Chapter 6 Kieso Revenue Recognition Test Bank Docx - Intermediate Accounting v1 13e | Canada | Test Bank by Donald E. Kieso. DOCX document preview.
CHAPTER 6
REVENUE RECOGNITION
CHAPTER STUDY OBJECTIVES
1. Understand the economics and legalities of selling transactions from a business perspective. It is critical to understand a transaction from a business perspective before attempting to account for it. The analysis should begin with what is being sold to the customer (goods or services) and also the nature and amount of the consideration. When one party is in a better bargaining position than the other, it may be able to negotiate concessions such as more lenient payment terms. These concessions often complicate the accounting because they introduce measurement uncertainty in many cases.
Selling transactions are based on contractual arrangements between a buyer and a seller. Contracts create rights and obligations under law that must be considered when accounting for the transactions. In addition to contract law, rights and obligations may exist under other forms of the law, such as common law or contract law. These should also be considered.
2. Identify the five steps in the revenue recognition process. The five steps in the revenue recognition process are (1) identify the contract with customers, (2) identify the separate performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the separate performance obligations, and (5) recognize revenue when each performance obligation is satisfied.
3. Identify the contract with customers. A contract is an agreement that creates enforceable rights or obligations. A company applies the revenue guidance to contracts with customers and must determine if new performance obligations are created by a contract modification.
4. Identify the separate performance obligations in the contract. A performance obligation is a promise in a contract to provide a product or service to a customer. A contract may be composed of multiple performance obligations. The accounting for multiple performance obligations is based on evaluation of whether the product or service is distinct within the contract. If each of the goods or services is distinct, but they are interdependent and interrelated, these goods and services are combined and reported as one performance obligation.
5. Determine the transaction price. The transaction price is the amount of consideration that a company expects to receive from a customer in exchange for transferring goods and services. In determining the transaction price, companies must consider the following factors: (1) variable consideration, (2) time value of money, (3) non-cash consideration, and (4) consideration paid or payable to a customer.
6. Allocate the transaction price to the separate performance obligations. If more than one performance obligation exists in a contract, allocate the transaction price based on relative fair values. The best measure of fair value is what the good or service could be sold for on a stand-alone basis (the stand-alone selling price). Estimates of stand-alone selling price can be based on (1) adjusted market assessment, (2) expected cost plus a margin approach, or (3) a residual approach.
7. Understand how to recognize revenue when the company satisfies its performance obligation. A company satisfies its performance obligation when the customer obtains control of the good or service. Companies satisfy performance obligations either at a point in time or over a period of time. Companies recognize revenue over a period of time if (1) the customer controls the asset as it is created or the company does not have an alternative use for the asset, and (2) the company has a right to payment.
8. Analyze and determine whether a company has earned revenues under the earnings approach. Under ASPE, revenues are earned when the risks and rewards of ownership are passed or when the company has done what it said it would do to be entitled to the revenues. Where the sale of goods is involved, legal title and possession provide evidence of this. The accounting is more complex when the contract is a long-term contract and when it involves both goods and services.
9. Identify other revenue recognition issues. Refer to Illustration 6.13 for a summary of the accounting for (1) repurchase agreements, (2) bill-and-hold sales, (3) principal-agent relationships, and (4) consignments.
10. Identify how revenues should be presented, disclosed, and analyzed. Under the asset-liability approach, to recognize revenue, companies present contract assets and contract liabilities on their balance sheets (net). Contract assets are rights to receive consideration. A contract liability is a company’s obligation to transfer goods or services to a customer for which the company has received consideration from the customer. Companies may also report assets associated with fulfillment costs and contract acquisition costs related to a revenue arrangement. Companies disclose qualitative and quantitative information about (1) contracts with customers with disaggregation of revenue, presentation of opening and closing balances in contract assets and contract liabilities, and significant information related to their performance obligations; (2) significant judgements that affect the determination of the transaction price, the allocation of the transaction price, and the determination of the timing of revenue; and (3) assets recognized from costs incurred to fulfill a contract.
11. Identify differences in accounting between IFRS and ASPE and potential changes. The main differences are identified in the chart in Illustration 6.16.
12. Apply the percentage-of-completion method for long-term contracts. To apply the percentage-of-completion method to long-term contracts, a company must have some basis for measuring the progress toward completion at particular interim dates. One of the most popular input measures used to determine the progress toward completion is the cost-to-cost basis. Using this basis, a company measures the percentage of completion by comparing costs incurred to date with the most recent estimate of the total costs to complete the contract. The company applies that percentage to the total revenue or the estimated total gross profit on the contract, to arrive at the amount of revenue or gross profit to be recognized to date.
13. Apply the zero-profit method for long-term contracts. Under this IFRS method, revenue equal to costs is recognized when the outcome is not determinable. This results in no profits being recognized. Otherwise the journal entries are the same as under the percentage-of-completion method.
14. Apply the completed-contract method for long-term contracts. Under this ASPE method, companies recognize revenue and gross profit only when the company completes the contract. Therefore, unlike the zero-profit method, no revenue is recognized until the contract is completed. The company accumulates costs of long-term contracts in process and current billings. It makes no interim charges or credits to income statement accounts for revenues, costs, and gross profit. The annual journal entries to record costs of construction, progress billings, and collections from customers are identical to those for the percentage-of-completion method—with the significant exclusion of the recognition of revenue and gross profit.
15. Account for losses on long-term contracts. There are two types of situations: losses in the period on a profitable contract and losses on an unprofitable contract (onerous contracts). For all three methods of accounting for long-term contracts, the second type must be accrued for. The first type must only be adjusted for when using the percentage-of-completion method.
Multiple Choice QUESTIONS
Answer No. Description
a 1. Definition of "acquired"
b 2. Definition of credit risk
c 3. Concept of commercial substance
d 4. Definition of concessionary terms
d 5. Concessionary or abnormal terms
c 6. Concessionary terms
c 7. Definition of constructive obligation
b 8. Allocation of selling price in bundled sales
b 9. Reasons to recognize revenue
a 10. Problems with the earnings approach
b 11. Definition of revenue
a 12. Definition of "recognition"
a 13. Revenue to be recognized under collection uncertainty
d 14. Calculation of the net contract position – contract-based approach
c 15. Control of an asset
c 16. Revenue recognition process
c 17. Definition of control
d 18. Sales on consignment
b 19. Reporting inventory on consignment
b 20. Calculate contract costs incurred during year.
b 21. IFRS 15
a 22. Contract signing
b 23. Accounting for a contract modification
b 24. Performance obligation
c 25. Warranty expense
d 26. Multiple performance obligations – warranties
b 27. Accounting for a volume rebate
d 28. Recording sales when right of return exists
c 29. Recording sales when right of return exists
c 30. Expected value approach
b 31. Returned asset
b 32. Right to return under IFRS
b 33. Transaction price variable consideration
b 34. Transaction price – right of return IFRS
c 35. Transaction price – volume discount IFRS
a 36. Transaction price – gift cards
a 37. Allocation approach
c 38. Selling price of a bundle
a 39. Allocating transaction price
b 40. Revenue recognition over a period of time
c 41. Revenue recognition over a period of time
c 42. Definition of earnings process
c 43. Definition of discrete earnings process
Answer No. Description
b 44. Defining the earnings process
d 45. Long-term contracts under ASPE
d 46. Calculate gross profit using percentage-of-completion method.
a 47. Calculate gross profit using completed-contract method.
d 48. Calculate gross profit using completed-contract method.
a 49. Consignment sales
b 50. Consignment sales—consignor vs. consignee
d 51. Consignment sales—revenue recognition
a 52. Revenue recognition in consignment sales
c 53. Revenue to be recognized from consignment sales
a 54. Contract liability
a 55. Conditional rights
a 56. Long-term contract revenue under ASPE
a 57. Contract assets / liabilities
b 58. Contract costs
a 59. ASPE requirements
c 60. ASPE requirements
b 61. Accounting for long-term contracts – principal factors
b 62. Preferred method under ASPE
c 63. Classification of contract asset/liability
a 64. Disclosure of earned but unbilled revenues
b 65. Disadvantage of using percentage-of-completion method
c 66. Measuring progress of long-term contracts
c 67. Gross profit to be recognized using percentage-of-completion
b 68. Gross profit to be recognized using percentage-of-completion
b 69. Calculate cash collected on long-term construction contract.
d 70. Calculate gross profit using percentage-of-completion.
c 71. Gross profit to be recognized using percentage-of-completion
b 72. Gross profit to be recognized using percentage-of-completion
b 73. Gross profit to be recognized using percentage-of-completion
c 74. Calculate total construction costs.
a 75. Application of the percentage-of-completion method
d 76. Revenue, cost, and gross profit under completed-contract method
c 77. Recognition of loss on long-term contract
a 78. Completed-contract method
b 79. Completed-contract method
b 80. Measuring progress of long-term contracts
c 81. Gross profit to be recognized using completed-contract method
a 82. Gross profit to be recognized using completed-contract method
c 83. Gross profit or loss to be recognized using completed-contract method
d 84. Gross profit to be recognized using completed-contract method
c 85. Reporting a current liability with completed-contract method
d 86. Reporting assets under completed-contract method
c 87. Definition of onerous contract
a 88. Recognition of loss on long-term contract
d 89. Recognition of loss on long-term contract
c 90. Measuring progress of long-term contracts
b 91. Loss on unprofitable contract
Item Description
E6-92 Constructive obligation
Ex-93 Constructive obligation
E6-94 Economies of a transaction
E6-95 Concessionary terms
E6-96 Definitions
E6-97 Terminology
E6-98 Revenue recognition process
E6-99 Revenue recognition process
E6-100 Contract identification
E6-101 Contract identification
E6-102 Multiple goods and services – warranties
Ex-103 Multiple goods and services – warranties
E6-104 Breakage
E6-105 Upfront fees
E6-106 Performance obligations
E6-107 Performance obligations
E6-108 Transaction price
E6-109 Allocate transaction price
E6-110 Discounted transaction price
E6-111 Bundled sales
E6-112 Contract-based approach
E6-113 Timing of revenue recognition
E6-114 Timing of revenue recognition/percentage of completion
E6-115 Percentage-of-completion method
E6-116 Risks and rewards of ownership
E6-117 Earnings approach to revenue recognition
E6-118 Percentage-of-completion method
E6-119 Bill-and-hold arrangement
E6-120 Performance obligations and warranties
E6-121 Revenue recognition
E6-122 Consignment sale
E6-123 Reporting of gross or net revenues
E6-124 Presentation and the percentage-of-completion method
E6-125 Percentage-of-completion method
E6-126 Advantages and disadvantages – completed-contract method
Item Description
P6-127 Long-term contract (contract-based approach)
P6-128 IFRS revenue recognition
P6-129 Long-term construction project accounting
P6-130 Accounting for long-term construction contracts
P6-131 Percentage-of-completion and completed-contract methods
P6-132 Percentage-of-completion and completed-contract methods
P6-133 Completed-contract method
P6-134 Consignment sales
P6-135 Consignment sales
P6-136 Percentage-of-completion method
P6-137 Completed-contract method and zero-profit method
MULTIPLE CHOICE QUESTIONS
1. When dealing with sales agreements, “acquired” means
a) consideration or rights to consideration.
b) goods to be delivered in the future.
c) dealing at arm’s length.
d) measurement of the transaction.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
2. If an entity sells on credit, the risk that the customer will NOT pay is called
a) price risk.
b) credit risk.
c) commercial substance.
d) credit policy.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Finance
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
3. The concept of commercial substance in purchase and sales transactions means that
a) the transaction is a bona fide purchase and sale.
b) the entity's cash flows are expected to change.
c) the transaction is a bona fide purchase and sale, and the entity's cash flows are expected to change.
d) the transaction must involve tangible assets.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
4. Terms negotiated by a party to the contract that are more favourable than normal are called
a) credit terms.
b) barter transactions.
c) arm’s length terms.
d) concessionary terms.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
5. Concessionary or abnormal terms may
a) reflect that risks and reward has not yet passed to the customer.
b) create additional recognition and measurement uncertainty.
c) indicate that no sale has taken place at all.
d) All of the choices are correct.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
6. Lonestar Deals sells household furniture and appliances. The manager decided to sell a couch to a customer at a75% discount with 9 months to pay, no interest and no deposit, because the couch was no longer in style and had been sitting in the back of the warehouse for over 2 years. Normally, the maximum discount is 10% and customers are never given more than 30 days to pay. The final sale price of the couch was $500. What would be the appropriate journal entry when the customer picks up the couch?
a) Sales 500
Account Receivable 500
b) Sales 110
Accounts Receivable 110
c) No Entry
d) Sales 500
Cash 500
Difficulty: Medium
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective (Concessionary terms)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
7. In many cases, an entity may have an implicit obligation even if it is NOT explicitly noted in a sales contract. This is called a(n)
a) onerous obligation.
b) legal obligation.
c) constructive obligation.
d) earnings obligation.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
8. When a sale involves goods and services, the selling price should NOT be
a) allocated to each of these parts.
b) allocated only to the part with the higher value.
c) allocated using the relative fair value method.
d) allocated using the residual method.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
9. Under the earnings approach for the sale of goods, which of the following would NOT be a reason to recognize revenue?
a) The risks and rewards are transferred to the buyer.
b) The vendor continues to have control over the goods sold.
c) collectability is reasonably assured.
d) Costs and revenues can be reliably measured.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
10. Under the earnings approach, revenue from selling products is generally recognized
a) at the point of delivery.
b) at the completion of production.
c) after costs are recovered.
d) as cash is collected.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
11. A credit that is realized through an entity's ordinary activities would be treated as
a) a gain.
b) revenue.
c) other income.
d) other comprehensive income.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
12. According to the AcSB guidelines, the process of reporting an item in the financial statements of an entity is
a) recognition.
b) realization.
c) allocation.
d) matching.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
13. On January 1, 2023, Milton Ltd. sold land that cost $180,000 for $240,000, receiving a note bearing interest at 10 percent. The note will be paid in three annual instalments of $96,510 starting December 31, 2023. Assuming that collection of the note is very uncertain, how much revenue from this sale should Milton recognize in 2023?
a) $0
b) $18,000
c) $24,000
d) $96,510
Difficulty: Medium
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $0
14. Star Company entered into a contract with Ringo Corporation, in which Star agreed to provide Ringo with building supplies. Ringo agreed to pay a total of $27,000 at delivery. Under the contract-based view, Star’s net contract position can be assumed to be
a) $27,000.
b) $18,000.
c) $9,000.
d) $0.
Difficulty: Medium
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $0
15. Control of an asset normally coincides with
a) transfer of possession to the buyer.
b) transfer of legal title to the buyer.
c) transfer of both possession and legal title to the buyer.
d) the receipt of payment from the buyer.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
Learning Objective: Identify the five steps in the revenue recognition process.
Section Reference: The Asset-Liability Approach to Revenue Recognition: An Overview of the Five-Step Process
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
16. The first step in the revenue recognition process under IFRS is
a) determine the transaction price.
b) identify the separate performance obligations of the contract.
c) identify the contract with customers.
d) allocate the transaction price to the separate performance obligations.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
Learning Objective: Identify the five steps in the revenue recognition process.
Section Reference: The Asset-Liability Approach to Revenue Recognition: An Overview of the Five-Step Process
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
17. Which of the following is NOT part of the definition of control?
a) ability to direct use of the asset
b) ability to obtain substantially all remaining benefits of the asset
c) ability to return the asset to its original owner
d) ability to prevent other companies from directing the use or receiving benefits from assets
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or As) Each Performance Obligation Is Satisfied—Step 5
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Use the following information for questions 18–19.
On April 1, Heavy Metal Corp. consigned 50 handcrafted benches to Disco Co. Heavy Metal’s cost was $350 per bench. Total freight costs were $700, which were paid by Disco. On August 1, Heavy Metal received a cheque for $14,100 from Disco which included the following information:
Number of units sold 20
Expenses deducted:
Freight $700
Commission (20% of sales price) ?
Advertising $450
Delivery $290
18. Under the earnings approach, total sales were
a) $15,540.
b) $18,550.
c) $19,060.
d) $19,425.
Difficulty: Medium
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: 80% Sales – $700 – $450 – $290 = $14,100 (cheque received)
80% Sales = $15,540
Sales = $19,425
19. The inventory of benches will be reported on whose statement of financial position and at what amount?
a) Heavy Metal’s statement of financial position, $10,500
b) Heavy Metal’s statement of financial position, $10,920
c) Disco’s statement of financial position $10,500
d) Disco’s statement of financial position, $10,920
Difficulty: Medium
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($350 x 30) + ($700 x 30 ÷ 50) = $10,920
20. Blues Construction Corp. has consistently used the percentage-of-completion method. During 2023, Blues entered into a fixed-price contract to construct an office building for $6,000,000. Information relating to the contract is as follows:
At December 31
2023 2024
Percentage of completion 15% 45%
Estimated total cost at completion $4,500,000 $4,800,000
Gross profit recognized (cumulative) 225,000 540,000
Under the earnings approach, contract costs incurred during 2024 were
a) $1,440,000.
b) $1,485,000.
c) $1,575,000.
d) $2,160,000.
Difficulty: Medium
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($4,800,000 × 45%) – ($4,500,000 × 15%) = $1,485,000
Use the following information for questions 21–22
A product and service are bundled together and sold to customers for $450. The fair values of the product and service are $350 and $150 respectively.
21. The IFRS standard, IFRS 15 Revenue from Contracts with Customers adopts a(n)
a) earnings approach to revenue recognition.
b) asset-liability approach to revenue recognition.
c) cash-based approach to revenue recognition.
d) earned and realized approach to revenue recognition.
Difficulty: Easy
Learning Objective: Identify the five steps in the revenue recognition process.
Section Reference: The Asset-Liability Approach to Revenue Recognition: An Overview of the Five-Step Process
Learning Objective: Identify differences in accounting between IFRS and ASPE and potential changes.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
22. At the time of contract signing,
a) no journal entry is recorded.
b) a contract liability is recorded.
c) a contract asset is recorded.
d) a note to the financial statements must be included.
Difficulty: Easy
Learning Objective: Identify the contract with customers.
Section Reference: Identifying the Contract with Customers—Step 1
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
23. Magenta Inc. sells art supplies to students and enters into a contract to sell 150 art easels to a local college for a total of $15,000 over the next ten months, or the regular academic year. Fifteen easels are delivered monthly. At month five of the existing contract the college also orders 100 pastel boxes at $35 each to be delivered immediately. Which of the following statements regarding the contract with the college is correct?
a) The first contract is now worth $18,500 in total.
b) These are two separate contracts worth $15,000 and $3,500 respectively.
c) By the end of month five Magenta will recognize $18,500 in revenues.
d) Magenta will not recognize any revenues until the end of month 10.
Difficulty: Medium
Learning Objective: Identify the contract with customers.
Section Reference: Identifying the Contract with Customers—Step 1
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: These are two separate contracts worth $15,000 and $35 x 100 = $35,000, respectively.
24. Where there are potentially multiple performance obligations within a single contract, if products or services are interdependent and interrelated, they must be
a) accounted for as multiple performance obligations.
b) combined and reported as a single performance obligation.
c) sold separately.
d) combined under a new contract.
Difficulty: Easy
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
25. Appliance’s R Us sold 1,000 high-end convection ovens during 2023 at a price of $1,620, with a warranty guarantee that the product was free from any defects. The cost of each oven is $1,090 and includes a $10 one-year assurance warranty. In addition, Appliance’s R Us sold extended warranties on 600 ovens for four years beyond the one-year period for $210,000. What is the value of the warranty expense that Appliance’s R US should recognize?
a) $220,000
b) $210,000
c) $10,000
d) $0
Difficulty: Medium
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: 1,000 x $10 = $10,000
26. Appliance’s R Us sold 1,000 high end convection ovens during 2023 at a price of $1,620, with a warranty guarantee that the product was free from any defects. The cost of each oven is $1,090 and includes a $10 one-year assurance warranty. In addition, Appliance’s R Us sold extended warranties on 600 ovens for four years beyond the one-year period for $350 each. What is the total value of the liability related to the warranties?
a) $220,000
b) $210,000
c) $10,000
d) $0
Difficulty: Medium
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: 600 x $350 + 1,000 x $10 = $220,000
27. Under IFRS, when a vendor gives a volume rebate to a customer, the vendor should account for it as a(n)
a) expense.
b) reduction of revenue.
c) reduction of inventory.
d) other gain or loss.
Difficulty: Easy
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price —Step 3
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
28. When a vendor is exposed to continued risks of ownership because of potential return of the product, which of the following accounting procedures should NOT be used?
a) recording the sale, and accounting for returns as they occur in future periods
b) not recording the sale until all return privileges have expired
c) recording the sale, but reducing revenue by an estimate of future returns
d) recording the sale, but ignoring future returns
Difficulty: Easy
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
29. Under the earnings approach, if a company sells its product but gives the buyer the right to return the product, revenue from the sales transaction should be recognized at the time of sale if
a) the market for returnable goods is untested.
b) there is a transfer of the risks and rewards of ownership.
c) the amount of future returns can be reasonably estimated.
d) the amount of goods returned is likely to be high.
Difficulty: Easy
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
30. Which of the following is NOT true regarding the expected value approach to measuring earnings?
a) It must be highly probable that there will not be a significant reversal of revenue previously recognized.
b) The company likely has experience with similar contracts.
c) It must be highly probable that there will be a significant reversal of revenue previously recognized.
d) The company can estimate the cumulative amount of net revenue.
Difficulty: Easy
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
31. A returned asset should
a) be recorded as a direct reduction to inventory.
b) be recorded in a separate account from inventory if the amount is material.
c) be recorded at the same value it was sold for, without considering impairment.
d) never be recorded.
Difficulty: Easy
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
32. Under IFRS, where a right to return exists,
a) sales returns and allowances are recognized as contra accounts to Revenues and Accounts Receivable.
b) a refund liability is recognized.
c) this right is disclosed in the financial statements, no accrual necessary.
d) this right does not need to be disclosed or accrued anywhere.
Difficulty: Easy
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
33. Hank’s Handyman Services contracts with a customer to build a commercial garage for $500,000. There is a performance bonus of 10% of the contract value for on time completion. This bonus declines by 10% for every week the project is late. Based on past estimates, Hank’s believe that there is an 80% chance that the garage will be completed on time and a 20% chance it will be 2 weeks late. What is the transaction price?
a) $500,000
b) $548,000
c) $549,000
d) $550,000
Difficulty: Medium
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: 80% x (($500,000 + ($500,000 x 10%)) + 20% (($500,000 + ($500,000 x 10% x 80%)) = $548,000
34. Abergine Corp. is a publicly traded company and sells 1,000 units of product at $50 / unit to Crimson Corp. Abergine offers 30-day payment terms and full refunds for any undamaged product returned within 90 days. The cost of the items sold is $35 and 3% of items sold are expected to be returned. Assuming that a perpetual inventory system is used, what is the cost of goods sold recorded when the sale is made?
a) $35,000
b) $33,950
c) $50,000
d) $48,500
Difficulty: Medium
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: 1,000 x $35 x 97% = $33,950
35. Beige Inc. is a publicly traded company and offers its customers a 5% volume discount if they purchase at least $3,500,000 worth of product annually. In the past Taupe Ltd. has received the volume discount; however, at the end of the first quarter Taupe has only purchased $500,000 in product from Beige. Which of the following represents the correct treatment of the sale?
a) cr. Sales revenue $25,000
b) cr. Allowance for sales returns and allowances $25,000
c) cr. Contract liability $25,000
d) cr. Sales discounts $25,000
Difficulty: Medium
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $500,000 x 5% = $25,000
36. Relax Spa Inc. regularly sells gift cards for beauty services. Based on past redemption rates it estimates that 18% of all gift cards are NOT used. The total value of outstanding gift cards is $10,000. A customer redeems $150 on a gift card. Which of the following partial entries would Relax make? Round to 2 decimal places.
a) cr. Revenue $182.93
b) cr. Revenue $150.00
c) cr. Contract Liability $150.00
d) cr. Contract Liability $182.93
Difficulty: Medium
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $10,000 x (1 – .18) = $8,200, $150 x ($10,000 / $8,200) = $182.93
37. Which of the following is NOT an acceptable allocation approach to transaction pricing?
a) expected value approach
b) adjusted market assessment approach
c) expected cost plus a margin approach
d) residual approach
Difficulty: Easy
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
38. When a company sells a bundle of goods or services, the selling price of the bundle
a) will always be greater than the sum of individual stand-alone prices.
b) will always be equal to the sum of individual stand-alone prices.
c) may be less than the sum of individual stand-alone prices.
d) will always be less than the sum of individual stand-alone prices.
Difficulty: Easy
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
39. Savvy Tech Inc. sells new accounting software and user support bundled together. The fair value of its software is $750, and the fair value of the associated user support is $275. The user support is valid for a period of 12 months from the date of software purchase. To be able to compete with Savvy Tech’s product and service offering as a new competitor, Power Ltd. decided to sell its own software and service as a bundle for $800. During its first month of sales, 100 units of this software bundle were sold at the discounted price, and expenses were $50,000. Using the adjusted market approach what value should Savvy Tech assign to user support for the first month? Round to the nearest whole number.
a) $21,400
b) $27,500
c) $75,000
d) $80,000
Difficulty: Medium
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $275 x [$800 / ($750 + $275)] = $214 x 100 units = $21,400
40. Which of the following is NOT a scenario under which a company may recognize revenue over a period in time?
a) The customer receives and consumes the benefits as the seller performs.
b) The company’s earnings would be more consistent under this approach.
c) The customer controls the asset as it is created or enhanced.
d) The company does not have an alternative use for the asset created or enhanced.
Difficulty: Easy
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or As) Each Performance Obligation Is Satisfied—Step 5
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
41. The most popular input measure used to determine the progress toward completion in the event a company qualifies to recognize revenue over a period of time is
a) cost-benefit basis.
b) percentage-of-completion basis.
c) cost-to-cost basis.
d) collection basis.
Difficulty: Easy
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or As) Each Performance Obligation Is Satisfied—Step 5
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
42. The actions a company takes to add value are referred to as the
a) critical event.
b) earnings approach.
c) earnings process.
d) risks and rewards of ownership.
Difficulty: Easy
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
43. If the earnings process has a critical event, it is often referred to as a
a) point of delivery.
b) constructive obligation.
c) discrete earnings process.
d) transfer of risks and rewards of ownership.
Difficulty: Easy
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
44. Revenue recognition under ASPE is based on the
a) contract-based approach.
b) earnings approach.
c) balance sheet method.
d) cash method.
Difficulty: Easy
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
45. The two methods of accounting for long-term contracts under ASPE are the
a) percentage-of-completion method and the income statement method.
b) earnings method and the balance sheet method.
c) earnings method and the zero-profit method.
d) percentage-of-completion method and the completed-contract method.
Difficulty: Easy
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
46. PLC Construction Corp. has consistently used the percentage-of-completion method. In 2023, PLC started work on a $10,500,000 construction contract that was completed in 2024. The following information was taken from PLC’s 2023 accounting records:
Billings to date $3,300,000
Costs incurred 3,150,000
Collections to date 2,100,000
Estimated costs to complete 6,300,000
Under the earnings approach, what amount of gross profit should PLC recognize in 2023 on this contract?
a) $1,050,000
b) $700,000
c) $525,000
d) $350,000
Difficulty: Medium
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $3,150,000
—————– × ($10,500,000 – $9,450,000) = $350,000
$9,450,000
Use the following information to answers questions 47–48.
During 2023, Cherry Corp. started a construction job with a total contract price of $1,050,000. Cherry has consistently used the completed-contract method. The job was completed on December 15, 2024. Additional data are as follows:
2023 2024
Actual costs incurred $405,000 $457,500
Estimated remaining costs 405,000 —
Billings to date 360,000 690,000
Collections to date 200,000 480,000
47. For 2023, what amount should Cherry recognize as gross profit?
a) $0
b) $120,000
c) $142,500
d) $187,500
Difficulty: Medium
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $0
48. For 2024, what amount should Cherry recognize as gross profit?
a) $0
b) $120,000
c) $142,500
d) $187,500
Difficulty: Medium
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Apply the completed contract-method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $1,050,000 – $405,000 – $457,500 = $187,500
49. Under a consignment arrangement, the risk that merchandise might NOT sell is
a) held with the consignor.
b) held with the consignee.
c) shared by the consignor and the consignee.
d) There is no risk associated with goods held on consignment.
Difficulty: Easy
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
50. Under a consignment sales arrangement,
a) the consignor receives the merchandise to sell.
b) the consignor retains legal title.
c) the consignee ships the merchandise to the consignor.
d) the consignee retains legal title.
Difficulty: Easy
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
51. Under a consignment sales arrangement, revenue is recognized under the earnings approach
a) upon shipment of the merchandise to the consignee.
b) upon receipt of the merchandise by the consignee.
c) upon sale by the consignee.
d) upon receipt by the consignor of notification of the sale.
Difficulty: Easy
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
52. The journal entries to recognize the revenue from a consignment sale would likely be identical under the earnings and the contract-based approaches assuming
a) the contract is entered into at the same time as when control over the goods is passed to the customer.
b) the underlying goods or services are valued under the residual value method.
c) the completed-contract method is used.
d) the percentage-of-completion method is used.
Difficulty: Easy
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
53. On June 1, Freedom Distributions (FD) shipped 100 TVs to Universal TV (UTV) on consignment. FD buys these TVs from their supplier for $600 each and sells them to UTV for $800. UTV then retails them for $1,200 each. By the end of June, Universal TV reported that they had sold 60 of these TVs and remitted the appropriate amount to FD. How much revenue should be recorded by FD in connection with this transaction?
a) $72,000
b) $60,000
c) $48,000
d) $36,000
Difficulty: Medium
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: 60 x $800 = $48,000
54. A contract liability is often referred to as all of the following, except for
a) a contra-contract asset.
b) a performance obligation.
c) unearned revenue.
d) return liability
Difficulty: Easy
Learning Objective: Identify how revenues should be presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
55. Conditional rights should be reported on the statement of financial position
a) as contract assets.
b) as receivables.
c) only once the conditions have been met.
d) as contract liabilities.
Difficulty: Easy
Learning Objective: Identify how revenues should be presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
56. The appropriate approach to recognize long-term contract revenue under ASPE is
a) earnings approach to revenue recognition.
b) asset-liability approach to revenue recognition.
c) cash-based approach to revenue recognition.
d) earned and realized approach to revenue recognition.
Difficulty: Easy
Learning Objective: Identify differences in accounting between IFRS and ASPE and potential changes.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
57. Bergman Construction Inc. began work on a $6,000,000 non-cancellable contract in 2023 to construct a retail building. During 2023, Bergman incurred costs of $1,700,000 and billed its customers for $1,550,000 (non-refundable) and collected $1,250,000. At December 31, 2023, the total estimated future costs to complete is $2,200,000. Which of the following partial entries to record the cost of construction is correct if Bergman is using the percentage-of-completion method?
a) dr. Contract asset / liability $1,700,000
b) cr. Contract asset / liability $1,550,000
c) dr. Accounts receivable $1,550,000
d) dr. Materials, payables, cash $1,700,000
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
58. Builder Bob Construction Inc. began work on a $7,500,000 non-cancellable contract in 2023 to construct a retail building. During 2023, Builder Bob incurred costs of $1,500,000 and billed its customers for $1,400,000 (non-refundable) and collected $1,000,000. At December 31, 2023, the estimated future costs to complete the project total $2,500,000. What is the construction expense, assuming Builder Bob is using the percentage-of-completion method?
a) $1,400,000
b) $1,500,000
c) $3,900,000
d) $4,000,000
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
59. When there is a continuous earnings process, but the progress toward completion is NOT measurable, ASPE requires the use of the
a) completed-contract method.
b) percentage-of-completion method.
c) zero-profit method.
d) discrete earnings method.
Difficulty: Easy
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
60. Under ASPE, the profession requires that the percentage-of-completion method be used when certain conditions exist. Which of the following is NOT one of those necessary conditions?
a) Estimates of progress toward completion, revenues, and costs are reasonably dependable.
b) The contractor can be expected to perform the contractual obligation.
c) The buyer can be expected to satisfy some of the obligations under the contract.
d) The contract clearly specifies the enforceable rights of the parties, the consideration to be exchanged, and the manner and terms of settlement.
Difficulty: Easy
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
61. Under ASPE, when selecting an accounting method for a newly contracted long-term construction project, the principal factor to be considered should be
a) the terms of payment in the contract.
b) the degree to which a reliable estimate of the costs to complete and extent of progress toward completion can be made.
c) the method commonly used by the contractor to account for other long-term construction contracts.
d) the inherent nature of the contractor's technical facilities used in construction.
Difficulty: Easy
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
62. Under ASPE, when work to be done and costs to be incurred on a long-term contract can be estimated reliably, which of the following methods of revenue recognition is preferable?
a) instalment method
b) percentage-of-completion method
c) completed-contract method
d) zero-profit method
Difficulty: Easy
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
63. Under the percentage-of-completion method, how should the balances of contract asset/liability be disclosed in the financial statements prior to the completion of the contract?
a) as a deferred expense
b) as accounts receivable
c) net, as a current asset if a debit balance, and a current liability if a credit balance
d) net, as income from construction if a credit balance, and loss from construction if a debit balance
Difficulty: Easy
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
64. Under the percentage-of-completion method, how should earned but unbilled revenues on a long-term contract be disclosed on the statement of financial position?
a) as contract asset/liability in the current asset section
b) as contract asset/liability in the noncurrent asset section
c) as a receivable in the noncurrent asset section
d) in a note to the financial statements until the customer is formally billed for the portion of work completed
Difficulty: Easy
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
65. The principal disadvantage of using the percentage-of-completion method of recognizing revenue from long-term contracts is that it
a) is unacceptable for income tax purposes.
b) gives results based upon estimates which may be subject to considerable uncertainty.
c) is likely to assign a small amount of revenue to a period during which a large amount of revenue was earned.
d) no revenue is recognized during the contract.
Difficulty: Easy
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
66. The principal disadvantage of output measures in measuring progress toward completion of long-term contracts is
a) inefficiencies may cause the productivity relationship to change.
b) front-end loading.
c) units are not comparable in time, effort, or cost to complete.
d) the measures are not universally applicable.
Difficulty: Easy
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
67. Haven Corp. contracted to construct a building for $750,000. Construction began in 2023and was completed in 2024. Data relating to the contract follow:
Year Ended
December 31,
2023 2024
Costs incurred $300,000 $230,000
Estimated costs to complete 200,000 —
Haven uses the percentage-of-completion method. For the calendar years 2023and 2024, respectively, Haven should report gross profit of
a) $135,000 and $85,000.
b) $450,000 and $300,000.
c) $150,000 and $70,000.
d) $0 and $220,000.
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $300,000
—————————— × ($750,000 – $500,000) = $150,000
$300,000 + $200,000
($750,000 – $530,000) – $150,000 = $70,000
68. In 2023, Pop Construction Corp. began work on a contract for $3,700,000. Other details follow:
2023
Costs incurred during the year $1,800,000
Estimated costs to complete as of December 31 1,200,000
Billings during the year 1,650,000
Collections during the year 975,000
Pop uses the percentage-of-completion method. For calendar 2023, Pop should report gross profit of
a) $150,000.
b) $420,000.
c) $700,000.
d) $2,220,000.
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $1,800,000
——————————–— × ($3,700,000 – $3,000,000) = $420,000
$1,800,000 + $1,200,000
Use the following information for questions 69–70.
In 2023, Cement Inc. began a three-year construction contract for $3,500,000. Cement uses the percentage-of-completion method. The income to be recognized each year is based on the proportion of costs incurred to total estimated costs for completing the contract. The financial statement presentation relating to this contract for calendar 2023 follows:
Statement of Financial Position
Current assets:
Accounts receivable $150,000
Contract asset/liability 105,000
(Contract revenue $425,000 less billings of $320,000)
Income Statement
Income (before tax) on the contract recognized in 2023 $105,000
69. How much cash was collected in 2023 on this contract?
a) $25,000
b) $170,000
c) $200,000
d) $300,000
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $320,000 – $150,000 = $170,000
70. What was the initial estimated gross profit on this contract?
a) $381,430
b) $405,231
c) $650,204
d) $864,703
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $425,000 – $105,000 = $320,000
$320,000
————————— × ($3,500,000 – Total estimated cost) = $105,000
Total estimated cost
Total estimated cost = $2,635,294
$3,500,000 – $2,635,294 = $864,706
71. Mobey Construction Corp. uses the percentage-of-completion method. In 2023, Mobey began work on a contract for $2,475,000 which was completed in 2024. Data on the costs are:
Year Ended December 31
2023 2024
Costs incurred $877,500 $630,000
Estimated costs to complete 585,000 —
For the calendar years 2023 and 2024, Mobey should recognize gross profit of
2023 2024
a) $0 $967,500
b) $580,500 $387,000
c) $607,500 $360,000
d) $607,500 $967,500
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $877,500
——–——- × ($2,475,000 – $1,462,500) = $607,500
$1,462,500
($2,475,000 – $1,507,500) – $607,500 = $360,000
72. Hemsworth Ltd. began work in 2023 on a contract for $960,000. Other details follow:
2023 2024
Costs incurred during the year $160,000 $490,000
Estimated costs to complete as of December 31 480,000 0
Billings during the year 180,000 720,000
Collections during the year 150,000 675,000
Assume that Hemsworth uses the percentage-of-completion method of accounting. The portion of the total gross profit to be recognized in 2023 is
a) $60,000.
b) $80,000.
c) $240,000.
d) $320,000.
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $160,000
————— × ($960,000 – $640,000) = $80,000
$640,000
73. Classical Ltd. began work in 2023 on a contract for $1,250,000. Other data are:
2023 2024
Costs incurred during the year $540,000 $335,000
Estimated costs to complete as of December 31 360,000 —
Billings to date 420,000 1,250,000
Collections to date 300,000 1,000,000
If Classical uses the percentage-of-completion method, the gross profit to be recognized in 2023 is
a) $450,000.
b) $210,000.
c) $200,000.
d) $100,000.
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $540,000
————— × ($1,250,000 – $900,000) = $210,000
$900,000
74. A project was correctly accounted for under the percentage-of-completion method. At the end of the project, the Contract Asset/Liability account includes total debits and credits of $3,500,000. Assuming that total gross profit of $1,200,000 was recognized throughout the contract, total construction costs were
a) $4,600,000.
b) $3,500,000.
c) $2,300,000.
d) $2,100,000.
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $3,500,000 – $1,200,000 = $2,300,000
75. At the end of year 2, the accounting records for a multi-year construction project indicate actual costs incurred to date of $3,200,000, and the most recent estimate of total costs of $9,500,000. Assuming the percentage-of-completion method is used, to one decimal, at the end of year 2 the project is
a) 33.7% complete.
b) 31.2% complete.
c) 26.1% complete.
d) 25.2% complete.
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $3,200,000 ÷ $9,500,000 = 33.7%
76. Under the completed-contract method,
a) revenue, costs, and gross profit are recognized during the contract.
b) revenue and costs are recognized during the contract, but gross profit recognition is deferred until the contract is completed.
c) costs are recognized during the contract, but revenue and gross profit are not.
d) revenue, costs and gross profit are not recognized until the contract is finished.
Difficulty: Easy
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
77. Cost estimates at the end of the second year indicate a loss will result on completion of the entire contract. Which of the following statements is correct?
a) Under the completed-contract method, the loss is not recognized until the year the construction is completed.
b) Under the percentage-of-completion method, the gross profit recognized in the first year must not be changed.
c) Under the completed-contract method, when the billings exceed the accumulated costs, the amount of the estimated loss is reported as a current liability.
d) Under the completed-contract method, when the Contract Asset/Liability account has a debit balance, the estimated loss is added to the accumulated costs.
Difficulty: Easy
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
78. The completed contract method for accounting for long-term construction projects requires that
a) no revenue is recognized until the project is completed.
b) costs are accumulated, and revenue is recognized in proportion to cash collected.
c) gross profit is calculated each period but deferred until the end of the contract.
d) revenue is calculated each period but deferred until the end of the contract.
Difficulty: Easy
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
79. Which of the following statements does NOT describe a long-term construction project that is accounted for under the completed-contract method?
a) Revenues are recognized at the end of the contract.
b) Revenues are recognized evenly throughout the contract.
c) Gross profit is recognized at the end of the contract.
d) Losses are recognized immediately.
Difficulty: Easy
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
80. Which of the following statements regarding the completed-contract method is NOT true?
a) The company makes the same annual entries to record costs of construction, progress billings, and collections from customers as those under the percentage-of-completion method.
b) The company makes the same entries to recognize revenue as those under the percentage-of-completion method.
c) The company makes different entries to recognize revenue than under the percentage-of-completion method.
d) Losses on an unprofitable contract are immediately recorded.
Difficulty: Easy
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
81. Hemsworth Ltd. began work in 2023 on a contract for $960,000. Other details follow:
2023 2024
Costs incurred during the year $160,000 $490,000
Estimated costs to complete as of December 31 480,000 —
Billings during the year 180,000 720,000
Collections during the year 150,000 675,000
Assume that Hemsworth uses the completed-contract method of accounting. The portion of the total gross profit to be recognized in 2024 is
a) $120,000.
b) $180,000.
c) $310,000.
d) $960,000.
Difficulty: Medium
Learning Objective: Apply the completed contract method for long-term contracts.
Section Reference: Completed-Contract Method.
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $960,000 – $650,000 = $310,000
82. Classical Ltd. began work in 2023 on a contract for $1,250,000. Other data are:
2023 2024
Costs incurred during the year $540,000 $335,000
Estimated costs to complete as of December 31 360,000 —
Billings to date 420,000 1,250,000
Collections to date 300,000 1,000,000
If Classical uses the completed-contract method, the gross profit to be recognized in 2024 is
a) $375,000.
b) $400,000.
c) $850,000.
d) $1,000,000.
Difficulty: Medium
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $1,250,000 – $875,000 = $375,000
83. Bluegrass Builders Ltd. Is using the completed-contract method for a $2,000,000 contract that will take two years to complete. Data at December 31, 2023, the end of the first year, are
Costs incurred to date $ 925,000
Estimated costs to complete 1,100,000
Billings to date 850,000
Collections to date 700,000
The gross profit or loss that should be recognized for 2023 is
a) $50,000 gross profit.
b) $25,000 gross profit.
c) $25,000 loss.
d) $0.
Difficulty: Medium
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $2,000,000 – ($925,000 + $1,100,000) = ($25,000) loss; must be recognized in current year.
Use the following information for questions 84–86.
Folk Construction Corp. began operations in 2023. Construction activity for 2023 is shown below. Folk uses the completed-contract method.
Billings Collections Estimated
Contract Through Through Costs to Costs to
Contract Price 12/31/23 12/31/23 12/31/23 Complete
1 $1,280,000 $1,260,000 $1,040,000 $860,000 —
2 1,440,000 600,000 400,000 328,000 $752,000
3 1,320,000 760,000 700,000 900,000 480,000
84. Which of the following should be shown on the income statement for 2023 related to Contract 1?
a) gross profit, $180,000
b) gross profit, $240,000
c) gross profit, $400,000
d) gross profit, $420,000
Difficulty: Medium
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $1,280,000 – $860,000 = $420,000
85. Which of the following should be shown on the statement of financial position at December 31, 2023 related to Contract 2?
a) inventory, $272,000
b) inventory, $328,000
c) liability, $272,000
d) liability, $600,000
Difficulty: Medium
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $600,000 – $328,000 = $272,000
86. Which of the following should be shown on the statement of financial position at December 31, 2023 related to Contract 3?
a) current asset contract asset/liability, $140,000
b) current liability contract asset/liability, $60,000
c) accounts receivable, $760,000
d) current asset contract asset/liability, $80,000
Difficulty: Medium
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Overall loss expected: ($900,000 + $480,000) – $1,320,000 = $60,000
$900,000 – $760,000 = $140,000 less loss of $60,000 = $80,000
87. When a contract becomes unprofitable to an entity, this is called a(n)
a) uncompleted contract.
b) zero-profit contract.
c) onerous contract.
d) unenforceable contract.
Difficulty: Easy
Learning Objective: Account for losses on long-term contracts.
Section Reference: Losses on Long-Term Contracts
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
88. Cost estimates on a long-term contract may indicate that a loss will result on completion of the entire contract. In this case, the entire expected loss should be
a) recognized in the current period, regardless of whether the percentage-of-completion or completed-contract method is used.
b) recognized in the current period under the percentage-of-completion method, but the completed-contract method should defer recognition of the loss to the time when the contract is completed.
c) recognized in the current period under the completed-contract method, but the percentage-of-completion method should defer the loss until the contract is completed.
d) deferred and recognized when the contract is completed, regardless of whether the percentage-of-completion or completed-contract method is used.
Difficulty: Easy
Learning Objective: Account for losses on long-term contracts.
Section Reference: Losses on Long-Term Contracts
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
89. Losses on unprofitable long-term construction projects
a) are generally deferred until the contract is complete.
b) are only recognized immediately under the completed-contract method.
c) are only recognized immediately under the percentage-of-completion method.
d) are recognized immediately under both the completed-contract method and the percentage-of-completion method.
Difficulty: Easy
Learning Objective: Account for losses on long-term contracts.
Section Reference: Losses on Long-Term Contracts
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
90. Losses in a current period on a profitable contract
a) are generally deferred until the contract is complete.
b) are only recognized immediately under the completed-contract method.
c) are only recognized immediately under the percentage-of-completion method.
d) are recognized immediately under both the completed-contract method and the percentage-of-completion method.
Difficulty: Easy
Learning Objective: Account for losses on long-term contracts.
Section Reference: Losses on Long-Term Contracts
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
91. Almost Right Ltd. bid on a contract to complete a stretch of highway for the local municipality. The project manager with the company just started and unfortunately made a mistake in estimating the costs. The contract price accepted by the municipality is $2,500,000. The following are the costs of the project: Trade labour $1,400,000, Materials $1,200,000. What is the gross profit and is this an onerous contract?
a) $100,000 / No
b) ($100,000) / Yes
c) $100,000 / Yes
d) ($100,000) / No
Difficulty: Medium
Learning Objective: Account for losses on long-term contracts.
Section Reference: Losses on Long-Term Contracts
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Gross profit: $2,500,000 – ($1,400,000 + $1,200,000) = -$100,000; given the loss it is an onerous contract.
Exercises
Ex. 6-92 Constructive obligation
Picot Ltd. Sells goods worth $200 with a standard return policy. The policy states customers may return goods within 30 days of purchase if defective. This policy is stated on the bill and contract; however, Picot advertises that it stands by its products 100%. In the past, they have been known to accept returns beyond the 30-day return policy. Sally made her purchase from Picot 45 days ago and now wishes to return it.
Instructions
Discuss whether Picot has an obligation to accept Sally’s return. Explain your answer.
Solution 6-92
Yes, Picot has an obligation to accept customer returns for any reason at any time because it has created an expectation. This is known as a constructive obligation.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-93 Constructive Obligation
Big Rig Equipment Ltd. sells farm equipment throughout the region. For customers that are located more than 40 kilometers away, the company has in the past always sent out a service technician on a site visit to ensure that the equipment is working according to specifications one month after delivery. Since the customer is located far away, management adopted this practice to minimize customer inconvenience should service issues arise that require the equipment to be brought into the service centre for servicing. A new controller has started with the company and has noticed that when a sales transaction is processed, there is no recognition on the financial statements for this obligation to the customer. The most recent example is the sale of an $80,000 piece of equipment that was paid for by cash. The company normally charges $1,200 for similar service calls.
Instructions
a) What would the journal entry be based on current practice?
b) Prepare what the journal entry should be based on the controller’s observation.
Solution 6-93
a) Current entry:
Cash 80,000
Sales Revenue 80,000
b) Entry should be:
Cash 80,000
Sales Revenue 78,800
Deferred Revenue 1,200
Difficulty: Medium
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Communication
CPA: Financial Reporting
Bloomcode: Application
AACSB: Communication
Ex. 6-94 Economics of a transaction
The following are independent situations that require professional judgement for determining when to recognize revenue from the transactions.
- Volkswagen sells all its vehicles with the promise that any service required in the first year of ownership will be free of charge.
- Walmart sells you a new wardrobe online. The wardrobe is shipped and arrives in November, and you charge it to your Walmart credit card. In December, you receive your Walmart credit card statement and pay the amount due.
- Norwegian Cruise lines sells you a 10-day Mediterranean cruise. The cost includes your transportation (of course), room and board, and meals and entertainment on the ship. Shore excursions are an additional cost.
- You go back to Walmart and buy some hangers and socks to go in your new wardrobe. You pay with cash.
- Students pre-register for online classes at Royal Roads University year round, one month in advance of their course start-date.
- In February, Splashes sells dishwashers with 3 year extended warranties. The dishwashers are delivered in April, and payment is due upon delivery. Warranty plans are normally sold separately.
Instructions
For each scenario, identify what is being “sold”: goods, services, or a combination.
Solution 6-94
- Combination. The car is a goods, while the promised service is a service.
- Combination. The wardrobe is a good. By using Walmart’s credit card, you have also used their credit-lending services.
- Combination. The room is a good (though if cleaned, part of the room is a service). The food is part good/part service. Entertainment is a service. Transportation is a service.
- Good
- Service
- Combination
Difficulty: Medium
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-95 Concessionary terms
Explain what concessionary terms are and give four examples.
Solution 6-95
Concessionary terms are terms that are more favourable than normal. This is often seen when supply exceeds demand, and the buyer can negotiate a better deal than usual.
Examples include:
1. Deep discounts on selling price
2. Looser credit policy (e.g., giving the customer a longer period to pay)
3. Extended trial periods, with the sale subject to customer acceptance after the trial period
4. Seller provides ongoing or additional services that are beyond normal practice
5. Extended warranties or free warranties
6. More lenient (looser) return policies than normal
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-96 Definitions
Provide clear, concise answers for the following:
1. Explain the conceptual difference between the earnings approach and the contract-based approach to accounting for revenues.
2. How is revenue recognized under the earnings approach?
3. How is revenue recognized under the contract-based approach?
4. How are sales accounted for in the presence of collection and measurement uncertainty?
5. What are the two main methods to account for long-term construction projects allowed under ASPE?
6. Why is it important to understand the business perspective of selling transactions?
7. Explain the term onerous contracts and its implications.
Solution 6-96
- The earnings approach focuses on the earnings process itself and how value is added. The contract-based approach focuses on the creation of contractual rights and obligations that are created by sales contracts.
2. Under the earnings approach, revenue is recognized when performance is substantially complete, the transaction can be measured, and collection is reasonably assured.
3. Under the contract-based approach, the net contract position is initially recognized (through assets and corresponding liabilities) when the contract has been entered into. Revenue is subsequently recognized as the contract obligations are fulfilled.
4. In the absence of reasonable expectation of collection and/or ability to measure the related revenue, sales should not be booked.
5. The two main methods allowed under ASPE are the percentage-of-completion and the completed-contract methods.
6. The business perspective includes the physical and reciprocal nature as well as any concessionary terms of the transaction. This may impact the timing, measurement and recognition of those sales.
7. Onerous contracts are contracts that are no longer profitable to the company. These contracts should be remeasured and a loss should be recognized.
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
Learning Objective: Identify the five steps in the revenue recognition process.
Section Reference: The Asset-Liability Approach to Revenue Recognition: An Overview of the Five-Step Process
Learning Objective: Identify the contract with customers.
Section Reference: Identifying the Contract with Customers—Step 1
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-97 Terminology
In the space provided at right, write the word or phrase that is defined or indicated.
1. A contract that is no longer ______
profitable to the company.
2. An entity may have an implicit obligation ______
even if it is NOT explicitly noted
in the sales contract.
3. Sales that are comprised of ______
several individual components.
4. The party acting as an agent for ______
the seller.
5. The method to allocate sales prices ______
to individual components of a sales
bundle where the fair value of the
undelivered item is subtracted from
the overall purchase price.
6. The method used to account for ______
long-term contracts that do NOT
recognize profits before the completion
of the project.
7. The account used in the percentage-of ______
completion and completed-contract
methods to accumulate costs and
recognize profits.
8. Cash or other assets an entity ______
receives in return for the provision
of goods or services.
9. The actions a company takes to ______
add value.
Solution 6-97
- onerous
2. constructive obligation
3. bundled sales
4. consignee
5. residual value method
6. completed-contract method
7. Contract Asset/Liability account
8. consideration
9. earnings process
Difficulty: Easy
Learning Objective: Understand the economics and legalities of selling transactions from a business perspective.
Section Reference: Understanding the Nature of Sales Transactions from a Business Perspective
Learning Objective: Identify the five steps in the revenue recognition process.
Section Reference: The Asset-Liability Approach to Revenue Recognition: An Overview of the Five-Step Process
Learning Objective: Identify the contract with customers.
Section Reference: Identifying the Contract with Customers—Step 1
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Ex. 6-98 Revenue recognition process
Assume that Bombardier Inc. signs a contract to sell light-rail-transit (LRT) vehicles to the Region of Waterloo for $15 million.
Instructions
Using this transaction as an example, illustrate the five steps in the revenue recognition process for Bombardier.
Solution 6-98
1. A contract is an agreement between two parties that creates enforceable rights or obligations. In this case, Bombardier has signed a contract to deliver LRT vehicles to Waterloo.
2. Bombardier has only one performance obligation: to deliver LRT vehicles to Waterloo.
3. Transaction price is the amount of consideration that a company expects to receive from a customer in exchange for transferring a good or service. In this case, the transaction price is straightforward. It is $15 million.
4. In this case, Bombardier has only one performance obligation, to deliver LRT vehicles to the Region of Waterloo.
5. Bombardier recognizes revenue of $15 million for the sale of LRT vehicle when it satisfies its performance obligation, the delivery of the LRT vehicles to the Region of Waterloo.
Difficulty: Easy
Learning Objective: Identify the five steps in the revenue recognition process.
Section Reference: The Asset-Liability Approach to Revenue Recognition: An Overview of the Five-Step Process
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-99 Revenue recognition process
How would your answer to Exercise 6-98 change if Bombardier had also contracted to maintain the LRT vehicles for the Region of Waterloo?
Solution 6-99
1. Bombardier may have signed two contracts, or the maintenance could be included in the initial contract. Either way they should acknowledge that one deliverable is relatively punctuated and the other is long term.
2. A separate performance obligation is recorded for the promise to maintain the cars in whatever magnitude of cost the expected maintenance is anticipated to create.
3. The transaction price would need to be estimated unless, for example, a flat annual rate were set out in the original contract.
4. In this case, Bombardier has two performance obligations – to deliver LRT vehicles and to maintain them.
5. Bombardier recognizes revenue of $15 million for the sale of LRT vehicle when it satisfies its performance obligation, the delivery of the LRT vehicles to the Region of Waterloo. Cost relating to the service portion of the contract would be recognizes as service is provided, or with the passage of time, depending on the terms of the contract.
Difficulty: Easy
Learning Objective: Identify the five steps in the revenue recognition process.
Section Reference: The Asset-Liability Approach to Revenue Recognition: An Overview of the Five-Step Process
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-100 Contract identification
Coffee Co. enters into a contract to delivery coffee to the House of Commons on July 1, 2023. The House agrees to pay the full price of $3,000 on August 1, 2023. The cost of goods is $1,400. Coffee Co. delivers the coffee to the House on July 1, 2023 and receives payment on August 1, 2023.
Instructions
Prepare the journal entries for Coffee Co. related to this contract.
Solution 6-100
On July 1, 2023, Coffee Co. delivers and therefore should recognize the revenue on that date because it satisfies the performance obligation by delivering the coffee to the House. There is now an unconditional right to receive the payment (and therefore an accounts receivable)
The journal entry to record the sale and related cost of goods sold is as follows:
July 1, 2023
Accounts Receivable 3,000
Sales Revenue 3,000
Costs of Goods Sold 1,400
Inventory 1,400
After receiving payment on August 1, 2023, Coffee Co makes the following entry:
August 1, 2023
Cash 3,000
Accounts Receivable 3,000
Difficulty: Medium
Learning Objective: Identify the contract with customers.
Section Reference: Identifying the Contract with Customers—Step 1
Learning Objective: Identify how revenues should be presented, disclosed and analyzed.
Section Reference: Presentation and Disclosure
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex 6-101 Contract identification
Tiger Ltd. has an ongoing contract with to deliver 700 medical testing strips to Orange Inc. over a seven-month period for $7,000. After 400 testing strips have been delivered, Tiger modifies the contract by promising to deliver 140 more testing strip for $1,120, or $8 per strip (which is the stand-alone selling price at the time of contract modification). Tiger regularly sells testing strips separately.
Instructions
a) Will the delivery of the additional testing strips be considered part of the original contract? Explain.
b) Prepare the journal entries for Tiger Ltd. for the additional testing strips.
Solution 6-101
a)
In this situation, the contract modification for the additional 140 stripes is, in effect, a new and separate contract because it meets both of the conditions:
1. The promised goods or services are distinct
2. The price increased by an amount of consideration that reflects the stand-alone selling price of the promised goods or services (in this case, the stripes).
b)
Accounts Receivable 1,120
Sales 1,120
It does not affect the accounting for the original service.
Difficulty: Medium
Learning Objective: Identify the contract with customers.
Section Reference: Identifying the Contract with Customers—Step 1
Learning Objective: Identify how revenues should be presented, disclosed and analyzed.
Section Reference: Presentation and Disclosure
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication
Ex 6-102 Multiple goods and services – warranties
Appliance Plus sold 1,000 refrigerators during 2023 at a total price of $1,620,000, with a warranty guarantee that the product was free from any defects. The cost of the refrigerators sold was $1,080,000. The term of the assurance warranty is one year, with an estimated cost of $10,000. In addition, Appliance Plus sold extended warranties on 600 refrigerators for four years beyond the one-year period for $210,000.
Instructions
Prepare the journal entries to record the sale and related warranties for 2023.
Solution 6-102
Cash 1,830,000
Warranty Expense 10,000
Warranty Liability 10,000
Unearned Revenue 210,000
Sales Revenue 1,620,000
(To record revenue and liabilities related to the warranties)
Cost of Goods Sold 1,080,000
Inventory 1,080,000
(To reduce inventory and recognize cost of goods sold)
Difficulty: Medium
Learning Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations – Step 2.
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex-103 Multiple goods and services – warranties
Appliance Plus sold four-year extended warranties on 600 refrigerators in 2023 for a total of $210,000. The cash received for these sales was properly recorded to Unearned Revenue. How will the company record the recognition of revenue over the next four years?
Instructions
a) Show the amount of revenue to be recognized from unearned revenue assuming management believes that the service warranty will be used up evenly over the four years.
b) Show the amount of revenue to be recognized from unearned revenue assuming management believes that 10% will be used fully in the 1st year, 20% in the 2nd year, 35% in the 3rd year, and the remaining 35% in the 4th year.
c) Critical thinking – If management receives a yearly bonus based on profitability of the company, what options would they most likely choose and explain why?
Solution 6-103
a)
2024 2025 2026 2027
Revenue 52,500 52,500 52,500 52,500
b)
2024 2025 2026 2027
Revenue 21,000 42,000 73,500 73,500
c) If management receives a bonus based on profits, they will be motivated to choose accounting policies that either maximize revenue sooner or defer expenses. Either of these strategies will result in higher profits sooner. The option in part a. will recognize revenue sooner ($52,500 in 2024 and 2025 vs $21,000 and $42,000 in 2024 and 2025 respectively).
Difficulty: Medium
Learning Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations – Step 2.
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex 6-104 Breakage
What does “breakage” refer to in terms of loyalty points or gift certificates?
Solution 6-104
Often only a percentage of the total value of loyalty points or gift certificates will be redeemed by a customer. The unredeemed amount of loyalty points or gift certificates awarded by a company, is known as breakage.
Difficulty: Easy
Learning Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations – Step 2
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication
Ex 6-105 Upfront fees
Explain what upfront fees are and give three examples.
Solution 6-105
Companies sometimes receive payments from customers before they deliver a product or perform a service which are referred to as upfront fees. Upfront payments generally relate to the initiation, activation, or set-up of a good or service to be provided or performed in the future. In most cases, these upfront payments are non-refundable.
Examples include:
1. Fees paid for membership in a health club or buying club
2. Activation fees for phone, Internet, or cable
3. Gift cards
Difficulty: Easy
Learning Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations – Step 2.
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-106 Performance obligations
Trikonasana Inc. enters into a contract to design and build a bridge connecting a busy downtown core to a shoreline across the way that is home to many commuters. Trikonasana is responsible for overall management of the project and identifies various goods and services to be provided, including engineering, site clearance, foundation, procurement, construction of the structure, and so on.
Instructions
Under IFRS, does Trikonasana have a single performance obligation to the city in this revenue arrangement?
Solution 6-106
The overall management of the bridge construction project and the construction itself are interdependent, and therefore should be accounted for as one performance obligation.
Difficulty: Easy
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-107 Performance obligations
Island Foods Inc. has a promotional program whereby for every $10 spent in store, customers receive stamps which can later be redeemed for knives and cookware.
Instructions
Under IFRS does Island Foods have a single performance obligation to its customers in this revenue arrangement?
Solution 6-107
For the items customers buy in store, Island Foods has fulfilled its performance obligation. The rights associated with the stamps are essentially giving the customer future items for free and should be treated as separate performance obligations as they provide the customer with a right they would otherwise not be entitled to (i.e., Without the stamps they would need to pay for such knives and cookware). A portion of the customer’s bill is hence advance payment for future goods and services, and the transaction price must be allocated accordingly, between the two separate performance obligations.
Difficulty: Easy
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-108 Transaction price
Presented below are three revenue recognition situations:
a) Bliss sells goods to Jusu for $10,000, payment due at delivery.
b) Bliss sells goods on account to Saanich for $23,000, payment due in 30 days.
c) Bliss sells goods to Nourish for $50,000, due in two instalments: the first instalment payable in 20 months, and the second payment due 4 months later. The present value of the future payments is $47,000.
Instructions
Indicate the transaction price for each of these transactions and when revenue will be recognized.
Solution 6-108
a) $10,000 recognized at time of delivery.
b) $23,000 recognized at time of delivery, less any allowance to account for estimated bad debts.
c) $47,000 recognized at the time of delivery/ sale. The $3,000 imputed interest income will be recognized with the passage of time at the imputed rate, which discounts the payments ($50,000) to the current value of $47,000.
Difficulty: Medium
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Exercise 6-109 Allocate transaction price
Periwinkle Company manufactures equipment and is a publicly traded company. Periwinkle’s products range from simple automated machinery to complex systems containing numerous components. Unit selling prices range from $140,000 to $1,200,000 and are quoted inclusive of installation. The installation process does NOT involve changes to the features of the equipment to perform specifications. Periwinkle has the following relationship with Rose Inc.
- Rose can purchase equipment from Periwinkle for a price of $200,000 and contracts with Periwinkle to install the equipment. Using market data, Rose determines installation service is estimated to have a fair value of $20,000. The cost of the equipment is $78,000.
- Rose is obligated to pay Periwinkle the $200,000 upon delivery and installation of the equipment.
Periwinkle delivers the equipment on August 1, 2023, and completes the installation of the equipment on October 1, 2023. The equipment has a useful life of 7 years. Assume the equipment and the installations are two distinct performance obligations that should be accounted for separately.
Instructions
a) How should the transaction price of $200,000 be allocated among the service obligations?
b) Prepare the journal entries for Periwinkle for this revenue arrangement for 2023, assuming Periwinkle receives payment when installation is completed.
Solution 6-109
a) Having been provided the market value of the installation, the residual approach is used here, and allocation is as follows:
$20,000 Installation
$180,000 Equipment
b) Journal Entries
August 1, 2023: Equipment Delivery
Accounts Receivable 180,000
Sales Revenue 180,000
Cost of Equipment Sold 78,000
Equipment Inventory 78,000
October 1, 2023: Equipment Installation
Cash 200,000
Installation Revenue 20,000
Accounts Receivable 180,000
If there was a cost of labour associated with installation, we would record that here, too; however, this information was not provided in the question.
Difficulty: Medium
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
CPA: Communication
CPA: Financial Reporting
Bloomcode: Application
AACSB: Communication
Ex. 6-110 Discounted transaction price
Gabby Inc., is selling tickets to a conference. In addition, Gabby offers an online course. Online courses are often sold separately at a rate of $249 per course.
Item Stand-alone Selling Price Price when Bundled
Conference $60
Course $249
Both $185
Total $309 $185
Instructions
How should the discount be allocated to the elements of the revenue arrangement?
Solution 6-110
In this case, the discount applies to the performance obligations related to providing the course. As a result, Gabby allocates the discount solely to the course, as follows:
Allocated Amounts
Courses $125
Conference 60
Difficulty: Medium
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
CPA: Communication
CPA: Financial Reporting
Bloomcode: Application
AACSB: Communication
Ex. 6-111 Bundled sales
Canucks Inc., a software company sells new accounting software and user support bundled together. The fair value of its software is $1,500 and the fair value of the associated user support is $500. The user support is valid for a period of 12 months from the date of software purchase. To be able to compete with Canucks’ product and service offering as a new competitor, Loon Ltd. decided to sell its own software and service as a bundle and at a discount for $1,800.
During its first month of sales, 100 units of this software bundle were sold at the discounted price, and expenses were $50,000.
Instructions
a) Calculate the sale price that should be allocated to each component of the bundle using the adjusted market assessment approach.
b) Calculate the sale price that should be allocated to each component of the bundle using the residual approach.
c) Assuming that the relative fair value method is used and the income tax rate is 30%, calculate the net income applicable to Loon's first month of sales.
Solution 6-111
a) Adjusted Market Assessment Approach:
Software: $1,500 x [$1,800 / ($1,500 + $500)] = $1,350
User Support: $500 x [$1,800 / ($1,500 + $500)] = 450
$1,800
b) Residual approach:
Software: $1,800 – $500 $1,300
User Support: $1,800 – $1,300 500
$1,800
c) Net income calculation:
Sales ($1,800 x 100) $180,000
Less: Expenses (50,000)
User Support Unearned Portion (41,250)
[($450 x 100) x 11÷12]
Income before tax 88,750
Less income tax (30%) (26,625)
Net Income $ 62,125
Difficulty: Medium
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-112 Contract-based approach
In January 2023, Bruins Construction Corp. contracted to construct a building for $6,000,000. Construction started in early 2023 and was completed in 2024. The following additional information is available:
2023 2024
Costs incurred $2,430,000 $2,700,000
Estimated costs to complete 2,600,000 —
Collections during the year 2,400,000 3,600,000
Bruins uses the percentage-of-completion method.
Instructions
Under the contract-based approach,
a) How much revenue should Bruins report for 2023 and 2024?
b) Prepare all journal entries for 2023 and 2024 for this contract.
Solution 6-112
a)
2023: [$2,430,000 ÷ ($2,430,000 + $2,600,000)] x $6,000,000 = $2,898,608
2024: [($2,430,000 + $2,700,000) ÷ ($2,430,000 + 2,700,000 + $0) x $6,000,000] – $2,898,608 = $3,101,392
b)
2023:
Contract asset 6,000,000
Contract liability 6,000,000
To record contract rights and obligations—January 2023
Contract liability 2,430,000
Materials, Cash, Payables etc. 2,430,000
To record construction cost—2023
Cash 2,400,000
Contract asset 2,400,000
To record collections—2023
Construction expenses 2,430,000
Contract liability 2,430,000
To recognize revenue and gross profit—2023
Contract asset 2,898,608
Revenue from long-term contract 2,898,608
2024:
Contract liability 2,700,000
Materials, Cash, Payables etc. 2,700,000
To record construction cost—2024
Cash 3,600,000
Contract asset 3,600,000
To record collections—2024
Construction expenses 2,700,000
Contract liability 2,700,000
To recognize revenue and gross profit—2024
Contract asset 3,101,392
Revenue from long-term contract 3,101,392
Difficulty: Medium
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-113 Timing of revenue recognition
Asana Inc. enters into a contract with Modo Company to develop and install a customized enterprise resource planning system (ERP). Progress payments are made upon completion of each stage of the contract. If the contract is terminated, the partly completely ERP will pass to Modo Company. Asana is prohibited from directing the software to another customer (and besides, it is likely much too customized to do so, anyway). Asana Inc. prepares its financial statements in accordance with IFRS.
Instructions
At what point should Asana recognize revenue related to its contract with Modo Company?
Solution 6-113
Asana creates an asset with no alternative use because it is prohibited from redirecting the software. In addition, Asana is entitled to payments for performance to date and expects to complete the project. Therefore, Asana concludes that the contract meets the criteria for recognition of revenue over time.
Difficulty: Easy
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-114 Timing of revenue recognition/percentage of completion
Crush Inc. provides demolition services. In order to determine the progression of its projects, the company could use several measures, including estimated labour hours, total machine hours, and output of material demolished. A project Crush currently has underway has taken 400 labour hours, 900 machine hours, and 2,000 tons of material output. The estimated total resources required (and resulting outputs) for this project are 1,000 labour hours, 1,400 machine hours and 4,500 tons of materials.
Instructions
Consider the three alternative means of tracking percentage completion. Under each method, calculate the percentage-completion rate for this project.
Solution 6-114
a) Labour Hours
400 hours / 1,000 hours = 40% complete
b) Machine Hours
900 hours / 1,400 hours = 64% complete
c) Material Output
2,000 tons / 4,500 tons = 45% complete
Difficulty: Medium
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-115 Percentage-of-completion method
Jets Ltd. was contracted to build a high-rise for $6,000,000. Construction began in 2023and is expected to be completed in 2025. Data for 2023 and 2024 are:
2023 2024
Costs incurred $ 900,000 $1,700,000
Estimated costs to complete 3,600,000 2,400,000
Instructions
Using the percentage-of-completion method and the cost-to-cost basis,
a) How much gross profit should be reported for 2023? Show your calculation.
b) How much gross profit should be reported for 2024? Show your calculation.
c) Prepare the journal entry to record the revenue and gross profit for 2024.
Solution 6-115
a) $900,000
————–— × ($6,000,000 – $4,500,000) = $300,000
$4,500,000
b) $2,700,000
————––— × ($6,000,000 – $5,000,000) = $520,000
$5,000,000
Less 2023 gross profit (300,000)
Gross profit in 2024 $220,000
c) Contract Asset/Liability ….................................................. 1,920,000
Revenue from Long-term Contracts 1,920,000
Construction Expenses 1,700,000
Contract Asset/Liability 1,700,000
Difficulty: Medium
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-116 Risks and rewards of ownership
Describe the factors one must consider in determining who has the risk and rewards of ownership and, therefore, whether a sale has occurred at the point of delivery, under the earnings approach.
Solution 6-116
- Who has possession of the goods?
- Who has legal title?
- Who is exposed to risk of loss?
- Who recognizes the related goods or services as an asset?
Difficulty: Medium
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
CPA: Communication
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-117 Earnings approach to revenue recognition
Fab=Athletics sends an outfit to monthly subscribers each month. If the customer does NOT want the outfit in a given month, they can send it back before the last day of that month free of charge in exchange for a store credit. The company prepares its financial statements in accordance with ASPE.
Instructions
Describe when these transactions should be recognized as sales under the earnings approach.
Solution 6-117
The shipment of the goods signifies Fab has completed their performance obligation in relation to the sale only if the customer chooses not to return the item. Thus, after the final day of the month revenues can be recognized. The balance related to any returned goods is considered unearned revenue until the customers redeem it for credits. If Fab has sufficient sales history to estimate the amount of returns it may recognize a proportion of revenue commensurate with past experience.
Difficulty: Easy
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
Ex. 6-118 Percentage-of-completion method
Oilers Construction was awarded a contract to construct an interchange at the junction of two major freeways in a Canadian city at a total contract price of $10,000,000. The estimated total cost to complete the project is $8,000,000, and it is expected to take two years.
Instructions
Using the percentage-of-completion method and the cost-to-cost basis,
a) Prepare the journal entry to record construction costs of $4,400,000 for the first year.
b) Prepare the journal entry to record progress billings of $5,000,000 for the first year.
c) Prepare the journal entry to recognize the revenue and gross profit for the first year.
Solution 6-118
% complete = 4,400,000 ÷ 8,000,000 = 55%
a) Contract Asset/Liability 4,400,000
Materials, Cash, A/P, etc. 4,400,000
b) Accounts Receivable 5,000,000
Contract Asset/Liability 5,000,000
c)
Contract Asset/Liability 5,500,000
Revenue from Long-term Contract (55% x $10,000,000) 5,500,000
To record revenue
Construction Expenses 4,400,000
Contract Asset/Liability 4,400,000
To record construction expenses
Difficulty: Medium
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-119 Bill-and-Hold arrangement
Explain what a bill-and-hold sale is and why a customer might engage in such an arrangement.
Solution 6-119
A bill-and-hold arrangement is a contract under which an entity bills a customer for a product, but the entity retains physical possession of the product until it is transferred to the customer at a point in the future. Bill-and-hold sales result when the buyer is not yet ready to take delivery but does take title and accepts billing. For example, a customer may request that a company enter into such an arrangement because of (1) lack of available space for the product, (2) delays in its production schedule, or (3) more than sufficient inventory in its distribution channel.
Difficulty: Easy
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex 6-120 Performance obligations and warranties
Kimbo Corporation sold 500 widgets during 2023 at a total price of $1.4 million, with a warranty guarantee that the widgets were free from any defects. The cost of widgets sold is $600,000. The term of the assurance warranty is one year, with an estimated cost of $10,000.
Instructions
What are the journal entries that Kimbo Company should make in 2023 related to the sale and the related warranties?
Solution 6-120
To record the revenue and liabilities related to the warranties:
Cash 1,400,000
Warranty Expense 10,000
Warranty Liability 10,000
Sales Revenue 1,400,000
Warranty expenses would be recorded as incurred and the liability reduced accordingly
To reduce inventory and recognize cost of goods sold:
Cost of goods sold 600,000
Inventory 600,000
Difficulty: Medium
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Exercise 6-121 Revenue recognition
Alpine sells forklifts to Cusco Ltd. Cusco places an order for 50 forklifts to take advantage of a volume discount. Cusco does NOT have storage space to store the forklifts; therefore, they request that Alpine store the forklifts and provide them a delivery schedule. Cusco provides Alpine with insurance coverage for the forklifts and acknowledges that they are taking title to the forklifts immediately. Alpine stores the forklifts in a separate part of the warehouse and specifically identifies them as belonging to Cusco. Alpine invoices Cusco once the paperwork is complete and requires payment within the customary 30-day term.
Instructions
Explain when Alpine can recognize the revenue related to sale of forklifts to Cusco and why.
Solution 6-121
The transaction between Cusco and Alpine meets the criteria for a bill-and-hold sale and can therefore be recognized as revenue at the time of invoicing. These criteria are:
1. Probability that delivery will be made
2. Item is on hand, identified, and ready for delivery to the buyer
3. The buyer specifically recognizes the deferred delivery instructions
4. The usual payment terms apply.
Alpine has transferred control to Cusco; that is, Alpine has the right to payment for the forklifts and legal title has transferred.
Difficulty: Easy
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 6-122 Consignment sale
In 2023, the following transaction occurred between Senators Wholesale Corp. (consignor) and Canadiens Stores (consignee):
On March 2, 2023 Senators shipped merchandise costing $52,000 to Canadiens. Senators paid $4,000 for freight and Canadiens paid $3,000 for advertising (to be reimbursed by Senators). By the end of the third quarter of 2023 (September 30, 2023), Canadiens advised Senators that all the merchandise has been sold for $70,000 and forwarded the proceeds (net of a 15% commission and the outlay for advertising) to Senators.
Instructions
a) Prepare all entries for Canadiens to account for this transaction.
b) Prepare all entries for Senators to account for this transaction.
Solution 6-122
a) Canadiens
Accounts Receivable 3,000
Cash 3,000
To set up receivable for advertising
Cash 70,000
Accounts Payable 70,000
To record sale
Accounts Payable 70,000
Accounts Receivable 3,000
Commission Revenue* 10,500
Cash 56,500
To record remittance to consignor
*$70,000 x 15% = $10,500
b) Senators
Inventory on Consignment 52,000
Inventory 52,000
To record shipment of consigned merchandise
Inventory on Consignment 4,000
Cash 4,000
To record payment of freight costs
Cash 56,500
Advertising Expense 3,000
Commission Expense 10,500
Revenue from Consignment Sales 70,000
To record remittance from consignee
Cost of Goods Sold ($52,000 + $4,000) 56,000
Inventory on Consignment 56,000
To record cost of sales for consignment sales
Difficulty: Medium
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-123 Reporting of gross or net revenues
Discuss three factors to consider in determining whether gross or net revenues should be reported on the income statement.
Solution 6-123
Factors to consider:
1. Is the company acting as principal or are they acting as agent or broker? If as principal, this would support reporting gross revenue; if as agent/broker, this would support reporting net revenue.
2. Is the company taking title to the goods being sold? Taking title supports reporting gross revenue.
3. Who has the risks and rewards of ownership of the goods being sold? Having the risks and rewards supports reporting gross revenue.
Difficulty: Easy
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
Bloomcode: Application
AACSB: Communication
Ex. 6-124 Presentation and the percentage-of-completion method
Thuxton Inc. began work on a $6,000,000 non-cancellable contract in 2023 to construct a retail building. During 2023, Thuxton incurred costs of $1,500,000 and billed its customers for $1,400,000 (non-refundable) and collected $1,000,000. At December 31, 2023, the estimated future costs to complete the project total $2,500,000.
Instructions
Prepare Thuxton’s 2023 journal entries using the percentage-of-completion method.
Solution 6-124
To record the cost of construction:
Contract asset/liability 1,500,000
Materials, Payables, Cash etc. 1,500,000
To record progress billings:
Accounts receivable 1,400,000
Contract asset/liability 1,400,000
The debit represents an unconditional right to receive consideration because the billings are non-refundable and the contract non-cancellable.
To record collections:
Cash 1,000,000
Accounts receivable 1,000,000
To record revenues:
Contract asset/liability 2,250,000
Revenue from long-term contracts 2,250,000
(($1,500,000/$4,000,000) x 6,000,000) = 2,250,000
To record construction expenses:
Construction expenses 1,500,000
Contract asset/liability 1,500,000
Difficulty: Medium
Learning Objective: Identify how revenues should be presented, disclosed and analyzed.
Section Reference: Presentation and Disclosure
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-125 Percentage-of-completion method
Flames Corp. contracted to build a bridge for $5,000,000. Construction began in 2023 and was completed in 2024. Data relating to the construction are:
2023 2024
Costs incurred $1,620,000 $1,400,000
Estimated costs to complete 1,380,000 —
Instructions
Using the percentage-of-completion method and the cost-to-cost basis,
a) How much revenue should be reported for 2023? Show your calculation.
b) Prepare the journal entry to record progress billings of $1,700,000 during 2023.
c) Prepare the journal entry to record the revenue and gross profit for 2023.
d) How much gross profit should be reported for 2024? Show your calculation.
Solution 6-125
a) $1,620,000
————–— × $5,000,000 = $2,700,000
$3,000,000
b) Accounts Receivable 1,700,000
Contract Asset/Liability 1,700,000
c)
Contract Asset/Liability 2,700,000
Revenue from Long-term Contracts 2,700,000
To record revenue
Construction Expenses 1,620,000
Contract Asset/Liability 1,620,000
To record construction expenses
d) Revenue $5,000,000
Less actual costs (3,020,000)
Total gross profit 1,980,000
Recognized in 2023 (1,080,000)
Recognized in 2024 $ 900,000
OR
Total revenue $5,000,000
Recognized in 2023 (2,700,000)
Recognized in 2024 2,300,000
Actual costs in 2024 (1,400,000)
Gross profit in 2024 $ 900,000
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 6-126 Advantages and disadvantages – completed-contract method
Explain the advantages and disadvantages of the completed-contract method.
Solution 6-126
The main advantage of the completed-contract method is that reported revenue reflects final results rather than estimates of unperformed work. Its major disadvantage is that it does not reflect current performance when the period of a contract extends into more than one accounting period. Although operations may be fairly uniform during the period of the contract, the company will not report revenue until the year of completion, which distorts earnings.
Difficulty: Easy
Learning Objective: Apply the completed contract method for long-term contracts.
Section Reference: Completed-Contract Method.
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
PROBLEMS
Pr. 6-127 Long-term contract
On January 1, 2023, Charger Corp., a management consulting firm, entered into a contract with Viking Company to provide advisory services over a four-year period. The contract price was $4,000,000 and was to be paid in four equal annual payments at the end of each year. Charger’s expenses relating to this contract were $650,000, $730,000, $780,000 and $710,000 for 2023–2026. Collectibility was reasonably assured throughout the duration of the contract and measurement uncertainties were NOT an issue.
Instructions
Using the contract-based revenue recognition model, prepare journal entries for all four years.
Solution 6-127
2023 | 2024 | 2025 | 2026 | |||||
Debit | Credit | Debit | Credit | Debit | Credit | Debit | Credit | |
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To record contract expenses: |
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Contract Asset/Liability | 650,000 |
| 730,000 |
| 780,000 |
| 710,000 |
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Materials, Cash, Payables etc. | 650,000 |
| 730,000 |
| 780,000 |
| 710,000 | |
To record collections: |
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Cash | 1,000,000 |
| 1,000,000 |
| 1,000,000 |
| 1,000,000 |
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Contract asset/liability | 1,000,000 |
| 1,000,000 |
| 1,000,000 |
| 1,000,000 | |
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To recognize revenue |
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and gross profit: |
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Construction Expenses | 650,000 |
| 730,000 |
| 780,000 |
| 710,000 |
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Contract asset/ liability | 650,000 |
| 730,000 |
| 780,000 |
| 710,000 | |
Contract asset/liability | 1,000,000 |
| 1,000,000 |
| 1,000,000 |
| 1,000,000 |
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Revenue from long-term contract | 1,000,000 |
| 1,000,000 |
| 1,000,000 |
| 1,000,000 | |
Difficulty: Medium
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or As) Each Performance Obligation Is Satisfied—Step 5
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 6-128 IFRS Revenue Recognition
WizKidz Tech Group has been contracted by the government to build a brand new application (software program) to facilitate the booking, reservation, and payment of fees for camp sites in the province. The old system was very manual and needed to be completely replaced. A contract was signed on July 1, 2023 by WizKidz and the Minister responsible for technology in the government. As per the agreement, WizKidz is charging the government $2,000,000 to build the program (to be completed within 1 year), host the application on its servers and provide the associated storage, and service the system over the next four years. The service portion of the contract promises 50 hours of technical support per year over the next four years. The average cost of a technical support staff is $45 per hr. It is also expected that the server/storage costs are $55.10 per TB each year and that the government will need about 500 TB of storage. WizKidz uses IFRS to prepare its annual financial statements.
Instructions
a) Use the above to illustrate the 5 steps of the revenue recognition process.
b) Critical Thinking – If WizKidz reports its financial results on a quarterly basis, what revenue recognition method would be most appropriate related to the transaction price allocated for the software program?
Solution 6-128
a)
1. A contract exists as an agreement when it has been signed between the company and the government to provide a software solution, along with going service and support over four years.
2. There are multiple performance obligations in this agreement.
i. Build an application (software program)
ii. Provide hosting/storage over four years
iii. Provide 50 hours of technical support each year over four years
3. Determine the transaction price. The amount identified in the agreement is $6,000,000.
4. Allocate the transaction price. WizKidz should allocate to the performance obligations that have stand alone pricing first.
i. Technical support – 50 hrs x 4 years x $45 = $9,000
ii. Storage – 500 TB x $55.10 x 4 years = $110,200
iii. Software application – $2,000,000 – $9,000 – $110,200 = $1,880,800
5. Recognize the revenue as its earned.
i. Technical support revenue would be recognized as hours are used.
ii. Storage should be recognized as it is used
iii. Software application – Point in time when control passes or over time (when control passes) if certain criteria are met
b)
There are two options. WizKidz can recognize revenue at the point when control passes to the customer (at the end of the 1 year completion period), but this will not allow the company to recognize revenue any sooner than that. The other option is to recognize revenue over time if the follow criteria are met.
1. The customer receives and consumes the benefits as the seller performs.
2. The customer controls the asset as it is created or enhanced.
3. The company does not have an alternative use for the asset created or enhanced and the amount is collectible.
In this case, the software application being developed is specifically for the provincial government and is being created to the customer’s specifications with no alternative uses. Therefore, WizKidz could recognize revenue sooner, on a quarterly basis.
Difficulty: Medium
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 6-129 Long-term construction project accounting
Giants Construction Inc. specializes in the construction of commercial and industrial buildings. The company is experienced in bidding on long-term construction projects of this type, with the typical project lasting from fifteen to twenty-four months. Giants uses the percentage-of-completion method. Progress toward completion is measured on a cost-to-cost basis. Giants began work on a contract at the beginning of 2023. Data for 2023 follow:
Contract price……………………………………………….. $2,000,000
Estimated costs:
Labour $425,000
Materials and subcontracts 875,000
Indirect costs 200,000 1,500,000
Estimated gross profit $ 500,000
At the end of 2023, the following was the actual status of the contract:
Progress billings to date $1,115,000
Costs incurred to date:
Labour $207,000
Materials and subcontracts 519,000
Indirect costs 75,000 $801,000
Latest forecast of total costs $1,500,000
It should be noted that included in the above costs incurred to date were standard electrical and mechanical materials stored on the job site, but NOT yet installed, costing $51,000. These costs should NOT be considered in the costs incurred to date.
Instructions
a) Calculate the percentage of completion on the contract at the end of 2023.
b) Calculate the gross profit that would be reported on this contract for 2023.
c) Prepare the journal entry to record the revenue and gross profit for 2023 on Giants’ books.
d) Indicate the account(s) and the amount(s) that would be shown on Giants’ statement of financial position at the end of 2023 related to its construction accounts. Also show how these items would be classified on the statement of financial position. Cash collected during the year was $980,000.
e) Assume, instead of $1,500,000, the latest forecast of total costs at the end of 2023 was $2,050,000. How much income (loss) would Giant then report for the year 2023?
Solution 6-129
a) Costs to date $801,000
Less materials on job site (51,000)
$750,000
Costs Incurred to Date
—————————–— = Percentage of Completion
Total Estimated Costs
$750,000
————— = 50%
$1,500,000
b) 50% × $2,000,000 = $1,000,000
Costs incurred 750,000
Gross profit $ 250,000
c) Contract Asset/Liability 1,000,000
Revenue from Long-term Project 1,000,000
To record revenue
Construction Expense 750,000
Contract Asset/Liability 750,000
To record contract expenses
d) Current Asset
Accounts Receivable $135,000 ($1,115,000 – $980,000)
Current Liability
Contract Liability (net) $115,000 ($750,000 – $1,115,000 + $1,000,000 – $750,000)
e) Total loss reported in 2023
Contract price $2,000,000
Estimated cost to complete 2,050,000
Amount of loss to be reported $ (50,000)
Difficulty: Medium
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or As) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 6-130 Accounting for long-term construction contracts
The board of directors of Steelers Construction Corp. is meeting to choose between the completed-contract method and the percentage-of-completion method of accounting for long-term contracts in the company’s financial statements. You have been engaged to assist Steelers’ controller in the preparation of a presentation to be given at the board meeting. The controller provides you with the following information:
1. Steelers commenced doing business on January 1, 2023.
2. Construction activities for the year ended December 31, 2023, were as follows:
Total contract Billings through Cash collections
Project Price 12/31/23 through 12/31/23
A $ 615,000 $ 340,000 $ 310,000
B 450,000 135,000 135,000
C 475,000 475,000 390,000
D 600,000 240,000 160,000
E 480,000 400,000 400,000
$2,620,000 $1,590,000 $1,395,000
Contract costs Estimated
incurred through additional costs to
Project 12/31/23 complete contracts
A $ 510,000 $120,000
B 130,000 260,000
C 350,000 -0-
D 370,000 290,000
E 320,000 80,000
$1,680,000 $750,000
3. Each contract is with a different customer.
4. Any work remaining to be done on the contracts is expected to be completed in 2024.
Instructions
a) Prepare a schedule by project, calculating the amount of gross profit (or loss) for the 2023 calendar year, which would be reported under:
(1) The completed-contract method.
(2) The percentage-of-completion method (based on estimated costs).
b) Prepare the general journal entries to record revenue and gross profit on project B for 2023, assuming that the percentage-of-completion method is used.
c) Indicate the balances that would appear in the statement of financial position at December 31, 2023 for the following accounts for Project D, assuming that the percentage-of-completion method is used.
Accounts Receivable
Billings
Contract Asset/Liability
d) How would the balances in the accounts discussed in part c) change (if at all) for Project D, if the completed-contract method is used?
Solution 6-130
a) (1) and (2)
Projects A B C D E
Contract price $615,000 $450,000 $475,000 $600,000 $480,000
Contract costs incurred 510,000 130,000 350,000 370,000 320,000
Additional costs
to complete 120,000 260,000 -0- 290,000 80,000
Total cost 630,000 390,000 350,000 660,000 400,000
Total gross profit
(loss) $(15,000) $ 60,000 $125,000 $(60,000) $ 80,000
The amount reported as gross profit (loss) under the completed-contract method for 2023 is:
Project A $(15,000)
B -0-
C 125,000
D (60,000)
E -0-
$ 50,000
The amount reported as gross profit (loss) under the percentage-of-completion method for 2023is:
Project A $(15,000)
B 20,000 $60,000 × ($130,000 ÷ $390,000)
C 125,000
D (60,000)
E 64,000 $80,000 × ($320,000 ÷ $400,000)
$134,000
b) Contract Asset/Liability 150,000
Revenue from Long-term Contracts 150,000
Construction Expenses 130,000
Contract Asset/Liability 130,000
c) Billings $240,000
Cash collections 160,000
Accounts receivable $ 80,000
Costs incurred $370,000
Loss reported (60,000)
Contract Asset/Liability $310,000
d) The account balances would be the same.
Difficulty: Medium
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 6-131 Percentage-of-completion and completed-contract methods
On January 1, 2023, Falcon Construction Ltd. started a construction project for $4,500,000. Relevant data for 2023 and 2024 are as follows:
2023 2024
Current year construction costs $3,300,000 $ 620,000
Estimated remaining costs to complete 600,000 -0-
Current year billings 3,100,000 1,400,000
Current year collections 3,000,000 1,500,000
Instructions
Calculate the following amounts for each method:
Completed Percentage-of-
Contract Completion
2023 2024 2023 2024
a) Gross Profit $ $ $ $
b) Contract Asset/Liability
year-end balance $ $ $ $
c) Costs in excess of billings
(Billings in excess of costs) $ $ $ $
d) Critical thinking: Falcon Construction needs to raise equity capital and attract investors since management wants to be able to bid on larger projects but requires additional equipment and staff to do so. Investors typically look for profitability as part of their decision criteria to invest in a company. Based on this, which method would Falcon choose? Explain why.
Solution 6-131
Completed Percentage-of-
Contract Completion
2023 2024 2023 2024
a) Gross Profit -0- $580,000 $507,692 $72,308
b) Contract Asset/Liability $3,300,000 -0- $3,807,692 -0-
year-end balance
c) Costs in excess of billings $200,000 -0- $707,692 -0-
(Billings in excess of costs)
d) The completed contract method shows gross profit of $580,000, but not until 2024. The percentage-of-completion method will show gross profit of $507,692 as early as 2023, the first year of the project, with the remaining gross profit showing on the financial statements in 2024. Therefore, management should choose the percentage-of-completion method in order to demonstrate the most profit immediately independent of all other operating activities.
Calculations:
$4,500,000 – $3,300,000 – $620,000 = $580,000
$3,300,000 – $3,100,000 = $200,000
($4,500,000 – $3,300,000 – $600,000) x ($3,300,000 ÷ ($3,300,000 + $600,000)) = $507,692
$3,300,000 + $507,692 = $3,807,692
$3,807,692 – $3,100,000 = $707,692
[($4,500,000 – $3,300,000 – $620,000) x [($3,300,000 + $620,000) ÷ ($3,300,000 + $620,000)] – $507,692 = $72,308
Difficulty: Medium
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr.6-132 Percentage-of-completion and completed-contract methods
On June 15, 2023, Lion Construction signed a $360,000 contract to build a small building. Lion estimated that the total cost would be $320,000. Construction started immediately because the required completion date was August 31, 2024. Lion’s relevant data relating to this construction project were as follows:
2023 2024
Actual costs incurred $120,000 $204,000
Estimated costs to complete 200,000 -0-
Progress billings 112,000 248,000
Collections 110,000 250,000
Instructions
Calculate how much gross profit that Lion should recognize each year, assuming:
Method Used For 2023 For 2024
a) Completed contract
b) Percentage-of-completion
Solution 6-132
Method Used For 2023 For 2024
a) Completed contract -0- $ 36,000
b) Percentage-of-completion $15,000* $21,000**
*($360,000 – $320,000) x $120,000 ÷ $320,000 = $15,000
**$36,000 – $15,000 = $21,000
Difficulty: Medium
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 6-133 Completed-contract method
Broncos Construction Ltd. reported the following construction activity in 2023, their first year of operations:
Cash Costs Estimated
Total Billings collections Incurred Additional
Contract through through through Costs to
Contract Price 12/31/17 12/31/17 12/31/17 Complete
X $260,000 $170,000 $155,000 $182,000 $ 63,000
Y 325,000 130,000 130,000 100,000 247,000
Z 388,000 388,000 316,000 252,000 -0-
$973,000 $688,000 $601,000 $534,000 $310,000
Each of the above contracts is with a different customer, and any work remaining at December 31, 2023 is expected to be completed in 2024.
Instructions
Prepare a partial income statement and a partial statement of financial position to indicate how the above contract information would be reported. Broncos uses the completed-contract method.
Solution 6-133
BRONCOS CONSTRUCTION LTD.
Income Statement
For the Year Ended December 31, 2023
Revenue from long-term contracts (contract Z) $388,000
Cost of construction (contract Z) 252,000
Gross profit $136,000
Provision for loss (contract Y)* 22,000
*Contract costs through 12/31/23 $100,000
Estimated costs to complete 247,000
Total estimated costs 347,000
Total contract price 325,000
Loss recognized in 2023 $ 22,000
BRONCOS CONSTRUCTION LTD.
Statement of Financial Position
December 31, 2023
Current assets:
Accounts receivable ($688,000 – $601,000) $ 87,000
Contract Asset 12,000
Current liabilities:
Contract Liability 30,000
Estimated loss from long-term contracts 22,000
Difficulty: Medium
Learning Objective: Identify the separate performance obligations in the contract.
Section Reference: Identifying Separate Performance Obligations—Step 2
Learning Objective: Determine the transaction price.
Section Reference: Determining the Transaction Price—Step 3
Learning Objective: Allocate the transaction price to the separate performance obligations.
Section Reference: Allocating the Transaction Price to Separate Performance Obligations—Step 4
Learning Objective: Understand how to recognize revenue when the company satisfies its performance obligation.
Section Reference: Recognizing Revenue When (or As) Each Performance Obligation Is Satisfied—Step 5
Learning Objective: Analyze and determine whether a company has earned revenues under the earnings approach.
Section Reference: Earnings Approach to Revenue Recognition
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 6-134 Consignment sales
On July 2, Cardinal Corp. ships merchandise costing $460,000 on consignment to Dolphin Stores. Cardinal pays the freight of $10,000. Upon sale, Dolphin Stores will receive a 12% commission and a 6% allowance to offset its advertising expenses. At the end of the month, Dolphin notifies Cardinal that 50% of the merchandise has been sold for $560,000.
Instructions
Record the journal entries required by the two companies to account for this consignment.
Solution 6-134
Cardinal Dolphin
On shipment:
Inventory on Consignment 460,000
Inventory 460,000
Payment of freight:
Inventory on Consignment 10,000
Cash 10,000
Sales of consigned merchandise:
Cash 560,000
Accounts Payable 560,000
Notification of sales and expenses and remittance of cash:
Cash 459,200 Accounts Payable 560,000
Advertising Expense 33,600 Advertising Expense 33,600
Commission Expense 67,200 Commission Revenue 67,200
Revenue from Cash 459,200
Consignment Sales 560,000
Cost of Goods Sold 235,000
Inventory on Consignment 235,000
0.50 x ($460,000 + $10,000) = 235,000
$560,000 x 12% = $67,200
$560,000 x 6% = $33,600
$560,000 – $33,600 – $67,200 = $459,200
Difficulty: Medium
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 6-135 Consignment sales
Barik Medical Corp. sells medical equipment and supplies. For those existing clients who no longer have a use for medical equipment that they own or outgrow, Barik will take the medical equipment and sell it on their behalf. Most of this equipment requires refurbishment. The cost of the refurbishment work is deducted from the selling price (along with any advertising costs) that is paid to the client, who is effectively the consignor and Barik is the consignee. Barik’s policy is to keep 25% of the selling price.
Mr. Small brings in a wheelchair that his son has outgrown so that Barik can sell it on his behalf. Barik estimates that it can sell the wheelchair for $2,000 but it requires $300 worth of refurbishment work.
Instructions
a) Identify the transactions that have occurred and prepare any necessary journal entries for Barik Medical Corp. assuming that the equipment was sold by month end at the estimated selling price and an incurred advertising cost of $50.
b) How much cash will Mr. Small receive as the consignor?
Solution 6-135
a)
No entry for Barik Medical Corp. to receive the wheelchair
Entry for the refurbishment work
Materials Expense 300
Cash 300
Entry for the advertising cost
Advertising Expense 50
Cash 50
Entry to receive the cash from the sale
Cash 2,000
Accounts Payable 2,000
Entry to remit cash to Mr. Small
Accounts Payable 2,000
Commission Revenue 500*
Advertising Expense 50
Materials Expense 300
Cash 1,150
*500 = 2,000 x 25%
b) Mr. Small would receive $1,150 in cash, which is based on a selling price of $2,000 less the 25% commission of $500 that Barik is owed, less the refurbishment cost of $300 and the $50 advertising expense.
Difficulty: Medium
Learning Objective: Identify other revenue recognition issues.
Section Reference: Other Revenue Recognition Issues
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 6-136 Percentage-of-completion method
Coquel Company has a non-cancellable contract for $1,950,000 to construct a bridge. The contract is to start in July 2023, and the bridge is to be completed in September 2022. The following data pertain to the construction period. Assume that progress billings are non-refundable.
2023 | 2024 | 2025 | |
Costs during the year | $ 360,000 | $900,000 | $390,000 |
Estimated costs to complete | 1,260,000 | 380,000 | – |
Progress billings during the year | 305,000 | 765,000 | 880,000 |
Cash collected during the year | 280,000 | 760,000 | 910,000 |
Instructions
Assuming that Coquel Company uses the percentage-of-completion method, prepare the appropriate journal entries.
Solution 6-136
2023 | 2024 | 2025 | ||||
Contract Asset/Liability | 360,000 | 900,000 | 390,000 | |||
Materials, Payables, Cash, and so on (To record cost of construction) | 360,000 | 900,000 | 390,000 | |||
Accounts Receivable | 305,000 | 765,000 | 880,000 | |||
Contract Asset/Liability (To record progress billings) | 305,000 | 765,000 | 880,000 | |||
Cash | 280,000 | 760,000 | 910,000 | |||
Accounts Receivable (To record collections) | 280,000 | 760,000 | 910,000 | |||
Contract Asset/Liability | 433,334 | 1,064,836 | 451,830 | |||
Revenue from Long-Term Contracts (To record revenues) | 433,334 | 1,064,836 | 451,830 | |||
Construction Expense | 360,000 | 900,000 | 390,000 | |||
Contract Asset/Liability (To record construction expense) | 360,000 | 900,000 | 390,000 | |||
Difficulty: Medium
Learning Objective: Apply the percentage-of-completion method for long-term contracts.
Section Reference: Percentage-of-Completion Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 6-137 Completed-contract method and zero-profit method
Coquel Company has a non-cancellable contract for $1,950,000 to construct a bridge. The contract is to start in July 2023, and the bridge is to be completed in September 2025. The following data pertain to the construction period. Assume that progress billings are non-refundable.
2023 | 2024 | 2025 | |
Costs during the year | $360,000 | $900,000 | $390,000 |
Estimated costs to complete | 1,260,000 | 380,000 | – |
Progress billings during the year | 305,000 | 765,000 | 880,000 |
Cash collected during the year | 280,000 | 760,000 | 910,000 |
Instructions
- Assuming that Coquel Company uses the completed-contract method, prepare the appropriate journal entries.
- Assuming that Coquel Company uses the zero-profit method, prepare the appropriate journal entries to recognize revenue over the life of the contract.
Solution 6-137
2023 | 2024 | 2025 | ||||
Contract Asset/Liability | 360,000 | 900,000 | 390,000 | |||
Materials, Payables, Cash, and so on (To record cost of construction) | 360,000 | 900,000 | 390,000 | |||
Accounts Receivable | 305,000 | 765,000 | 880,000 | |||
Contract Asset/Liability (To record progress billings) | 305,000 | 765,000 | 880,000 | |||
Cash | 280,000 | 760,000 | 910,000 | |||
Accounts Receivable (To record collections) | 280,000 | 760,000 | 910,000 | |||
Contract Asset/Liability | 1,950,000 | |||||
Revenue from Long-Term Contracts (To record revenues) | 1,950,000 | |||||
Contract Expenses | 1,650,000 | |||||
Contract Asset/Liability To record contract expenses | 1,650,000 | |||||
2023 | 2024 | 2025 | ||||
Construction expense | 360,000 | 900,000 | 390,000 | |||
Contract Asset/Liability (To record construction expense) | 360,000 | 900,000 | 390,000 | |||
Contract Asset/Liability | 360,000 | 900.000 | 690,000 | |||
Revenue from Long-Term Contracts (To record revenues) | 360,000 | 900,000 | 690,000 | |||
Difficulty: Medium
Learning Objective: Apply the zero-profit method for long-term contracts.
Section Reference: Zero-profit Method
Learning Objective: Apply the completed-contract method for long-term contracts.
Section Reference: Completed-Contract Method
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
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Intermediate Accounting v1 13e | Canada | Test Bank
By Donald E. Kieso