Intermediate Accounting 9th Edition By Spiceland - Test Bank

Intermediate Accounting 9th Edition By Spiceland – Test Bank

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Sample Questions Are Posted Below

5–1
True/False Questions
1. Companies recognize revenue when goods or services are transferred to customers for the
amount the company expects to be entitled to receive in exchange for those goods or
services.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-01
Topic Area: Core principle and 5 steps to apply it
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
2. Companies always recognize revenue when goods or services are transferred to
customers for the amount the company expects to receive in exchange for those goods or
services.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-01
Topic Area: Core principle and 5 steps to apply it
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
3. “Determine whether it is probable the seller will collect the consideration it is entitled to
receive” is one of the five steps to applying the core revenue recognition principle.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-01
Topic Area: Core principle and 5 steps to apply it
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
4. Staff Accounting Bulletin No. 101 was issued by the FASB to clarify its guidelines on
revenue recognition.
Answer: False
Level of Learning: 1 Easy
5–2
Learning Objective: 05-01
Topic Area: Core principle and 5 steps to apply it
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Research
5. A transfer of goods or services is complete when the customer has control over the goods
or services.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-02
Topic Area: Transfer of control and indicators
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
6. Revenue always is recognized once the buyer has physical possession of goods.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-02
Topic Area: Transfer of control and indicators
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
7. Sellers should recognize revenue over time for a long term contract in which the seller is
receiving periodic payments for progress to date but may need to refund those payments
in the event the contract is cancelled.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-03
Topic Area: Revenue over time―Criteria
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
8. A common output method used to measure progress towards completion is to compare
cost incurred to date to total costs estimated to complete the job.
5–3
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-03
Topic Area: Revenue over time―Progress to completion
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
9. Revenue should be recognized over time for the construction of an annex to a building
that the customer owns, even if the seller will not receive payment until the annex is
completed.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-03
Topic Area: Revenue over time―Criteria
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
10. A common output method used to measure progress towards completion is to determine
the proportion of promised goods or services that have been transferred to date.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-03
Topic Area: Revenue over time―Progress to completion
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
11. No allocation of contract price is required if the transaction involves a performance
obligation to be satisfied over time.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-04
Topic Area: Revenue over time―Progress to completion
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
5–4
12. The transaction price should be allocated to the contract’s performance obligations in
proportion to the stand-alone selling prices of the performance obligations.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-04
Topic Area: Mult perf oblig―Allocate transact price
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
13. No allocation of contract price is required if the transaction involves multiple
performance obligations that are satisfied at different points in time.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-04
Topic Area: Mult perf oblig―Allocate transact price
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
14. If the contract contains multiple performance obligations, revenue must be recognized in
an amount equal to the fair value of each of the separate performance obligations.
Answer: False
Level of Learning: Easy
Learning Objective: 05-04
Topic Area: Mult perf oblig―Allocate transact price
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
15. The transaction price is only allocated to goods or services that are both capable of being
distinct and that are separately identifiable.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-04
Topic Area: Mult perf oblig―Identify the perf oblig
5–5
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
16. Goods or services are distinct if they are either capable of being distinct or are separately
identifiable.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-04
Topic Area: Mult perf oblig―Identify the perf oblig
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
17. A contract between a seller and a buyer need not be in writing to be enforceable.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Identify the contract
Blooms: Remember
AACSB: Reflective thinking
AICPA: BB Legal
18. If the contract is not in writing, revenue cannot be recognized, even though goods have
been transferred and payment is expected to be received in exchange.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Identify the contract
Blooms: Understand
AACSB: Reflective thinking
AICPA: BB Legal
19. The probability that the customer will pay the seller does not affect whether a contract
exists for purposes of revenue recognition.
Answer: False
5–6
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Identify the contract
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
20. A contract exists for purposes of revenue recognition if either the seller or customer has
performed an obligation specified by the contract.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Identify the contract
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
21. An option for a customer to purchase additional goods at a discount from list price is only
a performance obligation if the discount is a material right that the customer would not
receive otherwise.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Customer options
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
22. A warranty that the customer can purchase separately and that covers a long period of
time after the purchase date is likely to be a quality-assurance warranty.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Warranties
Blooms: Understand
AACSB: Reflective thinking
AICPA: BB Industry
5–7
23. If an option to purchase an extended warranty at a special discount is included with a
product when the product is purchased, a portion of the contract price needs to be
allocated to the option.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Warranties
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
24. A fee for recording a new customer in the seller’s information system should be treated
as a separate performance obligation and should be recognized upon payment.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-05
Topic Area: Contract features―Prepayments
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
25. An option for a customer to purchase additional goods at a discount from list price is
always a performance obligation, because it confers a material right.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-05
Topic Area: Contract features―Customer options
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
26. Accounting for quality-assurance warranties includes a credit to warranty expense and a
debit to contingent liability.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-05
Topic Area: Contract features―Warranties
Blooms: Analyze
AACSB: Analytical thinking
5–8
AICPA: FN Measurement
27. When a contract includes variable consideration, the probability-weighted amount must
be used when there are different probabilities of occurrence.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
28. To account for variable consideration using the most likely amount, the probability of
each possible amount is multiplied by the possible amount to get an expected contract
price.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
29. If the estimate of a transaction price is revised, the price change is allocated entirely to
the remaining performance obligations that are yet to be satisfied.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic: Transaction price―Variable consideration
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
30. The amount of variable consideration that can be recognized is limited to the amount for
which it is probable that there won’t be a significant reversal of revenue recognized to
date when uncertainty resolves in the future.
Answer: True
Level of Learning: 1 Easy
5–9
Learning Objective: 05-06
Topic Area: Transaction price―Variable consid constraint
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
31. The right of return is a separate performance obligation, and a portion of the transaction
price needs to be allocated to it for revenue recognition.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Right of return
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
32. When the right of return exists, revenue can be recognized at the point of sale if the seller
can make reliable estimates of future returns.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Right of return
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
33. If the seller is a principal, the seller has primary responsibility for delivering a product or
service.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: BB Legal
34. If the seller is a principal, the seller typically is not vulnerable to risks associated with
delivering the product or service.
Answer: False
Level of Learning: 1 Easy
5–10
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: BB Legal
35. If the seller is a principal, the seller typically is vulnerable to risks associated with returns
of inventory from the customer.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: BB Legal
36. If the seller is a principal, the seller should recognize gross revenue and cost of sales
associated with the transaction.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
37. If the seller is an agent, the seller typically is vulnerable to risk associated with delivering
the product or service.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: BB Legal
38. If the seller is an agent, the seller typically recognizes cost associated with the sale on its
own line in the income statement.
5–11
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
39. The transaction price should be adjusted to reflect the time value of money for interest
payable, but not for interest receivable.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Time value of money
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
40. Sellers are only required to adjust the transaction price to reflect the time value of money
when the contract has a significant financing component.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Time value of money
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
41. If a seller makes payments to a customer to purchase goods or services, and those
payments are equal to the stand-alone selling prices of those goods or services, part of
those payments are a refund to the customer.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Pay by seller to customer
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
5–12
42. The adjusted market assessment approach can be used to estimate the stand-alone selling
price of a good or service.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Adjusted market approach
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
43. The residual approach to estimate stand-alone selling prices is often used for goods or
services that are sold separately and that have stable prices.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Residual approach
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
44. Revenue typically should not be recognized when payment is received but the goods are
warehoused at the seller’s facility.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Bill-and-hold
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
45. In a bill-and-hold arrangement, revenue only can be recognized after the sale of the goods
to the end user.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Bill-and-hold
Blooms: Understand
AACSB: Reflective thinking
5–13
AICPA: FN Measurement
46. In franchise arrangements, the franchisor’s performance obligations are not separately
identifiable, so revenue must be recognized over time.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Franchises
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
47. The same revenue recognition requirements always apply to franchise arrangements that
apply to other selling arrangements.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: When Timing of rev rec―Franchises
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
48. In a consignment arrangement, revenue typically should not be recognized until sale to a
third party occurs, even though there has been a physical transfer of goods to the
consignee, because the consignor still retains legal title to the goods.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Consignment
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
49. Sellers recognize revenue for gift cards at the point in time control of the gift card is
transferred to the customer.
5–14
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Gift cards
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
50. If a license is acquired to use intellectual property for a 5-year period, revenue always is
recognized at the point in time the customer begins to benefit from the license.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
51. If a licensee benefits from the seller’s activity over the license period with respect to the
licensed intellectual property, revenue should be recognized over time.
Answer: True
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
52. Under U.S. GAAP, if a license gives a customer access to symbolic intellectual property,
revenue always should be recognized over time.
Answer: True
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
5–15
53, Under IFRS, if a license gives a customer access to symbolic intellectual property,
revenue always should be recognized over time.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: IFRS―Revenue recognition
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
54. If a license gives a customer access to functional intellectual property, revenue always
should be recognized at the point in time that the customer can begin using the intellectual
property.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
55. A license to use a company trademark should be viewed as an access right, with revenue
recognized over the license period.
Answer: True
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
56. Contract liability, deferred revenue and unearned revenue are all ways to describe a
liability that the seller recognizes with respect to unsatisfied performance obligations for
which the seller has already been paid.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-08
Topic Area: Disclosures―Balance sheet and Notes
5–16
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
57. An account receivable is recognized if the seller has a conditional right to receive
payment.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-08
Topic Area: Disclosures―Balance sheet and Notes
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
58. Disclosure notes to the financial statements regarding significant revenue recognition
policies are only required when they will not reveal important information to competitors,
suppliers or customers.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-08
Topic Area: Disclosures―Balance sheet and Notes
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
59. When recognizing revenue over time on a long-term contract, amounts billed and the
cash actually received affect income recognition.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-09
Topic Area: Long-term contracts―Accounting issues
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
60. When recognizing revenue over time on a long-term contract, the percent complete is
often estimated by comparing the cost incurred to date with the total estimated cost to
complete.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-09
5–17
Topic Area: Long-term contracts―Percentage complete
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
61. Firms have free choice as to whether to recognize revenue over time or at a point in time
to account for a long-term contract.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-09
Topic Area: Long-term contracts―Accounting issues
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
62. When revenue is recognized over time versus upon completion of the contract, different
amounts of total profit or loss are recognized for a particular contract.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-09
Topic Area: Long-term contracts―Accounting issues
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
63. Estimated losses on long-term contracts are recognized as ratable over the contract term
regardless of whether revenue is recognized over time or upon contract completion.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-09
Topic Area: Long-term contracts―Loss on contract
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
64. When a long-term contract does not qualify for revenue recognition over time, all gross
profit and loss recognition occurs when the contract is completed.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Accounting issues
5–18
Topic Area: Long-term contracts―Upon completion
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
65. Revenue is not recognized under the realization principle unless the earnings process is
complete or virtually complete and there is reasonable certainty about the expected
collection of the asset received.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Realization principle
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
66. Under IFRS, one of the conditions for revenue from product sales to be recognized is
when the risks and rewards of ownership have been transferred to the customer.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Remember
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
67. Use of the installment sales method requires that firms track the gross profit percentage
associated with a particular sale.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
68. When the expected collection of accounts receivable is difficult to estimate, companies
5–19
must use the cost recovery method.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
69. Use of the installment sales method indicates little uncertainty about collection of the
receivable.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
70. Over the life of a particular account receivable, the same total amount of gross profit is
recognized under the installment sales method and the cost recovery method.
Answer: True
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
71. When the right of return exists and a seller cannot make reliable estimates of future
returns, the installment sales method can be used.
Answer: False
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
5–20
72. Under IFRS, firms have free choice as to whether they use the percentage-of-completion
method or the cost recovery method to account for a long-term construction contract.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Understand
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
73. For long-term construction contracts, the cost recovery method under IFRS requires
recognizing equal amounts of revenue and cost until all costs are recovered.
Answer: True
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Remember
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
74. When the cost recovery method is used to account for a long-term construction contract
under IFRS, an equal amount of cost and revenue is typically recognized during the early
life of the contract, such that high initial gross profit is recognized in net income.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Analyze
AACSB: Analytical thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
5–21
AICPA: BB Industry
75. Under IFRS, firms typically use the cost recovery method if they conclude that the
percentage-of-completion method is not appropriate to account for a long-term
construction contract.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Remember
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
76. Revenue from the sale of computer software is always recognized at the point of sale.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
77. Revenue on a multiple-element contract typically is allocated to independent parts of the
contract based on their relative selling prices.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
78. Vendor-specific objective evidence of separate sales prices is required for multiple-
5–22
element software contracts, but estimated selling prices can be used for other multiple-
element contracts under U.S. GAAP.
Answer: True
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
79. Recognition of franchise fee revenue is dependent on judgments of both substantial
performance and expected collection of fees.
Answer: True
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Franchise sales
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
80. Initial franchise fees are always recognized on the date they are received.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Franchise sales
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
81. When accounting for multiple-element software arrangements, the revenue for each
element is based on the separate prices stated for each element in the software contract.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
5–23
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
82. When accounting for multiple-element arrangements, GAAP indicates that sellers can
separately record revenue for part of an arrangement even if the part does not have value
to the customer on a stand-alone basis.
Answer: False
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
83. IFRS provides detailed guidance concerning accounting for revenue with respect to
multiple-element contracts.
Answer: False
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Remember
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
Multiple Choice Questions
84. Companies recognize revenue only when
a. A contract is reasonably likely to exist
b. A performance obligation is designated in a written contract
c. A written contract is in place and payment is variable
d. Control over goods or services has been transferred from the seller to the
customer
Answer: d
5–24
Level of Learning: 2 Medium
Learning Objective: 05-01
Topic Area: Core principle and 5 steps to apply it
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: The key to revenue recognition is transfer of control of goods or services from
the seller to the customer.
85. Which of the following is one of the steps for recognizing revenue?
a. Identify the performance obligations of the contract.
b. Determine whether bad debts can be reasonably estimated.
c. Estimate the total transaction price of the contract based on fair value.
d. Allocate all revenue to the performance obligation with the largest stand-alone
selling price.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-01
Topic Area: Core principle and 5 steps to apply it
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: The second step requires identification of the performance obligations in the
contract.
86. Which of the following is not one of the five steps for recognizing revenue?
a. Recognize revenue when (or as) each performance obligation is satisfied.
b.Determine the transaction price.
c. Allocate the transaction price to each performance obligation.
d. Estimate variable consideration.
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-01
Topic Area: Core principle and 5 steps to apply it
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Estimating variable consideration is part of determining the transaction price..
87. Which one of the following is not one of the five steps for recognizing revenue?
a. Identify the contract with a customer
b. Recognize revenue when all the performance obligations have been satisfied
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c. Identify the separate performance obligation(s) in the contract
d. Allocate the transaction price to the separate performance obligations
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-01
Topic Area: Core principle and 5 steps to apply it
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: The fifth step is to recognize revenue when (or as) each performance
obligation is satisfied, not to wait until all have been satisfied.
88. For a typical manufacturing company, the most common critical point for recognizing
revenue is the date:
a. An order is received.
b. Production is completed.
c. The product is delivered.
d. Payment is received.
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-02
Topic Area: Transfer of control and indicators
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Control typically passes from the manufacturer to the customer when the
product is delivered.
89. Stayman Associates has sold a good to a buyer and wants to recognize revenue. Which
of the following is an indicator that control of a good has passed from Stayman to the
buyer?
a. Buyer has scheduled delivery.
b. Buyer has a strong credit history, such that bad debts are reasonably estimable.
c. Buyer has not scheduled delivery.
d. Buyer has assumed the risk and rewards of ownership.
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-02
Topic Area: Transfer of control and indicators
Blooms: Remember
AACSB: Reflective thinking
5–26
AICPA: FN Measurement
AICPA: BB Critical Thinking
Feedback: One of the indicators that control has passed from a seller to a buyer is if the
buyer has assumed the risk and rewards of ownership.
90. Which of the following is not an indicator that the customer is likely to have control over
a good?
a. Asset warehoused by seller-affiliated third party
b. Accepted the asset
c. Legal title to the asset
d. Physical possession of the asset
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-02
Topic Area: Transfer of control and indicators
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Critical thinking
Feedback: “Asset warehoused by seller-affiliated third party” is an indicator that control
has not passed.
91. On June 1st , Lucy & Bros received an order for 500 cupcakes. Lucy delivered the
cupcakes to the client on June 25th . A $50 deposit was received on June 5th and the
remaining $450 was paid on June 30th . Lucy likely would recognize revenue on
a. June 1st
b. June 5th
c. June 25th
d. June 30th
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-02
Topic Area: Transfer of control and indicators
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
Feedback: Revenue should be recognized when control passes to the customer, which
typically occurs upon delivery.
92. The core revenue principle states that
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a. Companies recognize revenue when the earnings process is virtually complete and
it is probable that payments will be received.
b. Companies recognize revenue when goods or services are transferred to
customers for the amount the company expects to be entitled to receive in
exchange for those goods or services.
c. Companies recognize revenue when goods or services are transferred to the
customer and payments are received.
d. Companies recognize revenue when the goods or services are transferred to the
customer in an arm’s length transaction.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-02
Topic Area: Core principle and 5 steps to apply it
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Recognizing revenue when the earnings process is virtually complete and it is
probably that payments will be received is incorrect because it includes the earnings
process notion from the realization principle. Recognizing revenue when goods or
services are transferred to the customer and payments are received is incorrect because it
focuses on receipt of payment. Recognizing revenue when the goods or services are
transferred to the customer in an arm’s length transaction is incorrect because it focuses
on arm’s length transactions and doesn’t consider the amount the company expects to be
entitled to receive.
93. Consider the following three scenarios:
I. ABC Lawncare performed lawn maintenance services for Drake Inc. on June 1st ,
and received payment of $500 for those services.
II. On June 1st, Melly Corp received payment for 100 pounds of raw material to be
delivered to Drake Inc. in 6 months
III. Lodo, LLC collected cash on June 1st for services rendered on May 1st.
Given these scenarios, revenue can not be recognized on June 1st for
a. I, II
b. I only
c. II, III only
d. III only
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-02
Topic Area: Transfer of control and indicators
Blooms: Analyze
5–28
AACSB: Analytical thinking
AICPA: FN Measurement
Feedback: Revenue can be recognized for scenario I because the seller has satisfied a
performance obligation. For scenario II, the seller must wait until raw material has been
delivered. For scenario III, the seller should have recognized revenue on May 1st when
the performance obligation was satisfied by rendering services.
94. Which of the following is not an indicator that revenue can be recognized over time?
a. The seller is enhancing an asset that the buyer controls as the service is performed.
b. The customer consumes the benefit of the seller’s work as the seller performs the
service.
c. The seller is creating an asset that has an alternative use to the seller, and the seller
can receive payment for its progress even if the customer cancels the contract.
d. None of these answer choices are correct.
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-03
Topic Area: Revenue over time―Criteria
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Critical Thinking
Feedback: An indicator that revenue recognition over time is appropriate is that the seller
is creating an asset that does not have an alternative use to the seller, and the seller can
receive payment for its progress even if the customer cancels the contract.
95. Revenue likely is recognized over time for all the following arrangements except for
a. Bank earning interest on a long term loan
b. Construction of a building
c. Providing a two-year gym membership
d. Manufacturing generally stocked items ordered by a favored customer
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-03
Topic Area: Revenue over time―Criteria
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Manufacturing generally stocked items ordered by a favored customer does
not meet any of the criteria for revenue recognition over time. The fact that the items are
5–29
ordered by a favored customer doesn’t matter, as they are generally stocked and therefore
not specific to that customer.
96. On November 1, 2018, Taylor signed a one-year contract to provide handyman services
on an as-needed basis to King Associates, with the contract to start immediately. King
agreed to pay Taylor $4,800 for the one-year period. Taylor is confident that King will
pay that amount, but payment is not scheduled to occur until 2019. Taylor should
recognize revenue in 2018 in the amount of
a. $0
b. $800
c. $2,400
d. $4,800
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-03
Topic Area: Revenue over time―Criteria
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: This arrangement qualifies for revenue recognition over time because the
customer consumes the benefit of the seller’s service as the seller provides it. Therefore,
Taylor would recognize revenue of $800 ($4,800 × 2/12 of the contract duration).
97. Mary signed up and paid $1200 for a 6 month ceramics course on June 1st with Choplet
Ceramics. As of August 1st , Choplet’s accounting records would indicate:
a. $400 of revenue, $800 of accounts receivable
b. $400 of revenue, $800 of deferred revenue
c. $1,200 of revenue, $1,200 of cash
d. $800 of revenue, $400 of accounts receivable
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-03
Topic Area: Revenue over time―Progress to completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: This arrangement qualifies for revenue recognition over time because the
customer consumes the benefit of the seller’s service as the seller provides it. Therefore,
Choplet would recognize revenue of $400 ($1,200 × 2/6 of the contract duration) and
deferred revenue of $800 ($1,200 contract price paid in advance – $400 revenue
recognized to date).
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98. On February 1st , H&B Bank originated a loan for $50,000 at an interest rate of 7.2%. On
March 15th , an interest payment of $300 was received. Which of the following best
describes when interest revenue should be recognized?
a. At a point in time (February 1st )
b. At a point in time (March 15th )
c. At a point in time (March 31st )
d. Over time
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-03
Topic Area: Revenue over time―Progress to completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: This arrangement qualifies for revenue recognition over time because the
customer consumes the benefit of the seller’s service as the seller provides it.
99. Rothbart Manufacturing agrees to manufacture bumper cars for 12 Banners Amusement
Parks. Under the terms of the contract, 12 Banners will pay Rothbart a total of $60,000,
and 12 Banners can cancel the contract if it so chooses but must pay Rothbart for work
completed. Rothbart believes that, if 12 Banners cancelled the contract, Rothbart could
sell the bumper cars to another amusement park and still make a profit. The
manufacturing contract is expected to last six months, and as of December 31, 2018, the
job is 80% complete. How much revenue should Rothbart recognize in 2018 for this
contract?
a. $0
b. $12,000
c. $48,000
d. $60,000
Answer: a
Level of Learning: 3 Hard
Learning Objective: 05-03
Topic Area: Revenue over time―Progress to completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: This arrangement does not qualify for revenue recognition over time, because
the asset the seller is creating has an alternative use to it. Therefore, Rothbart must wait
until completion of the contract before recognizing revenue.
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100. Which of the following is not a characteristic of a distinct good or service?
a. It can be used on its own or in combination with other goods or services the seller
could obtain elsewhere
b. It is not highly dependent on other goods or services in the contract
c. It has a stand-alone selling price
d. It is not interrelated with other goods or services in the contract
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-04
Topic Area: Mult perf oblig―Identify the perf oblig
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Critical thinking
Feedback: A good or service is distinct if it is both capable of being distinct, as in it can
be used on its own or in combination with other goods or services the seller could obtain
elsewhere, and it is separately identifiable, as in it is not interrelated with other goods or
services in the contract. The good or service having a stand-alone selling price is not part
of the definition of a distinct good or service.
101. For contracts that include more than one separate performance obligation:
a. Revenue is recorded over time at the fair value of each performance obligation.
b. Revenue is recognized in the amount of the contract price on the date the last
separate performance obligation is satisfied.
c. The contract price is allocated to each performance obligation in proportion to the
obligations’ stand-alone selling prices.
d. Revenue is recognized in the amount of the contract price on the date the contract
is signed.
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-04
Topic Area: Mult perf oblig―Allocate transact price
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Allocating the contract price to each performance obligation in proportion to
the obligations’ stand-alone selling prices is how companies apply the fourth step to
recognizing revenue, “Allocate the transaction price to each performance obligation.”
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102. Binz Company provides cleaning services and sells garbage bins to office clients.
On June 1st , Binz delivered 100 garbage bins to a client, and also entered into a 5-year
contract for Binz to provide cleaning services to that client. Which of the following is
most likely to be true?
a. Revenue for the garbage bins and the cleaning services must be recognized on
June 1st .
b. Revenue for the garbage bins is recognized on June 1st and no revenue will be
recognized for the cleaning services until the end of the 5th year.
c. Revenue for the garbage bins is recognized on June 1st and revenue for the
cleaning service is recognized over the 5 years as those services are performed.
d. Binz Company should not recognize any revenue until the end of the 5th year.
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-04
Topic Area: Mult perf oblig―Identify the perf oblig
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
Feedback: The garbage bins and cleaning services are two performance obligations, as
they are both capable of being distinct and separately identifiable. The cleaning services
qualify for revenue recognition over time, as the customer will consume those services as
they are provided. The garbage bins do not qualify for revenue recognition over time, so
revenue will be recognized at the point in time when control of the bins passes to the
customer, which occurs upon delivery.
103. Goods or services are capable of being distinct if:
a. The seller regularly sells the good or service separately.
b. A buyer could use the good or service on its own.
c. A buyer could use the good or service in combination with goods or services the
buyer could obtain elsewhere.
d. The seller regularly sells the good or service separately, or the buyer could use the
good or service on its own, or the buyer could use the good or service in
combination with goods or services the buyer could obtain elsewhere.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-04
Topic Area: Mult perf oblig―Identify the perf oblig
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Critical Thinking
Feedback: A good or service is capable of being distinct if the seller regularly sells the
5–33
good or service separately, or the customer could use the good or service on its own or in
combination with other goods or services it could obtain elsewhere.
104. Minarski Electronics sells computers and provides hardware maintenance
services. On April 1st , Minarski sold a package deal containing a computer and a one-year
unlimited maintenance/repair service for the computer at a bundle price of $1,000. If sold
separately, the computer costs $840 and the one-year unlimited maintenance/repair
service costs $360. How much revenue does Minarski Electronics recognize for the
month ended April 30th , assuming that revenue is accrued monthly?
a. $1,000
b. $870
c. $725
d. $30
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-04
Topic Area: Mult perf oblig―Identify the perf oblig
Topic Area: Mult perf oblig―Allocate transact price
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: The computer and maintenance services are distinct, because they are both
capable of being distinct and are separately identifiable. Therefore, they qualify as
performance obligations. The total bundle price of $1,000 would be allocated to each of
them, with $700 (computed as $1,000 × ($840 ÷ (840 + 360))) allocated to the computer,
and $300 (computed as $1,000 × ($360 ÷ (840 + 360))) allocated to the maintenance
contract. During April, Minarski has delivered the computer and one month of
maintenance, so it should recognize revenue of $725 (computed as $700 + ($300 × 1/12
of the duration of the contract)).
Use the following to answer questions 105-107:
On July 15, 2018, Ortiz & Co. signed a contract to provide EverFresh Bakery with an
ingredient-weighing system for a price of $90,000. The system included finely tuned scales
that fit into EverFresh’s automated assembly line, Ortiz’s proprietary software modified to
allow the weighing sytem to function in EverFresh’s automated system, and a one-year
contract to calibrate the equipment and software on an as-needed basis. (Ortiz competes with
other vendors who offer ongoing calibration contracts for Ortiz’s systems.) If Ortiz was to
provide these goods or services separately, it would charge $60,000 for the scales, $10,000
for the software, and $30,000 for the calibration contract. Ortiz delivered and installed the
equipment and software on August 1, 2018, and the calibration service commenced on that
date.
5–34
105. How many performance obligations exist in this contract?
a. 0
b. 1
c. 2
d. 3
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-04
Topic Area: Mult perf oblig―Identify the perf oblig
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Critical thinking
Feedback: Goods or services must be distinct to qualify as performance obligations. To
be distinct, goods or services must be both capable of being distinct and separately
identifiable. The scales and software appear capable of being distinct, as they could be
sold separately, but they are not separately identifiable, as they are integrated with each
other and not useable without each other. The one-year calibration contract is capable of
being distinct and separately identifiable, as other vendors could provide similar services.
Therefore, the contract has two performance obligations: the combination of the scales
and software, and the calibration contract.
106. Assume that the scales, software and calibration service are all separate
performance obligations. How much revenue will Ortiz recognize in 2018 for this
contract?
a. $0
b. $63,000
c. $74,250
d. $90,000
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-04
Topic Area: Mult perf oblig―Allocate transact price
Topic Area: Mult perf oblig―When (or as) satisfied
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: The scales will be allocated $54,000 of transaction price (computed as $90,000
× ($60,000 ÷ ($60,000 + 10,000 + 30,000))). The software will be allocated $9,000 of
transaction price (computed as $90,000 × ($10,000 ÷ ($60,000 + 10,000 + 30,000))). The
calibration contract will be allocated $27,000 of transaction price (computed as $90,000 ×
5–35
($30,000 ÷ ($60,000 + 10,000 + 30,000))). The revenue for the scales and software all
would be recognized upon delivery on August 1, 2018. Since the calibration contract has
a one-year duration and commenced on August 1, revenue for five months has been
earned in 2018, equal to $11,250 (computed as $27,000 × 5/12). Therefore, total revenue
recognized in 2018 is $74,250 (computed as $54,000 + 9,000 + 11,250).
107. Assume that the scales, software and calibration service are viewed as one
performance obligation. How much revenue will Ortiz recognize in 2018 for this
contract?
a. $0
b. $37,500
c. $63,000
d. $90,000
Answer: b
Level of Learning: 3 Hard
Learning Objective: 05-04
Topic Area: Mult perf oblig―When (or as) satisfied
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: If the contract has only one performance obligation, that revenue will be
recognized over time as the Ortiz provides the combination of scales, software and
calibration service. No revenue can be recognized upon delivery of the computer or
software. Since the contract has a one-year duration and commenced on August 1,
revenue for five months has been earned in 2018, equal to $37,500 (computed as $90,000
× 5/12).
108. A contract does not exist for purposes of applying the revenue recognition
principle in all of the following cases except for when:
a. The seller believes it is not probable that it will collect the amount it’s entitled to
receive under the contract.
b. The seller and buyer did not sign a formalized written contract.
c. The seller and buyer can terminate the contract without penalty and neither has
performed any obligations under the contract.
d. The seller believes it is highly likely but not certain that the buyer will agree to
the terms of the contract.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―General items
Blooms: Remember
5–36
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: The contract does not have to be written to exist for purposes of revenue
recognition.
109. Which of the following is a characteristic of a contract for purposes of revenue
recognition?
a. Commercial substance.
b. Nonverbal.
c. Reasonable profit margin.
d. Notarized within the company’s state of incorporation.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―General items
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: A contract must have commercial substance for revenue recognition to occur.
110. Waldman Associates received a written, approved contract to deliver economic
consulting services, with service and payment commencing in one month. The contract
specifies the services that Waldman is to perform, and the payment terms. Waldman and
the customer both can cancel the contract without penalty prior to commencing service.
Does Waldman have a contract for purposes of revenue recognition on the day the
contract is received?
a. Yes, because Waldman has a written approved contract.
b. No, because Waldman and the customer can cancel without penalty, and neither has
performed an obligation under the contract.
c. Maybe, depending on whether Waldman can estimate collectability of the receivable.
d. There is insufficient data on which to base an answer.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―General items
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: If both parties can cancel without penalty and the contract is wholly
unperformed, no contract exists for purposes of revenue recognition.
111. What is the effect of bad debts on revenue recognition?
5–37
a. The seller must believe it is probable it will collect the amounts it is entitled to
collect.
b. Bad debts must be of a remote likelihood in order to recognize revenue.
c. Bad debts are deducted from revenue to calculate net revenue on the income
statement, similar to sales returns.
d. Bad debts are ignored when determining whether to recognize revenue, but
recognized as an expense on the income statement.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-05
Topic Area: Contract features―General items
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: A contract does not exist for purposes of applying the revenue recognition
model if the seller believes it’s not probable that it will collect the amount it’s entitled to
receive under the contract.
112. Which of the following is considered a performance obligation?
a. Up-front registration fees for a gym membership
b. Extended warranties on electronic products
c. Quality-assurance warranties on electronic products
d. A processing fee to obtain a bank loan
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Identify the contract
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: An extended warranty represents a performance obligation. An up-front
registration fee and processing fee are prepayments, and a quality-assurance warranty
represents a promise to fulfill the performance obligation to provide goods of acceptable
quality.
113. Which of the following is not a performance obligation?
a. A good that the seller could sell separately and that is separately identifiable from
other goods or services in the contract.
b. A right of return.
c. An option for a customer to purchase goods under terms that are more advantageous
than those enjoyed by other customers.
5–38
d. An extended warranty.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Identify the contract
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Critical Thinking
Feedback: A right of return regards the completion of the performance obligation to
provide satisfactory goods in the first place, and so is not a separate performance
obligation.
114. Which of the following is an example of an extended warranty?
a. Fancy Headphones, Inc. provides assurance that its headphones are defect-free
after purchase.
b. Azalea’s Flowers assures clients that its flowers will stay fresh for at least a week.
c. Mark Electronics offers a warranty at an affordable price that provides additional
protection after the customer takes possession of the product.
d. Erickson Electronics promises to make repairs or replace any product found to be
defective within a week of purchase.
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-05
Topic Area: Contract features―Warranties
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: Industry
Feedback: Answer choices a, b, and d are examples of quality assurance warranties.
They are promises to fulfill the performance obligation to provide goods of acceptable
quality, rather than being performance obligations in their own right.
115. Orange Inc. offers a discount on an extended warranty on its oPhone when the
warranty is purchased at the time the oPhone is purchased. The warranty normally has a
price of $150, but Orange offers it for $120 when purchased along with an oPhone.
Orange anticipates a 75% chance that a customer will purchase the extended warranty
along with the oPhone. Assume Orange sells to 1,000 oPhones with the extended
warranty discount offer. What is the total stand-alone selling price that Orange would
use for the extended warranty discount option for purposes of allocating revenue among
the performance obligations in those 1,000 oPhone contracts?
5–39
a. $0
b. $22,500
c. $30,000
d. $120,000
Answer: b
Level of Learning: 3 Hard
Learning Objective: 05-05
Learning Objective: 05-06
Topic Area: Contract features―Warranties
Topic Area: Transaction price―Variable consideration
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: The $30 discount has a 75% chance of being taken by a customer, so the
stand-alone selling price associated with 1,000 oPhones is $22,500 (computed as $30 ×
75% × 1,000 phones).
116. In which of the following is the option described not a performance obligation?
a. Customers accumulate points for every dollar spent at Madeline’s Book Store.
The points can be redeemed for books once certain levels are met.
b. Customers can get 5% cash back for every $100 spent on eco-friendly products.
c. Customers can “buy two, get one free” at a menswear store.
d. Upon purchase of any name-brand TV, customers can purchase a 5-year extended
warranty at a 25% discount.
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-05
Topic Area: Contract features―Customer options
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Critical thinking
Feedback: 5% cash back is an adjustment of list price, and therefore must be considered
when calculating the transaction price. It is not a performance obligation.
117. Which of the following statement is most true?
a. Variable consideration means that the transaction price is uncertain.
b. Basing an estimate on the most likely amount is always superior to basing an
estimate on the expected value.
c. The most likely estimated amount is estimated by multiplying the possible
amounts with their respective probability of occurrence.
5–40
d. When the transaction price is uncertain, revenue should not be recognized.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Consideration is variable because it depends on the future resolution of some
uncertainty.
118. Which of the following is an example of a variable consideration?
a. John is expected to receive $100 for his tutoring services provided that he keeps
track of his hours.
b. Melody’s Piano will get paid for the 50 pianos sold provided that the pianos are
non-defective after the customer takes control.
c. Cantankerous Computers gets paid a base amount for every repair plus an
additional hourly fee of $10.
d. Excellent Electronics has a 10% mail-in rebate program for the Model X-001
speaker system. The company sold $10,000 worth of systems and believes there is
a 50% chance that rebates will be redeemed.
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
Feedback: The Excellent Electronics’ example is correct because it describes
consideration that has uncertainty that will be resolved by some future event. The
example of John’s tutoring services is not correct because it simply requires accurate
records in order to be paid a certain fee. The Melody’s Piano example is not correct
because it describes a quality assurance warranty, which does not change consideration
expected to be received. The Cantankerous Computers example is not correct because it
indicates a fee that is certain given the number of hours of service provided.
119. Which of the following is correct about changes in estimated variable
consideration?
a. Changes in estimated variable consideration should be recognized as an
adjustment to revenue in the period the change in estimate is made.
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b. Changes in estimated variable consideration should be applied retroactively to all
periods affected.
c. Changes in estimated variable consideration should be allocated retrospectively to
all prior periods.
d. Changes in estimated variable consideration are not recognized in periods after
transaction price is first estimated.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Like other changes in estimate, changes in estimated variable consideration are
applied prospectively, and should be recognized as an adjustment to revenue in the period
the change in estimate is made.
Use the following to answer questions 120 and 121:
On April 1st , Bob the Builder entered into a contract of one-month duration to build a
barn for Nolan. Bob is guaranteed to receive a base fee of $5,000 for his services in
addition to a bonus depending on when the project is completed. Nolan created incentives
for Bob to finish the barn as soon as he can without jeopardizing the structural integrity
of the barn. Nolan offered to pay an additional 30% of the base fee if the project finished
2 weeks early and 10% if the project finished a week early. The probability of finishing 2
weeks early is 30% and the probability of finishing a week early is 60%.
120. What is the expected transaction price with variable consideration estimated as
the expected value?
a. $4,750
b. $5,000
c. $5,500
d. $5,750
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–42
Feedback: The expected value of the transaction price is $5,750, computed as [$5,000
plus (30% × $5,000 × 30%) + (10% × $5,000 × 60%) + (0% × $5,000 x 10%)], or $5,000
+ 450 + 300 + 0.
121. What is the expected transaction price with variable consideration estimated as
the most likely amount?
a. $4,750
b. $5,000
c. $5,500
d. $5,750
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: The likelihood that the job is finished a week early = 60%, in which case it is
more likely that Bob would be paid the bonus than to not receive the bonus. The total
expected amount is $5,000 + ($5,000 × 10%) = $5,500.
Use the following to answer questions 122 – 124:
Sanjeev enters into a contract offering variable consideration. The contract pays him
$1,000/month for six months of continuous consulting services. In addition, there is a
60% chance the contract will pay an additional $2,000 and a 40% chance the contract will
pay an additional $3,000, depending on the outcome of the consulting contract. Sanjeev
concludes that this contract qualifies for revenue recognition over time.
122. Assume Sanjeev estimates variable consideration as the most likely amount. What
is the amount of revenue Sanjeev would recognize for the first month of the contract?
a. $1,000
b. $1,333
c. $1,400
d. $1,200
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Most likely amount
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Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: The most likely outcome is that Sanjeev receives the $2,000 bonus (likelihood
= 60%), in which case Sanjeev would be paid a total of ($1,000 × 6 months) + $2,000, or
$8,000. Therefore, Sanjeev would recognize $8,000 ÷ 6 = $1,333 each month.
123. Assume Sanjeev estimates variable consideration as the expected value. What is
the amount of revenue Sanjeev would recognize for the first month of the contract?
a. $1,000
b. $1,333
c. $1,400
d. $1,200
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: The expected value of the transaction price is $8,400, computed as $1,000 × 6
months + (60% × $2,000) + (40% × $3,000). Therefore, Sanjeev would recognize
$8,400 ÷ 6 = $1,400 each month.
124. Assume that Sanjeev estimates variable consideration as the most likely amount.
After Sanjeev has recognized revenue for two months of the contract, he changes his
assessment of the chance the contract will pay him $3,000 to 70%. What adjustment to
revenue should Sanjeev recognize to account for that change in estimate?
a. Debit of $1,000
b. Debit of $334
c. Credit of $1,000
d. Credit of $334
Answer: d
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–44
Feedback: In the first two months of the contract, the most likely outcome is that Sanjeev
receives a $2,000 bonus (likelihood = 60%), in which case Sanjeev would be paid a total
of ($1,000 × 6 months) + $2,000, or $8,000. Therefore, Sanjeev would recognize $8,000
÷ 6 = $1,333 each month, and after two months would have recognized $2,666. Then
Sanjeev concludes that the most likely outcome is that Sanjeev receives a $3,000 bonus
(likelihood = 70%), in which case Sanjeev would be paid a total of ($1,000 × 6 months) +
$3,000, or $9,000. Therefore, Sanjeev should have recognized $9,000 ÷ 6 = $1,500 each
month, and after two months should have recognized $3,000. The amount of adjustment
Sanjeev should record is a credit of $334, calculated as $3,000 – $2,666.
Use the following to answer questions 125 – 127:
On June 1, 2018, Emmet Property Management entered into a 2-year contract to oversee
leasing and maintenance for an apartment building. The contract starts on July 1, 2018.
Under the terms of the contract, Emmet will be paid a fixed fee of $50,000 per year and
will receive an additional 15% of the fixed fee at the end of each year provided that
building occupancy exceeds 90%. Emmet estimates a 30% chance it will exceed the
occupancy threshold, and concludes the revenue recognition over time is appropriate for
this contract.
125. Assume Emmet estimates variable consideration as the expected value. How
much revenue should Emmet recognize on this contract in 2018?
a. $25,000
b. $26,125
c. $28,750
d. $50,000
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: The expected value of the transaction price is $52,250 for one year, computed
as $50,000 + (30% × $50,000 × 15%). Since six months have elapsed, Emmet should
recognize revenue of $52,250 × 6/12 = $26,125.
126. Assume Emmet estimates variable consideration as the most likely amount. How
much revenue should Emmet recognize on this contract in 2018?
a. $25,000
b. $26,125
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c. $28,750
d. $50,000
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: The most likely amount to be received by Emmet is $50,000 per year. Since
there is a 30% chance of receiving an additional amount, there is a 70% (100% – 30%)
chance of not receiving any additional amount. Therefore the most likely amount of an
additional fee is zero. Since six months have elapsed, Emmet should recognize revenue
of only the fixed fee for that period: $50,000 × 6/12 = $25,000.
127. Assume that Emmet accrues revenue each month, and estimates variable
consideration as the most likely amount. On November 1, Emmet revises its estimate of
the chance the building will exceed the 90% occupancy threshold to a 70% chance. What
is the total amount of revenue Emmet should recognize on this contract in November of
2018?
a. $3,125
b. $4,167
c. $4,792
d. $7,291
Answer: d
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: In July, August, September, and October, Emmet would have based revenue
recognition on the most likely amount of $50,000, and so would have recognized revenue
of $50,000 × 4/12 = $16,667. Starting in November, Emmet believes the most likely
amount is $50,000 + ($50,000 × 15%) = $57,500, such that by the end of November
Emmet should have recognized revenue totaling $57,500 × 5/12 = $23,958. Therefore,
the amount of revenue Emmet should recognize in November to revise its estimate is
$7,291, calculated as $23,958 – $16,667.
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128. Which of the following is not an indicator that the constraint on recognizing
variable consideration should be applied?
a. Poor (limited) evidence on which to base an estimate
b. A broad range of outcomes that could occur
c. A short delay before uncertainty resolves
d. A history of the seller changing payment terms on similar contracts
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Variable consid constraint
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: A long delay before uncertainty resolves is an indicator that the constraint
applies.
129. On January 1, 2018, Elite Advertising was contracted to run a marketing
campaign for Pharm King’s new dieting pills. In addition to getting a base fee of
$150,000 for the 3-year campaign, Elite also may get an additional 5% of the base fee as
a bonus if a targeted sales level is reached at the end of three years. Elite currently lacks
sufficient information to make an estimate of the likelihood of the expected bonus, with
the marketing director indicating that “If you forced me to make an estimate, I’d say we
have a 50/50 chance. But don’t quote me on that – it’s really too early to tell.” Elite
concludes this contract qualifies for revenue recognition over time, and estimates variable
consideration using the most likely amount. How much revenue should Elite recognize as
of December 31, 2018?
a. $50,000
b. $51,250
c. $52,500
d. $57,500
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Topic Area: Transaction price―Variable consid constraint
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: Elite would not include the bonus in its estimate of the transaction price, as it
is not probable that the bonus revenue would not have to be reversed at a future date.
Therefore, Elite would use a $150,000 transaction price, and since it provided advertising
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services for 1/3 of the duration of the contract, would recognize revenue of $50,000 =
$150,000 × 1/3.
130. Boomerang Computer Company sells computers with an unconditional right to
return the computer if the customer is not satisfied. Boomerang has a long history selling
these computers under this returns policy and can provide precise estimates of the amount
of returns associated with each sale. Boomerang most likely should recognize revenue:
a. When Boomerang delivers a computer to a customer, ignoring potential returns.
b. When Boomerang delivers a computer to a customer, in an amount that is reduced
by the expected returns.
c. When Boomerang receives cash from the customer.
d. When a customer returns a computer.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Right of return
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
Feedback: Boomerang can estimate returns reliably enough for the constraint on
recognizing variable consideration to not apply, so Boomerang would adjust the
transaction price for expected returns and recognize revenue in that amount upon
delivery.
131. Gunk Goblin sells vacuums and just launched a policy where customers have the
right to return a vacuum during a three-year period following purchase. Gunk
management has no experience under this sort of policy and does not believe it can
accurately estimate returns. What is the longest period of time that Gunk may have to
wait before recognizing revenue associated with one of these sales?
a. No time delay, recognize revenue upon delivery.
b. Gunk should recognize revenue as cash is received.
c. Gunk should defer revenue recognition until costs are recovered.
d. Three years, after the right of return has expired.
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Right of return
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
5–48
Feedback: If returns can’t be estimated, the constraint on recognizing variable
consideration applies, and revenue should be deferred until returns can be estimated or
until the return of right expires.
132. Under which of the following circumstances is it most appropriate to use the
residual method to estimate stand-alone selling prices?
a. The seller hasn’t previously sold the product and hasn’t determined a price for it.
b. The seller provides the product bundled with other goods or services.
c. The seller does not have competitors from which to observe market prices of
similar products.
d. The seller is unable to accurately estimate variable consideration associated with
the contract.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Residual approach
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: The residual approach is allowed only if the stand-alone selling price is highly
uncertain, either because the seller hasn’t previously sold the good or service and hasn’t
yet determined a price for it, or because the seller provides the same good or service to
different customers at substantially different prices.
133. Which of the following is not an approach for estimating stand-alone selling
prices?
a. Adjusted market assessment approach
b. Expected cost plus margin approach
c. Residual approach
d. Fair market appraisal approach
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Expected cost plus margin
Topic Area: Transaction price―Residual approach
Topic Area: Transaction price―Adjusted market approach
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: The other three answers are the three methods indicated for assessing stand-
alone selling prices.
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Use the following to answer questions 134-136:
Wilson Links Products sells a product that involves two separate performance
obligations: the SwingRight golf club weight and the SwingCoach teaching software.
SwingRight has a stand-alone selling price of $150. Wilson sells both the SwingRight
and the SwingCoach as a package deal for $200. The SwingCoach software is not sold
separately. Wilson is aware that other vendors charge $100 for similar software, and
Wilson’s prices are generally 10% lower than what is charged by those vendors. Wilson
estimates that it incurs approximately $65 of cost per copy of the software, and usually
charges 50% above cost on similar products.
134. Estimate the stand-alone selling price of the software using the adjusted market
assessment approach.
a. $50
b. $80
c. $90
d. $97.50
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Adjusted market approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: Under the adjusted market assessment approach, Wilson considers the prices
charged by other vendors for similar goods and adjusts them as necessary. In this case,
Wilson would start with $100 charged by other vendors, and subtract 10% to estimate its
own stand-alone selling price, yielding an estimate of $90.
135. Estimate the stand-alone selling price of the software using the expected cost plus
margin approach.
a. $50
b. $80
c. $90
d. $97.50
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Expected cost plus margin
Blooms: Apply
AACSB: Knowledge application
5–50
AICPA: FN Measurement
Feedback: Under the expected cost plus margin approach, Wilson considers its cost and
then adds a normal margin. In this case, Wilson would start with its cost of $65 and add
its margin of $65 × 50%, or $32.50, yielding an estimate of $97.50.
136. Estimate the stand-alone selling price of the software using the residual approach.
a. $50
b. $80
c. $90
d. $97.50
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Residual approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: Under the residual approach, Wilson calculates the stand-alone selling price of
the software by subtracting the known stand-alone selling prices of other goods or
services in the contract from the total transaction price. In this case, Wilson would
calculate a stand-alone selling price of $50 (calculated as $200 – $150).
137. Which of the following does not apply to a seller who is a principal?
a. Has control over goods or services
b. Primarily responsible for providing goods or services to customer
c. Exposed to risks associated with holding inventory
d. Primary performance obligation is to facilitate the transfer of goods or services
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Legal
Feedback: An agent’s primary performance obligation is to facilitate the transfer of goods
or services.
138. Which of the following applies to a seller who is an agent?
a. Warehouses inventory
b. Liable for the delivery of goods or services to the client
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c. Charges a commission for each transaction
d. Records revenue at full transaction price
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Legal
Feedback: Agents recognize as revenue their commission for facilitating sales.
139. Explodia.com sells fireworks over the Internet. Customers access Explodia’s
website and select particular products, and Explodia refers the customer order to a
fireworks manufacturer who fulfills the order, ships to the customer, and pays Explodia a
20% commission. Which of the following is true about Explodia?
a. Explodia is an agent in this transaction.
b. Explodia is primarily responsible for providing the product to the customer.
c. Explodia’s income statement would report gross revenue and cost of sales
associated with these transactions.
d. Explodia warehouses inventory.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Critical thinking
Feedback: Explodia has the characteristics of an agent. It does not have control of the
fireworks that are purchased by customers, because it doesn’t have primary responsibility
for delivering the product, is not vulnerable to risks associated with holding inventory,
and doesn’t collect payment from the customer. Rather, Explodia is an agent, with its
primary performance obligation being to facilitate transactions between fireworks
customers and manufacturers.
140. Jing Statistical Services operates a website that links experienced statisticians
with businesses that need data analyzed. Statisticians post their rates, qualifications, and
references on the website, and Jing receives 25% of the fee paid to the statisticians in
exchange for identifying potential customers. VetMed Associates contacts Jing and
5–52
arranges to pay a consultant $1,500 in exchange for analyzing some data. Jing’s income
statement would include the following with respect to this transaction:
a. Revenue of $1,500
b. Revenue of $1,500, and cost of services of $1,125
c. Revenue of $375
d. Revenue of $1,875 and cost of services of $1,500
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: Jing is an agent. It doesn’t have primary responsibility for delivering the
statistics services and doesn’t collect payment from the customer. Rather, Jing is an
agent, with its primary performance obligation being to facilitate transactions between
customers and statisticians. Therefore, Jing would recognize as revenue only its
commission of $375 (computed as 25% x $1,500).
141. Assume a contract for the sale of goods specifies that payment is to be made four
months after delivery of a product. The seller is likely to do which of the following, with
respect to the time value of money over the life of the contract?
a. Recognize interest expense.
b. Recognize interest revenue.
c. Recognize additional cost of goods sold.
d. Ignore the time value of money.
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Time value of money
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: If the payment is made nine months after delivery, the seller is essentially
loaning money to the buyer. However, since the payment is within one year of delivery,
the financing component of the contract is viewed as insignificant, so the time value of
money is ignored.
142. Assume a contract for the sale of goods specifies that payment is to be made 15
months prior to delivery of a product. The seller is likely to do which of the following
with respect to the time value of money over the life of the contract?
a. Recognize interest expense.
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b. Recognize interest revenue.
c. Recognize additional cost of goods sold.
d. Ignore the time value of money.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Time value of money
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: If the payment is made fifteen months prior delivery, the contract includes a
financing component whereby the seller is essentially borrowing money from the
buyer. And, since the payment is outside one year of delivery, the financing
component is viewed as significant, so interest expense is recognized.
143. Johnson sells $100,000 of product to Robbins, and also purchases $10,000 of
advertising services from Robbins. The advertising services have a fair value of $8,000.
Johnson should record revenue on its sale of product to Robbins of:
a. $100,000
b. $98,000
c. $92,000
d. $90,000
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Pay by seller to customer
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: Johnson is paying more for advertising services than the fair value of those
services, so the excess of $2,000 (computed as $10,000 price paid – 8,000 fair value of
the services) is viewed as a refund of part of the $100,000 sale. Therefore, Johnson
records revenue of $98,000 (computed as $100,000 – 2,000).
144. Which of the following is not true?
a. Licensing fees are recognized as revenue over time whenever the seller expects its
ongoing activities to affect the benefits that the buyer receives from intellectual
property.
b. License fees are recognized as revenue over time for any license that is viewed as
providing a right of access.
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c. License fees are recognized as revenue at a point in time if the buyer expects that
the seller’s future activities will not affect the benefit the buyer derives from the
intellectual property.
d. Licensing fees are recognized as revenue at the end of the license period, when
the seller has completed its performance obligation to provide access to its
intellectual property.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: When (or as) performance obligation(s) satisfied – Licenses
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: If the seller provides access to its intellectual property, revenue is recognized
over the period of time for which access is provided, not deferred until the end of the
license period.
145. Which of the following is not true?
a. Licenses for functional intellectual property typically have revenue recognized at
a point in time.
b. Licenses for symbolic intellectual property convey a right of use, and not a right
of access.
c. Licenses for functional intellectual property can be viewed as conveying an
access right.
d. Software and media are examples of functional intellectual property.
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Licenses for symbolic intellectual property convey a right of access.
146. Maas LLP developed software that helps farmers to plow their fields in a manner that
prevents erosion and maximizes the effectiveness of irrigation. Sunny Dale paid a licensing
fee of $20,000 for a copy of the software. Although Sunny Dale can use the software as long
as it wants, Maas expects that Sunny Dale will use the software for approximately 5 years.
Maas does not anticipate any further interaction with Sunny Dale following transfer of the
license. How much revenue should Maas recognize in the first year of the contract?
a. $0
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b. $4,000
c. $5,000
d. $20,000
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: Industry
Feedback: Because Maas’s ongoing activities will not affect the value of the license, the
software has standalone functionality, and the license transfers a right of use. Therefore,
all license revenue can be recognized upon transfer of control of the software to the
customer.
Use the following to answer questions 147 – 148:
The Ultimate Frisbee League (UFL) licenses its trademark to Tank-Skin Apparel.
Under the license arrangement, Tank-Skin pays the UFL a $1 million initial license fee
plus a bonus when annual sales of Tank-Skin merchandise reach a threshold. The
license agreement is for 4 years.
147. How much of the $1 million initial license fee should the UFL recognize as
revenue in the first year of the contract?
a. $0
b. $250,000
c. $1,000,000
d. Cannot tell from information given.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: When (or as) performance obligation(s) satisfied – Licenses
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: The license is for symbolic intellectual property, so the presumption is that
the UFL’s ongoing activities affect the value of the trademark to Tank-Skin, and the UFL
should recognize revenue over time. Therefore, the amount of $1 million initial license
fee that the NFL should recognize as revenue is $250,000 (computed as $1 million ÷ 4
years).
5–56
148. Refer to the information in the previous question. Assume that the UFL anticipates that,
in addition to receiving the $1 million license fee, it will receive a bonus of $2 million in year
1 of the contract and a bonus of $3 million in years 2-4 of the contract based on Tank-Skin’s
sales. Also assume that the UFL is convinced that it is probable there will not be a
significant reversal of any revenue recognized with respect to the bonus in subsequent
periods. At the inception of the contract, what is the amount of transaction price that the
UFL would estimate with respect to this license arrangement?
a. $0
b. $1,000,000
c. $3,000,000
d. 12,000,000
Answer: b
Level of Learning: 3 Hard
Learning Objective: 05-06
Learning Objective: 05-07
Topic Area: Transaction price―Variable consideration
Topic Area: Timing of rev rec―Licenses
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Normally the UFL would include an estimate of variable consideration in its
estimate of the transaction price, yielding an estimate of $12 million (computed as $1
million initial fee + $2 million year 1 bonus + ($3 million × 3 years for subsequent-year
bonuses). However, ASU No. 2014-09 does not allow estimates of sales-based royalties
on licenses to be included in the transaction price until that consideration is no longer
variable, so those amounts would be excluded from the transaction price estimated at the
inception of the contract, and the transaction price would only include the $1 million
initial fee.
Use the following to answer questions 149 and 150:
The Fremont (Ireland) Flyers were a semi-professional carriage racing team that competed up
until the early 1930’s. Mary Smith owns the Fremont Fliers’ trademark, and recently licensed it
to the Fremont (California) Flyers roller derby team. The license allows the roller derby team to
use the trademark for five years for a total of $15,000.
149. Under U.S. GAAP, how much revenue would Mary recognize in year 1 of the license?
a. $0
b. $1,500
c. $3,000
d. 15,000
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Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-03
Learning Objective: 05-07
Topic Area: Recognizing revenue over time
Topic Area: Timing of rev rec―Licenses
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: A trademark is symbolic intellectual property, so U.S. GAAP requires
recognizing revenue over time. $15,000 ÷ 5 years = $3,000 revenue recognized in year 1
of the license.
150. Under IFRS, how much revenue would Mary recognize in year 1 of the license?
a. $0
b. $1,500
c. $3,000
d. 15,000
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: IFRS―Revenue recognition
Blooms: Apply
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
Feedback: Even though a trademark is symbolic intellectual property, IFRS requires the seller to
focus on whether the seller is providing continuing service over the license period. Given that
the old Fremont Flyers have not operated in almost 100 years, there are no ongoing activities
associated with the trademark, so IFRS would view the license as conveying a right of use and
recognize all $15,000 in the first year of the license.
151. Which of the following is not true about accounting for revenue from franchise
arrangements?
a. Franchise arrangements often include a performance obligation for a license as
well as for delivery of goods or services.
b. Franchise arrangements typically include one or more performance obligations for
which revenue is recognized at a point in time.
c. Franchise arrangements typically include one or more performance obligations for
which revenue is recognized over a period of time.
d. Franchise arrangements typically include one performance obligation because the
goods or services included in the arrangement are not separately identifiable.
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Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Franchises
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Franchise arrangements typically include multiple performance obligations
because the goods or services included in the arrangement are both capable of being
distinct and are separately identifiable.
152. Pita Pal sells fast-food franchises. Pita Pal receives $75,000 from a new franchisee for
providing initial training, equipment, and furnishings that together have a stand-alone selling
price of $75,000. Pita Pal also receives $36,000 per year for use of the Pita Pal name and for
ongoing consulting services (starting on the date the franchise is purchased). Rachel became
a Pita Pal franchisee on March 1, 2018, and on May 1, 2018 Rachel had completed training
and was open for business. How much revenue in 2018 will Pita Pal recognize for its
arrangement with Rachel?
a. $75,000
b. $99,000
c. $105,000
d. $111,000
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Franchises
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Because Rachel had completed training and was open for business on May 1,
2018, Pita Pal apparently has satisfied its performance obligation with respect to the
initial training, equipment and furnishings, so it would recognize $75,000 of revenue in
2018. In addition, since Rachel was a franchisee and using the Pita Pal name and
consulting services for the last ten months of 2018, Pita Pal should recognize 10 ÷ 12 of a
yearly fee of $36,000, or $30,000. In total, Pita Pal recognizes revenue from Rachel of
$75,000 + 30,000 = $105,000 in.2018.
153. Which of the following is typically true for a bill-and-hold arrangement?
a. Revenue is recognized at the point in time when the arrangement is made.
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b. Revenue is recognized at the point in time when goods are manufactured.
c. Revenue is recognized at the point in time when the delivery of goods is made.
d. Revenue is recognized at the point in time at which payment from the customer is
received.
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Bill-and-hold
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Bill-and-hold arrangements normally do not qualify for revenue recognition
until delivery is made to the customer. Prior to that point, control of goods is not viewed
as having passed to the customer.
154. On June 1st , Joseph & Company received a $500 deposit for 80 cases of wine. On
June 10th the customer identified specific vintages that are included in Joseph’s inventory,
and asked that Joseph not ship the wine until June 20 so the customer could ready space
to store the wine, so Joseph set those wines aside for the customer, boxed and ready for
shipment to the customer. On June 20th the wine was shipped and delivered to the
customer. Joseph likely would recognize revenue on
a. June 20th
b. June 10th
c. June 1st
d. Upon consumption of the wine by the customer
Answer: b
Level of Learning: 3 Hard
Learning Objective: 05-07
Topic Area: Timing of rev rec―Bill-and-hold
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
Feedback: Bill-and-hold arrangements normally do not qualify for revenue recognition
until delivery is made to the customer. Prior to that point, control of goods is not viewed
as having passed to the customer. However, sellers can recognize revenue prior to
delivery if it is concluded that the customer controls the product (the customer
specifically identified the goods), there is good reason for the bill-and-hold arrangement
(the customer needed time to make space for the wine), and the product is specifically
identified as belonging to the customer and is ready for shipment (Joseph has a good faith
deposit, the customer selected the goods, the goods were prepared for shipment and set
aside from regular goods for sale).
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155. Which of the following is most true regarding consignment arrangements?
a. Revenue is recognized at the point in time when the consignment arrangement is
made.
b. Revenue is recognized when goods are transferred to the consignee.
c. Revenue is recognized upon sale by the consignee to an end customer.
d. Revenue is never recognized because GAAP does not allow such arrangements.
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Consignment
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Consignment arrangements normally do not qualify for revenue recognition
until delivery is made to the end customer. Prior to that point, control of goods is viewed
as having been retained by the consignor, not by the consignee.
Use the following to answer questions 156 –157:
Todd Sweeney is an artist who sells his work under consignment (he displays his work in local
barbershops, and customers purchase his work there). Sweeney recently transferred a painting on
consignment to a local barbershop.
156. Sweeney most likely should recognize revenue when:
a. He paints the painting, because the painting is produced while he works.
b. When he transfers the painting to a barbershop.
c. When the barbershop sells the painting.
d. When the barbershop’s right of return expires.
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Consignment
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
Feedback: Consignment arrangements normally do not qualify for revenue recognition
until delivery is made to the end customer. Prior to that point, control of goods is viewed
as having been retained by the consignor, not by the consignee.
157. After Sweeney has transferred a painting to a barbershop, the painting:
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a. Should be counted in Sweeney’s inventory until the barbershop sells it.
b. Should be counted in the barbershop’s inventory, as the barbershop now possesses
it.
c. Should be counted in either Sweeney’s or the barbershop’s inventory, depending
on which incurred the cost of preparing the painting for display.
d. We lack sufficient information to know who should carry the painting in
inventory.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Consignment
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Consignment arrangements normally do not qualify for revenue recognition
until delivery is made to the end customer. Prior to that point, control of goods is viewed
as having been retained by the consignor, not by the consignee, so the consignor retains
the goods in the consiginor’s inventory. In this case, that means that Sweeney will retain
the painting in its inventory until the painting is sold to an end customer.
158. Bull’sEye sells gift cards redeemable for Bull’sEye products either in-store or
online. During 2018, Bull’sEye sold $2,000,000 of gift cards, and $1,800,000 of the gift
cards were redeemed for products. As of December 31, 2018, $150,000 of the remaining
gift cards had passed the date at which Bull’sEye concludes that the cards will never be
redeemed. How much gift card revenue should Bull’sEye recognize in 2018?
a. $2,000,000
b. $1,950,000
c. $1,850,000
d. $1,800,000
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec― Gift cards
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: Sale of a gift card created deferred revenue, as it is a prepayment by a
customer for goods or services to be delivered at a future date. Revenue is recognized
when goods or services are delivered or when the likelihood of redemption is remote. In
this case, $1,800,000 were redeemed and another $150,000 were viewed as broken,
yielding total revenue of $1,950,000.
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159. Which of the following is not true about contract assets?
a. Contract assets are recorded when payment depends on something other than the
passage of time.
b. Contract assets are recognized when the seller has a conditional right to receive
payment.
c. Contract assets are recognized when the seller has been paid in advance for at
least partially fulfilling its performance obligations.
d. Contract assets are not the same as accounts receivable.
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-08
Topic Area: Disclosures―Balance sheet and Notes
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Contract assets are recognized when the seller has at least partially fulfilled its
performance obligations but not yet been paid, and payment depends on something other
than the passage of time.
160. Which of the following is not true about contract liabilities?
a. Contract liabilities are only recognized when the seller has a conditional right to
receive payment.
b. Contract liabilities might be called deferred revenue.
c. Contract liabilities are recognized when the seller has been paid in advance of
satisfying its performance obligations.
d. Contract liabilities may be shown on a separate line of the balance sheet.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-08
Topic Area: Disclosures―Balance sheet and Notes
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Contract liabilities are not conditional obligations. They are an obligation that
arises due to a customer prepayment.
161. Gupta Industries received a $300,000 prepayment from Packard Associates for
the sale of new equipment. Gupta will bill Packard an additional $100,000 upon delivery
of the equipment. Upon receipt of the $300,000 prepayment, how much should Gupta
recognize for a contract asset, a contract liability, and accounts receivable?
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a. Contract asset: $0; contract liability: $300,000, accounts receivable, $0.
b. Contract asset: $300,000; contract liability: $0, accounts receivable, $0.
c. Contract asset: $0; contract liability: $300,000, accounts receivable, $100,000.
d. Contract asset: $300,000; contract liability: $0, accounts receivable, $100,000.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-08
Topic Area: Disclosures―Balance sheet and Notes
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: The $300,000 is a prepayment and so is a contract liability. The $100,000
owed upon delivery is neither a contract asset nor an account receivable, because Gupta
has not fulfilled its performance obligation and so has neither a conditional nor an
unconditional right to receive payment.
162. Which of the following is not something that revenue recognition disclosures
typically should help investors to understand?
a. Timing of revenue and cash flows
b. Outstanding performance obligations
c. Significant judgments used to estimate transaction prices
d. Significant fluctuations in long-term debt necessary to increase revenue in the
future
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-08
Topic Area: Disclosures―Balance sheet and Notes
Blooms: Understand
AACSB: Reflective thinking
AICPA: BB Critical Thinking
Feedback: Long-term debt fluctuations to finance future revenue increases are not
specific to revenue recognition practices, so are least likely to appear with revenue
recognition disclosures.
163. Which of the following is not true about revenue recognition with respect to long-
term construction contracts?
a. Long-term construction contracts often are viewed as having a single performance
obligation, because goods or services fail the “separately identifiable” criterion.
b. Long-term construction contracts often satisfy the criteria for recognizing revenue
over time.
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c. Long-term construction contracts require accounting for construction in progress
as well as billings to customers.
d. Long-term construction contracts typically include multiple performance
obligations because of all the different types of goods or services included for
each project.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-08
Topic Area: Long-term contracts―Accounting issues
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Long-term contracts include goods or services that are highly interrelated, so
they are not viewed as separately identifiable and are combined into a single performance
obligation. Long-term contracts often qualify for revenue recognition over time, either
because the customer owns the seller’s work in process, such that the seller is creating an
asset that the customer controls as it is completed, or because the seller is creating an
asset that is customized for the customer, so the seller has no other use for the asset and
has the right to be paid for progress even if the customer cancels the contract.
164. Which of the following is least likely to be a reason why a long-term construction
contract would qualify for revenue recognition over time?
a. The customer consumes the benefit of the seller’s work as it is performed.
b. The customer controls the asset as it is created.
c. The seller is creating an asset that has no alternative use to the seller, and the
seller has the legal right to receive payment for progress to date.
d. The seller is constructing an addition to property that is owned by the customer.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-08
Topic Area: Long-term contracts―Accounting issues
Topic Area: Long-term contracts―Percentage complete
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: A construction contract is least likely to be viewed as a service that the
customer consumes as it is provided. Long-term contracts often qualify for revenue
recognition over time for the other two reasons: either because the customer owns the
seller’s work in process, such that the seller is creating an asset that the customer controls
as it is completed (which would be the case if the seller is constructing an addition to
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property that is owned by the customer), or because the seller is creating an asset that is
customized for the customer, so the seller has no other use for the asset and has the right
to be paid for progress even if the customer cancels the contract.
165. Which of the following is true about accounting for contract assets (CIP in excess
of billings) in each balance sheet prior to completion of long-term construction contracts?
a. Contract assets are likely to be larger if revenue is recognized over time than if
revenue is recognized at a point in time.
b. Contract assets are likely to be smaller if revenue is recognized over time than if
revenue is recognized at a point in time.
c. Contract assets are likely to be the same size regardless of whether revenue is
recognized over time or at a point in time.
d. There is no way to tell how revenue recognition timing will affect the size of
contract assets without more information.
Answer: a
Level of Learning: 3 Hard
Learning Objective: 05-08
Topic Area: Long-term contracts―Accounting issues
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Construction in progress includes both cost and gross profit (or overall
contract loss) when revenue is recognized over time, but only cost (and overall contract
loss) when revenue is recognized upon contract completion, so the contract asset is likely
to be larger when revenue is recognized over time.
166. Which of the following is not true about accounting for long-term construction
contracts?
a. Long-term construction contracts could show a contract asset or contract liability,
depending on the relation between construction in progress and billings.
b. Billings on contracts in progress is a contra account to accounts receivable.
c. Gross profit is debited to construction in progress.
d. When a customer is billed for payment due, billings on contracts in progress is
credited at the same time accounts receivable is debited.
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-08
Topic Area: Long-term contracts―Accounting issues
Blooms: Analyze
AACSB: Analytical thinking
5–66
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Billings is contra to Construction in progress, not Accounts receivable.
167. A rationale for recognizing revenue over the life of a contract rather than at a
single point in time is that:
a. Results are more conservative.
b. It provides a better measure of periodic accomplishment.
c. It is a better match with legal ownership.
d. It results in a lower income tax.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-09
Topic Area: Long-term contracts―Accounting issues
Topic Area: Long-term contracts―Percentage complete
Blooms: Remember
AACSB: Reflective thinking
AICPA: BB Critical Thinking
Feedback: Recognizing revenue over time better conveys the benefit to the company of
satisfying performance obligations over time.
168. Revenue on a long-term contract should not be recognized according to the
proportion of the performance obligation that has been completed if:
a. Completion rates are certain.
b. Profits are low.
c. Projects are more than five years to completion.
d. The arrangement does not qualify for revenue recognition over time.
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-09
Topic Area: Long-term contracts―Accounting issues
Topic Area: Long-term contracts―Percentage complete
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: The same three criteria for determining whether it is appropriate to recognize
revenue over time apply to long-term contracts as apply to other contracts.
169. With respect to delaying revenue recognition until completion of a long-term
contract, it is the case that:
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a. Estimated losses on the overall contract are recognized before the contract is
completed.
b. Expenses are recognized each period, but revenue is only recognized when the
contract is completed.
c. Use of this approach is not permitted under generally accepted accounting principles.
d. Neither gains nor losses are recognized until the contract is completed.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-09
Topic Area: Long-term contracts―Accounting issues
Topic Area: Long-term contracts―Upon completion
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
Feedback: Even when revenue recognition over time is not appropriate, such that
revenue recognition is delayed until the completion of a contract, estimated losses on the
overall contract are recognized in the period in which the company realizes that those
losses become evident.
170. When accounting for revenue over time for a long-term contract, the percentage
of completion used to recognize revenue in the first year usually is determined by
measuring:
a. Costs incurred in the first year, divided by estimated remaining costs to complete the
project.
b. Costs incurred in the first year, divided by estimated total costs for the completed
project.
c. Costs incurred in the first year, divided by estimated gross profit.
d. Costs incurred in the first year, divided by estimated total costs to be incurred in the
remaining years of the project.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Use of a “cost-to-cost” ratio to estimate percentage of completion is typical.
Use the following to answer questions 171–173:
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Arizona Desert Homes (ADH) constructed a new subdivision during 2017 and 2018 under
contract with Cactus Development Co. Relevant data are summarized below:
Contract
amount
$3,000,000
Cost: 2017
1,200,000
2018 600,000
Gross profit: 2017 800,000
2018 400,000
Contract
billings:
2017 1,500,000
2018 1,500,000
ADH recognizes revenue over time with respect to these contracts.
171. What would be the journal entry made in 2017 to record revenue?
a. Accounts receivable 1,500,000
Revenue from long-term
contracts
1,500,000
b. Accounts receivable 2,300,000
Gross profit 800,000
Revenue from long-term
contracts
1,500,000
c. Construction in progress 800,000
Cost of construction 1,200,000
Revenue from long-term
contracts
2,000,000
d. Accounts receivable 1,500,000
Billings in excess of cost 300,000
Revenue for long-term contracts 1,800,000
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
AACSB: Knowledge Application
AICPA: FN Measurement
AICPA: BB Industry
Feedback:
Percentage complete = $1,200,000 / ($1,200,000 + $600,000) = 2/3
Revenue recognized = 2/3 x $3,000,000 = $2,000,000
Cost recognized = $1,200,000
Gross profit recognized = $2,000,000 – $1,200,000 = $800,000
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172. In its December 31, 2017, balance sheet, ADH would report:
a. The contract asset, cost and profits in excess of billings, of $500,000.
b. The contract liability, billings in excess of cost, of $300,000.
c. The contract asset, contract amount in excess of billings, of $1,500,000.
d. The contract asset, deferred profit, of $400,000.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
Blooms: Analyze
AACSB: Knowledge application
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback:
Cost + profits: $1,200,000 + 800,000 = $2,000,000
Billings: 1,500,000
Excess: $ 500,000
173. For 2018, what is the journal entry to record revenue?
a. Accounts receivable 1,500,000
Revenue from long-term
contracts
1,500,000
b. Construction in progress 400,000
Cost of construction 600,000
Revenue from long-term
contracts
1,000,000
c. Cost of construction 2,000,000
Gross profit 1,000,000
Revenue from long-term
contracts
3,000,000
d. Accounts receivable 1,500,000
Cost of construction 600,000
Gross profit 600,000
Deferred revenue 300,000
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
5–70
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback:
Total revenue $3,000,000 – Revenue previously recognized $2,000,000 = Revenue to
recognize this year $1,000,000.
Cost recognized = $600,000
Gross profit recognized = $1,000,000 – $600,000 = $400,000
Use the following to answer questions 174–176:
Arizona Desert Homes (ADH) constructed a new subdivision during 2017 and 2018 under
contract with Cactus Development Co. Relevant data are summarized below:
Contract
amount
$3,000,000
Cost: 2017
1,200,000
2018 600,000
Gross profit: 2017 800,000
2018 400,000
Contract
billings:
2017 1,500,000
2018 1,500,000
ADH recognizes revenue upon completion of the contract.
174. For 2017, what is the journal entry to record revenue?
a. Accounts receivable 1,500,000
Revenue from long-term
contracts
1,500,000
b. Accounts receivable 2,300,000
Gross profit 800,000
Revenue from long-term
contracts
1,500,000
c. Construction in progress 800,000
Cost of construction 1,200,000
Revenue from long-term
contracts
2,000,000
d. No entry.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-09
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Topic Area: Long-term contracts―Upon completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: When the contract revenue is recognized upon completion of the contract, no
entry would be recorded.
175. In its December 31, 2017, balance sheet, ADH would report:
a. The contract asset, cost and profits in excess of billings, of $500,000.
b. The contract liability, billings in excess of cost, of $300,000.
c. The contract asset, contract amount in excess of billings, of $1,500,000.
d. The contract asset, deferred profit, of $400,000.
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Upon completion
Blooms: Apply
Blooms: Analyze
AACSB: Knowledge application
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback:
Cost + profits: $1,200,000 + 0 = $1,200,000
Billings: 1,500,000
Excess: $ (300,000)
176. What is the journal entry in 2018 to record revenue?
a. Accounts receivable 1,500,000
Revenue from long-term
contracts
1,500,000
b. Construction in progress 400,000
Cost of construction 600,000
Revenue from long-term
contracts
1,000,000
c. Cost of construction 2,000,000
Gross profit 1,000,000
Revenue from long-term
contracts
3,000,000
d. Construction in progress 1,200,000
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Cost of construction 1,800,000
Revenue from long-term
contracts
3,000,000
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Upon completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: When revenue is recognized at a point in time for long-term contracts, total
revenue, total cost, and total gross profit are recognized at the completion of the contract.
Use the following to answer questions 177–179:
JRE2 Inc. entered into a contract to install a pipeline for a fixed price of $2,200,000. JRE2
recognizes revenue upon contract completion.
Cost incurred Estimated Cost to
Complete
2017 $ 250,000 $1,550,000
2018 1,600,000 500,000
2019 450,000 0
177. In 2017, JRE2 would report (rounded to the nearest thousand) gross profit (loss)
of:
a. $0.
b. $(100,000).
c. $ 56,000.
d. $ 73,000.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Upon completion
Topic Area: Long-term contracts―Loss on contract
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: Total estimated gross profit ($2,200,000 – 250,000 – 1,550,000 = $400,000),
so don’t need to recognize any contract loss.
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178. In 2018, JRE2 would report (rounded to the nearest thousand) gross profit (loss)
of:
a. $(223,000).
b. $(150,000).
c. $(206,000).
d. $0.
Answer: b
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Upon completion
Topic Area: Long-term contracts―Loss on contract
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
In 2018: $2,200,000 – ($250,000 + 1,600,000 + 500,000) = $(150,000) loss to recognize.
179. In 2019, JRE2 would report (rounded to the nearest thousand) gross profit (loss)
of:
a. $(100,000).
b. $50,000.
c. $123,000.
d. $2,000.
Answer: b
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Upon completion
Topic Area: Long-term contracts―Loss on contract
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
In 2019: $2,200,000 – ($250,000 + 1,600,000 + 450,000) = $(100,000)
$(100,000) – (150,000) = $50,000
Use the following to answer questions 180 – 182:
Indiana Co. began a construction project in 2018 with a contract price of $150 million to be
received when the project is completed in 2020. During 2018, Indiana incurred $36 million of
costs and estimates an additional $84 million of costs to complete the project. Indiana
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recognizes revenue over time and for this project recognizes revenue over time according to the
percentage of the project that has been completed.
180. Indiana:
a. Recognized no gross profit or loss on the project in 2018.
b. Recognized $6 million loss on the project in 2018.
c. Recognized $9 million gross profit on the project in 2018.
d. Recognized $36 million loss on the project in 2018.
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: The project is expected to make a gross profit of $30 million (i.e., $150
million – $36 million – $84 million) and the % completed is 30% (i.e., $36 million / $120
million). Therefore, 30% x $30 million = $9 million.
181. In 2019, Indiana incurred additional costs of $58.5 million and estimated an
additional $40.5 million in costs to complete the project. Indiana:
a. Recognized $15 million gross profit on the project in 2019.
b. Recognized $13.5 million gross profit on the project in 2019.
c. Recognized $6 million gross profit on the project in 2019.
d. Recognized $1.5 million gross profit on the project in 2019.
Answer: d
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: The project is 70% complete after 2019 (i.e., $94.5 million costs to date/ $135
million estimated total costs). The estimated gross profit is now $15 million (i.e., $150
million – $135 million), so gross profit to date is $10.5 million (70% x $15 million). $9
million was recognized in 2018, per prior question, so $1.5 million more is recognized in
2019.
5–75
182. Suppose that, in 2019, Indiana incurred additional costs of $63.75 million and
estimated an additional $42.75 million in costs to complete the project. Indiana:
a. Recognized $3.75 million loss on the project in 2019.
b. Recognized $5.25 million gross profit on the project in 2019.
c. Recognized $7.5 million gross profit on the project in 2019.
d. Recognized $1.5 million loss on the project in 2019.
Answer: a
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Topic Area: Long-term contracts―Loss on contract
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: The project is 70% complete after 2019 (i.e., $99.75 million costs to date/
$142.5 million estimated total costs). The estimated gross profit is now $7.5 million (i.e.,
$150 million – $142.5 million), so gross profit to date is $5.25 million. $9 million was
recognized in 2018, so a $3.75 million loss is recognized in 2019.
Use the following to answer questions 183–187:
In 2018, Cupid Construction Co. (CCC) began work on a two-year fixed price contract project.
CCC recognizes revenue over time according to percentage of completion for this contract, and
provides the following information (dollars in millions):
Accounts receivable, 12/31/2018 (from construction progress
billings)
$37.5
Actual construction costs incurred in 2018 $135
Cash collected on project during 2018 $105
Construction in progress, 12/31/2018 $207
Estimated percentage of completion during 2018 60%
183. What is the amount of gross profit on the project recognized by CCC during
2018?
a. $160 million.
b. $72 million.
c. $48 million.
d. Cannot be determined from the given information.
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-09
5–76
Topic Area: Long-term contracts―Percentage complete
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Construction in progress = Actual costs incurred + Gross profit recognized;
so $207 million = $135 million + X. Solve for X. X = $72 million.
184. What are CCC’s estimated remaining construction costs on the project at the end
of 2018?
a. $90 million.
b. $135 million.
c. $225 million.
d. $0.
Answer: a
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Percentage completion to date = 60 % = Actual costs to date of $135 million /
Total estimated project costs of $X. Solve for X. Estimated total costs = $225 million;
therefore, Estimated remaining costs of construction = $225 million – $135 million = $90
million.
185. What is the fixed contract price for CCC’s project?
a. $120 million.
b. $225 million.
c. $345 million.
d. $349.5 million.
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Gross profit recognized in 2018 of $72 million = 60% of estimated gross
5–77
project on the project. Therefore, total gross profit is estimated at $72 million/.6 = $120
million. Since Gross profit = Contract price – Estimated total construction costs of $225
million, the Contract price = $120 million + $225 million = $345 million. Alternatively,
construction in progress = cost to date + profit recognized to date = $207 million (given)
= 60% of total project price. $207 million/.6 = $345 million contract price.
186. What were the construction billings by CCC during 2018?
a. $142.5 million.
b. $67.5 million.
c. $37.5 million.
d. Cannot be determined from the given information.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Billings – Cash collections = Accounts receivable, so Billings = Accounts
receivable at year-end of $37.5 million + Cash collections of $105 million = $142.5
million.
187. How much cash remains to be collected by CCC on the project?
a. $70 million.
b. $202.5 million.
c. $240 million.
d. Cannot be determined from the given information.
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Total contract price of $345 million – cash collected to date of $105 million =
$240 million remaining.
Use the following to answer questions 188 – 190:
5–78
Summary data for Benedict Construction Co.’s (BCC) Job 1227, which was completed in 2018,
are presented below:
Bid price $450,000
Contract cost: 2017 (180,000 )
2018 (195,000 )
Gross profit: 75,000
Estimated cost to
complete:
12/31/2017 $200,000
12/31/2018 0
188. Assuming BCC recognizes revenue over time according to percentage of
completion for this contract, the gross profit recognized in 2017 would be (rounded to the
nearest thousand):
a. $33,000.
b. $36,000.
c. $69,000.
d. $30,000.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: $180,000/($180,000 + 200,000) = 47.37% complete
47.37% x ($450,000 – 180,000 – 200,000) = $33,159 or $33,000 rounded.
189. Assuming BCC recognizes revenue over time according to percentage of
completion for this contract, the gross profit recognized in 2018 would be (rounded to the
nearest thousand):
a. $ 6,000.
b. $39,000.
c. $42,000.
d. $45,000.
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-09
5–79
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: 2018: Total profit = $450,000 – ($180,000 + 195,000) = $75,000 – 33,159 =
$41,841 or $42,000 rounded.
190. Assuming BCC recognizes revenue upon project completion, what would gross
profit have been in 2017 and 2018 (rounded to the nearest thousand)?
2017 2018
a. $36,000 $39,000
b. $30,000 $45,000
c. $70,000 $ 5,000
d. $ 0 $75,000
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-09
Topic Area: Long-term contracts―Upon completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: No revenue is recognized until completion of project in year 2018.
191. Under the realization principle, revenue should not be recognized until the
earnings process is deemed virtually complete and:
a. Revenue is realized.
b. Any receivable is collected.
c. Collection is reasonably certain.
d. Collection is absolutely assured.
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Realization principle
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
5–80
192. Under IFRS, which of the following is not a condition for recognizing revenue?
a) The amount of revenue and costs associated with the transaction can be measured
reliably.
b) It is reasonably possible that the economic benefits associated with the transaction
will flow to the seller.
c) For sales of goods, the seller has transferred to the buyer the risks and rewards of
ownership and doesn’t effectively manage or control the goods.
d) For sales of services, the stage of completion can be measured reliably.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Remember
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
193. Under IFRS, revenue for a product sale should occur when:
a) Inventory production is complete.
b) Warranty fulfillment is viewed as unlikely.
c) The seller has transferred to the buyer the risks and rewards of ownership and doesn’t
effectively manage or control the goods.
d) The buyer has paid a preponderance of installment amounts due.
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Remember
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
194. Slick’s Used Cars sells pre-owned cars on the installment basis and carries its own
notes because its customers typically cannot qualify for a bank loan. Default rates tend to
be high or unpredictable. However, in the event of nonpayment, Slick’s can usually
repossess the cars without loss. The revenue method Slick would use is the:
a) Installment sales method.
b) Point of sales method.
c) Cost recovery method.
5–81
d) Installment sales method or cost recovery method.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
195. Bert’s Meat Market sells quarters and sides of beef on the installment basis.
Losses on receivables are very difficult to predict, and meat products cannot be
repossessed. The revenue recognition method used by Bert would be:
a) Point of sale.
b) Installment sales.
c) Cost recovery.
d) Installment sales or cost recovery.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
Use the following to answer questions 196 – 199:
On December 15, 2018, Rigsby Sales Co. sold a tract of land that cost $3,600,000 for
$4,500,000. Rigsby appropriately uses the installment sales method of accounting for this
transaction. Terms called for a down payment of $500,000 with the balance in two equal annual
installments payable on December 15, 2019, and December 15, 2020. Ignore interest charges.
Rigsby has a December 31 year-end.
196. In 2018, Rigsby would recognize realized gross profit of:
a. $500,000.
b. $0.
c. $900,000.
d. $100,000.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
5–82
Topic Area: Chapter Supp―Installment sales method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
Gross profit % = ($4,500,000 – 3,600,000)/$4,500,000 = 20%
2018: 20% x $500,000 = $100,000
197. In 2019, Rigsby would recognize realized gross profit of:
a. $0.
b. $450,000.
c. $300,000.
d. $400,000.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
Gross profit % = ($4,500,000 – 3,600,000)/$4,500,000 = 20%
2018: 20% x $500,000 = $100,000
2019: 20% x [($4,500,000 – 500,000)/2] = $400,000
198. In its December 31, 2018, balance sheet, Rigsby would report:
a. Realized gross profit of $100,000.
b. Deferred gross profit of $100,000.
c. Installment receivables (net) of $3,200,000.
d. Installment receivables (net) of $4,000,000.
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
Sale: Installment receivables 4,500,000
Inventory 3,600,000
Deferred gross profit 900,000
5–83
Payment: Cash 500,000
Installment receivables 500,000
Deferred gross profit 100,000
Realized gross profit 100,000
Balance sheet:
Installment receivables $4,500,000 – 500,000 $4,000,000
Deferred gross profit: $900,000 – 100,000 800,000
Installment receivables (net) $3,200,000
199. At December 31, 2019, Rigsby would report in its balance sheet:
a. Realized gross profit of $500,000.
b. Deferred gross profit of $400,000.
c. Realized gross profit of $400,000.
d. Cost of installment sales $1,600,000.
Answer: b
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
12/15/2019 Cash 2,000,000
Installment receivables 2,000,000
Deferred gross profit 400,000
Realized gross profit 400,000
Balance sheet:
Deferred gross profit: $800,000 – 400,000 = $400,000
Realized gross profit of $400,000 would be reported in the income statement.
Use the following to answer questions 200 – 204:
Reliable Enterprises sells distressed merchandise on extended credit terms. Collections on these
sales are not reasonably assured, and bad debt losses cannot be reasonably predicted. It is
unlikely that repossessed merchandise is in condition to be re-sold. Therefore, Reliable uses the
cost recovery method. Merchandise costing $30,000 was sold for $55,000 in 2017. Collections
on this sale were $20,000 in 2017, $15,000 in 2018, and $20,000 in 2019.
200. In 2017, Reliable would recognize gross profit of:
5–84
a. $0.
b. $25,000.
c. $ 8,090.
d. $ 8,333.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Cost recovery method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: Costs not yet recovered.
201. In 2018, Reliable would recognize gross profit of:
a. $0.
b. $ 6,000.
c. $ 5,000.
d. $10,000.
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Cost recovery method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
Cost $30,000 2018 payment $15,000
2017 cost recovery (20,000 ) Cost recovery (10,000 )
Remaining cost $10,000 Gross profit $5,000
202. In 2019, Reliable would recognize gross profit of:
a. $0.
b. $ 6,000.
c. $ 8,000.
d. $20,000.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Cost recovery method
Blooms: Apply
5–85
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
Cost $30,000
2017 cost recovery (20,000 )
2018 cost recovery (10,000 )
Remaining cost 0
The entire $20,000 payment received in 2019 is recognized as gross profit.
203. In its 2017 year-end balance sheet, Reliable would report installment receivables (net) of:
a. $20,000.
b. $35,000.
c. $25,909.
d. $10,000.
Answer: d
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Cost recovery method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
Sale: Installment receivables 55,000
Inventory 30,000
Deferred gross profit 25,000
Payment: Cash 20,000
Installment
receivables
20,000
Balance sheet:
Installment receivables $55,000 – 20,000 $35,000
Deferred gross profit (25,000 )
Installment receivables (net) $10,000
204. In its 2018 year-end balance sheet, Reliable would report installment receivables (net) of:
a. $0.
b. $20,000.
c. $ 4,000.
d. $15,000.
Answer: a
5–86
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Cost recovery method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
Sale: Installment receivables 55,000
Inventory 30,000
Deferred gross profit 25,000
2017: Cash 20,000
Installment
receivables
20,000
Cash 15,000
Installment
receivables
15,000
2018: Deferred gross profit 5,000
Realized gross profit 5,000
Balance sheet:
Installment receivables $20,000
Deferred gross profit (20,000 )
Installment receivables (net) $ 0
Use the following to answer questions 205 – 209:
Lake Power Sports sells jet skis and other powered recreational equipment. Customers pay one-
third of the sales price of a jet ski when they initially purchase the ski, and then pay another one-
third each year for the next two years. Because Lake has little information about the ability to
collect these receivables, it uses the installment sales method for revenue recognition. In 2017,
Lake began operations and sold jet skis with a total price of $900,000 that cost Lake $450,000.
Lake collected $300,000 in 2017, $300,000 in 2018, and $300,000 in 2019 associated with those
sales. In 2018, Lake sold jet skis with a total price of $1,500,000 that cost Lake $900,000. Lake
collected $500,000 in 2018, $400,000 in 2019, and $400,000 in 2020 associated with those sales.
In 2020, Lake also repossessed $200,000 of jet skis that were sold in 2018. Those jet skis had a
fair value of $75,000 at the time they were repossessed.
205. Total cash collections on installment sales during 2018 would be:
a. $700,000.
b. $300,000.
c. $800,000.
d. $0
Answer: c
5–87
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: $300,000 (2017 sales) + $500,000 (2018 sales) = $800,000
206. In 2017, Lake would recognize realized gross profit of:
a. $150,000.
b. $0.
c. $300,000.
d. $450,000.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
Gross profit % = ($900,000 – $450,000)/$900,000 = 50%
2017: 50% x $300,000 = $150,000
207. In 2019, Lake would recognize realized gross profit of:
a. $0.
b. $450,000.
c. $310,000.
d. $700,000.
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
2017 sales:
Gross profit % = ($900,000 – $450,000)/$900,000 = 50%
50% x $300,000 received in 2019 = $150,000
2018 sales:
5–88
Gross profit % = ($1,500,000 – $900,000)/$1,500,000 = 40%
40% x $400,000 received in 2019 = $160,000
Total: $150,000 + $160,000 = $310,000
208. In its December 31, 2018, balance sheet, Lake would report:
a. Deferred gross profit of $700,000.
b. Deferred gross profit of $1,050,000.
c. Installment receivables (net) of $750,000.
d. Installment receivables (net) of $900,000.
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Installment sales method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: As of 12/31/2018, the installment receivable would be as follows:
2017
Sales: Installment receivables = $900,000 – $300,000 (2017 collections)
– $300,000 (2018 collections) = $300,000
Deferred gross profit = $450,000 – $150,000 (2017 collections)
– $150,000 (2018 collections) = $150,000
Net installment receivable for 2017 sales = $150,000
2018 Sales: Installment receivables = $1,500,000 –
$500,000 (2018 collections) = $1,000,000
Deferred gross profit = $600,000 – $200,000 (2018 collections) = $400,000
Net installment receivable for 2018 = $600,000
Total = $750,000
209. In 2020, Lake would record a loss on repossession of:
a. $45,000.
b. $200,000.
c. $120,000.
d. $80,000
Answer: a
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
5–89
Topic Area: Chapter Supp―Installment sales method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
Installment receivable = $200,000
Deferred gross profit = $80,000 ($200,000 x 40%)
Fair value = $75,000
Repossessed inventory $75,000
Deferred gross profit $80,000
Loss on repossession (plug) $45,000
Installment receivable $200,000
Use the following to answer questions 210 – 212:
Lake Power Sports sells jet skis and other powered recreational equipment. Customers pay one-
third of the sales price of a jet ski when they initially purchase the ski, and then pay another one-
third each year for the next two years. Because Lake has little information about the ability to
collect these receivables, it uses the cost recovery method to recognize revenue on these
installment sales. In 2017, Lake began operations and sold jet skis with a total price of $900,000
that cost Lake $450,000. Lake collected $300,000 in 2017, $300,000 in 2018, and $300,000 in
2019 associated with those sales. In 2018, Lake sold jet skis with a total price of $1,500,000 that
cost Lake $900,000. Lake collected $500,000 in 2018, $400,000 in 2019, and $400,000 in 2020
associated with those sales. In 2020, Lake also repossessed $200,000 of jet skis that were sold in
2018. Those jet skis had a fair value of $75,000 at the time they were repossessed.
210. In 2017, Lake would recognize realized gross profit of:
a. $150,000.
b. $0.
c. $300,000.
d. $450,000.
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Cost recovery method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
$450,000 cost – $300,000 collections = $150,000 unrecovered costs
5–90
211. In 2019, Lake would recognize realized gross profit of:
a. $0.
b. $300,000.
c. $310,000.
d. $700,000.
Answer: b
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Cost recovery method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback:
2017 sales:
Cost = $450,000; $300,000 collected in each year 2017–2019. $300,000 of cost
recovered in 2017, the other $150,000 of cost recovered in 2018, so $150,000 of
gross profit recognized in 2018, leaving $300,000 recognized in 2019.
2018 sales:
Cost = $900,000; $500,000 collected in 2018, $400,000 collected in 2019.
$500,000 of cost recovered in 2018, the other $400,000 of cost recovered in 2018,
so $0 of gross profit recognized in 2019.
Total: $300,000 + $0 = $300,000
212. In its December 31, 2018, balance sheet, Lake would report:
a. Deferred gross profit of $700,000.
b. Deferred gross profit of $600,000.
c. Installment receivables (net) of $700,000.
d. Installment receivables (net) of $400,000.
Answer: d
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Cost recovery method
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Feedback: As of 12/31/2018, the installment receivable would be as follows:
2017 Sales: Installment receivables = $900,000 – $300,000 (2017 collections)
– $300,000 (2018 collections) = $300,000
Deferred gross profit = $450,000 – $0 (all 2017 collections to cost recovery)
– $150,000 ($150,000 of 2018 collections to cost recovery) = $300,000
Net installment receivable for 2017 sales = $0
5–91
2018 Sales: Installment receivables = $1,500,000 – $500,000 (2018 collections) =
$1,000,000
Deferred gross profit = $600,000 – $0 (all 2018 collections to
cost recovery) = $600,000
Net installment receivable for 2018 sales = $400,000
Total = $400,000
213. When using the cost recovery method of accounting for long-term construction contracts
under IFRS:
a. Estimated losses on the overall contract are recognized before the contract is
completed.
b. Expenses are recorded each period, but revenue is only recognized when the contract
is completed.
c. Companies can use the percentage-of-completion method if that is their preference.
d. Neither gains nor losses are recognized until the contract is completed.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Remember
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
214. When using the cost recovery method of accounting for long-term construction contracts
under IFRS, early in the life of the contract it is typically the case that:
a. Expenses in excess of revenues are recognized.
b. Revenues in excess of expenses are recognized.
c. An equal amount of revenue and expense is recognized.
d. There is no predictable pattern of revenue and expense.
Answer: c
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Understand
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
5–92
215. The cost recovery method of accounting for long-term construction contracts under IFRS
is sometimes referred to as the:
a. “Sales-neutral approach.”
b. “Completed contract method.”
c. “Multi-step approach.”
d. “Zero profit method.”
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Remember
AACSB: Reflective thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
216. The percentage-of-completion method violates the general rule for revenue recognition
that:
a. Collection is reasonably assured.
b. Costs are known or reasonably estimated.
c. The earnings process is complete.
d. Collections have been received.
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Realization principle
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
Use the following to answer questions 217 – 219:
Sahara Desert Homes (SDH) reports under IFRS and constructed a new subdivision during 2017
and 2018 under contract with Cactus Development Co. Relevant data are summarized below:
Contract
amount
$3,000,000
Cost: 2017
5–93
1,200,000
2018 600,000
Gross profit: 2017 800,000
2018 400,000
Contract
billings:
2017
2018
1,500,000
1,500,000
SDH uses the cost recovery method under IFRS to recognize revenue.
217. What is the journal entry in 2017 to record revenue?
a. Accounts receivable 1,500,000
Revenue fron long-term
construction contracts
1,500,000
b. Accounts receivable 2,300,000
Gross profit 800,000
Revenue from long-term
construction contracts
1,500,000
c. Construction in progress 800,000
Cost of construction 1,200,000
Revenue from long-term
construction contracts
2,000,000
d. Cost of construction 1,200,000
Revenue from long-term
construction contracts
1,200,000
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Apply
AACSB: Knowledge application
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
Feedback: Under the IFRS cost recovery method, record equal amounts of revenue and
cost until cost recovered.
218. In its December 31, 2017, balance sheet, SDH would report:
a. The asset, cost and profits in excess of billings, of $500,000.
b. The liability, billings in excess of cost, of $300,000.
c. The asset, contract amount in excess of billings, of $1,500,000.
d. The asset, deferred profit, of $400,000.
5–94
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Analyze
AACSB: Analytical thinking
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
Feedback:
Cost + profits: $1,200,000 + 0 = $1,200,000
Billings: 1,500,000
Excess: $ (300,000)
219. What is SDH’s journal entry to record revenue in 2018?
a. Accounts receivable 1,500,000
Revenue from long-term
construction contracts
1,500,000
b. Construction in progress 400,000
Cost of construction 600,000
Revenue from long-term
construction contracts
1,000,000
c. Cost of construction 2,000,000
Gross profit 1,000,000
Revenue from long-term
construction contracts
3,000,000
d. Construction in progress 1,200,000
Cost of construction 600,000
Revenue from long-term
construction contracts
1,800,000
Answer: d
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Apply
AACSB: Knowledge application
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
Feedback: Under the IFRS cost recovery method, record equal amounts of revenue and
cost until cost recovered, and then record gross profit. In 2017, recorded revenue and cost
5–95
of $1,200,000, so record remaining cost of $600,000 and all gross profit of $1,200,000 in
2018.
220. Summary data for Benedict Construction Co.’s (BCC) Job 1227, which was completed in
2018, are presented below:
Bid price $450,000
Contract cost: 2017 (180,000 )
2018 (195,000 )
Gross profit: 75,000
Estimated cost to
complete:
12/31/2017 $200,000
12/31/2018 0
Assuming BCC used the cost recovery method to recognize revenue under IFRS, what
would gross profit have been in 2017 and 2018 (rounded to the nearest thousand)?
2017 2018
a. $36,000 $39,000
b. $30,000 $45,000
c. $70,000 $ 5,000
d. $ 0 $75,000
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―IFRS Revenue recognition
Blooms: Apply
AACSB: Knowledge application
AACSB: Diversity
AICPA: FN Measurement
AICPA: BB Global
AICPA: BB Industry
Feedback: No revenue is recognized until completion of project in year 2018.
Use the following to answer questions 221 – 223:
Flapper Jack’s Pancake Restaurants Inc. sells franchises for an initial fee of $36,000 plus
operating fees of $500 per month. The initial fee covers site selection, training, computer and
accounting software, and on-site consulting and troubleshooting, as needed, over the first five
years. On March 15, 2017, Tim Cruise signed a franchise contract, paying the standard $6,000
down with the balance due over five years with interest.
5–96
221. Assuming that the initial services to be performed by Flapper Jack’s subsequent to the
signing are substantial and that collection of the receivable is reasonably assured, the
journal entry required at signing would include a credit to:
a. Unearned franchise fee revenue for $36,000.
b. Unearned franchise fee revenue for $30,000.
c. Franchise fee revenue for $36,000.
d. Franchise fee revenue for $ 6,000.
Answer: a
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Franchise sales
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback:
Cash 6,000
Note receivable 30,000
Unearned franchise fee revenue 36,000
222. Assume that at the time of signing the contract, collection of the receivable was assured
and that service obligations were substantial. However, by October 20, 2017,
substantially all continuing obligations had been met. The journal entry required at
October 20, 2017 would include a:
a. Credit to franchise fee receivable for $27,000.
b. Debit to unearned franchise fee revenue for $36,000.
c. Credit to franchise fee revenue for $9,000.
d. Debit to unearned franchise fee revenue for $27,000.
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Franchise sales
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback:
10/20/2017:
Unearned franchise fee revenue 36,000
Franchise fee revenue 36,000
5–97
223. Assume at March 15, 2017, the time of signing the contract, collection of the receivable
was reasonably assured and there were no significant continuing obligations. The journal
entry at signing would include a:
a. Credit to franchise fee revenue for $36,000.
b. Credit to franchise fee revenue for $9,000.
c. Credit to unearned franchise fee revenue for $36,000.
d. Credit to unearned franchise fee revenue for $27,000.
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Franchise sales
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback:
Cash 6,000
Note receivable 30,000
Franchise fee revenue 36,000
Use the following to answer questions 224 – 226:
The Racquet Store (RS) sells franchise agreements in which it charges an up-front fee of $50,000
for assistance in setting up a store, and then a monthly fee of $1,000 for national advertising and
administrative assistance. Steffi Hingis signs a franchise agreement with RS.
224. Assume that Steffi paid the $50,000 in cash when she signed the agreement. RS
can recognize revenue associated with the $50,000:
a. When Steffi signs the agreement and pays the cash.
b. As soon as RS has assisted Steffi in setting up the store.
c. Gradually as RS provides advertising and administration services.
d. Only after the store has operated long enough for the chance of business failure to be
remote.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Franchise sales
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Substantial performance has occurred.
5–98
225. Assume that Steffi signed a $50,000 installment note when she signed the
franchise agreement. RS can recognize revenue associated with the $50,000:
a. When Steffi signs the agreement, so long as RS has sufficient experience with similar
arrangements to estimate uncollectible accounts.
b. As soon as RS has assisted Steffi in setting up the store, so long as RS has sufficient
experience with similar arrangements to estimate uncollectible accounts.
c. Gradually as RS provides advertising and administration services.
d. When RS receives installment payments from Steffi, so long as RS has sufficient
experience with similar arrangements to estimate uncollectible accounts.
Answer: b
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Franchise sales
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Substantial performance has occurred and can estimate bad debts.
226. Assume that Steffi signed a $50,000 installment note when she signed the franchise
agreement. RS has no experience estimating uncollectible accounts associated with these
sorts of notes. RS can recognize:
a. $50,000 of revenue when Steffi signs the agreement.
b. $50,000 of revenue as soon as it has assisted Steffi in setting up the store.
c. Revenue under the installment sales method, starting when Steffi signs the
agreement.
d. Revenue under the installment sales method, as soon as it has assisted Steffi in setting
up the store.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Franchise sales
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Substantial performance has occurred but cannot estimate bad debts, so use the
installment sales method.
Use the following to answer questions 227 – 228:
5–99
Sullivan Software sells packages of a software program and one year’s worth of technical
support for $500. Its packaging lists the $500 sales price as comprised of a software program at a
price of $450 and technical support with a price of $100, with a $50 discount for the package
deal. All of Sullivan’s sales are for cash, and there are no returns. Sullivan sells the software
program separately for $475 and offers a year of technical support separately for $75.
227. Sullivan should recognize revenue for the two parts of the arrangement as follows:
a. Recognize the entire $500 when the customer pays cash to buy the package.
b. Recognize the portion of the $500 attributable to the software program when the
customer pays cash to buy the package; defer the portion attributable to technical
support and recognize over the support period.
c. Defer the entire $500 and recognize over the support period.
d. Recognize the entire $500 upon conclusion of the support period.
Answer: b
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Analyze
AACSB: Analytical thinking
AICPA: FN Measurement
AICPA: BB Industry
228. The amount of revenue that GAAP, regarding software revenue recognition, would
require Sullivan to attribute to the software program (as opposed to the technical
support) is (rounded):
a. $450.
b. $475.
c. $432.
d. $400.
Answer: c
Level of Learning: 3 Hard
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
AICPA: BB Industry
Feedback: Per GAAP regarding software revenue recognition based on relative fair
values, the amount attributable to the program is ($475 / {$475 + $75}) x $500 = $432.
229. GAAP that covers revenue recognition for multiple-element arrangements requires that a
5–100
seller recognize revenue for a particular part if:
a. The part has value on a stand-alone basis.
b. Customer acceptance of the part is not contingent on successful delivery of a later
part.
c. The part constitutes at least a “preponderance of the fair value” of the total
arrangement.
d. Both the part has value on stand-alone basis and customer acceptance of the part is
not contingent on successful delivery of a later part are required.
Answer: d
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
230. Under GAAP, with respect to multiple-element arrangements, if the revenue for a
particular part of a multiple-element arrangement does not qualify for separate
recognition, it is:
a. Never recognized.
b. Recognized when the contract is signed or persuasive evidence of an arrangement
exists.
c. Recognized when revenue for the other parts is recognized.
d. Recognized at the end of the contract.
Answer: c
Level of Learning: 2 Medium
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
231. “VSOE” stands for:
a. “Vendor-specific objective evidence.”
b. “Vendor substantiation of earnings.”
c. “Value-specified operating earnings.”
d. “Variable set overhead earned.”
Answer: a
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
5–101
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
232. “VSOE” is necessary to separately recognize revenue in multiple-element contracts for:
a. All service contracts.
b. All product contracts.
c. All contracts that involve at least one non-software element.
d. Software contracts.
Answer: d
Level of Learning: 1 Easy
Learning Objective: 05-Supplement
Topic Area: Chapter Supp―Software–Multiple-element
Blooms: Remember
AACSB: Reflective thinking
AICPA: FN Measurement
AICPA: BB Industry
Problems
233. Squeaky Shine provides car washing services in Jersey City, New Jersey. A
three-month pass for automatic car wash sells for $60, which entitles the customer for an
unlimited number of car washes during the contract period. Squeaky Shine estimates that pass
holders wash their cars equally throughout the three-month period. On December 1st,
customers purchased $1,260 of the three-month passes, with purchases of the passes
occurring evenly throughout December.
Required:
1) Prepare the journal entries that Squeaky Shine would record on December 1 and on December
31, 2018, with respect to this transaction.
2) State the account titles and amounts that will be included in Squeaky Shine’s 2018 income
statement and balance sheet.
Answer:
1) December 1
Cash 1,260
Deferred revenue 1,260
December 31
If purchases occurred evenly throughout December, on average they occurred half-way through
the month. Therefore, on average a pass is 1/6 expired, so Squeaky should recognize 1/6 ×
$1,260 = $210 of revenue.
Deferred revenue 210
5–102
Sales Revenue 210
2) $210 is included as revenue in the income statement, $1,260 of cash is included in the
balance sheet, and $1,050 is included as deferred revenue in the balance sheet.
Level of Learning: 2 Medium
Learning Objective: 05-03
Topic Area: Revenue over time―Progress to completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–103
234. Assume that a customer enrolls in AAA’s Premier Membership, which provides 12
months of roadside assistance for $120. On August 1, 2018, a customer purchases a contract
that runs from that date through July 31, 2019. Given that roadside assistance requests occur
equally throughout the contract period, AAA uses “proportion of time” as its measure of
progress toward completion.
Required:
1) Prepare the journal entries that AAA would record on August 1 and on December 31, 2018,
with respect to this transaction.
2) State the amounts included in relevant accounts in AAA’s 2018 income statement and
balance sheet.
Answer:
1) August 1
Cash 120
Deferred revenue 120
December 31
5/12 of a year of service has been provided, so AAA should recognize 5/12 × $120 = $50 of
revenue.
Deferred revenue 50
Sales Revenue 50
2) $50 is included as revenue in the income statement, and $70 is included in current liability
section of the balance sheet.
Level of Learning: 2 Medium
Learning Objective: 05-03
Topic Area: Revenue over time―Progress to completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–104
235. Lux Hotels, Inc. has signed a service outsourcing contract with Deluxe Rooms, Inc. for
$3 million, which was received in cash at contract inception. Under the agreement, Deluxe
Rooms is obligated to clean and prepare over 5,000 hotels rooms managed by Lux Hotel on a
daily basis from August 1, 2018 to July 31, 2019.
Required: Prepare any journal entry that Delux would record:
(1) at inception of the contract and
(2) at the end of 2018 to recognize all revenue associated with this contract that should be
recognized in 2018.
Answer:
This service contract qualifies for revenue recognition over time, because the customer
consumes the benefit of the seller’s work as it is performed. Hence, at the end of 2018, Deluxe
Rooms should recognize $3 million × 5/12 = $1.25 million of revenue.
(1) August 1, 2018:
Cash 3,000,000
Deferred revenue 3,000,000
(2) December 31, 2018:
Deferred revenue 1,250,000
Revenue 1,250,000
Level of Learning: 1 Easy
Learning Objective: 05-03
Topic Area: Revenue over time―Progress to completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–105
236. Poseidon Corporation, based in Greece, specializes in painting cargo ships. On
December 1, 2018 Poseidon received $300,000 in advance from Worldwide Shipping, Inc. to
paint a 40,000-ton cargo vessel. The painting process is scheduled to begin on December 1,
2018, and the ship is to be returned to Worldwide in four months. Worldwide retains legal
title to the ship during the contract period, and can sell the ship to another shipper during the
contract period if it so chooses.
Required: Assuming Poseidon uses “proportion of time” as its measure of progress toward
completion, prepare any journal entry that Poseidon would record:
(1) at inception of the contract
(2) at the end of 2018 to recognize all revenue associated with this contract that should be
recognized in 2018. Ignore any costs associated with providing the painting service.
Answer:
This contract qualifies for revenue recognition over time, because the customer controls the
asset as it is being worked on. Hence, Poseidon should recognize $10 million × 1/4 = $2.5
million of revenue.
(1) December 1, 2018:
Cash 10,000,000
Deferred revenue 10,000,000
(2) December 31, 2018
Deferred revenue 2,500,000
Revenue 2,500,000
Level of Learning: 1 Easy
Learning Objective: 05-03
Topic Area: Revenue over time―Progress to completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–106
237. Accorsi & Sons specializes in selling and installing upscale home theater systems. On
March 1, 2018, Accorsi sold a premium home theater package that includes a projector, set of
surround speakers, and high quality leather seats, along with complete installation service, for
$32,500. If sold separately, each of these goods or services would have cost $15,000
(projector), $12,500 (speakers), $17,500 (seats), and $3,000 (installation), respectively.
Required:, How much of the transaction price would be allocated to the projector, the speakers,
the leather seats, and the installation service, assuming that each of these four parts of the
contract is a separate performance obligation? Show your work.
Answer:
Accorsi & Sons must identify each obligation’s share of the sum of the stand-alone selling
prices of all performance obligations:
Projector: $15,000 = 31.25%
$15,000 + 12,500 + 17,500 + 3,000
Surround speakers: $12,500 = 26.04%
$15,000 + 12,500 + 17,500 + 3,000
Leather seats: $17,500 = 36.46%
$15,000 + 12,500 + 17,500 + 3,000
Installation service: $3,000 = 6.25%
$15,000 + 12,500 + 17,500 + 3,000
Accorsi & Sons would allocate the total selling price of $32,500 based on the stand-alone
selling prices, as shown below:
Projector: $32,500 × 31.25% = $10,156.25
Surround speakers: $32,500 × 26.04% = $8,463.00
Leather seats: $32,500 × 36.46% = $11,849.50
Installation service: $32,500 × 6.25% = $2,031.25
Total: 100% $32,500
Level of Learning: 2 Medium
Learning Objective: 05-04
Topic Area: Mult perf oblig―Allocate transact price
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–107
238. Baldi Piano manufactures customized pianos for concert halls. On July 1, 2018, Baldi
signed a contract to deliver a concert piano for $150,000. Under the contract, Baldi is also
obligated to provide a one-year maintenance service. If sold separately, the piano and the
maintenance service would have cost $140,000 and $20,000, respectively.
Required: How much of the transaction price would be allocated to the piano and the
maintenance service, assuming they are separate performance obligations? Show your work.
Answer:
Baldi must identify each performance obligation’s share of the sum of the stand-alone selling
prices of all performance obligations:
Piano (including delivery): $140,000 = 87.50%
$140,000 + 20,000
Maintenance service: $20,000 = 12.50%
$140,000 + 20,000
Baldi would allocate the total selling price of $150,000 based on the stand-alone selling prices,
as shown below:
Piano (including delivery): $150,000 × 87.50% = $131,250
Maintenance service: $150,000 × 12.50% = $18,750
Total: 100% $150,000
Level of Learning: 1 Easy
Learning Objective: 05-04
Topic Area: Mult perf oblig―Allocate transact price
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–108
Use the following information for questions 239 – 240:
The Rink offers annual $200 memberships that entitle members to unlimited use of ice-skating
facilities and locker rooms. Each new membership also entitles the member to receive ten “20%
off a $5 meal” coupons that are redeemable at the Rink’s snack bar. The Rink estimates that
approximately 80% of the coupons will be redeemed, and that, if the coupons weren’t redeemed,
$5 meals still would be discounted by 5% because of ongoing promotions.
239. Calculate how much of the transaction price should be allocated to each performance
obligation in the contract. Show your work.
Answer:
The discount coupon provides a material right to the customer that the customer would not
receive otherwise (a 20% discount rather than a 5% discount). This discount 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 providing
membership access, so this contract has two performance obligations.
To allocate the contract price to the performance obligation, we should first consider that the Rink
would offer a 5% discount on $5 meals sold to all customers. So, a 20% discount provides a
customer with an incremental value of 15% (20% – 5%). Thus, the estimated stand-alone selling
price of the meal coupons is $6 (= 10 coupons x $5 base price of meal x 15% savings x 80%
redeemed). Since the stand-alone selling price of the annual membership fee is $200, the Rink
would allocate $5.83 {= $200 × [6 ÷ (6+200)]} of the $200 transaction price to the discount
coupon.
Level of Learning: 3 Hard
Learning Objective: 05-04
Learning Objective: 05-05
Topic Area: Mult perf oblig―Allocate transact price
Topic Area: Contract features―Prepayments
Topic Area: Contract features―Customer options
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
240. Prepare the journal entry to recognize the sale of a new membership. Clearly identify
revenue or deferred revenue associated with each performance obligation.
Answer:
Since the discount coupon would be a performance obligation, the Rink would recognize deferred
revenue for the sale of the annual membership fee and deferred revenue for the sale of the
discount coupon.
Cash $200
Deferred revenue, membership fees 194.17
Deferred revenue, meal coupons 5.83
Level of Learning: 2 Medium
Learning Objective: 05-05
5–109
Topic Area: Contract features―Customer options
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
241. Antonio’s Car Services provides maintenance services for motorized vehicles. In
March 2018, Rick placed an order for a new set of tires for $350. When a customer purchases
goods or services in excess of $300, Antonio’s gives the customer a 25% discount coupon for
future purchases made in the next three months. Antonio’s estimates that approximately 80%
of customers utilize the coupon and that on average those customers will purchase goods or
services that typically sell for $75.
Required:
(a) How many performance obligations are in Rick’s contract? Explain the reasons for your
answer.
(b) Prepare a journal entry to record revenue for this transaction, assuming that Antonio’s uses
the residual method to estimate the stand-alone selling price of new tires sold without the
discount coupon.
Answer:
(a) Number of performance obligations in the contract: 2.
The delivery and installation of new tires 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. This discount
option 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 and installing new tires. Hence, the discount coupon is distinct and qualifies as a
performance obligation. The seller’s role is not to integrate and customize them to create one
product.
(b)
Cash 350
Sales revenue (to balance) 335
Deferred revenue (discount option)* 15
* $75 average purchase price × 25% discount × 80% coupon utilization rate
Level of Learning: 2 medium
Learning Objective: 05-04
Learning Objective: 05-05
Learning Objective: 05-06
Topic Area: Mult perf oblig―Identify the perf oblig
Topic Area: Contract features―Customer options
Topic Area: Transaction price―Residual approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–110
242. DGA Associates, Inc. sells computer workstations designed for architects. In 2018, it sold
120 workstations for $360,000. For each workstation sold, DGA distributed a 40% discount
coupon for any additional future purchases made in the next 12 months. Based on historical
experience, DGA expects that approximately 30% of the coupons will be utilized, and the
goods purchased with the coupons would normally sell for $350.
Required:
(a) How many performance obligations are in a contract to purchase a computer workstation?
Explain the reasons for your answer.
(b) Prepare a journal entry to record revenue for the sale of 120 computer workstations,
assuming that DGA uses the residual method to estimate the stand-alone selling price of the
workstations sold without the discount coupon.
Answer:
(a) Number of performance obligations in the contract: 2
The delivery of computer workstations 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. This discount option 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
computer workstations. Hence, the discount coupon is distinct and qualifies as a performance
obligation. The seller’s role is not to integrate and customize them to create one product.
(b)
Cash 360,000
Sales revenue (to balance) 354,960
Deferred revenue (discount option)* 5,040
* 120 units × $350 average purchase price × 40% discount × 30% coupon utilization rate
Level of Learning: 2 medium
Learning Objective: 05-04
Learning Objective: 05-05
Learning Objective: 05-06
Topic Area: Mult perf oblig―Identify the perf oblig
Topic Area: Contract features―Customer options
Topic Area: Transaction price―Residual approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
243. On February 12, 2018, Mohawk Home and Garden enters into contract with a local
business to provide weekly grass-cutting services between May and September of that year,
and receives $2,000 in advance. As part of a local business promotion, Mohawk offers a 50%
discount on any barbecue grill with a list price in excess of $200. In the past, Mohawk
charged the same amount ($2,000) for the same weekly grass-cutting service, but without the
grill discount coupon. Based on historical experience with other clients, Mohawk estimates
5–111
that about 40% of the coupons will be redeemed, purchasing grills with an average total list
price of $400.
Required:
(a) How many performance obligations are in this contract? Explain the reasons for your
answer.
(b) Prepare the journal entry to account for the transaction as of February 12, 2018, clearly
identifying the revenue or deferred revenue associated with each performance obligation.
Answer:
(a) Number of performance obligations in the contract: 2.
Performing the grass-cutting services is one performance obligation. The 50% discount coupon
on any barbecue grill with a list price in excess of $200 qualifies as a second performance
obligation. First, it is an option that conveys a material right to the recipient (as opposed to a
general marketing offer), so it is a performance obligation. Second, it 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 grass-cutting services, so
it is distinct and qualifies as a performance obligation. Mohawk will record deferred revenue
associated with the coupons, and recognize revenue when either the coupon is exercised or the
company estimates that it will not be redeemed.
(b) Mohawk must first establish stand-alone selling prices of each performance obligation:
Value of the discount coupon: 50% discount × $400 average purchase price = $200
Estimated redemption × 40%
Stand-alone selling price of coupon $80
Stand-alone selling price of grass-cutting service $2,000
Total of stand-alone prices $2,080
Mohawk should identify each performance obligation’s share of the sum of the stand-alone
selling prices of all deliverables:
Grass-cutting services: $2,000 = 96.15%
$2,000 + 80
Discount coupon for grills: $80 = 3.85%
$2,000 + 80
Mohawk would allocate the total selling price of $2,000 based on the stand-alone selling prices,
as shown below:
Grass-cutting services: $2,000 × 96.15% = $1,923
Discount coupon for grills: $2,000 × 3.85% = $77
Total: 100% $2,000
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Upon receiving $2,000, the journal entry would be:
Cash 2,000
Deferred revenue (grass-cutting services) 1,923
Deferred revenue (discount option) 77
Note: The amount of revenue Mohawk should recognize upon receipt of the service fee is $0.
Mohawk has not delivered goods or services at the time of the payment, so it should be viewed
as a prepayment for future delivery of goods or services. Hence, Mohawk should record
deferred revenue (current liability). Later, when services are delivered, deferred revenue will be
reduced and revenue would be recognized.
Level of Learning: 3 Hard
Learning Objective: 05-04
Learning Objective: 05-05
Topic Area: Mult perf oblig―Identify the perf oblig
Topic Area: Contract features―Prepayments
Topic Area: Contract features―Customer options
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
244. Mammoth Publishing, Inc. owns a weekly magazine called “Nova Health,” and sells
annual subscriptions for $96. Customers prepay their subscription fee and receive 52 issues
starting in the following month. The company also offers new subscribers a 25% discount
coupon on its other weekly magazine called “Fishing & Camping,” which has a list price of
$84 for an annual subscription. Mammoth estimates that approximately 10% of the discount
coupons will be redeemed.
Required:
(a) How many performance obligations are in a single subscription contract? Explain the
reasons for your answer.
(b) Prepare the journal entry to account for one new subscription of “Nova Health,” clearly
identifying the revenue or deferred revenue associated with each performance obligation.
Answer:
(a) Number of performance obligations in the contract: 2.
Delivery of “Nova Health” magazines on a weekly basis is one performance obligation. The
25% discount coupon on an annual subscription of “Fishing & Camping” qualifies as a second
performance obligation. First, it is an option that conveys a material right to the recipient (as
opposed to a general marketing offer), so it is a performance obligation. Second, it 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
“Nova Health” magazines, so it is distinct and qualifies as a performance obligation. Mammoth
will record deferred revenue associated with the coupons, and recognize revenue when either
the coupon is exercised or the company estimates that it will not be redeemed.
(b) Mohawk must first establish stand-alone selling prices of each performance obligation:
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Value of the discount coupon: 25% discount × $84 for “Fishing & Camping” = $21
Estimated redemption × 10%
Stand-alone selling price of coupon $2.10
Stand-alone selling price of annual subscription for “Nova Health” $96
Total of stand-alone prices $98.10
Mammoth should identify each performance obligation’s share of the sum of the stand-alone
selling prices of all deliverables:
Nova Health subscription: $96 = 97.86%
$96 + 2.10
Fishing & Camping
subscription:
$2.10 = 2.14%
$96 + 2.10
Mammoth would allocate the total selling price of $96 based on the stand-alone selling prices,
as shown below:
Nova Health subscription: $96 × 97.86% = $93.95
Fishing & Camping
subscription:
$96 × 2.14% = $2.05
Total: 100% $96
Upon receiving $96, the journal entry would be:
Cash 96
Deferred revenue (Nova Health) 93.95
Deferred revenue (Fishing & Camping) 2.05
Note: The amount of revenue Mammoth should recognize upon receipt of the service fee is $0.
Mammoth has not delivered goods or services at the time of the payment, so it should be viewed
as a prepayment for future delivery of goods or services. Hence, Mammoth should record
deferred revenue (current liability). Later, when services are delivered, deferred revenue will be
reduced and revenue would be recognized.
Level of Learning: 3 Hard
Learning Objective: 05-04
Learning Objective: 05-05
Topic Area: Mult perf oblig―Identify the perf oblig
Topic Area: Contract features―Prepayments
Topic Area: Contract features―Customer options
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–114
Use the following information for questions 245 – 246:
On July 1, Wiggins Associates enters into a contract to provide consulting services to
Pennsylvania University (PU). The contract is anticipated to last four months and is intended to
achieve significant cost savings at the university. The contract stipulates that PU will pay
Wiggins $25,000 at the end of each month, and, if total cost savings reach a specific target, PU
will pay an additional $20,000 to Wiggins at the end of the contract. Wiggins estimates a 75%
chance that cost savings will reach the target.
245. Assume that Wiggins estimates uncertain consideration as the most likely amount.
Required: Do the following for Wiggins:
a. Prepare the journal entry on July 31 to record the first month of revenue under the
contract.
b. Assuming total cost savings exceed the target, prepare the journal entry, if any, on
October 31 to record receipt of the $20,000 bonus (ignore the normal October payment of
$25,000).
c. Assuming total cost savings do not reach the target, prepare the journal entry, if any, on
October 31 to record failure to receive the $20,000 bonus (ignore the normal October
payment of $25,000).
Answer:
a. The most likely amount to be received under the contract is (4 x $25,000) + $20,000 =
$120,000 (since there is a 75% chance that the $20,000 payment will be received). Therefore,
each month Wiggins would recognize $30,000 ($120,000 ÷ 4) of revenue, using the following
journal entry:
Cash 25,000
Bonus receivable 5,000
Revenue 30,000
b. After four months, the expected bonus receivable will have accumulated to $20,000 (4 ×
$5,000). If Wiggins receives the bonus, it will make the following entry:
Cash 20,000
Bonus receivable 20,000
c. After four months the expected bonus receivable will have accumulated to $20,000 (4 ×
$5,000). If Wiggins does not receive the bonus, it will make the following entry:
Revenue 20,000
Bonus receivable 20,000
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Most likely amount
5–115
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
246. Assume that Wiggins estimates variable consideration as the expected value.
Required: Prepare the journal entry on July 31 to record the first month of revenue under the
contract.
Wiggins would estimate the transaction price as follows:
Possible Expected
Prices Probability Consideration
$120,000 ([$25,000 × 4] + $20,000) 75% $90,000
$100,000 ($25,000 × 4) 25% 25,000
Expected contract price at inception $115,000
Each month Wiggins would recognize $28,750 ($115,000 ÷ 4) of revenue, using the
following journal entry:
Cash 25,000
Expected bonus receivable 3,750
Revenue 28,750
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
247. Dr. Privacy, Inc. specializes in shredding office documents and destroying computer hard
drives for various clients in the U.S. In June 2018, it enters into a contract with the U.S.
government to properly discard computer hard drives. The contract specifies a fixed fee of
$50,000 for the first 25,000 hard drives, and an additional $5,000 for each incremental 10,000
drives. The company estimates a 65% chance of handling 25,000 drives or fewer, 30%
chance of handling more than 25,000 drives but fewer than 35,000 drives, and 5% chance of
handling more than 35,000 drives but fewer than 45,000 drives.
Required: Assuming that the company determines transaction price as the expected value of the
consideration, what is Dr. Privacy’s estimate of the transaction price for this contract?
Answer:
The expected value would be calculated as follows:
Possible amounts Probabilities Expected amounts
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$50,000 ($50,000 + 0 bonus) × 65% = $32,500
$55,000 ($50,000 + 5,000 bonus) × 30% = $16,500
$60,000 ($50,000 + 10,000 bonus) × 5% = $ 3,000
Expected contract price at inception = $52,000
Level of Learning: 2 medium
Learning Objective: 05-06
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
248. In February 2018, Omnibus Interior Corporation enters into a contract with Pike Realty to
remodel a 6-unit luxury condominium in New York City. Under the contract, the company is
entitled to receive a fixed fee of $1 million, and an additional performance bonus of $500,000
if the property is sold during the same year.
Required: Given a strong demand for housing, Omnibus estimates that the property would most
likely be sold within the same year, and bases estimates of variable consideration on the most
likely estimate. On what transaction price should Omnibus base revenue recognition?
Answer:
Based on the most likely amount, the transaction price is $1,000,000 + $500,000 = $1,500,000,
because there is a greater chance of the property being sold within the year than not being sold.
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge Application
AICPA: FN Measurement
Use the following to answer questions 249 – 251:
Brunetti Co. designed and installed customized signs for Di Antonio CPA, Inc. Brunetti’s
contract specifies that it will receive a flat fee of $15,000 for providing the customized signs, and
an additional $1,000 if 30% of Di Antonio’s new customers indicate they first learned of Di
Antonio because of the signs. Based on historical experience, Brunetti estimates that there is a
90% chance it will achieve the threshold to receive a bonus.
249. Assuming Brunetti uses the most likely value to estimate the variable consideration,
calculate the transaction price.
Answer:
Based on the most likely amount, the transaction price is $150,000 + $10,000 = $160,000,
because there is a greater chance of receiving the bonus than not receiving it.
5–117
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
250. Assuming Brunetti determines transaction price as the “expected value” of the variable
consideration, what would be the appropriate transaction price for this contract?
Answer:
Possible amounts Probabilities Expected amounts
$160,000 ($150,000 + 10,000 bonus) × 90% = $144,000
$150,000 ($150,000 + 0 bonus) × 10% = $15,000
Expected contract price at inception = $159,000
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
251. Assume Brunetti uses the “expected value” approach, but is very uncertain of that
estimate due to a lack of experience with similar arrangements. What would be the
appropriate transaction price?
Answer:
Because the seller is very uncertain of its estimates, it cannot argue that it is probable that it will
not have to reverse (adjust downward) a significant amount of revenue in the future due to a
change in returns. Therefore, Brunetti should not include the variable consideration (bonus) in
the transaction price. Hence, the transaction price at the time of contract inception would be
$150,000.
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Variable consid constraint
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
252. Omni-Resistor, Inc. specializes in waterproofing homes, office buildings and other
structures. Recently it completed a waterproofing renovation for a building at a local
university. The contract specifies that Omni-Resistor will receive a flat lump sum of
$100,000 for the renovation, and an additional $2,500 if there is no roof leaking through the
5–118
roof within the first year after the renovation. The seller estimates that there is an 85% chance
that no leakage will occur within the first year.
Required: (a) Assuming Omni-Resistor uses the most likely value to estimate the variable
consideration, calculate the transaction price. (b) Assuming Omni-Resistor determines
transaction price as the “expected value” of the variable consideration, calculate the transaction
price. (c) Assume Omni-Resistor uses the “expected value” approach, but is very uncertain of
that estimate due to a lack of experience with similar renovations. Calculate the transaction price.
Answer:
Part a): Based on the most likely amount, the transaction price is $100,000 + $2,500 = $102,500,
because there is a greater chance of finding a leak during the first year than otherwise.
Part b)
Possible amounts Probabilities Expected amounts
$102,500 ($100,000 + 2,500 bonus) × 85% = $87,125
$100,000 ($100,000 + 0 bonus) × 15% = $15,000
Expected contract price at inception = $102,125
Part c): Because the seller is very uncertain of its estimates, it cannot argue that it is probable that
it will not have to reverse (adjust downward) a significant amount of revenue in the future due to
a change in returns. Therefore, Omni-Resistor, Inc. should not include the variable consideration
(bonus) in the transaction price. Hence, the transaction price at the time of contract inception
would be only $100,000.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Variable consid constraint
Topic Area: Transaction price―Expected value
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Use the following to answer questions 253 – 255:
Portelli Services provides room-cleaning arrangements for hotels in Pennsylvania. On April 1,
Silvia Hotels & Resorts signed an agreement to outsource its room-cleaning functions to Portelli.
The contract specifies the service fee to be $15,000 per month, and all payments are to be made
shortly after the end of each quarter. It also specifies that Portelli will receive an additional
quarterly bonus of $3,000 if, during that quarter, Silvia receives no more than five complaints
from customers about room cleanliness.
• On April 1, based on historical experience, Portelli estimated that there is a 75% chance that
it will earn the quarterly bonus.
• On May 5, Portelli learned that, during March, there were two complaints from customers
related to room cleanliness. Based on this new information, Portelli revised its estimate
downward to 40% that it would earn the quarterly bonus.
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• On June 30, Silvia notified Portelli that, for the quarter ended, there were four complaints
associated with room cleanliness, so Portelli would receive the bonus. Two days later,
Portelli received all payments due for all services rendered in the second quarter, including
the bonus.
Portelli bases estimates of variable consideration on the most likely amount it expects to
receive.
253. Prepare Portelli’s April 30 journal entry to account for the revenue earned in April.
Answer:
During the month of April, Portelli estimates a greater than 50% chance it will earn the bonus, so
using the “most likely amount” approach, it assumes that the bonus will be achieved, and
estimates its revenue for the month as $15,000 + ($3,000 × 1/3 of a quarter) = $16,000.
Accounts receivable 15,000
Bonus receivable 1,000
Service revenue 16,000
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
254. Prepare Portelli’s May 31 journal entry to record the revenue earned in May, as well as
any appropriate adjustments to the revenue earned in April.
During the month of May, Portelli earns service revenue of another $15,000. At this point,
Portelli estimates that it will most likely not be able to earn the quarterly bonus, based on the
trend in the number of customer complaints. Thus, Portelli must reduce its bonus receivable
recorded in April to zero and record the offsetting adjustment in revenue.
Accounts receivable 15,000
Service revenue 15,000
Service revenue 1,000
Bonus receivable 1,000
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
255. Prepare Portelli’s June 30 and July 2 journal entries to record additional service revenue
earned, as well as any necessary adjustments to revenue and receipt of payment from Silvia.
5–120
Answer:
At the end of June, Portelli earns service revenue of another $15,000, as well as the quarterly
bonus of $3,000. Then, on July 2, it receives cash payment for all amounts earned during the
quarter.
June 30
Accounts receivable 15,000
Bonus receivable 3,000
Service revenue 18,000
July 2
Cash 48,000
Accounts receivable 45,000
Bonus receivable 3,000
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Use the following for questions 256 – 258:
Romano Services provides room cleaning arrangements for hotels in Ohio. On April 1, Silvia
Hotels & Resorts signed an agreement to outsource its room cleaning functions to Romano. The
contract specifies the service fee to be $15,000 per month, and all payments are to be made
shortly after the end of each quarter. It also specifies that Romano will receive an additional
quarterly bonus of $3,000, if during that quarter, Silvia receives no more than five complaints
from customers about room cleanliness.
• On April 1, based on historical experience, Romano estimated that there is a 75% chance that
it will earn the quarterly bonus.
• On May 5, Romano learned that, during March, there were two complaints from customers
related to room cleanliness. Based on this new information, Romano revised its estimate
downward to 40% that it would earn the quarterly bonus.
• On June 30, Silvia notified Romano that, for the quarter ended, there were four complaints
associated with room cleanliness, so Romano would receive the bonus. Two days later,
Romano received all payments due for all services rendered in the second quarter, including
the bonus.
Romano bases estimates of variable consideration on the expected value of the consideration it
expects to receive.
256. Prepare Romano ’s April 30 journal entry to account for the revenue earned in April.
Answer:
5–121
During the month of April, Romano earns the fixed monthly revenue of $15,000. In addition,
Romano estimates a 75% chance it will earn the quarterly bonus of $3,000, so its estimate of the
expected value of the bonus revenue earned in April is:
Possible amounts Probabilities Expected amounts
$1,000 ($3,000 bonus ÷ 3) × 75% = $750
$0 × 25% = $0
Expected bonus due as of April 30 = $750
Romano’s April 30 journal entry would be:
Accounts receivable 15,000
Bonus receivable 750
Service revenue 15,750
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
257. Prepare Romano’s May 30 journal entry to record the revenue earned in May, as well as
any appropriate adjustments to the revenue earned in April.
Answer:
During the month of May, Romano earns fixed service revenue of another $15,000. At this point,
Romano believes there is a 40% chance that it will earn the quarterly bonus, based on the trend in
the number of customer complaints. Thus, Romano must revise the expected value of the bonus
revenue earned to date:
Possible amounts Probabilities Expected amounts
$2,000 [($3,000 bonus × 2 ÷ 3)] × 40% = $800
$0 × 60% = $0
Expected bonus due as of May 30 = $800
Romano’s May 30 journal entry would be:
Accounts receivable 15,000
Service receivable ($800 – $750) 50
Service revenue 15,050
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–122
258. Prepare Romano’s June 30 and July 2 journal entries to record additional service revenue
earned, as well as any necessary adjustments to revenue and receipt of payment from Silvia.
Answer:
At the end of June, Romano earns service revenue of another $15,000, as well as the quarterly
bonus of $3,000. Then, on July 2, it receives cash payment for the revenue earned.
June 30
Accounts receivable 15,000
Bonus receivable ($3,000 – $800) 2,200
Service revenue 17,200
July 2
Cash 48,000
Accounts receivable 45,000
Bonus receivable 3,000
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Use the following to answer questions 259 – 261:
Veras Bus Transportation provides on-campus bus services for universities. On January 1, it
enters into a one-year contract with Moose University to operate five bus lines traveling
throughout the campus. Under the contract, Veras will be paid $100,000 on the last day of each
month. In addition, Veras will receive an additional $120,000 at the end of each six-month
period, provided it remains free of accidents.
• On January 1, based on historical experience, Veras estimated that there is a 75% chance that
it will remain free of accidents for the entire year.
• On March 20, three of the most senior drivers at Veras abruptly left. As a result, Veras had to
hire inexperienced drivers to fill the vacant positions. Consequently, Veras revised its
estimate to a 30% chance that it would earn the semiannual bonus.
• On June 30, Moose confirmed that there was no accident between January and June, so
Veras would be entitled to the semiannual bonus.
Veras bases estimates of variable consideration on the most likely amount it expects to receive.
259. Prepare Veras’ January 31 journal entry to account for the revenue earned from January 1
– January 31.
Answer:
In January, Veras estimates a greater than 50% chance that it will earn the semiannual bonus, so
using the “most likely amount” approach it assumes that the bonus will be earned, and estimates
its revenue for the month as $100,000 + ($120,000 × 1/6 of semiannual period) = $120,000.
5–123
Cash 100,000
Bonus receivable 20,000
Service revenue 120,000
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
260. Prepare Veras’ March 31 journal entry to record the revenue earned from March 1 –
March 31, as well as any appropriate adjustments to the revenue already presumed recorded
as earned from January 1 – February 28.
Answer:
In March, Veras’ earns monthly service revenue of $100,000. Veras also estimates that it will
most likely not be able to earn the semiannual bonus, based on employee turnover situation. Thus,
Veras must reduce its bonus receivable accrued in January and February to zero and record the
offsetting adjustment in revenue.
Cash 100,000
Service revenue 100,000
Service revenue 40,000
Bonus receivable (2×$20,000; Jan-Feb) 40,000
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
261. Prepare Veras’ June 30 journal entry to account for the revenue earned from June 1 –
June 30, as well as any necessary adjustments to revenue presumed to have been previously
recorded.
Answer:
At the end of June, Veras earns monthly service revenue of $100,000. It also earns the
semiannual bonus of $120,000.
June 30
Cash 220,000
Service revenue 220,000
Level of Learning: 2 medium
Learning Objective: 05-06
5–124
Topic Area: Transaction price―Most likely amount
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Use the following for questions 262 – 264:
Terra Bus Transportation provides on-campus bus services for universities. On January 1, it
enters into a one-year contract with Moose University to operate five bus lines traveling
throughout the campus. Under the contract, Terra will be paid $100,000 on the last day of each
month. In addition, Terra will receive an additional $120,000 at the end of each six-month
period, provided it remains free of accidents.
• On January 1, based on historical experience, Terra estimated that there is a 75% chance that
it will remain free of accidents for the entire year.
• On March 20, three of the most senior drivers at Terra abruptly left. As a result, Terra had to
hire inexperienced drivers to fill the vacant positions. Consequently, Terra revised its
estimate to a 30% chance that it would earn the semiannual bonus.
• On June 30, Moose confirmed that there was no accident between January and June, so Terra
would be entitled to the semiannual bonus.
Terra bases estimates of variable consideration on the expected value it expects to receive.
262. Prepare Terra’s January journal entry to account for the revenue earned from January 1 –
January 31.
Answer:
In January, Terra earns the fixed monthly revenue of $100,000. In addition, Terra estimates a
75% chance that it will earn the semiannual bonus, so its estimate of the expected value of the
bonus revenue earned to date is:
Possible amounts Probabilities Expected amounts
$20,000 ($120,000 ÷ 6 months) × 75% = $15,000
$0 ($0 bonus ÷ 6 months) × 25% = $0
Expected bonus as of January 31 = $15,000
Terra’s January 31 journal entry would be:
Cash 100,000
Bonus receivable 15,000
Service revenue 115,000
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–125
263. Prepare Terra’s March 31 journal entry to record the revenue earned from March 1 –
March 31, as well as any appropriate adjustments to the revenue presumed already recorded
as earned from January 1 – February 28.
Answer:
In March, Terra’s earns monthly service revenue of $100,000. Terra also estimates that it has a
30% chance to earn the semiannual bonus. Thus, the new estimate of the expected value of the
bonus revenue earned to date is:
Possible amounts Probabilities Expected amounts
$60,000 [3× ($120,000 ÷ 6 months)] × 30% = $18,000
$0 [3×($0 bonus ÷ 6 months)] × 70% = $0
Expected bonus as of March 31 = $18,000
Terra’s March 31 journal entry would be as follows. As of the end of February, Terra would have
accrued a bonus receivable of $30,000. At the end of March, this amount must now be downward
revised to $18,000, which means Terra must have a $12,000 offset to revenue.
Cash 100,000
Service revenue 100,000
Service revenue 12,000
Bonus receivable ($30,000 – 18,000) 12,000
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
264. Prepare Terra’s June 30 journal entry to account for the revenue earned from June 1 –
June 30, as well as any necessary adjustments to revenue.
Answer:
At the end of June, Terra earns monthly service revenue of $100,000. It also earns the semiannual
bonus of $120,000. At the end of March, bonus receivable has an outstanding balance of $18,000.
For the next two months (April – May), Terra accrues bonus receivable at a rate of $6,000 per
month. Hence, at the end of May, the balance is $18,000 + (2×$6,000) = $30,000. Hence, when it
is confirmed at the end of June that Terra is entitled to the full $120,000 semiannual bonus, and
so will receive $220,000 of cash, Terra must recognize an additional $90,000 service revenue
associated with bonus and reduce its $30,000 bonus receivable to zero.
June 30
Cash 220,000
Bonus receivable 30,000
Service revenue 190,000
5–126
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Expected value
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
265. Assume that GM signs a contract to deliver 10 buses to the Tompkins Consolidated Area
Transit (TCAT), which provides transit service throughout Tompkins County, for $4 million.
Under the contract, TCAT makes a cash payment of $4 million to GM, and the 10 buses are
shipped immediately from GM’s existing inventory. At the same time, GM obtains the right
to advertise its products on all of TCAT buses for six months, and makes a cash payment of
$20,000 to GM for the advertising service. The fair value of the advertising service is
$18,000.
Required: Prepare the journal entries GM should record to account for the sale of the buses and
the purchase of the advertisements. Indicate the amount of revenue GM should recognize for its
sale of buses to TCAT.
Answer:
GM makes an immediate payment of $20,000 to TCAT, which is $2,000 more than the fair
value of such advertising services. Therefore, the original transaction price of bus sales ($4
million) should be reduced by the overpayment of $2,000. Hence, the amount of revenue that
GM should recognize for sale of buses is $4,000,000 – $2,000 = $3,998,000.
Recording the sale of buses:
Cash 4,000,000
Sales revenue 4,000,000
Recording the purchase of advertisements:
Advertising expense 18,000
Sales revenue 2,000
Cash 20,000
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Pay by seller to customer
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
266. Typhoon Sons & Co. manufactures various types of golf clubs to third party vendors. On
April 1, 2018, Typhoon delivers a large quantity of golf clubs to Resona Country Club. Under
the sales agreement, Resona is obligated to pay Typhoon $200,000 within six months. On
May 1, Typhoon purchases for cash the right to advertise its products during Resona’s annual
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golf tournament event for $3,000. Resona normally charges $2,500 for such services. On
August 15, Resona pays Typhoon all amounts owed.
Required: Prepare the journal entries Typhoon should record to account for the transaction on
April 1, May 1 and August 15. Indicate the amount of revenue that Typhoon should recognize on
its sale of golf clubs to Resona.
Answer:
At the time of original sale (April 1, 2018), there was no indication that Typhoon would
purchase a service from Resona at a price higher than its fair value. Hence, the original sale
would be recorded based on the full transaction price of $200,000. Then, on May 1, Typhoon’s
overpayment of $500 for the services offered by the buyer (Resona) reduces the original
transaction price by $500, so Typhoon should debited sales revenue as part of the transaction.
Thus, Typhoon recognizes revenue of $200,000 – $500 = $199,500.
April 1, 2018:
Accounts receivable 200,000
Sales revenue 200,000
May 1, 2018:
Advertising expense 2,500
Sales revenue 500
Cash 3,000
August 15, 2018:
Cash 200,000
Accounts receivable 200,000
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Pay by seller to customer
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
267. AgriFoods, Inc. prepares and delivers agricultural products to industrial-scale kitchens
and food service providers. One of its key customers is Home Kitchen & Co., which provides
cafeteria solutions for corporations and universities. On January 1, 2018, AgriFoods obtained
a one-year contract to supply a pre-specified amount of vegetables to Home Kitchen, and
received $600,000 in cash. Then, on March 15, AgriFoods hired Home to run one of its
employee cafeterias for a period of six months, from April to September, and paid $70,000 in
cash. For similar arrangements, Home usually charged $50,000.
Required: (a) Prepare the journal entries AgriFoods would record on January 1, 2018 and
January 31, 2018 with respect to the sales contract. Assume revenue is accrued on a monthly
basis. (b) Prepare the journal entry to account for AgriFoods’ purchase of Home’s services.
Answer:
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Part a) AgriFoods would record deferred revenue at contract inception, and then fully earn it by
the end of the year.
January 1
Cash 600,000
Deferred revenue 600,000
January 31
Deferred revenue (600,000 ÷ 12) 50,000
Sales revenue 50,000
Part b) The cafeteria service fee has a fair value of $50,000, and AgriFoods paid $70,000. The
difference of $20,000 is viewed as a sales refund, reducing revenue for the year 2018 by that
amount.
Advertising expense 50,000
Sales revenue 20,000
Cash 70,000
Level of Learning: 2 Medium
Learning Objective: 05-03
Learning Objective: 05-06
Topic Area: Revenue over time―Progress to completion
Topic Area: Transaction price―Pay by seller to customer
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Use the following to answer questions 268 – 270:
Beaumont Company enters into a contract to provide a high quality diving-certification
preparation package, including goggles, snorkels, air tanks, fins, a wetsuit, and 5 private lessons
to get ready for diving certifications. The entire package sells for $2,500.
268. Other competing sellers in the same region charge an average of $250 for a set of goggles
and $750 for the lessons, if sold separately. Beaumont Company usually sells at a 5%
discount compared to other shops, since it is a bit farther away from the ocean. Required:
What would be Beaumont’s stand-alone selling price of the goggles and the lessons, based on
adjusted market assessment approach?
Answer:
Under the adjusted market assessment approach, Beaumont would base its estimate of the
stand-alone selling price of the goggles and the lessons on the prices charged by other sellers for
those goods, adjusted as necessary. Because Beaumont typically sells at a 5% discount, it would
estimate the stand-alone selling price of the goggles and the lessons to be $250 × 95% =
$237.50 and $750 × 95% = $712.50, respectively.
Level of Learning: 2 Medium
Learning Objective: 05-06
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Topic Area: Transaction price―Adjusted market approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
269. Typically, Beaumont incurs $375 on compensation and other costs to provide the private
lessons, and earns an average of 40% profit over cost on service offerings. Required:
Assuming that the diving equipment and the certification lessons are separate performance
obligations, estimate the stand-alone selling price of the certified lessons based on the
expected cost plus margin approach.
Answer:
Under the expected cost plus margin approach, Beaumont would base its estimate of the stand-
alone selling price of the private lessons on the $375 cost it incurs to provide the services, plus
its normal margin of 40% × $375 = $150. Therefore, Beaumont would estimate the stand-alone
selling price of the private lessons to be $375 + $150 = $525.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Expected cost plus margin
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
270. Typically, if Beaumont were to sell the equipment only, it would ask for $2,000.
Required: Assuming that the diving equipment and the certification lessons are separate
performance obligations, estimate the stand-alone selling price of the lessons based on the
residual approach.
Answer:
Under the residual approach, Beaumont would base its estimate of the stand-alone selling price
of the private lessons on the total selling price of the package ($2,500) minus the observable
stand-alone selling price of equipment ($2,000). Therefore, Beaumont would estimate the stand-
alone price of the lessons to be $2,500 – $2,000 = $500.
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Residual approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
271. CompuLand Center sells a full assortment of computer parts, including motherboards,
video cards, and cables, and also offers complementary computer assembly services. The
assembly service is offered by other vendors for $100 on average, and CompuLand typically
charges approximately 20% more than other vendors for similar services on a stand-alone
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basis. Required: Estimate the stand-alone selling price of the assembly service using the
adjusted market assessment approach.
Answer:
Under the adjusted market assessment approach, CompuLand would base its estimate of the
stand-alone selling price of the assembly service on the prices charged by other vendors for the
same service, adjusted as necessary. Because CompuLand typically charges 20% more than
competitors, it would estimate the stand-alone price of the assembly service to be $100 × 120%
= $120.
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Adjusted market approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
272. CompuValue Center sells a full assortment of computer parts, including motherboards,
video cards, and cables, and also offers complementary computer assembly services.
CompuValue estimates that it incurs $50 in labor and materials on average to complete one
assembly order, with an average of 75% profit based on cost. Required: Assuming that
computer parts and assembly service are separate performance obligations, estimate the
stand-alone selling price of the assembly service based on the expected cost plus margin
approach.
Answer:
Under the expected cost plus margin approach, ComputValue would base its estimate of the
stand-alone selling price of the assembly service on the $50 cost it incurs, plus its normal
margin of 75% × $50 = $37.50. Therefore, CompuValue would estimate the stand-alone selling
price of the assembly service to be $50 + $37.50 = $87.50.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Expected cost plus margin
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
273. CompuTime Center sells a full assortment of computer parts, including motherboards,
video cards, and cables. It also offers complementary computer assembly services. A
customer places an order for an advanced workstation, and CompuTime asks for $3,500. If
CompuTime were to sell only the parts in an advanced workstation, with no assembly, the
price would be $3,300.
Required: Assuming that computer parts and assembly service are separate performance
obligations, estimate the stand-alone selling price of the assembly service based on the residual
approach.
Answer:
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Under the residual approach, CompuTime would base its estimate of the stand-alone selling
price of the assembly service on the total selling price of the workstation ($3,500) minus the
observable stand-alone selling price of parts ($3,300). Therefore, CompuTime would estimate
the stand-alone price of the assembly to be $3,500 – $3,300 = $200.
Level of Learning: 1 Easy
Learning Objective: 05-06
Topic Area: Transaction price―Residual approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
274. Bria Furniture sells bed frames and mattresses. One of its products is a premium
therapeutic bed set produced by OmniSleep, which comes with a mattress and a bed frame.
Bria offers a package consisting of the mattress, the frame, and on-site installation by its staff.
All of these components can be sold separately, as often done by other vendors, so Bria
concludes that these are separate performance obligations. Bria sells the OmniSleep package
for $3,000. The mattress and the frame are sold separately for $2,000 and $900, respectively.
Other vendors in the same area typically charge $200 for on-site installation. Bria does not
sell on-site installation separately. On average, the prices charged by Bria are 10% higher
than those of its competitors. Bria estimates that it incurs about $100 of compensation and
other costs to provide the installation service. The profit margin over cost is estimated to be
approximately 35%.
Required: Estimate the stand-alone selling price of the installation service using (a) the adjusted
market assessment approach, (b) the expected cost plus margin approach, and (3) the residual
approach.
Answer:
Part a) Under the adjusted market assessment approach, Bria would base its estimate of the
stand-alone selling price of the installation service on the prices charged by other vendors for the
same or similar service, adjusted as necessary. Since Bria’s selling prices are 10% higher on
average, Bria would estimate the stand-alone selling price of the installation service to be $200 +
($200 × 10%) = $220.
Part b) Under the expected cost plus margin approach, Bria 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 mark-up of 35% × $100 = $35. Therefore, Bria would estimate the stand-alone selling price of
the installation service to be $100 + 35 = $135.
Part c) Under the residual approach, Bria would base its estimate of the stand-alone selling price
of the installation service on the total selling price of the package ($3,000) less the observable
stand-alone selling prices of the OmniSleep mattress ($2,000) and the frame ($900). Therefore,
Bria would estimate the stand-alone selling price of the installation service to be $3,000 –
($2,000 + $900) = $100.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Allocate the transaction price – Adjusted market assessment approach
Topic Area: Allocate the transaction price – Expected cost plus margin approach
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Topic Area: Transaction price―Residual approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
275. Mahogany Billiards sells upscale pool tables and related supplies. It sells a premium
package consisting of a pool table imported from Europe, a full set of cues and balls, and on-
site installation by its staff. Mahogany determines that each of these components is a
performance obligation. Mahogany sells the pool table separately for $3,000 and the set of
cues and balls for $1,000. The entire package is sold at $4,500. Mahogany does not offer on-
site installation separately, as part of company policy. It also estimates that it incurs about
$350 of compensation and other costs per each installation. Other competing vendors sell on-
site installation separately for $450, on average. Mahogany typically earns a profit margin of
40% over cost, and its prices are generally 5% lower than those charged by competitors.
Required: Estimate the stand-alone selling price of the installation service using (a) the adjusted
market assessment approach, (b) the expected cost plus margin approach, and (3) the residual
approach.
Answer:
Part a) Under the adjusted market assessment approach, Mahogany would base its estimate of the
stand-alone selling price of the installation service on the prices charged by other vendors for the
same or similar service, adjusted as necessary. Since Mahogany carries selling prices that are 5%
lower on average, Mahogany would estimate the stand-alone selling price of the installation
service to be $450 – ($450 × 5%) = $427.50.
Part b) Under the expected cost plus margin approach, Mahogany would base its estimate of the
stand-alone selling price of the installation service on the $350 cost it incurs to provide the
service, plus its mark-up of 40% × $350 = $140. Therefore, Mahogany would estimate the stand-
alone selling price of the installation service to be $350 + 140 = $490.
Part c) Under the residual approach, Mahogany would base its estimate of the stand-alone selling
price of the installation service on the total selling price of the package ($4,500) less the
observable stand-alone selling prices of the pool table ($3,000) and the set of cues and balls
($1,000). Therefore, Mahogany would estimate the stand-alone selling price of the installation
service to be $4,500 – ($3,000 + $1,000) = $500.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Residual approach
Topic Area: Transaction price―Expected cost plus margin
Topic Area: Transaction price―Adjusted market approach
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
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276. Assume that, on April 1, 2018, a customer visits MicrosoftStore.com and purchases
Microsoft Windows 7 Ultimate for $170. Windows 7 Ultimate comes in a DVD format which
the customer can use permanently, and Microsoft does not expect that its actions subsequent
to April 1, 2018 will affect the value the customer obtains from using the software.
Required: How much revenue should Microsoft recognize in 2018 with respect to this particular
transaction?
Answer:
The software license for Windows 7 Ultimate is a right of use for functional intellectual
property. The customer does not expect Microsoft’s subsequent activity to change the
functionality of the software, so Microsoft can recognize the entire $170 upon transfer of the
right. Microsoft recognizes revenue of $170 in 2018.
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
277. Smith & Sons is a CPA firm that provides proprietary software to its clients. One of its
software packages sells for $150 and contains pre-programmed tutorials on basic accounting
concepts. Another product sells for $3,000 and contains Smith & Sons’ archive of accounting
standards and articles, which Smith & Sons updates on a weekly basis and downloads to
archive users for the two years following purchase of the product.
Required: If a customer purchases both software packages on June 1, 2018, how much revenue
should Smith & Sons recognize for the year?
Answer:
The software license for tutorials is a right of use for functional intellectual property. The
customer does not expect for Smith & Sons’ subsequent activity to change the functionality of
the software, so Smith & Sons can recognize the entire $150 upon transfer of the right.
However, the license to use the accounting archive is an access right, as the customer should
expect that Smith & Sons’ activity during the license period will affect the value of the software
to the customer, so Smith & Sons should recognize revenue as that access is consumed over 24
months. Since the customer uses the archive software for seven months in 2018 (June through
December), Smith & Sons should recognize revenue of 7 ÷ 24 = 7/24 of $3,000, or $875 for that
access right in 2018.
In total, Smith & Sons recognizes revenue of $150 + $875 = $1,025 in 2018.
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
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278. Berry Farm produces organic tomatoes and strawberries. In June 2018, it transported 100
boxes of strawberries with a price of $20 per box to the Bay Farmers’ Market. Berry Farm
paid an upfront fee of $100 to present its products at the market for one week, and the market
earns a 25% profit margin on each item sold, but Berry Farm is responsible for any items that
remain unsold at the end of the week.
Required: The market was able to sell 65 boxes of strawberries to customers. How much
revenue should Berry Farm recognize with respect to this transaction?
Answer:
65 × $20 = $1,300. Berry Farm has a consignment arrangement with Bay Farmers’ Market, so it
should not recognize transfer of 100 boxes of strawberries as sales. Although the market has
physical possession of the asset for the sales period, Berry Farm retains legal title to the asset as
well as the risks and rewards of ownership for the goods placed on consignment.
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Consignment
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
279. Holmgren Seafoods, Inc. catches and processes salmon and tuna caught off the coast of
Maine. In May 2018, it placed 100 freshly caught wild salmon with a retail price of $75 each
in Joe’s Fish Shop. Holmgren’s contract with the shop stipulates that the shop will earn a
15% commission on each salmon sold. Joe’s is responsible for purchasing any fish that
remain unsold at the end of a three-day period.
Required: During the three-day period, Joe’s Fish Shop was able to sell 88 of the 100
salmon. How much revenue should Holmgren recognize with respect to this transaction?
Answer:
100 × $75 = $7,500. Holmgren Seafoods, Inc. has transferred control of the salmon to Joe’s Fish
Shop, because Joe’s holds the risks and rewards of ownership. If a fish is unsold, Joe’s must
pay for it, so Holmgren is guaranteed to receive payment for all 100 fish. Therefore, Holmgren
would view its transfer of fish to Joes’ as a sale rather than as a consignment arrangement.
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Consignment
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–135
280. Colombo Coffee sells gift cards that can be used at its 55 branches. During 2017,
customers purchased $25,000 of gift cards, of which $3,000 were redeemed during 2018. It is
estimated that a balance of $1,500 of cards sold in 2017 remains unused as of the end of
2018, and Colombo determines that this amount will never be redeemed, based on historical
experience. During 2018, Colombo further sold $32,000 of gift cards, of which $26,000 were
redeemed and $6,000 remain unused but may be used by customer in 2019.
Required: How much gift card revenue should Colombo recognize in 2018?
Answer:
Colombo should not recognize revenue when it sells the gift cards, because it has not yet
satisfied its performance obligation to provide goods upon redemption of the cards. Colombo
should recognize revenue only to the extent gift cards are redeemed, plus the amount it
estimates will never be redeemed. Hence, the revenue to be recognized for 2018 is $3,000 +
$1,500 + $26,000 = $30,500.
Level of Learning: 1 Easy
Learning Objective: 05-07
Topic Area: Timing of rev rec―Gift cards
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
281. Moretti Department Store sells gift cards that expire three years from the date of
purchase. During 2016, Moretti sold $50,000 of gift cards, of which $1,500 were redeemed
during 2018. At the end of 2018, it is estimated that approximately $800 of the 2016 balance
remains unused, and Moretti concludes that it will never be redeemed. Moretti sold another
$55,000 of gift cards in 2017, of which $22,000 were redeemed in 2018, and $60,000 of gift
cards in 2018, of which $40,000 were redeemed in 2018.
Required: How much revenue with respect to gift cards should Moretti recognize in 2018?
Answer:
Moretti should recognize revenue only to the extent gift cards are redeemed, plus the amount it
estimates will never be redeemed. Hence, the revenue to be recognized for 2018 is $1,500 +
$800 + $22,000 + $40,000 = $64,300.
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Gift cards
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Use the following to answer questions 293 and 294:
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282. Beck Construction Company began work on a new building project on January 1, 2017.
The project is to be completed by December 31, 2019, for a fixed price of $108 million. The
following are the actual costs incurred and estimates of remaining costs to complete the
project that were made by Beck’s accounting staff:
Years Actual costs incurred in each year Estimated remaining costs to complete the
project (measured at Dec. 31 of each year)
2017 $30 million $60 million
2018 $45 million $45 million
2019 $35 million $ 0
Required: What amount of gross profit (or loss) would Beck record on this project in each year,
assuming that Beck recognizes revenue for this project upon completion of the project? Place
answers in the spaces provided below and show supporting computations.
Years Gross Profit (or Loss) recognized Supporting computations
2017
2018
2019
Answer:
Years Gross Profit (or Loss)
recognized
Supporting computations
2017 $0 ($108 – 90) = $18 anticipated gross profit, so no need to
recognize a gross loss
2018 ($12 million) Total loss is ($108 – 120) = ($12 million)
2019 $10 million Total loss is ($108 – 110) = ($2 million)
To date, $12 million loss was recorded; therefore,
($2 million) – ($12 million) = $10 million in 2019
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Loss on contract
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
283. Beck Construction Company began work on a new building project on January 1, 2017.
The project is to be completed by December 31, 2019, for a fixed price of $108 million. The
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following are the actual costs incurred and estimates of remaining costs to complete the
project that were made by Beck’s accounting staff:
Years Actual costs incurred in each year Estimated remaining costs to complete the
project (measured at Dec. 31 of each year)
2017 $30 million $60 million
2018 $45 million $45 million
2019 $35 million $ 0
Required: What amount of gross profit (or loss) would Beck record on this project in each year,
assuming that Beck recognizes revenue for this project over time according to percentage of
completion? Place answers in the spaces provided below and show supporting computations.
Years Gross Profit (or Loss) recognized Supporting computations
2017
2018
2019
Answer:
Years Gross Profit (or Loss) recognized Supporting computations
2017 $6 million ($108 – 90) x ($30 /$90) = $6 million
2018 ($18 million) Total loss is ($108 – 120) = ($12 million)
To date, $6 million profit was recorded; therefore,
($12 million) – $6 million = ($18 million) in 2018
2019 $10 million Total loss is ($108 – 110) = ($2 million)
To date, $12 million loss was recorded; therefore,
($2 million) – ($12 million) = $10 million in 2019
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Loss on contract
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
Use the following to answer questions 284 – 287:
Beavis Construction Company was the low bidder on a construction project to build an earthen dam for
$1,800,000. The project was begun in 2017 and completed in 2018. Cost and other data are presented
below:
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2017 2018
Costs incurred during the year $ 450,000 $1,100,000
Estimated costs to complete 1,050,000 0
Billings during the year 400,000 1,400,000
Cash collections during the year 300,000 1,500,000
284. Assume that Beavis recognizes revenue on this contract over time according to
percentage of completion. Required: Compute the amount of gross profit recognized during
2017 and 2018.
Answer:
2017:
Contract price $1,800,000
Actual costs to date $ 450,000
Estimated costs to complete 1,050,000
Total estimated project costs 1,500,000
Estimated total gross profit 300,000
Percentage of completion:
$450,000/ $1,500,000 30%
Gross profit recognized $ 90,000
2018:
Contract price $1,800,000
Costs incurred:
2017 $ 450,000
2018 1,100,000
Total cost 1,550,000
Total gross profit 250,000
Recognized in 2017 90,000
Recognized in 2018 $ 160,000
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
285. Assume that Beavis recognizes revenue on this contract over time according to
percentage of completion.
Required: Prepare all journal entries to record costs, billings, collections, and profit recognition.
Answer:
2017:
Construction in progress 450,000
Cash or A/P 450,000
Accounts receivable 400,000
Billings on construction contract 400,000
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Cash 300,000
Accounts receivable 300,000
Construction in progress 90,000
Cost of construction 450,000
Revenue from long-term contracts 540,000
2018:
Construction in progress 1,100,000
Cash or A/P 1,100,000
Accounts receivable 1,400,000
Billings on construction contract 1,400,000
Cash 1,500,000
Accounts receivable 1,500,000
Construction in progress 160,000
Cost of construction 1,100,000
Revenue from long-term contracts 1,260,000
Billings on construction contract 1,800,000
Construction in progress 1,800,000
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
286. Assume that Beavis recognizes revenue upon completion of the project.
Required: Compute the amount of gross profit recognized during 2017 and 2018.
Answer:
2017: $0
2018:
Contract price $1,800,000
Costs incurred: 2017 $ 450,000
2018 1,100,000
Total cost 1,550,000
Total gross profit $ 250,000
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Upon completion
Blooms: Apply
AACSB: Knowledge application
5–140
AICPA: FN Measurement
287. Assume that Beavis recognizes revenue upon completion of the project.
Required: Prepare all journal entries to record costs, billings, collections, and profit
recognition.
Answer:
2017:
Construction in progress 450,000
Cash or A/P 450,000
Accounts receivable 400,000
Billings on construction contract 400,000
Cash 300,000
Accounts receivable 300,000
2018:
Construction in progress 1,100,000
Cash or A/P 1,100,000
Accounts receivable 1,400,000
Billings on construction contract 1,400,000
Cash 1,500,000
Accounts receivable 1,500,000
Construction in progress 250,000
Cost of construction 1,550,000
Revenue from long-term contracts 1,800,000
Billings on construction contract 1,800,000
Construction in progress 1,800,000
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Upon completion
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
288. In 2018, Chicago Construction began work on a three-year construction project to build a
new performing arts complex (the PAC). The PAC contract price is $150 million. Chicago
recognizes revenue on this contract over time according to percentage of completion. At the
end of 2018, the following financial statement information indicates the results to date for the
PAC (missing items denoted by letter):
INCOME STATEMENT:
Revenue $ w million
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Cost of construction 35 million
Gross profit $ x million
BALANCE SHEET:
Accounts receivable from construction billings $14 million
Construction in progress $50 million
Less: Billings on construction ($y million)
Net billings in excess of construction in progress $z million
CASH FLOW STATEMENT
Cash collections $46 million
Required: Compute the following, placing your answer in the spaces provided and showing
supporting computations below:
Item to compute Answer
Total revenue recognized during 2018 (w):
Gross profit recognized during 2018 (x):
Billings on construction (y):
Net billings in excess of construction in progress (z):
Calculate the percentage of PAC that was completed during 2018:
Answer:
Item to compute Answer
Total revenue recognized during 2018 (w):
CIP contains cost + gross profit = revenue, so w = $50
$ 50 million
Gross profit recognized during 2018 (x): $50 – $35 = $15 $ 15 million
Billings on construction (y): $14 + $46 = $60 $ 60 million
Net billings in excess of construction in progress (z): Billings of $60 – CIP of $50 $10 million
Calculate the percentage of PAC that was completed during 2018:
50/150 = 33.33%
33.33%
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Upon completion
Blooms: Apply
AACSB: Knowledge application
AICPA: BB Critical Thinking
AICPA: FN Measurement
289. In 2018, KP Building Inc. began work on a four-year construction project (called Cincy
One). The contract price is $300 million. KP recognizes revenue on this contract over time
according to percentage of completion. At the end of 2018, the following financial statement
information indicates the results to date for Cincy One:
INCOME STATEMENT:
Gross profit (before-taxes) recognized in 2018 $22 million
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BALANCE SHEET:
Accounts receivable from construction billings $10 million
Construction in progress $66 million
Less: Billings on construction ($75 million)
Net billings in excess of construction in progress $9 million
Required: Compute the following, placing your answer in the spaces provided and showing
supporting computations below.
Item to compute Answer
Cash collected by KP on Cincy One during 2018
Actual costs incurred by KP on Cincy One during 2018
At 12/31/2018, the estimated remaining costs to complete Cincy One
The percentage of Cincy One that was completed during 2018
Answer:
Item to compute Answer
Cash collected by KP on Cincy One during 2018. ($75 billings – $10 A/R) $ 65 million
Actual costs incurred by KP on Cincy One during 2018 ($66 CIP – $22 gross profit) $ 44 million
At 12/31/2018, the estimated remaining costs to complete Cincy One
(44/{44 + x})(300 – {44 + x}) = 22; x = 156
$ 156 million
The percentage of Cincy One that was completed during 2018 22%
100 x (44 / {44 + 156})
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Apply
AACSB: Knowledge application
AICPA: BB Critical Thinking
AICPA: FN Measurement
Use the following to answer questions 290 – 292:
McCombs Contractors received a contract to construct a mental health facility for $2,500,000.
Construction was begun in 2017 and completed in 2018. Cost and other data are presented below:
2017 2018
Costs incurred during the year $1,500,000 $1,300,000
Estimated costs to complete 1,200,000 0
Billings during the year 1,200,000 1,300,000
Cash collections during the year 1,000,000 1,500,000
290. Assume that McCombs recognizes revenue on this contract over time according to
percentage of completion.
Required: Compute the amount of gross profit recognized during 2017 and 2018.
Answer:
2017:
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Contract price $2,500,000
Actual cost to date $1,500,000
Estimated costs to complete 1,200,000
Total estimated project costs 2,700,000
Estimated loss, recognized in 2017 $ (200,000)
2018:
Contract price $2,500,000
Cost incurred: in 2017…………… $1,500,000
in 2018…………… 1,300,000
Total cost 2,800,000
Total loss $ (300,000)
Recognized in 2017 (200,000)
Recognized in 2018 $ (100,000)
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Loss on contract
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
291. Assume that McCombs recognizes revenue on this contract over time according to
percentage of completion.
Required: Prepare all journal entries to record costs, billings, collections, and profit (loss)
recognition. Round your answers to the nearest whole dollar.
Answer:
2017:
Construction in progress 1,500,000
Cash or A/P 1,500,000
Accounts receivable 1,200,000
Billings on construction contract 1,200,000
Cash 1,000,000
Accounts receivable 1,000,000
Cost of construction 1,588,889
Construction in progress (loss) 200,000
Revenue from long-term contracts* 1,388,889
2018:
Construction in progress 1,300,000
Cash or A/P 1,300,000
Accounts receivable 1,300,000
Billings on construction contract 1,300,000
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Cash 1,500,000
Accounts receivable 1,500,000
Cost of construction 1,211,111
Construction in progress (loss) 100,000
Revenue from long-term contracts** 1,111,111
Billings on construction contract 2,500,000
Construction in progress 2,500,000
*$2,500,000 x ($1,500,000/$2,700,000)
** $2,500,000 – 1,388,889
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Loss on contract
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
292. Assume that McCombs recognizes revenue upon project completion.
Required: Compute the amount of gross profit recognized by McCombs during 2017 and 2018.
Answer:
2017: $(200,000) due to projected loss
2018:
Contract price $2,500,000
Cost incurred: 2017 $1,500,000
2018 1,300,000
Total cost 2,800,000
Total loss on contract $ ( 300,000)
Loss recognized in 2017 (200,000)
Loss recognized in 2018 $ (100,000)
Level of Learning: 3 Hard
Learning Objective: 05-09
Topic Area: Long-term contracts―Loss on contract
Blooms: Apply
AACSB: Knowledge application
AICPA: FN Measurement
5–145
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Essay
Instructions:
The following answers point out the key phrases that should appear in students’ answers. They are not
intended to be examples of complete student responses. It might be helpful to provide detailed
instructions to students on how brief or in-depth you want their answers to be.
293. Silica Corporation constructs highly specialized communication satellites. A customer in
Hong Kong recently placed an order for a cable TV satellite at a price of $20 million. The
order was placed in April 2018, and the satellite is to be delivered in one year. The customer
has guaranteed to pay in full at the end of 2018, regardless of progress or cancellation. Silica
uses “proportion of time” as its measure of progress toward completion.
Required: When should Silica recognize revenue: at completion, or as the construction is
performed?
Answer:
This contract qualifies for revenue recognition over time, because 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.
Level of Learning: 1 Easy
Learning Objective: 05-03
Topic Area: Revenue over time―Criteria
Blooms: Understand
AACSB: Reflective thinking
AICPA: FN Measurement
294. Hans Cars & Trucks sells various types of used vehicles with a one-year warranty that
covers any defects. When customers make a purchase, they also receive a coupon for 10 free
engine oil changes and an option to change all of the tires for $50 after 30,000 miles.
Typically, customers pay $25 for an oil change and $250 for a new set of tires.
Required:
(a) Given the information above, how many performance obligations exist in the contract to
purchase a vehicle?
(b) Assume the same contract but that it offers customers an option to change all of the tires for
$250 after 30,000 miles. How many performance obligations exist in the contract to purchase a
vehicle?
Answer:
(a) In total, there are three performance obligations. We need to consider four aspects of the car
purchase contract: delivery of the vehicle, the one-year quality-assurance warranty, the option to
receive 10 oil changes for free, and the option to change the tires for $50. Delivery of the
vehicle 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 provide the vehicle of appropriate quality. The option to receive oil changes for
free is a performance obligation within the contract to purchase a vehicle, because (1) it
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provides a material right to the customer that the customer would not receive otherwise, and
thus counts as a performance obligation; (2) the option is capable of being distinct, as the
customer could purchase oil changes separately, and it is separately identifiable, as the vehicle
itself could be sold without free oil changes. The option to change tires for $50 also constitutes a
performance obligation, as it is (1) a material right to the customer that the customer would not
receive otherwise, and thus counts as a performance obligation; (b) this option is capable of
being distinct, as a new set of tires could be sold separately, and it is also separately identifiable,
as the vehicle itself could be sold without a new set of tires.
(b) There are two performance obligations. The option to change tires for $250 is not a
performance obligation, because customers can purchase the tires for the same amount at other
times, so the option itself does not present a material right.
Level of Learning: 2 Medium
Learning Objective: 05-04
Learning Objective: 05-05
Topic Area: Mult perf oblig―Identify the perf oblig
Topic Area: Contract features―Warranties
Blooms: Analyze
AACSB: Analytical thinking
AACSB: Communication
AICPA: FN Measurement
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295. Lexikon Pianos sells customized concert pianos throughout the U.S. Its grand concert
piano sells for $200,000, which includes delivery and installation. The product comes with a
two-year warranty that covers any product defects, and customers can choose to add an
extended three-year warranty for maintenance and repair at a price of $2,000. Customers also
get an option to upgrade traditional plastic keys to bone ones for an additional $20,000. The
extended warranty would normally sell for $3,500, and the installation of bone keys carries a
standalone price of $30,000.
Required:
(a) Given the information above, how many performance obligations exist in the contract to
purchase a grand concert piano?
(b) Now, assume that the standalone price of the extended warranty is $2,000, and that of the
bone key upgrade is $20,000. How many performance obligations exist in the contract to
purchase a grand concert piano?
Answer:
(a) In total, there are three performance obligations. We need to consider four aspects of the
piano purchase contract: delivery and installation of the piano, the two-year quality-assurance
warranty, the option to purchase an extended three-year warranty for $2,000, and the option to
upgrade to bone keys for $20,000. Delivery of the piano is a performance obligation. The two-
year quality-assurance warranty is not a performance obligation, but rather is part of the
obligation to provide a piano of appropriate quality. The option to purchase the extended
warranty is a performance obligation within the contract to purchase the piano, because it
provides (1) a material right to the customer that the customer would not receive otherwise, and
thus counts as a performance obligation; (2) the option is capable of being distinct, as the
customer could purchase the extended warranty separately, and it is also separately identifiable,
as the piano could be sold without an extended warranty. The option to upgrade to bone keys is
also a performance obligation for the same reasons.
(b) There is only one performance obligation. The option to purchase the extended warranty or
the bone keys is no longer a material right, because customers can purchase them for the same
amount at other times. Hence, the seller has only one performance obligation – delivery and
installation of the piano itself.
Level of Learning: 2 Medium
Learning Objective: 05-04
Learning Objective: 05-05
Topic Area: Mult perf oblig―Identify the perf oblig
Topic Area: Contract features―Warranties
Blooms: Analyze
AACSB: Analytical thinking
AACSB: Communication
AICPA: FN Measurement
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296. Summerhill Construction builds luxury houses in remote areas. On June 1, 2018, the
company signed a contract to build a house in an undeveloped section of a mountainside, and
received $2 million in advance for the job. To complete the project, the company must
construct a pathway leading to the building lot, clear a large hillside, and construct a wooden
house. Normally, the company would charge $400,000, $1,400,000, and $500,000,
respectively, for each of these tasks if done separately.
Required: Given the information above, how many performance obligations are included in this
contract?
Answer:
Number of performance obligations in the contract: 1.
Summerhill enters into a contract to construct a house on difficult terrain. The components are
not separately identifiable, because each component is highly interrelated with each other, as
Summerhill is obligated to integrate the components into a combined final product for delivery
to the customer.
Level of Learning: 2 Medium
Learning Objective: 05-04
Learning Objective: 05-09
Topic Area: Mult perf oblig―Identify the perf oblig
Topic Area: Long-term contracts―Accounting issues
Blooms: Analyze
AACSB: Analytical thinking
AACSB: Communication
AICPA: FN Measurement
297. Optimus Pools, Inc. constructs outdoor swimming pools for wealthy individuals.
Recently it obtained an order to build a three-lane swimming pool of 25 yards in length in the
customer’s backyard. Under the contract, Optimus is also obligated to install a water heater
and a filtration system, which are necessary to make a swimming pool fully functional. Total
price for the construction was $55,000. Each of these smaller components would typically
cost $40,000, $10,000, and 20,000 if installed separately.
Required: Given the information above, how many performance obligations are included in this
contract?
Answer:
Number of performance obligations in the contract: 1.
Optimus enters into a contract to construct a functioning swimming pool. The smaller
components are not separately identifiable, because each component is highly interrelated with
each other, as Optimus is obligated to integrate the components into a combined final product
for delivery to the customer.
Level of Learning: 2 Medium
Learning Objective: 05-04
Topic Area: Mult perf oblig―Identify the perf oblig
Blooms: Analyze
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AACSB: Analytical thinking
AACSB: Communication
AICPA: FN Measurement
298. FlexMotors, Inc. manufactures a variety of electronic drills and grass cutters. Recently, it
introduced a new line of handheld drills that generates much less noise and consumes much
less energy, but carries a much higher price tag. The company is currently considering
whether it should record $1.2 million of revenue upon shipment. Under the contract,
FlexMotors is obligated to accept any products from the distributors if they are not sold
within 6 months. The company is confident that the new model will sell, but is unable to
accurately estimate returns, because it has never sold anything quite like it.
Required: How much revenue should FlexMotors recognize upon shipment to distributors?
Answer:
The seller should recognize $0 of revenue upon delivery to distributors. The seller should
recognize revenue, for the amount it is entitled to receive, net of estimated returns, only to the
extent it is probable that it will not have to reverse (adjust revenue downward) for estimated
returns in the future. Here, the seller is uncertain about estimated returns, so it cannot plausibly
assume it will not have to reverse (adjust downward) a significant amount of the $1.2 million
revenue in the future due to a change in returns. Hence, the seller must postpone recognizing
any revenue until the uncertainty about returns is resolved, which would occur when (a) it can
better estimate returns, (b) sales to end consumers take place over time, or (c) distributors
eventually return unsold amounts at the end of the 6-month period. At the point of shipment, the
seller should treat the transaction as if it is placing those goods on consignment with
independent distributors, since it cannot reasonably estimate returns.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Right of return
Blooms: Analyze
AACSB: Analytical thinking
AACSB: Communication
AICPA: FN Measurement
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299. Horowitz Paint Shop sold $3,000 of paint to a local construction company for cash on
June 25, 2018. Because of a flood in the area, the customer requested that Horowitz not ship
the items from its warehouse until July 3, 2018, so Horowitz set aside the paint on June 25,
packaged and ready to ship on July 3.
Required: For the second quarter ending on June 30, how much revenue should Horowitz
recognize for the sale to the local construction company? Explain your answer.
Answer:
$3,000. In a bill-and-hold arrangement, the key issue normally is that the customer does not
have physical possession of the asset until the seller has delivered it. However, since the
customer requested that Horowitz hold the goods, has been paid for the goods, and the goods are
separated from Horowitz’s inventory and ready for shipment, Horowitz likely would be viewed
as shifting control to the customer in June.
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Bill-and-hold
Blooms: Analyze
AACSB: Analytical thinking
AACSB: Communication
AICPA: FN Measurement
300. On December 28, 2018, Omega Steel, Inc. sold $100,000 of steel sheets to a car
manufacturer. Due to holidays, Omega was unable to find a truck driver to deliver the
product. Delivery was finally made on January 5, 2019.
Required: How much revenue should Omega recognize in 2018 for the sale to the car
manufacturer? Explain your answer.
Answer:
$0. In a bill-and-hold arrangement, the key issue is that the customer does not have physical
possession of the asset until the seller has delivered it. The shipping delay was caused by
Omega and was not in response to a customer request. Since the seller maintains control of the
inventory prior to delivery, it should not recognize revenue.
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Bill-and-hold
Blooms: Analyze
AACSB: Analytical thinking
AACSB: Communication
AICPA: FN Measurement
Chapter 5 Revenue Recognition and Profitability Analysis
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301. The following disclosure note appeared in a recent annual report to stockholders of
Dell Inc., the computer manufacturer: “Net revenue includes sales of hardware, software
and peripherals, and services (including extended service contracts and professional
services). These products and services are sold either separately or as part of a multiple-
element arrangement. Dell allocates fees from multiple-element arrangements to the
elements based on the relative fair value of each element, which is generally based on the
relative list price of each element. For sales of extended warranties with a separate
contract price, Dell defers revenue equal to the separately stated price. Revenue associated
with undelivered elements is deferred and recorded when delivery occurs. Product revenue
is recognized, net of an allowance for estimated returns, when both title and risk of loss
transfer to the customer, provided that no significant obligations remain. Revenue from
extended warranty and service contracts, for which Dell is obligated to perform, is
recorded as deferred revenue and subsequently recognized over the term of the contract or
when the service is completed. Revenue from sales of third-party extended warranty and
service contracts, for which Dell is not obligated to perform, is recognized on a net basis
at the time of sale.”
Briefly explain why Dell Computer recognizes revenue at different times for (a) product sales,
(b) extended warranty and service contracts for which Dell is obligated to perform, and (c)
extended warranty and service contracts for which a third party is obligated to perform.
Answer: (a) Dell recognizes revenue for products at the point in time it transfers control of the
goods to buyers, which coincides with transfer of title and risk of loss to the customer.
Because of the material possibility of product returns in the computer business, sales returns
must be estimated and the sales price adjusted to reflect them in the period of sale. (b) Dell
typically collects in advance for service and extended warranty contracts. On contracts that
Dell is obligated to perform, it recognizes revenue over time as the customer consumes the
benefit of the contract (coverage for warranty and service). (c) However, on contracts that it
sells for which a third party is obligated to perform, Dell essentially acts as an agent, and it
recognizes net revenue (basically its sales commission) at the time of sale.
Level of Learning: 3 Hard
Learning Objective: 05-02
Learning Objective: 05-03
Learning Objective: 05-04
Learning Objective: 05-06
Learning Objective: 05-08
Topic Area: Transfer of control and indicators
Topic Area: Revenue over time―Progress to completion
Topic Area: Contract features―Warranties
Topic Area: Transaction price―Principal or agent
Topic Area: Disclosures―Balance sheet and Notes
Blooms: Analyze
AACSB: Analytical thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement
302. Are the following separate performance obligations: prepayments, quality-assurance
warranty, extended warranty, right of return? For each, indicate yes or no, and explain.
Chapter 5 Revenue Recognition and Profitability Analysis
5–169
Answer:
o Prepayment: No, not a separate performance obligation. Rather, the upfront fee is an
advance payment for future products or services and should be included in the
transaction price.
o Quality-assurance warranty: No, not a separate performance obligation. Rather, it is a
cost of satisfying the performance obligation to provide products of acceptable
quality.
o Extended warranty: Yes, it is a separate performance obligation. It provides
protection beyond the manufacturer’s quality-assurance warranty, so it provides a
material right. It is capable of being distinct, as it can be sold separately, and it is
separately identifiable, as it is distinct in the context of the contract.
o Right of return: No, not a separate performance obligation. Rather, it represents a
potential failure to satisfy the original performance obligation to provide satisfactory
goods to the customer.
Level of Learning: 2 Medium
Learning Objective: 05-04
Topic Area: Mult perf oblig―Identify the perf oblig
Blooms: Remember
AACSB: Reflective thinking
AICPA: BB Critical thinking
AICPA: FN Measurement
303. Explain two approaches a seller can use to estimate variable consideration, and when
each approach is likely to be more appropriate.
Answer: A seller estimates variable consideration as either (a) the expected value (calculated
as the sum of each possible amount multiplied by its probability), or (b) the most likely
amount, depending on which estimation approach better predicts the amount that the seller
will receive. If there are several possible outcomes, the expected value will be more
appropriate. On the other hand, if only two outcomes are possible, the most likely amount
might be the best indication of the amount the seller will likely receive.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Variable consideration
Blooms: Remember
AACSB: Reflective thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement
304. Are sellers ever constrained from including variable consideration in the transaction
price used to estimate revenue? Explain, providing indicators of circumstances that could
require that constraint.
Answer: Sellers only include an estimate of variable consideration in the transaction price to
the extent it is probable that a significant revenue reversal will not occur when the uncertainty
associated with the variable consideration is resolved. Indicators that a significant revenue
reversal could occur include (a) poor evidence on which to base an estimate, (b) dependence
of the estimate on factors outside the seller’s control, (c) a history of the seller changing
Chapter 5 Revenue Recognition and Profitability Analysis
5–170
payment terms on similar contracts, (d) a broad range of outcomes that could occur, and (e) a
long delay before uncertainty resolves.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Variable consid constraint
Blooms: Remember
AACSB: Reflective thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement
305. Briefly describe at least two indicators that can be used to distinguish whether a seller
is a principal or an agent according to GAAP.
Answer: Indicators that a company is a principal are:
1. Company has primary responsibility for delivering a product or service
2. Company is vulnerable to risks associated with
a. holding inventory,
b. delivering the product or service, and
c. setting prices.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: BB Critical thinking
AICPA: FN Measurement
306. Explain the differences between how a principal and agent would show a sale of a
product that has gross revenues of $1,000, cost of goods sold of $750, and a commission
paid by the principle of 10% of gross sales on their respective income statements.
Answer: The principal would report revenue of $1,000, cost of goods sold of $750, and a
commission expense of $100 for a gross profit of $250 and net income before taxes of $150.
The agent reports commission revenue of $100.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Principal or agent
Blooms: Remember
AACSB: Reflective thinking
AICPA: BB Critical thinking
AICPA: FN Measurement
307. Explain briefly how a company who sells to distributors with a right of return might
manage earnings if the company was falling short of profit projections. What sort of
ethical problems could result from that earnings management?
Chapter 5 Revenue Recognition and Profitability Analysis
5–171
Answer: The most apparent way would be to change the percentage used to estimate returns.
Additionally, a company could ship extra product to distributors and recognize sales to meet
profit projections (this is commonly called “channel stuffing”). However, if the company is
pushing product onto distributors (that is, it is borrowing sales from the next period), and/or if
the company thinks the product will be returned but does not make allowance for that fact, the
company is behaving unethically because it is manipulating how the accounting system
portrays its underlying economic activity.
Level of Learning: 2 Medium
Learning Objective: 05-06
Topic Area: Transaction price―Right of return
Blooms: Create
AACSB: Ethics
AACSB: Communication
AICPA: BB Critical thinking
AICPA: Risk analysis
308. Many high-tech companies sell products with the opportunity for retailers to return the
merchandise if it is unsold after a certain period. This reduces the retailer’s risk of
inventory obsolescence. Explain the implications on revenue recognition under this kind
of policy. Include a specific example.
Answer: Assume that the company allows the retailer up to one year to determine if it chooses
to keep and sell the merchandise or return it with no questions asked. Allowing returns means
that the transaction price includes variable consideration. The seller must estimate that
variable consideration and only recognize revenue net of anticipated returns. The seller
should only recognize revenue for the amount it is entitled to receive net of the estimate for
returns, to the extent that it is probable that a significant reversal of revenue will not occur in
the future due to returns being higher than the seller anticipated.
Level of Learning: 3 Hard
Learning Objective: 05-06
Topic Area: Transaction price―Right of return
Blooms: Create
Blooms: Understand
AACSB: Reflective thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement
309. Briefly explain the circumstances in which license revenue is recognized over time
versus at a point in time. Provide an example of each.
Answer: Some licenses transfer a right to use the seller’s functional intellectual property as it
exists when the license is granted. Functional intellectual property is viewed as having
standalone functionality which is not affected by the seller’s subsequent activity. If a license
transfers such a right of use, revenue is recognized at the point in time the right is transferred.
Examples include software like Microsoft Office, music CDs, and movie DVDs. For these
licenses, subsequent activity by the seller doesn’t affect the benefit that the customer receives.
Other licenses provide the customer with access to the seller’s symbolic intellectual property
Chapter 5 Revenue Recognition and Profitability Analysis
5–172
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 seller’s symbolic intellectual property, the seller satisfies its performance obligation
over time as the customer receives benefits of the seller’s ongoing activities, so revenue is
recognized over the period of time for which access is provided. Examples include licenses to
use a company’s brand or trademark. Sellers also will recognize revenue for functional
intellectual property over time if the seller is expected to make changes to the intellectual
property during the license period and the licensee has to use the changed intellectual
property. An example is anti-virus software, for which frequent updates are key to its
functionality.
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Licenses
Blooms: Understand
Blooms: Create
AACSB: Reflective thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement
310. Briefly explain the circumstances that indicate the seller has a bill-and-hold sale and a
consignment sale, and how that affects the timing of revenue recognition for each.
Answer: A bill-and-hold arrangement exists when a customer purchases goods but requests
that the seller not ship the product until a later date. Sellers usually conclude that control has
not been transferred and revenue should not be recognized until actual delivery to the
customer occurs. Consistent with SEC guidance, sellers can recognize revenue prior to
delivery only if (a) they conclude that the customer controls the product, (b) there is a good
reason for the bill-and-hold arrangement, and (c) the product is specifically identified as
belonging to the customer and is ready for shipment.
A consignment arrangement exists when the seller (the “consignor”) arranges for another
company to sell its product, but the consignor retains legal title. The consignor still has title
and retains many of the risks and rewards of ownership for goods it has placed on
consignment. Therefore, it’s likely that the consignor would be judged to retain control after
transfer to the consignee and would postpone recognizing revenue until sale to an end
customer occurs.
Level of Learning: 2 Medium
Learning Objective: 05-07
Topic Area: Timing of rev rec―Bill-and-hold
Topic Area: Timing of rev rec―Consignment
Blooms: Understand
AACSB: Reflective thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement
311. Briefly explain the difference between an account receivable, a contract asset, and a
contract liability, with respect to balance sheet disclosure.
Chapter 5 Revenue Recognition and Profitability Analysis
5–173
Answer:
• An account receivable is recognized 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.
• A contract asset is recognized if the seller satisfies a performance obligation but
payment depends on something other than the passage of time.
• A contract liability, such as deferred revenue, is recognized if a customer pays the
seller before the seller has satisfied a performance obligation, or if the customer has
been billed before work has been done.
Level of Learning: 2 Medium
Learning Objective: 05-08
Learning Objective: 05-09
Topic Area: Disclosures―Balance sheet and Notes
Topic Area: Long-term contracts―Accounting issues
Blooms: Understand
AACSB: Reflective thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement
312. What is the objective of disclosures about revenue recognition? Indicate at least two
common types of important revenue recognition disclosures.
Answer: The objective of revenue recognition disclosures is to help users of financial
statements understand the nature, amount, timing, and uncertainty of revenue and cash flows
arising from contracts with customers. Examples of important disclosures are:
• Categories of revenue, such as product lines, geographic regions, types of customers,
or types of contracts.
• Amounts included in revenue that were previously recognized as deferred revenue or
that resulted from changes in transaction prices.
• Description of outstanding performance obligations.
• Discussion of how performance obligations typically are satisfied and important
contractual provisions like payment terms and policies for refunds, returns, and
warranties.
• Any significant judgments used to estimate transaction prices, to allocate transaction
prices to performance obligations, and to determine when performance obligations
have been satisfied.
• Explanations of significant changes in contract assets and contract liabilities that
occurred during the period.
Level of Learning: 2 Medium
Learning Objective: 05-08
Topic Area: Disclosures―Balance sheet and Notes
Blooms: Understand
AACSB: Reflective thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement
Chapter 5 Revenue Recognition and Profitability Analysis
5–174
313. Imagine that the Ace Construction Company (ACC) concludes that it must switch
from recognizing revenue on long-term contracts over time according to percentage of
completion to recognizing revenue upon completion of each contract. Assume that none of
their construction projects are going to produce a loss. Is it possible that, in a particular
year, ACC will show higher gross profit under the new approach (recognizing revenue
upon contract completion) than they did under the old approach (recognizing revenue over
time according to percentage of completion)? Explain.
Answer: Yes. Under the old approach (recognition over time), a percentage of total profit is
recognized each year, while under the new approach (recognition at the end of the contract),
the total profit is recognized when the project is completed. Therefore, during the year the
project is completed, the new approach will show higher gross profit for that year on the
project than would be shown under the old approach. But both methods result in the same total
amount of gross profit over the life of the contract.
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Accounting issues
Blooms: Analyze
AACSB: Analytical thinking
AICPA: BB Critical thinking
AICPA: FN Measurement
314. Briefly explain how a company that recognized revenue over time by
estimating percentage of completion using a cost-to-cost ratio could manage earnings
upward to meet a profit projection. What sort of ethical problems could result from that
earnings management?
Answer: A company could understate its total estimated cost to complete (thus overstating the
cost-to-cost ratio by understating the denominator), thereby allowing it to recognize income
sooner. The company also could requisition materials to the job sooner than they are needed
and count those materials as costs (thus overstating the cost-to-cost ratio by overstating the
numerator), thereby allowing it to recognize income sooner. Companies are supposed to adjust
cost-to-cost ratios for such manipulation, but it might not be easy for an auditor or investor to
detect. Each of these is an unethical, deceptive reporting practice because the company is
manipulating how the accounting system portrays its underlying economic activity.
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Accounting issues
Blooms: Analyze
AACSB: Ethics
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Risk analysis
315. Briefly explain how gross profit is recorded when revenue on long-term
construction projects is recognized over time according to percentage of completion.
Answer: When revenue is recognized over time, gross profit for long-term construction
projects is allocated to each period in which the earnings process occurs based on total
Chapter 5 Revenue Recognition and Profitability Analysis
5–175
estimated gross profit times the percentage of projected total cost incurred to date. This is also
known as the cost-to-cost method. When an overall loss is projected, the loss should be
recognized in the first period that the overall loss is anticipated.
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Remember
AACSB: Reflective thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement
316. Under what circumstances can revenue on long-term construction contracts be
recognized over time according to percentage of completion?
Answer: Revenue recognition over time is required for long-term construction contracts under
the same circumstances that apply to other contracts:
1. The customer consumes the benefit of the seller’s work as it is performed, as when a
company provides cleaning services to a customer for a period of time, or
2. The customer controls the asset as it is created, as when a contractor builds an extension
onto a customer’s existing building, or
3. The seller is creating an asset that has no alternative use to the seller, and the seller has
the legal right to receive payment for progress to date.
Most long-term contracts qualify for revenue recognition over time. Often the customer owns
the seller’s work in process, such that the seller is creating an asset that the customer controls
as it is completed. Also, often the seller is creating an asset that is customized for the
customer, so the seller has no other use for the asset and has the right to be paid for progress
even if the customer cancels the contract. In either of those cases, the seller recognizes
revenue over time.
Level of Learning: 2 Medium
Learning Objective: 05-09
Topic Area: Long-term contracts―Percentage complete
Blooms: Remember
AACSB: Reflective thinking
AACSB: Communication
AICPA: BB Critical thinking
AICPA: FN Measurement