CPA Exam - FAR - Area II - Revenue Recognition
Town, Inc., is preparing its financial statements for the year ending December 31, 20X1. On December 1, 20X1, Town was awarded damages of $75,000 in a patent infringement suit it brought against a competitor. The defendant did not appeal the verdict, and payment was received in January 20X2, prior to the issuance of the financial statements. What is the reporting requirement?
• Both accrual and disclosure
On January 2, 20X1, Yardley Co. sold a plant to Ivory, Inc., for $1,500,000. On that date, the plant's carrying cost was $1,000,000. Ivory gave Yardley $300,000 cash and a $1,200,000 note, payable in four annual installments of $300,000 plus 12% interest. Ivory made the first principal and interest payment of $444,000 on December 31, 20X1. Yardley uses the installment method of revenue recognition. In its 20X1 income statement, what amount of realized gross profit should Yardley report?
• For installment sales, one must compute the annual gross profit percentage on sales for the year. As the installment receivables are received in cash, the gross profit is recognized as the gross profit percentage multiplied by the cash collections for the period. Gross profit on sale = $1,500,000 - $1,000,000 = $500,000 Gross profit rate = $500,000 / $1,500,000 = 33-1/3% Cash collected in 20X1 ($300,000 + $444,000) $744,000 Less interest collected ($444,000 - $300,000) 144,000 --------- Cash collected from sales 600,000 Times gross profit rate x 33-1/3% --------- Gross profit reported in 20X1 $200,000 =========
Ace Corp. entered into a troubled debt restructuring (TDR) agreement with National Bank. National agreed to accept land with a carrying amount of $75,000 and a fair value of $100,000 in payment and cancellation of a note (from Ace) with a carrying amount of $150,000. Disregarding income taxes, what amount should Ace report as a gain from the restructuring in its income statement?
• In a transfer of assets to satisfy debt in a TDR, the debtor: recognizes a gain or loss on the transfer of assets (equal to the difference between the fair value of $100,000 and recorded value of $75,000 of the asset transferred), or $25,000, and recognizes a gain on the restructuring of a debt (equal to the difference between the $100,000 fair value of the asset and the $150,000 carrying value of the debt), or $50,000. Even though a total gain of $75,000 is recognized on the income statement, the portion attributable to the restructuring is $50,000.
At the end of the third year of a contract, total estimated project cost exceeds the contract price. In both of the first two years, the firm recognized gross profit on the contract under percentage of completion. What is the ending balance in the construction-in-progress account at the beginning of year four on the contract under the percentage-of-completion method (PC), and under the completed-contract method (CC), had that method been used?
An overall loss is expected, because total estimated cost exceeds contract price. Under PC, the construction-in-progress account is increased by cost and gross profit. If the gross profit is negative (an overall loss), the loss is subtracted from construction in progress. The loss recognized in the year as overall loss becomes evident includes any previous profit. Therefore, the previously recognized gross profit is removed when the total loss is recognized. Under CC, the same idea applies, except that there is no gross profit from previous years to remove. The ending construction-in-progress balance is the same for both methods.
• Falton Co. had the following first-year amounts related to its $9,000,000 construction contract: Actual costs incurred and paid $2,000,000 Estimated costs to complete 6,000,000 Progress billings 1,800,000 Cash collected 1,500,000 What amount should Falton recognize as a current liability at year-end, if revenue is recognized over time?
At year-end, Falton should record an account receivable of $300,000 (1,800,000 - 1,500,000) and inventory of $2,000,000. However, no current liability exists. Journal entries: Construction in Progress 2,250,000 Cash and profit 2,250,000 Accounts Receivable 1,800,000 Progress Billings 1,800,000 Cash 1,500,000 Accounts Receivable 1,500,000
• Reid Partners, Ltd., which began operations on January 1, 20X1, has elected to use cash-basis accounting for tax purposes and accrual-basis accounting for its financial statements. Reid reported sales of $175,000 and $80,000 in its tax returns for the years ending December 31, 20X2 and 20X1, respectively. Reid reported accounts receivable of $30,000 and $50,000 in its balance sheets as of December 31, 20X2 and 20X1, respectively. What amount should Reid report as sales in its income statement for the year ending December 31, 20X2?
Beginning Ending accounts + Sales - Collections = accounts receivable receivable $50,000 + Sales - $175,000 = $30,000 Sales = $175,000 + $30,000 - $50,000 Sales = $155,000
Stacy Company enters into a contract with Molly Company on February 5. The contract requires Stacy to deliver 100 units of Product A and 250 units of Product B to Molly by September 1. Stacy is entitled to payment for Product A after 125 units of Product B have been delivered. The following deliveries are made by Stacy to Molly: On March 15, Stacy delivers 100 units of Product A. On May 21, Stacy delivers 100 units of Product B. On August 1, Stacy delivers an additional 150 units of Product B. The amounts related to Product A to be reported on Stacy's March 31 balance sheet, June 30 balance sheet, and September 30 balance sheet, respectively, should be presented as a:
Contract Asset with conditional rights; Contract Asset with conditional rights; Accounts Receivable.
Daisy Company enters into a contract to build a custom piece of equipment for Lou Company. Lou Company agrees to pay Daisy $80,000 for the equipment. Lou Company would like the piece of equipment as soon as possible so it offers a bonus of $12,000 if Daisy can complete the equipment within six weeks; otherwise, no bonus will be paid. Daisy estimates that there is a 65% probability that the equipment will be completed in six weeks and a 35% probability that the equipment will take longer than six weeks to complete. What is the transaction price of the contract?
Correct! The transaction price of the contract is $92,000. Daisy should use the most likely amount method to determine the transaction price because there are two distinct possible outcomes. Daisy has determined the most likely outcome based on likelihood is that the equipment will be completed in time to earn the performance bonus. Therefore, the value of the contract will include both the sales prices of the equipment ($80,000) and the value of the performance bonus ($12,000).
• Information pertaining to dividends from Wray Corp.'s common stock investments for the year ending December 31, 20X1, follows: On September 8, 20X1, Wray received a $50,000 cash dividend from Seco, Inc., in which Wray owns a 30% interest. A majority of Wray's directors are also directors of Seco. On October 15, 20X1, Wray received a $6,000 liquidating dividend from King Co. Wray owns a 5% interest in King Co. Wray owns a 2% interest in Bow Corp., which declared a $200,000 cash dividend on November 27, 20X1, to stockholders of record on December 15, 20X1, payable on January 5, 20X2. What amount should Wray report as dividend income in its income statement for the year ending December 31, 20X1?
Dividend income for 20X1 = Dividends from Bow Corp. = 0.02 x $200,000 = $4,000The liquidating dividend from King Co. is not income, but rather a return of investment to owners.
• NuCorp. agreed to give Rand Co. a machine in full settlement of a note payable to Rand. The machine's original cost was $140,000. The note's face amount was $110,000. On the date of the agreement: the note's carrying amount was $105,000, and its present value was $96,000. the machine's carrying amount was $109,000, and its fair value was $96,000. Assuming that this trade was made as part of troubled debt restructuring, what amount of gains/losses should NuCorp. recognize, and how should these be classified in its income statement?
FASB ASC 470-60-35-2 requires that a debtor in a troubled debt restructuring recognize a gain measure as "the excess of (i) the carrying amount of the payable settled...over (ii) the fair value of the assets transferred to the creditor." The total gain/loss in this case is the difference between the carrying value of the debt, $105,000, and the carrying value of the machine, $109,000 and its fair value of $96,000 conceivably could be deemed to be an impairment loss. However, we do not have enough information to know that this $13,000 part of the loss qualifies as an impairment loss. Nevertheless, even if it did, it would be included in income from continuing operations. The best answer is that the $4,000 net loss should be recognized as an ordinary loss to be included in income from continuing operations.
• The following pertains to Pell Co.'s construction jobs, which commenced during 20X1: Project 1 Project 2 Contract price $420,000 $300,000 Costs incurred during 20X1 240,000 280,000 Estimated costs to complete 120,000 40,000 Billed to customers during 20X1 150,000 270,000 Received from customers during 20X1 90,000 250,000 If Pell used the recognized revenue over time, based on cost incurred, what amount of gross profit (loss) would Pell report in its 20X1 income statement?
For Project 1: Percentage Completed = 20X1 costs / Estimated total costs = $240,000 / ($240,000 + $120,000) = 2/3 Contract price recognized in 20X1 (2/3 x $420,000) $280,000 Less 20X1 cost incurred 240,000 Gross profit from Project 1 $ 40,000 For Project 2: Contract price $300,000 Less actual and estimated costs to complete ($280,000 + $40,000) 320,000 Estimated loss (20,000) Pell's total 20X1 gross profit (loss) under percentage-of-completion $ 20,000 ======== Because Project 2 reflects an anticipated loss, the entire amount of the loss (not the percent completion of loss) must be recognized in accordance with the conservatism principle
• Lang Co. uses the installment method of revenue recognition. The following data pertain to Lang's installment sales for the years ending December 31, 20X1 and 20X2: 20X1 20X2 ------- ------- Installment receivables at year-end on 20X1 sales $60,000 $30,000 Installment receivables at year-end on 20X2 sales - 69,000 Installment sales 80,000 90,000 Cost of sales 40,000 60,000 What amount should Lang report as deferred gross profit in its December 31, 20X2, balance sheet?
Gross profit rates: 20X1 = ($80,000 - $40,000) / $80,000 = 50% 20X2 = ($90,000 - $60,000) / $90,000 = 33.33% Deferred gross profit on December 31, 20X2:
• On January 2, 20X1, Blake Co. sold a used machine to Cooper, Inc., for $900,000, resulting in a gain of $270,000. On that date, Cooper paid $150,000 cash and signed a $750,000 note bearing interest at 10%. The note was payable in three annual installments of $250,000 beginning January 2, 20X2. Blake appropriately accounted for the sale under the installment method. Cooper made a timely payment of the first installment on January 2, 20X2, of $325,000 which included accrued interest of $75,000. What amount of deferred gross profit should Blake report on December 31, 20X2? Gross profit rate = $270,000 ÷ $900,000 = 30% Cash collected prior to December 31, 20X2:
January 2, 20X1 $150,000 January 2, 20X2 250,000 -------- Total $400,000 ======== Cash remaining to be collected = $900,000 - $400,000 = $500,000 Deferred gross profit to be reported on December 31, 20X2 = 30% × $500,000 = $150,000
• House Publishers offered a contest in which the winner would receive $1,000,000 payable over 20 years. On December 31, 20X1, House announced the winner of the contest and signed a note payable to the winner for $1,000,000, payable in $50,000 installments every January 2. Also on December 31, 20X1, House purchased an annuity for $418,250 to provide the $950,000 prize monies remaining after the first $50,000 installment, which was paid on January 2, 20X2. In its 20X1 income statement, what should House report as contest prize expense?
January 2, 20X2, installment $ 50,000 Amount required to meet future installment requirements (i.e., present value of 19 annual payments of $50,000) 418,250 -------- Total $468,250
• The following information pertains to Spee Co.'s 20X1 sales: Cash Sales Gross $40,000 Returns and allowances 2,000 Credit Sales Gross 60,000 Discounts 3,000 On January 1, 20X1, customers owed Spee $20,000. On December 31, 20X1, customers owed Spee $15,000. Spee uses the direct write-off method for bad debts. No bad debts were recorded in 20X1. Under the cash basis of accounting, what amount of revenue should Spee report for 20X1?
One needs to convert from accrual to cash method income (revenue when collected in cash). Cash collected from cash sales ($40,000 - 2,000) = $ 38,000 Cash collected from credit sales: Net credit sales for 20X1 ($60,000 - 3,000) $57,000 January 1, 20X1, accounts receivable 20,000 ------- Subtotal $77,000 Less December 31, 20X1, accounts receivable 15,000 62,000 ------- -------- Cash basis revenue for 20X1 $100,000 ========
Sally collects a nonrefundable up-front fee of $192 when a new customer signs up for a 24-month contract for services. A monthly fee of $32 is also assessed for each customer. How much revenue does Sally record on the date the contract is signed?
Sally does not recognize revenue until services have been provided. The nonrefundable up-front fee of $192 is recognized over the life of the contract, in this case, over 24 months.
Kinnamont Company manufactures farming equipment that includes navigational systems as part of the standard equipment package and offers optional training on any navigational systems for an additional fee. Smith Company enters into a contract with Kinnamont that includes a combine, a navigational system, and training. Identify the performance obligations to which Smith should allocate the transaction price:
The combine including the navigational system and the training as two separate performance obligations.
• Frame Construction Company's contract requires the construction of a bridge in 3 years. The expected total cost of the bridge is $2,000,000, and Frame will receive $2,500,000 for the project. The actual costs incurred to complete the project were $500,000, $900,000, and $600,000, respectively, during each of the 3 years. Progress payments received by Frame were $600,000, $1,200,000, and $700,000, respectively. Assuming revenue is recognized over time, what amount of gross profit would Frame report during the last year of the project?
The first step is to figure the total profit on the contract, as follows: Total revenue was $2,500,000. Total actual costs are known (since the project has been completed) to be $2,000,000 (made up of $500,000 + $900,000 + $600,000 from the 3 years of work). This gives us a profit of $500,000 on the contract ($2,500,000 - $2,000,000). At the beginning of the third year, Frame had expended a total cost of $1,400,000 ($500,000 from the first year, and $900,000 more from the second year combined). At the start of Year 3, Frame was thus 70% complete (based on total cost expended so far, $1,400,000, divided by total cost estimated to finish, $2,000,000). Frame would have already recognized 70% of the total contract profit so far ($350,000, or 0.7 × $500,000 total profit). Thus, Frame has only $150,000 profit remaining to be recognized in Year 3 (Total profit of $500,000 - Profit already recognized of $350,000). Since the total expected cost was the total actual cost, in this particular case the percentage completed in Year 3 times the total contract profit will also give the correct answer: $600,000 ÷ $2,000,000 = 0.3 0.3 × $500,000 = $150,000
Frame construction company's contract requires the construction of a bridge in three years. The expected total cost of the bridge is $2mn, and Frame will receive $2.5mn for the project. The actual costs incurred to complete the project were $500,000, $900,000, and $600,000, respectively, during each of the three years. Progress payments received by Frame were $600,000, $1.2mn, and $700,000 in each year, respectively. Assuming that the percentage-of-completion method is used, what amount of gross profit should Frame report during the last year of the project?
The gross profit recognized for the first two years must be computed first. Then, the difference between the $500,000 final total gross profit on the project (= $2.5mn − $2mn), and the gross profit for the first two years, is the amount of gross profit recognized in the last (third) year. The percentage of completion at the end of the first two years is 70% (= $500,000 + $900,000)/$2mn). The gross profit recognized through the end of year two is $350,000 [= .70($2.5mn − $2mn)]. Therefore, gross profit for year three is $150,000 (= $500,000 total gross profit on project − $350,000).
A contractor recognized $42,000 of gross profit on a contract at the end of year one of the contract under the percentage-of-completion method. At the end of year two, total estimated project cost exceeded the contract price by $100,000. What amount of loss is to be recognized for year two alone under the percentage-of-completion method (PC), and also under the completed-contract method (CC), had that method been used?
The overall loss on this contract is $100,000—the excess of total estimated cost and contract price, as given in the problem. Under PC, the previously recognized gross profit (year one) must be removed. The $142,000 loss recognized in year two yields a $100,000 combined loss for both years—the amount of the overall loss. For CC, the overall loss is recognized immediately. There is no year-one gross profit to remove, because CC recognizes no gross profit until completion of the contract
Falton Co. has the following first-year amounts related to its $9mn construction contract: Actual costs incurred and paid $2mn Estimated costs to complete $6mn Progress billings $1.8mn Cash collected $1.5mn What amount should Falton recognize as a current liability at year end, using the percentage-of-completion method?
The percentage of completion is ($2mn)/($2mn + $6mn) = 25%. This is the ratio of cost incurred to date, divided by the total project cost, which is the sum of cost to date and estimated remaining costs. Gross profit recognized is therefore .25($9mn − $2mn − $6mn) = $250,000. The contract price is $1mn more than the total estimated project cost. At 25% complete, the firm recognizes $250,000 of gross profit. The construction-in-progress balance is therefore $2mn + $250,000 = $2.25mn, the sum of cost to date, plus gross profit to date. With billings only $1.8mn so far, the firm reports a net asset equal to the difference between $2.25mn, the balance in construction in progress, and $1.8mn of billings. Billings are contra to construction in progress for reporting. This $450,000 difference is labeled "cost and profit in excess of billings on long-term contracts" in the balance sheet. No current liability is reported, because the asset balance (construction in progress) exceeds billings.
A company enters into a contract to sell 50 products to a customer for $30 each. After the company transfers 30 of the 50 products, the customer wants an additional 25 products. The contract is modified and the additional 25 products are priced at $15 each, a price that is not reflective of the standalone selling price. What is the price per product for the remaining 45 products (20 products from the original contract and 25 products from the modification)?
To calculate the blended price, 20 remaining products at $30 each represent revenue of $600 plus 25 additional products at $15 each represent revenue of $375. Total revenue left to be recognized over the remaining 45 products is $975. $975 divided by 45 products yields a blended price of $21.67 per product.
Ichor Co. reported equipment with an original cost of $379,000 and $344,000, and accumulated depreciation of $153,000 and $128,000, respectively, in its comparative financial statements for the years ending December 31, 20X2 and 20X1. During 20X2, Ichor purchased equipment costing $50,000, and sold equipment with a carrying value of $9,000. What amount should Ichor report as depreciation expense for 20X2?
• In the context of this problem accumulated depreciation is affected by the asset disposal when the carrying value of the asset sold is written off and by depreciation expense for the current period. These two items account for the net increase of $25,000 ($153,000 - $128,000) in the credit balance of the accumulated depreciation account. The debit change in accumulated depreciation caused by the asset disposal needs to be determined from the facts provided. The equipment account had a beginning balance of $344,000. The $50,000 purchase of new equipment would cause this balance to increase to $394,000. However, the ending balance was $379,000. The only other transaction affecting the equipment account was the disposal of a piece of equipment. Therefore, the original cost of the disposed equipment was $15,000 ($394,000 - $379,000). Since the disposed equipment had a cost of $15,000 and a carrying value of $9,000 (carrying value = cost - accumulated depreciation), the accumulated depreciation associated with the disposed equipment was $6,000 ($9,000 = $15,000 - accumulated depreciation). The beginning credit balance in the accumulated depreciation control account was $128,000. It would have been decreased (debited) for the $6,000 of accumulated depreciation related to the disposed equipment. That would leave a credit balance of $122,000. However, the ending balance was a credit of $153,000. Depreciation expense for the period would also change (increase or credit) the balance of accumulated depreciation. Since the ending balance was $153,000, and the balance without the effect of depreciation expense was $122,000, the depreciation expense must have been $31,000 ($153,000 - $122,000).
On January 2, 20X1, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a $600,000 non-interest-bearing note due January 2, 20X4. There was no established exchange price for the equipment. The prevailing rate of interest for a note of this type on January 2, 20X1, was 10%. The present value of 1 at 10% for three periods is 0.75. In Emme's 20X1 income statement, what amount should be reported as interest income?
• Interest is revenue charged in relation to money lent. One must recognize it based on the amount lent and the agreed-upon rate. Present value of note = 75 × $600,000 = $450,000 Interest income for 20X1 = 0.10 × $450,000 = $45,000
On January 1, 20X1, Card Corp. signed a 3-year, noncancelable purchase contract, which allows Card to purchase up to 500,000 units of a computer part annually from Hart Supply Co. at $.10 per unit and guarantees a minimum annual purchase of 100,000 units. During 20X1, the part unexpectedly became obsolete. Card had 250,000 units of this inventory at December 31, 20X1, and believes these parts can be sold as scrap for $.02 per unit. What amount of probable loss from the purchase commitment should Card report in its 20X1 income statement?
• Minimum purchase commitment for 20X2 and 20X3 (100,000 units x $.10/u x 2 years) $20,000 Less scrap recovery (100,000 units x $.02 x 2 years) 4,000 ------- Probable loss from purchase commitment $16,000 =======
Lew Co. sold 200,000 corrugated boxes for $2 each. Lew's cost was $1 per unit. The sales agreement gave the customer the right to return up to 60% of the boxes within the first six months, provided an appropriate reason was given. It was immediately determined, with appropriate reason, that 5% of the boxes would be returned. Lew absorbed an additional $10,000 to process the returns and expects to resell the boxes. What amount should Lew report as operating profit from this transaction?
• Operating profits will take into account the estimated returns and operating costs. Sales (200,000 x $2) $ 400,000 Cost (200,000 x $1) (200,000) ---------- Tentative Gross Profit 200,000 Est Returns (5% x 200,000) (10,000) Added costs (10,000) ---------- Operating profit $ 180,000
On October 1, Year 1, Acme Fuel Co. sold 100,000 gallons of heating oil to Karn Co. at $3 per gallon. Fifty-thousand (50,000) gallons were delivered on December 15, Year 1, and the remaining 50,000 gallons were delivered on January 15, Year 2. Payment terms were 50% due on October 1, Year 1, 25% due on first delivery, and the remaining 25% due on second delivery. What amount of revenue should Acme recognize from this sale during Year 1?
• Revenue is recognized when the performance obligation is complete and control has passed to the buyer. Therefore, revenue would be: 50,000 gallons × $3/per gallon = $150,000
Fenn Stores, Inc., had sales of $1,000,000 during December 20X1. Experience has shown that merchandise equaling 7% of sales will be returned within 30 days and an additional 3% will be returned within 90 days. Returned merchandise is readily resalable. In addition, merchandise equaling 15% of sales will be exchanged for merchandise of equal or greater value. What amount should Fenn report for net sales in its income statement for the month of December 20X1?
• Sales should be adjusted for the expected returns (7% + 3% = 10%) only (as an allowance reducing sales.) The sales related to expected exchanges for merchandise of equal or greater value are recognized as revenue in the period in which the original sale is made with no adjustment for the expected exchanges because the entire amount of the original sale is expected to result in an inflow of assets. Sales reported for month of December 20X1 $1,000,000 Less expected returns (10% x $1,000,000) 100,000 ---------- Net sales for December 20X1 $ 900,000 ==========
On January 1 of the current year, Wren Co. leased a building to Brill under an operating lease for 10 years at $50,000 per year, payable the first day of each lease year. Wren paid $15,000 to a real estate broker as a finder's fee. The building is depreciated $12,000 per year. For the year, Wren incurred insurance and property tax expense totaling $9,000. Wren's net rental income for the year should be:
• The revenue under the lease is the $50,000 each year, and the expenses include the depreciation and the property tax for the year. The broker's fee ($15,000) should be amortized equally based over the 10 years of the lease, or $1,500 a year. Thus, the net rental income should be $27,500: $50,000 - $12,000 - $9,000 - $1,500 = $27,500
• In February, Colt Corp. sold merchandise to Sink Co. for $10,000. Colt is using the cost recovery method to account for this sale, which had cost of goods sold of $2,500. Colt received the following payments from Sink during the year: Date Amount June $1,000 August 1,500 October 200 December 700 $3,400 What amounts of gross profit should Colt recognize in its June 30 and December 31 income statements?
• Under U.S. GAAP, profit is deemed to be realized at the point of sale unless the collection of the sales price is not reasonably assured. The cost recovery method (CRM) is only allowed in limited situations (e.g., where receivables are collectible over an extended period of time and, because of the terms of the transaction or other uncertainties, there is no reasonable basis for estimating the degree of collectibility). Under the CRM, the early payments are considered entirely a recovery of cost, and not until the cost is completely recovered is any gross profit recognized. Accordingly, Colt should classify the first two payments as recovery of cost ($2,500) and the second two payments ($900) as gross profit on the December 31 income statement.
Drew Co. produces expensive equipment for sale on installment contracts. When there is doubt about eventual collectibility, the income recognition method least likely to overstate income is
• the cost recovery method.