Schroeder Ch.5 Income, Revenue, Reporting Complete Test Bank

Chapter 5

Multiple Choice

1. One concept of income suggests that income be measured by determining the net change over time in the discounted present value of net cash flow expected to be received by the firm. Under this concept of income, which of the following, ignoring income taxes would not affect the amount of income for a period?
   1. Providing services to outsiders and investments of the funds received
   2. Production of goods or services not yet sold not yet delivered to customers or clients.
   3. Windfall gains and losses due to external causes.
   4. The method used to depreciate property, plant and equipment.
2. The term revenue recognition originally referred to
   1. The process of identifying transactions to be recorded as revenue in an accounting period.
   2. The process of measuring and relating revenue and expenses of an enterprise for an accounting period.
   3. The earning process that gives rise to revenue realization.
   4. The process of identifying those transactions that result in an inflow of assets from customers.
3. In the traditional transactions approach to income determination, income was measured by subtracting the expenses resulting from specific transactions during the period from revenues of the period also resulting from transactions. Under a strict transactions approach to income measurement, which of the following would not be considered a transaction?
   1. Sale of goods on account at 20 percent markup
   2. Exchange of inventory at a regular selling price for equipment
   3. Adjustment of inventory in lower of cost or market inventory valuations when market is below cost.
   4. Payment of salaries
4. Conventionally accountants measure income
   1. By applying a value added concept
   2. By using a transactions approach
   3. As a change in the value of owners’ equity
   4. As a change in the purchasing power of owners’ equity
5. The principal disadvantage of using the percentage of completion method of recognizing revenue from long-term contracts is that it
   1. Is unacceptable for income tax purposes
   2. May require that intraperiod tax allocation procedures be used
   3. Gives results bases upon estimates that may be subject to considerable uncertainty
   4. Is likely to assign a small amount of revenue to a period during which much revenue was actually earned
6. One of the basic features of financial accounting is the
   1. Direct measurement of economic resources and obligations and changes in them in terms of money and sociological and psychological impact
   2. Direct measurement of economic resources and obligations and changes in them in terms of money
   3. Direct measurement of economic resources and obligations and changes in them in terms of money and sociological impact
   4. Direct measurement of economic resources and obligations and changes in them in terms of money and psychological impact

7 Which of the following is an argument for using historical cost in accounting?

a. Fair values are more relevant.

b. Historical costs are based on an exchange transaction.

c. Historical costs are reliable.

d. Fair values are subjective

8. The basic accounting concept that refers to the tendency of accountants to resolve uncertainty in favor of understating assets and revenues and overstating liabilities and expenses is known as

a. the doctrine of conservatism.

b. the materiality constraint.

c. the substance over form principle.

d. the industry practices constraint.

1. Uncertainty and risks inherent in business situations should be adequately considered in financial reporting. This statement is an example of the concept of
   1. Conservatism
   2. Completeness
   3. Neutrality
   4. Representational faithfulness
2. Determining periodic earnings and financial position depends on measuring economic resources and obligations and changes in them as these changes occur. This explanation pertains to
   1. Disclosure
   2. Accrual accounting
   3. Materiality
   4. The matching concept
      • 1. Which of the following is not a concept of income identified by Bedford?
           1. Psychic
           2. Real
           3. Investment
           4. Money
        2. The definition of the economic concept of income is usually attributed to which of the following economists?
           1. J. R. Hicks
           2. Paul Samuelson
           3. Ben Bernanke
           4. Adam Smith
        3. Which of the following is not an approach to determining current value?
           1. Replacement cost
           2. Thrift value
           3. Selling price
           4. Discounting present value
        4. Each asset—inventory, plant, equipment, and so on—would be valued based on the selling price that would be realized if the firm chose to dispose of it is the definition of which of the following current value concepts?
           1. Replacement cost
           2. Entry price
           3. Exit value
           4. Discounted present value
        5. The cost to replace assets with similar assets in a similar condition is the definition of which of the following current value concepts?
           1. Replacement cost
           2. Selling price
           3. Exit value
           4. Discounted present value
        6. Income is equal to the difference between the present value of the net assets at the end of the period and their present value at the beginning of the period, excluding the effects of investments by owners and distributions to owners is the definition of which of the following current value concepts?
           1. Replacement cost
           2. Selling price
           3. Exit value
           4. Discounted present value
        7. Which of the following is not a criterion outlined in SEC Staff Accounting Bulletin No. 101 for the recognition of revenue?
           1. Persuasive evidence of an arrangement exists.
           2. Delivery has not occurred.
           3. The vendor’s fee is fixed or determinable.
           4. Collectability is probable.
        8. Which of the following accounting theorists called of conservatism the most influential principle of valuation in accounting?
           1. Henry Sweeney
           2. Robert Sprouse
           3. Robert Sterling
           4. Edgar Edwards
        9. The one-time overstatement of restructuring charges to reduce assets, which reduces future expenses, is the definition of which of the following earnings management techniques?
           1. Taking a bath
           2. Creative acquisition accounting
           3. Creasing “cookie jar” reserves
           4. Abusing the materiality concept
        10. Deliberately recording errors or ignoring mistakes in the financial statements under the assumption that their impact is not significant, is the definition of which of the following earnings management techniques?
            1. Taking a bath
            2. Creative acquisition accounting
            3. Creasing “cookie jar” reserves
            4. Abusing the materiality concept
        11. Overstating sales returns or warranty costs in good times and using these overstatements in bad times to reduce similar charges, is the definition of which of the following earnings management techniques?
            1. Taking a bath
            2. Creative acquisition accounting
            3. Creasing “cookie jar” reserves
            4. Abusing the materiality concept

22. Under FASB ASC 606, the first step in the revenue recognition process is to

a. Determine the transaction price

b. Identify the contract with customers

c. Allocate transaction price to the separate performance obligations

d. Identify the separate performance obligations in the contract

23. Under FASB ASC 606, the second step in the revenue recognition process is to

a. Allocate transaction price to the separate performance obligations

b. Determine the transaction price

c. Identify the contract with customers

d. Identify the separate performance obligations in the contract

24. Under FASB ASC 606, the third step in the revenue recognition process is to

a. Determine the transaction price

b. Identify the separate performance obligations in the contract

c. Allocate transaction price to the separate performance obligations

d. Recognize revenue when each performance obligation is satisfied

25. Under FASB ASC 606, the fourth step in the revenue recognition process is to

a. Recognize revenue when each performance obligation is satisfied

b. Identify the separate performance obligations in the contract

c. Allocate transaction price to the separate performance obligations

d. Determine the transaction price

26. Under FASB ASC 606, the last step in the revenue recognition process is to

a. Allocate transaction price to the separate performance obligations

b. Recognize revenue when each performance obligation is satisfied

c. Determine the transaction price

d. Identify the contract with customers

27. According to FASB ASC 606, a company must account for a contract modification as a new contract if the

a. Goods or services are interdependent on each other

b. Promised goods or services are distinct

c. Company has the right to receive consideration equal to standalone price

d. Goods or services are distinct and company has right to receive the standalone price

28. Under FASB ASC 606, when a contract modification does not result in a separate performance obligation, the additional products are priced at the

a. Standalone price of the product

b. Blended price of original contract and contract modification

c. Average selling price of original selling price and standalone price

d. Selling price specified in contract modification

29. According to FASB ASC 606, the transaction price

a. Excludes discounts, volume rebates, coupons and free products, or services

b. Is the amount of consideration that a company expects to receive from a customer

c. Excludes time value of money if the contract involves a significant financing component

d. Does not consider noncash consideration such as donations, gifts, equipment or labor

30. According to FASB ASC 606, a transaction price for multiple performance obligations should be allocated

a. Based on selling price from the company’s competitors

b. Based on what the company could sell the goods for on a standalone basis

c. Based on forecasted cost of satisfying performance obligation

d. Based on total transaction price less residual value

31. According to FASB ASC 606, a performance obligation exists when

a. A company receives the right to receive consideration

b. A contract is approved and signed

c. A company provides a distinct product or service

d. A company provides interdependent product or service

32. Under FASB ASC 606, when multiple performance obligations exist in a contract, they should be accounted for as a single performance obligation when

a. Each service is interdependent and interrelated

b. Both performance obligations are distinct but interdependent

c. The product is distinct within the contract

d. Determination cannot be made

33. Under the provisions of FASB ASC 606, when a customer purchases a product but is not yet ready for delivery, this is referred to as

a. A repurchase agreement

b. A consignment

c. A principal-agent relationship

d. A bill-and-hold arrangement

34. Under the provisions of FASB ASC 606 A company has satisfied its performance obligation when the

a. The company has transferred physical possession of the asset

• 1. The company has received payment for goods or services
  2. The company has significant risks and rewards of ownership
  3. The company has legal title to the asset

35. Phoenix Music Company manufactures and sells stereo systems that include an assurance-type warranty for the first 120 days. Phoenix also offers an optional extended coverage plan under which it will repair or replace any defective part for 2 years beyond the expiration of the assurance-type warranty. The total transaction price for the sale of the stereo system and the extended warranty is $2,000. The standalone price of each is $1,600 and $400, respectively. The estimated cost of the assurance-warranty is $200. The amount assigned to the assurance warranty as unearned warranty revenue should be

a. $2,000

b. $1,600

c. $400

d. $200

36. Consignments are a specialized marketing method whereby the

a. Consignee purchases goods for sale and sends payment when goods are sold

b. Consignee (agent) holds title to the product

c. Consignee pays for good up front and is paid when merchandise is sold

d. Consignee takes possession of merchandise but title remains with manufacturer

37. Business organizations have long recognized that primarily using financial measures such as sales or profitability to measure performance often fails to provide information about the factors that result in success. One of these factors is sustainability. Which of the following is not a pillar of sustainability identified in chapter 5?

a. Phycological

b. Economic

c. Social

d. Environmental

Essay

• • • 1. List three reasons why income reporting is important to our economic society.

1. As the basis of one of the principal forms of taxation.
2. In public reports as a measure of the success of a corporation’s operations.
3. As a criterion for determining the availability of dividends.
4. By rate-regulating authorities for investigating whether those rates are fair and reasonable.
5. As a guide to trustees charged with distributing income to a life tenant while preserving the principal for a remainderman.
6. As a guide to management of an enterprise in the conduct of its affairs
   • • 1. Discuss the differences between the economic and accounting concepts of income.
       2. Discuss the three basic concepts of income as defined by Bedford.
7. Psychic income. Which refers to the satisfaction of human wants.
8. Real income. Which refers to increases in economic wealth.
9. Money income. Which refers to increases in the monetary valuation of resources.
   • • 1. Explain the transaction approach to measuring income. Why is the transaction approach to income measurement preferable to other ways of measuring income?
       2. Discuss the difference between financial capital maintenance and physical capital maintenance.
       3. Define the following terms:
   1. Entry price
   2. Exit price
   3. Discounted present value
      • 1. Discuss the four types of income defined by Edwards and Bell.
        2. What conditions must be satisfied in order to recognize revenue according to Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements?
10. Persuasive evidence of an arrangement exists.
11. Delivery has occurred.
12. The vendor’s fee is fixed or determinable.
13. Collectability is probable.
    • • 1. Discuss how revenue might be recognized at various points in a company’s production - sale cycle.

When production of the company’s product carries over into two or more periods, the allocation of revenue to the various accounting periods is considered essential for proper reporting. In such cases a method of revenue recognition termed percentage of completion may be used.

When the company’s product can be sold at a determinable price on an organized market, revenue may be realized when the goods are ready for sale.

In service contracts, realization should generally be connected with the performance of services, and revenue should be recognized in relation to the degree of services performed.

In certain circumstances, where the ultimate collectability of the revenue is in doubt, recognition is delayed until cash payment is received. The installment method and the cash recovery method are examples of delaying revenue recognition until the receipt of cash. However, the APB stated that revenue recognition should not be delayed unless ultimate collectability is so seriously doubted that an appropriate allowance for the uncollectible amount cannot be estimated.

In some cases, where binding contracts do not exist or rights to cancel are in evidence, the level of uncertainty may dictate that revenue recognition be delayed until the point of ratification or the passage of time. For example, some states have passed laws that allow door-to-door sales contracts to be voided within certain periods of time. In such cases, recognition should be delayed until that period has passed.

• • • 1. Discuss the matching concept.
      2. Define the following terms:
  1. Holding gains
  2. Materiality
  3. Conservatism
     • 1. Discuss the concepts of earnings quality and earnings management including:
          1. Taking a bath
          2. Cookie jar reserves
          3. Improper revenue recognition
  4. Taking a bath
  5. Cookie jar reserves
  6. Improper revenue recognition

1. FASB ASC 606 introduces the concept of a performance obligation in recognizing revenue. Discuss:
   1. How a performance obligation is defined under FASB ASC 606?
   2. How companies determine if a performance obligation exists?
   3. A performance obligation is a promise in a contract to provide a product or service to a customer. This promise may be explicit, implicit, or possibly based on customary business practice.
   4. To determine whether a performance obligation exists, a company must determine whether the customer can benefit from the good or service on its own or together with other readily available resources.
2. List the five steps in the revenue recognition process under FASB ASC 606.
3. Norford Truck Company sells tractors to area farmers. The price of each tractor includes GPS service for 12 months The GPS service is regularly sold on a standalone basis by Norford for a monthly fee. After the 12-month period, the consumer can renew the service on a fee basis. How many performance obligations does Norford have?
4. FASB ASC 606 discusses the concept of transaction price.
   1. What is the transaction price according to FASB ASC 606?
   2. What are some additional factors related to the transaction price that must be considered in determining the transaction price?
   3. The transaction price is defined by FASB ASC 606 as the amount of consideration that a company expects to receive from a customer in exchange for transferring goods and services.
   4. Some additional factors companies must consider include: (1) Variable consideration, (2) The time value of money, (3) Noncash consideration, and (4) Consideration paid or payable to customer.
5. FASB ASC 606 discusses the concept of variable consideration.
   1. Under FASB ASC 606, what is variable consideration?
   2. What are some examples of variable consideration?
   3. What are the two approaches for estimating variable consideration?
      • • 1. Variable consideration under FASB ASC 606 occurs when the price of a good or service is dependent on future events.
          2. Variable consideration includes items such as price or volume discounts, rebates, credits, performance bonuses, or royalties. A company estimates the amount of variable consideration it will receive from the contract to determine the amount of revenue to recognize.
          3. Companies use either (1) the expected value, which is a probability weighted amount, or (2) the most likely amount in a range of possible amounts to estimate variable consideration. Companies select among these two methods based on which approach better predicts the amount of consideration to which a company is entitled. The price of a good or service that is dependent on future events includes such elements as price or volume discounts, rebates, credits, performance bonuses, or royalties. A company estimates the amount of variable consideration it will receive from the contract to determine the amount of revenue to recognize.
6. Felix Corp. is evaluating a contract to determine proper revenue recognition. The contract is for construction of 10 yachts for a total price of $10,000,000. The customer needs the boats in its showrooms by March 1, 2018, for the yacht purchase season; the customer will provide a bonus payment of $100,000 if all yachts are delivered by the March 1 deadline. The bonus is reduced by $25,000 each week that the boats are delivered after the deadline until no bonus is paid if the boats are delivered after March 22, 2018. Felix frequently includes such bonus terms in it contracts and thus has good historical data for estimating the probabilities of completion at different dates. It estimates an equal probability (25%) for each full delivery outcome. How should Felix determine the transaction price under FASB ASC 606 for this contract?
7. Felix Corp. is evaluating a contract to determine proper revenue recognition. The contract is for construction of 10 yachts for a total price of $10,000,000. The customer needs the boats in its showrooms by March 1, 2018, for the yacht purchase season; the customer will provide a bonus payment of $100,000 if all yachts are delivered by the March 1 deadline. The bonus is reduced by $25,000 each week that the boats are delivered after the deadline until no bonus is paid if the boats are delivered after March 22, 2018. Felix frequently includes such bonus terms in it contracts and thus has good historical data for estimating the probabilities of completion at different dates. It estimates an equal probability (25%) for each full delivery outcome. Assume that Felix has limited experience with a construction project on the same scale as the 10 yachts. How should Felix determine the transaction price for this contract?
8. When measuring the transaction price under the provisions of FASB ASC 606, how does a company account for
   1. The existence of a significant financing component (i.e., time value of money), and
   2. Noncash considerations.
      1. The existence of a significant financing component—A company must account for the time value of money if the contract involves a significant financing component. When a sales transaction involves a significant financing component the fair value is determined either by measuring the consideration received or by discounting the payment using an imputed interest rate. To determine whether a financing component is significant, a company considers all relevant facts and circumstances, including:
   3. The difference, if any, between the promised consideration and the cash price that would be paid if the customer had paid as the goods or services are delivered.
   4. The combined effects of the promised consideration and the cash price that would be paid if the customer had paid as the goods or services are delivered.
   5. The expected length of time between delivery of the goods or services and the receipt of payment.
   6. The prevailing market interest rates.
      1. Noncash consideration—If a company receives consideration in the form of goods, services, or other noncash consideration, the company should generally recognize revenue on the basis of the fair value of what is received. If a customer promises consideration in a form other than cash, a company should measure the noncash consideration (or promise of noncash consideration) at fair value. If a company cannot reasonably estimate the fair value of the noncash consideration, it should measure the consideration indirectly by reference to the stand‐alone selling price of the goods or services promised in exchange for the consideration.
9. Under FASB ASC 606:
   1. How is the transaction price allocated when there are various performance obligations?
   2. What approaches may be used to allocate the transaction price.
   3. If an allocation of transaction price to various performance obligations is required, the allocation is based on the amount the company could sell the good or service on a standalone basis, which is referred to as the standalone selling price. If this information is not available, companies should use their best estimate of what the good or service might sell for as a standalone unit.
   4. The three approaches for estimating standalone selling price are (1) Adjusted market assessment approach; (2) Expected cost plus a margin approach, and (3) Residual approach.
10. Under the provisions of FASB ASC 606
    1. When does a company satisfy a performance obligation?
    2. What are the indicators of the satisfaction of a performance obligation?
    3. A company satisfies its performance obligation when the customer obtains control of the good or service.
    4. Indications that the customer has obtained control are:
11. Under the provisions of FASB ASC 606, companies satisfy performance obligations either at a point in time or over a period of time. Under what conditions does a company recognize revenue over a period of time?
12. According to the provisions of FASB ASC 606 How do companies recognize revenue from a performance obligation over time?
13. Explain the accounting for sales with right of return under the provisions of FASB ASC 606.
14. FASB ASC 606 discusses bill-and-hold sales.
    1. How does FASB ASC 606 define a bill-and-hold sale?
    2. When is revenue recognized in bill-and-hold sales situation?
       • • 1. A bill-and-hold sale results when the buyer is not yet ready to take delivery but the buyer takes title and accepts billing.
           2. Revenue is recognized at the time title passes, if all of the following criteria are met and the control provisions related to revenue recognition are met:
15. FASB ASC 606 identifies two types of warranties.
    1. What are the two types of warranties?
    2. Explain the accounting for each type.
       • • 1. The two types of warranties are:

Assurance warranties. Warranties that the product meets agreed-upon specifications in the contract at the time the product is sold. This type of warranty is included in the sale price of the company’s product and is often referred to as an assurance-type warranty.

Service warranties. Warranties that provide an additional service beyond the assurance-type warranty. This warranty is not included in the sale price of the product and is referred to as a service-type warranty.

• 1. Companies do not record a separate performance obligation for assurance-type warranties. These types of warranties are nothing more than a quality guarantee that the good or service is free from defects at the point of sale. These types of obligations should be expensed in the period the goods are provided or services performed. In addition, the company should record a warranty liability. The estimated amount of the liability includes all the costs that the company will incur after sale and that are incident to the correction of defects or deficiencies required under the warranty provisions.

1. FASB ASC 606 outlines the accounting for contract modifications. Discuss accounting for contract modifications.
2. Recently a new method of reporting on corporate value, termed sustainability reporting, has been developed.
3. What are the reasons for this trend?
4. Discuss the three pillars of sustainability.
5. What are sustainability reports and how do they benefit business organizations?
6. Business organizations have long recognized that primarily using financial measures such as sales or profitability to measure performance often fails to provide information about the factors that result in success. The drivers of performance and value extended beyond financial results to non-financial issues, such as customer, supplier, and employee relationships, as well as environmental and social matters. Additionally, most financial measures are historic in nature and companies need information that pertains to future treads. In contrast, nonfinancial measures generally are future oriented and provide better indicators of future financial performance. Therefore, it is necessary for companies to identify and attempt to measure all the factors, both financial and nonfinancial, that increase a company’s value.
7. The three pillars of sustainability are environmental. social and economic. They are defined as follows:/
8. Sustainability reports contain disclosures about business organizations’ economic, environmental and social impacts that are caused by their everyday activities. A sustainability report also presents the organization's values and governance model and demonstrates the link between its strategy and its commitment to a sustainable global economy. Sustainability reports can help organizations to measure, understand and communicate their economic, environmental, social and governance performance, and then set goals, and manage change more effectively.