Chapter 18 Intermediate Accounting

The payments received in return for the continuing rights granted by the franchise agreement and for providing such services as management training, advertising and promotion, legal assistance, and other support.

Continuing franchise fees.

There are two types: (1) unconditional rights to receive consideration because the company has satisfied its performance obligation with a customer, and (2) conditional rights to receive consideration because the company has satisfied one performance obligation but must satisfy another performance obligation in the contract before it can bill the customer.

Contract assets.

A company's obligation to transfer goods or services to a customer for which the company has received consideration form the customer also generally referred to as Unearned Sales Revenue.

Contract liabilities.

When parties to a contract change the contract terms while it is ongoing.

Contract modification.

An agreement that creates enforceable rights or obligations.

Contract.

Bretts Construction Company had a contract starting April 2017, to construct a $6,000,000 building that is expected to be completed in September 2018, at an estimated cost of $5,500,000. At the end of 2017, the costs to date were $2,530,000 and the estimated total costs to complete had not changed. The progress billings during 2017 were $1,200,000 and the cash collected during 2017 was $800,000. *22. (L.O. 5) At December 31, 2017, Bretts would report Construction in Process in the amount of: A. $ 230,000. B. $2,530,000. C. $2,760,000. D. $2,360,000.

*22. (C) $2,530,000 of costs accumulated in the Construction in Process account to maintain a record of the total costs incurred. In addition, the gross profit of $230,000 computed in 21 above would also be debited to Construction in Process. Therefore at December 31, 2017, the account Construction in Process would have an ending balance of $2,760,000 ($2,530,000 + $230,000).

*23. (L.O. 6) Under the completed contract method of accounting for long-term construction contracts, interim charges and/or credits to the income statement are made for: Revenues/ Costs/ Gross Profit A. Yes No No B. No No No C. No Yes No D. Yes Yes Yes

*23. (B) Under the completed-contract method, costs of long-term contracts in process and current billings are accumulated, but there are no interim charges or credits to income statement accounts for revenues, costs, and gross profit.

*24. (L.O. 7) The Nathan Company is involved in the construction of an asset under a long-term construction contract. At the end of the third year of the five year contract, the cost estimates indicate that a loss will result on the completion of the entire contract. In accounting for this contract, the entire expected loss must be recognized in the current period under the: Percentage-of-Completed-Completion Method Contract Method A. Yes No B. Yes Yes C. No Yes D. No No

*24. (B) Cost estimates at the end of the current period may indicate that a loss will result on completion of the entire contract. Under both the percentage-of-completion method and completed-contract method, the entire expected contract loss must be recognized in the current period.

1. (L.O. 1) The converged standard on revenue recognition entitled Revenue from Contracts with Customers was developed because: A. GAAP had only one basic standard on revenue recognition B. GAAP had numerous standards related to revenue recognition C. IFRS had numerous inconsistent standards on revenue recognition. D. GAAP had more of a principles-based approach.

1. (B) The principles-based IFRS was criticized because it had one basic standard on revenue recognition—plus some limited guidance related to certain minor topics. In contrast, the rules-based GAAP had numerous standards related to revenue recognition (B), but many believed the standards were inconsistent with one another.

(L.O. 5) Under the percentage-of-completion method, the difference between the Construction in Process and the Billings on Construction in Process accounts is reported in the balance sheet as a current asset if a debit, and as a contra asset if a credit. Indicate whether each of the following is true (T) of false (F)

20. (F) Under the percentage-of-completion method, the difference between the Construction in Process and the Billings on Construction in Process accounts is reported in the balance sheet as a current asset if a debit, and as a current liability if a credit.

(L.O. 6) The principle advantage of the completed-contract method in accounting for long-term construction contracts is that reported income is based on final results rather than on estimates of unperformed work. Indicate whether each of the following is true (T) of false (F)

21. (T)

(L.O. 6) The major disadvantage of the completed-contract method as compared with the percentage-of-completion method is that total net income over the life of the construction contract is normally smaller under the completed-contract method. Indicate whether each of the following is true (T) of false (F)

22. (F) The total net income or gross profit over the life of a construction contract is the same under both the percentage-of-completion method and the completed-contract method. The major difference between the methods is the timing of the recognition of gross profit during the life of the contract.

(L.O. 6) The annual entries to record costs of construction, progress billings, and collections from customers under the completed-contract method would be identical to those illustrated under the percentage-of-completion method with significant exclusion of the recognition of revenue and gross profit. Indicate whether each of the following is true (T) of false (F)

23. (T)

(L.O. 7) When there is a loss in the current period on a profitable contract, under both the percentage-of-completion and the completed-contract methods, the estimated cost increase requires a current period adjustment of excess gross profit recognized on the project in prior periods. Indicate whether each of the following is true (T) of false (F)

24. (F) When there is a loss in the current period on a profitable contract, under the percentage-of-completion method only, the estimated cost increase requires a current period adjustment of excess gross profit recognized on the project in prior periods.

(L.O. 8) When a franchisor provides access to the rights of the franchise rather than transferring control, the franchise revenue is recognized over time, rather than at a point in time. Indicate whether each of the following is true (T) of false (F)

25. (T)

3. (L.O. 1) Which of the following best describes the current revenue recognition principle? A. Identify separate performance obligations in the contract. B. Recognize revenue in the accounting period when cash is received. C. Recognize revenue when it is earned. D. Recognize revenue in the accounting period when the performance obligation is satisfied.

3. (D) The new revenue recognition principle is worded as "recognize revenue in the accounting period when the performance obligation is satisfied." The old revenue recognition principle was worded as "revenue is recognized when (1) it is realized or realizable and (2) it is earned"—similar to (C). Answer (A) is a step in the fivestep process for revenue recognition; and answer (B) is incorrect and does not reflect that the performance obligation is different from the transfer of cash.

(L.O. 2) To entice more customers into the store on Mondays, Strassberg Company is selling a slice of pizza for $1 less on Mondays. Normally a slice of pizza sells for $3. When Barbara buys a slice of pizza from Strassberg Company on a Monday with cash, how should Strassberg Company recognize the transaction? A. Revenue of $3 should be recognized and $1 as a discount expense. B. Revenue of $2 should be recognized. C. Revenue of $2 should be recognized and $1 of unrealized revenue recognized. D. Revenue of $2 should be recognized and $1 of discount liability recognized.

4. (B) Because the transaction price for the slice pizza is $2, not $3, the $2 is the contractual transaction price expected to be received from the customer. Therefore Strassberg Company should recognize $2 of revenue when Barbara receives the slice of pizza.

(L.O. 3) A billandhold sale results when the buyer has not taken title nor billing but has taken delivery of the item. Indicate whether each of the following is true (T) of false (F)

9. (F) Billandhold sales result when the buyer is not yet ready to take delivery but does take title and accepts billing.

1. __ practices are currently the most prevalent reason for accounting restatements. In response to fraudulent activities—and the increasing attention investors have focused on revenue numbers—the FASB and IASB issued a new standard on revenue recognition. This new standard provides a set of guidelines to follow in determining when revenue should be reported and how it should be measured.

Revenue recognition

3. __ is recognized to depict the __ of goods or services to customers in an amount that reflects the __ that the company receives, or expects to receive, in exchange for these goods or services.

Revenue, transfer, consideration

The principle recognizes revenue when the performance obligation is satisfied.

Revenue-recognition principle.

When a customer returns a product in exchange for a refund, a credit against amounts owed or that will be owed, and/or another product in exchange.

Sales returns and allowances.

When a company accounts for a contract modification as a new contract if (1) the promised goods are distinct, and (2) the company has the right to receive an amount of consideration that reflects the standalone selling price of the promised goods or services.

Separate performance obligation.

A warranty that provides an additional service beyond the assurance-type warranty.

Service-type warranty.

2. (L.O. 1) Most revenue transactions pose few problems because the transaction is initiated and completed at the same time. However, not all transactions are that simple. The new standard adopts an __ as the basis for revenue recognition. The __ recognizes and measures revenue based on changes in assets and liabilities arising from contracts with customers. The new standard first identifies the key objective of revenue recognition, followed by a five-step process that companies should use to ensure that revenue is measured and reported correctly, with the culmination of the process being the revenue recognition principle.

asset-liability approach, asset-liability approach

The consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer), who is to act as an agent for the consignor in selling the merchandise.

Consignment.

The party that sends goods to a consignee under consignment.

Consignor.

(L.O. 2) Revenue should be recognized when the two parties have signed the contract even if neither party has started to perform under the contract. Indicate whether each of the following is true (T) of false (F)

(F) A key feature of revenue recognition is that the signing of the contract by the two parties is not recorded (does not result in a journal entry) until one or both of the parties perform under the contract.

(L.O. 1) The new standard, Revenue from Contracts with Customers, adopts an expense liability approach as the basis for revenue recognition. T or F.

(F) The new standard, Revenue from Contracts with Customers, adopts an asset-liability approach as the basis for revenue recognition.

Cushing Corporation recently received a longterm contract to construct a luxury liner. The contract will take 3 years to complete at a cost of $3,500,000. The price of the liner is set at $5,000,000. The cost estimates at the end of the first year are in line with original estimates, and $1,050,000 of the costs were incurred during the first year. *19. (L.O. 5) The amount of gross profit recognized at the end of the first year using the percentageofcompletion method is: A. $1,500,000. B. $1,050,000. C. $ 735,000. D. $ 450,000.

*19. (D) Total cost............................................................. $3,500,000 Cost incurred......................................................... $1,050,000 % of total cost incurred $1,050,000 / $3,500,000 = .30 Estimated gross profit: $5,000,000 - $ 3,500,000 = $1,500,000 Gross profit recognized in the first year $1,500,000 x .30 = $450,000

Cushing Corporation recently received a longterm contract to construct a luxury liner. The contract will take 3 years to complete at a cost of $3,500,000. The price of the liner is set at $5,000,000. The cost estimates at the end of the first year are in line with original estimates, and $1,050,000 of the costs were incurred during the first year. *20. (L.O. 5) At the end of the first year which of the following entries would be made to recognize revenue and gross profit on the contract? A. Accounts Receivable—Construction Contracts Revenue from Long-Term Contracts B. Billings on Construction in Process Revenue from Long-Term Contracts C. Construction in Process Construction Expenses Revenue from Long-Term Contracts D. Billings on Contraction in Process Construction in Process

*20. (C) Under the percentageofcompletion method, the Construction in Process account is used to record revenue throughout the contract period.

Bretts Construction Company had a contract starting April 2017, to construct a $6,000,000 building that is expected to be completed in September 2018, at an estimated cost of $5,500,000. At the end of 2017, the costs to date were $2,530,000 and the estimated total costs to complete had not changed. The progress billings during 2017 were $1,200,000 and the cash collected during 2017 was $800,000. *21. (L.O. 5) For the year ended December 31, 2017, Bretts would recognize gross profit on the building of: A. $210,833. B. $230,000. C. $270,000. D. $ 0.

*21. (B) Bretts would calculate the estimated total gross profit and the percentage completed on the building as follows: Contract price $6,000,000 Less estimated cost: Costs to date $2,530,000 Estimated costs to complete 2,970,000 Estimated total costs 5,500,000 Estimated total gross profit $ 500,000 Percent complete ($2,530,000/$5,500,000): 46% Therefore the gross profit recognized in 2017 would be $230,000 (46% of $500,000).

2. (L.O. 1) The new standard, Revenue from Contracts with Customers, recognizes revenue based on a(n): A. Revenue-expense approach. B. Liability-Equity approach. C. Asset-Liability approach. D. Asset-Equity approach.

2. (C) The new standard, Revenue from Contracts with Customers, recognizes revenue based on an asset-liability approach.

10. (L.O. 2) Ostro Company enters into a contract with Zelman Company to give financial advice for a one year term. Ostro will receive a weekly set fee and in addition will receive a performance based incentive at the end of the year based on complicated formula but generally based on the investment profits Zelman Company receives related to the assets that Ostro manages. At what point should Ostro recognize the management fee and the performance based incentive related to Zelman? A. Ostro should not recognize the weekly fee and the performance based incentive until at the end of the year. B. Ostro should recognize the weekly fee each week after Ostro performed its obligation, but should not recognize the performance based incentive until at the end of the year. C. Ostro should recognize both the weekly fee and an estimate of the performance based incentive each week. D. Ostro should recognize both the weekly fee and an estimate of the performance based incentive at each financial reporting period—with adjustments taking into account the previously reported amounts.

10. (B) A company only allocates variable consideration if it is reasonably assured that it will be entitled to that amount. Ostro can recognize the weekly fee as the performance obligation has been met, but revenue recognition of the performance-based incentive should be constrained until the year end because high variability of possible consideration amounts. Therefore answer B is the best answer.

(L.O. 3) In a principal-agent relationship, amounts collected on behalf of the principal are recorded as revenue by the agent. Indicate whether each of the following is true (T) of false (F)

10. (F) In a principal-agent relationship, amounts collected on behalf of the principal are not recorded as revenue by the agent. Instead, revenue for the agent is the amount of commission it receives (usually a percentage of total revenue).

11. (L.O. 2) On January 1, 2017 Heybach Company sold goods to Barshinger Company for $400,000 in exchange for $100,000 in cash and a 5year zerointerest bearing note with a face amount of $401,468 and a present value of $300,000. Heybach also determined that the note has an imputed interest rate of 6%. The goods have an inventory cost on Heybach's books of $275,000. Which of the following will be part of a correct entry by Heybach? A. On January 1, 2017 Heybach should record a debit to Notes Receivable in the amount of $300,000. B. On January 1, 2017 Heybach should record a debit to Inventory of $275,000. C. On December 31, 2017 Heybach should record a credit to Interest Revenue of $18,000. D. On January 1, 2017 Heybach should record a credit to Sales Revenue of $401,468.

11. (C) Heybach Company would record the following entries: January 1, 2017 Notes Receivable 401,468 Cash 100,000 ----Discount on Notes Receivable 101,468 ----Sales Revenue 400,000 . Cost of Goods Sold 275,000 ----Inventory 275,000 December 31, 2017 Discount on Notes Receivable 18,000 ----Interest Revenue 18,000

12. (L.O. 2) Cain Company offers its customers a 2% volume discount if they purchase at least $600,000 of its product during the calendar year. On May 31, 2017 Cain has made sales of $400,000 to Kao Co. In the previous 2 years, Cain has made sales of on average of $800,000 to Kao Co. in the period June 1 to December 31. Which of the following will be part of a correct entry by Cain? A. On May 31, 2017 Cain should recognize a debit to Sales Revenue of $400,000. B. On May 31, 2017 Cain should recognize a credit to Sales Revenue of $392,000. C. On May 31, 2017 Cain should recognize a credit to Sales Revenue of $588,000. D. On May 31, 2017 Cain should recognize a credit to Sales Revenue of $400,000.

12. (B) Cain Company would record the following entries: May 31, 2017 Accounts Receivable 392,000 ----Sales Revenue 392,000

(L.O. 3) An assurance-type warranty is a warranty that provides an additional service beyond the servicetype warranty. Indicate whether each of the following is true (T) of false (F)

12. (F) An assurance-type warranty is a warranty that the product meets agreed upon specifications in the contract at the time the product is sold. A servicetype warranty is a warranty that provides an additional service beyond the assurance type warranty.

13. (L.O. 2) The best measure of fair value is what the company could sell the good or service for on a standalone basis, referred to as the standalone selling price. If this information is not available, companies should use their best estimate of what the good or service might sell for as a standalone unit. The preferred allocation approach is the: A. adjusted market assessment approach. B. expected cost plus a margin approach. C. estimated standalone market approach. D. residual approach.

13. (A) When estimating the standalone selling price, the preferred order of use for the approaches are (1) adjusted market assessment approach, (2) expected cost plus a margin approach (answer B), and (3) the residual approach (answer D). Answer C is not an actual estimation approach.

(L.O. 3) Servicetype warranties represent a separate service and are an additional performance obligation. Indicate whether each of the following is true (T) of false (F)

13. (T)

14. (L.O. 3) On February 1, 2017 Whitus Company sells 300 hard drives for $200 each on account to Walsh Company. Whitus allows Walsh to return any used hard drives within 30 days of purchase. The cost to Whitus of each hard drive is $120. On February 24, 2017 Walsh returns six hard drives because they are defective. On February 28, 2017, Whitus prepares financial statements and determines that it is likely that only two more hard drives will be returned. Which of the following will be part of a correct entry by Whitus? A. On February 1, 2017 Whitus should record a credit to Inventory in the amount of $35,040. B. On February 24, 2017 Whitus should record a credit to Accounts Receivable of $1,200. C. On February 28, 2017 Whitus should record a credit to Sales Revenue of $400. D. On February 28, 2017 Whitus should record a debit to Allowance for Sales Returns and Allowances of $400.

14. (B) Whitus Company would record the following entries: February 1, 2017 Accounts Receivable (300 x $200) 60,000 ----Sales Revenue 60,000 Cost of Goods Sold (300 x $120) 36,000 ----Inventory 36,000 February 24, 2017 Sales Returns and Allowances (6 x $200) 1,200 ----Accounts Receivable 1,200 Returned Inventory (6 x $120) 720 ----Cost of Goods Sold 720 February 28, 2017 Sales Returns and Allowances (2 x $200) 400 ----Allowance for Sales Returns and Allowances 400 Estimated Inventory Returns (2 x $120) 240 ----Cost of Goods Sold 240

(L.O. 4) Conditional rights should be reported separately from unconditional rights (receivables) on the balance sheet. Indicate whether each of the following is true (T) of false (F)

14. (T)

15. (L.O. 3) Bradley, Inc. a car dealer sells cars on January 1, 2017 to Stephens Company for $500,000. Bradley agrees to repurchase the cars (an unconditional obligation) from Stephens on December 31, 2017 for a price of $510,000. Which of the following is true regarding the transaction? A. An imputed interest rate will have to be used to record interest revenue by Bradley. B. The transaction should be accounted for as a lease. C. An imputed interest rate will have to be used to record interest expense by Bradley. D. On January 1, 2017 Bradley will have a credit entry to InventoryCars.

15. (C) For a sale and repurchase agreement, the terms of the agreement need to be analyzed to determine whether Bradley Inc. has transferred control to the customer, Stephens Company. In this case, Bradley Inc. continues to have control of the asset because it has agreed to repurchase the asset and an amount greater than the selling price. Therefore, this agreement is a financing transaction and not a sale. Thus, the asset is not removed from the books of Bradley (answer D therefore incorrect). As a financing agreement, Bradley will need to recognize interest expense (with a debit entry) on December 31, 2017.

16. (L.O. 3) Green Co. ships merchandise costing $60,000 on consignment to Butters Company. Green pays $2,500 of freight costs, and Butters pays $3,200 for local advertising costs that are reimbursable from Green. By the end of the period, Butters has sold one-fourth of the consigned merchandise for $80,000 cash. Butters notifies Green of the sales, retains a 20% commission, and remits the cash due Green. Which of the following entries is correct? A. When Butters receives the consigned goods from Green, Butters needs to debit Inventory for the amount of the goods received. B. When Butters pays the advertising costs, Butters needs to debit Advertising Expense. C. When Butters sells the consigned inventory, Butters needs to record a debit to Sales Revenue. D. When Butters receives the consigned inventory from Green, no entry should be made by Butters because the goods are still considered an asset on Green's books.

16. (D) When there is a consignment, the consignor carries the merchandise as inventory throughout the consignment. The consignee does not record the merchandise as an asset on its books—therefore answer A is incorrect. If the consignor pays costs that will be reimbursable by the consignor, then an expense is not debited but rather a Receivable from the Consignor—therefore answer B is incorrect. When the goods are sold on consignment, the consignee records a liability for the amount payable to the consignor—therefore answer C is incorrect.

(L.O. 4) Under the revenue guidance—as long as a contract exists (it is probable that the customer will pay)—the amount recognized as revenue is not adjusted for customer credit risk. Indicate whether each of the following is true (T) of false (F)

16. (T)

17. (L.O. 3) Ringo Company sold 2,000 televisions on June 1, 2017 at a total price of $2,000,000, with a warranty guarantee that they were free of defects. The cost of the televisions is $1,200,000. The term of this assurance warranty is 3 years with an estimated cost of $100,000. In addition Ringo sold extended warranties related to 600 televisions for 2 years beyond the 3year period for $40,000. On December 12, 2017, Ringo incurred labor costs of $5,000 and part costs of $12,000 related to the assurance warranties. Ringo prepares financial statements on December 31, 2017. It estimates that the future assurance warranty costs will total $50,000 at December 31, 2017. Which of the following entries is correct? A. On June 1, 2017 Ringo will make a credit to Sales Revenue of $2,040,000. B. On December 12, 2017 Ringo will make a debit to Warranty Expense of $17,000. C. On December 31, 2017 Ringo will make a debit to Warranty Expense of $67,000. D. On December 31, 2017 Ringo will make a debit to Warranty Expense of $50,000.

17. (B) Ringo Company would record the following entries: June 1, 2017 Cash ($2,000,000 + $40,000) 2,040,000 Sales Revenue 2,000,000 Unearned Warranty Revenue 40,000 Cost of Goods Sold 1,200,000 Inventory 1,200,000 December 12, 2017 Warranty Expense 17,000 Salaries and Wages Payable 5,000 Inventory (parts) 12,000 December 31, 2017 Warranty Expense 50,000 Warranty Liability 50,000

(L.O. 5) When a long-term construction contract exists and a company's performance creates or enhances an asset that the customer controls as the asset is created or enhanced, it should probably use the completed-contract method. Indicate whether each of the following is true (T) of false (F)

17. (F) Under a longterm contract, a company satisfies a performance obligation and recognizes revenue over time if one of three criteria are met and one of the criteria is that "the company's performance creates or enhances an asset that the customer controls as the asset is created or enhanced." Therefore, since one of the criteria is met it should recognize revenue over time—which is better recognized using the percentage-of-completion method than the completed-contract method.

*18. (L.O. 2) Which of the following is not part of the criteria to determine when a company would recognize revenue over a period of time? A. The company's performance creates or enhances an asset that the customer controls as the asset is created or enhanced. B. The company's performance does not create and asset with an alternative use. C. The customer simultaneously receives and consumes the benefits of the entity's performance as the entity performs. D. The company has no right to payment for its performance completed to date.

18. (D) A company satisfies a performance obligation and recognizes revenue over time if at least one of the following two criteria is met: 1. The customer receives and consumes the benefits of the entity's performance as the entity performs (answer C). 2. The company's performance creates or enhances an asset that the customer controls as the asset is created or enhanced (answer A); or 3. The company's performance does not create an asset with an alternative use (answer B). In addition to this alternative use element, at least one of the following criteria must be met: a. The customer receives the benefits as the company performs and therefore the task would not need to be re-performed. b. The company has a right to payment and that right is enforceable (the opposite of answer D).

(L.O. 5) Output measures can produce inaccurate results if the units used are not comparable in time, effort, or cost to complete. Indicate whether each of the following is true (T) of false (F)

18. (T)

5. (L.O. 2) Franiuk Hotdogs and Grill normally sells hotdogs for $2.00 but also t-shirts with the name of the business and its logo prominently displayed for $10. The t-shirts haven't been selling that well lately, so Franiuk has decided to sell a combination of the t-shirt for $10 with a free hot dog. Donovan buys the combination of the t-shirt and hot dog for $10 in cash. How should Franiuk account for the transaction? A. Franiuk should recognize $10 revenue, comprised of $10 for the tshirt and$0 for the hot dog. B. Franiuk should recognize $12 revenue, comprised of $10 for the tshirt, $2 for the hot dog, and $2 for discount expense. C. Franiuk should recognize $12 revenue, comprised of $10 for the tshirt, $2 for the hot dog and $2 as a liability. D. Franiuk should recognize $10 revenue, comprised of $8.33 for the tshirt and $1.67 for the hot dog.

5. (D) Franiuk should allocate the transaction price to the two performance obligations based on their standalone selling prices. The standalone selling price of the t-shirt is$10 and the hot dog is $2. The allocation for the t-shirt is $8.33 ($10 x $10/$12) and the allocation for the hot dog is $1.67 ($10 x $2/$12).

(L.O. 2) For revenue arrangements with multiple performance obligations and it is difficult to estimate what the good or service would sell for as standalone units the company should combine the items into a new aggregated revenue item and allocate the total transaction price to this new separate revenue item. Indicate whether each of the following is true (T) of false (F)

5. (F) For revenue arrangements with multiple performance obligations, and it is difficult to estimate what the good or service would sell for as standalone units, the company should use their best estimate of what the good or service might sell for as a standalone unit and allocate the transaction price to the separate performance obligations.

6. (L.O. 2) Which of the following is not a condition in the determination of when a valid contract exists: A. The contract has to be in writing. B. The payment terms are identified. C. The parties have approved the contract. D. It is probable that the consideration will be collected.

6. (A) A valid contract exists when (1) the contract has commercial substance, (2) the parties have approved the contract (answer C), (3) the contract identifies the rights of the parties, (4) payment terms are identified (answer B), and (5) it is probable that the consideration will be collected (answer D). A valid contract does not have to be in writing.

7. (L.O. 2) On April 4, Rudek Company enters into a contract to transfer a product to Gwinner Company on June 12. The contract is modified on May 6 with the price terms changing and transfer of the product changed to June 22. The modified contract is structured such that Gwinner is required to pay the full contract price of $3,500 on July 10. The cost of goods transferred is $2,700. Rudek delivers the product to Gwinner on June 22. When should Rudek recognize revenue on the transaction? A. Rudek should recognize revenue on April 4 only. B. Rudek should recognize revenue on April 4, but then enter an adjusting entry to reflect the modified contract terms on May 6. C. Rudek should recognize revenue on June 22. D. Rudek should recognize on July 10.

7. (C) No entry is required on April 4 (answer A) nor May 6 (answer B) because neither party has performed on the contract on those dates. On June 22 Rudek delivers the product and therefore should recognize revenue on that date as Rudek satisfies its performance obligation by delivering the product to Gwinner. Since Rudek has met its performance obligation on June 22, waiting until July 10 (answer D) is incorrect.

(L.O. 2) Companies often make payments to their customers such as discounts, volume rebates, coupons and free products. These elements have no effect on revenue but should be accordingly expensed. Indicate whether each of the following is true (T) of false (F)

7. (F) When companies make payments to their customers such as discounts, volume rebates, coupons and free products, these elements reduce the consideration received and the revenue to be recognized. They are not treated as an expense.

8. (L.O. 2) Which of the following is false concerning the identification of separate performance obligations? A. When two goods are not distinct within a contract, a company should still separate them into distinct performance obligations because products should never be combined and reported as one performance obligation. B. To determine whether a company has to account for multiple performance obligations, the company's promise to sell the good or service to the customer must be separately identifiable from other promises with the contract. C. When two goods are not distinct within a contract, a company should combine and report them as one performance obligation. D. A product or service is distinct when a customer is typically able to benefit from a good or service on its own or together with other readily available resources.

8. (A) When two goods are not distinct within a contract, that is, they are highly interdependent or interrelated within the contract, the products should be combined and reported as one performance obligation (similar to answer D). Therefore, answer A is false. Answers B and C are true statements in the determination of identifying separate performance obligations.

(L.O. 2) The best measure of fair value is what the company could sell the good or service for on a standalone basis. Indicate whether each of the following is true (T) of false (F)

8. (T)

9. (L.O. 2) When the price of a good or service is dependent on future events (such as price increases, volume discounts, and rebates) companies estimate the amount of variable consideration using either the expected value method (probability-weighted amount) or the most likely amount (in a range of possible amounts) method. Which of the following indicates that the most likely amount method should be used? A. If a company has a large number of contracts with similar characteristics. B. The variable consideration can be based on a limited number of discrete outcomes and probabilities. C. The contract has only two possible outcomes. D. The goods or services are not highly interdependent.

9. (C) When companies select among the expected value method or the most likely amount method they should look at which approach better predicts the amount of consideration to which a company is entitled. The expected value method would be preferred when a company has a large number of contracts with similar characteristics (answer A) or the variable consideration can be based on a limited number of discrete outcomes and probabilities (answer B). The most likely amount method would be appropriate if the contract has only two possible outcomes (answer C). The issue of interdependency of goods or services is related to separate performance obligations.

The party that receives goods from a consignor under a consignment.

Consignee.

The approach recognizes and measures revenue based on changes in assets and liabilities.

Asset-liability approach

A warranty that the product meets agreed-upon specifications in the contract at the time the product is sold.

Assurance-type warranty

The risk that a customer will be unable to pay the amount of consideration in accordance with a contract.

Collectibility.

The accounting for long-term construction contracts where revenues and gross profit are recognized at a point in time, that is, when the contract is completed.

Completed-contract method.

A contract under which an entity bills a customer for a product but the entity retains physical possession of the product until it is transferred to the customer at a point in time in the future.

Bill-and-hold arrangement.

Under the percentage-of-completion method, the balance in this account is subtracted from Construction in Process to avoid double-counting the inventory.

Billings account.

A method used under the percentage-of-completion method to estimate the extent of progress toward completion. Compares costs incurred to date with the most recent estimate of the total costs required to complete the contract.

Cost-to-cost basis.

A contractual arrangement whereby a franchisor grants business rights and provides services to a franchisee who in return agrees to pay an initial franchise fee to operate a business and pay continuing fees based on the operations of the business.

Franchise.

The party who operates the franchised business.

Franchisee.

The party who grants business rights under the franchise.

Franchisor.

A payment for establishing the franchise relationship and providing some initial services.

Initial franchise fee.

When measuring the extent of progress under the percentage-of-completion method, these are the costs incurred and labor hours worked and other efforts devoted to a contract.

Input measures.

When measuring the extent of progress under the percentage-of-completion method, these are the quantities or units completed on the project (such as tons produced, floors of building completed, miles of highway completed).

Output measures.

The accounting for long-term construction contracts where revenues, costs, and gross profit are recognized as a company makes progress toward completion of the contract based on the percentage of completion.

Percentage-of-completion method.

4. (L.O. 2) The fives-step revenue recognition model is as follows: 1. Identifying the Contract with Customers 2. Identifying Separate __ 3. Determining the __ 4. Allocating the Transaction Price to Separate Performance Obligations 5. Recognizing Revenue When (or as) Each Performance Obligation is __

Performance Obligations, Transaction Price, Satisfied

A promise to provide a product or service to a customer.

Performance obligation.

The principal's performance obligation is to provide goods or perform services for a customer. The agent's performance obligation is to arrange for the principal to provide these goods or services to a customer.

Principal-agent relationship.

This results when additional products are not a separate performance obligation because (1) the promised goods or services are not distinct, or (2) the new products are not priced at the proper stand-alone selling price.

Prospective modification.

An agreement which allows a company to transfer an asset to a customer but have an unconditional forward obligation or unconditional right (call option) to repurchase that asset at a later date.

Repurchase agreement.

(L.O. 1) The revenue recognition principle states that revenue is recognized when the performance obligation is satisfied. Indicate whether each of the following is true (T) of false (F)

T

(L.O. 2) The first step of the five step revenue recognition model is to identify the contract with customers. Indicate whether each of the following is true (T) of false (F)

T

(L.O. 2) When a customer gives cash for a shirt at a retail store and takes the shirt from the store after paying, revenue is recognized at that point in time because the performance obligation by the store has been satisfied. Indicate whether each of the following is true (T) of false (F)

T

(L.O. 3) During a consignment relationship, the consignee does not record the merchandise as an asset on its books. Indicate whether each of the following is true (T) of false (F)

T

The amount of consideration that a company expects to receive from a customer in exchange for transferring goods and services.

Transaction price.

Payments that a company receives from customers before they deliver a product or perform a service. They generally relate to the initiation, activation, or setup of a good or service to be provided or performed in the future. In most cases these fees are nonrefundable.

Upfront fees (nonrefundable).

A warranty can be an assurance-type (product meets agreed-upon specifications) or service-type (provides additional service beyond the assurance-type warranty).

Warranty.

5. First there must be a determination whether a valid __ exists. A __ is an agreement between two or more parties that creates enforceable rights or obligations. Contracts can be written, oral, or implied from customary business practice. Revenue is recognized only when a valid contract exists. The components of a valid contract and how it affects the parties are as follows: a. The contract has commercial substance; b. The parties have approved the contract; c. Identification of the rights of the parties; d. Payment terms identified; and e. It is probable that the consideration will be collected. In some cases, there are multiple contracts related to an arrangement; accounting for each contract may or may not occur, depending on the circumstances. These situations often develop when not only a product is provided but some type of service is performed as well. If the contract is wholly unperformed and each party can unilaterally terminate the contract without compensation, then revenue should not be recognized until one or both of the parties has performed. Until performance occurs, no net asset or net liability occurs.

contract, contract

A company accounts for a 'Contract Modification' as a New Contract

if both (1) the promised goods or services are distinct, and (2) the company has the right to receive an amount of consideration that reflects the standalone selling price of the promised goods or services.

z

z