Gross profit
recognized

2016

-0-

2017

-0-

2018

$200,000

Total gross profit

$200,000

Exercise 521
(continued)
Situation 3 - Revenue Recognized Over Time
2016 2017 2018
Contract price $5,000,000

$5,000,000

$5,000,000

Actual costs to date 1,500,000


3,600,000
5,200,000
Estimated costs to complete 3,000,000
1,500,000
-0Total estimated costs 4,500,000
5,100,000
5,200,000
Estimated gross profit (loss)
(actual in 2018)
$ 500,000
$ (100,000) $ (200,000)
Gross profit (loss) recognized:

2016:
Revenue =

$1,500,000
= 33.3333% $5,000,000 = $1,666,667
$4,500,000

Gross Profit = $1,666,667 1,500,000 = $166,667


Note: can calculate gross profit directly as
$1,500,000
= 33.3333% $500,000 = $
166,667
$4,500,000

2017:
Overall loss of $5,000,000 5,100,000 = $(100,000)
Gross profit = $(100,000) 166,667 = $(266,667)

2018:
Overall loss of $5,000,000 5,200,000 = $(200,000)
Gross profit = $(200,000) (100,000) = $(100,000)

Exercise 521 (continued)


Situation 3 - Revenue Recognized Upon Completion

Year

Gross profit (loss)


recognized

2016

-0-

2017

$(100,000)

2018

(100,000)

Total project
loss

$(200,000)

Situation 4 - Revenue Recognized Over Time


2016 2017 2018
Contract price $5,000,000
$5,000,000
$5,000,000
Actual costs to date
500,000
3,500,000
4,500,000
Estimated costs to complete 3,500,000
875,000
-0Total estimated costs 4,000,000
4,375,000
4,500,000
Estimated gross profit
(actual in 2018)
$1,000,000
$ 625,000
$ 500,000
Gross profit (loss) recognized:
2016:
Revenue =

$ 500,000
= 12.5% $5,000,000 = $625,000
$4,000,000

Gross Profit = $625,000 500,000 = $125,000


Note: can calculate gross profit directly as
$500,000
= 12.5% $1,000,000 = $125,000
$4,000,000

Exercise 521 (continued)

2017:
Revenue =

$3,500,000
= 80% $5,000,000 = $4,000,000 625,000
$4,375,000
= $3,375,000

Gross Profit = $3,375,000 3,000,000 = $375,000


Note: can calculate gross profit directly as
$3,500,000
= 80.0% $625,000 = $500,000 125,000 = $
375,000
$4,375,000
2018:
Revenue = $5,000,000 4,000,000 = $1,000,000
Gross Profit = $1,000,000 1,000,000 = $ - 0
Situation 4 - Revenue Recognized Upon Completion

Year

Gross profit
recognized

2016

-0-

2017

-0-

2018

$500,000

Total gross
profit

$500,000

Situation 5 - Revenue Recognized Over Time


2016 2017 2018
Contract price $5,000,000
$5,000,000
$5,000,000
Actual costs to date
500,000
3,500,000
4,800,000

Estimated costs to complete 3,500,000


1,500,000
-0Total estimated costs 4,000,000
5,000,000
4,800,000
Estimated gross profit
(actual in 2018)
$1,000,000
$
- 0 - $ 200,000
Exercise 521 (continued)
Gross profit (loss) recognized:
2016:
Revenue =

$ 500,000
= 12.5% $5,000,000 = $625,000
$4,000,000

Gross Profit = $625,000 500,000 = $125,000


Note: can calculate gross profit directly as
$500,000
= 12.5% $1,000,000 = $125,000
$4,000,000
2017:

$0 125,000 = $(125,000)

2018: $200,000 0 = $200,000


Situation 5 - Revenue Recognized Upon Completion

Year

Gross profit
recognized

2016

-0-

2017

-0-

2018

$200,000

Total gross
profit

$200,000

Exercise 521 (concluded)


Situation 6 - Revenue Recognized Over Time
2016 2017 2018
Contract price $5,000,000
$5,000,000
$5,000,000
Actual costs to date
500,000
3,500,000
5,300,000
Estimated costs to complete 4,600,000
1,700,000
-0Total estimated costs 5,100,000
5,200,000
5,300,000
Estimated gross profit (loss)
(actual in 2018)
$ (100,000) $ (200,000) $ (300,000)
Gross profit (loss) recognized:
2016: $(100,000)
2017: $(200,000) (100,000) = $(100,000)
2018: $(300,000) (200,000) = $(100,000)
Situation 6 - Revenue Recognized Upon Completion

Year

Gross profit (loss)


recognized

2016

$(100,000)

2017

(100,000)

2018

(100,000)

Total project
loss

$(300,000)

Exercise 522
Requirement 1
Construction in progress = Costs incurred + Profit recognized
$100,000

$20,000

Actual costs incurred in 2016 = $80,000

Requirement 2
Billings = Cash collections + Accounts receivable
$94,000 =

30,000

Cash collections in 2016 = $64,000


Requirement 3
Let A = Actual cost incurred + Estimated cost to complete
Actual cost incurred
(Contract price A) = Profit recognized
A
$80,000
($1,600,000 A) = $20,000
A
$128,000,000,000 80,000A = $20,000A
$100,000A = $128,000,000,000
A = $1,280,000
Estimated cost to complete = $1,280,000 80,000 = $1,200,000
Exercise 522 (concluded)
Requirement 4
$80,000
= 6.25%
$1,280,000

Alternatively, Requirement 4 can be answered as follows:


Contract price $1,600,000
Less: Total estimated cost
1,280,000
Estimated gross profit $ 320,000

Proportion of gross profit recognized to date:


$20,000

= 6.25%
$320,000
Exercise 523
Requirement 1
Inventory turnover ratio
=
Average inventory

Cost of goods sold

$1,840,000
[$690,000 + 630,000] 2

2.79 times

Requirement 2
By itself, this one ratio provides very little information. In general, the higher the inventory
turnover, the lower the investment must be for a given level of sales. It indicates how well
inventory levels are managed and the quality of inventory, including the existence of obsolete or
overpriced inventory.
However, 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.
Its just one piece in the puzzle, though. Other points of reference should be considered. For
instance, a high turnover can be achieved by maintaining too low inventory levels and
restocking only when absolutely necessary. This can be costly in terms of stockout 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 524
Turnover ratios for Anderson Medical Supply Company for 2016:
Inventory turnover ratio
=
$4,800,000
[$900,000 + 700,000] 2
=

6 times

Receivables turnover ratio =


$8,000,000
[$700,000 + 500,000] 2
=

13.33 times

Average collection period

365

13.33
=
Asset turnover ratio

27.4 days
=
$8,000,000
[$4,300,000 + 3,700,000] 2
2 times

The company turns its inventory over 6 times per year compared to the industry average of 5
times per year. The asset turnover ratio also is slightly better than the industry average (2 times
per year versus 1.8 times). These ratios indicate that Anderson is able to generate more sales
per dollar invested in inventory and in total assets than the industry averages. However,
Anderson takes slightly longer to collect its accounts receivable (27.4 days compared to the
industry average of 25 days).

Exercise 525
Requirement 1
a.
Profit margin on sales
$180 $5,200 = 3.5%
b.
Return on assets
$180 [($1,900 + 1,700) 2] = 10%
c.
Return on shareholders equity
$180 [($550 + 500) 2] = 34.3%
Requirement 2
Retained earnings beginning of period
Add: Net income
180,000
280,000
Less: Retained earnings end of period
Dividends paid
$130,000

$100,000

150,000

Exercise 526
Requirement 1
a.
Profit margin on sales
$180 $5,200 = 3.46%
b.
Asset turnover
$5,200 [($1,900 + 1,700) 2] = 2.89
c. Equity multiplier [($1,900 + 1,700) 2] [($550 + 500) 2] = 3.43
d.
Return on shareholders equity
$180 [($550 + 500) 2] = 34.3%
Requirement 2

Profit margin Asset turnover Equity multiplier = ROE


3.46% 2.89 3.43
= 34.3%
Appendix exercises
Exercise 527
Requirement 1
2016 cost recovery %:
$234,000
= 65% (gross profit % = 35%)
$360,000
2017 cost recovery %:
$245,000
= 70% (gross profit % = 30%)
$350,000
2016 gross profit:
Cash collection from 2016 sales of $150,000 x 35% =

$52,500

2017 gross profit:


Cash collection from 2016 sales of $100,000 x 35% =
$35,000
+ Cash collection from 2017 sales of $120,000 x 30% =
36,000
Total 2017 gross profit
$71,000
Exercise 527 (concluded)
Requirement 2
2016 deferred gross profit balance:
2016 initial gross profit ($360,000 234,000)
$126,000
Less: Gross profit recognized in 2016
(52,500)
Balance in deferred gross profit account
$ 73,500
2017 deferred gross profit balance:
2016 initial gross profit ($360,000 234,000)
$126,000
Less: Gross profit recognized in 2016
(52,500)
Gross profit recognized in 2017
(35,000)
2017 initial gross profit ($350,000 245,000)
105,000
Less: Gross profit recognized in 2017
(36,000)
Balance in deferred gross profit account
$107,500
Exercise 528
2016

Installment receivables
Inventory
Deferred gross profit
To record installment sales

360,000
234,000
126,000

2016
Cash

150,000
Installment receivables
150,000
To record cash collections from installment sales
2016
Deferred gross profit
52,500
Realized gross profit
52,500
To recognize gross profit from installment sales
2017
Installment receivables
Inventory
Deferred gross profit
To record installment sales

350,000
245,000
105,000

2017
Cash

220,000
Installment receivables
220,000
To record cash collections from installment sales
2017
Deferred gross profit
71,000
Realized gross profit
71,000
To recognize gross profit from installment sales
Exercise 529
Requirement 1
Year Income recognized
2016 $180,000 ($300,000 120,000)
2017 - 0 2018 - 0 2019
-0Total $180,000
Requirement 2
Cost recovery %:
$120,000
------------- = 40% (gross profit % = 60%)

$300,000

Year

Cash
Collected

Cost
Recovery(40%)

Gross Profit(60%)

2016

$ 75,000

$ 30,000

$ 45,000

2017

75,000

30,000

45,000

2018

75,000

30,000

45,000

2019

75,000

30,000

45,000

$300,000

$120,000

$180,000

Totals

Requirement 3

Year

Cash
Collected

Cost
Recovery

2016

$ 75,000

$ 75,000

2017

75,000

45,000

2018

75,000

-0-

75,000

2019

75,000

-0-

75,000

$300,000

$120,000

$180,000

Totals

Exercise 530
Requirement 1
July 1, 2016
Installment receivables
Sales revenue
To record installment sale

300,000
300,000

Gross
Profit
-0$ 30,000

Cost of goods sold


120,000
Inventory
120,000
To record cost of installment sale
Cash

75,000
Installment receivables
75,000
To record cash collection from installment sale
July 1, 2017
Cash
75,000
Installment receivables
75,000
To record cash collection from installment sale
Exercise 530 (continued)
Requirement 2
July 1, 2016
Installment receivables
Inventory
Deferred gross profit
To record installment sale

300,000
120,000
180,000

Cash

75,000
Installment receivables
75,000
To record cash collection from installment sale
Deferred gross profit
45,000
Realized gross profit
45,000
To recognize gross profit from installment sale
July 1, 2017
Cash
75,000
Installment receivables
75,000
To record cash collection from installment sale
Deferred gross profit
45,000
Realized gross profit
45,000
To recognize gross profit from installment sale
Exercise 530 (concluded)
Requirement 3
July 1, 2016
Installment receivables
Inventory

300,000
120,000

Deferred gross profit


To record installment sale

180,000

Cash

75,000
Installment receivables
75,000
To record cash collection from installment sale
July 1, 2017
Cash
75,000
Installment receivables
75,000
To record cash collection from installment sale
Deferred gross profit
30,000
Realized gross profit
30,000
To recognize gross profit from installment sale
Exercise 531
Requirement 1
Cost of goods sold ($1,000,000 600,000) $400,000
Add: Gross profit if using cost recovery method
100,000
Cash collected
$500,000
Requirement 2
Gross profit percentage = $600,000 $1,000,000 = 60%

Cash collected Gross profit percentage = Gross profit recognized


$500,000 60% = $300,000 gross profit
Exercise 532
October 1, 2016
Installment receivable
4,000,000
Inventory
1,800,000
Deferred gross profit
2,200,000
To record the installment sale
Cash

800,000
Installment receivable
800,000
To record the cash down payment from installment sale
Deferred gross profit ($800,000 x 55%*)
440,000
Realized gross profit
440,000
To recognize gross profit from installment sale

October 1, 2017
Repossessed inventory (fair value)
1,300,000
Deferred gross profit (balance)
1,760,000
Loss on repossession (difference)
140,000
Installment receivable (balance)
To record the default and repossession

3,200,000

*$2,200,000 $4,000,000 = 55% gross profit percentage


Exercise 533
Requirement 1
April 1, 2016
Installment receivables
Land
Gain on sale of land
To record installment sale

2,400,000
480,000
1,920,000

April 1, 2016
Cash
120,000
Installment receivables
120,000
To record cash collection from installment sale
April 1, 2017
Cash
120,000
Installment receivables
120,000
To record cash collection from installment sale
Requirement 2
April 1, 2016
Installment receivables
2,400,000
Land
480,000
Deferred gain
1,920,000
To record installment sale
Exercise 533 (concluded)
When payments are received, gain on sale of land is recognized, calculated by applying the
gross profit percentage ($1,920,000 $2,400,000 = 80%) to the cash collected (80% x
$120,000).

April 1, 2016
Cash
120,000
Installment receivables
120,000
To record cash collection from installment sale
Deferred gain
96,000
Gain on sale of land (80% x $120,000)
To recognize profit from installment sale

96,000

April 1, 2017
Cash
120,000
Installment receivables
120,000
To record cash collection from installment sale
Deferred gain
96,000
Gain on sale of land (80% x $120,000)
To recognize profit from installment sale
Exercise 534

96,000

The FASB Accounting Standards Codification represents the single source of authoritative U.S.
generally accepted accounting principles. Regarding circumstances indicating when the
installment method or cost recovery method is appropriate for revenue recognition, the
appropriate citation is:
FASB ASC 60510254: Revenue RecognitionOverallRecognition
Installment and Cost Recovery Methods of Revenue Recognition. (Note: ASC 60510253
also provides some guidance, as it indicates when installment method is not acceptable).
Exercise 535
2016:
Revenue:
Cost:
Gross profit:
2017:
Revenue:
Cost:
Gross profit:
2018:
Revenue:

$40
40
$0

$80
80
$0

$100 ($220 contract price 40 80)

Cost:
Gross profit:

50
$ 50

Exercise 536
As written, the question implies that there is no VSOE (vendor specific sales price evidence),
because the question refers to the prices as estimated. Under the assumption that there is no
VSOE, the correct answer to this problem is as follows:
Requirement 1
Revenue should be recognized at date of shipment of the upgrade, which occurs on
January 1, 2017, because there is no vendor-specific evidence with which to allocate
transaction price to the various software deliverables.
Requirement 2
July 1, 2016
Cash
243,000
Deferred revenue
To record sale of software

243,000

If instead the Exercise had said that Easywrite sold each of those components separately for
the amounts listed, Easywrite would have VSOE for each component, and the correct answer
would be:
Requirement 1
Revenue should be recognized as follows:
Software

date of shipment, July 1, 2016


Technical support

evenly over the 12 months of the agreement


Upgrade

date of shipment, January 1, 2017


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
$210,000 $270,000 x $243,000
=
Technical support
$ 30,000 $270,000 x $243,000
Upgrade
$ 30,000 $270,000 x $243,000
=
Total
$243,000
Exercise 536 (concluded)
Requirement 2
July 1, 2016
Cash
243,000
Revenue

189,000

$189,000
=
27,000
27,000

Deferred revenue ($27,000 + 27,000)


To record sale of software
Exercise 537
Requirement 1

54,000

Conveye
r

($20,000 50,000) x $45,000 =


$18,000

Labeler

($10,000 50,000) x $45,000 =

9,000

Filler

($15,000 50,000) x $45,000 =

13,500

Capper

($5,000 50,000) x $45,000 =

4,500

Total

$45,000

Requirement 2

All $45,000 of revenue is delayed until installation of the conveyer, because the usefulness of
the other elements of the multi-part arrangement is contingent on its delivery.
Exercise 538
Requirement 1
Conveye
r

($20,000 50,000) x $45,000 =


$18,000

Labeler

($10,000 50,000) x $45,000 =

9,000

Filler

($15,000 50,000) x $45,000 =

13,500

Capper

($5,000 50,000) x $45,000 =

4,500

Total

$45,000

Requirement 2

Under IFRS, its likely that Richardson would recognize revenue the same as in Requirement 1,
because (a) revenue for each part can be estimated reliably and (b) the receipt of economic
benefits is probable.
Exercise 539

October 1, 2016
Cash (10% $300,000)
30,000
Notes receivable
270,000
Unearned revenue franchise fee
To record franchise agreement and down payment
January 15, 2017
Unearned revenue franchise fee
Franchise fee revenue
To recognize franchise fee revenue

300,000

300,000
300,000

cpa / cma rEVIEW qUESTIONS


CPA Exam Questions
1. b. The earnings process is completed upon delivery of the product. Therefore, in 2017,
revenue for 50,000 gallons at $3 each is recognized on January 15. The payment terms do not
affect revenue recognition.
2. b. The $3,000 transaction price would be divided between the paint and the labor. The
paints percentage of the sum of the stand-alone selling prices is $1,200 ($1,200 + $2,800) =
30%, so the paint would be allocated $3,000 30% = $900.
3. b. Because Triangle cant estimate the stand-alone sales price of the additional guided
tours, it would use the residual method to allocate transaction price to that performance
obligation, so the basic Bahama Get-Away portion would be assigned an amount of the
transaction price equal to its stand-alone selling price of $2,000.
4. c. The contract has two performance obligations. Delivery of the washing machine is a
performance obligation. So is the option to purchase a dryer, as it includes a discount that is
greater than the customer could normally obtain. The quality-assurance warranty is not a
performance obligation, but rather is simply an aspect of fulfilling the obligation to deliver a
washing machine of appropriate quality. The coupon for the extended warranty is not a
performance obligation, as it only offers a right that customers would have absent the coupon.
5. c. The expected value is $165,000 (75% ($10,000 12 + $60,000)) + (25% ($10,000
12)). After eight months, Mowry would have recognized 8/12 of that amount, or $110,000.
6. d. Construction-in-progress represents the costs incurred plus the cumulative pro-rata share
of gross profit when revenue is recognized over time on long-term contracts.
CPA Review Questions (continued)
7. c.
2016 actual costs

$20,000

Total estimated costs

60,000

Ratio

= 1/3

Contract price

x 100,000

Revenue

33,333

2016 actual costs

20,000

Gross profit

$13,333

8. d. Since the total cost of the contract, $3,100,000 ($930,000 + 2,170,000), is projected to
exceed the contract price of $3,000,000, the excess cost of $100,000 must be recognized as a
loss in 2016.
Appendix CPA Exam Questions
9. d. The deferred gross profit in the balance sheet at December 31, 2017, should be the
balances in the accounts receivable accounts on that date for 2016 and 2017 sales multiplied by
the appropriate gross profit percentage:
Accounts receivable: sales in
Total sales
Less: Collections to
date
Less: Write-offs to
date
Accounts receivable balance

2016

2017

$
600,000

$900,000

(300,000) (300,000)

(200,000)

(50,000)

100,000

550,000

Gross profit rate

30%

Deferred gross profit

$ 30,000

40%
$220,000

The combined deferred gross profit in the balance sheet is $250,000 ($30,000 + 220,000).
CPA Review Questions (concluded)
10. a.
Year of sale
2016

2017

a. Gross profit realized

$240,000

$200,000

b. Percentage

30%

40%

c. Collections on sales (a/b)

$800,000

$500,000

Sales

1,000,000

2,000,000

Balance uncollected
at December 31

$200,000

$1,500,000

The total uncollected balance is $1,700,000 ($200,000 + 1,500,000).


11. c. Cash collection is at least reasonably possible is not a requirement for revenue
recognition under IFRS.
12. a. Under the cost recovery approach, an amount of revenue is recognized that is equal to
cost incurred, so long as cost incurred is probable to be recovered. Since $1,000,000 of cost
was incurred, $1,000,000 of revenue is recognized.
13. a. IFRS does not provide extensive guidance determining how contracts are to be
separated into components for purposes of revenue recognition.
CMA Exam Question

b.
Given that one-third of all costs have already been incurred ($6,000,000), the
company should recognize revenue equal to one-third of the contract price, or
$8,000,000. Revenues of $8,000,000 minus costs of $6,000,000 equals a gross profit of
$2,000,000.

Appendix CMA Exam Question

c.
Revenue is recognized when (1) realized or realizable and (2) earned. On May
28, $500,000 of the sales price was realized while the remaining $500,000 was
realizable in the form of a receivable. The revenue was earned on May 28 when the title
of the goods passed to the purchaser. The cost-recovery method is not used because
the receivable was not deemed uncollectible until June 10.

problems
Problem 5-1
Requirement 1
Number of performance obligations in the contract: 2
.
The unlimited access to facilities and classes for one year is one performance obligation.
Because the discount voucher provides a material right to the customer that the customer would
not receive otherwise (a 25% discount rather than a 10% discount), it is a second performance

obligation. The discount voucher is capable of being distinct because it could be sold or
provided separately, and it is separately identifiable, as it is not highly interrelated with the other
performance obligation of providing access to Fit & Slims facilities, and the sellers role is not to
integrate and customize them to create one product or service. So, the discount coupon
qualifies as a performance obligation.

To allocate the contract price to the performance obligations, we should first consider
that Fit & Slim would offer a 10% discount on the yoga course to all customers as part of
its normal promotion strategy. So, a 25% discount provides a customer with an
incremental value of 15% (25% 10%). Thus, the estimated stand-alone selling price of
the course voucher provided by Fit & Slim is $30 ($500 initial price of the course 15%
incremental discount 40% likelihood of exercising the option).

F&Ss estimated stand-alone selling price of the discount option is:


Value of the yoga discount voucher:
(25% discount 10% normal discount) $500 = $ 75
Estimated redemption 40%
Stand-alone selling price of yoga discount voucher: $ 30
Stand-alone selling price of gym membership:
720
Total of stand-alone prices $750
Problem 5-1 (continued)
F&S must identify each performance obligations share of the sum of the stand-alone selling
prices of all deliverables:
Yoga discount voucher:

$30

= 4%

$30 +
720
Gym membership:

$720

= 96%

$30 +
720
100%
F&S then allocates the total selling price based on stand-alone selling prices, as follows:
$700
Transaction Price
$700
Transaction Price

96%

96%
4%
4%

$28
Yoga discount voucher
$28
Yoga discount voucher
$672
Gym membership
$672
Gym membership

The journal entry to record the sale is:


Cash
Deferred revenuemembership fees
Deferred revenueyoga coupon

700
672

28

Problem 5-1 (concluded)


Requirement 2
Number of performance obligations in the contract: 1
.
The access to the gym for 50 visits is one performance obligation. The option to pay $15 for
additional visits does not constitute a material right because it requires the same fee as would
normally be paid by nonmembers. Therefore, it is not a performance obligation in the contract.
(Note: It could be argued that the coupon book actually includes 50 performance obligations
one for each visit to the gym. That would end up producing a very similar accounting outcome,
as the $500 cost of the book would be allocated to the 50 visits with revenue recognized for
each visit.)

Since the option to visit on additional days is not a performance obligation, F&S should
not allocate any of the contract price to the option. Therefore, the entire $500 payment is
allocated to the 50 visits associated with the coupon book.

Cash
Deferred revenuecoupon book
Problem 52

500
500

Requirement 1
Number of performance obligations in the contract: 2
.
Delivery of a Protab computer is one performance obligation.
The option to purchase a Probook at a 50% discount is a second performance obligation
because it provides a material right to the customer that the customer would not receive
otherwise. The option is capable of being distinct because it could be sold or provided
separately, and it is separately identifiable, as it is not highly interrelated with the other
performance obligation of delivering a Protab computer, and the sellers role is not to integrate
and customize them to create one product. So, the discount coupon qualifies as a performance
obligation.
The 6-month quality assurance warranty is not a performance obligation. It is not sold
separately and is simply a cost to assure that the product is of good quality. The seller will
estimate and recognize an expense and related contingent warranty liability in the period of
sale. Accounting for warranties is covered in Chapter 13.
The coupon providing an option to purchase an extended warranty does not provide a material
right to the customer because the extended warranty costs the same whether or not it is
purchased along with the Protab. Therefore, that option does not constitute a performance
obligation within the contract to purchase a Protab package.
Problem 5-2 (continued)
Requirement 2
Allocation of purchase price to performance obligations:

Performanc
e
obligation:
Protab tablet
Option to
purchase a
Probook
Total
1

Stand-alone
selling price of
the performance
obligation:

$76,000,0001

4,000,0002
$80,000,000

Percentage of the sum of


the stand-alone selling
prices of the performance
obligations:

95%3

5%4
100.00%

Allocation of total
transaction price to
each performance
obligation:

$74,100,0005

3,900,0006
$78,000,000

$76,000,000 = $760/unit 100,000 units.


$4,000,000 = 50% discount $400 normal Probook price 100,000 discount coupons issued
20% probability of redemption.
2

95% = $76,000,000 $80,000,000


5% = $4,000,000 $80,000,000
5
$74,100,000 = 95.00% ($780 100,000 units)
6
$3,900,000 = 5.00% ($780 100,000 units)
4

Problem 5-2 (concluded)


Requirement 3
Creative then allocates the total selling price based on stand-alone selling prices, as follows:
$78,000,000
Transaction Price
$78,000,000
Transaction Price

95%
95%
5%
5%

$3,900,000
Probook discount vouchers
$3,900,000
Probook discount vouchers
$74,100,000
Protab computers
$74,100,000
Protab computers

The journal entry to record the sale is:


Cash ($780 100,000 units)

78,000,00
0

Sales revenue

74,100,00
0

Deferred revenuediscount option

3,900,000

Problem 53
Requirement 1

Number of performance obligations in the contract: 3


.
Delivery of a Protab computer is one performance obligation.
The option to purchase a Probook at a 50% discount is a second performance obligation
because it provides a material right to the customer that the customer would not receive
otherwise. The option is capable of being distinct because it could be sold or provided
separately, and it is separately identifiable, as it is not highly interrelated with the other
performance obligations in the contract, so the discount coupon qualifies as a performance
obligation.
The 6-month quality assurance warranty is not a performance obligation. It is not sold
separately and is simply a cost to assure that the product is of good quality. The seller will
estimate and recognize an expense and related contingent warranty liability in the period of
sale. Accounting for warranties is covered in Chapter 13.
The option to purchase the extended warranty provides a material right to the customer, as the
extended warranty costs less when purchased with the coupon that was included in the Protab
Package ($50) than it does when purchased separately ($75), so it is a third performance
obligation. The option is capable of being distinct because it could be sold or provided
separately, and it is separately identifiable, as it is not highly interrelated with the other
performance obligations in the contract, and the sellers role is not to integrate and customize
them to create one product or service. So, the discount coupon qualifies as a performance
obligation.
Problem 5-3 (continued)
Requirement 2
Allocation of purchase price to performance obligations:

Performanc
e
obligation:
Protab tablet
Option to
purchase
Probook
Option to
purchase
extended

Percentage of the sum of the


Stand-alone
stand-alone selling prices of the
selling price of
performance obligations (to two
the performance decimal places):
obligation:

Allocation of total
transaction price to
each performance
obligation:

$76,000,0001

$73,187,4007

4,000,0002

1,000,0003

93.83%4

4.94%5

3,853,2008

1.23%6

959,4009

warranty
Total

$81,000,000

100.00%

$78,000,000

$76,000,000 = $760/unit 100,000 units.


$4,000,000 = 50% discount $400 normal Probook price 100,000 discount coupons issued
20% probability of redemption.
3
$1,000,000 = ($75 price of warranty sold separately minus $50 price of warranty sold at time of
software purchase) 100,000 units sold 40% probability of exercise of option.
4
93.83% = $76,000,000 $81,000,000
5
4.94% = $4,000,000 $81,000,000
6
1.23% = $1,000,000 $81,000,000
7
$73,187,400 = 93.83% ($780 100,000 units)
8
$3,853,200 = 4.94% ($780 100,000 units)
9
$959,400 = 1.23% ($780 100,000 units)
Problem 5-3 (concluded)
Requirement 3
Creative then allocates the total selling price based on stand-alone selling prices, as follows:
$78,000,000
Transaction Price
$78,000,000
Transaction Price
2

93.83%
93.83%
1.23%
1.23%
4.94%
4.94%

$959,400
Extended warranty
$959,400
Extended warranty
$3,853,200
Probook discount vouchers
$3,853,200
Probook discount vouchers
$73,187,400

Protab computers
$73,187,400
Protab computers

The journal entry to record the sale is:


Cash ($800 100,000 units)

78,000,00
0

Sales revenue

73,187,40
0

Deferred revenuediscount option

3,853,200

Deferred revenueextended
warranty

959,400

Problem 5-4
Requirement 1
The delivery of Supply Clubs normal products is one performance obligation. The promise to
redeem loyalty points represent a material right to customer that they would not receive
otherwise, so that loyalty points represent a second performance obligation. The loyalty
program really provides customers with a discount option on future purchases. That option is
capable of being distinct because it could be sold or provided separately, and it is s eparately
identifiable, as it is not highly interrelated with the other performance obligation of delivering
products under normal sales agreements (the customer can redeem loyalty points for future
purchases). Therefore, the promise to redeem loyalty points qualifies as a performance
obligation.
Because there are two performance obligations associated with a single transaction price
($135,000), the transaction price must be allocated between the two performance obligations on
the basis of stand-alone prices.
Supply Clubs estimated stand-alone selling price of the loyalty points is:
Value of the loyalty points:
125,000 points $0.20 discount per point = $ 25,000
Estimated redemption
60%
Stand-alone selling price of loyalty points: $ 15,000
Stand-alone selling price of purchased products:
135,000
Total of stand-alone prices $150,000
Supply Club must identify each performance obligations share of the sum of the stand-alone
selling prices of all deliverables:

Loyalty points:

$15,000

= 10%

$15,000 +
135,000

Purchased
products:

$135,000

= 90%

$15,000 +
135,000
100%
Problem 5-4 (concluded)
Supply Club then allocates the total selling price based on stand-alone selling prices, as follows:
$135,000
Transaction Price
$135,000
Transaction Price

90%
90%
10%
10%

$13,500
Loyalty points
$13,500
Loyalty points
$121,500
Purchased products
$121,500
Purchased products

The journal entry to record July sales would be:

Cash ($135,000 80%)

108,00
0

Accounts receivable ($135,000


20%)

27,000

Sales revenue

121,50
0

Deferred revenueloyalty points

13,500

Requirement 2
Cash ($60,000 75% 80%)*

36,00
0

Accounts receivable ($60,000 25% 80%)*

12,00
0

Deferred revenueloyalty points**

10,80
0

Sales revenue (to balance)

58,80
0

Sales are discounted by 20% when points are redeemed, so only 80% of each dollar sold is
received. 75% of sales are for cash, and 25% are on credit.
**
Supply Club expected that 60% of the 125,000 awarded points would eventually be redeemed.
60% 125,000 = 75,000. Therefore, the 60,000 August redemptions constitute 60,000 75,000
= 80% of total redemptions expected. Because Supply Club assigned $13,500 of deferred
revenue to the July loyalty points, Supply Club should recognize revenue of $13,500 80% =
$10,800.
Problem 55
Requirement 1
The contract requires 6 payments of $20,000, plus or minus $10,000 at the end of the contract.
So the contract will provide either [(6 $20,000) + $10,000] = $130,000, or [(6 $20,000)
$10,000] = $110,000.
Revis would estimate the expected value of the transaction price as follows:
Possible
Prices

Expected
Probability Consideration

$130,000 ([$20,000 6] + $10,000)


$110,000 ([$20,000 6] $10,000)

80% $104,000
20%
22,000

Expected value of contract price at inception$126,000


Each month Revis will recognize $21,000 ($126,000 6) of revenue, recording the following
journal entry:
Cash
20,000
Bonus receivable
1,000
Service revenue
21,000
Requirement 2
After six months the bonus receivable will have accumulated to $
6,000 (6 $1,000). If Revis
receives the bonus, it will record the following entry:
Cash

10,000
Bonus receivable
6,000
Service revenue
4,000
Problem 5-5 (concluded)
Requirement 3
If Revis pays the penalty, it will record the following entry:
Service revenue
Bonus receivable
Cash

16,000
6,000
10,000

Problem 56
Requirement 1

Cash

80,00
0

Deferred
revenue

80,00
0

Because Super Rise believes that unexpected delays are likely and that it will not earn the
$40,000 bonus, Super Rise is not likely to receive the bonus. Thus, the $40,000 is not included
in the transaction price, and only the fixed payment of $80,000 is recognized as deferred
revenue.
Requirement 2
Deferred revenue ($80,000

8,00

10)
Bonus receivable ($40,000
10)

0
4,00
0
12,00
0

Service revenue

Super Rise earns revenue of $12,000 associated in the month of January. Because Super Rise
believes it is likely to receive the bonus, it will estimate the transaction price to be $120,000
($80,000 fixed payment + $40,000 bonus), and will recognize 1/10 of that amount each month.
Requirement 3
8,000
Deferred revenue ($80,000 10)
20,00
Bonus receivable [($40,000 10) 5] 0
28,00
0

Service revenue

Super Rise earns revenue of $8,000 in each month, including May, based on the original
transaction of $80,000 ($80,000 10 months). However, no bonus receivable had been
recognized prior to May because unexpected delays were considered likely and thus no bonus
was expected. In May, Super Rise concludes it is likely to receive the bonus, so it will revise the
transaction price to $120,000 ($80,000 fixed payment + $40,000 contingent bonus). This means
Super Rise must record additional revenue of $20,000 to adjust revenue to the appropriate
amount [($40,000 bonus receivable 10 months) 5 months], and recognize a receivable for
that amount.
Problem 57
Requirement 1

Cash
Deferred
revenue

80,00
0
80,00
0

Because Super Rise has high uncertainty about its bonus estimate, it cant argue that it is
probable that it wont have to reverse (adjust downward) a significant amount of revenue in the
future because of a change in its estimate. Therefore, the $40,000 is not included in the
transaction price, and only the fixed payment of $80,000 is recognized as deferred revenue.
Requirement 2
Deferred revenue ($80,000 10)

8,000

Bonus receivable [($40,000 10) 5] 20,00


0
Service revenue

28,00
0

Super Rise earns revenue of $8,000 in the month of May based on the original transaction of
$80,000 ($80,000 10 months). In addition, now that Super Rise can make an accurate
estimate, it can argue that it is probable that it wont have to reverse (adjust downward) a
significant amount of revenue in the future because of a change in its estimate. Therefore,
Super Rise will revise the transaction price to $120,000 ($80,000 fixed payment + $40,000
contingent bonus). This means Super Rise must record additional revenue of $20,000 to adjust
revenue to the appropriate amount [($40,000 bonus receivable 10 months) 5 months], and
recognize a receivable for that amount.
Problem 5-8
Requirement 1
At the contracts inception, Velocity calculates the transaction price to be the expected value of
the two possible eventual prices:
Possible
Expected
Prices Probabilities Consideration
$500,000 ([$60,000 8] + $20,000) 80%
$460,000 ([$60,000 8] $20,000) 20%
Expected value at contract inception:

$400,000
92,000
$492,000

Because its consulting services are provided evenly over the eight months, Velocity will
recognize revenue of $61,500 ($492,000 8 months = $61,500). Because Velocity is
guaranteed to receive only $60,000 per month ($1,500 less than the revenue recognized), it will
recognize a bonus receivable of $1,500 in each month to reflect the expected value of the
bonus amount to be received at the end of the contract. Therefore, Velocitys journal entry to
record the revenue each month for the first four months is as follows:
Accounts receivable
60,000
Bonus receivable
1,500
Service revenue
61,500
Problem 58 (continued)
Requirement 2
By the end of the fourth month, the bonus receivable account would have a balance of $6,000
(4 $1,500), equal to half of the expected value of the bonus of $12,000 ($492,000 [8

$60,000]). After four months, the estimated likelihood of receiving the bonus is revised so the
estimated transaction price decreases:
Possibl
e
Prices

Expected
Probabilitie
s

Consideratio
n

$500,000 ([$60,000 8] +
$20,000)

60
%

$460,000 ([$60,000 8] $20,000)

40
%

$300,000
184,000

Transaction price after four months:

$484,000

So, after four months, the bonus receivable account should have a balance of $2,000, which is
half of the new expected value of the bonus of $4,000 ($484,000 [8 $60,000]). Because the
bonus receivable account was increased to $6,000 in the first four months, an adjustment of
$4,000 is needed to reduce the bonus receivable down to $2,000:
Service revenue
Bonus receivable

4,000
4,000

This entry reduces the bonus receivable from $6,000 to $2,000, with the offsetting debit being a
reduction in revenue. Over the remaining four months, the bonus receivable will increase by
$500 each month, accumulating to $4,000 by the end of the contract.
Problem 58 (concluded)
Requirement 3
Because services are provided evenly over the eight months, Velocity would recognize revenue
of $60,500 ($484,000 8 months) in each of months five through eight. Because Velocity
received $60,000 per month ($500 less than the revenue recognized), Velocity would recognize
a bonus receivable of $500 each month to reflect the additional service revenue in excess of its
unconditional right to $60,000. The journal entry would be:
Accounts receivable
Bonus receivable
Service revenue
Requirement 4

60,000
500
60,500

At the end of contract, Velocity learns that it will receive the bonus of $20,000. It already has
recognized revenue of $4,000 associated with the bonus. Therefore, when Velocity receives the
cash bonus, it will recognize additional revenue of $16,000.
Cash
Bonus receivable
Service revenue

20,000
4,000
16,000

Problem 5-9
Requirement 1
The FASB Accounting Standards Codification represents the single source of authoritative U.S.
generally accepted accounting principles. Regarding accounting for sales-based royalties from
licenses, the appropriate citation is:
FASB ASC 606105565: Revenue from Contracts with CustomersOverallImplementation
Guidance and IllustrationsSales-Based or Usage-Based Royalties.
That citation requires that both of the following two events have occurred:
The sales that utilize the intellectual property have occurred.
The performance obligation to which the royalty has been allocated has been satisfied.
Therefore, Tran cant recognize revenue for sales-based royalties on the Lyon license until
sales have actually occurred.
Requirement 2
If Tran accounts for the Lyon license as a right of use that is conveyed on April 1, 2016, Tran
can recognize revenue of $500,000 on that date, because that is the date upon which Tran
transfers to Lyon the right to use its intellectual property. The journal entry would be:
Cash
500,000
License revenue
500,000
Requirement 3
Tran recognizes revenue for sales-based royalties in the period in which uncertainty is resolved.
Tran earned $1,000,000 of royalties on Lyons sales in 2016, so it should recognize revenue in
that amount. The journal entry would be:
Cash
License revenue

1,000,000
1,000,000

Problem 59 (concluded)
Requirement 4
If Tran accounts for the Lyon license as an access right for the period from April 1, 2016,
through March 31, 2021, Tran cannot recognize any revenue on April 1, 2016, because it fulfills
its performance obligation over the access period and no time has yet passed. Instead, Tran
must recognize deferred revenue of $500,000. The journal entry would be:
Cash

500,000

Deferred revenue

500,000

As of December 31, 2016, Tran has partially fulfilled its performance obligation to provide
access to its intellectual property. Given that the access right covers a five-year period (from
April 1, 2016, through March 31, 2021), and Tran provided access for nine months of 2016
(from April 1, 2016, through December 31, 2016), Tran has provided 15% [9 (5 12)] of the
access right during 2016, and should recognize 15% $500,000 = $75,000 of revenue. Tran
also should recognize revenue for the $1,000,000 of royalties arising from Lyons sales in 2016.
So, total revenue recognized in 2016 is $75,000 + 1,000,000 = $1,075,000. The journal entry
would be:
Cash
License revenue

1,075,000
1,075,000

Problem 510
Requirement 1
2016 2017 2018
Contract price $10,000,000 $10,000,000 $10,000,000
Actual costs to date 2,400,000
6,000,000
8,200,000
Estimated costs to complete 5,600,000
2,000,000
-0Total estimated costs 8,000,000
8,000,000
8,200,000
Estimated gross profit (loss)
(actual in 2018)
$ 2,000,000 $ 2,000,000 $ 1,800,000
Revenue recognition:
2016: $2,400,000
= 30.0% $10,000,000 = $3,000,000
$8,000,000
2017: $6,000,000
= 75.0% $10,000,000 3,000,000 = $
4,500,000
$8,000,000
2018: $10,000,000 7,500,000 = $
2,500,000
Gross profit (loss) recognition:
2016: $3,000,000 2,400,000 = $600,000
2017: $4,500,000 3,600,000 = $900,000

2018: $2,500,000 2,200,000 = $300,000


Note: Also can calculate gross profit directly using the percentage of completion:
2016: $2,400,000
= 30.0% $2,000,000 = $600,000
$8,000,000
2017: $6,000,000
= 75.0% $2,000,000 = $1,500,000 600,000 = $
900,000
$8,000,000
2018: $1,800,000 1,500,000 = $300,000
Problem 510 (continued)
Requirement 2

Construction in progress

Various accounts

2016

2017

2018

2,400,00
0

3,600,00
0

2,200,00
0

2,400,00
0

3,600,00
0

2,200,00
0

2,000,00
0

4,000,00
0

4,000,00
0

2,000,00
0

4,000,00
0

4,000,00
0

1,800,00
0

3,600,00
0

4,600,00
0

To record construction costs

Accounts receivable

Billings on construction contract


To record progress billings

Cash

1,800,00
0

3,600,00
0

4,600,00
0

Construction in progress
(gross profit)

600,000

900,000

300,000

Cost of construction
(cost incurred)

2,400,00
0

3,600,00
0

2,200,00
0

Revenue from long-term


contracts

3,000,00
0

4,500,00
0

2,500,00
0

Accounts receivable
To record cash collections

To record gross profit

Requirement 3

Balance Sheet

2016

2017

$
200,000

$600,000

Current assets:
Accounts receivable
Construction in progress
Less: Billings
Costs and profit in
excess
of billings

$3,000,000

$7,500,000

(2,000,000
)

(6,000,000
)

1,000,00
0

1,500,00
0

Note: Construction in progress in excess of billings is a contract asset; Billings in excess of


construction in progress is a contract liability.
Problem 510 (continued)
Requirement 4
2016 2017 2018

Costs incurred during the year


$2,400,000
$3,800,000
Estimated costs to complete
as of year-end
5,600,000
3,100,000
-

$3,200,000

2016 2017 2018


Contract price $10,000,000 $10,000,000 $10,000,000
Actual costs to date 2,400,000
6,200,000
9,400,000
Estimated costs to complete 5,600,000
3,100,000
-0Total estimated costs 8,000,000
9,300,000
9,400,000
Estimated gross profit
(actual in 2018)
$ 2,000,000 $ 700,000 $ 600,000
Revenue recognition:
2016: $2,400,000
= 30.0% $10,000,000 = $3,000,000
$8,000,000
2017: $6,200,000
= 66.6667% $10,000,000 3,000,000 = $
3,666,667
$9,300,000
2018: $10,000,000 6,666,667 = $
3,333,333
Gross profit (loss) recognition:
2016: $3,000,000 2,400,000 = $600,000
2017: $3,666,667 3,800,000 = $
(133,333)
2018: $3,333,333 3,200,000 = $133,333
Problem 510 (continued)
Note: Also can calculate gross profit directly using the percentage of completion:
2016: $2,400,000
= 30.0% $2,000,000 = $
600,000
$8,000,000
2017: $6,200,000
= 66.6667% $700,000 = $466,667 600,000 = $
(133,333)
$9,300,000

2018: $600,000 466,667 = $


133,333
Requirement 5
2016 2017 2018
Costs incurred during the year
$2,400,000
$3,800,000
Estimated costs to complete
as of year-end
5,600,000
4,100,000
-

$3,900,000

2016 2017 2018


Contract price $10,000,000 $10,000,000 $10,000,000
Actual costs to date 2,400,000
6,200,000
10,100,000
Estimated costs to complete 5,600,000
4,100,000
-0Total estimated costs 8,000,000
10,300,000
10,100,000
Estimated gross profit (loss)
(actual in 2018)
$ 2,000,000 $ (300,000) $ (100,000)
Revenue recognition:
2016: $2,400,000
= 30.0% $10,000,000 = $3,000,000
$8,000,000
2017: $6,200,000
= 60.19417% $10,000,000 3,000,000 = $
3,019,417
$10,300,000
2018: $10,000,000 6,019,417 = $
3,980,583

Problem 510 (concluded)


Gross profit (loss) recognition:
2016: $3,000,000 2,400,000 = $600,000
2017: $(300,000) 600,000 = $(900,000)
2018: $(100,000) (300,000) = $200,000
Problem 511
Requirement 1

Year

Revenue
recognized

Gross profit
recognized

2016

-0-

-0-

2017

-0-

-0-

2018

$10,000,000

$1,800,000

Total

$10,000,000

$1,800,000

Requirement 2

Construction in progress

Various accounts

2016

2017

2018

2,400,00
0

3,600,00
0

2,200,000

2,400,00
0

3,600,00
0

2,200,000

2,000,00
0

4,000,00
0

4,000,000

2,000,00
0

4,000,00
0

4,000,000

1,800,00
0

3,600,00
0

4,600,000

1,800,00
0

3,600,00
0

4,600,000

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 profit)

1,800,000

Cost of construction
(costs incurred)

8,200,000

Revenue from long-term contracts (contract


price)

10,000,00
0

To record gross profit

Problem 511 (concluded)


Requirement 3

Balance Sheet

2016

2017

$
200,000

$
600,000

Current assets:
Accounts receivable
Construction in progress

$2,400,000

$6,000,000

Less: Billings

(2,000,000)

(6,000,000
)

Costs in excess of billings

400,000

Note: Construction in progress in excess of billings is a contract asset.


Requirement 4
2016 2017 2018
Costs incurred during the year
$2,400,000
$3,800,000
Estimated costs to complete
as of year-end
5,600,000
3,100,000
-

Year

Revenue
recognized

Gross profit
recognized

-0-

$3,200,000

2016

-0-

-0-

2017

-0-

-0-

2018

$10,000,000

$600,000

Total

$10,000,000

$600,000

Requirement 5
2016 2017 2018
Costs incurred during the year
$2,400,000
$3,800,000
Estimated costs to complete
as of year-end
5,600,000
4,100,000
-

Year

Revenue
recognized

Gross profit (loss)


recognized

2016

-0-

-0-

2017

-0-

$(300,000)

2018

$10,000,000

200,000

Total

$10,000,000

$(100,000)

$3,900,000

Problem 512
Requirement 1
2016 2017 2018
Contract price $4,000,000
$4,000,000
$4,000,000
Actual costs to date
350,000
2,500,000
4,250,000
Estimated costs to complete 3,150,000
1,700,000
-0Total estimated costs 3,500,000
4,200,000
4,250,000
Estimated gross profit (loss)
(actual in 2018)
$ 500,000
$ (200,000) $ (250,000)

Year

Gross profit (loss)


recognized

2016

-0-

2017

$(200,000)

2018

(50,000)

Total project

$(250,000)

loss
Requirement 2
Gross profit (loss) recognition:
2016: Revenue: (10% $4,000,000) 350,000 cost = $
50,000
2017: $(200,000) 50,000 = $(250,000)
2018: $(250,000) (200,000) = $(50,000)
Requirement 3

Balance Sheet

2016

2017

Current assets:
Costs less loss ($2,300,000*) in
excess of billings
($2,170,000)

$
130,000

Current liabilities:
Billings ($720,000) in excess
of costs and profit ($400,000)

$
320,000

*Cumulative costs ($2,500,000) less cumulative loss recognized ($200,000) =


$2,300,000
Problem 513
Requirement 1
Recognizing revenue upon completion of long-term construction contracts is equivalent to
recognizing revenue at the point in time at which deliver occurs. Recognizing revenue over time
requires assigning a share of the projects expected revenues and costs to each construction
period. The share is estimated based on the project's costs incurred each period as a
percentage of the project's total estimated costs.

Requirement 2
2016 2017
Contract price $20,000,000 $20,000,000
Actual costs to date
4,000,000 13,500,000
Estimated costs to complete 12,000,000
4,500,000
Total estimated costs 16,000,000
18,000,000
Estimated gross profit
$ 4,000,000 $ 2,000,000
a.
Revenue recognition: If revenue is recognized upon project completion, Citation would
not report any revenue in the 2016 or 2017 income statements.
b.

Gross profit recognition:


If revenue is recognized upon project completion, Citation would not report gross profit
until the project is completed. 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
recognize one.

Problem 513 (continued)


c.

Balance Sheet
At December 31, 2016
Current assets:
Accounts receivable

$
200,000

Costs ($4,000,000*) in
excess
of billings ($2,000,000)

2,000,00
0

* If revenue is recognized upon project completion, this account would only include costs
of $4,000,000
Requirement 3
2016

2017

Contract price $20,000,000 $20,000,000


Actual costs to date
4,000,000 13,500,000
Estimated costs to complete 12,000,000
4,500,000
Total estimated costs 16,000,000 18,000,000
Estimated gross profit
$ 4,000,000 $ 2,000,000
a.

Revenue recognition:

2016:
Revenue:

$ 4,000,000
= 25% $20,000,000 = $5,000,000
$16,000,000

2017:
Revenue:

b.

$13,500,000
= 75% $20,000,000 = $15,000,000
$18,000,000
Less: 2016 revenue
5,000,000
2017 revenue
$10,000,000

Gross profit recognition:

2016: Gross Profit: $5,000,000 4,000,000 = $1,000,000

2017: Gross Profit: $10,000,000 9,500,000 = $


500,000
Problem 513 (continued)
c.

Balance Sheet
At December 31, 2016
Current assets:
Accounts receivable
Costs and profit ($5,000,000*) in

$
200,000

excess
of billings ($2,000,000)

3,000,00
0

* Costs ($4,000,000) + profit ($1,000,000)


Requirement 4
2016 2017
Contract price $20,000,000 $20,000,000
Actual costs to date
4,000,000 13,500,000
Estimated costs to complete 12,000,000
9,000,000
Total estimated costs 16,000,000 22,500,000
Estimated gross profit
$ 4,000,000 ($ 2,500,000)
a. Revenue recognition:
Total revenue recognized to date = (percentage complete)(total revenue)
= ($13,500,000 22,500,000) x ($20,000,000)
= (60%) x ($20,000,000)
= $12,000,000
Revenue recognized in 2017 = total revenue recognized in prior periods
= $12,000,000 5,000,000 = $7,000,000
b.

Gross profit recognition:

2017: Overall loss of ($2,500,000) previously recognized gross profit of $1,000,000 =


$3,500,000.

Problem 513 (continued)


c.

Balance Sheet
At December 31, 2017
Current assets:
Accounts receivable
Current liabilities:

$
1,600,000

Billings ($12,000,000) in excess of costs and profit ($11,000,000*)

1,000,000

* 2016 costs ($4,000,000) + 2016 profit ($1,000,000) + 2017 costs ($9,500,000) 2017
loss ($3,500,000)
Requirement 5
Citation should recognize revenue at the time of delivery, when the homes are completed and
title is transferred to the buyer. Recognizing revenue over time is not appropriate in this case,
because the criteria for revenue recognition over time are not met. Specifically, the customers
are not consuming the benefit of the sellers work as it is performed (criterion 1 in Illustration
5-5), the customer does not control the asset as it is created (criterion 2), and the homes have
an alternative use to the seller and seller does not have the right to receive payment for
progress to date (criterion 3). Until completion of the home, transfer of title does not occur and
the full sales price is not received, so control of the homes has not passed from Citation to the
buyers.
Requirement 6
Income statement:
Sales revenue (3 x $600,000)
$1,800,000
Cost of goods sold (3 x $450,000) 1,350,000
Gross profit $ 450,000
Balance sheet:
Current assets:
Inventory (work in process)
$2,700,000
Current liabilities:
Customer deposits (or deferred revenue) $300,000*
*$600,000 x 10% = $60,000 x 5 = $300,000
Problem 514
1.
2.
3.
4.
5.
6.
7.
8.

Inventory turnover ratio


$6,300 [($800 + 600) 2] = 9.0
Average days in inventory
365 9.0 = 40.56 days
Receivables turnover ratio $9,000 [($600 + 400) 2] = 18.0
Average collection period
365 18.0 = 20.28 days
Asset turnover ratio $9,000 [($4,000 + 3,600) 2] = 2.37
Profit margin on sales
$300 $9,000 = 3.33%
Return on assets
$300 [($4,000 + 3,600) 2] = 7.89%
or:
3.33% x 2.37 times = 7.89%
Return on shareholders equity
$300 [($1,500 + 1,350) 2] = 21.1%

9.
Equity multiplier
10. DuPont framework

[($4,000 + 3,600) 2] [($1,500 + 1,350) 2] = 2.67


3.33% x 2.37 x 2.67 = 21.1%

Problem 515
Requirement 1
Receivables turnover =
Net sales
Accounts receivable
J&J

$41,862

= 6.37 times

$45,188

= 5.15 times

$6,574
Pfizer =
$8,775
Average collection period =
Receivables turnover
J&J

365

365

= 57 days

365

= 71 days

6.37
Pfizer =
5.15
On average, J&J collects its receivables in 14 days less than Pfizer.
Problem 515 (continued)
Inventory turnover
=
Cost of goods sold
Inventories
J&J

$12,176

= 3.39 times

$9,832

= 1.68 times

$3,588
Pfizer

=
$5,837

Average days in inventory =


Inventory turnover

365

J&J

= 108 days

365
3.39

Pfizer

365

= 217 days

1.68
On average, J&J sells its inventory twice as fast as Pfizer.
Requirement 2
Rate of return on assets
Total assets
J&J

$7,197
$48,263

Net income

14.9%

Pfizer =

$1,639
=
1.4%
$116,775
The return on assets indicates a company's overall profitability, ignoring specific sources of
financing. In this regard, J&Js profitability is significantly higher than that of Pfizer.
Problem 515 (continued)
Requirement 3
Profitability can be achieved by a high profit margin, high turnover, or a combination of the two.
Rate of return on assets
=
Profit margin
Asset
on sales
turnover
=
Net sales
J&J

=
Pfizer

Net income
Total assets
=
$ 7,197
$41,862

Net sales
$41,862
$48,263

=
14.9%

17.19%

0.867 times

$ 1,639
$45,188

$45,188
$116,775

=
3.63%
0.387 times
=
1.4%
No, the combinations of profit margin and asset turnover are not similar. J&Js profit margin is
much higher than that of Pfizer, as is its asset turnover. These differences combine to produce
a significantly higher return on assets for J&J.
Problem 515 (concluded)
Requirement 4
Rate of return on
=
Net income
shareholders equity
Shareholders equity

J&J

$7,197
$26,869

Pfizer =

$1,639
$65,377
J&J provided a much greater return to shareholders.
Requirement 5
Equity multiplier
shareholders equity
J&J

26.8%

2.5%

Total Assets
Shareholders equity

$48,263
$26,869

1.80

Pfizer =

$116,775
=
1.79
$65,377
The two companies have virtually identical equity multipliers, indicating that they are using
leverage to the same extent to earn a return on equity that is higher than their return on assets.
Problem 516
a.

Times interest earned ratio = (Net income + Interest + Taxes) Interest = 17

(Net income + $2 + 12) $2 = 17


Net income + $14 = 17 x $2
Net income = $20
b.
Return on assets = Net income Total assets = 10%
Total assets = $20 10% = $200
c.
Profit margin on sales = Net income Sales = 5%
Sales = $20 5% = $400
d.
Gross profit margin = Gross profit Sales = 40%
Gross profit = $400 x 40% = $160
Cost of goods sold = Sales Gross profit = $400 160 = $240
e.
Inventory turnover ratio = Cost of goods sold Inventory = 8
Inventory = $240 8 = $30
f.
Receivables turnover ratio = Sales Accounts receivable = 20
Accounts receivable = $400 20 = $20
g.

Current ratio =

Current assets Current liabilities = 2.0

Acid-test ratio = Quick assets Current liabilities = 1.0


Current assets 2 = Current liabilities
Quick assets 1 = Current liabilities
Current assets 2 = Quick assets 1
Current assets = 2 x Quick assets
Cash + Accts. rec. + Inventory = 2 x (Cash + Accounts receivable)
Cash + $20 + 30 = (2 x Cash) + (2 x $20)
Cash + $50 = Cash + Cash + $40
Cash = $10
h.
Acid-test ratio = (Cash + Accounts receivable) Current liabilities = 1.0
Current liabilities = ($10 + 20) 1.0 = $30
Problem 516 (concluded)
i.

Noncurrent assets = Total assets Current assets


= $200 ($10 + 20 + 30) = $140

j.
Return on shareholders equity = Net income Shareholders equity = 20%
Shareholders equity = $20 20% = $100
k.
Debt to equity ratio = Total liabilities Shareholders equity = 1.0
Total liabilities = $100 1.0 = $100
Long-term liabilities = Total liabilities Current liabilities = $100 30 = $70
CADUX CANDY COMPANY
Balance Sheet
At December 31, 2016
Assets
Current assets:
Cash $ 10
Accounts receivable (net)
20
Inventories
30
Total current assets
60
Property, plant, and equipment (net) 140
Total assets
$200
Liabilities and Shareholders Equity
Current liabilities
$ 30
Long-term liabilities
70
Shareholders equity
100
Total liabilities and shareholders' equity $200

Problem 517
Requirement 1
Rate of return on assets
Total assets

Net income

Metropolitan

=
$4,021.5

$ 593.8

14.8%

Republic

=
$4,008.0

$ 424.6

10.6%

The return on assets indicates a company's overall profitability, ignoring specific sources of
financing. In this regard, Metropolitans profitability exceeds that of Republic.
Requirement 2
Profitability can be achieved by a high profit margin, high turnover, or a combination of the two.
Rate of return on assets
=
Profit margin x
Asset
on sales
turnover
=

Net income
Net sales

Metropolitan =

=
Republic

Net sales
Total assets

$ 593.8
$5,698.0

$5,698.0
$4,021.5

10.4%

1.42 times =

$ 424.6
$7,768.2

$7,768.2
$4,008.0

1.94 times =

5.5%

14.8%

10.7%

Republics profit margin is much less than that of Metropolitan, but partially makes up for it with
a higher turnover.
Problem 517 (continued)
Requirement 3
Rate of return on
=
Net income
shareholders equity
Shareholders equity
Metropolitan =
$593.8
$144.9 + 2,476.9 904.7

34.6%

Republic

43.6%

=
$424.6
$335.0 + 1,601.9 964.1

Republic provides a greater return to common shareholders.


Requirement 4
Equity multiplier
=
Total assets
Shareholders equity
Metropolitan =
$4,021.5
$144.9 + 2,476.9 904.7

2.34

Republic
=
$4,008.0
$335.0 + 1,601.9 964.1

4.12

When the return on shareholders equity is greater than the return on assets, management is
using debt funds to enhance the earnings for stockholders. Both firms do this. Republics higher
leverage has been used to provide a higher return to shareholders than Metropolitan, even
though its return on assets is less. Republic increased its return to shareholders 4.07 times
(43.6% 10.7%) the return on assets. Metropolitan increased its return to shareholders 2.34
times (34.6% 14.8%) the return on assets.
Problem 517 (continued)
Requirement 5
Current ratio =
Current assets
Current liabilities
Metropolitan =
$1,280.2

$1,203.0

0.94

Republic

$1,478.7

0.83

Metropolitan =
$1,203.0 466.4 134.6
$1,280.2

0,47

Republic

0.21

=
$1,787.1

Acid-test ratio =
Quick assets
Current liabilities

=
$1,478.7 635.2 476.7
$1,787.1

The current ratios of the two firms are comparable and within the range of the rule-of-thumb
standard of 1 to 1. The more robust acid-test ratio reveals that Metropolitan is more liquid than
Republic.

Problem 517 (concluded)


Requirement 6
Receivables turnover ratio =
Accounts receivable
Metropolitan =
$422.7

Sales

$5,698.0

= 13.5 times

=
$7,768.2
$325.0
Inventory turnover ratio
=
Inventory

= 23.9 times

Metropolitan =
$466.4

$2,909.0

= 6.2 times

Republic

$4,481.7

= 7.1 times

Republic

=
$635.2

Cost of goods sold

Republics receivables turnover is more rapid than Metropolitans, perhaps suggesting that its
relative liquidity is not as bad as its acid-test ratio indicated.
Requirement 7
Times interest
=
Net income plus interest plus taxes
earned ratio
Interest
Metropolitan =
$56.8

$593.8 + 56.8 + 394.7

= 18.4 times

Republic

$424.6 + 46.6 + 276.1

= 16.0 times

=
$46.6

Both firms provide an adequate margin of safety.


Appendix problems
Problem 518

REAGAN CORPORATION
Income Statement

For the Year Ended December 31, 2016

Income before income taxes and


extraordinary item

[1]
$3,680,000

Income tax expense

1,472,000

Income before extraordinary item

2,208,000

Extraordinary item:
Gain from settlement of lawsuit (net of
$400,000 tax expense)
Net income

$2,808,000

Income before extraordinary item


Extraordinary gain
Net income

[1]

600,000

2.21
0.60
$ 2.81

Income from continuing operations before income taxes:


Unadjusted $4,200,000
Add: Gain from sale of equipment 50,000
Deduct:
Inventory write-off
(400,000)
Depreciation expense (2016) (50,000)
Overstated profit on installment sale (120,000) *
Adjusted
$3,680,000

*Profit recognized ($400,000 240,000) $160,000


Profit that should have been recognized
(gross profit ratio of 40% x $100,000)
(40,000)
Overstated profit
$120,000

Problem 519
Requirement 1
2016 cost recovery % :

$180,000
= 60% (gross profit % = 40%)
$300,000
2017 cost recovery %:
$280,000
= 70% (gross profit % = 30%)
$400,000
2016 gross profit:
Cash collection from 2016 sales = $120,000 x 40% =

$48,000

2017 gross profit:


Cash collection from 2016 sales = $100,000 x 40% =
+ Cash collection from 2017 sales = $150,000 x 30% =
Total 2017 gross profit
$85,000
Requirement 2
2016
Installment receivables
Inventory
Deferred gross profit
To record installment sales

300,000
180,000
120,000

Cash

120,000
Installment receivables
120,000
To record cash collections from installment sales
Deferred gross profit
48,000
Realized gross profit
48,000
To recognize gross profit from installment sales
Problem 519 (continued)
2017
Installment receivables
Inventory
Deferred gross profit
To record installment sales

400,000
280,000
120,000

$ 40,000
45,000

Cash

250,000
Installment receivables
250,000
To record cash collections from installment sales
Deferred gross profit
85,000
Realized gross profit
85,000
To recognize gross profit from installment sales
Requirement 3

Date

Cash
Collected

Cost
Recovery

Gross
Profit

$120,000

$120,000

-0-

2016
2016 sales

2017
2016 sales

$100,000

$ 60,000

$40,000

2017 sales

150,000

150,000

-0-

2017
totals

$250,000

$210,000

$40,000

Problem 519 (concluded)


2016
Installment receivables
Inventory
Deferred gross profit
To record installment sales
Cash

300,000
180,000
120,000

120,000
Installment receivables
120,000
To record cash collection from installment sales

2017
Installment receivables
Inventory
Deferred gross profit
To record installment sales

400,000
280,000
120,000

Cash

250,000
Installment receivables
250,000
To record cash collection from installment sales
Deferred gross profit
40,000
Realized gross profit
40,000
To recognize gross profit from installment sales
Problem 520
Requirement 1
Total profit = $500,000 300,000 = $200,000
Installment sales method: Gross profit % = $200,000 $500,000 = 40%

8/31/16

8/31/17

8/31/18

8/31/19

8/31/20

Cash collections

$100,00
0

$100,00
0

$100,00
0

$100,00
0

$100,00
0

a. Point of delivery
method

$200,00
0

-0-

-0-

-0-

-0-

$ 40,000

$ 40,000

$ 40,000

$ 40,000

$40,000

-0-

-0-

-0-

$100,00
0

$100,00
0

b. Installment sales
method
(40% x cash collected)

c. Cost recovery method

Problem 520 (continued)


Requirement 2

Point of
Delivery
Installment receivable

Cost
Recovery

500,000

Sales revenue

500,000

Cost of goods sold

300,000

Inventory

Installment
Sales

300,000

To record sale on 8/31/16

Installment receivable

500,000

500,000

300,000

300,000

200,000

200,000

100,000

100,000

100,000

100,000

100,000

100,000

Inventory
Deferred gross profit
To record sale on 8/31/16

Cash
Installment receivable
To record cash collections
(Entry made each Aug. 31)

Deferred gross profit

40,000

Realized gross profit


To record gross profit
(Entry made each Aug. 31)

40,000

Deferred gross profit

100,000

Realized gross profit


To record gross profit
(Entry made 8/31/19 & 8/31/20)

100,000

Problem 520 (concluded)


Requirement 3

Point of
Delivery

Installment
Sales

Cost
Recovery

400,000
(160,000)
240,000

400,000
(200,000)
200,000

300,000
(120,000)
180,000

300,000
(200,000)
100,000

December 31, 2016


Assets
Installment receivables
Less: Deferred gross profit
Installment receivables,
net

400,000

December 31, 2017


Assets
Installment receivables
Less: Deferred gross profit
Installment receivables,
net

300,000

Problem 521
Requirement 1
All jobs consist of four equal payments: one payment when the job is completed and three
payments over the next three years.
Bluebird:
Job completed in 2014, so down payment made in 2014, another payment in 2015, and two
payments remain. $400,000 gross receivable at 1/1/2016 implies payments of ($400,000 2) =

$200,000 in 2016 and 2017. Four payments of $200,000 implies total revenue of 4 x $200,000 =
$800,000 on the job. Twenty-five percent gross profit ratio implies cost of 75% x $800,000 =
$600,000.
Cost recovery method gross profit: Payments in 2014 and 2015 have already recovered
$400,000 of cost, so cost remaining to be recovered as of 1/1/2016 is $600,000 total $400,000
already recovered = $200,000. Therefore, the entire 2016 payment of $200,000 will be applied
to cost recovery, and no gross profit is recognized in 2016.
Installment sales method gross profit: $200,000 payment x 25% gross profit ratio = $50,000 of
gross profit recognized in 2016.
PitStop:
Job completed in 2013, so down payment made in 2013, another payment in 2014, another in
2015, and one payment remains. $150,000 gross receivable at 1/1/2016 implies a single
payment of $150,000 in 2016. Four payments of $150,000 implies total revenue of 4 x $150,000
= $600,000 on the job. Thirty-five percent gross profit ratio implies cost of 65% x $600,000 =
$390,000.
Cost recovery method gross profit: Payments in 2013, 2014, and 2015 of a total of $450,000
have already recovered the entire $390,000 of cost and allowed recognition of $60,000 of gross
profit. Therefore, the entire 2016 payment of $150,000 will be applied to gross profit.
Installment sales method gross profit: $150,000 payment x 35% gross profit ratio = $52,500 of
gross profit recognized in 2016.
Problem 521 (concluded)
Totals:
Cost recovery method: $0 (Bluebird) + 150,000 (PitStop) = $150,000.
Installment sales method: $50,000 (Bluebird) + 52,500 (PitStop) = $102,500.
Requirement 2
If Dan is focused on 2016, he would not be happy with a switch to the installment sales method,
because that would produce gross profit of only $102,500, which is $47,500 less than he would
show under the cost recovery method. It is true that the installment sales method recognizes
gross profit faster than does the cost recovery method, but the installment sales method also
recognizes gross profit more evenly than does the cost recovery method. The timing of these
jobs is such that 2016 is a year in which almost all of the gross profit associated with the PitStop
job gets recognized, so 2016 looks more profitable under the cost recovery method.

Problem 522
Requirement 1

Year

Gross profit
recognized

2016

-0-

2017

-0-

2018

$1,800,000

Total gross
profit

$1,800,000

Requirement 2

Construction in progress

Various accounts

2016

2017

2018

2,400,00
0

3,600,00
0

2,200,00
0

2,400,00
0

3,600,00
0

2,200,00
0

2,000,00
0

4,000,00
0

4,000,00
0

2,000,00
0

4,000,00
0

4,000,00
0

1,800,00

3,600,00

4,600,00

To record construction costs

Accounts receivable

Billings on construction contract


To record progress billings

Cash

Accounts receivable

1,800,00
0

3,600,00
0

4,600,00
0

To record cash collections

Construction in progress
(gross profit)

1,800,00
0

Cost of construction
(costs incurred)

2,400,00
0

3,600,00
0

2,200,00
0

Revenue from long-term contracts (contract


price)

2,400,00
0

3,600,00
0

4,000,00
0

To record gross profit

Problem 522 (concluded)


Requirement 3

Balance Sheet

2016

2017

$
200,000

$
600,000

Current assets:
Accounts receivable
Construction in progress

$2,400,000

$6,000,000

Less: Billings

(2,000,000)

(6,000,000
)

Costs in excess of billings

Requirement 4

400,000

-0-

2016 2017 2018


Costs incurred during the year
$2,400,000
$3,800,000
Estimated costs to complete
as of year-end
5,600,000
3,100,000
-

Year

Gross profit
recognized

2016

-0-

2017

-0-

2018

$600,000

Total gross
profit

$600,000

Requirement 5
2016 2017 2018
Costs incurred during the year
$2,400,000
$3,800,000
Estimated costs to complete
as of year-end
5,600,000
4,100,000
-

Year

Gross profit (loss)


recognized

2016

-0-

2017

$(300,000)

2018

200,000

Total project
loss

$(100,000)

Problem 523
Requirement 1
a.

January 30, 2016

Cash
200,000
Notes receivable
1,000,000
Unearned revenue franchise fee
b.

September 1, 2016

1,200,000

$3,200,000

$3,900,000

Unearned revenue franchise fee


Franchise fee revenue
c.

September 30, 2016

Accounts receivable ($40,000 x 3%)


Service revenue
d.

1,200,000
1,200,000

1,200
1,200

January 30, 2017

Cash

100,000
Notes receivable
Problem 523 (continued)
Requirement 2
a.
January 30, 2016
Cash
200,000
Notes receivable
1,000,000
Deferred franchise fee revenue

b.

100,000

1,200,000

September 1, 2016

Deferred franchise fee revenue


200,000
Franchise fee revenue (cash collected)
c.

September 30, 2016

Accounts receivable ($40,000 x 3%)


Service revenue

1,200
1,200

Problem 5-23 (concluded)


d.

January 30, 2017

Cash

100,000
Notes receivable

Deferred franchise fee revenue


Franchise fee revenue
Requirement 3

100,000
100,000
100,000

200,000

Balance Sheet
At December 31, 2016
Current assets:
Installment notes receivable ($1,000,000) less deferred franchise fee revenue
($1,000,000)

$ -0-

Current liabilities:
Unearned franchise fee revenue

$200,00
0

Explanation: Revenue recognition on the entire note receivable is deferred. In addition,


$200,000 of unearned revenue must be shown as a liability.

cases
Research Case 51
(Note: This case requires the student to reference a journal article.)

Abuse

Explanation

1. Cutoff
manipulation

The company either closes their books early (so some current-year
revenue is postponed until next year) or leaves them open too long
(so some next-year revenue is included in the current year).

2. Deferring
too much or
too little
revenue

The company has an arrangement under which revenue should be


deferred, but it doesnt defer the revenue. Or, a company could defer
too much revenue to shift income into future periods.

3.
Bill-and-hold
sale

The company records sales even though it hasnt yet delivered the
goods to the customer.

4.
Right-of-return

The company sells to distributors or other customers and cant


estimate returns with sufficient accuracy due to the nature of the

sale

selling relationship.
Manipulating estimates of percentage complete in order to manipulate gross profit
recognition.
These abuses tended to increase income (75% of the time), consistent with
management generally having an incentive to increase income.
The auditors tended to require adjustment (56% of the time), consistent with auditors
being concerned about income-increasing earnings management.

Judgment Case 52
Determining whether Toys4U satisfies the performance obligation requires the company to
consider indicators of whether McDonalds has obtained control of the dolls. Management
should evaluate these indicators individually and in combination to decide whether control has
been transferred. The indicators include, but are not limited to the following:

The customer has accepted the asset. T


here is no acceptance provision indicated, but
given that McDonalds returns unsold dolls to Toys4U, it does not appear that
McDonalds has irrevocably accepted the dolls.

The customer has legal title. The facts do not state whether title transfers.

The customer has physical possession of goods. M


cDonalds has possession of the
dolls.

The customer has the risks and rewards of ownership. Given that McDonalds
returns unsold dolls to Toys4U, McDonalds does not appear to be holding the risks of
ownership.

The customer has an obligation to pay the seller. In this case, McDonalds does not
pay Toys4U until the dolls are sold, so McDonalds is conditionally (not unconditionally)
obliged to pay for the toys.

In this case, Toys4U has not transferred control upon delivery because McDonalds has not
accepted the asset, does not have the risks and rewards of ownership, and does not have an
obligation to pay Toys4U unless the dolls are sold. Therefore, Toys4U has not satisfied its
performance obligation. This is essentially a consignment arrangement, and Toys4U should not
recognize revenue until McDonalds sells dolls to customers.
Judgment Case 53
In this case, Kerry obtained the access code for Level I on December 1, meaning that Kerry has
obtained the control of the right to use the software for Level I on that date. On that date Cutler
should recognize $50 of revenue for Level I.

Tom passed the Level I test on December 10 and Kerry purchased access to Level II on the
same day. However, Kerry received the access code for Level II on December 20, so control
over the Level II software was not transferred to Kerry until December 20. Cutler should
recognize $30 of revenue for Level II on December 20.
Ethics Case 54
Discussion should include these elements.
Facts:
Horizon Corporation, a computer manufacturer, reported profits from 2011 through 2014, but
reported a $20 million loss in 2015 due to increased competition. The chief financial officer
(CFO) circulated a memo suggesting the shipment of computers to J.B. Sales, Inc., in 2016 with
a subsequent return of the merchandise to Horizon in 2017. Horizon would record a sale for the
computers in 2016 and avoid an inventory write-off that would place the company in a loss
position for that year.
The CFO is clearly asking Jim Fielding to recognize revenue in 2016 that he knows will be
reversed as a sales return in 2017.
Ethical Dilemma:
Is Jim's obligation to challenge the memo of the CFO and provide useful information to users of
the financial statements greater than the obligation to prevent a company loss in 2016 that may
lead to bankruptcy?
Who is affected?
Jim Fielding
CFO and other managers
Other employees
Shareholders
Potential shareholders
Creditors
Auditors
Judgment Case 5-5
Scenario 1: The terms of the contract and all the related facts and circumstances indicate that
Star controls the room as it is built. Crown is entitled to receive payments throughout the
contract as evidenced by the required progress payments (with no refund of payment for any
work performed to date) and by the requirement to pay for any partially completed work in the
event of contract termination. Consequently, Crowns performance obligation is to provide Star
with construction services, and Crown would recognize revenue over time throughout the
construction process.
Scenario 2: 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. If the contract is terminated prior to
completion, Crown retains the equipment, suggesting that Crown retains control of the

equipment throughout the job. Consequently, Crowns performance obligation is to provide Star
with a completed gym, and Crown would recognize revenue upon contract completion.
Scenario 3: 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 has no alternate use to CostDriver.
Therefore, the CostDriver Companys performance obligation is to provide the restaurant with
services continuously during the three months of the contract, and CostDriver should recognize
revenue over the life of the contract.
Scenario 4: The terms of the contract and all the related facts and circumstances indicate that
Edwards, the customer, obtains control of the apartment upon completion of the contract.
Edwards obtains title and physical possession of the apartment only on completion of the
contract. Consequently, the Towers performance obligation is to provide the customer with a
completed apartment, and the Tower should not recognize revenue until delivery of the
apartment.
Judgment Case 5-6
The license granted by Pfizer is not a performance obligation, because it is not separately
identifiable. The only way to exploit the license is by utilizing ongoing R&D services from Pfizer.
The license does not provide utility on its own or together with other goods or services that
HealthPro has received previously from Pfizer or that are available from other entities. Rather,
the license requires Pfizers R&D services and proprietary expertise to be valuable. Therefore,
Pfizer would combine the license with the R&D services to HealthPro and account for them as a
single performance obligation.
Communication Case 57
The critical question that student groups should address is how to account for punches in the
punch card and the option to possibly receive a free ice cream cone that it provides. Students
should benefit from participating in the process, interacting first with other group members, then
with the class as a whole.
The preferred solution should include the idea that the sale of an ice cream cone to a person
who has a card involves two performance obligations:
Providing the ice cream cone
Eventually providing an additional ice cream cone, if and when a customer reaches 10
punches on a card and redeems the card for the free cone.
Students should recognize that each punch on the punch card contributes to an option to
receive a future ice cream cone. That option is capable of being distinct because it could be
sold or provided separate from selling a cone, and it is s eparately identifiable, as it is not highly
interrelated with selling a cone (for example, cones certainly could be sold without offering the
punch card program, and in fact that is how Jerrys currently does business). Therefore, each
punch on the punch card is distinct from the cone that is sold at the same time, and each punch
qualifies as a performance obligation.

Students also should recognize that not all cards will be redeemed for ice cream cones. Some
may be lost, and some may never fill up with the required 10 punches. Therefore, Jerry must
estimate the chance that a punch results in a future ice cream cone. He likely would come up
with some estimate. For example, he might conclude that half of all punches end up unused,
such that a punch on average leads to Jerry providing 1/20 of a free future cone. In that case,
the revenue for each cone should be allocated to the two performance obligations based on
their stand-alone selling prices, and a journal entry is recorded upon sale of a cone as follows:
Cash
xxx
Sales Revenue
xxx
Deferred revenue, punch cards
xxx
Case 57 (concluded)
In the future, when a card is redeemed, the deferred revenue account would be reduced and
revenue recognized for deferred revenue related to ten punches.
Sales of ice cream cones to people who do not have cards have only a single performance
obligation to deliver the ice cream cone and so can be accounted for in the same manner as
they were previously.
Other solutions that are likely to emerge:
1.
Treat providing the occasional free cone as a cost of doing business and dont view
provision of that cone as a separate performance obligation. The idea here is that the deferral
of revenue associated with the free cones is time-consuming and is not likely to provide a
material amount of additional information to financial statement users. This approach would be
an immaterial departure from GAAP.
2.
Ignore revenue recognition and instead accrue an estimated cost. This solution views
the free ice cream cone as a promotional expense. The estimated cost of the free cone should
be expensed as the 10 required cones are sold. A corresponding liability is recorded which
should increase to an amount equal to the cost of the free cone. When the free cone is
awarded, the liability and inventory are reduced. This approach ignores the idea that there is a
revenue-recognition aspect to the promise of free cones, so is not correct.
Its important that each student actively participate in the process. Domination by one or two
individuals should be discouraged. Students should be encouraged to contribute to the group
discussion by (a) offering information on relevant issues, and (b) clarifying or modifying ideas
already expressed, or (c) suggesting alternative direction.
Judgment Case 5-8
When other parties are involved in providing goods or services to a sellers customer, the seller
must determine whether its performance obligation is to provide the goods or services, making
the seller a principal, or the seller arranges for another party to provide those goods or
services, making the seller an a
gent. That determination affects whether the seller recognizes
revenue in the amount of consideration received in exchange for those goods or services (if

principal) or in the amount of any fee or commission received in exchange for arranging for the
other party to provide the goods or services (if agent).
Requirement 1
AuctionCo is a principal because it obtained control of the used bicycle before the bicycle was
sold. Therefore, AuctionCo should recognize revenue of $300.
Requirement 2
AuctionCo is an agent because it never controlled the product before it was sold. Therefore,
AuctionCo should recognize revenue for the commission fees of $100 received upon sending
$200 to the original owner.
Requirement 3
If AuctionCo must pay the bicycle owner the $200 price regardless of whether the bicycle is
sold, then AuctionCo would appear to have purchased the bicycle and should be treated as a
principal.
Real World Case 59
Requirement 2
Excerpt from Orbitzs 2013 Annual Report:
Under 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 booking. Initially, we record these customer receipts as accrued
merchant payables and either deferred income or net revenue, depending on the travel product.
In the merchant model, we do not take on credit risk with the customer, however we are subject
to charge-backs and fraud risk which we monitor closely; we have the ability to determine the
price; we are not responsible for the actual delivery of the flight, hotel room or car rental; we
take no inventory risk; we have no ability to determine or change the products or services
delivered; and the customer chooses the supplier. We recognize net revenue under the
merchant model when we have no further obligations to the customer.
Under the retail model, we pass reservations booked by our customers to the travel supplier for
a commission. In the retail model, we do not take on credit risk with the customer; we are not
the primary obligor with the customer; we have no latitude in determining pricing; we take no
inventory risk; we have no ability to determine or change the products or services delivered; and
the customer chooses the supplier. We recognize 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.
Case 59 (continued)
Excerpt from Priceline.coms 2013 Annual Report:

The Name Your Own Price service connects consumers that are willing to accept a level of
flexibility regarding their travel itinerary with travel service providers that are willing to accept a
lower price in order to sell their excess capacity without disrupting their existing distribution
channels or retail pricing structures. The Company's Name Your Own Price services use a
unique pricing system that allows consumers to "bid" the price they are prepared to pay when
submitting an offer for a particular leisure travel service. The Company accesses databases in
which participating travel service providers file secure discounted rates, not generally available
to the public, to determine whether it can fulfill the consumer's offer. The Company selects the
travel service provider and determines the price it will accept from the consumer. Merchant
revenues and cost of merchant revenues include the selling price and cost, respectively, of the
Name Your Own Price travel services and are reported on a gross basis.
Merchant Retail Services: Merchant revenues for the Company's merchant retail services are
derived from transactions where consumers book accommodation reservations or rental car
reservations from travel service providers at disclosed rates which are subject to contractual
arrangements. Charges are billed to consumers by the Company at the time of booking and are
included in deferred merchant bookings until the consumer completes the accommodation stay
or returns the rental car. Such amounts are generally refundable upon cancellation, subject to
cancellation penalties in certain cases. Merchant revenues and accounts payable to the travel
service provider are recognized at the conclusion of the consumer's stay at the accommodation
or return of the rental car. The Company records the difference between the reservation price to
the consumer and the travel service provider cost to the Company of its merchant retail
reservation services on a net basis in merchant revenue.
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, global distribution system ("GDS") reservation
booking fees and customer processing fees, and are reported at the net amounts received,
without any associated cost of revenue. Such revenues are generally recognized by the
Company when the customers complete their travel.
Case 59 (continued)
Requirement 3
Orbitzs merchant model revenues:
This is reported net: We recognize net revenue under the merchant model when we have no
further obligations to the customer.

Orbitzs retail model revenues:

This is reported net: We recognize 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.

Priceline.coms merchant revenues for Name Your Own Price services:

This is reported gross: Merchant revenues and cost of merchant revenues include the selling
price and cost, respectively, of the Name Your Own Price travel services and are reported on a
gross basis.

Priceline.coms merchant retail services:

This is reported net: The Company records the difference between the reservation price to the
consumer and the travel service provider cost to the Company of its merchant retail reservation
services on a net basis in merchant revenue.

Priceline.coms agency revenues:

This is reported net: Agency revenues . . . are reported at the net amounts received, without
any associated cost of revenue.
Case 59 (concluded)
Requirement 4
Yes, it appears that relatively similar services can be accounted for as gross or net depending
on how they are structured. Pricelines Name your own Price service appears similar to
services that Orbitz might offer under its merchant model, yet Priceline would recognize revenue
gross and Orbitz would recognize revenue net. If similar items are treated differently,
comparability is reduced.
Research Case 510
Requirement 1
FASB ASC 606105536: Revenue from Contracts with CustomersOverallImplementation
Guidance and IllustrationsPrincipal versus Agent Considerations.
Requirement 2
FASB ASC 606105539: Revenue from Contracts with CustomersOverallImplementation
Guidance and IllustrationsPrincipal versus Agent Considerations.
The Codification lists the following indicators for use of the gross method:
Another party is primarily responsible for fulfilling the contract.
The entity does not have inventory risk before or after the goods have been ordered by a
customer, during shipping, or on return.
The entity does not have discretion in establishing prices for the other partys goods or
services and, therefore, the benefit that the entity can receive from those goods or
services is limited.
The entitys consideration is in the form of a commission.
The entity is not exposed to credit risk for the amount receivable from a customer in
exchange for the other partys goods or services.

Requirements 3 and 4
For their AdSense program, Googles 2013 10K states: We recognize as revenues the fees
charged to advertisers each time a user clicks on one of the ads that appears next to the search
results or content on our websites or our Google Network Members websites. For those
advertisers using our cost-per-impression pricing, we recognize as revenues the fees charged
to advertisers each time their ads are displayed on our websites or our Google Network
Members websites. We report our Google AdSense revenues on a gross basis principally
because we are the primary obligor to our advertisers. That is consistent with the first indicator
listed above, so Googles reasoning appears appropriate.
Real World Case 511
Requirement 1
A bill and hold strategy accelerates the recognition of revenue. In this case, sales that would
normally have occurred in 1998 were recorded in 1997. Assuming a positive gross profit on
these sales, earnings in 1997 is inflated.
Requirement 2
A customer would probably not be expected to pay for goods purchased using this bill and hold
strategy until the goods were actually received. Receivables would therefore increase.
Requirement 3
Sales that would normally have been recorded in 1998 were recorded in 1997. This bill and hold
strategy shifted sales revenue and therefore earnings from 1998 to 1997.
Requirement 4
Earnings quality refers to the ability of reported earnings (income) to predict a companys future
earnings. Sunbeams earnings management strategy produced a 1997 earnings figure that was
not indicative of the companys future profit-generating ability.
Judgment Case 512
Bills argument is that recognizing revenue upon project completion is preferable because it is
analogous to point of delivery revenue recognition. That is, no revenue is recognized until the
completed product is delivered. Johns argument is that the important factor is the process of
satisfying the performance obligation and that revenue should be recognized as the process
takes place.
Johns argument is correct. In situations when the earnings process takes place over long
periods of time, like long-term construction contracts, it is preferable to recognize revenue over
time, rather than to wait until the contract has been completed.
Communication Case 513
Suggested Grading Concepts and Grading Scheme:
Content (70%)
25
Income differences.

Revenue recognition over time recognizes gross profit during construction based on an
estimate of percent complete.
If a project doesnt qualify for revenue recognition over time, no gross profit is recognized
until project completion.
Estimated losses are fully recognized in the first period an overall loss is anticipated.
20
Balance sheet differences.
The two approaches are similar. However, for profitable projects, the construction in
progress account during construction will have a higher balance when revenue is
recognized over time due to the inclusion of gross profit.
25
According to generally accepted accounting principles, revenue should be
recognized over time if:
The customer consumes the benefit of the sellers work as it is performed,
The customer controls the asset as it is created, or
The seller is creating an asset that has no alternative use to the seller, and the seller can
receive payment for its progress even if the customer cancels the contract.
The second and third of these situations likely apply to Willinghams construction contracts, so
those contracts probably require revenue recognition over time.
70 points
Writing (30%)
6
Terminology and tone appropriate to the audience of a company
controller.
12
Organization permits ease of understanding.
Introduction that states purpose.
Paragraphs that separate main points.
12
English
Sentences grammatically clear and well organized, concise.
Word selection.
Spelling.
Grammar and punctuation.
30 points
Analysis Case 514
This case encourages students to obtain hands-on familiarity with an actual annual report and
library sources of industry data. They also must apply the techniques learned in the chapter.
You may wish to provide students with multiple copies of the same annual reports and compare
responses. Another approach is to divide the class into teams who evaluate reports from a
group perspective.

Judgment Case 515


Apparently, a significant increase in assets occurred during the last quarter. Total assets were
$324 million and now they total $450 million, as can be calculated as follows:
Return on shareholders equity
= Net income Shareholders equity = 14%
Shareholders equity = $21 million 14% = $150 million
Debt to equity ratio = Total liabilities Shareholders equity = 2
Total liabilities
= $150 million x 2 = $300 million
Total assets
= Total liabilities + Shareholders equity
= $300 million + 150 million = $450 million
Integrating Case 516
Balance Sheet
Assets
Cash $ 15,000
given
Accounts receivable (net)
12,000 (e)
Inventory
30,000 (d)
Prepaid expenses and other current assets 3,000
Current assets
60,000
(h)
Property, plant, and equipment (net) 140,000
(j)
$200,000
(b)
Liabilities and Shareholders Equity
Accounts payable
$ 25,000
(g)
Short-term notes
5,000
given
Current liabilities
30,000
(f)
Bonds payable
20,000
(l)
Shareholders equity 150,000
(k)
$200,000
(b)
Income Statement
Sales $300,000
(a)
Cost of goods sold
(180,000)
(c)
Gross profit 120,000
(c)
Operating expenses (96,000)
(o)
Interest expense
(2,000)
(m)
Tax expense
(7,000)
(n)
Net income $ 15,000
given
Case 516 (concluded)
Calculations ($ in 000s):
a.
Profit margin on sales = Net income Sales = 5%
Sales = $15 5% = $300

(i)

b.
Return on assets = Net income Total assets = 7.5%
Total assets = $15 7.5% = $200
c.
Gross profit margin = Gross profit Sales = 40%
Gross profit = $300 x 40% = $120
Cost of goods sold = Sales Gross profit = $300 120 = $180
d.
Inventory turnover ratio = Cost of goods sold Inventory = 6
Inventory = $180 6 = $30
e.
Receivables turnover ratio = Sales Accounts receivable = 25
Accounts receivable = $300 25 = $12
f.
Acid-test ratio = Cash + AR + ST Investments Current liabilities = .9
Current liabilities = ($15 + 12 + 0) .9 = $30
g.
Accounts payable = Current liabilities Short-term notes = $30 5 = $25
h.
Current ratio = Current assets Current liabilities = 2
Current assets = $30 x 2 = $60
i.
Prepaid expenses and other current assets =
Current assets (Cash + AR + Inventory) = $60 (15 + 12 + 30) = $3
j.
Property, plant, and equipment = Total assets Current assets = $200 60 = $140
k.
Return on shareholders equity = Net income Shareholders equity =10%
Shareholders equity = $15 10% = $150
l.
Debt to equity ratio = Total liabilities Shareholders equity = 1/3
Total liabilities = $150 x 1/3 = $50
Bonds payable = Total liabilities Current liabilities = $50 30 = $20
m. Interest expense = 8% x (Short-term notes + Bonds )
Interest expense = 8% x ($5 + 20) = $2
n
Times interest earned ratio = (Net income + Interest +Taxes) Interest = 12
Times interest earned ratio = ($15 + 2 + Taxes) 2 = $12
Times interest earned ratio = ($15 + 2 + Taxes) = $24
Tax expense = $24 (15 + 2) = $7
o.
Operating expenses = (Sales Cost of goods sold Interest expense Tax expense)
Net income = ($300 180 2 7) 15 = $96
Air FranceKLM Case
Requirement 1
AFs balance sheet indicates current deferred revenue on ticket sales of 2,371 million
as of December 31, 2013.

The journal entry would be:

Deferred revenue on ticket sales


Sales revenue

2,371
2,371

This seems consistent with U.S. GAAP. A liability for deferred revenue is recognized
when tickets are purchased, and then the deferred revenue is reduced and revenue is
recognized when the transportation service is provided.
Requirement 2
From note 4.7: In accordance with the IFRIC 13, these miles are considered as 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 miles and deferred until the Groups commitments
relating to these miles has been met.
The deferred amount due in relation to the acquisition of miles by members is estimated:
- According to the fair value of the miles, defined as the amount at which the benefits can be
sold separately.
- After taking into account the redemption rate, corresponding to the probability that the miles
will be used by members, using a statistical method.

Per the balance sheet, AF has a liability for Frequent flyer programs of 755 million.
AFs approach is consistent with ASU No. 2014-09, in that the transaction price for
airfare is allocated to the performance obligations of (1) providing the airfare and (2)
providing future airfare or other goods and services upon redemption of miles. The
revenue associated with AF miles is deferred and recognized separately from the
revenue associated with the flights that customers use to earn the miles.

Appendix cases
Judgment Case 517
Requirement 1
The three methods that could be used to recognize revenue and costs for this situation are (1)
point of delivery, (2) the installment sales method, and (3) the cost recovery method.
2016 gross profit under the three methods:
(1) point of delivery:
$80,000 40,000 = $40,000
(2) installment sales method:
$40,000
= 50% = gross profit %
$80,000
50% x $30,000 (cash collected) = $
15,000
(3) cost recovery method:

No gross profit recognized since cost ($40,000) exceeds cash collected ($30,000).
Case 5-17 (concluded)
Requirement 2
Customers sometimes are allowed to pay for purchases in installments over long periods of
time. Uncertainty about collection of a receivable normally increases with the length of time
allowed for payment. In most situations, the increased uncertainty concerning the collection of
cash from installment sales can be accommodated satisfactorily by estimating uncollectible
amounts. In these situations, point of delivery revenue recognition should be used.
If, however, the installment sale creates a situation where there is significant uncertainty
concerning cash collection making it impossible to make 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.
IFRS Case 518
Vodafones revenue recognition policies for products and services are similar to revenue
recognition policies in the U.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 risks and
rewards of ownership have been transferred to the buyer. Sales of services are recognized as
the services are provided. Revenue for multiple-deliverable contracts is allocated to separate
deliverables based on relative fair values. The terminology is somewhat different, but the end
results, as compared to U.S. policies, should be similar in most cases.

IFRS Case 519


Requirement 1
Per the revenue recognition section of ThyssenKrupps 2013 annual report, note 1: Summary of
Significant Accounting Policies:
Revenue recognition
Construction contract revenue and expense are accounted for using the
percentage-of-completion method, which recognizes 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.
Where the income of a construction contract cannot be estimated reliably, contract revenue
that is probable to be recovered is recognized to the extent of contract costs incurred. Contract
costs are recognized as expenses in the period in which they are incurred.
Requirement 2
Similar accounting would be used under U.S. GAAP.

Trueblood Accounting Case 520


A solution and extensive discussion materials can be obtained from the Deloitte Foundation.
Trueblood Accounting Case 521
A solution and extensive discussion materials can be obtained from the Deloitte Foundation.
Trueblood Accounting Case 522
A solution and extensive discussion materials can be obtained from the Deloitte Foundation.
Real World Case 523
Requirement 3
The following is from the 2013 10K of Jack in the Box, Inc. The responses to the question will
vary if the company has since changed its revenue recognition policy.
These fees are first recorded as deferred revenue and then recognized as revenue when
the company has substantially performed all of its contractual obligations and the
restaurant is open for business. This policy agrees with GAAP.
Continuing payments (royalties) are based on a percentage of sales.
Requirement 4
Answers to this question will, of course, vary because students will research financial
statements of different companies. Likely candidates for comparison include most of the
fast-food chains such as McDonalds, and Wendys, and Arbys.