18 Revenue Recognition EXERCISES 18.1
EXERCISES
E18-1 (LO1) (Fundamentals of Revenue Recognition) Presented below are five different situations. Provide an answer to each of these questions.
1. The Kawaski Jeep dealership sells both new and used Jeeps. Some of the Jeeps are used for demonstration purposes; after 6 months, these Jeeps are then sold as used vehicles. Should Kawaski Jeep record these sales of used Jeeps as revenue or as a gain?
2. One of the main indicators of whether control has passed to the customer is whether revenue has been earned. Is this statement correct?
3. One of the five steps in determining whether revenue should be recognized is whether the sale has been realized. Do you agree?
4. One of the criteria that contracts must meet to apply the revenue standard is that collectibility of the sales price must be reasonably possible. Is this correct?
5. Many believe the distinction between revenue and gains is important in the financial statements. Given that both revenues and gains increase net income, why is the distinction important?
E18-2 (LO1) (Fundamentals of Revenue Recognition) Respond to the questions related to the following statements.
1. A wholly unperformed contract is one in which the company has neither transferred the promised goods or services to the customer nor received, or become entitled to receive, any consideration. Why are these contracts not recorded in the accounts?
2. Performance obligations are the unit of account for purposes of applying the revenue recognition standard and therefore determine when and how revenue is recognized. Is this statement correct?
3. Elaina Company contracts with a customer and provides the customer with an option to purchase additional goods for free or at a discount. Should Elaina Company account for this option?
4. The transaction price is generally not adjusted to reflect the customer’s credit risk, meaning the risk that the customer will not pay the amount to which the entity is entitled to under the contract. Comment on this statement.
E18-3 (LO1,2) (Existence of a Contract) On May 1, 2017, Richardson Inc. entered into a contract to deliver one of its specialty mowers to Kickapoo Landscaping Co. The contract requires Kickapoo to pay the contract price of $900 in advance on May 15, 2017. Kickapoo pays Richardson on May 15, 2017, and Richardson delivers the mower (with cost of $575) on May 31, 2017.
Instructions
(a) Prepare the journal entry on May 1, 2017, for Richardson.
(b) Prepare the journal entry on May 15, 2017, for Richardson.
(c) Prepare the journal entry on May 31, 2017, for Richardson.
E18-4 (LO2) (Determine Transaction Price) Jupiter Company sells goods to Danone Inc. by accepting a note receivable on January 2, 2017. The goods have a sales price of $610,000 (cost of $500,000). The terms are net 30. If Danone pays within 5 days, however, it receives a cash discount of $10,000. Past history indicates that the cash discount will be taken. On January 28, 2017, Danone makes payment to Jupiter for the full sales price.
Instructions
(a) Prepare the journal entry(ies) to record the sale and related cost of goods sold for Jupiter Company on January 2, 2017, and the payment on January 28, 2017. Assume that Jupiter Company records the January 2, 2017, transaction using the net method.
(b) Prepare the journal entry(ies) to record the sale and related cost of goods sold for Jupiter Company on January 2, 2017, and the payment on January 28, 2017. Assume that Jupiter Company records the January 2, 2017, transaction using the gross method.
E18-5 (LO2) (Determine Transaction Price) Jeff Heun, president of Concrete Always, agrees to construct a concrete cart path at Dakota Golf Club. Concrete Always enters into a contract with Dakota to construct the path for $200,000. In addition, as part of the contract, a performance bonus of $40,000 will be paid based on the timing of completion. The performance bonus will be paid fully if completed by the agreed-upon date. The performance bonus decreases by $10,000 per week for every week beyond the agreed-upon completion date. Jeff has been involved in a number of contracts that had performance bonuses as part of the agreement in the past. As a result, he is fairly confident that he will receive a good portion of the performance bonus. Jeff estimates, given the constraints of his schedule related to other jobs , that there is 55% probability that he will complete the project on time, a 30% probability that he will be 1 week late, and a 15% probability that he will be 2 weeks late.
Instructions
(a) Determine the transaction price that Concrete Always should compute for this agreement.
(b) Assume that Jeff Heun has reviewed his work schedule and decided that it makes sense to complete this project on time. Assuming that he now believes that the probability for completing the project on time is 90% and otherwise it will be finished 1 week late, determine the transaction price.
E18-6 (LO2) (Determine Transaction Price) Bill Amends, owner of Real Estate Inc., buys and sells commercial properties. Recently, he sold land for $3,000,000 to the Blackhawk Group, a developer that plans to build a new shopping mall. In addition to the $3,000,000 sales price, Blackhawk Group agrees to pay Real Estate Inc. 1% of the retail sales of the mall for 10 years. Blackhawk estimates that retail sales in a typical mall project is $1,000,000 a year. Given the substantial increase in online sales that are occurring in the retail market, Bill had originally indicated that he would prefer a higher price for the land instead of the 1% royalty arrangement and suggested a price of $3,250,000. However, Blackhawk would not agree to those terms.
Instructions
What is the transaction price for the land and related royalty payment that Real Estate Inc. should record?
E18-7 (LO2) (Determine Transaction Price) Blair Biotech enters into a licensing agreement with Pang Pharmaceutical for a drug under development. Blair will receive a payment of $10,000,000 if the drug receives regulatory approval. Based on prior experience in the drug-approval process, Blair determines it is 90% likely that the drug will gain approval and a 10% chance of denial.
Instructions
(a) Determine the transaction price of the arrangement for Blair Biotech.
(b) Assuming that regulatory approval was granted on December 20, 2017, and that Blair received the payment from Pang on January 15, 2018, prepare the journal entries for Blair. The license meets the criteria for point-in-time revenue recognition.
E18-8 (LO2,3) (Determine Transaction Price) Aaron’s Agency sells an insurance policy offered by Capital Insurance
Company for a commission of $100 on January 2, 2017. In addition, Aaron will receive an additional commission of $10 each year for as long as the policyholder does not cancel the policy. After selling the policy, Aaron does not have any remaining performance obligations. Based on Aaron’s significant experience with these types of policies, it estimates that policyholders on average renew the policy for 4.5 years. It has no evidence to suggest that previous policyholder behavior will change.
Instructions
(a) Determine the transaction price of the arrangement for Aaron, assuming 100 policies are sold.
(b) Determine the revenue that Aaron will recognize in 2017.
E18-9 (LO2,3) (Determine Transaction Price) Taylor Marina has 300 available slips that rent for $800 per season. Payments must be made in full by the start of the boating season, April 1, 2018. The boating season ends October 31, and the marina has a December 31 year-end. Slips for future seasons may be reserved if paid for by December 31, 2018. Under a new policy, if payment for 2019 season slips is made by December 31, 2018, a 5% discount is allowed. If payment for 2020 season slips is made by December 31, 2018, renters get a 20% discount (this promotion hopefully will provide cash flow for major dock repairs).
On December 31, 2017, all 300 slips for the 2018 season were rented at full price. On December 31, 2018, 200 slips were reserved and paid for the 2019 boating season, and 60 slips were reserved and paid for the 2020 boating season.
Instructions
(a) Prepare the appropriate journal entries for December 31, 2017, and December 31, 2018.
(b) Assume the marina operator is unsophisticated in business. Explain the managerial significance of the above accounting to this person.
E18-10 (LO2,3) (Allocate Transaction Price) Geraths Windows manufactures and sells custom storm windows for threeseason porches. Geraths also provides installation service for the windows. The installation process does not involve changes in the windows, so this service can be performed by other vendors. Geraths enters into the following contract on July 1, 2017, with a local homeowner. The customer purchases windows for a price of $2,400 and chooses Geraths to do the installation. Geraths charges the same price for the windows irrespective of whether it does the installation or not. The installation service is estimated to have a standalone selling price of $600. The customer pays Geraths $2,000 (which equals the standalone selling price of the windows, which have a cost of $1,100) upon delivery and the remaining balance upon installation of the windows. The windows are delivered on September 1, 2017, Geraths completes installation on October 15, 2017, and the customer pays the balance due. Prepare the journal entries for Geraths in 2017. (Round amounts to nearest dollar.)
E18-11 (LO2,3) (Allocate Transaction Price) Refer to the revenue arrangement in E18-10. Repeat the requirements, assuming
(a) Geraths estimates the standalone selling price of the installation based on an estimated cost of $400 plus a margin of 20% on cost, and (b) given uncertainty of finding skilled labor, Geraths is unable to develop a reliable estimate for the standalone selling price of the installation. (Round amounts to nearest dollar.)
E18-12 (LO3) (Allocate Transaction Price) Shaw Company sells goods that cost $300,000 to Ricard Company for $410,000 on January 2, 2017. The sales price includes an installation fee, which has a standalone selling price of $40,000. The standalone selling price of the goods is $370,000. The installation is considered a separate performance obligation and is expected to take 6 months to complete.
Instructions
(a) Prepare the journal entries (if any) to record the sale on January 2, 2017.
(b) Shaw prepares an income statement for the first quarter of 2017, ending on March 31, 2017 (installation was completed on June 18, 2017). How much revenue should Shaw recognize related to its sale to Ricard?
E18-13 (LO3) (Allocate Transaction Price) Crankshaft Company manufactures equipment. Crankshaft’s products range from simple automated machinery to complex systems containing numerous components. Unit selling prices range from $200,000 to $1,500,000 and are quoted inclusive of installation. The installation process does not involve changes to the features of the equipment and does not require proprietary information about the equipment in order for the installed equipment to perform to specifications. Crankshaft has the following arrangement with Winkerbean Inc.
• Winkerbean purchases equipment from Crankshaft for a price of $1,000,000 and contracts with Crankshaft to install the equipment. Crankshaft charges the same price for the equipment irrespective of whether it does the installation or not. Using market data, Crankshaft determines installation service is estimated to have a standalone selling price of $50,000. The cost of the equipment is $600,000.
• Winkerbean is obligated to pay Crankshaft the $1,000,000 upon the delivery and installation of the equipment.
Crankshaft delivers the equipment on June 1, 2017, and completes the installation of the equipment on September 30, 2017. The equipment has a useful life of 10 years. Assume that the equipment and the installation are two distinct performance obligations which should be accounted for separately.
Instructions
(a) How should the transaction price of $1,000,000 be allocated among the service obligations?
(b) Prepare the journal entries for Crankshaft for this revenue arrangement on June 1, 2017 and September 30, 2017, assuming Crankshaft receives payment when installation is completed.
E18-14 (LO3) (Allocate Transaction Price) Refer to the revenue arrangement in E18-13.
Instructions
Repeat requirements (a) and (b) assuming Crankshaft does not have market data with which to determine the standalone selling price of the installation services. As a result, an expected cost plus margin approach is used. The cost of installation is $36,000; Crankshaft prices these services with a 25% margin relative to cost.
E18-15 (LO3) (Allocate Transaction Price) Appliance Center is an experienced home appliance dealer. Appliance Center also offers a number of services for the home appliances that it sells. Assume that Appliance Center sells ovens on a standalone basis. Appliance Center also sells installation services and maintenance services for ovens. However, Appliance Center does not offer installation or maintenance services to customers who buy ovens from other vendors. Pricing for ovens is as follows.
Oven only $ 800
Oven with installation service 850
Oven with maintenance services 975
Oven with installation and maintenance services 1,000
In each instance in which maintenance services are provided, the maintenance service is separately priced within the arrangement at $175. Additionally, the incremental amount charged by Appliance Center for installation approximates the amount charged by independent third parties. Ovens are sold subject to a general right of return. If a customer purchases an oven with installation and/or maintenance services, in the event Appliance Center does not complete the service satisfactorily, the customer is only entitled to a refund of the portion of the fee that exceeds $800.
Instructions
(a) Assume that a customer purchases an oven with both installation and maintenance services for $1,000. Based on its experience, Appliance Center believes that it is probable that the installation of the equipment will be performed satisfactorily to the customer. Assume that the maintenance services are priced separately (i.e., the three components are distinct). Identify the separate performance obligations related to the Appliance Center revenue arrangement.
(b) Indicate the amount of revenue that should be allocated to the oven, the installation, and to the maintenance contract.
E18-16 (LO3) EXCEL (Sales with Returns) On March 10, 2017, Steele Company sold to Barr Hardware 200 tool sets at a price of $50 each (cost $30 per set) with terms of n/60, f.o.b. shipping point. Steele allows Barr to return any unused tool sets within 60 days of purchase. Steele estimates that (1) 10 sets will be returned, (2) the cost of recovering the products will be immaterial, and (3) the returned tools sets can be resold at a profit. On March 25, 2017, Barr returned six tool sets and received a credit to its account.
Instructions
(a) Prepare journal entries for Steele to record (1) the sale on March 10, 2017, (2) the return on March 25, 2017, and (c) any adjusting entries required on March 31, 2017 (when Steele prepares financial statements). Steele believes the original estimate of returns is correct.
(b) Indicate the income statement and balance sheet reporting by Steele at March 31, 2017, of the information related to the Barr sales transaction.
E18-17 (LO3) EXCEL (Sales with Returns) Refer to the revenue arrangement in E18-16. Assume that instead of selling the tool sets on credit, that Steele sold them for cash.
Instructions
(a) Prepare journal entries for Steele to record (1) the sale on March 10, 2017, (2) the return on March 25, 2017, and (c) any adjusting entries required on March 31, 2017 (when Steele prepares financial statements). Steele believes the original estimate of returns is correct.
(b) Indicate the income statement and balance sheet reporting by Steele at March 31, 2017, of the information related to the Barr sale.
E18-18 (LO3) EXCEL (Sales with Allowances) On October 2, 2017, Laplante Company sold $6,000 of its elite camping gear
(with a cost of $3,600) to Lynch Outfitters. As part of the sales agreement, Laplante includes a provision that if Lynch is dissatisfied with the product, Laplante will grant an allowance on the sales price or agree to take the product back (although returns are rare, given the long-term relationship between Laplante and Lynch). Lynch expects total allowances to Lynch to be $800. On October 16, 2017, Laplante grants an allowance of $400 to Lynch because the color for some of the items delivered was a bit different than what appeared in the catalog.
Instructions
(a) Prepare journal entries for Laplante to record (1) the sale on October 2, 2017, (2) the granting of the allowance on October 16, 2017, and, (c) any adjusting required on October 31, 2017 (when Laplante prepares financial statements). Laplante now estimates additional allowances of $250 will be granted to Lynch in the future.
(b) Indicate the income statement and balance sheet reporting by Laplante at October 31, 2017, of the information related to the Lynch transaction.
E18-19 (LO3) EXCEL (Sales with Returns) On June 3, 2017, Hunt Company sold to Ann Mount merchandise having a sales price of $8,000 (cost $6,000) with terms of n/60, f.o.b. shipping point. Hunt estimates that merchandise with a sales value of $800 will be returned. An invoice totaling $120 was received by Mount on June 8 from Olympic Transport Service for the freight cost.
Upon receipt of the goods, on June 8, Mount returned to Hunt $300 of merchandise containing flaws. Hunt estimates the returned items are expected to be resold at a profit. The freight on the returned merchandise was $24, paid by Hunt on June 8. On July 16, the company received a check for the balance due from Mount.
Instructions
Prepare journal entries for Hunt Company to record all the events in June and July.
E18-20 (LO3) (Sales with Returns) Organic Growth Company is presently testing a number of new agricultural seeds that it has recently harvested. To stimulate interest, it has decided to grant to five of its largest customers the unconditional right of return to these products if not fully satisfied. The right of return extends for 4 months. Organic Growth estimates returns of 20%. Organic Growth sells these seeds on account for $1,500,000 (cost $750,000) on January 2, 2017. Customers are required to pay the full amount due by March 15, 2017.
Instructions
(a) Prepare the journal entry for Organic Growth at January 2, 2017.
(b) Assume that one customer returns the seeds on March 1, 2017, due to unsatisfactory performance. Prepare the journal entry to record this transaction, assuming this customer purchased $100,000 of seeds from Organic Growth.
(c) Assume Organic Growth prepares financial statements quarterly. Prepare the necessary entries (if any) to adjust Organic Growth’s financial results for the above transactions on March 31, 2017, assuming remaining expected returns of $200,000.
