CHAPTER 11

FINANCIAL REPORTING CONCEPTS

CHAPTER STUDY OBJECTIVES

1. Explain the importance of having a conceptual framework of accounting, and list the key components. The conceptual framework ensures that there is a consistent and coherent set of accounting standards. Key components of the conceptual framework are the: (1) objective of financial reporting; (2) elements of the financial statements; (3) qualitative characteristics; (4) recognition and measurement concepts; and (5) foundational concepts, assumptions, and constraints.

2. Explain the objective of financial reporting, and define the elements of the financial statements. The objective of financial reporting is to provide useful information for investors and creditors in making decisions in their capacity as capital providers. The elements are assets, liabilities, equity, revenue, and expense. Each element has a specific definition. The definitions provide important guidance on when an element should be recognized.

3. Apply the fundamental and enhancing qualitative characteristics of the conceptual framework to financial reporting situations. The fundamental qualitative characteristics are relevance and faithful representation. Financial information has relevance if it makes a difference in a decision. Materiality is an important component of relevance. An item is material when it is likely to influence the decision of a reasonably careful investor or creditor. Information is faithfully represented when it shows the economic reality and is complete, neutral, and free from material error.

The enhancing qualitative characteristics are comparability, verifiability, timeliness, and understandability. Comparability enables users to identify the similarities and differences between companies. The consistent use of accounting policies from year to year is part of the comparability characteristic. Information is verifiable if two knowledgeable and independent people would generally agree that it faithfully represents the economic reality. Timeliness means that financial information is provided when it is still highly useful for decision-making. Understandability enables reasonably informed users to interpret and comprehend the meaning of the information provided in the financial statements.

4. Apply the recognition and measurement criteria of the conceptual framework to financial reporting situations. General recognition criteria require that elements be recognized in the financial statements when it is probable that any economic benefit associated with the item will flow to or from the business and the item has a cost or value that can be measured or estimated with a reasonable amount of reliability. There are two approaches to revenue recognition: (1) contract-based and (2) earnings. The contract-based approach requires that revenue be recognized when promised goods or services are transferred and the amount reflects the consideration the business expects to receive. The earnings approach requires that revenue be recognized when the earnings process is complete, the risks and rewards of ownership have been transferred, and the amount can be reliably measured. Expenses are recognized when there is a decrease in an asset or increase in a liability, excluding transactions with owners, which result in a decrease in owners’ equity. Four measurements used in accounting are (1) historical cost, (2) current cost, (3) realizable value, and (4) present value. Incorrect application of the basic recognition and measurement concepts can lead to material misstatements in the financial statements. Incorrect application can be due to error or intentional misstatement.

5. Apply the foundational concepts, assumptions, and constraints of the conceptual framework to financial reporting situations. The foundational concepts, assumptions, and constraints form the bedrock of accounting and are used to achieve the objective of financial reporting. The reporting entity concept requires that accounting for a reporting entity’s activities be kept separate and distinct from the accounting for the activities of its owner and all other reporting entities. The going concern assumption assumes that the company will continue operating for the foreseeable future. The monetary unit concept means that money is the common denominator of economic activity. The periodicity concept guides businesses in dividing up their economic activities into distinct time periods. The cost constraint is a pervasive constraint that ensures the value of the information provided is greater than the cost of providing it. The full disclosure concept requires companies to fully disclose circumstances and events that make a difference to financial statement users.

Exercises

Exercise 1

The conceptual framework for accounting discusses the following:

Code:

A Objective of Financial Reporting

B Qualitative Characteristics of Accounting Information

C Elements of Financial Statements

Instructions

For each item below, indicate the area of the conceptual framework that pertains to that item by selecting the appropriate code.

Example:

C Asset (An asset is an element of financial statements.)

____ 1. Information that is helpful in assessing management’s performance

____ 2. Owners' equity

____ 3. Timeliness

____ 4. Neutral

____ 5. Expense

____ 6. Confirmatory value

____ 7 Faithful representation

____ 8 Comparability-consistency

____ 9. Information that is useful in making resource allocation decisions

____ 10 Full disclosure principle

Exercise 2

For each item below, indicate whether the item is a(an) (1) Fundamental Qualitative Characteristic, (2) Enhancing Qualitative Characteristic, (3) Element of the Financial Statements, (4) Concept, or (5) Constraint.

Example:

(3)_ Asset (An asset is an element of financial statements.)

____ a) Relevance

____ b) Comparability

____ c) Cost-Benefit

____ d) Timeliness

____ e) Revenue

____ f) Owner’s equity

____ g) Faithful representation

____ h) Going concern

____ i) Reporting entity

____ j) Monetary unit

Exercise 3

Presented below are some business transactions that occurred during 2021 for Kilgana Company:

1. A heavy-duty stapler costing $ 25 is being depreciated over 5 years. The following entry was made:

Depreciation Expense—Stapler 5

Accumulated Depreciation—Stapler 5

2. The owner of Kilgana Company took a vacation to France and charged the travel expenses to the company. The following entry was made:

Travel Expense 4,000

Cash 4,000

3. An account receivable has been deemed a bad debt. The following entry was made:

Allowance for Doubtful Accounts 9,000

Accounts Receivable 9,000

4. Merchandise Inventory with a cost of $ 420,000 is reported at its fair value of $ 510,000. The following entry was made:

Merchandise Inventory 90,000

Gain on Fair Value Adjustment of Inventory 90,000

5. Equipment worth $ 75,000 was acquired at a cost of $ 60,000 from a company that was going out of business. The following entry was made:

Equipment 75,000

Cash 60,000

Gain from on Fair Value Adjustment on Equipment 15,000

Instructions

For each situation above, identify the assumption, concept, or constraint that has been violated, if any. If the entry is incorrect, prepare the entry that should have been made, if any.

Exercise 4

An inexperienced accountant for Can’t Add Company recorded the following transactions in the records of the company for the year ended December 31, 2021. The controller has questioned the appropriateness of the entries since she thinks that they have not been recorded in accordance with generally accepted accounting principles. Profit for the year, including the entries described below, is $ 200,000.

1. On January 1, the company president, the owner of the company, took a personal vacation trip to the Gaspé. The trip cost $ 3,000. The accountant recorded the entry as follows:

Travel Expense 3,000

Accounts Payable 3,000

2. The company purchased on account a wastebasket on December 31 at a cost of $ 20. The accountant made the following entry:

Office Equipment 20

Accounts Payable 20

3. Merchandise inventory that cost $ 14,000 had a current net replacement value of $ 22,000. The accountant made the following entry as a result:

Merchandise Inventory 8,000

Gain on fair value adjustment 8,000

4. Equipment with a fair market value of $ 15,000 was acquired in a liquidation sale for cash at a cost of $ 10,000. The accountant recorded the transaction as follows:

Equipment 15,000

Cash 10,000

Gain on fair value adjustments 5,000

5. Can’t Add uses the allowance method. A customer's account receivable for $ 17,000 was uncollectible and the following entry was made:

Bad Debt Expense 17,000

Accounts Receivable 17,000

Instructions

a) For each of the above entries, indicate the concept or constraint that was violated.

b) Determine the correct profit for 2021.

Exercise 5

The following are independent situations observed by Aqua Company’s senior accountant at December 31, 2021, the company’s year end. Aqua Company has not adopted the revaluation model for accounting for long-lived assets.

1. Aqua purchased land in February at a cost of $ 60,000 for the purpose of expanding the size of their parking lot, although this project has not yet been started at year end. Due to increases in real estate values, this land has a value of $ 100,000 by year end. An entry to record this increase in value has been recorded, crediting “Gain on Land.”

2. One of the items making up Aqua ’s total current assets of $ 354,000 is an amount of $ 1,400 for Supplies. The company owner asks one of the accounting staff whether she thinks this balance is correct. The staff person takes two days of work time to count the actual supplies on hand and another day to research the exact cost of the items, and subsequently adjusts the balance of Supplies to its exact balance of $ 1,425. As a result of this task, the month-end financial statements are submitted to the company’s lender two days after the reporting deadline.

3. A $ 96,300 payment for a 12-month insurance policy effective March 1 had been debited to Insurance Expense.

4. Included in Accrued Interest Payable is interest on a $ 200,000, 3% note payable. Interest has been paid to December 2, 2021. Accrued interest payable was calculated and recorded as $ 500 by applying the following formula: $ 200,000 x 3% x 1÷12. However, the accountant was concerned because part of December’s interest has already been paid and the formula included a full month’s accrual. He therefore reduces the accrued interest payable by $ 33 ($ 200,000 x 3% x 2÷365).

5. On January 15, 2022, before the financial statement preparation for December 31, 2021 had been completed, a fire destroyed General’s warehouse, which had a carrying value of $ 1,500,000, and inventory with a cost of $ 900,000. The lost assets are insured, but will result in a 6-month interruption in business while being reconstructed. No mention of this event is found in the financial statements.

6. The company completed its year-end inventory count and the controller noticed that obsolete inventory had been included in the physical count and that it was valued at its original cost less an obsolescent factor of 10%. When the controller asked how long the inventory had been on hand, he was told that it was 4 years old; most of their inventory is 6 months old.

Instructions

For each of the events, indicate the accounting assumption, concept, or constraint that has been violated and provide your reason. Prepare the correcting entry required, or if no entry is required, explain what other change, if any, should be made to ensure that Aqua’s financial statements comply with GAAP.

Exercise 6

Generally accepted accounting principles include the following assumptions, concepts, and constraints:

A Going concern assumption

B Economic entity concept

C Revenue recognition criteria

D Matching

E Full disclosure

F Cost concept

G Cost constraint

H Materiality constraint

The following independent situations occurred in different companies:

1. One third of the company's sales were made to a related party and this fact is disclosed in the financial statements.

2. The company's inventory's cost is $ 50,000, its retail value is $ 120,000, and if liquidated could be sold at auction for $ 30,000. The inventory is reported at $ 50,000 on the company's balance sheet.

3. A company's accountant notices that the petty cash account was not adjusted prior to preparing the year-end financial statements and the account balance is incorrect by $ 13.52. However, the accountant decides to release the financial statements without making the correction.

4. The proprietor of an unincorporated business maintains two bank accounts and two sets of accounting records—one for household expenses, and the other for business purposes.

5. The company records revenue when services are provided, not when the customers pay for the service.

6. The company has a large number of accounts receivable that individually have small balances. In order to determine the allowance for doubtful accounts, the company uses an estimate based on past experience rather than taking the time to evaluate the collectibility of individual accounts.

7. Insurance expense is recorded each month, although the insurance policy covers a full year and is paid annually.

8. A patent with an indefinite life has an original cost of $ 12,500 although the company was recently offered $ 1,000,000 by another company who wants to buy it.

9. Interest is payable semi-annually and is recorded only when paid, with no adjustment at year end even though payment dates do not coincide with the year-end date.

10. A former employee has sued the company for a large amount, but no mention is made of this case in the financial statements.

11. After obtaining an independent appraisal that indicated a significant increase in value over original cost, the company restated its land at the higher amount. The company has not adopted the revaluation model for accounting for long-lived assets.

12. The company accountant recently spent two days calculating the accrued utilities expense on 130 individual apartments for the last few days of the year. In the past, the amounts were estimated.

13. The company's sales are made on credit, but to keep accounting costs down, sales are recorded when the customer accounts are paid.

14. When preparing financial statements, the company's policy is to record all correcting entries, whether the correction is for $ 200,000 or $ 2.

15. The proprietor's babysitting costs are recorded in the company expense accounts.

16. All assets are restated at their liquidation values.

Instructions

For each of the situations, identify the assumption, concept, constraint, or recognition criteria that provides the best explanation by selecting the appropriate code. Each code will be used more than once; however, each situation only has one correct answer.

Exercise 7

A number of unrelated transactions recorded by Abba Company are as follows:

1. At year end the Depreciation expense is calculated as $ 10,000, which results in a net book value that is $ 14,000 greater than the equipment’s liquidation value:

Loss on fair value adjustment 14,000

Depreciation Expense 10,000

Accumulated Depreciation 24,000

2. The proprietor of Abba paid for her household cleaning costs out of the business bank account:

Cleaning Expense 140

Cash 140

3. A customer pays for November services in October. The October entry is:

Cash 525

Service Revenue 525

4. Abba guaranteed the loan of a related party, Provincial Corp., and Provincial defaulted on its loan. In December, the bank demanded payment of $ 100,000 from Abba, who negotiated to make the payments in 4 equal monthly instalments, the first of which was made in December. The following entry was recorded by Abba when the December payment was made. No further information was provided in its financial statements because it is probable that Provincial will be able to make the remainder of the payments.

Loss on Loan Guarantee 25,000

Cash 25,000

Instructions

For each of the above situations, identify the accounting assumption, concept, constraint, or recognition criteria that have been violated. Prepare the correct journal entry as it should have been made. If no entry should have been made, or if additional financial statement disclosure is required, explain.

Exercise 8

For each of the independent situations described below, list the assumption, characteristic, concept, or constraint that has been violated, if any. List only one term for each case.

1. The Who Company reports only current assets and current liabilities on its balance sheet. Intangible assets and a 20-year mortgage payable are reported as a current asset and a current liability, respectively. Liquidation of the company is unlikely.

2. Gabi Company is in its third year of operation and has yet to issue financial statements. (Do not use full disclosure principle.)

3. Griffin Company is carrying inventory at its net realizable value of $ 110,000. The inventory had an original cost of $ 135,000.

4. Paul Company expenses some office equipment that is inexpensive even though it has a useful life that exceeds 1 year.

5. Singh Corporation has selected FIFO as its inventory cost flow formula during the current year. Next year it plans to change to the weighted average cost formula.

Exercise 9

The following are independent situations observed by Mersey’s senior accountant at December 31, 2021, the company’s year end. Mersey has not adopted the revaluation model for accounting for long-lived assets.

1. The draft financial statements include an item listed under non-current assets “Human resources” but there is no financial amount included.

2. Mersey’s employees are paid a bonus based on profit. Mersey’s management would like to minimize the amount of bonus paid, and so they instructed a junior accountant to write down inventory by $ 1,000,000 and record a Loss on Inventory. Their argument is that the “fire sale” value of the inventory would be lower than recorded cost by this amount. Mersey has no intention of liquidating the inventory under such circumstances, but expects to sell the inventory in the normal course of business at amounts significantly above cost.

3. A building being constructed for a customer was 90% complete, and accordingly 90% of the related revenue had been correctly included in sales for the year. The total projected cost of construction is $ 600,000. Of the $ 540,000 cost of the project incurred to date, $ 200,000 has been expensed to COGS

4. Mersey owns 5% of the shares of Liverpool Investments. A note to Liverpool’s financial statements describes a valuable new patent registered by Liverpool and the anticipated profits that are expected to result. A junior accountant at Mersey recorded an entry “Debit Intangible Assets; Credit Gain on Patent Registration” in the amount of $ 220,000, which is 5% of the amount at which Liverpool has recorded the cost of the patent.

5. In November, Mersey entered into a service contract to provide maintenance services to a client for a fee of $ 20,000 per month. On signing the contract, the client paid Mersey a $ 40,000 deposit on services to be provided. The term of the contract is from December 15, 2021 through December 15, 2022. The $ 40,000 deposit was recorded as Service Revenue.

Instructions

For each of the events, indicate an accounting assumption, concept, constraint, or recognition criteria that have been violated and provide your reason. Prepare the correcting entry required, or if no entry is required, explain what other change, if any, should be made to ensure that Mersey’s financial statements comply with GAAP.

Exercise 10

The following are independent situations observed by Dino Industrial’s senior accountant at December 31, 2021, the company’s year end:

1. Dino has parts inventory for use in its construction department (not for resale). The inventory includes over 1,500 different items, with between 10 and 100 of each item in stock. The cost of the individual items ranges from $ 0.30 to $ 1.50. In the past, the inventory quantities have been estimated by weighing the parts bins. This year, the accountant had the individual items counted and priced to provide more precise information. The total estimated value of the items is $ 45,000, which is material in total. It took four staff a full day to count the inventory at a cost of $ 1,000 in labour costs, and it would have taken two staff a half day to complete the estimate by weighing at a cost of $ 250. After the count, an entry of $ 27 was needed to reduce the inventory balance to actual. The entry was debited to Construction Supplies Expense.

2. Goods with a sales price of $ 55,000 were shipped to a customer FOB shipping point. The goods were picked up by the shipping company on December 31, 2021, and delivered to the customer on January 2, 2022. The customer’s invoice was prepared and recorded in January 2022.

3. Prepaid expenses include $ 12,000 in prepaid rent related to the long-term lease of a branch office. When the lease was signed 4 years ago, Dino had to pay a $ 6,000 deposit, which comprises the final month’s rent. Rental rates have since doubled in that location, so an entry has been recorded to reflect this value as follows: “Debit Prepaid Rent $ 6,000; Credit Rent Expense $ 6,000.” The junior accountant’s argument for making this entry is that the company has benefited from the long-term lease and the financial statements should reflect this benefit.

4. One of the owners of Dino purchased a vacation property for $ 190,000 with company funds. The transaction was recorded as a debit to Property, Plant, and Equipment, and a credit to Cash.

Instructions

For each of the events, indicate the accounting assumption, concept, constraint, or recognition criteria that have been violated and provide your reason. Prepare the correcting entry required, or if no entry is required, explain what other change, if any, should be made to ensure that Dino’s financial statements comply with GAAP.

Exercise 11

A number of unrelated transactions recorded by Farm Company are as follows:

1. At the end of the month, the obsolete inventory was valued at $ 17,000. No entry was made.

2. Provincial, which owns an art gallery, purchases a valuable painting for $ 40,000 in November, and sells it in January, which is after the company’s year end. The entry made when the painting is purchased is:

Cost of Goods Sold 40,000

Cash 40,000

3. Equipment was purchased for $ 8,000 from a store that is going out of business. The equipment was appraised at $ 10,000.

Equipment 10,000

Cash 8,000

Retained Earnings 2,000

Instructions

For each of the above situations, identify the accounting assumption, concept, constraint, or recognition criteria that have been violated. Prepare the correct journal entry as it should have been made. If no entry should have been made, or if additional financial statement disclosure is required, explain.

Exercise 12

For each of the independent situations described below, list the assumption, concept, constraint, or recognition criteria that have been violated, if any. List only one term for each case.

1. Chris Burgess, MD, had the clinic accountant prepare his personal tax return. He paid the accountant using clinic funds and debited the clinic's "Professional Fees" account.

2. Chu Company does not use an account for allowance for doubtful accounts. Instead, accounts receivable are written off directly to Bad Debt Expense if they remain unpaid after 24 months.

3. Equipment is carried at its fair value on the Chipawa Company balance sheet, which is $ 25,000 higher than cost. Fontaine Chipawa has not adopted the revaluation model for accounting for long-lived assets.

4. Depreciation Expense for Rowland Company is $ 15,000. The company will have a net loss of $ 12,000 if the depreciation is recorded, but a profit of $ 3,000 if depreciation is deferred a year. The decision is made to defer the depreciation to next year which is expected to be more profitable.

5. The land of Fountain Company is appraised at $ 200,000 more than its cost. The new accountant for the company recommends booking the appraised value and showing a "Gain from Revaluation" on the income statement. Fountain Company has not adopted the revaluation model for accounting for long-lived assets.

Exercise 13

Match the following qualitative characteristics of financial statements to the appropriate code:

Code:

A Faithful representation

B Timeliness

C Neutral

D Verifiable

E Relevance

F Complete

1. Information is available to decision makers before the information loses its ability to influence decisions.
2. Accounting information reports the economic reality of a transaction, not its legal form.
3. All of the information necessary to show the economic reality of transactions is provided.
4. Information makes a difference in a decision.
5. Users are assured that the financial information shows the economic reality of the transaction.
6. Information is free from bias that is intended to attain a predetermined result.

Exercise 14

For each of the independent situations described below, list the assumption, concept, constraint, or recognition criteria that have been violated and describe the appropriate treatment.

1. MacDonald Industrial purchased a piece of land that was listed for $ 150,000. The company worked very hard in negotiations and both parties agreed on a purchase price of $ 139,000. Lawson’s accountant has recorded the land on the books at $ 150,000 because she felt this was the most representative fair value at the time of purchase.

2. Chantal’s Hair Salon purchases many different hair and cosmetic supplies to be used within the salon and sold to customers. Darlene only has one credit card that she uses to make personal and business purchases. She often gets confused which purchases are for business purposes so she records all credit card transactions through the salon.

3. Buddie’s Furniture operates in a small town and often sells on credit without any detailed credit checks. The company sold merchandise to Darcy last year and he failed to pay the amount owing so Buddie wrote off his account. Buddie has recently made another sale to Darcy on credit for $ 12,000 without any security on the transaction. Buddie records all sale transactions once the goods are delivered and title passes.

4. Fancy Diamonds is a Canadian company that reports its financial statements in Canadian dollars. The company often sells its diamonds to customers in the United States and receives U.S. dollars. Fancy records the U.S. dollar amounts within the accounting records without any currency exchange.

Exercise 15

Comfort King Ltd. sells central air units and furnaces to local residents as well as ongoing maintenance plans. Jack Frost agreed to an arrangement with Comfort King to purchase a central air package for $ 4,000 on May 1, 2021. In addition to the sale, the arrangement includes installation, maintenance on the central air unit for two years, and a one-time furnace cleaning, which will occur when the central air unit is installed. Jack Frost is receiving a great deal as the full contract price represents the stand-alone value of the central air unit. Comfort King also provides installation, central air maintenance, and furnace cleaning services separately to its customers as follows: installation fee $ 400, annual central air maintenance fee $ 250, and furnace cleaning fee $ 100. Comfort King installed the unit and cleaned the furnace on May 20, 2021, and was immediately paid the agreed-upon price by Jack Frost.

Instructions

Complete the following steps to determine if the appropriate criteria have been met for Comfort King to recognize revenue under the contract-based approach to revenue recognition. Be sure to conclude whether Comfort King can recognize the revenue and when it would be appropriate to do so.

1. Is there a contract?
2. What is the performance obligation?
3. What is the transaction price?
4. Is there a need to allocate the selling price?
5. Has the performance obligation been satisfied?

Exercise 16

Comfort King Ltd. sells central air units to local residents as well as ongoing maintenance plans. Jack Frost agreed to an arrangement with Comfort King to purchase a central air package for $ 4,000 on May 1, 2021. In addition to the sale, the arrangement includes unit installation and maintenance on the central air unit for two years. Jack Frost is receiving a great deal as the full contract price represents the stand-alone value of the central air unit. Comfort King also provides installation and central air maintenance separately to its customers as follows: installation fee $ 400 and annual central air maintenance fee $ 250. Comfort King installed the unit on May 20, 2021, and was immediately paid the agreed-upon price by Jack Frost.

Instructions

Complete the following steps to determine if the appropriate criteria have been met for Comfort King to recognize revenue under the contract-based approach to revenue recognition. Be sure to conclude whether Comfort King can recognize the revenue and when it would be appropriate to do so.1. Is there a contract?

1. 2. What is the performance obligation?
2. 3. What is the transaction price?
3. 4. Is there a need to allocate the selling price?
4. 5. Has the performance obligation been satisfied?

Exercise 17

Comfort King Ltd. sells central air units to local residents. Jack Frost agreed to an arrangement with Comfort King to purchase a central air unit for $ 4,000 on May 1, 2021. In addition to the sale, the arrangement includes unit installation which was completed on May 20, 2021. Comfort King only provides installation services for its customers who purchase new units. Comfort King was immediately paid the agreed-upon price by Jack Frost.

Instructions

Complete the following steps to determine if the appropriate criteria have been met for Comfort King to recognize revenue under the contract-based approach to revenue recognition. Be sure to conclude whether Comfort King can recognize the revenue and when it would be appropriate to do so.

1. Is there a contract?

2. What is the performance obligation?

3. What is the transaction price?

4. Is there a need to allocate the selling price?

5. Has the performance obligation been satisfied?

Exercise 18

The following transactions occurred during 2021:

1. A television set is delivered to the customer in August. Six instalment payments of $ 200 per month begin the following January. Ignore interest considerations.

2. Goods are sold FOB shipping point. An item with a retail value of $ 10,000 is loaded onto the truck on May 31, but not unloaded until June 3 because the recipient delayed paying the freight bill until then. The vendor prepares and mails the invoice to the customer on June 10.

3. A computer network system and related cables are delivered to the customer's premises on March 31. Installation is completed by April 30, after which the system is ready for use. The vendor provides monthly support and upgrades for 4 months following the month of installation (through end of August). The value of the system and cables is $ 50,000, the value of the installation services is $ 22,000, and the value of the monthly support totals $ 6,000.

4. Goods are sold FOB destination. An order with an invoice total of $ 3,500 is loaded onto the truck January 31 and delivered on February 1.

5. A customer prepays for 10 oil changes for a total of $ 300. During December, two oil changes are completed for this customer.

Instructions

Identify in which month revenue should be recognized in each situation. If revenue should be recognized in more than one month, calculate the amounts that apply to each relevant month.

Exercise 19

Spanish Marine Supplies is a marine supplier of tugboat engines. As part of the selling process, the company will install the tugboat engine, conduct sea trials on the engine, provide any servicing required on the engine for the first year of operation, and not require a payment from the client until 60 days after the client’s acceptance of the engine. The engine will remain the property of Spanish until the first payment is made, even though the boat is not the property of Spanish. The company’s customers frequently ask Spanish to customize the engines to suit their needs. These customization changes can be extensive and may take several months.

Instructions

Comment on when you think Shediac should recognize revenue.

Exercise 20

Target Security Company provides surveillance services to numerous corporate customers. The company has recently signed a new surveillance contract with Martin Manufacturing on January 1 for a period of one month at a cost of $ 500. On January 31, Target completed the contract and invoiced Martin for the full contract price due in 30 days.

Instructions

Complete the following steps to determine if the appropriate criteria have been met for Target to recognize revenue under the contract-based approach to revenue recognition. Be sure to conclude whether Target can recognize the revenue and when it would be appropriate to do so.

1. Is there a contract?
2. What is the performance obligation?
3. What is the transaction price?
4. Is there a need to allocate the selling price?
5. Has the performance obligation been satisfied?

Exercise 21

Ed Sullivan Sailing Ltd. sold $ 175,500 of boat parts on credit in September. A total of 30% of the goods were shipped FOB destination and 70% were shipping FOB shipping point. At September 30, $ 25,000 of the goods that were FOB destination, were in transit. During September the company collected $ 100,000 cash from its customers. The company estimates that about 2% of the sales will become uncollectible and that about 8% of the sales will be returned by the customer. How much revenue should the company recognize for the month?

Exercise 22

In the following transactions, indicate when revenue should be recognized:

1. In September, La Cloche University collects tuition revenue for the term from students. The term runs from September through December.

2. Burns Island Company sells merchandise with terms of 2/10, n/30, FOB destination.

3. The Ottawa Senators sell season tickets to games in Canadian Tire Centre. Fans can purchase the tickets at any time, although the season doesn’t officially begin until September. It runs from September through May.

4. Canada Airline sells you a refundable airline ticket in September for your flight home at Christmas.

5. The University Bookstore has the following return policy for textbook sales: “Textbooks (new and used) may be returned for seven calendar days from the start of classes. After that time, textbooks (new and used) may be returned within 48 hours of purchase.”