QUESTIONS
1. Explain the current environment regarding revenue recognition.
Answer:
Most revenue transactions pose few problems for revenue recognition. This is because, in many
cases, the transaction is initiated and completed at the same time. However, due to the
complexity of some transactions, many believe the revenue recognition process is increasingly
complex to manage, more prone to error, and more material to financial statements compared to
any other area of financial reporting. In addition, even with the many standards, no
comprehensive guidance was provided for service transactions. As a result, the FASB and IASB
have indicated that the present state of reporting for revenue is unsatisfactory and the Boards
issued a standard, “Revenue from Contracts with Customers”. This new standard provides a new
approach for how and when companies should report revenue. The standard is comprehensive
and applies to all companies. As a result, comparability and consistency in reporting revenue
should be enhanced.
2. What was viewed as a major criticism of GAAP as it relates to revenue recognition?
Answer:
GAAP had numerous standards related to revenue recognition, but many believed the standards
were often inconsistent with one another.
3. Describe the revenue recognition principle.
Answer:
The revenue recognition principle indicates that revenue is recognized in the accounting period
when a performance obligation is satisfied. That is, a company recognizes revenue to depict the
transfer of goods or services to customers in an amount that reflects the consideration that it
receives, or expects to receive, in exchange for those goods or services.
4. Identify the five steps in the revenue recognition process.
Answer:
The five steps in the revenue recognition process are:
1. Identify the contract(s) 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.
5. Recognize revenue when each performance obligation is satisfied.
5. Describe the critical factor in evaluating whether a performance obligation is satisfied.
Answer:
Change in control is the deciding factor in determining when a performance obligation is satisfied.
Control is transferred when the customer has the ability to direct the use of and obtain
substantially all the remaining benefits from the asset or service. Control is also indicated if the
customer has the ability to prevent other companies from directing the use of, or receiving the
benefit, from the asset or service.
6. When is revenue recognized in the following situations?
(a) Revenue from selling products, (b) revenue from services performed, (c) revenue from permitting others to use company assets, and (d) revenue from disposing of assets other than products.
Answer:
Revenues are recognized generally as follows:
(a) Revenue from selling products—date of delivery to customers.
(b) Revenue from services performed—when the services have been performed (performance
obligation satisfied).
(c) Revenue from permitting others to use company assets—as time passes or as the assets
are used.
(d) Revenue from disposing of assets other than products—at the date of sale.
7. Explain the importance of a contract in the revenue recognition process.
Answer:
The first step in the revenue recognition process is the identification of a contract or contracts
with the customer. A contract is an agreement between two or more parties that creates
enforceable rights or obligations. That is, the contract identifies the performance obligations in a
revenue arrangement. Contracts can be written, oral, or implied from customary business
practice. In some cases, there may be multiple contracts related to the transaction, and
accounting for each contract may or may not occur, depending on the circumstances. These
situations often develop when not only a product is provided but some type of service is
performed as well.
8. On October 10, 2017, Executor Co. entered into a contract with Belisle Inc. to transfer Executor’s specialty products (sales value of $10,000, cost of $6,500) on December 15, 2017. Belisle agrees to make a payment of $5,000 upon delivery and signs a promissory note to pay the remaining balance on January 15, 2018. What entries does Executor make in 2017 on this contract? Ignore time value of money considerations.
Answer:
No entry is required on October 10, 2017, because neither party has performed on the contract.
That is, neither party has an unconditional right as of October 10, 2017. On December 15, 2017,
Executor delivers the product and therefore should recognize revenue on that date as it satisfied
its performance obligation on that date.
The journal entry to record the sales revenue and related cost of goods sold is as follows.
December 15, 2017
Notes Receivable .................................................. 5,000
Cash ...................................................................... 5,000
Sales Revenue .......................................... 10,000
Cost of Goods Sold ............................................... 6,500
Inventory ................................................... 6,500
9. What is a performance obligation? Under what conditions does a performance obligation exist?
Answer:
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. To
determine whether a performance obligation exists, the company must determine whether the
customer can benefit from the good or service on its own or together with other readily available
resources.
10. When must multiple performance obligations in a revenue arrangement be accounted for separately?
Answer:
To determine whether a performance obligation exists, the company must provide a distinct
product or service to the customer. To determine whether a company has to account for multiple
performance obligations, the company’s promise to sell the good or service to the customer must
be separately identifiable from other promises within the contract (that is, the good or service
must be distinct within the contract). In other words, the objective is to determine whether the
nature of a company’s promise is to transfer individual goods and services to the customer or to
transfer a combined item (or items) for which individual goods or services are inputs.
11. Engelhart Implements Inc. sells tractors to area farmers. The price for each tractor includes GPS positioning service for 9 months (which facilitates field settings for planting and harvesting equipment). The GPS service is regularly sold on a standalone basis by Engelhart for a monthly fee. After the 9-month period, the consumer can renew the service on a fee basis. Does Engelhart have one or multiple performance obligations? Explain.
12. What is the transaction price? What additional factors related to the transaction price must be considered in determining the transaction price?
13. What are some examples of variable consideration? What are the two approaches for estimating variable consideration?
14. Allee Corp. is evaluating a revenue arrangement to determine proper revenue recognition. The contract is for construction of 10 speedboats for a contract price of $400,000. The customer needs the boats in its showrooms by February 1, 2018, for the boat purchase season; the customer provides a bonus payment of $21,000 if all boats are delivered by the February 1 deadline. The bonus is reduced by $7,000 each week that the boats are delivered after the deadline until no bonus is paid if the boats are delivered after February 15, 2018. Allee 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. What approach should Allee use to determine the transaction price for this contract? Explain.
15. Refer to the information in Question 14. Assume that Allee has limited experience with a construction project on the same scale as the 10 speedboats. How does this affect the accounting for the variable consideration?
16. In measuring the transaction price, explain the accounting for (a) time value of money, and (b) noncash consideration.
17. What is the proper accounting for volume discounts on sales of products?
18. On what basis should the transaction price be allocated to various performance obligations? Identify the approaches for allocating the transaction price.
19. Fuhremann Co. is a full-service manufacturer of surveillance equipment. Customers can purchase any combination of equipment, installation services, and training as part of Fuhremann’s security services. Thus, each of these performance obligations are separate with individual standalone selling prices. Laplante Inc. purchased cameras, installation, and training at a total price of $80,000. Estimated standalone selling prices of the equipment, installation, and training are $90,000, $7,000, and $3,000, respectively. How should the transaction price be allocated to the equipment, installation, and training?
20. When does a company satisfy a performance obligation? Identify the indicators of satisfaction of a performance obligation.
21. Under what conditions does a company recognize revenue over a period of time?
22. How do companies recognize revenue from a performance obligation over time?
23. Explain the accounting for sales with right of return.
24. What are the reporting issues in a sale with a repurchase agreement?
25. Explain a bill-and-hold sale. When is revenue recognized in these situations?
26. Explain a principal-agent relationship and its significance to revenue recognition.
27. What is the nature of a sale on consignment?
28. What are the two types of warranties? Explain the accounting for each type.
29. Campus Cellular provides cell phones and 1 year of cell service to students for an upfront, nonrefundable fee of $300 and a usage fee of $5 per month. Students may renew the service for each year they are on campus (on average, students renew their service one time). What amount of revenue should Campus Cellular recognize in the first year of the contract?
30. Describe the conditions when contract assets and liabilities are recognized and presented in financial statements.
31. Explain the accounting for contract modifications.
32. Explain the reporting for (a) costs to fulfill a contract and (b) collectibility.
33. What qualitative and quantitative disclosures are required related to revenue recognition?
34. What are the two basic methods of accounting for longterm construction contracts? Indicate the circumstances that determine when one or the other of these methods should be used.
35. For what reasons should the percentage-of-completion method be used over the completed-contract method whenever possible?
36. What methods are used in practice to determine the extent of progress toward completion? Identify some “input measures” and some “output measures” that might be used to determine the extent of progress.
37. What are the two types of losses that can become evident in accounting for long-term contracts? What is the nature of each type of loss? How is each type accounted for?
38. Why in franchise arrangements may it be improper to recognize the entire franchise fee as revenue at the date of sale?
39. How should a franchisor account for continuing franchise fees and routine sales of equipment and supplies to franchisees?
