Exam 2 ACCTG 331

In what 3 situations is it necessary to impute an interest rate for notes receivable?

1) no interest rate is stated for the transaction, or (2) the stated interest rate is unreasonable, or (3) the stated face amount of the note is materially different from the current cash price for the same or similar items or from the current market value of the debt instrument.

Distinguish among the following: 1.) A general checking account 2.)An imprest bank account 3.) A lock box account

1)The general checking account is the principal bank account of most companies and frequently the only bank account of small companies. Most if not all transactions are cycled through the general checking account, either directly or on an imprest basis. (2)Imprest bank accounts are used to disburse cash (checks) for a specific purpose, such as dividends, payroll, commissions, or travel expenses. Money is deposited in the imprest fund from the general fund in an amount necessary to cover a specific group of disbursements. (3)Lockbox accounts are local post office boxes to which a multi-location company instructs its customers to mail remittances. A local bank is authorized to empty the box daily and credit the company's accounts for collections.

What are the two methods of recording accounts receivable transactions when a cash discount situation is involved

1.) Record receivables and sales gross. 2.) Record receivables and sales net.

Identify the five steps in the revenue recognition process

1. Identify the contract(s) with customers. 2. Identify the separate performance obligations in the contract. 3. Determine the transaction price. 4. Allocate the transaction price to the separate performance obligations. 5. Recognize revenue when each performance obligation is satisfied.

Under what 3 conditions does a company recognize revenue over a period of time

1. The customer receives and consumes the benefits as the seller performs. 2. The customer controls the asset as it is created or enhanced (e.g., a builder constructs a building on a customer's property). 3. The company does not have an alternative use for the asset created or enhanced (e.g., an aircraft manufacturer builds specialty jets to a customer's specifications) and either (a) the customer receives benefits as the company performs and therefore the task would not need to be re-performed, or (b) the company has a right to payment and this right is enforceable.

Indicate three reasons why a company might sell its receivables to another company

1.) A company might sell receivables because money is tight and access to normal credit is not available or prohibitively expensive. 2.) Also, a company may have to sell its receivables, instead of borrowing, to avoid violating existing lending arrangements. 3.) In addition, billing and collection of receivables are often time-consuming and costly.

How do companies recognize revenue from a performance obligation over time

A company recognizes revenue from a performance obligation over time by measuring the progress toward completion. The method selected for measuring progress should depict the transfer of control from the company to the customer. The most common are the cost-to-cost and units-of-delivery methods. The objective of these methods is to measure the extent of progress in terms of costs, units, or value added. Companies identify the various measures (costs incurred, labor hours worked, tons produced, floors completed, etc.) and classify them as input or output measures. Input measures (costs incurred, labor hours worked) are efforts devoted to a contract. Output measures (with units of delivery measured as tons produced, floors of a building completed, miles of a highway completed) track results. Neither is universally applicable to all long-term projects. Their use requires the exercise of judgment and careful tailoring to the circumstances. The most popular input measure used to determine the progress toward completion is the cost-to-cost basis. Under this basis, a company measures the percentage of completion by comparing costs incurred to date with the most recent estimate of the total costs required to complete the contract.

Indicate the circumstances that determine when one or the other of these methods should be used

A company satisfies a performance obligation and recognizes revenue over time if at least one of the following three criteria is met: 1. The customer simultaneously receives and consumes the benefits of the entity's performance as the entity performs. 2. The company's performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced; or 3. The company's performance does not create an asset with an alternative use. For example, the asset cannot be used by another customer. In addition to this alternative use element, at least one of the following criteria must be met: (a) Another company would not need to substantially re-perform the work the company has completed to date if that other company were to fulfill the remaining obligation to the customer. (b) The company has a right to payment for its performance completed to date, and it expects to fulfill the contract as promised. Therefore, if criterion 1 or 2 is met, then a company recognizes revenue over time if it can reasonably estimate its progress toward satisfaction of the performance obligations. That is, it recognizes revenues and gross profits each period based upon the progress of the construction—referred to as the percentage-of-completion method. The rationale for using percentage-of-completion accounting is that under most of these contracts the buyer and seller have enforceable rights. The buyer has the legal right to require specific performance on the contract. The seller has the right to require progress payments that provide evidence of the buyer's ownership interest. As a result, a continuous sale occurs as the work progresses. Companies should recognize revenue according to that progression. The right to payment for performance completed to date does not need to be for a fixed amount. However, the company must be entitled to an amount that would compensate the company for performance completed to date (even if the customer can terminate the contract for reasons other than the company's failure to perform as promised). Alternatively, if the criteria for recognition over time are not met (e.g., the company does not have a right to payment for work completed to date), the company recognizes revenues and gross profit at a point in time, that is, when the contract is completed. This approach is referred to as the completed-contract method.

When does a company satisfy a performance obligation

A company satisfies its performance obligation when the customer obtains control of the good or service.

Define a "compensating balance."

A compensating balance is that portion of any demand deposit maintained by a corporation which constitutes support for existing borrowing arrangements of a corporation with a lending institution.

How should a compensating balance be reported

A compensating balance representing a legally restricted deposit held against short-term borrowing arrangements should be stated separately among the cash and cash equivalent items. A restricted deposit held as a compensating balance against long-term borrowing arrangements should be separately classified as a noncurrent asset in either the investments or other assets section.

CA 18-1 B.) Explain the importance of contracts when analyzing revenue arrangements

A contract is an agreement between two or more parties that creates enforceable rights between two or more parties that creates enforceable rights or obligations. Contracts can be written, oral, or implied from customary business practice. By definition, revenue from a contract with a customer cannot be recognized until a contract exists. On entering into a contract with a customer, a company obtains rights to receive consideration from the customer and assumes obligations to transfer goods or service to the customer (performance obligations). In some cases, there are multiple contracts related to the transaction, and accounting for each contract may or may not occur, depending on the circumstance. These situations often develop when not only a product is provide but some type of service is performed as well

Explain the accounting for contact modifications

A contract modification occurs if a company changes the contract terms during the term of the contract. When a contract is modified, the company must determine whether a new performance obligation has occurred or whether it is a modification of the existing performance obligation. If it is a modification of an existing performance obligation, then the change is generally reported prospectively or as a cumulative effect adjustment to revenue, depending on the circumstances. If the modification results in a separate performance obligation, then this performance obligation should be accounted for separately.

What are the general rules for measuring and recognizing gain or loss by both the debtor and the creditor in an impairment

A loan is considered impaired when it is probable that the creditor will be unable to collect all amounts due (both principal and interest) according to the contractual terms of the loan. If a loan is considered impaired, the loss due to impairment should be measured as the difference between the investment in the loan and the expected future cash flows discounted at the loan's historical effective-interest rate. The loss is recorded on the books of the creditor. The debtor would not be aware of the entry made by the creditor and would not make an entry until settlement or if a modification of terms resulted.

Of what merit is the contention that the allowance method lacks the objectivity of the direct write-off method? Discuss in terms of accounting's measurement function

A major part of accounting is the measurement of financial data. Estimates of uncollectibility should be recognized so that receivables are reported at net realizable value and in order for accounting to provide useful information on a periodic basis. The very existence of accounts receivable is based on the decision that a credit sale is an objective indication that revenue should be recognized. The alternative is to wait until the debt is paid in cash. If revenue is to be recognized and an asset recorded at the time of a credit sale, the need for fairness in the statements requires that both expenses and the asset be adjusted for the estimated amounts of the asset that experience indicates will not be collected. The argument may be persuasive that the evidence supporting write-offs permits a more accurate decision than that which supports the allowance method. The latter method, however, is "objective" in the sense in which accountants use the term and is justified by the need for fair presentation of receivables and income. The direct write-off method is not wholly objective; it requires the use of judgment in determining when an account has become uncollectible.

What is a performance obligation

A performance obligation is a promise in a contract to provide a product or service to a customer. This promise may be explicit, implicit, or possibly based on customary business practice.

What is the nature of a sale on consignment

A sale on consignment is the shipment of merchandise from a manufacturer (or wholesaler) to a dealer (or retailer) with title to the goods and the risk of sale being retained by the manufacturer who becomes the consignor. The consignee (dealer) is expected to exercise due diligence in caring for the merchandise and the dealer has full right to return the merchandise. The consignee receives a commission upon the sale and remits the balance of the cash collected to the consignor. The consignor recognizes a sale and the related revenue upon notification of sale from the consignee and receipt of the cash. The consigned goods are carried in the consignor's inventory, not the consignee's, until sold.

When should a transfer of receivables be recorded as a sale?

A transfer of receivables should be recorded as a sale when the following three conditions are met: (a) The transferred asset has been isolated from the transferor (put beyond reach of the transferor and its creditors). (b) The transferees have obtained the right to pledge or exchange either the transferred assets or beneficial interests in the transferred assets. (c) The transferor does not maintain effective control over the transferred assets through an agreement to repurchase or redeem them before their maturity.

What account should cash in a bank that is in receivership be classified as

A/R

What account should NSF check (returned with bank statement) be classified as

A/R, a loss if uncollectible

Sprinsteen Inc. reported in a recent annual report "Restricted cash for debt redemption." What section of the balance sheet would report this item

Restricted cash for debt redemption would be reported in the long-term asset section, probably in the investments section. Another alternative is the other assets section. Given that the debt is long term, the restricted cash should also be reported as long term.

What is the proper accounting for volume discounts on sales on products

Any discounts or volume rebates should reduce consideration received and reduce revenue recognized.

Identify some "input measures" and some "output measures" that might be used to determine the extent of progress

Costs incurred and labor hours worked are examples of input measures, while tons produced, stories of a building completed, and miles of highway completed are examples of output measures.

Explain how the accounting for bad debts can be used for earnings management

Because estimation of the allowance account balance requires judgment, management could either over-estimate or under-estimate the amount of uncollectible accounts depending on whether a higher or lower earnings number is desired. For example, Sun Trust bank (referred to in the chapter) was having a very profitable year. By over-estimating the amount of bad debts, Sun Trust could record a higher allowance and expense, thereby reducing income in the current year. In a subsequent year, when earnings are low, they could under-estimate the allowance, record less expense and get a boost to earnings.

You are evaluating Woodlawn Racetrack for a potential loan. An examination of the notes to the financial statements indicates restricted cash at year-end amounts to $100,000. Explain how you would use this information in evaluating Woodlawn's liquidity

Because the restricted cash cannot be used by Woodlawn to meet current obligations, it should not be reported as a current asset—it should be reported in investments or other assets. Thus, although this item has cash in its label, it should not be reflected in liquidity measures, such as the current or acid-test ratios.

Explain a bill-and-hold sale

Bill-and-hold sales result when the buyer is not yet ready to take delivery but the buyer takes title and accepts billing.

What account should coins and currency be classified as

Cash

What account should deposits in transit be classified as

Cash

What account should petty cash be classified as

Cash

What account should savings and checking accounts be classified as

Cash

What may be included under the heading of "cash

Cash normally consists of coins and currency on hand, bank deposits, and various kinds of orders for cash such as bank checks, money orders, travelers' checks, demand bills of exchange, bank drafts, and cashiers' checks. Balances on deposit in banks which are subject to immediate withdrawal are properly included in cash. Money market funds that provide checking account privileges may be classified as cash. There is some question as to whether deposits not subject to immediate withdrawal are properly included in cash or whether they should be set out separately. Savings accounts, certificates of deposit, and time deposits fall in this latter category. Unless restrictions on these kinds of deposits are such that they cannot be converted (withdrawn) within one year or the operating cycle of the entity, whichever is longer, they are properly classified as current assets. At the same time, they may well be presented separately from other cash and the restrictions as to convertibility reported.

Describe the critical factor in evaluating whether a performance obligation is satisfied

Change in control is the deciding factor in determining when a performance obligation is satisfied. Control is transferred when the customer has the ability to direct the use of and obtain substantially all the remaining benefits from the asset or service. Control is also indicated if the customer has the ability to prevent other companies from directing the use of, or receiving the benefit, from the asset or service.

Describe the estimation of the allowance, based on expected cash flows

Companies commonly evaluate loans (long-term notes receivable) for collectability based on an analysis of the expected contractual cash flows. They then apply discounted expected cash flow methods, to measure the allowance to report the loan at net realizable value. The allowance for doubtful accounts and related bad debt expense on a loan or note receivable can be estimated as the difference between the investment in the loan (generally the principal plus accrued interest or amortized cost) and the expected future cash flows discounted at the loan's historical effective-interest rate.

Explain the reporting for costs to : (a) fulfill a contract and (b) collectibility

Companies divide fulfillment costs (contract acquisition costs) into two categories: (1) those that give rise to an asset, and (2) those that are expensed as incurred. Companies recognize an asset for the incremental costs, if these costs are incurred to obtain a contract with a customer. In other words, incremental costs are costs that a company would not incur if the contract had not been obtained (for example, selling commissions). Other examples are: (a) Direct labor, direct materials, and allocation of costs that relate directly to the contract (such as costs of contract management and supervision, insurance, and depreciation of tools and equipment), and (b) Costs that generate or enhance resources of the company that will be used in satisfying performance obligations in the future. Costs include intangible design or engineering costs that will continue to benefit in the future. Companies capitalize costs that are direct, incremental, and recoverable (assuming that the contract period is more than one year). Collectibility - Any time a company sells a product or performs a service on account, a collectibility issue occurs. Collectibility refers to a customer's credit risk, that is, the risk that a customer will be unable to pay the amount of consideration in accordance with the contract. 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. Thus, companies report the revenue gross (without consideration of credit risk) and then present an allowance for any impairment due to bad debts recognized initially and subsequently in accordance with the respective bad debt guidance). An impairment related to bad debts is reported as an operating expense in the income statement. Whether a company will get paid for satisfying a performance obligation is not a consideration in determining revenue recognition.

Explain the accounting type for each type of warranty

Companies do not record a separate performance obligation for assurance-type warranties. These types of warranties are nothing more than a quality guarantee that the good or service is free from defects at the point of sale. These types of obligations should be expensed in the period the goods are provided or services performed. In addition, the company should record a warranty liability. The estimated amount of the liability includes all the costs that the company will incur after sale and that are incident to the correction of defects or deficiencies required under the warranty provisions. Warranties that provide the customer a service beyond fixing defects that existed at the time of sale represent a separate service and are an additional performance obligation. As a result, companies should allocate a portion of the transaction price to this performance obligation. The company recognizes revenue in the period that the service type warranty is in effect.

CA 18-1 C.) How are fair value measurement concepts applied in implementation of the five-step process

Companies often have to allocate the transaction pirce to more than one performance obligation in a crontract. If an allocation is needed, the transaction price allocated to the various performance obligations is based on standalone selling prices. If this information is not available, conpanies should use thier best estimate of what the good or ervice might sell for as a standalone unit. Depending on the circrumstances companies use the following appraches to determine standalond selling price: (1) Adjusted market assessment approach-Evaluate the market in whihc it sells goods or services and estimate the price that customers in that market are willing to pay for those goods or services. That approach also might include referring to prices from the company's competitors for similar goods or serices and adjusting those prices as necessary to reflect the company's costs and margins (2) Expected cost plus a margin approach-Forecast expected costs of satisfying a performance obligation and then add an appropriate margin for that good or service; or (3) Residual approach- If the standalone selling price of a good or service is highly variable or uncertain, then a company may estiate the standalone selling prices of other goods or servicees promised in the contract. A selling price is highly variable when a company sells the same good or service to different customers (at or near the same time) for a broad range of amounts. A selling price is uncertain when a company has not yet establsihed a rpice for a good or service and the good or service has not previously been sold

CA 18-1 D.) How does the five-step process reflect application of the definitions of assets and liabilities

Companies use an asset-liabilty model to recognize revenue. For example, when a company delivers a product (satisfyiing its performance obligation), it has a right to consideration and therefore has a contract asset. If on the other hand, the customer performs first by prepaying the seller has a contract liability. Companies must present these contract assets and contract liabilites on their balance sheets. Contract assets are of 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. Companies should report unconditional rights to receive consideration as a receivable on the balance sheet. Conditional rights on the balance sheet should be reported separate as contract assets. A contract liability is a company's obligation to transfer goods or services to a customer for which the company has received consideration from the customer. It is generally shown in an unearned revenue account

What are the two approaches for estimating variable consideration

Companies use either (1) the expected value, which is a probability weighted amount, or (2) the most likely amount in a range of possible amounts to estimate variable consideration. Companies select among these two methods based on which approach better predicts the amount of consideration to which a company is entitled.

How should a franchisor account for continuing franchise fees and routine sales of equipment and supplies to franchisees

Continuing franchise fees should be reported as revenue when the performance obligations related to those fees have been satisfied by the franchisor. These revenues are generally recognized over time as the related product and services are provided. Continuing product sales would be accounted for in the same manner as would any other product sales.

How is each type of loss that becomes evident in accounting for long-term contracts accounted for

Cost estimates at the end of the current period may indicate that a loss will result upon completion of the entire contract. Under both percentage-of-completion and completed contract methods, the entire loss must be recognized in the current period.

What are two basic methods of accounting for long-term construction contracts

For the most part, companies recognize revenue at the point of sale because that is when the performance obligation is satisfied. Under certain circumstances, companies recognize revenue over time. The most notable context in which revenue is recognized over time is long-term construction contract accounting. Long-term contracts frequently provide that the seller (builder) may bill the purchaser at intervals, as it reaches various points in the project.

What was viewed as a major criticism of GAAP as it relates to revenue recognition?

GAAP had numerous standards related to revenue recognition, but many believed the standards were often inconsistent with one another.

What are the reporting issues in a sale with a repurchase agreement

If a company sells a product in one period and agrees to buy it back in the next period, legal title may have transferred, but the economic substance of the transaction is that the seller retains the risks of ownership. When companies enter into repurchase agreements, they are allowed to transfer an asset to a customer but have an unconditional (forward) obligation or unconditional right (call option) to repurchase the asset at a later date. In these situations, the question is whether the company sold the asset. Generally, companies report these transactions as a financing (borrowing). That is, if the company has a forward obligation or call option to repurchase the asset for an amount greater than or equal to its selling price, then the transaction is a financing transaction.

On what basis should the transaction price e allocated to various performance obligations

If an allocation of transaction price to various performance obligations is needed, the allocation is based on what the company could sell the good or service 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.

What is the normal procedure for handling the collection of accounts receivable previously written off using the allowance method

If the allowance method is used, then the accountant would debit Accounts Receivable and credit the Allowance for Doubtful Accounts. An entry is then made to credit the customer's account and debit Cash upon receipt of the remittance.

What is the normal procedure for handling the collection of accounts receivable previously written off using the direct write-off method

If the direct write-off method is used, the only alternative is to debit Cash and credit a revenue account entitled Uncollectible Amounts Recovered.

What is "imputed interest"?

Imputed interest is the interest ascribed or attributed to a situation or circumstance which is void of a stated or otherwise appropriate interest factor. Imputed interest is the result of a process of interest rate estimation called imputation

Explain a principal-agent relationship and its significance to revenue recognition

In a principal-agent relationship, 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. In a principal-agent relationship, amounts collected on behalf of the principal are not revenue of the agent. The revenue for the agent is the amount of the commission it receives (usually a percentage of the selling price or total revenue).

What are the considerations in imputing an appropriate interest rate

In imputing an appropriate interest rate, consideration should be given to the prevailing interest rates for similar instruments of issuers with similar credit ratings, the collateral, and restrictive covenants.

What additional factors related to the transaction price must be considered in determining the transaction price

In other contracts, companies must consider the following factors (1) Variable consideration, (2) Time value of money, (3) Non-cash consideration, and (4) Consideration paid or payable to customer.

Engelhart Implements Inc. sells tractors to area farmers. The price for each tractor includes GPS positioning service for 9 months (which facilitates field settings for planting and harvesting equipment). The GPS service is regularly sold on a standalone basis by Engelhart for a monthly fee. After the 9-month period, the consumer can renew their service on a fee basis. Does Engelhart have one or multiple performance obligations? Explain.

In this situation, it appears that Engelhart has two performance obligations: (1) one related to providing the tractor and (2) the other related to the GPS services. Both are distinct (they can be sold separately) and are not interdependent.

Identify the 5 indicators of satisfaction of a performance obligation

Indications that the customer has obtained control are: 1. The company has a right to payment for the asset. 2. The company transferred legal title to the asset. 3. The company transferred physical possession of the asset. 4. The customer has the significant risks and rewards of ownership. 5. The customer has accepted the asset.

What account should U.S. Treasury (government) bonds be classified as

Investments

What account should cash to be used for retirement of long-term bonds be classified as

Investments, possibly other assets

Why in franchise arrangements may it be improper to recognize the entire franchise fee as revenue at the date of sale

It is improper to recognize the entire franchise fee as revenue at the date of sale when many of the services of the franchisor are yet to be performed.

Explain the current environment regarding revenue recognition

Most revenue transactions pose few problems for revenue recognition. This is because, in many cases, the transaction is initiated and completed at the same time. However, due to the complexity of some transactions, many believe the revenue recognition process is increasingly complex to manage, more prone to error, and more material to financial statements compared to any other area of financial reporting. In addition, even with the many standards, no comprehensive guidance was provided for service transactions. As a result, the FASB and IASB have indicated that the present state of reporting for revenue is unsatisfactory and the Boards issued a standard, "Revenue from Contracts with Customers". This new standard provides a new approach for how and when companies should report revenue. The standard is comprehensive and applies to all companies. As a result, comparability and consistency in reporting revenue should be enhanced.

What account should deposit in foreign bank (exchangeability limited) be classified as

Other assets if not expendable, cash if expendable for goods and services in the foreign country

What other 2 methods, besides an aging analysis, can be used for estimating uncollectible accounts

Other methods that companies may use employ estimates based on historical loss ratios for customers with different credit ratings as a basis for estimating uncollectible accounts. Or a company may utilize a probability-weighted discounted cash flow model (as illustrated in Chapter 6) to estimate expected credit losses.

What account should stamps be classified as

Postage expense, or prepaid expense, or office supplies inventory

What account should travel advances be classified as

Receivable from employee if the company is to be reimbursed; otherwise, prepaid expense

What account should postdated checks be classified as

Receivable if collection expected within one year; otherwise, other asset

Moon Hardware is planning to factor some of its receivables. The cash received will be used to pay for inventory purchases. The factor has indicated that it will require "recourse" on the sold receivables. Explain to the controller of moon Hardware what "recourse" is and how the "recourse" is and how the recourse will be reflected in Moon's financial statements after the sale of the receivables.

Recourse is a guarantee from Moon that if any of the sold receivables are uncollectible, Moon will pay the factor for the amount of the uncollectible account. This recourse obligation represents continuing involvement by Moon after the sale. Under the financial components model, the estimated fair value of the recourse obligation will be reported as a liability on Moon's balance sheet.

When is revenue recognized when revenue from disposing of assets other than products

Revenue from disposing of assets other than products—at the date of sale.

When is revenue recognized when revenue from permitting others to use company assets

Revenue from permitting others to use company assets—as time passes or as the assets are used.

When is revenue recognized when revenue from selling products

Revenue from selling products—date of delivery to customers.

When is revenue recognized when revenue from services performed

Revenue from services performed—when the services have been performed (performance obligation satisfied).

When is revenue recognized in a bill-and-hold sale

Revenue is recognized at the time title passes, if all of the following criteria are met and the control provisions related to revenue recognition are met: (a) The reason for the bill-and-hold arrangement must be substantive. (b) The product must be identified separately as belonging to the customer. (c) The product currently must be ready for physical transfer to the customer. (d) The seller cannot have the ability to use the product or to direct it to another customer.

How does accounting for sales allowance relate to the concept of variable consideration

Since management must estimate expected allowances to be granted in the future, which affects the final transaction price, sales allowances result in variable consideration.

What are the two types of warranties

a. Warranties that the product meets agreed-upon specifications in the contract at the time the product is sold. This type of warranty is included in the sale price of the company's product and is often referred to as an assurance-type warranty. b. Warranties that provide an additional service beyond the assurance-type warranty. This warranty is not included in the sale price of the product and is referred to as a service-type warranty.

CA 18-1: A.) Briefly describe the five-step process

Step 1: Identify the contract with customers A contract is an agreement that creates enforceable rights or obligations and (1) has commercial substance (2) has been approved and both parties are committed to performing their obligations (3) the company can identify each party's rights regarding the goods or services to be transferred (4) they payment terms (5) it is probable that consideration will be collected. A company applies the revenue guidance to contracts with customers and must determine if new performance obligations are created by a contract modification Step 2: Identify the separate performance obligations in the contract A performance obligation is a promise in a contract to provide a product or service to a customer. A performance obligation exists if the customer can benefit from the good or service on its own or together with other readily available resources. A contract may be comprise of multiple performance obligations. The accounting for multiple performance obligations is based on evaluation of wether the product or service is distinct within the contract. If each other goods or services is distinct within the contract. If each of the goods or services is distinct, but is interdependent and interrelated, these goods and services are combined and reported as one performance obligation. In other words, the objective is to determine whether the nature of a company's promise is to transfer individual goods and services to the customer or to transfer a combined item (or items) for which individual goods or services are inputs Step 3: Determine the transaction price The transaction price is the amount of consideration that a company expects to receive from a customer in exchange for transferring goods and services. In determining the transaction price, companies must consider the 5 following factors 1.) Variable considers 2.)Time value of money 3.) Noncash consideration 4.) Consideration paid to a customer 5.)Upfront cash payments Step 4: Allocate the transaction price to separate performance obligations If there is more than on performance obligation, allocate the transaction price based on what the good or service could be sold for on a standalone basis (standalone selling price). Estimates of standalone selling price can be based on (1) adjusted market assessment, (2) expected cost pus a margin approach, or (3) a residual approach Step 5: Recognize revenue when each performance obligation is satisfied A company satisfies its performance obligation when the customer obtains control of the good or service. Companies satisfy performance obligations either at a point in time or over a period of time. Companies recognize revenue over a period of time if one of the following three criteria is met. 1.) The customer receives and consumers the benefits as the seller performs 2.) The customer controls the asset as it is created or enhance (e.g., a builder contracts a building on a customer's property) 3.) The company does not have an alternative use for the asset created or enhance (e.g.,/ an aircraft manufacturer builds specialty jets to a customer's specification) and either (1) the customer receives benefits as the company performs and therefore the task would not need to be re-performed or (b) the company has a right to payment and this right is enforceable

How to find NRV

Subtract the costs required to prepare the item for sale from the expected selling price. The result is the net realizable value of the item in inventory.

What account should certificate of deposit (matures in 3 months) be classified as

Temporary Investments

Where do companies that elect the fair value option report unrealized holding gains and losses?

The Board believes that fair value measurement for financial instruments provides more relevant and understandable information than historical cost. If companies choose the fair value option, the receivables are recorded at fair value, with unrealized gains or losses reported as part of net income

What is the accounts receivable turnover

The accounts receivable turnover ratio is computed by dividing net sales by average net receivables outstanding during the year.

Allowance Method for Bad debt expense

The allowance method anticipates and estimates that some of the accounts receivable will not be collected. In other words, prior to knowing exactly which customers or clients will not be paying, the company will debit Bad Debts Expense and will credit Allowance for Doubtful Accounts for the estimated amount. (The Allowance for Doubtful Accounts is a contra asset account that when presented along with Accounts Receivable indicates a more realistic amount that will be turning to cash.)

What are the 3 basic problems that occur in the valuation of accounts receivable

The basic problems that relate to the valuation of receivable are (1) the determination of the face value of the receivable, (2) the probability of future collection of the receivable, and (3) the length of time the receivable will be outstanding. The determination of the face value of the receivable is a function of the trade discount, cash discount, and certain allowance accounts such as the Allowance for Sales Returns and Allowances.

Direct Write off Method for Bad debt expense

The direct write-off method requires that a customer's uncollectible account be removed from Accounts Receivable and at that time the following entry is made: debit Bad Debts Expense and credit Accounts Receivable.

What 3 qualitative and quantitative disclosures are required related to revenue recognition

The disclosure requirements for revenue recognition are designed to help financial statement users understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. To achieve that objective, companies disclose qualitative and quantitative information about all of the following: Contracts with Customers - These disclosures include the disaggregation of revenue, presentation of opening and closing balances in contract assets and contract liabilities, and significant information related to their performance obligations. Significant judgments. - These disclosures include judgments and changes in these judgments that affect the determination of the transaction price, the allocation of the transaction price, and the determination of the timing of revenue. Assets recognized from costs incurred to fulfill a contract. -These disclosures include the closing balances of assets recognized to obtain or fulfill a contract, the amount of amortization recognized, and the method used for amortization.

What is the fair value option?

The fair value option gives companies the option of using fair value as the measurement basis for financial instruments.

When is the financial components approach to recording the transfers of receivables used?

The financial components approach is used when receivables are sold but there is continuing involvement by the seller in the receivable. Examples of continuing involvement are recourse provisions or continuing rights to service the receivable.

Explain the importance of a contract in the revenue recognition process

The first step in the revenue recognition process is the identification of a contract or contracts with the customer. A contract is an agreement between two or more parties that creates enforceable rights or obligations. That is, the contract identifies the performance obligations in a revenue arrangement. Contracts can be written, oral, or implied from customary business practice. In some cases, there may be multiple contracts related to the transaction, and 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.

What is the nature of each type of loss when the types of losses become evident in accounting long-term contracts

The first type of loss is actually an adjustment in the current period of gross profit recognized on the contract in prior periods. It arises when, during construction, there is a significant increase in the estimated total contract costs but the increase does not eliminate all profit on the contract. Under the percentage-of-completion method, the estimated cost increase necessitates a current period adjustment of previously recognized gross profit; the adjustment results in recording a current period loss. No adjustment is necessary under the completed-contract method because gross profit is only recognized upon completion of the contract.

Which of these two, 1. to record receivable and sales gross or 2. to record receivables and sales net, are used in practice more of the time? Why?

The gross method for receivables and sales is used in practice normally because it is expedient and its use does not generally have any significant effect on the presentation of the financial statements.

What methods are used in practice to determine the extent of progress toward completion

The methods used to determine the extent of progress toward completion are the cost-to-cost method and units-of-delivery method.

Which of these two, 1. to record receivable and sales gross or 2. to record receivables and sales net, are more theoretically correct? Why?

The net method is desirable from a theoretical standpoint because it values the receivable at its net realizable value. In addition, recording the sales at net provides a better assessment of the revenue that was recognized from the sale of the product. If the purchasing company fails to take the discount, then the company should reflect this amount as income.

Indicate how the percentage-of-receivables mehtod, based on an aging schedule, accomplishes the objectives of the allowance method of accounting for bad debts

The percentage of receivables method based on an aging schedule calculates each year's debit to the expense account and credit to the allowance account by evaluating the collectability of open accounts receivable at the close of the year. An analysis of the accounts according to their due dates is a common procedure. For each of the age categories established in the analysis, average percentage rates may be developed on the basis of past experience and applied to the accounts in the respective age categories. This method may also utilize individual analysis for some accounts, especially those that are considerably past due, in arriving at estimated uncollectible receivables. On the basis of the foregoing analysis the balance in the valuation account is then adjusted to the amount estimated to be uncollectible. This method of providing for uncollectible accounts is quite accurate for purposes of reporting accounts receivable at their estimated net realizable value in the balance sheet. From the stand-point of the income statement, however, the aging method may not match accurately bad debt expenses with the sales which caused them because the charge to bad debt expense is not based on sales. The accuracy of both the charge to bad debt expense and the reported value of receivables depends on the current estimate of uncollectible accounts. The accuracy of the expense charge, however, is additionally dependent upon the timing of actual write-offs.

Because of calamitous earthquake losses, Bernstein Company, one of your client's oldest and largest customers, suddenly and unexpectedly became bankrupt. Approximately 30% of your client's total sales have been made to Bernstein Company during each of the past several years. The amount due from Bernstein Company - none of which is collectible - equals 22% of total accounts receivable, an amount that is considerably in excess of what was determined to be an adequate provision for doubtful accounts at the close of the preceding year. How would your client record the write-off the Bernstein Company receivable if it is using the allowance method of accounting for bad debts? Justify your suggested treatment

The receivable due from Bernstein Company should be written off to an appropriately named loss account and reported in the income statement as part of income from operations. In this case, classification as an unusual item would seem appropriate. The loss may properly be reduced by the portion of the allowance for doubtful accounts at the end of the preceding year that was allocable to the Bernstein Company account. Estimates for doubtful accounts are based on a firm's prior bad debt experience with due consideration given to changes in credit policy and forecasted general or industry business conditions. The purpose of the allowance method is to anticipate only that amount of bad debt expense which can be reasonably forecasted in the normal course of events.

Describe the revenue recognition principle

The revenue recognition principle indicates that revenue is recognized in the accounting period when a performance obligation is satisfied. That is, a company recognizes revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it receives, or expects to receive, in exchange for those goods or services.

What are the reasons that a company gives distinct trade discounts

The seller normally uses trade discounts to avoid frequent changes in its catalogs, to quote different prices for different quantities purchased, and to hide the true invoice price from competitors.

What is the theoretical justification of the allowance method as contrasted with the direct write-off method of accounting for bad debts

The theoretical superiority of the allowance method over the direct write-off method of accounting for bad debts is two-fold. First, since revenue is considered to be recognized at the point of sale on the assumption that the resulting receivables are valid liquid assets merely awaiting collection, periodic income will be overstated to the extent of any receivables that eventually become uncollectible. The proper matching of revenue and expense requires that gross sales in the income statement be partially offset by a charge to bad debt expense that is based on an estimate of the receivables arising from gross sales that will not be converted into cash. Second, accounts receivable on the balance sheet should be stated at their estimated net realizable value. The allowance method accomplishes this by deducting from gross receivables the allowance for doubtful accounts. The latter is derived from the charges for bad debt expense on the income statement.

Identify the approaches for allocating the transaction price

The three approaches for estimating standalone selling price are (1) Adjusted market assessment approach; (2) Expected cost plus a margin approach, and (3) Residual approach.

Campus Cellular provides cell phones and 1 year of cell service to student for an upfront, nonrenewable fee of $300 and a usage fee of $5 per month. Students may renew the service for each year they are on campus (on average, students renew their service one time). What amount of revenue should Campus Cellular recognize in the first year of the Contract

The total transaction price is $420 [$300 + ($5 X 24)]. That is, Campus Cellular is providing a service in the second year without receiving an upfront fee. Thus the upfront fee should be recognized as revenue over two periods. As a result, Campus Cellular recognizes revenue of $210 ($420 ÷ 2) in both year 1 and year 2.

What is the transaction price

The transaction price is the amount of consideration that a company expects to receive from a customer in exchange for transferring goods and services. The transaction price in a contract is often easily obtained because the customer agrees to pay a fixed amount to the company over a short period of time

What are the two types of losses that can become evident in accounting for long-term contracts

The two types of losses that can become evident in accounting for long-term contracts are: (1) A current period loss involved in a contract that, upon completion, is expected to produce a profit. (2) A loss related to an unprofitable contract.

What type of information does an accounts receivable turnover pf information provide

This ratio is used to assess the liquidity of the receivables. It measures the number of times, on average, receivables are collected during the period. It provides some indication of the quality of the receivables and how successful the company is in collecting its outstanding receivables.

In measuring the transaction price, explain the accounting for time of value of money

Time value of money - When a sales transaction involves a significant financing component (that is, interest is accrued on consideration to be paid over time), the fair value (transaction price) is determined either by measuring the consideration received or by discounting the payment using an imputed interest rate. The imputed interest rate is the more clearly determinable of either (1) the prevailing rate for a similar instrument of an issuer with a similar credit rating, or (2) a rate of interest that discounts the nominal amount of the instrument to the current sales price of the goods or services. The company will report the effects of the financing either as interest expense or interest revenue.

Explain the accounting for sales with right of return

To account for sales with rights of return, (and for some services that are provided subject to a refund), companies generally recognize all of the following. a. Revenue for the transferred products in the amount of consideration to which seller is reasonably assured to be entitled considering the products expected to be returned or allowances granted. b. An asset (and corresponding adjustment to cost of goods sold) for its right to recover inventory from the customer. If the company is unable to reliably estimate the level of returns, it should not report revenue until the returns are predictable.

Under what conditions does a performance obligation exist

To determine whether a performance obligation exists, the company must determine whether the customer can benefit from the good or service on its own or together with other readily available resources.

When must multiple performance obligations in a revenue arrangement be accounted for separately

To determine whether a performance obligation exists, the company must provide a distinct product or service to the customer. 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 within the contract (that is, the good or service must be distinct within the contract). In other words, the objective is to determine whether the nature of a company's promise is to transfer individual goods and services to the customer or to transfer a combined item (or items) for which individual goods or services are inputs.

Why are trade discounts not recorded in the accounts like cash discounts

Trade discounts are not recorded in the accounts because the price finally quoted is generally an accurate statement of the fair market value of the product on that date. In addition, no subsequent changes can occur to affect this value from an accounting standpoint. With a cash discount, the buyer receives a choice and events subsequent to the original transaction dictate that additional entries may be needed.

What account should 100 shares of HP stock (intention is to sell in one year or less) be classified as

Trading securities

Describe the conditions when contract assets and liabilities are recognized and present in financial statements

Under the asset-liability model for recognizing revenue, companies recognize assets and liabilities according to the definitions of assets and liabilities in a revenue arrangement. For example, when a company has a right to consideration for meeting a performance obligation, it has a right to consideration from the customer and therefore has a contract asset. A contract liability is a company's obligation to transfer goods or services to a customer for which the company has received consideration from the customer. Thus, if the customer performs first, by prepaying for the product, then the seller has a contract liability. Companies must present these contract assets and contract liabilities on their balance sheet. Contract assets are of two types: (a) Unconditional rights to receive consideration because the company has satisfied its performance obligation with the customer, and (b) 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. Companies should report unconditional rights to receive consideration as a receivable on the balance sheet. Conditional rights on the balance sheet (e.g., unbilled receivables) should be reported separately as contract assets.

For what reasons should the percentage-of-completion method be used over the completed-contract method whenever possible

Under the percentage-of-completion method, income is reported to reflect more accurately the production effort. Income is recognized periodically on the basis of the percentage of the job completed rather than only when the entire job is completed. The principal disadvantage of the completed-contract method is that it may lead to distortion of earnings because no attempt is made to reflect current performance when the period of the contract extends into more than one accounting period. The percentage-of-completion method recognizes revenues, costs, and gross profit as a company makes progress toward completion on a long-term contract. To defer recognition of these items until completion of the entire contract is to misrepresent the efforts (costs) and accomplishments (revenues) of the accounting periods during the contract.

What are some examples of variable consideration

Variable consideration (when the price of a good or service is dependent on future events), includes such elements as price or volume discounts, rebates, credits, performance bonuses, or royalties. A company estimates the amount of variable consideration it will receive from the contract to determine the amount of revenue to recognize.

Discuss the accounting for sales allowance and how they relate to the concept of variable consideration

When companies, sell a product with a sales allowance for possible dissatisfaction or other issues, they should record the accounts receivable and related revenue at the amount of consideration expected to be received. The use of a Sales Returns and Allowances account is helpful to management because it highlights the problems associated with inferior merchandise, inefficiencies in filling orders, or delivery or shipment mistakes.

In measuring the transaction price, explain the accounting for non cash considerations

When noncash consideration is involved, revenue is generally recognized on the basis of the fair value of what is received. If the fair value cannot be determined, then the company should estimate the selling price of the goods delivered or services performed and recognize this amount as revenue. In addition, companies sometimes receive contributions (donations, gifts). A contribution is often some type of asset (such as securities, land, buildings or use of facilities) but it could be the forgiveness of debt. Similarly, this consideration should be recognized as revenue based on the fair value of the consideration received.