Ch. 5 Revenue Recognition and Profitability Analysis

Dowell Fishing Supply, Inc., sold $50,000 of Dowell Rods on December 15, 2018, to Bassadrome. Because of a shipping backlog, Dowell held the inventory in Dowell's warehouse until January 12, 2019 (having assured Bassadrome that it would deliver sooner if necessary). How much revenue should Dowell recognize in 2018 for the sale to Bassadrome?

$0

Finerly Corporation sells cosmetics through a network of independent distributors. Finerly shipped cosmetics to its distributors and is considering whether it should record $300,000 of revenue upon shipment of a new line of cosmetics. Finerly expects the distributors to be able to sell the cosmetics, but is uncertain because it has little experience with selling cosmetics of this type. Finerly is committed to accepting the cosmetics back from the distributors if the cosmetics are not sold. How much revenue should Finerly recognize upon delivery to its distributors?

$0

Kerianne paints landscapes, and in late 2018 placed four paintings with a retail price of $250 each in the Holmstrom Gallery. Kerianne's arrangement with Holmstrom is that Holmstrom will earn a 20% commission on paintings sold to gallery patrons. As of December 31, 2018, one painting had been sold by Holmstrom to gallery patrons. How much revenue with respect to these four paintings should Kerianne recognize in 2018?

$250. Kerianne would recognize Holmstrom's commission as an expense.

Lewis Co. sold merchandise to AdCo for $60,000 and received $60,000 for that sale one month later. One week prior to receiving payment from AdCo, Lewis made a $10,000 payment to AdCo for advertising services that have a fair value of $7,500. After accounting for any necessary adjustments, how much revenue should Lewis Co. record for the merchandise sold to AdCo?

$57,500

Long-Term Contract Losses

A periodic loss that occurs for a project that is projected to be profitable overall An overall loss projected to occur for the entire project Sellers must update their estimates and recognize losses as necessary

Estimating the transaction price involves a variety of considerations, including:

Estimating variable consideration Identifying whether the seller is acting as a principal or an agent Considering the time value of money Accounting for payments by the seller to the customer

TrueTech enters into a contract with ProSport Gaming to add ProSport's online games to the Tri-Net network. ProSport offers popular games like Brawl of Bands, and wants those games offered on the Tri-Net so ProSport can sell gems, weapons, health potions, and other game features that allow players to advance more quickly in a game. The terms of the contract are: On January 1, 2016, ProSport pays TrueTech an up-front fixed fee of $300,000 for six months of featured access. ProSport also will pay TrueTech a bonus of $180,000 if Tri-Net users access ProSport games for at least 15,000 hours during the six-month period. TrueTech estimates a 75% chance that it will achieve the usage target and receive the $180,000 bonus. Requirement: Determine transaction price and recognize revenues using 1) expected value and 2) mostly like amount estimation.

Expected value: 435,000 Most likely amount: 480,000

Input-based estimate

Measured as the proportion of effort expended relative to the total expected effort expected

Not performance obligations:

Prepayments Quality-assurance warranties Right of return

When do we Recognize Revenue at a Single Point in Time

When control has transferred from the seller to the customer: An obligation to pay the seller Legal title to the asset Physical possession of the asset Assumed the risks and rewards of ownership Accepted the asset

When to Recognize Revenue over a Period of Time

When the customer *consumes the benefit* of the seller's work as it is performed The customer *controls the asset as it is created* The seller is creating an *asset that has no alternative use* to the seller and has the legal right to receive payment for progress to date even if the contract is cancelled

Braun Computer Company sells computers with an unconditional right to return the computer if the customer is not satisfied. Braun has a long history selling these computers under this returns policy and can provide precise estimates of the amount of returns associated with each sale. Braun most likely should recognize revenue: a. When Braun delivers a computer to a customer, ignoring potential returns. b. When Braun delivers a computer to a customer, in an amount that is reduced by the expected returns. c. When a customer returns a computer. d. When Braun receives cash from the customer.

b. When Braun delivers a computer to a customer, in an amount that is reduced by the expected returns.

Assume that Amazon.com sells the MacBook Pro, a computer produced by Apple, for a retail price of $1,500. Amazon arranges its operations such that customers receive products directly from Apple Stores rather than Amazon. Customers purchase from Amazon using credit cards, and Amazon forwards cash to Apple equal to the retail price minus a $150 commission that Amazon keeps. In this arrangement, how much revenue will Amazon recognize for the sale of one MacBook Pro?

$150

Siddhi enters into a contract offering variable consideration. The contract pays Siddhi $2,000/month for six months of continuous consulting services. In addition, there is a 60% chance the contract will pay an additional $4,000 and a 40% chance the contract will pay an additional $6,000, depending on the outcome of the consulting contract. Siddhi concludes that this contract qualifies for revenue recognition over time. Assume Siddhi estimates variable consideration as the most likely amount. What is the amount of revenue Siddhi would recognize for the first month of the contract?

$2,666

Siddhi enters into a contract offering variable consideration. The contract pays Siddhi $2,000/month for six months of continuous consulting services. In addition, there is a 60% chance the contract will pay an additional $4,000 and a 40% chance the contract will pay an additional $6,000, depending on the outcome of the consulting contract. Siddhi concludes that this contract qualifies for revenue recognition over time. Assume Siddhi estimates variable consideration as the expected value. What is the amount of revenue Siddhi would recognize for the first month of the contract?

$2,800

Zack developed software that helps farmers to plow their fields in a manner that prevents erosion and maximizes the effectiveness of irrigation. Spurlock paid a licensing fee of $60,000 for a copy of the software. Although Spurlock can use the software as long as it wants, Zack expects that Spurlock will use the software for approximately 5 years. Zack does not anticipate any further interaction with Spurlock following transfer of the license. How much revenue should Zack recognize in the first year of the contract?

$60,000

Allen Co. wrote a contract that involves two performance obligations. Product A has a stand-alone selling price of $100, and product B has a stand-alone selling price of $200. The price for the combined product is $240. How much of the transaction price would be allocated to the performance obligation for delivering product A?

$80

Adam sells $100,000 of product to Bob, and also purchases $10,000 of cleaning services from Bob. The cleaning services have a fair value of $7,000. Adam should record revenue on its sale of product to Bob of:

$97,000

Revenue recognized this period =

(total est rev X % completed to date/ cumulative rev to be recognized to date) - Rev recognized in prior periods

As a promotion, TrueTech Industries offers a 50% coupon for a gaming headset with the purchase of a Tri-Box at its normal price of $240. The headset costs $120 without a coupon (and $60 with a coupon), and the coupon must be exercised within one year of the Tri-Box purchase. TrueTech estimates that 80% of customers will take advantage of the coupon. 1. How would TrueTech account for the cash sale of 100 Tri-Boxes sold under this promotion on January 1,2016? 2.How would TrueTech account for this arrangement if it normally sells a headset at a 15% discount off its $120 list price? (Assume all other facts are unchanged.)

1. Cash 24000 Sales rev 20000 Def rev 4000 2. Cash 24,000 Sales rev 21053 Def rev 2947

Five Steps to Revenue Recognition

1. Identify the contract 2. Identify the performance obligation(s) 3. Determine the transaction price 4. Allocate the transaction price 5. Recognize revenue when (or as) each performance obligation is satisfied.

Saar Associates sells two licenses to Kim & Company on September 1, 2018. First, in exchange for $100,000, Saar provides Kim with a copy of its proprietary investment management software, which Saar does not anticipate updating and which Kim can use permanently. Second, in exchange for $90,000, Saar provides Kim with a three-year right to market Kim's financial advisory services under the name of Saar Associates, which Saar advertises on an ongoing basis. How much revenue will Saar recognize in 2018 under this arrangement?

110,000

McAfee sells a subscription to its antivirus software along with a subscription renewal option that allows renewal at half the prevailing price for a new subscription. How many performance obligations exist in this contract?

2

On July 1, 2018, Apache Company, a real estate developer, sold a parcel of land to a construction company for $3,000,000. The book value of the land on Apache's books was $1,200,000. Terms of the sale required a down payment of $150,000 and 19 annual payments of $150,000 plus interest at an appropriate interest rate due on each July 1 beginning in 2019. How much revenue will Apache recognize for the sale (ignoring interest), assuming that it recognizes revenue at the point in time at which it transfers the land to the construction company?

3,000,000

Leo Consulting enters into a contract with Highgate University to restructure Highgate's processes for purchasing goods from suppliers. The contract states that Leo will earn a fixed fee of $25,000 and earn an additional $10,000 if Highgate achieves $100,000 of cost savings. Leo estimates a 50% chance that Highgate will achieve $100,000 of cost savings. Assuming that Leo determines the transaction price as the expected value of expected consideration, what transaction price will Leo estimate for this contract?

35,000 x 50% = 17,500 25,000 x 50% = 12,500 30,000

Lake Power Sports sells jet skis and other powered recreational equipment. Customers pay one-third of the sales price of a jet ski when they initially purchase the ski, and then pay another one-third each year for the next two years. Because Lake has little information about the ability to collect these receivables, it uses the cost recovery method to recognize revenue on these installment sales. In 2017, Lake began operations and sold jet skis with a total price of $1,050,000 that cost Lake $525,000. Lake collected $350,000 in 2017, $350,000 in 2018, and $350,000 in 2019 associated with those sales. In 2018, Lake sold jet skis with a total price of $2,100,000 that cost Lake $1,260,000. Lake collected $700,000 in 2018, $560,000 in 2019, and $560,000 in 2020 associated with those sales. In 2020, Lake also repossessed $280,000 of jet skis that were sold in 2018. Those jet skis had a fair value of $105,000 at the time they were repossessed. In 2019, Lake would recognize realized gross profit of:

350,000

Hooper Inc. offers a discount on an extended warranty on its eyePhone when the warranty is purchased at the time the eyePhone is purchased. The warranty normally has a price of $300, but Hooper offers it for $240 when purchased along with an eyePhone. Hooper anticipates a 75% chance that a customer will purchase the extended warranty along with the eyePhone. Assume Hooper sells 1,000 eyePhones with the extended warranty discount offer. What is the total stand-alone selling price that Hooper would use for the extended warranty discount option for purposes of allocating revenue among the performance obligations in those 1,000 eyePhone contracts?

45,000

Noah sells gift cards redeemable for Noah products either in-store or online. During 2016, Noah sold $6,000,000 of gift cards, and $5,400,000 of the gift cards were redeemed for products. As of December 31, 2016, $450,000 of the remaining gift cards had passed the date at which Noah concludes that the cards will never be redeemed. How much gift card revenue should Noah recognize in 2016?

5,850,000

On May 1, 2018, Varga Tech Services signed a $6,000 consulting contract with Shaffer Holdings. The contract requires Varga to provide computer technology support services whenever requested over the period from May 1, 2018, to April 30, 2019, with Shaffer paying the entire $6,000 on May 1, 2018. How much revenue should Varga recognize in 2018?

6000/12 = 500 x 8 = $4,000

TopChop sells hairstyling franchises. TopChop receives $50,000 from a new franchisee for providing initial training, equipment and furnishings that have a stand-alone selling price of $50,000. TopChop also receives $30,000 per year for use of the TopChop name and for ongoing consulting services (starting on the date the franchise is purchased). Carlos became a TopChop franchisee on July 1, 2018, and on August 1, 2018, had completed training and was open for business. How much revenue in 2018 will TopChop recognize for its arrangement with Carlos?

65,000

GoodBuy sells gift cards redeemable for GoodBuy products either in store or online. During 2018, GoodBuy sold $1,000,000 of gift cards, and $840,000 of the gift cards were redeemed for products. As of December 31, 2018, $30,000 of the remaining gift cards had passed the date at which GoodBuy concludes that the cards will never be redeemed. How much gift card revenue should GoodBuy recognize in 2018?

870,000

Assume TrueTech sells 1,000 Tri-Boxes with a one-year Tri-Net subscription at $250. The stand-alone selling price of the Tri-Box is $240. The stand-alone selling price of the one-year subscription is highly uncertain because TrueTech hasn't established a price for it. Requirement: Allocate transaction price using the residual approach: Under the residual approach:

A/R 250,000 Sales rev 240,000 Deferred rev 10,000

Sarjit Systems sold software to a customer for $80,000. As part of the contract, Sarjit promises to provide "free" technical support over the next six months. Sarjit sells the same software without technical support for $70,000 and a stand-alone six-month technical support contract for $30,000, so these products would sell for $100,000 if sold separately. Prepare Sarjit's journal entry to record the sale of the software.

A/R 80,000 Sales Rev 56,000 Deferred Rev 24,000

Various approaches available to estimate stand-alone selling prices:

Adjusted market assessment approach Expected cost plus margin approach Residual approach Unknown stand-alone selling price = Total price - Known stand-alone selling price

If the seller purchases distinct goods or services from the customer:

At the fair value, the seller accounts for that purchase as a separate transaction Pays more than the fair value, those excess payments are viewed as a refund Subtracted from the amount the seller is entitled to receive when calculating the transaction price of the sale to the customer

Assume that TrueTech sold 1,000 Tri-Boxes to CompStores for $240 each. TrueTech estimates that CompStores will return five percent of the Tri-Boxes purchased.

Cash 240,000 Sales rev 240,000 Sales returns 12,000 Refund liability 12,000

Which of the following is not true about contract liabilities? a. Contract liabilities might be called deferred revenue. b. Contract liabilities are recognized when the seller has been paid in advance of satisfying its performance obligations. c. Contract liabilities are only recognized when the seller has a conditional right to receive payment. d. Contract liabilities may be shown on a separate line of the balance sheet.

Contract liabilities are only recognized when the seller has a conditional right to receive payment.

Bill-and-Hold Sales

Customers purchase goods but request that the seller not ship the product until a later date. Revenue is recognized when actual delivery occurs.

Performance obligations:

Extended warranties Options

Which of the following is not true about accounting for revenue from franchise arrangements? a. Franchise arrangements often include a performance obligation for a license as well as for delivery of goods and services. b. Franchise arrangements typically include one or more performance obligations for which revenue is recognized at a point in time. c. Franchise arrangements typically include one or more performance obligations for which revenue is recognized over a period of time. d. Franchise arrangements typically include one performance obligation because the goods and services included in the arrangement are not separately identifiable.

Franchise arrangements typically include one performance obligation because the goods and services included in the arrangement are not separately identifiable.

The right to sell the franchisor's products and use its name.

Include a license, as well as goods and services transferred at the start and over the life of the franchise. Initial fees recognized when goods and services are transferred; continuing fees recognized over time.

Some common arrangements can have complicated revenue recognition timing:

Licenses Franchises Bill-and-hold arrangements Consignment arrangements Gift cards

Which of the following is not true? a. License fees are recognized over time for any license that is viewed as providing a right of access. b. Licensing fees are recognized as revenue over time for any licenses for which the seller expects its ongoing activities to affect the benefits that the buyer receives from intellectual property. c. License fees are recognized as revenue at a point in time if the buyer expects that the seller's future activities will not affect the benefit the buyer derives from the intellectual property. d. Licensing fees always are recognized as revenue at the end of the license period, when the seller has completed its performance obligation to provide access to its intellectual property.

Licensing fees always are recognized as revenue at the end of the license period, when the seller has completed its performance obligation to provide access to its intellectual property.

Output-based estimate

Measured as the proportion of the goods or services transferred to date

How should the balances of progress billings and construction in process be shown at reporting dates prior to the completion of a long-term contract? a. Progress billings as deferred income, construction in progress as a deferred expense. b. Progress billings as income, construction in process as inventory. c. Net balance, as a current asset if debit balance, and current liability if credit balance. d. Net balance, as income from construction if credit balance, and loss from construction if debit balance.

Net balance, as a current asset if debit balance, and current liability if credit balance.

Aria Perfume, Inc., sold 3,210 boxes of white musk soap during January of 2018 at the price of $90 per box. The company offers a full refund to unsatisfied customers for any product returned within 30 days from the date of purchase. Based on historical experience, Aria expects that 3% of sales will be returned. How many performance obligations are there in each sale of a box of soap? How much revenue should Aria recognize in January?

Number of performance obligation: 1. Net revenue $280,233

eLean is an online fitness community, offering access to workout routines, nutrition advice, and eLean coaches. Customers pay a $50 fee to become registered on the website, and then pay $5 per month for access to all eLean services. How many performance obligations exist in the implied contract when a customer registers for the services?

Number of performance obligations in the contract: 1. Access to eLean services is one performance obligation. Registration on the website is not a performance obligation, but rather is part of the activity eLean must provide to satisfy its performance obligation of providing access to eLean's on-line services

Which of the following is typically true for a bill-and-hold arrangement? a. Revenue is recognized when goods are manufactured. b. Revenue is recognized when the arrangement is made. c. Revenue is recognized when the delivery of goods is made. d. Revenue is recognized at the point in time at which payment from the customer is received.

Revenue is recognized when the delivery of goods is made.

Clayton Consulting operates a website that links experienced statisticians with businesses that need data analyzed. Statisticians post their rates, qualifications, and references on the website, and Clayton receives 25% of the fee paid to the statisticians in exchange for identifying potential customers. Lovelace Associates contacts Clayton and arranges to pay a consultant $4,500 in exchange for analyzing some data. Clayton's income statement would include the following with respect to this transaction: a. Revenue of $4,500 b. Revenue of $4,500, and cost of services of $3,375 c. Revenue of $1,125 d. Revenue of $5,625 and cost of services of $4,500

Revenue of $1,125

Licenses

Right of use: revenue is recognized at the start of the license period, when the right is transferred. Example: a music download. Right of access: revenue is recognized over the period of time for which access is provided. Example: an NFL trademark granted to a company over a period of time.

Allen Co. wrote a contract that involves two separate performance obligations. Allen cannot estimate the stand-alone selling price of product A. Product B has a stand-alone selling price of $200. The price for the combined product is $240. How much of the transaction price would be allocated to the performance obligation for delivering product A?

S40

Gift Cards

Sales of gift cards are recognized as deferred revenue Gift card revenue is recognized when a gift card is redeemed or the likelihood of redemption is remote.

Alex Guerin is an artist who sells his work under consignment (he displays his work in local barbershops, and customers purchase his work there). Guerin recently transferred a painting on consignment to a local barbershop. After Guerin has transferred a painting to a barbershop, the painting: a. Should be counted in the barbershop's inventory, as the barbershop now possesses it. b. Should be counted in Guerin's inventory until the barbershop sells it. c. We lack sufficient information to know who should carry the painting in inventory. d. Should be counted in either Guerin's or the barbershop's inventory, depending on which incurred the cost of preparing the painting for display.

Should be counted in Guerin's inventory until the barbershop sells it.

Consignment Arrangements

The consignor physically transfers the goods to the consignee retains legal title. The consignee If a buyer is found, remits the selling price less commission. If a buyer is not found, returns the goods to the consignor. Revenue is recognized when sale to a third party occurs.

Which of the following is an indicator that revenue for a service should be recognized over time? a. The seller is enhancing an asset that the buyer controls as the service is performed. b. The seller is providing continuous effort to the buyer. c. The seller can estimate the percent of work completed. d. The sales price is fixed and determinable.

The seller is enhancing an asset that the buyer controls as the service is performed.

Which of the following is not an indicator that control of a good has passed from the seller to the buyer? a. Buyer has legal title. b. Buyer has an unconditional obligation to pay. c. Buyer has scheduled delivery. d. Buyer has assumed the risk and rewards of ownership

c. buy has scheduled delivery

A contract does not exist if:

neither the seller nor the customer has performed any obligations and both the seller and the customer can terminate the contract without penalty