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Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th edition 6-1
Chapter 6: Revenue and Expense Recognition
Suggested Time
Case 6-1 Solar Power Inc.
6-2 Princely Entertainment Ltd.
6-3 Time-Lice Books Ltd.
6-4 Thomas Technologies Corp.
Technical Review
TR6-1 Net versus Gross…………………………….. 5
TR6-2 Prepaid Deposits and Revenue Recognition……. 5
TR6-3 Predictable Rights of Return…………………….. 5
TR6-4 Warranty – Cost deferral…………………………… 5
TR6-5 Licensing Fees……………………………….. 5
TR6-6 Output Measure……………………………… 5
TR6-7 Customer Loyalty Program Revenue Recognition 5
TR6-8 Deferred payments…………………………………. 5
TR6-9 Multiple deliverable……………………………… 5
TR6-10 Contract costs…………………………………. 5
Assignment A6-1 Revenue Recognition—Gross or Net ............... 15
A6-2 IFRS—Revenue Recognition (*W) ................. 15
A6-3 IFRS—Revenue Recognition,Four Cases ........ 20
A6-4 IFRS—Revenue Recognition, Performance Completed
10
A6-5 ASPE—Revenue Recognition, Critical Event . 15
A6-6 IFRS—Revenue Recognition ........................... 20
A6-7 ASPE - Entries for Critical Events (*W) ......... 35
A6-8 IFRS- Revenue Recognition (*W) ................... 35
A6-9 IFRS – Return Policy ....................................... 20
A6-10 ASPE – Unconditional Right of Return ........... 20
A6-11 IFRS - Licensing Fees ..................................... 20
A6-12 IFRS—Customer Loyalty Program .................. 15
A6-13 IFRS - Warranty—Two Accounting Methods . 20
A6-14 IFRS - Warranty—Two Accounting Methods . 30
A6-15 IFRS - Multiple Deliverables ........................... 10
A6-16 ASPE - Multiple Deliverables ......................... 10
A6-17 IFRS—Biological Assets and Agricultural Produce 15
A6-18 IFRS—Biological Assets and Agricultural Produce 10
A6-19 IFRS—Construction Contract .......................... 30
A6-20 IFRS—Construction Contract .......................... 25
A6-21 ASPE - Construction Contract ......................... 30
A6-22 IFRS - Asset Exchanges—Five Situations ....... 30
A6-23 ASPE - Asset Exchanges—Four Situations ..... 25
A6-24 SCF Impact (*W) ............................................. 20
A6-25 Revenue and Expense Recognition .................. 35
*W The solution to this assignment is on the text website, Connect.
This solution is marked WEB.
Cases
Case 6-1 Solar Power Inc.
Overview
SPI’s primary financial statement user is the banker who is placing reliance on the
financial statements to determine the amount of bank loans that will be extended.
Management is very motivated to have the funds of this loan be as high as possible which
may influence the selection of accounting policies. Management will want to maximize
EBITDA to ensure that the loan balance does not exceed three times the EBTDA amount.
This translates to a bias towards accounting policies which maximize the recognition of
revenue and delay/minimize expense recognition.
Issues
(1) Sharone contract - This contract is a multiple deliverable: the delivery of the panels
and installation and the 5 year maintenance contract. The $4 million contract will have
to be allocated based on the stand alone fair values of the panels and installation and the 5
year maintenance contract. The revenue related to the panels and installation will be
recognized when delivery and installation is complete. The portion of the contract related
to the 5 year maintenance contract will be deferred and recognized evenly over the 5 year
period or at intervals when the service is actually performed. In either case, the unearned
revenue will be recognized as a liability. The warranty, being an assurance warranty, will
be recognized as a provision at the time of the sale of the panels.
Allocation based on the fair values:
Standalone fair
values
$
Allocation Contract allocation
$
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Panels and
installation
3,200,000 68% 2,720,000
Maintenance
contract
$300,000 X 5
1,500,000 32% 1,280,000
$4,700,000 4,000,000
At December 31, 20X9, the amount of revenue that can be recognized is:
Sale of panels and installation $2,720,000
Maintenance Sept - Dec - 4/60 months X $1,280,000* 85,333
Total $2,805,333
*assumes maintenance is performed evenly throughout the 5 year period
This means that $594,667 ($3,400,000 - 2,805,333) of revenue will have to be reversed
and reported as unearned as at December 31, 20X9.
The warranty likely is an assurance warranty, that is, not sold separately and therefore not
another deliverable. Therefore, the warranty will be recognized using the cost deferral
method. A provision of $150,000 and related warranty costs will be recognized at the
time of delivery and installation.
The non-refundable deposit is recognized as unearned revenue until the revenue is
earned. Even though the deposit is non-refundable, this does not mean that it can be
recognized immediately. Once the delivery and installation is complete, the $3 million
(75%) will be invoiced to Sharone. Regardless of how the cash flows to the company, the
revenue is recognized based on performance completion and meeting the recognition
criteria.
Overall, EBITDA will be reduced by $594,667 for the revenue, and $150,000 for the
recognition of the warranty costs.
(2) Bakers contract - This contract appears to be a bill and hold arrangement. In order
for the revenue to be recorded prior to delivery of the panels, Baker must take title
and control of all of goods. Control of the units shifts to Baker when all of the
following conditions are met:
• The reason for the bill-and-hold arrangement is substantive i.e. the customer has
requested the arrangement. This criterion is met since it was at Baker’s request that
the inventory not be shipped.
• The buyer’s inventory is separately identified as belonging to the buyer (that is, held
apart from the seller’s other inventory). We are told that these items are in a separate
part of the warehouse.
• The inventory is ready to be delivered. This criterion is met; and
• The seller does not have the ability to use the product or sell to another customer
and then replace it. It is indicated that the panels are specific to Baker’s requirements and
so we assume that this criterion is also met. Since all of these criteria are met, SPI may
recognize the full amount of $6 million revenue on the sale of these panels in 20X9.
Since the company has only recognized $5.1 million to date, there is another $0.9 million
that can be recognized. This will increase EBITDA by the gross margin, assuming that
the company has also not recognized fully the related cost of goods sold.
(3) Mason contract – This contract has a fixed and variable component. Variable
consideration is any amount of the consideration that is not fixed and can vary based on
certain terms of the contract. In this case, the amount of the variable consideration is
based on the credit that the customer will receive on selling excess power back to the
power grid. SPI will receive 30% of the amount that Mason receives on selling excess
power. In determining the amount of consideration under the contract, the seller must
estimate the amount of the variable consideration using an expected value or more likely
amount. This amount is included in the transaction price only if it is highly probable (i.e.
likely to occur) that a significant amount will not later be reversed once the uncertainty is
resolved. So the test is to determine if the amount of variable consideration is highly
probable to be received or not. If not, then it should not be included in the price until the
amount is known with certainty.
In this case, there is no support for determining how much of the variable consideration
will be highly probable as the company has no past history with this type of contract.
Therefore, revenue from the variable consideration will be recognized as received. Since
Mason has control of the panels on installation, $55,700 (the initial $50,000 plus the
$5,700) can be recognized by December 31, 20X9.
Although SPI has estimated that $120,000 may be received, this is not the contract
amount and is certainly not highly probable. Mason is only responsible for paying the
upfront amount of $50,000 and remitting 30% of the amount that he sells back to the
grid. Therefore, SPI cannot recognize $120,000 as revenue. SPI must instead only
recognize the revenue as it is received from Mason (or receivable once the monthly
amount is known). The $120,000 should be reversed and only $55,700 recognized as
revenue to December 31, 20X9.
The other issue related to this contract is when the cost of goods sold related to this
contract should be reported. One alternative is to use the cost recovery method and report
costs equal to the amount of revenue reported each period. However, the amount of
revenue is not known at all, and so the amount of deferred gross margin is also not
known.
Since the final revenue amount is not known, the cost of goods should likely be expensed
at October, 20X9 and the variable revenue recognized as it is received.
These adjustments will result in EBITDA declining by $64,300 (120,000 - 55,700) net of
any cost of goods sold not yet recognized.
(d) To determine if this is an agency relationship a variety of factors must be assessed.
Solution does not bear any inventory risk and the 15% fee it receives is fixed. Solution
is also not responsible for shipping to the customer. It also appears that Solution
cannot change the price in any way; the price is set by SPI. However, Solution is
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responsible for collection and therefore bears credit risk. Based on this analysis, it
appears that Solution is most likely acting as an agent. This makes SPI the principal
and therefore, SPI will report revenue at gross and the related cost of goods sold and
the commission paid to Solution as expenses. The product that was given to Solutions
for demonstration should be expensed as promotional material. The cost of this
product will reduce the EBITDA if it has not already been expensed.
Case 6-2 Princely Entertainment Ltd.
Suggested solution:
1. Basis of reporting; IFRS vs ASPE
PEL has been a very small company, with three on-line games that generate
revenue through upgrades. Shareholders are the primary financial statement users
along with, likely, CRA. There is no debt financing because of the risk of the
industry. There is now a royalty to pay based on one particular revenue stream.
This is new in 20X3. With one game showing major growth, the primary
owner/manager is thinking about the prospect of being a takeover target, or a
future public offering. This is likely premature because PEL is still very small.
IFRS compliance would not likely be cost-effective at this point. ASPE should be
used as a reporting basis, to provide some structure for reporting in general, and
the royalty payment in particular.
2. Financial reporting issues
a. Revenue recognition, consumables versus durables (unearned revenue)
Revenue is recognized when performance is complete, measurement is possible,
and collection is assured. Performance would be regarded as being achieved
when all of the following criteria have been met:
Seller’s performance is complete; Seller has transferred the significant risks and
rewards of ownership to the buyer.
The amount of revenue can be measured reliably.
The benefit of the revenue will actually flow to the seller.
The seller can reliably measure all costs relating to the transaction, past and
future.
The seller retains no continuing managerial involvement or control over the goods
sold.
Collection is not an issue because of the advance payment. Advance payment
establishes the presence of an arrangement. Performance criteria must be met for
revenue to be recognized. These are contracts to provide services. The real
question is when services have been rendered/performance has been achieved and
how apportionment of delayed services rendered can be measured.
For items that are immediately consumed (e.g., rain or extra life), service is
rendered immediately and all revenue is recognized up front, on collection.
For durables (e.g., stronger engines or tires), the service might be argued to be
delivered up front, with PEL having no ongoing obligations to the customer. The
game itself is provided for free and there is no service obligation present.
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However, the alternative point of view is that the revenue from durables can only
be recognized when the durable is used over the playing life of the customer. PEL
has an ongoing obligation to keep the game operational for these customers. A
critical estimate is the playing life, which has been estimated at 5-8 months. This
is used to measure the revenue to be recognized. The average used might be
different for different games and must be substantiated. A final alternative is to
defer all revenue until the player ceases playing. This seems excessively
conservative.
If the playing life estimate is reliable, then deferred revenue recognition for
durables seems appropriate. Revenue has been re-calculated as shown in
Appendix 1. Revenue is lower than cash collected, and an unearned revenue
account of $435,000 is reflected on the balance sheet as a liability.
For DOOM, the developer who gets royalties would prefer earlier revenue
recognition (revenue when collected) to maximize his royalties. PEL might prefer
later revenue recognition to preserve cash flow. This is more than just a timing
issue: there would be unearned revenue from durables at the end of the royalty
agreement, not subject to royalties, and this is a permanent reduction in the royalty
the developer would receive.
b. Revenue recognition, virtual currency (also unearned revenue, but with a
separate analysis)
Revenue for the virtual currency could be recognized:
a. When received – (possibility for unused 10-30%)
b. When used / enters another revenue stream.
Performance criteria must be met for revenue to be recognized. Measurability is
straight-forward, and this payment establishes the presence of an arrangement.
Virtual currency is akin to a gift card that does not expire.
PEL has the obligation to keep the game ―alive‖ for a reasonable period to allow
consumers to use their virtual currency. Since PEL has the obligation to provide
services (either consumables or durables) when the virtual currency is used,
revenue should be recognized at that point, based on the revenue stream that the
virtual currency joins. (i.e., immediately on transfer for consumables, over the
average playing life for durables; consistent with the conclusions in a).
If 10-30% of the amount collected for virtual currency will never be used, it could
be recognized as revenue immediately. If the estimate is reliable, then some
revenue recognition up front seems appropriate. That is, the liability unearned
revenue might be measured at 70-90% of the gross amount.
However, the 10-30% figures are on-line industry averages, and PEL presently has
no historical information about its own experience. The virtual currency never
expires, so there is no legal cut off point. Virtual currency is new in 20X3, and a
past history of sufficient length may not be present. Without historical data, there
should be no revenue recognition for virtual currency that may not be used until
after a few years, at which point historical data would become available.
Accordingly, revenue has been re-calculated as in Appendix 1. A liability of
141,000 for unused virtual currency would be shown on the balance sheet.
Revenue is lower by this amount because PEL has not yet earned the revenue.
c. Gross versus net revenue
The question is whether revenue should be reported net, at $7 and $9.65, or gross,
at $10, with a $3 or $0.65 financing fee. The presentation will affect the perceived
size of the revenue streams, which are possibly important in looking at PEL as an
acquisition target or an IPO candidate. Separate recognition will encourage the
financial statement users to understand that financing fees are a significant
expense (Facebook© is more expensive than Paypal©). For the DOOM revenue
stream, the outcome may affect the royalty payment, because higher gross
revenues may result in higher royalties. As with the issue in a, this contract should
be re-examined with the developer for unintended consequences.
PEL appears to be the principal in these transactions as the other parties in the
channel of distribution, Facebook© and Paypal© do not take on the significant
risks and rewards of providing the service. PEL sets the price and provides the
product. Accordingly, PEL should use the gross method to report revenues. It is
not possible to quantify the impact of this recommendation, because the split of
cash flow between Paypal© and Facebook© is not known. Presentation will be
affected, but not bottom line net income except if there are changes to the royalty
payable for DOOM.
d. DOOM investment
The cost of the investment in the tangible asset – DOOM asset, and the related share
equity issued, are currently recorded at $1. This is a non-monetary transaction that
should be recorded at either fair value if there is commercial substance or at carrying
value if there is no commercial value. (Note that this is not a related party transaction
so none of the guidance for related parties is relevant.)
There is commercial substance in this transaction since the cash flows related to
shares given up would be very different from the timing, risk and amount of
cashflows related to the game received.
Under ASPE, if the non-monetary transaction has commercial substance, the
transaction is reported at the fair value of either the asset given up or the asset
received, depending on which value is more reliably measurable.
For PEL’s transaction, an equity element is given up.
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In general the Board of Directors is responsible to existing shareholders, under
legislation, for the obligation to issue common share at fair value. This prevents any
disadvantage to existing shareholders from dilution. Accordingly, valuation of issued
shares at fair value is prudent.
The recommendation is that PEL should value the acquisition at fair value.
As a result, the fair value must be established. PEL must have had some idea as to the
value of the game when it was acquired, as the basis for the number of shares being
issued. It is unlikely that the PEL shares could be valued as a reference point because
the shares are closely held by family members. However, the basis of negotiations
between PEL and the developer is the logical starting point to ascertain an estimate of
fair value.
Objective evidence to support the value of the transaction must be gathered and
assessed. The value as of the transaction date must be set, not the value of the
modified game at the end of the year. The transaction value can be informed by the
first year of revenue from the product.
Appendix 1 – Revised revenue
Prince Entertainment Limited, nine months ended September 30, 20X3
(in 000’s)
Princely Princely Princely Total
CRASH RATS DOOM
Revenue - Consumables No change $ 2,245 $ 110 $ 260 $ 2,615
Revenue - Durables 680 95 170 945
Less: adj
Unearned
revenue
315 10 110 (435)
365 85 60 510
Revenue – Virtual
currency
180 5 30 215
Less: adj
Liability for
Virtual
Currency
120 1 20 141
60 4 10 74
$3,199
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Case 6-3 Time-Lice Books Ltd.
Overview
The general objective of this case is to give students practice in applying their
professional judgment to recommend an accounting policy for revenue and expense
recognition. Students must identify the reporting objectives for the company, and must
apply qualitative criteria in deciding what the most appropriate policy is. Note that since
this company is publicly traded, IFRS is the accounting standard that must be applied.
Reporting objectives
1. Minimum disclosure and compliance with securities acts: The company is a public
company; its shares are widely traded and are listed on the Toronto Stock Exchange.
Therefore, a clean audit opinion is important. This reporting objective will cause the
adoption of accounting policies that result in accounting numbers that are reliable and
verifiable.
2. Cash flow prediction: The heirs of the founder own 30% of the common shares and
are likely to be concerned about the dividend flow. The heirs are not actively involved
in the company and retain a professional financial advisor, who may be presumed to
be sophisticated. Since 30% is no doubt the largest single block of stock, the heirs
probably have a substantial say in who is on the Board. Thus the needs of the heirs
must be given consideration in developing accounting policies.
3. Performance evaluation: Similarly, the heirs’ analyst will be evaluating the
performance of management in order to advise the heirs on how to vote their shares.
4. Income tax deferral: The company probably will be permitted to deduct expenses
when incurred and include revenues when received for income tax purposes, in view
of the nature of the operations. If tax is affected by the revenue recognition policies,
then the tax deferral objective is relevant, but probably would be a secondary
objective.
Since revenue and expense recognition is principle based and subject to a lot of
judgement under IFRS, it is critical that the primary user and objective be identified at
this point in time. Otherwise it will be difficult to provide a recommendation for the
client.
Revenue/expense recognition alternatives
Some students may try to fit the recognition of revenue into the molds of recognition at
(1) the point of production, (2) point of sale, or (3) point of cash receipt. This case does
not fit into those molds, however, since all three events are occurring simultaneously (at
different rates) through time. Some students may also concentrate exclusively on revenue
recognition and overlook the related issues of expense recognition.
Students should apply the five steps for revenue recognition under the contract based
approach.
To determine when revenue should be recognized, the five steps must be addressed for
each customer contract:
1. Identify the contract with the customer;
2. Identify separate performance obligations, if they exist.
3. Determine the overall contract price;
4. Allocate the contract price to the separate performance obligations; and
5. Determine when the performance obligation is satisfied and revenue can be recognized.
Revenue is recognized when control of the goods is transferred to the customer and the
performance obligation has been completed.
Initial promotional costs: The initial promotional expenses cannot be deferred but must
be expensed immediately. Under IFRS, in order to justify deferral treatment as ―assets‖,
measurable future benefits have to be demonstrated. This is especially true since the
promotional materials are ―internally generated‖ intangibles. For internally generated
intangible assets to be capitalized they would have to represent development costs and
meet the six criteria for capitalization. Since this is not the case, these promotional costs
must be expensed.
Advance sales – Customers paying upfront for all of the books in the series— At what
point in time is control of the books transferred to the customer? Applying the five steps
for revenue recognition, we have:
1. Identify the contract with the customer. The customer has sent back notification of
their subscription to the series, so this would represent the contract with the customer.
2. Identify separate performance obligations, if they exist. Are the goods distinct? Goods
are distinct if the customer can use each book individually and it is also sold separately.
In addition, each book has to be separately identifiable within the contract. Both of
these criteria are met, and therefore, the delivery of each book is treated as a separate
performance obligation. Note also, that the contract can be cancelled at any time by
the customer.
3. Determine the overall contract price. The contract price will be the total that is paid in
advance when customers opt for this payment choice.
4. Allocate the contract price to the separate performance obligations. The fair value of
each book in the series will be used to allocate the contract price. Each book has a
stand-alone value since books can be paid for individually as received (the alternative
payment method). These values can be used to allocate the contract price.
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5. Determine when the performance obligation is satisfied and revenue can be recognized.
Each performance obligation will be completed as each book in the series is delivered
to the customer.
Since the cancellation rate is very low, the provision for cancellations would be relatively
small but required nonetheless. The provision should be based on historical data.
So under this method, the payments received in advance will be deferred as a contract
liability. As each book is shipped, its proportion of the contract price will be recognized
as revenue, reducing the contract liability. Related costs for the book will also be
expensed at this time. To the extent that costs can be identified with a specific book
series, they should be capitalized as inventory until delivered at which time, the cost of
goods sold is recognized. Any other related costs would be capitalized as contract assets
and amortized over the period of the series.
Costs that cannot be identified with or reasonably allocated to specific series must be
treated as period costs.
Installment subscribers - Customers who pay as each book is delivered — For these types
of sales, we can again review the five steps to determine the amount and timing of the
revenue recognition.
1. Identify the contract with the customer. The customer has sent back notification of
their subscription to the series, so this would represent the contract with the customer.
2. Identify separate performance obligations, if they exist. Are these goods distinct?
Goods are distinct if the customer can use each book individually and it is also sold
separately. In addition, each book has to be separately identifiable within the contract.
Both of these criteria are met, and therefore, the delivery of each book is treated as a
separate performance obligation. Additionally, the contract can be cancelled at any
time.
3. Determine the overall contract price. In this case, the contract is paid for over time. If
the period is longer than one year, then the amount of consideration must be determined
based on the present value of the cash to be received. Any difference between this
amount and the total cash proceeds received, would be recognized as interest income as
time passed. A portion of the contract will be set up as a long-term accrued receivable
until the book is delivered and an invoice issued. Then the long-term accrual is reduced
and accounts receivable is increased.
4. Allocate the contract price to the separate performance obligations. The fair value of
each book in the series will be used to allocate the contract price. Each book has a
stand-alone value since books can be paid for individually as received (the alternative
payment method). These values can be used to allocate the contract price. In this case,
this also represents the cash that will be received since the customer only pays for each
book as it is delivered.
5. Determine when the performance obligation is satisfied and revenue can be recognized.
Each performance obligation will be completed as each book in the series is delivered
to the customer.
So here again, revenue recognition would follow delivery of the books and represent
some portion of the contract. An accrued receivable for the full discounted amount
would be reported, with an offsetting contract liability account. As the books are shipped,
an invoice is prepared, reducing the accrued receivable, and increasing accounts
receivable for the portion related to the book delivered. In addition, the contract liability
is reduced and revenue recognized for this portion of the contract related to the specific
book shipped.
Relationship to objectives
The foregoing discussion does consider the quality of the earnings information under the
various alternatives, but it does not relate directly to the financial reporting objectives that
were identified earlier. Contract compliance calls for reliable measurements, and in both
cases for the advance sales and installment sales - revenue should be recognized as
performance is completed. That is, revenue will be deferred and a percentage recognized
as each book in the series is delivered.
For both cash flow prediction and performance evaluation, early revenue recognition for
each individual series would seem to be desirable, especially for the performance
evaluation objective since management makes the important decisions at the start of each
series. However, early recognition depends on the completion of the performance, which
has not been achieved. Therefore, TLBL must recognize revenue and the related earnings
from a particular series over several accounting periods.
Spreading revenue/expense recognition over the life of the series will result in each
period's reported earnings consisting largely of earnings being realized on series (projects)
started in earlier periods. This will be advantageous to the company because spreading the
earnings of multiple on-going series over several years will help to stabilize TLBL’s
earnings and therefore the share prices.
Similarly, the overall cash flow consequences of the book series are more clearly
represented if the cash flow consequences of a series are reported together, in a single
period. However, revenue (and expense) recognition at the time of subscription does not
lead to ―high quality‖ earnings, because much of the revenue will not be received until a
later period.
In summary, it would appear that the earliest that revenue could be realized (and thereby
satisfy the cash flow prediction and the performance evaluation objectives) and still have
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sufficient reliability to satisfy the minimum disclosure objective is to recognize the
revenue as each book is shipped. This is the only method that will be in compliance with
IFRS which is a constraint for this company.
CASE 6-4 Thomas Technologies Corporation
Overview
The management of Thomas Technologies seems intent on increasing reported revenue
(and earnings) in 20X4 by devising contracts that support early recognition. The ethics of
management’s deal-making is suspect, because they seem to be engaging in deliberate
efforts to misrepresent the revenue-generating ability of the company in the short run.
Situation 1
TTC has arranged a 3-year, $6.6 million contract for engineering services that has front-
loaded payments. The company has recognized revenue based on the payment scheme,
with $3.0 million recognized in the first year alone.
There is no indication that TTC is performing almost half of the total contracted services
in the first year, 20X4. Indeed, the company doesn’t even track the costs of services
rendered under this contract, which suggests that either (1) the contract is a relatively
unimportant part of TTC’s operations or (2) management is intentionally hiding the cost
of services in order to justify a revenue recognition pattern that does not match the reality
of services being provided to Howard. The latter reason would be quite unethical.
Instead of recognizing revenue on the basis of cash payments, TTC should recognize
revenue evenly over the term of the contract, as it appears that services are likely
provided evenly over time. Should another basis be more appropriate, TTC must support
this basis to the auditors.
Because payments are made over a three-year period, the total value of the contract is the
present value of these payments. Assuming a discount rate of 6% (assumption required),
the total consideration is only:
$3 million + $2 million /1.06 + $1.6 million/1.062 = $3 million +1.9 million + $1.4
million = $6.3 million.
The total contract price of $6.3 million should be recognized at the rate of $2.1 million
per year. The total contract price should be recognized as $6.3 million and initially
recognized as a contract liability. A long term receivable is also recognized for $3.3
million ($1.9 million + $1.4 million) that is still outstanding. Each year, $2.1 million will
be recognized as revenue. In addition, interest income of $0.3 million ($3 + $2 + $1.6 -
$6.3) will be recognized in 20X5 and 20X6 using the effective interest rate method.
The company also should track the costs of service to determine profitability. Any initial
contract costs to fulfill the contract that have been incurred or to obtain the contract, and
that directly relate to the contract, can be capitalized as contract assets and amortized over
the three year term.
Situation 2
For this contract, the five steps of revenue recognition are examined.
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1. Identify the contract with the customer. TTC has entered into a signed agreement to
provide a special-purpose piece of equipment and four years of maintenance service.
2. Identify separate performance obligations, if they exist. There appear to be two
deliverables: the delivery of the equipment and the delivery of the maintenance
services over four years.
3. Determine the overall contract price. In this case, the contract price is paid over a
period of time: $2,240,000 (40% x $5,600,000) on delivery, $3,360,000 (60% x
$5,600,000) within the first 90 days, and $1,500,000 paid annually with the first
payment due within 120 days after delivery. Since these payments are received over
more than one year, the later payments need to be discounted to determine the total
contract price. The estimate of the discounted cash flows, assuming a 6% discount rate
is: 2,240,000 + 3,360,000 + 150,000 + 150,000PVIFA( 6%, 3 years)
= 2,240,000 + 3,360,000 + 1,500,000 + 4,009,520 = 11,109,520
The difference between the total payments of $11,600,000 and the present value of
$11,109,520 will represent interest earned over the term of the contract.
4. Allocate the contract price to the separate performance obligations.
TTC has entered into a contract that has two deliverables: (1) special-purpose equipment
and (2) a 4-year service contract. As per the contract, the equipment seems to be
overpriced, and the service contract appears to be underpriced. As in Situation 1, TTC
seems to be engaging in special agreements with this customer in an attempt to accelerate
revenue recognition, an unethical practice. Overpricing of the equipment is apparent not
only from the relatively lower price that might have been obtained from another
manufacturer, but also from the fact that the manufacturing cost of $3.4 million is only
about 60% of the contracted sales price—an unusually high profit margin.
Overall, the contract provides for total revenue of $11.6 million. The contract allocates
$5.6 million to the equipment and $6.0 million (over four years) to the service contract.
However, under IFRS, the contract price of a contract is allocated based on the stand
alone values of the distinct goods and services. Stand-alone values can be determined by
examining the prices set by competitors. The equipment could be obtained elsewhere for
about 20% less. Therefore, the fair value of the equipment seems to be closer to $4.5
million (that is, $5.6 million × 80%) and the fair value of the service contract is $8.0
million (i.e., $6.0 million ÷ 75%). The auditor should require TTC to reallocate the
revenue on the basis of the fair values of the two components:
Component Fair value Proportion Revenue allocation
Equipment $ 4,500,000 36% $3,999,427
Service contract ($1.5m × 4) ÷ .75 8,000,000 64% 7,110,093
Total $12,500,000 100% $11,109,520
Interest income 490,480
Total contract 11,600,000
5. Determine when the performance obligation is satisfied and revenue can be
recognized.
TTC should recognize revenue of only $3,999,427 (approximately) for the equipment at
the time of delivery (point of transfer of control), with the excess $1,600,573 ($5.6
million - $3,999,427) recorded as a contract liability. As the payments of $1.5 million are
received, the contract liability will be increased. At the same time, the service revenue
will be recognized evenly over the four-year contract period. As well, the interest income
earned will also be recognized using the effective interest rate method.
An additional consideration is that TTC is recognizing Parker’s first $1.5 million annual
payment prematurely. The contract is for the next four years, and yet the revenue was
recognized in 20X4, with an accrual for cost of services not yet rendered. Parker has not
paid the first year’s fee yet, and the indication is that they are not required to pay it within
the next year—thus TTC cannot record this amount as a receivable yet since there is no
obligation for the customer to pay.
Summary
TTC seems to be engaging in some very unethical practices in order to hype their
revenue for 20X4. It would be interesting to know if the company is in financial
difficulty, perhaps in near-violation of some restrictive covenants such as the times-
interest-earned ratio.
It is precisely to curb such revenue manipulation that accounting standard setters have
established criteria for multiple-deliverable contracts.
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Technical Review
Technical Review 6-1
Phillips Co is the principal and Crane is the agent in this relationship. Phillips will record
the gross sale of $60,000, commission expense of $9,000 and cost of goods sold of
$37,000. Crane, acting as the agent, would report on a net basis - Commission revenue of
$9,000.
Technical Review 6-2
The following are the journal entries required:
15 August:
Dr. Cash 150
Cr. Contract liability (Unearned revenue) 150
21 August
Dr. Contract liability (Unearned revenue) 50
Dr. Cash 200
Cr. Sales Revenue 250
2 September
Dr. Contract liability (Unearned revenue) 100
Dr. Cash 400
Cr. Sales Revenue 500
Technical Review 6-3
Since the returns can be estimated, Sojourn estimates revenue to be the most likely
consideration it will receive. This amount is $48,000, which represents 960 (1,000 units
× 96%) products expected to be retained by the customer, multiplied by the price of $50
per unit. At the same time, a refund liability for the products expected to be returned
will be reported at $2,000. This is based on 40 units expected to be returned (4% × 1,000
units) at a price of $50 per unit. A right to recovery asset is set up for the units at $1,400
(40 units at $35 each). This will result in a cost of goods sold equal to $33,600, which
represents 960 units at $35 each. Below, are the entries to record the sale on delivery to
the customer:
1 April :
Dr. Accounts receivable (1,000 × $50) 50,000
Cr. Revenue 48,000
Cr. Refund liability 2,000
Dr. Cost of goods sold 33,600
Dr. Right to recovery asset 1,400
Cr. Inventory (1,000 × $35) 35,000
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Technical Review 6-4
The following are the journal entries required:
26 February:
Dr. Cash 1,250
Cr. Revenue 1,250
26 February
Dr. Warranty expense 150
Cr. Provision for warranty 150
Technical Review 6-5
The license fee revenue will be all immediately recognized since there are no further
performance obligations to change the software in any way. In addition, the license is
perpetual with no finite period. The entry for this sale will be:
16 November
Dr. Accounts Receivable 50,000
Cr. Revenue - software licenses 50,000
Technical Review 6-6
Revenue for each year is calculated as follows:
20X10 : 15/50 x $40 million = $12 million
20X11: 22/50 x $40 million = $17.6 million
20X12: 13/50 x $40 million = $10.4 million
Alternatively
Revenue for each year is calculated as follows:
20X10 : 15/50 x $40 million = $12 million
20X11: Total revenue earned to date 37/50 x $40 million = $29.6 million
Revenue to recognize in 20X11: Total revenue earned to date less revenue recognized in
previous years: $29.6 million less $12 million = $17.6 million
20X12: Total revenue earned to date 50/50 x $40 million = $40 million
Revenue to recognize in 20X12: Total revenue earned to date less revenue recognized in
previous years: $40 million less $29.6 million = $10.4 million
Technical Review 6-7
The journal entry for May is:
Dr. Cash 60,000
Cr. Sales revenue 58,500
Cr. Provision for loyalty program awards 1,500
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Technical Review 6-8
With the delayed payments, the contract consideration is the present value of the future
cash flows to be received. Using 7% as the discount rate, the contract price is:
500,000 + 300,000/(1.07) + 300,000/(1.07)2
= 500,000 + 280,374 + 262,032 = 1,042,406
The table below shows how the interest is calculated for each period, using the effective
rate method.
Payment Interest at 7% Principal Balance
Aug 1 20X1 542,406
Aug 1, 20X2 300,000 37,968 262,032 280,374
Aug 1, 20X3 300,000 19,626 280,374 0
Aug 1, 20X1
Dr. Long-term Accounts receivable 542,406
Dr. Cash 500,000
Cr. Revenue 1,042,406
Aug 1, 20X2
Dr. Cash 300,000
Cr. Long-term Accounts receivable 262,032
Cr. Interest income 37,968
Aug 1, 20X3
Dr. Cash 300,000
Cr. Long-term Accounts receivable 280,374
Cr. Interest income 19,626
Technical Review 6-9
This is a multiple deliverable and therefore the contract price must be allocated based
on stand-alone fair values to the equipment and the service contract.
Stand-along fair
value
Percentage Allocation
Equipment 400,000 89% 364,900
Contract 50,000 11% 45,100
450,000 100% 410,000
June 1, 20X1
Dr. Accounts receivable 410,000
Cr. Revenue – equipment 364,900
Cr. Contract liability 45,100
Every month from June 30 to November 30 (6 months in total)
Dr. Contract liability 7,517
Cr. Revenue (44,000/36 x 6) 7,517
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Technical Review 6-10
Only directly related costs are capitalized and amortized over the term of the contract.
Travel costs and the legal costs are specific to the contract; whereas marketing and meals
are costs that would have been incurred regardless. The entry is as follows:
Dr. Marketing expenses 2,500
Dr. Meals expenses 7,000
Dr. Contract costs 15,000
Cr. Cash /Accounts payable 24,500
Assignments
Assignment 6-1
a. Gross revenue, if the company actually buys the books from the publisher and bears
the inventory risk.
Net revenue, if the publisher is sending the books on consignment with full return
privileges and the company never acquires title to the inventory. The publisher is then
bearing all of the risk.
b. Net revenue. The interior design company carries no inventory. Orders are transmitted
directly to the manufacturer, who bears all of the inventory risk.
c. Net revenue. Title remains with the producer until they are sold to the builder.
Presumably, CanLight can return the goods to the producer if they are not sold. On the
other hand, CanLight bears risk of physical loss while the goods are in its inventory.
On balance, it appears that CanLight is acting as a consignee, especially since
CanLight owes no money to the producer until cash has been collected from the
buyer. Canlight also earns a fixed fee of 30% of the sale amount.
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Assignment 6-2 (WEB)
a) Interest revenue is recognized as time passes using the effective interest rate method.
b) Interest revenue is recognized as time passes using the effective interest rate method.
c) Revenue recognition would be recognized at a single point in time when the
passenger makes the flight and transporting the passenger is completed.
d) Revenue would be recognized as soon as the service is completed; that is the
transporting of the freight is completed (delivery).
e) As the Christmas trees are biological assets, the change in the fair value of the
maturing trees will be recognized as a gain or loss each year until harvest and sale, at
which point the final gain/loss will be recognized.
f) Revenue will be recognized at a single point in time when the title to the house is
transferred to the buyer. Houses under construction are included in inventory at cost
until sold
g) Revenue is recognized over time since the government owns the land and the homes
during the contract period.. Either an output measure or an input measure is used to
measure the revenue to be recognized, without regard to when payment is received.
h) Revenue is recognized at the point when title to the land transfers to the buyer.
Due to the long-term payment contracts, the contract price represents the present
value of the future cash flows; and interest income is earned during the payment
period using the effective interest rate method. The foregoing assumes that
collection is probable given the long payment terms and the contract is valid. If
collection is considered not probable, then the contract is not valid and revenue is not
recognized until a valid contact is in place, which might be once all of the
consideration has been received.
i) Revenue is recognized over time, i.e., straight-line over 24 months. The large initial
payment will initially be accounted for as a contract liability. The 24 monthly payments
to be received over the two-year period will be discounted to determine the total contract
consideration and a long term receivable will be recognized. Interest income will be
earned over the two-year period using the effective interest rate method.
j) Revenue is earned over time since the government owns the space arm as it is being
constructed. Revenue will be measured using either input or output measure. If
costs cannot be assessed, then an output measure might be more appropriate.
k) No revenue is recorded until title of the silver is transferred to a customer. The costs
to produce the silver will be recognized as inventory until a point of sale.
Assignment 6-3 (WEB)
Case A
1. Revenue from the sale of the machine is recognized at a point of time on delivery on
5 January 20X6 when title transfers to the customer. In addition, since there is a
delayed payment, interest income will also be earned over the year to the next
payment date. The effective interest rate method is used to measure the interest
income earned.
2. 31 December 20x5:
Dr. Cash ................................................................................ 30,000
Cr. Contract liability ....................................................... 30,000
3. It is tempting to record the sale on the transaction date of 31 December but delivery
has not yet taken place and control of the equipment has not yet been transferred.
Case B
1. Recognize revenue over time since this represents revenue to be available as needed;
i.e., month by month from 1 May 20X5 to 30 Apr 20X6.
2. 17 April 20X5:
Dr. Cash ................................................................................ 30,000
Cr. Contract liability ....................................................... 30,000
3. Because the ―retainer‖ is not tied to specific services but instead represents a
readiness to serve whenever called upon to do so, revenue is recognized over the
time of the contract i.e. 12 months.
Case C
1. Revenue recognition on delivery when control of the cement transfers to the buyer.
2. 15 November 20x5
Dr. Goods receivable.................................................................... 600
Cr. Sales revenue ................................................................... 600
3. This is a non-monetary exchange of dissimilar goods and therefore is measured at the
fair value of the consideration received. Therefore, the transaction is measured at the
value of the consideration received, which is $600 (three units worth $200 each).
Case D
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1. Revenue recognition is over time - month by month - as revenue is earned by
delivery of each month’s magazine.
2. 2 August 20x5—To recognize collection of the subscription price:
Cash........................................................................................ 720
Contract liability / Unearned subscription revenue .......... 720
3. The cash was collected in advance of delivery. Revenue is recognized as earned (by
delivery), not when cash is collected. Only one magazine issue was delivered in
20x5. The entry to record revenue earned in 20X5 (not required) is:
Contract liability / Unearned subscription revenue ................ 20
Subscription revenue ........................................................ 20
$720 × 1/36 = $20
Assignment 6-4
a. This is a bill and hold transaction.
The five steps to revenue recognition:
1. Identify the contract with the customer - As noted an invoice is prepared as the
order of the windows is completed and put into the warehouse until the time of
delivery.
2. Identify separate performance obligations, if they exist - There is one performance
obligation requiring Rory to deliver the windows to its customer.
3. Determine the overall contract price - The contract price is set out in the invoice.
4. Allocate the contract price to the separate performance obligations - There is only
one performance obligation.
5. Determine when the performance obligation is satisfied and revenue can be
recognized. In this case, the customer has requested that the delivery not be made
until they are ready for the installation. This is a bill-and-hold arrangement. As
such, performance is complete when the customer controls the units. Under this
type of arrangement, the customer has control when all of the following
conditions are met:
The reason for the bill-and-hold arrangement is practical. The hold
makes sense since the builder has nowhere likely to store the windows and
to prevent theft and damage delivery is made when the windows can be
immediately installed.
The buyer’s inventory is separately identified as belongings to the buyer -
In this case, the goods are tagged and stored in the warehouse separately
from the rest of Rory’s inventory.
The inventory is ready to be delivered - Yes, the inventory is fully
completed and ready for delivery.
The seller cannot use the product or sell to another customer and then
replace it. It appears that the windows have all been cut to specific sizes
and shapes to fit the homes and likely could not be reused by other
customers.
Since all of the above conditions are met, control has been completed prior to delivery
and revenue can be recognized as the order is completed and put into the warehouse
awaiting delivery. Related costs for the windows will be expensed also at this time, for
example, cost of goods sold.
b. This is a case where the contract is long-term and it must be determined if control of
the machine is transferred over time or at a single point in time.
The five steps to revenue recognition:
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1. Identify the contract with the customer - As noted a contract is signed
outlining the standard sections to be used in building the machine and the
consideration to be paid.
2. Identify separate performance obligations, if they exist - There is one
performance obligation requiring the seller to deliver the machine to its
customer.
3. Determine the overall contract price - The contract price is set out in the
contract.
4. Allocate the contract price to the separate performance obligations - There is
only one performance obligation.
5. Determine when the performance obligation is satisfied and revenue can be
recognized. The issue here is when is control transferred to the customer?
For this we examine the following criteria:
............................ Does the customer receive and consume
benefits from the asset throughout the contract period? In this
case, the answer is ―no‖ since the customer does use the
machine until it is delivered.
............................ Does the contract improve or create an asset
controlled by the customer? No, the customer does not
control this asset until it is delivered.
............................ Can a partially completed machine be re-
sold to another customer and does the seller have the right to
payment for work completed to date? It appears that the
partially completed machine could be easily disassembled and
resold to another customer. Also, it appears that the seller
does not have the right to any payment until the machine is
delivered and inspected by the customer.
As a result, it appears that performance is not complete until delivery has
been made. So all costs would be inventoried as incurred, and once the
machine is completed and delivered (and inspected) by the customer, the
performance is complete and revenue is recognized.
c. The five steps to revenue recognition:
1. Identify the contract with the customer - As noted a contract is signed with the
customer outlining the terms and conditions.
2. Identify separate performance obligations, if they exist - There are several
performance obligations. To assess which performance obligations are distinct,
we consider if either of the following criteria are met:
A customer can use the good or service on its own or with other resources
that it can readily obtain. Evidence of this is when the good or service is
sold separately. In this case, only the ongoing service is sold separately.
Software, training and testing are sold as a package. It is likely that no
other company can provide the on-site installation, testing and training for
the software since it is all custom-designed. It is also unlikely that another
company could provide the upgrades and service for the customized
software.
The seller’s promise to deliver the goods or service is separately
identifiable. This holds true if the good or service are not higher
dependent or integrated with each other. In this case, the customer cannot
use the software until it is installed, tested and employees are trained. The
service contract would be a distinct service since the software will operate
without it.
From this analysis, it appears there are two performance obligations: (1) development of
the software along with the installation, testing and training; and (2) the upgrade and
service agreement for two years.
3. Determine the overall contract price - The contract price is set out in the contract.
4. Allocate the contract price to the separate performance obligations - There are two
performance obligations. The allocation of the total consideration is based on the
stand-alone fair values of each good and service making up each obligation. The
relative method would be used based on the stand-alone fair values of each of the
performance obligations.
5. Determine when the performance obligation is satisfied and revenue can be
recognized. For the performance obligation related to the software, installation,
testing and training, this is complete at the point that the training has been completed
which is likely the last step to be performed after the installation and testing. For the
upgrade and service revenue, this is performed over time and will be recognized
evenly over a 24 month period, starting when the training is complete. Costs
incurred for the software development, installation, testing and training would be
deferred as contract assets, until the training is complete and the revenue and related
costs then can be recognized. Payments received would be reported as contract
liability until the time that revenue could be recognized based on the above
discussion.
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Assignment 6-5
1. The revenue should be recognized as the batch of windows are delivered to the
building site. The contractor takes title at that point, which is indicated by the fact that
the contractor takes responsibility for window breakage after Luke delivers them, and
the contractor also is responsible for proper installation.
Luke is still vulnerable to some risk after delivery, including (1) potential liability for
design or manufacturing defects and (2) non-payment by the contractor. The risk of
liability for defects is a contingent liability. The risk of non-payment can usually be
estimated in advance of any financial difficulties experienced by the contractor. Even
if the contractor is unable to pay, Luke still has a lien on the property and can demand
payment (through the courts) from the house owner.
2. Although the contract may run for several years, the production process is not a long-
term contract. Percentage of completion accounting is not appropriate! As each batch
is completed and delivered, revenue is recognized along with the related costs.
The ―bid‖ costs should be expensed when incurred. Luke will win some bids and
lose others. Bidding is a routine part of the business—a selling cost.
Production costs should be accumulated in inventory. When the windows are
delivered to the building site, the inventory cost should be moved to COS and revenue
should be recognized.
Any estimated warranty costs should be established when the revenue is
recognized and set up as a provision for warranty costs, and adjusted thereafter.
Assignment 6-6
Requirement 1
The five steps to revenue recognition are outlined below.
1. Identify the contract with the customer. An agreement has been signed but only
outlines that PGIL will acquire the rights and formulas any time before December 31
20X6.
2. Identify separate performance obligations, if they exist. There is only one performance
obligation and that is the transfer of control of the formulas and rights to Scourge.
3. Determine the overall contract price. The consideration is $16 million which was
agreed to in early 20X6. However, since payments are received in five equal
installments from 20X6 to 20X10, the consideration is the present value of these
payments. In addition, depending on when revenue is actually recognized, SDC may
have an interest expense on advance payments and interest income on delayed
payments.
4. Allocate the contract price to the separate performance obligations. As outline earlier,
there is only one performance obligation.
5. Determine when the performance obligation is satisfied and revenue can be recognized.
This will occur once control of the formula and rights are transferred to PGIL. Does
this happen when the option is exercised on March 6, 20X6 or on delivery in January
20X7. Until January 20X7 there is no item that is actually functional. The formulas
are delivered in January 20X7 once they are fully completed. Prior to this date, SDC
still has the obligation to finish the formulas that can actually be used. So the
performance obligation is not completed until delivery to PGIL in January 20X7.
Requirement 2
Costs
The research costs of $3.16 million incurred in 20x4 must be charged to expense in 20x4
because there is no reason to believe in 20x4 that a commercially saleable product has
been created. Accounting standards require that research be expensed for this reason.
20x5 expenditures, which are on an established product with an obvious market, can be
capitalized as development costs. Costs will be accumulated to development costs as
follows:20X5 1,540,000 + 1,800,000 = 3,340,000
20X6 540,000
20X7 260,000
In January 20X7 when revenue is recognized, the total capitalized costs of $4,140,000
will be expensed.
Revenue
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SDC received $6,400,000 at the time of the sale and delayed payments of $2,400,000 for
the next five years. To determine the contract consideration, interest income must be
determined from the point of sale which is January 20X7 as follows:
Payment date Amount Contract
Consideration
January 2, 20X7 6,400,000 6,400,000
December 31, 20X7 2,400,000 2,400,000 / (1.06)= 2,264,151
December 31, 20X8 2,400,000 2,400,000 / (1.06)2= 2,135,991
December 31, 20X9 2,400,000 2,400,000 / (1.06)3= 2,015,086
December 31, 20X10 2,400,000 2,400,000 / (1.06)4= 1,901,025
Total 16,000,000 14,716,253
The interest income for each year is determined in the table below using the effective
interest rate:
Revenue
recognized
Payments Interest income
(expense)
(Contract
liability)/Receivable
Balance
January 1,
20X7
14,956,253 14,716,253
January 1,
20X7
6,400,000 8,316,253
December 31,
20X7
2,400,000 8,316,253 x 6% =
498,975
6,415,228
December 31,
20X8
2,400,000 6,415,228 x 6% =
384,914
4,400,142
December 31,
20X9
2,400,000 4,400,142 x 6% =
264,009
2,264,151
December 31,
20X10
2,400,000 2,264,151 x 6% =
135849
0
January 20X7
Dr. Cash ........................................................ 6,400,000
Dr. Long-term receivable .............................. 8,316,253
Cr. Revenue .............................................. 14,716,253
December 31, 20X7
Dr. Cash ........................................................ 2,400,000
Cr Interest income ................................... 498,975
Cr. Long-term receivable ....................... 1,901,025
December 31, 20X8
Dr. Cash ........................................................ 2,400,000
Cr Interest income ................................... 384,914
Cr. Long-term receivable ....................... 2,015,086
December 31, 20X9
Dr. Cash ........................................................ 2,400,000
Cr Interest income ................................... 264,009
Cr. Long-term receivable ....................... 2,135,991
December 31, 20X10
Dr. Cash ........................................................ 2,400,000
Cr Interest income ................................... 135,849
Cr. Long-term receivable ....................... 2,264,151
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th edition 6-37
Assignment 6-7 (WEB)
Requirement (b) Revenue Recognition on
Date (a)Revenue Recognition at
Delivery Cash Receipt (c) Bill and Hold
18 July Inventory 456,000 Inventory 456,000 Inventory 456,000
Cash 456,000 Cash 456,000 Cash
456,000
24 August Inventory 60,000 Inventory 60,000 Inventory 60,000
Cash 60,000 Cash 60,000 Cash
Accts Rec
COS
Sales
Inventory
712,000
516,000
60,000
712,000
516,000
10 September Accts Rec 712,000 Accts Rec 712,000
Sales 712,000 Inventory
Deferred
gross
margin
516,000
196,000
COS
Inventory
516,000
516,000
22 November Cash 712,000 Cash 712,000 Cash 712,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th edition 6-39
Accts Rec 712,000 Accts Rec
COS
Deferred gross
margin
Sales
516,000
196,000
712,000
712,000
Accts Rec 712,000
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6-40 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Requirement 2
a. Delivery is the normal revenue recognition point, based on the presumption that the
risks and rewards of ownership pass on this date and that the sales amount is realizable
b. Revenue recognition on cash receipt is appropriate when the collection is not assured
at the point of sale. In these circumstances, revenue cannot be recognized prior to
collection. In this case, the gross margin is deferred until collection is assured and then
the sale and related cost of goods sold can be recognized in net income.
c. The third situation appears to be a bill and hold.
The customer has given approval to be invoiced and accepts title to the goods. As long as
all the criteria are met for the bill and hold arrangement, revenue can be recognized prior
to delivery. The criteria for the bill and hold special treatment are:
The buyer has acknowledged the deferred delivery instructions;
Delivery is probable;
The buyer’s inventory is separately identified as belonging to the buyer (that is, held
apart from the seller’s other inventory);
The inventory is ready to be delivered; and
The customary payment terms apply to the invoice.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-41
Assignment 6-8 (WEB)
Requirement 1
The five steps for revenue recognition are:
1. Identify the contract with the customer. Dominion has a signed contract with the
customer to deliver teledine as it is mined.
2. Identify separate performance obligations, if they exist. Performance obligation is to
deliver all of the teledine produced in the year. The teledine is only produced once a
year, so delivery will take place once the material has been produced. But the customer
also has the right to return defective materials within 60 days of delivery.
3. Determine the overall contract price. The contract price if $13,500,000, as agreed.
4. Allocate the contract price to the separate performance obligations. There is only the
one performance obligation to deliver the teledine once produced.
5. Determine when the performance obligation is satisfied and revenue can be recognized.
The performance obligation is satisfied on delivery, if an estimate of returns can be
made at the point of delivery. If there is no reasonable estimate of returns that can be
made at the time of delivery, then the revenue cannot be recognized until after the
return period. Since Dominion is able to estimate potential returns at 7%, revenue can
be recognized at the point of delivery with an estimate of the returns also recognized.
Journal entries (in thousands $’s) Date
30 August Inventory 4,300
Cash, etc. 4,300
30 September Inventory 640
Cash 640
Cash
Contract Liability
1,350
1,350
15 October Accts rec
Contract Liability
12,150
1,350
Revenue 12,555
Refund Liability (7% x 13,500) 945
COGS 4,594
Right to recovery asset (7% x 4,940) 346
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6-42 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Inventory 4,940
Cash
Accounts Rec
6,750
6,750
25 October Refund Liability (5% x 13,500) 675
Accts rec 675
Loss on unsalable product (5% x
4,940)
247
Right to recovery asset 247
Refund Liability (2% x 13,500) 270
Revenue 270
COGS (2% x 4,940) 99
Right to recovery asset 99
30 November Cash 4,725
Accts Rec 4,725
Requirement 2
If the customer asked Dominion to hold 30% until they were ready for delivery, this
would qualify as a bill and hold as long as all of the following criteria were met:
As such, performance is complete when the customer controls the units. Under this type
of arrangement, the customer has control when all of the following conditions are met:
The reason for the bill-and-hold arrangement is practical. The customer
has requested the bill and hold and it likely makes since the buyer not
require all of the inventory ( which is only shipped once per year) or have
the storage space available.
The buyer’s inventory is separately identified as belongings to the buyer -
In this case, this is the only inventory that Dominion has since all of its
production is sold to this single buyer.
The inventory is ready to be delivered - Yes, the inventory is fully
completed and ready for delivery.
The seller cannot use the product or sell to another customer and then
replace it. This is true since all of the production goes to this customer
only.
Since all of the above conditions are met, control has been completed prior to delivery
and revenue can be recognized as the order is completed and put into the warehouse
awaiting delivery. As such, the journal entries would be the same as above in
Requirement 1. Revenue is recognized at the time of delivery.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-43
Assignment 6-9 - Revenue Recognition - Return policy
a. The five steps to revenue recognition:
1. Identify the contract with the customer - As noted, a contract is prepared and signed
that outlines the particulars of the sale, the return policy and the payment terms.
Carnegie ―stands ready‖ to take back up to 50% of the items within 6 months from the
date of sale.
2. Identify separate performance obligations, if they exist - There is one performance
obligation requiring Carnegie to deliver the books to its customer.
3. Determine the overall contract price - The contract price is set out in the contract at
$25,000.
4. Allocate the contract price to the separate performance obligations - There is only one
performance obligation.
5. Determine when the performance obligation is satisfied and revenue can be recognized.
- The performance obligation is complete once control of the books is transferred to the
customer. However, there is significant uncertainty about the actual number of books
that will actually remain with the customer and how many will actually be returned due
to the generous return policy. Non-profit organizations (NPOs) can over-order and
then return half of the books within 6 months. Although Carnegie may have a good
historical record of average returns, there can be substantial variation, which makes it
difficult to predict the number and type of books that will be returned, given the long
return period.
Conclusion: Record revenue on 50% of the books that cannot be returned and defer 50%
of the revenue until the return period is completed.
b. Based on revenue being recognized at the end of the return period, the following
journal entries are required:
1 June
Dr. Accounts receivable 25,000
Cr. Revenue 12,500
Cr. Refund liability 12,500
Dr. Cost of goods sold (12,500 x 65%) 8,125
Dr. Right to recovery asset (12,500 x 65%) 8,125
Cr. Inventory 16,250
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6-44 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
15 August:
Dr. Refund liability 4,000
Cr. Accounts receivable 4,000
Dr. Inventory ($4,000 x 65%) 2,600
Cr. Right to recovery asset 2,600
3 October
Dr. Refund liability 5,500
Cr. Accounts receivable 5,500
Dr. Inventory ($5,500 x 65%) 3,575
Cr. Right to recovery asset 3,575
December 1 (end of return period)
Dr. Refund liability 3,000
Cr. Revenue 3,000
Dr. Cost of goods sold ($3,000 x 65%) 1,950
Cr. Right to recovery asset 1,950
December 20
Dr. Cash 15,500
Cr. Accounts receivable 15,500
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-45
©2014 McGraw-Hill Ryerson Ltd. All rights reserved
6-46 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 6-10 (WEB)
Requirement 1
Cash....................................................................................................... 532,000
Deferred gross margin ..................................................................... 244,000
Inventory (48,000 × $6) .................................................................. 288,000
Requirement 2
Inventory (4,500 × $6) .......................................................................... 27,000
Deferred gross margin* ......................................................................... 20,000
Cash................................................................................................. 47,000
*(3,500 × $4) + (1,000 × $6)
Requirement 3
A B A-B
Month
of Sale
Units
Sold
Sales
Price
Monthly
Sales
Gross Units
ROR
Expired *
Total Units
Returned
Net Units
ROR Expired †
ROR Expired
Sales Amount §
September 10,000 $10 $100,000 4,000 2,500 1,500 $15,000
October 12,000 10 120,000 3,600 1,000 2,600 26,000
November 15,000 12 180,000 3,000 1,000 2,000 24,000
December 11,000 12 132,000 1,100 0 1,100 13,200
Totals 48,000 $532,000 11,700 4,500 7,200 $78,200
*
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
6-47
Gross number of units sold this month, times 10% times number of months since sale.
For example, at 31 December, 20x5, four months have passed since the September
sales, thus 4 × 10%, or 40% of the right of return (ROR) has expired; (40% × 10,000
units = 4,000 units).
† Equal to gross units for which ROR expired, less units returned.
§ Equal to Net units for which ROR has expired times sale price per unit for this month
sales.
Realized gross margin in 20x5 = $78,200 – (7,200 units × $6) = $78,200 – $43,200 =
$35,000
To record realized gross margin on expired and unused right of return units
shipped:
Cost of Goods Sold (7,200 × $6) ....................................................... 43,200
Deferred gross margin ....................................................................... 35,000
Sales .............................................................................................. 78,200
Requirement 4
Month
of Sale
Units Available
for Return or
Sale**
Units
Returned
Units Sold
in 20x6 ††
Unit Sale
Price
Sales
Amount
September 6,000 1,000 5,000 $10 $ 50,000
October 8,400 2,000 6,400 10 64,000
November 12,000 2,500 9,500 12 114,000
December 9,900 4,000 5,900 12 70,800
9,500 26,800 $298,800
× $6 × $6
Cost of returns $57,000
Costs of units sold $160,800
** Equal to total sold for this month, less those returned or recorded as sold in 20x5 (see
Requirement 3). (Example: For September: units sold of 10,000 less gross units
right-of-return expired is 4,000. Therefore, units available for return or sale is
6,000.
†† Equal to Units available (column 2) less units returned.
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6-48 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Entry to record returns in 20x6:
Inventory (9,500 units × $6) ......................................................... 57,000
Deferred gross margin .................................................................. 51,000
Cash .......................................................................................... 108,000*
*Refund amount on returned units:
(1,000 units × $10) + (2,000 units x $10) + ($2,500 units × $12) + (4,000 units ×
$12) = $108,000
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-49
Entry to record realized gross margin in 20x6 related to 20x5 sales:
Cost of goods sold ..................................................................... 160,800
Deferred gross margin ............................................................... 138,000
Sales ...................................................................................... 298,800
Reconciliation:
Total units sold in period September–December ....................... 48,000
Total dollar sales amount for period September–December ..... $532,000
Cost of units sold in period September–December ................... 288,000
Total gross margin ..................................................................... $244,000
Units: 20x5 20x6 Total
Returned .................................................. 4,500 9,500 14,000
Not returned (sold) .................................. 7,200 26,800 34,000
Totals ........................................................... 11,700 36,300 48,000
Gross Sales:
Returned .................................................. $ 47,000 $108,000 $155,000
Not returned ............................................ 78,200 298,800 377,000
Totals ........................................................... $125,200 $406,800 $532,000
Cost of sales:
Returned .................................................. $ 27,000 $ 57,000 $ 84,000
Not returned (sold) .................................. 43,200 160,800 204,000
Totals ........................................................... $ 70,200 $217,800 $288,000
Gross margin:
Returned (not realized)............................ $ 20,000 $ 51,000 $ 71,000
Not returned (sold) .................................. 35,000 138,000 173,000
Totals ........................................................... $ 55,000 $189,000 $244,000
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6-50 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 6-11
Requirement 1
The initial $1,000 amount is to cover the assessment of the franchisee and is separate
revenue from the franchise fee. This will be recognized at the end of the assessment
period, which is usually four days after receipt of the cash.
For the franchise fee, the franchise arrangement allows the franchisee to use the GRI’s
trademark for a period of three years. At the end of the initial contract period, the
contract can be extended for an additional two years with an additional payment. This is
a licensing arrangement allowing the franchisee to use the trademark. License
agreements can be designed to either transfer a right to use the license or a promise to
provide access to the seller’s intellectual property for a period of time. Based on the
contract terms which limits the franchisees use to three years, this franchise fee revenue is
recognized over the three-year period. It is a right of access the trademark. During these
three years, GRI will undertake activities that will change the trademark value itself,
thereby impacting the value to the franchisee.
Although there are delayed payments, all of the $150,000 is received within the year, and
so no discounting is required.
Requirement 2
Date of signing
contract
Number of
licenses sold
Months
expired to Dec
31 20X4
(1)
Monthly fees
earned
(2)
$
Revenue
earned in
20X4
(1) X (2)
$
April 3 April - Dec - 9 $150,000 X 3 /
36 = 12,500
9 X 12,500 =
112,500
July 7 6 $150,000 X 7 /
36 = 29,167
175,002
October 5 3 $150,000 X 5 /
36 = 20,833
62,499
November 4 2 $150,000 X 4 /
36 = 16,667
33,334
Total 19 $383,335
Because the one contract in July was revoked, only 7 license agreements were completed.
Journal entries
For 20X4
The problem should read that the $1,000 upfront fee is not part of the $150,000 fee.
Cash (20 x $1,000) ................................................................. 20,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-51
Revenue – Assessment fees ........................................................ 20,000
Accounts receivable (20 X 150,000) ................................. 3,000,000
Contract liability ......................................................................... 3,000,000
To record sales of licenses.
Cash ............................................................................... 2,700,000
Accounts Receivable ................................................................... 2,700,000
To record receipt of cash during the year.
Contract liability .................................................................. 150,000
Cash (100,000 - 7,500) ................................................................ 92,500
Revenue - other (revoked contract) (150,000 x 5%) Note 1 ....... 7,500
Accounts receivable .................................................................... 50,000
To record the revoked contract and the return of cash.
Contract liability .................................................................. 383,335
Revenue - license fees ................................................................. 383,335
To record sales for the year.
Requirement 3
The balances on SFP:
Accounts receivable ........................................................... $250,000
$3,000,000 – 2,700,000 - 50,000 = $250,000
Contract liability (3,000,000 - 150,000 - 383,335) 2,466,665
Note 1 - The $150,000 relates to the July 20X4 license that was revoked.
The amount on the SCI
Revenue - franchise fees ..................................................... 383,335
Revenue - other ........................................................................ 7,500
Revenue – assessment fees .................................................... 20,000
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6-52 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 6-12 (WEB)
$
% allocation Allocation
$
Goods sold 1,725,000 98.32% 1,696,020
Points sold
(1,725,000 x $0.017)
29,325 1.68% 28,980
Total 1,754,325 100% 1,725,000
Journal entries required for March, 20X4
Dr. Cash 1,725,000
Cr. Sales 1,696,020
Cr. Provision for loyalty program awards 28,980
To record the sales for the month.
Dr. Provision for loyalty program awards 20,400
Cr. Sales 20,400
To record points redeemed for sales during March 20X4.
(1,200,000 x $0.017)
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-53
Assignment 6-13 (WEB)
Requirement 1 — Cost Deferral Method
30 April 20X2:
Accounts receivable 600,000
Revenue 600,000
To record the sale
Note: The product cost should also be removed from inventory with a debit to cost of
goods sold and a credit to inventory. This information has not been provided.
Warranty expense 50,000
Provision for warranty 50,000
To set up the estimated warranty provision
1 May through 31 December 20X2:
Provision for warranty 20,000
Cash, A/P, etc. 20,000
To record costs incurred
31 December 20X2:
Provision for warranty 17,000 Warranty expense 17,000
To reduce warranty provision to new estimate.
1 January through 30 April 20X3:
Provision for warranty 11,000 Cash, A/P, etc. 11,000
To record costs incurred
30 April 20X3:
Provision for warranty 2,000 Warranty expense 2,000
To close out unused warranty provision
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
6-54 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Requirement 2 — Revenue Deferral Method
This contract now has multiple performance obligations and so the contract consideration
has to be allocated between the product and the warranty. The consideration is allocated
based on relative stand-alone values as follows:
Stand-alone values Percentage Allocation
Product 580,000 88.5% 531,000
Warranty 75,000 11.5% 69,000
655,000 $600,000
30 April 20X2:
Accounts receivable 600,000
Sales revenue 531,000
Contract liability - warranty 69,000
To record the sale, with deferral for warranty
Note: The product cost should also be removed from inventory with a debit to cost of
goods sold and a credit to inventory. This information has not been provided.
1 May through 31 December 20X2:
Warranty expense 20,000
Cash, A/P, etc. 20,000
To record costs incurred
Contract liability - warranty 46,000
Sales revenue 46,000
To amortize 8/12 of deferred revenue (May 1 to December 31, 20X2).
1 January through 30 April 20X3:
Warranty expense 11,000 Cash, A/P, etc. 11,000
To record costs incurred
Contract liability - warranty 23,000
Sales revenue 23,000
To amortize 4/12 of deferred revenue (Jan 1 to April 31, 20X3)
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-55
Assignment 6-14
Requirement 1 — Cost Deferral Method
30 September 20X1:
Accounts receivable 2,000,000
Revenue 2,000,000
To record the sale
Cost of goods sold 1,400,000
Inventory 1,400,000
To record the cost of goods sold related to the sale.
Warranty expense 100,000
Provision for warranty 100,000
To set up the estimated warranty provision
1 October through 31 December 20X1:
Provision for warranty 25,000
Cash, A/P, etc. 25,000
To record costs incurred
31 December 20X1:
Warranty expense 30,000 Provision for warranty 30,000
To increase warranty provision to new estimate.
1 January through 31 December 20X2:
Provision for warranty 40,000 Cash, A/P, etc. 40,000
To record costs incurred
31 December 20X2:
Provision for warranty 45,000 Warranty expense 45,000
To reduce warranty provision to $20,000
1 January through 30 September 20X3:
Provision for warranty 15,000 Cash, A/P, etc. 15,000
To record costs incurred
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
6-56 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
30 September 20X3:
Provision for warranty 5,000 Warranty expense 5,000
To close out warranty provision
Requirement 2 — Revenue Deferral Method
This contract now has multiple performance obligations and so the contract consideration
has to be allocated between the product and the warranty. The consideration is allocated
based on relative stand-alone values as follows:
Stand-alone values Percentage Allocation
Machine 1,900,000 92.7% 1,854,000
Warranty 150,000 7.3% 146,000
2,050,000 $2,000,000
30 September 20X1:
Accounts receivable 2,000,000
Revenue - Machine 1,854,000
Unearned revenue - warranty 146,000
To record the sale, with deferral for warranty
Cost of goods sold 1,400,000
Inventory 1,400,000
To record the cost of goods sold related to the sale.
1 October through 31 December 20X1:
Warranty expense 25,000
Cash, A/P, etc. 25,000
To record costs incurred
31 December 20X1:
Unearned revenue - warranty 18,250
Revenue - warranty 18,250
To amortize 3/24 of deferred revenue
1 January through 31 December 20X2:
Warranty expense 40,000 Cash, A/P, etc. 40,000
To record costs incurred
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-57
31 December 20X2:
Unearned revenue - warranty 73,000
Revenue - warranty 73,000
To amortize 12/24 of deferred revenue
1 January through 30 September 20X3:
Warranty expense 15,000 Cash, A/P, etc. 15,000
To record costs incurred
30 September 20X3:
Unearned revenue - warranty 54,750
Revenue - warranty 54,750
To amortize 9/24 of deferred revenue
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6-58 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 6-15 (WEB)
This $180,000 sale has two deliverables:
fork lift truck, sales price $140,000
3-year service contract, value $60,000
Requirement 1 — Relative Stand-alone Value Method:
The revenue must be divided into two components on the basis of stand-alone values of
each component:
Component
stand-
alone
value
Proportion Revenue
allocation
Fork-lift truck $140,000 70% $126,000
Service contract 60,000 30% 54,000
Total $200,000 100% $180,000
Journal entry:
Accounts receivable ................................................................ 180,000
Revenue – equipment sales ............................................... 126,000
Unearned revenue – service contract ................................ 54,000
Requirement 2 — Residual Value Method:
The residual value method can only be used if either one of the following conditions
exist:
a. The entity sells the same good or service to different customers for a wide
range of different selling prices; or
b. A price for the good or service has not yet been stablished and has not
been previously sold on a stand-alone basis.
In this case, the first criterion is met since the BigBoy sells the service contract for a range
of values. So the residual value method can be used.
The revenue is assigned first to the fork-lift truck, which has a known sales price of
$140,000. The residual revenue is assigned to the service contract and deferred:
Journal entry:
Accounts receivable ................................................................ 180,000
Revenue – equipment sales ............................................... 140,000
Deferred revenue – service contract ................................. 40,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-59
Assignment 6-16
New subscribers are being given a new cell phone at a ―special‖ low price for the monthly
telephone service. In return, however, they will pay a higher monthly fee. In total, new
subscribers pay $3,700 for product and services:
a mobile phone costing $100; and
36 months of service worth $100 per month, a total of $3,600
Regular subscribers pay $3,160 for the same services:
a mobile phone costing $1,000
36 months of service worth $60 per month, a total of $2,160
Revenue recognition will differ depending on which allocation method is used.
Stand-Alone Value Method
The $3,700 would be allocated proportionately to the two components:
cell phone: $3,700 × ($1,000 ÷ $3,160) = $3,700 × 31.65% = $1,171
service contract: $3,700 × ($2,160 ÷ $3,160) = $3,700 × 68.35% = $2,529
$1,171 revenue from the cell phone would be recognized immediately. Since only $100 is
received up-front from a new subscriber, an asset of ―contract asset‖ or ―accrued revenue‖
of $1,071 should be recognized. The $1,071 will then be offset against the monthly $100
service payments over 36 months at $29.75 per month, thereby reducing monthly service
revenue to $70.25 per month, higher than the normal charge to regular subscribers. In
substance, the phone is being sold at a price 17% higher than normal. The higher price
might be due to expected defaults (and non-recovery of the phones).
Residual Value Method
In this method, the normal price of the phone, $1,000, would be recognized at the
inception of the contract, offset by $100 cash received and $900 ―contract asset‖ or
―accrued revenue‖. The remaining $2,700 (i.e. $3,700 - $1,000) would be recognized
monthly over 36 months, at $75 per month (that is, $2,700 ÷ 36).
Discussion
The company’s motivation probably is to attract new subscribers by offering the
―bargain‖ price of $100 for an expensive phone. Nevertheless, since the bargain price is
linked to a 36-month contract, the company will recover all of the value of the phone.
Either allocation method will, in this example, recognize revenue recognition that is more
realistic of the value of what the company is delivering. Nevertheless, since fair values
are available for both components of the deal, the market value method is preferrable.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
6-60 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Journal entries (not required) for initial transaction and first subsequent payment:
Stand-alone value method:
Initial transaction:
Cash 100
Unbilled revenue 1,071
Sales revenue 1,171
First monthly payment:
Cash 100.00
Service contract revenue 70.25
Unbilled revenue (1,071 ÷ 36) 29.75
Residual value method:
Initial transaction:
Cash 100
Unbilled revenue 900
Sales revenue 1,000
First monthly payment:
Cash 100
Service contract revenue 75
Unbilled revenue (900 ÷ 36) 25
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-61
Assignment 6-17 Requirement 1
Journal entries for 20X3
Dr. Agricultural produce - logs 600,000 x 95% 570,000
Cr. Biological assets - timber 570,000
To record the timber harvested into logs
Dr. Inventory - lumber (570,000 x 80%) 456,000
Cr. Agricultural produce 456,000
To record the transfer of the logs into the production of lumber.
Dr. Inventory - lumber 175,000
Cr. Cash or Accounts payable 175,000
To record production costs
Dr. Cost of goods sold (456,000 + 175,000) x 60% 378,600
Cr. Inventory - lumber 378,600
To record lumber sold during the year.
Dr. Biological asset - timber 997,500
Cr. Change in value of biological asset 997,500 To adjust the timber to fair value less costs to sell at year end.
9,350,000(.95) - (8,900,000 (.95) - 570,000) = 8,882,500 - 7,885,000
Requirement 2
Balances on SFP
Inventory - lumber (456,000+175,000 - 378,600) 252,400
(net realizable value 310,000 x 93% = 288,300)
Agricultural produce (570,000-456,000) 114,000
(net realizable value 125,000 x 95% = 118,750)
Biological asset - timber (9,350,000 x 95%) 8,882,500
Balances on SCI
Cost of goods sold (378,600)
Change in fair value of biological asset 997,500
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
6-62 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 6-18
Requirement 1— Items qualifying for carrying at fair value less costs to sell
Biological asset Agricultural produce Inventory
Sheep Wool Yarn
Trees Logs Lumber
Chicken Eggs Frozen omelets
Requirement 2 — General discussion
Biological assets are recorded at fair value less selling costs at each reporting period, with
changes being recognized in current income.
Agricultural produce - is recorded at fair value less costs to sell at the time of harvest.
The rules of lower of cost or net realizable value are applied after the point of harvest.
Inventory - is recorded at cost - ( lower of cost and net realizable value).
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-63
Assignment 6-19 (WEB)
Requirement 1
Year
Costs
incurred
Costs
incurred to
date
%
Complete
Revenue
to date2
Revenue for
current
year3
Gross
profit4
20X5 $ 2,700,000 $ 2,700,000 30.51%1
$ 3,340,845 $ 3,340,845 $ 640,845
20X6 4,500,000 7,200,000 81.36%1
8,908,920 5,568,075 1,068,075
20X7 1,800,000 9,000,000 100.00% 10,950,000 2,041,080 241,080
$ 9,000,000 $10,950,000 $ 1,950,000
1 Costs incurred to date total estimated cost of $8,850,000
2 Contract revenue of $10,950,000 percentage of completion
3 Total revenue to date – previous year’s revenue to date
4 Revenue for current year – costs incurred during current year
Requirement 2
20X5 20X6 20X7
To record costs of
construction:
Contract costs 2,700,000 4,500,000 1,800,000
Cash, payables,
etc.
2,700,000 4,500,000 1,800,000
To record progress
billings:
Accounts receivable 2,300,000 4,900,000 3,750,000
Contract liability 2,300,000 4,900,000 3,750,000
To record cash
received:
To recognize
revenue for
performance
completed to date :
Contract asset 1,040,845 668,075 1,708,920
Contract liability 2,300,000 4,900,000 3,750,000
Revenue—long-
term contracts
3,340,845 5,568,075 2,041,080
To recognize costs
related to revenue
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6-64 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
recognized to date
Construction costs 2,700,000 4,500,000 1,800,000
Contract costs 2,700,000 4,500,000 1,800,000
Requirement 3
If the customer does not take title until the building is constructed, then revenue is not
recognized until the building is completed in 20X7. Costs are accumulated in inventory
until the building is completed and sold.
20X5 20X6 20X7
To record costs of
construction:
Construction-in-
progress inventory
2,700,000 4,500,000 1,800,000
Cash, payables,
etc.
2,700,000 4,500,000 1,800,000
To record progress
billings:
Accounts receivable 2,300,000 4,900,000 3,750,000
Contract liability 2,300,000 4,900,000 3,750,000
To record cash
received:
To recognize
revenue for
performance
completed to date :
Contract liability 10,950,000
Revenue—long-
term contracts
10,950,000
To recognize costs
related to revenue
recognized to date
Construction costs 9,000,000
Construction-in-
progress
inventory
9,000,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-65
Assignment 6-20 (EXCEL) (WEB)
Requirement 1
20x5 20x6 20x7 1. Costs of construction:
Contract costs ....................................... 180,000 450,000 195,000
Cash, payables, etc. ......................... 180,000 450,000 195,000
2. Progress billings:
Accounts receivable .............................. 153,000 382,500 439,500
Contract liability ............................. 153,000 382,500 439,500
3. Collections on billings:
Cash ..................................................... 140,000 380,000 455,000
Accounts receivable ........................ 140,000 380,000 455,000
4. Recognition of income:
Contract asset ....................................... 63,667 149,918 213,585
Contract liability ................................... 153,000 382,500 439,500
Revenue - Construction ............... 216,667 532,418 225,915
Construction costs ................................ 180,000 450,000 195,000
Contract costs .................................. 180,000 450,000 195,000
Computations: 20x5 20x6 20x7
Contract price ................................................... $975,000 $975,000 $975,000
Actual costs to date .......................................... 180,000 630,000 825,000
Estimated costs to complete ............................. 630,000 190,000
Total estimated costs ........................................ 810,000 820,000 825,000
Estimated total contract income ....................... $165,000 $155,000 $150,000
% complete ....................................................... 22.22 76.83 100
Apportionment:
20x5: ($180,000 $810,000) × $975,000 = $216,667.
20x6: [($630,000 $820,000) × $975,000] – $216,667 = $532,418.
20x7: $975,000 – $216,667 – $532,418 = $225,915.
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6-66 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Requirement 2
20x5 20x6 20x7
Statement of Financial Position:
Current assets:
Accounts receivable ...................................... $ 13,000 $ 15,500 $ 0
Contract asset ................................................ 63,667 213,585 0
Income statement:
Income on construction (net) ........................... $ 36,667 $ 82,418 $30,915
Check: $36,667 + $82,418 + $30,915 = $150,000 which is the profit from the contract
($975,000 - $825,000)
Requirement 3
20x5 20x6 20x7 1. Costs of construction:
Construction-in-progress
inventory ............................................. 180,000 450,000 195,000
Cash, payables, etc. ......................... 180,000 450,000 195,000
2. Progress billings:
Accounts receivable .............................. 153,000 382,500 439,500
Contract liability ............................. 153,000 382,500 439,500
3. Collections on billings:
Cash ..................................................... 140,000 380,000 455,000
Accounts receivable ........................ 140,000 380,000 455,000
4. Recognition of income:
Construction costs ................................ 825,000
Construction-in-progress inventory . 825,000
Contract liability ................................... 975,000
Revenue - Construction ................... 975,000
20x5 20x6 20x7
Statement of Financial Position:
Current assets:
Accounts receivable ...................................... $ 13,000 $ 15,500 $ 0
Inventory:
Construction-in-progress inventory .............. 180,000 630,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-67
Liabilities
Contract liability .............................................. 153,000 535,500 0
Income statement:
Income on construction (net) ........................... $ 0 $0 150,000
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6-68 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 6-21
Requirement 1
Calculations (thousands):
20x3 20x4 20x5
Contract price $ 1,600 $ 1,600 $ 1,600
Actual costs to date 470 1,170 1,365
Estimated costs to complete 830 210 —
Total 1,300 1,380 1,365
Estimated total profit $ 300 $ 220 $ 235
Actual costs to date $ 470 $ 1,170 $ 1,365
Estimated total costs 1,300 1,380 1,365
Percentage complete 36.2% 84.8% 100.0%
Revenue to be recognized:
20x4: $1,600 × 36.2% $ 579
20x5: ($1,600 × 84.8%) – $579 $ 778
20x6: $1,600 – ($579 + $778) $ 243
Gross profit to be recognized:
Revenue for current period less costs
incurred in current period
20x4: $579 – $470 $ 109
20x5: $778 – $700 $ 78
20x6: $243 – $195 $ 48
Journal entries: in thousands $’s
20X3:
Construction-in-progress inventory ................................................. 470
Cash, accounts payable, etc. ...................................................... 470
Accounts receivable ......................................................................... 380
Billings on contract .................................................................... 380
Cash ................................................................................................. 290
Accounts receivable ................................................................... 290
Cost of construction ......................................................................... 470
Construction in progress inventory .................................................. 109
Construction revenue ................................................................. 579
20X4:
Construction-in-progress inventory ................................................. 700
Cash, accounts payable, etc. ...................................................... 700
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-69
Accounts receivable ......................................................................... 990
Billings on contract .................................................................... 990
Cash ................................................................................................. 870
Accounts receivable ................................................................... 870
Cost of construction ......................................................................... 700
Construction in progress inventory .................................................. 78
Construction revenue ................................................................. 778
20X5:
Construction-in-progress inventory ................................................. 195
Cash, accounts payable, etc. ...................................................... 195
Accounts receivable ......................................................................... 230
Billings on contract .................................................................... 230
Cash ................................................................................................. 440
Accounts receivable ................................................................... 440
Cost of construction ......................................................................... 195
Construction in progress inventory .................................................. 48
Construction revenue ................................................................. 243
Billings on contract ....................................................................... 1,600
Construction-in-progress inventory ........................................... 1,600
Requirement 2
20x3 20x4 20x5
Statement of Financial Position:
Current assets:
Accounts receivable ...................................... $90,000 $ 210,000 $ 0
Inventory (or Liability)
Construction-in-progress inventory .............. 579,000 1,357,000
Billings on contracts...................................... 380,000 1,370,000 0
Costs in excess of billings ............................. 199,000 (13,000)
(or Billings in Excess of costs)
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6-70 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Income statement:
Income on construction (net) ........................... $ 109,000 $78,000 48,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-71
Assignment 6-22
Transaction Value of new asset on
the SFP
Amount on the income
statement. Indicate if a gain
or a loss. If no gain or loss
is recorded, enter ―zero‖
a. GYT Company exchanges a
machine that cost $4,000 and has
accumulated depreciation of
$2,560 for a similar machine.
GYT also receives $25 in the
exchange. The fair market value
of the old asset is $750. The fair
market value of the new asset is
$725. There is no commercial
substance to the transaction.
$725
(net book value of old,
$1,440 ($4,000 –
$2,560) less cash
received, $25 = $1,415
However, cap is fair
value of the new
machine, $725.
Loss of $690
$1,415 – $725 = $690
(essentially, an impairment
loss)
b. FST Company exchanges a
machine that cost $4,000 and has
accumulated depreciation of
$3,560 for a similar machine.
FST also receives $25 in the
exchange. The fair market value
of the old asset is $750. The fair
market value of the new asset is
$725. There is no commercial
substance to the transaction.
$415
(net book value of old,
$440 ($4,000 –
$3,560) less cash
received, $25.
Zero
c. LKC Company pays $250 and
exchanges a machine that cost
$3,000 and has accumulated
depreciation of $1,900 for
another machine. The fair
market value of the old asset is
undeterminable. The fair market
value of the new asset is $690.
The transaction has commercial
substance.
$690
With commercial
substance, the asset is
recorded at fair value
of the asset received
since the fair value of
the asset given up is
not determinable.
Loss of $660
Net book value is $1,100
($3,000 – $1,900);
Consideration paid was
$1,100 + 250 = $1,350
Value of new asset $690
Loss = 1,350 - 690 = 660
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6-72 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
d. HRT Company pays $250 and
exchanges a machine that cost
$2,000 and has accumulated
depreciation of $1,400 for
another machine. The fair
market value of the old asset is
$435. The fair market value of
the new asset is $680. The
transaction has commercial
substance.
$680
With commercial
substance, the asset is
recorded at fair value
Loss of $170
Net book value is $600
($2,000 – $1,400); cash
paid is $250. New asset
recorded at $680:
$600 + $250 – $680 = $170
e. AML Company pays $500 and
exchanges a machine that cost
$9,000 and has accumulated
depreciation of $8,400 for
another machine. The fair
market value of the new asset is
$1,580. The transaction has
commercial substance.
$1,580
With commercial
substance, the asset is
recorded at fair value
Gain of $480
Net book value is $600
($9,000 – $8,400);
Consideration paid was
$600 + 500 = $1,100
Value of new asset $1,580
Gain = 1,580 - 1,100 = 480
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-73
Although not asked for in the question, here are the journal entries for 6-22:
a) Loss on trade
690
Machine
725
Accumulated Depreciation
2,560
Cash
25
Machine
4,000
b) Machine
415
Accumulated Depreciation
3,560
Cash
25
Machine
4,000
c) Loss on trade
660
Machine
690
Accumulated Depreciation
1,900
Machine
3,000
Cash
250
d) Loss on trade
170
Machine
680
Accumulated Depreciation
1,400
Machine
2,000
Cash
250
e) Machine
1,580
Accumulated Depreciation
8,400
Machine
9,000
Cash
500
Gain on trade
480
e)
If no commercial substance:
Machine
1,100
Accumulated Depreciation
8,400
Machine
9,000
Cash
500
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6-74 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 6-23 (WEB)
a. There is no evidence of commercial substance. The new equipment is recorded at the
net book value of the old equipment:
Equipment (new) .................................................................... 144,000
Accumulated depreciation (old) ............................................... 288,000
Equipment (old) ................................................................... 432,000
b. There seems to be commercial substance, since new business can be attracted with the
new equipment. The new equipment is recorded at its fair value, and a gain is
recognized on the exchange:
Equipment (new) .................................................................... 285,000
Accumulated depreciation (old) ............................................... 288,000
Equipment (old) ................................................................... 432,000
Gain on equipment ............................................................... 141,000
c. There is commercial substance. The new equipment is recorded at the fair value of the
old equipment, adjusted for cash, as the more reliable measure. A gain is recognized on
the exchange:
Equipment (new) .................................................................... 249,000
Accumulated depreciation (old) ............................................... 288,000
Equipment (old) ................................................................... 432,000
Cash ..................................................................................... 24,000
Gain on equipment ............................................................... 81,000
d. There is no commercial substance. The new equipment is recorded at the book value of
the old equipment plus the cash consideration given. No gain or loss is recognized:
Equipment (new) .................................................................... 168,000
Accumulated depreciation (old) ............................................... 288,000
Equipment (old) ................................................................... 432,000
Cash ..................................................................................... 24,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-75
e. There is no commercial substance to this transaction, and therefore the new truck is
recorded at the net book value of the old truck plus the cash paid:
Truck (new)………………………………………………. 60,000
Accumulated amortization (old)………………………….. 60,000
Truck (old)……………………………………. 100,000
Cash……………………………………………. 20,000
f. This transaction has commercial substance since it enables a new type of operation for
Rochester Shipping Company and thereby can be expected to significantly affect the
future cash flows of the company. It seems likely that the fair value of the land and
building given up is more readily determinable than the fair value of the boat, since it
remained unsold for two years and also requires substantial work before it can return
to service. Therefore, the boat should be recorded based on the fair value of the land
and building.
Ferry …………………………………………………….. 1,150,000
Accumulated amortization – building……………………. 210,000
Building………………………………………... 700,000
Land……………………………………………. 300,000
Gain on capital asset disposal……………… 360,000
The additional cost for necessary upgrading and maintenance is added to the cost of the
boat when the work is done:
Ferry…………………………………………………….. 350,000
Cash, accounts payable, etc………………….. 350,000
This brings the recorded ferry value to $1,500,000, which may exceed fair value.
Alternatively, the $1,500,000 may be appropriate; it depends on whether the
expenditures improve the ferry, or just get it into serviceable shape.
The value now assigned to the ferry should be reviewed. It should be reduced if it is
more than fair value. If it is reduced, it seems logical that the gain on capital asset
disposal should be reduced rather than a loss recorded.
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6-76 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 6-24 (WEB)
Requirement 1
All of the impacts will be in the operating activities:
Change in accounts receivable (215,000)
Change in contract costs (44,0000)
Change in contract liabilities 68,000
Change in provision for warranties 11,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition 6-77
Assignment 6-25
The 20X0 subscription campaign yielded a total of $706,300 (294,100 + 224,700 +
187,500) in new subscriptions. The revenue from these subscriptions should be
recognized over the term of the subscriptions, as the ―product‖ is delivered to the
subscribers. There is a slight risk of non-payment, and therefore an allowance for doubtful
accounts should be established as a valuation account for accounts receivable.
As at December 31, 20X0, the following revenue amounts are calculated:
Length of
subscription
Total
subscription
revenue
$
Months of
revenue earned
Number of
months
Oct - Dec
Revenue
recognized
$
Unearned
Revenue
$
One year 294,100 3/12 73,525 220,575
Three year 224,700 3/36 18,725 205,975
Five year 187,500 3/60 9,375 178,125
706,300 101,625 604,675
Total revenue to be recognized in 20X0 was $101,625.
The costs fall into four categories:
1. $110,000 for the subscription list
2. $89,000 in direct costs for the subscription campaign—telephone and direct salary
expense
3. The costs of actually producing the newsletter.
If the newsletter production costs are not high, the new subscription revenue clearly will
exceed the cost of the subscription campaign; the campaign costs will result in a net
benefit to the company. The accounting issue is:
Which (if any) of these costs can be deferred and amortized, or should they all be
expensed in Year 0?
The subscription list is a purchased intangible asset. It has resulted in increased revenue,
and if a reasonable proportion of subscriptions are renewed, then it will have future
benefits as well. A strong argument can be made for capitalizing the purchased list as an
intangible capital asset. Subscription lists are usually amortized and are subject to
impairment tests. In this case, an impairment test can be based on the actual renewal rate
when it is known in future years.
The direct costs of the subscription campaign must be expensed as incurred since any
future benefits are unclear and they are not clearly tied to getting the contracts. Such
costs are viewed as being costs of maintaining or enhancing the entity’s internal goodwill
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6-78 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
and should be expensed when incurred. The company will continually be incurring costs
to develop its subscription base, and this campaign was just one of a potential series of
such initiatives. Therefore, these costs are expensed.
The bulk of the production costs will be incurred when the newsletter is produced, and
should be expensed as the revenue is recognized. Some costs (e.g., editorial salaries;
information-gathering costs) are incurred in advance of the publication date. Many costs
will have been incurred in 20X0 for 20X1 issues, but these are continuing operating costs.
They should be expensed when incurred.