CHAPTER 18REVENUE RECOGNITION CHAPTER LEARNING OBJECTIVES 1. Understand revenue recognition issues. 2. Identify the five steps in the revenue recognition process. 3. Identify the contract with customers. 4. Identify the separate performance obligations in the contract. 5. Determine the transaction price. 6. Allocate the transaction price to the separate performance obligations. 7. Recognize revenue when the company satisfies its performance obligation. 8. Identify other revenue recognition issues. 9. Describe presentation and disclosure regarding revenue. *10. Apply the percentage-of-completion method for long-term contracts. *11. Apply the cost-recovery method for long-term contracts. *12. Identify the proper accounting for losses on long-term contracts. *13. Explain revenue recognition for franchises. 18 - 2 Test Bank for Intermediate Accounting, IFRS Edition, 2e TRUE-FALSE—Conceptual 1. The new revenue recognition standard adopted a liability approach as the basis for revenue recognition. 2. Revenue is recognized in the accounting period when the performance obligation is satisfied. 3. The first step in the revenue recognition process is to identify the separate performance obligations in the contract. 4. Revenue from a contract with a customer cannot be recognized until a contract exists. 5. Whether a contract modification is treated as a separate performance obligation or prospectively, the same amount of revenue is recognized before and after the modification. 6. If the performance obligation is not highly dependent on, or interrelated with, other promises in the contract, then each performance obligation should be accounted for separately. 7. A performance obligation is a written guarantee in a contract to provide a product or service to a customer. 8. Companies always use the expected value, a probability-weighted amount, to estimate variable consideration. 9. When a sales transaction involves a significant financing component, the fair value is determined either by measuring the consideration received or by discounting the payment using an imputed interest rate. 10. Companies rarely have to allocate the transaction price to more than one performance obligation in a contract. 11. When a company sells a bundle of goods at a discount, the discount should be allocated to the product that caused the discount and not to the entire bundle. Revenue Recognition 18 - 3 12. A company recognizes revenue from a performance obligation over time by measuring the progress toward completion. 13. A company can only satisfy its performance obligations at a point in time. 14. When a company sells a product but gives the buyer the right to return it, revenue should not be recognized until the sale is collected. 15. Warranties that the product meets agreed-upon specifications in the contract at the time the product is sold are referred to as assurance-type warranties. 16. 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. *17. The most popular input measure used to determine the progress toward completion in long-term contracts is the cost-to-cost basis. *18. If the difference between the Construction in Process and the Billings on Construction in Process account balances is a debit, the difference is reported as a current asset. *19. The Construction in Process account includes only construction costs under the percentage-of-completion method. *20. Under the cost-recovery method, companies recognize costs only when the contract is completed. *21. The principal advantage of the cost-recovery method is that reported revenue reflects final results rather than estimates. *22. Companies must recognize the entire expected loss on an unprofitable contract in the current period under the percentage-of-completion method but not the cost-recovery method. *23. A loss in the current period on a profitable contract must be recognized under both the percentage-of-completion and cost-recovery method. *24. Neither the Billings account balance nor the Construction in Process account balance can exceed the long-term contract price. *25. The provision for a loss on an unprofitable contract may be combined with the Construction in Process account balance under percentage-of-completion but not cost-recovery. True-False Answers—Conceptual Item 1. 2. 3. 4. 5. Ans. F T F T T Item 6. 7. 8. 9. 10. Ans. T F F T F Item 11. 12. 13. 14. 15. Ans. T T F F T Item 16. 17. 18. 19. 20. Ans. T T T F F Item 21. 22. 23. 24. 25. Ans. T F F T F 18 - 4 Test Bank for Intermediate Accounting, IFRS Edition, 2e MULTIPLE CHOICE—Conceptual 26. To address inconsistencies and weaknesses, a comprehensive revenue recognition model was developed entitled the a. Revenue Recognition Principle. b. Principle-based Revenue Accounting. c. Rules-based Revenue Accounting. d. Revenue from Contracts with Customers. 27. The converged standard on revenue recognition a. reduces the number of disclosures required for revenue reporting. b. increases the complexity of financial statement preparation. c. recognizes and measures revenue based on changes in assets and liabilities. d. simplifies revenue recognition practices across entities and industries. 28. The first step in the process for revenue recognition is to a. determine the transaction price. b. identify the contract with the customer. c. allocate the transaction price to the separate performance obligations. d. identify the separate performance obligations in the contract. 29. The second step in the process for revenue recognition is to a. allocate transaction price to the separate performance obligations. b. determine the transaction price. c. identify the contract with customers. d. identify the separate performance obligations in the contract. 30. The third step in the process for revenue recognition is to a. determine the transaction price. b. identify the separate performance obligations in the contract. c. allocate transaction price to the separate performance obligations. d. recognize revenue when each performance obligation is satisfied. 31. The fourth step in the process for revenue recognition is to a. recognize revenue when each performance obligation is satisfied. b. identify the separate performance obligations in the contract. c. allocate transaction price to the separate performance obligations. d. determine the transaction price. 32. The last step in the process for revenue recognition is to a. allocate transaction price to the separate performance obligations. b. recognize revenue when each performance obligation is satisfied. c. determine the transaction price. d. identify the contract with customers. 33. A contract a. must be in writing to be an enforceable contract. b. is an agreement that creates enforceable rights and obligations. c. is enforceable if each party can unilaterally terminate the contract. d. does not need to have commercial substance. Revenue Recognition 18 - 5 34. Revenue from a contract with a customer a. is recognized when the customer receive the rights to receive consideration. b. is recognized even if the contract is still wholly unperformed. c. can be recognized even when a contract is still pending. d. cannot be recognized until a contract exists. 35. Signing of the contract by the two parties is a. not recorded until one or both parties perform under the contract. b. recorded at the time the contract is approved by both parties. c. not recorded until both parties perform under the contract. d. recorded immediately after the contract is signed. 36. On January 15, 2015, Bella Vista Company enters into a contract to build custom equipment for ABC Carpet Company. The contract specified a delivery date of March 1. The equipment was not delivered until March 31. The contract required full payment of $75,000 30 days after delivery. This contract should be a. recorded on January 15, 2015. b. recorded on March 1, 2015. c. recorded on March 31, 2015. d. recorded on April 30, 2015. 37. A company must account for a contract modification as a new contract if a. Goods or services are interdependent on each other. b. The promised goods or services are distinct. c. The company has the right to receive consideration equal to standalone price. d. Goods or services are distinct and company has right to receive the standalone price. 38. When a contract modification does not result in a separate performance obligation, the additional products are priced at the a. standalone price of the product. b. blended price of original contract and contract modification. c. average selling price of original selling price and standalone price. d. selling price specified in contract modification 39. A performance obligation exists when a. a company receives the right to receive consideration. b. a contract is approved and signed. c. a company provides a distinct product or service. d. a company provides interdependent product or service. 40. When multiple performance obligations exists in a contract, they should be accounted for as a single performance obligation when a. each service is interdependent and interrelated. b. the performance obligations are distinct but interdependent. c. the product is distinct within the contract. d. determination cannot be made. 18 - 6 Test Bank for Intermediate Accounting, IFRS Edition, 2e 41. New Age Computers manufactures and sells pagers and radio paging systems which include a 180 day warranty on product defects. It also sells an extended warranty which provides an additional two years of protection. On May 10, it sold a paging system for $3,850 and an extended warranty for another $1,200. The journal entry to record this transaction would include a. a credit to Service Revenue of $5,050. b. a credit to Service Revenue of $1,200 c. a credit to Sales of $3,850 and a credit to Service Revenue of $1,200 d. a credit to Unearned Service Revenue of $1,200. 42. Seadrill Engineering licensed software to oil-drilling firms for 5 years. In addition to providing the software, the company also provides consulting services and support to ensure smooth operation of the software. The total transaction price is $350,000. Based on standalone values, the company estimates the consulting services and support have a value of $100,000 and the software license has a value of $250,000. Assuming the performance obligations are not interdependent, the journal entry to record the transaction includes a. a credit to Sales Revenue for $250,000 and a credit to Unearned Service Revenue of $100,000. b. a credit to Service Revenue of $100,000. c. a credit to Unearned Service Revenue of $100,000. d. a credit to Sales Revenue of $350,000. 43. The transaction price a. excludes discounts, volume rebates, coupons and free products, or services. b. is the amount of consideration that a company expects to receive from a customer c. excludes time value of money if the contract involves a significant financing component. d. does not consider noncash consideration such as donations, gifts, equipment or labor. 44. Companies can use the expected value to estimate variable consideration when a. the contract has only two possible outcomes. b. a company has a small number of contracts with similar characteristics. c. a company can use the most likely amount in a range of possible outcomes. d. a company has a large number of contracts with similar characteristics. 45. If a contract involves a significant financing component, a. the time value of money is used to determine the fair value of the transaction. b. the time value of money is not required to determine transaction price, if the payment is more than a year. c. the transaction amount should be based on the current sales price of goods or services. d. interest is not accrued as a result of the financing component. 46. Noncash consideration should be a. recognized on the basis of fair value of what is given up. b. recognized on the basis of original cost paid by customer. c. recognized on the basis of fair value of what is received. d. recognized on the basis of fair value of equivalent goods or services. Revenue Recognition 18 - 7 47. Consideration paid or payable to customers a. includes volume rebates which increases the cost to the customer. b. includes discounts which reduces the cost of purchases to the company. c. reduces the consideration received and the revenue to be recognized. d. includes prompt settlement discount which increases revenues. 48. The transaction price for multiple performance obligations should be allocated a. based on selling price from the company’s competitors. b. based on what the company could sell the goods for on a standalone basis. c. based on forecasted cost of satisfying performance obligation. d. based on total transaction price less residual value. 49. When the bundle price is less than the sum of the standalone prices, the discount should be allocated to a. the product (or products) associated with the discount. b. the entire bundle of products or services. c. the product cost, thereby increasing product margin. d. the selling price of product or services provided. 50. A company has satisfied its performance obligation when the a. company has received payment for goods or services. b. company has significant risks and rewards of ownership. c. company has legal title to the asset. d. company has transferred physical possession of the asset. 51. The most popular input measure used to determine the progress toward completion is a. units-of-delivery method. b. cost-to-cost basis. c. labor hours worked. d. tons produced. 52. The cost-to-cost basis measures progress towards completion by a. comparing costs incurred to date with total costs to complete the contract. b. tracking results of work completed to date; it is an output measure. c. tracking floors of a building completed versus floors still to be completed. d. tracking miles of a highway completed versus miles of highway still to be completed. 53. When sales are made with a right of return, the company a. should not recognize any revenue. b. should recognize revenue for the full sales price. c. records the returned asset in a separate inventory account. d. record the estimated returns in the Sales Returns account. 54. When a company has an obligation or right to repurchase an asset for an amount greater than or equal to its selling price, the transaction should be treated as a a. outright sale. b. financing transaction. c. repurchase transaction. d. put option. 18 - 8 Test Bank for Intermediate Accounting, IFRS Edition, 2e 55. When a customer purchases a product but is not yet ready to accept delivery, this is referred to as a. a repurchase agreement. b. a consignment. c. a principal-agent relationship. d. a bill-and-hold arrangement 56. The role of the agent in a Principal-Agent relationship is to a. arrange for the principal to provide goods or services to a customer. b. provide the goods or services for a customer. c. market the principal goods and services to prospective customers. d. develop and maintain goodwill of the principal’s customers. 57. The use of the net method of recognizing revenue by an agent a. is appropriate as long as both revenue and costs are included. b. is the correct method in a principal-agent relationship. c. could result in an overstatement of the agent’s revenue. d. could result in an understatement of the agent’s revenue. 58. Consignments are a specialized marketing method whereby the a. Consignee purchases goods for sale and sends payment when goods are sold. b. Consignee (agent) holds title to the product. c. Consignee pays for good up front and is paid when merchandise is sold. d. Consignee takes possession of merchandise but title remains with manufacturer. 59. Consigned goods are recognized as revenues by the a. consignor when a sale to a third party has occurred. b. consignor when the merchandise has been shipped to a consignee. c. consignee when a sale to a third party has occurred. d. consignor when it receives payment from consignee for goods sold. 60. A warranty provided when a customer exercises an option to purchase a warranty is recorded as a. an expense in the period the goods or services are sold. b. a warranty liability for all costs incurred after sale due to correction of defects. c. revenue in the period that the service-type warranty is in effect. d. an assurance type warranty which is included in the sales price of the product. 61. Nonrefundable upfront fees a. should be recognized immediately upon receipt of payment. b. such as activation fees for cable should be recognized as revenue immediately. c. such as a one-time initiation fee in a health club should be recognized immediately. d. should not be recorded as revenue at the time of payment if they are for future delivery of products and services. Revenue Recognition 18 - 9 62. Entertainment Tonight, Inc. manufactures and sells stereo systems that include an assurance-type warranty for the first 90 days. Entertainment Tonight also offers an optional extended coverage plan under which it will repair or replace any defective part for 2 years beyond the expiration of the assurance-type warranty. The total transaction price for the sale of the stereo system and the extended warranty is $3,000. The standalone price of each is $2,300 and $800, respectively. The estimated cost of the assurance-warranty is $350. The accounting for warranty will include a a. debit to Warranty Expense, $800. b. debit to Warranty Liability, $350 c. credit to Warranty Liability, $800 d. credit to Unearned Warranty Revenue, $800 63. Unconditional rights to receive consideration because a performance obligation has been satisfied are a. reported as a receivable on the statement of financial position. b. reported as a contract asset on the statement of financial position. c. reported as a contract liability on the statement of financial position. d. are not reported on the balance sheet. 64. Partial satisfaction of a multiple performance obligation is reported on the statement of financial position as a. contract liability. b. receivable. c. contract asset. d. unearned service revenue. 65. Contract liability is a company’s obligations to transfer goods or services to a customer for which the company has received consideration from the customer. An example of a contract liability is a. Prepaid subscription. b. Unearned magazine subscription. c. Mortgage Payable. d. Service Revenue. 66. On July 31, O’Malley Company contracted to have two products built by Taylor Manufacturing for a total of $185,000. The contract specifies that payment will only occur after both products have been transferred to O’Malley Company. O’Malley determines that the standalone prices are $100,000 for Product 1 and $85,000 for Product 2. On August 1, when Product 1 has been transferred, the journal entry to record this event include a a. debit to Accounts Receivable for $100,000. b. debit to Accounts Receivable for $85,000. c. debit to Contract Assets for $85,000. d. debit to Contract Assets for $100,000. 67. Disclosure related to revenue a. does not require capitalized costs to obtain and fulfill a contract. b. does not require judgments that affect amount and timing of revenues from contracts. c. requires disclosure of remaining performance obligations. d. requires disclosure of average balance of contract assets. 18 - 10 Test Bank for Intermediate Accounting, IFRS Edition, 2e *68. The percentage-of-completion method a. recognizes revenue and gross profit each period based upon progress. b. is used primarily for short-term contracts. c. accumulates construction costs in the Billings on Construction in Progress account. d. recognizes revenue and gross profits only when contract is completed. *69. In selecting an accounting method for a newly contracted long-term construction project, the principal factor to be considered should be a. the terms of payment in the contract. b. the degree to which a reliable estimate of the costs to complete and extent of progress toward completion is practicable. c. the method commonly used by the contractor to account for other long-term construction contracts. d. the inherent nature of the contractor's technical facilities used in construction. *70. 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. *71. In accounting for a long-term construction-type contract using the percentage-ofcompletion method, the gross profit recognized during the first year would be the estimated total gross profit from the contract, multiplied by the percentage of the costs incurred during the year to the a. total costs incurred to date. b. total estimated cost. c. unbilled portion of the contract price. d. total contract price. *72. The Billings on Construction in Progress account is a(n) a. contract revenue account. b. inventory account. c. contra-inventory account. d. construction expense account. *73. The principal advantage of the cost-recovery method is that a. reported revenue is based on final results rather than estimates of unperformed work. b. it reflects current performance when the period of a contract extends into more than one accounting period. c. it is not necessary to recognize revenue at the point of sale. d. a greater amount of gross profit and net income is reported than is the case when the percentage-of-completion method is used. Revenue Recognition 18 - 11 *74. Under the cost-recovery method a. revenue, cost, and gross profit are recognized during the production cycle. b. revenue and cost are recognized during the production cycle, but gross profit recognition is deferred until the contract is completed. c. revenue, cost, and gross profit are recognized at the time the contract is completed. d. None of these answers are correct. *75. Cost estimates on a long-term contract may indicate that a loss will result on completion of the entire contract. In this case, the entire expected loss should be a. recognized in the current period, regardless of whether the percentage-of-completion or cost-recovery method is employed. b. recognized in the current period under the percentage-of-completion method, but the cost-recovery method defers recognition of the loss to the time when the contract is completed. c. recognized in the current period under the cost-recovery method, but the percentageof-completion method defers the loss until the contract is completed. d. deferred and recognized when the contract is completed, regardless of whether the percentage-of-completion or cost-recovery method is employed. *76. Cost estimates at the end of the second year indicate that a loss will result on completion of the entire contract. Which of the following statements is correct? a. Under the cost-recovery method, the loss is not recognized until the year the construction is completed. b. Under the percentage-of-completion method, the gross profit recognized in the first year does not affect the computation of loss for the second year. c. Under the cost-recovery method, when the billings exceed the accumulated costs, the amount of the estimated loss is reported as a current liability. d. Under the cost-recovery method, when the Construction in Process balance exceeds the billings, the estimated loss is added to the accumulated costs. *77. When there is a significant increase in the estimated total contract costs but the increase does not eliminate all profit on the contract, which of the following is correct? a. Under both the percentage-of-completion and the cost-recovery methods, the estimated cost increase requires a current period adjustment of excess gross profit recognized on the project in prior periods. b. 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. c. Under the cost-recovery method only, the estimated cost increase requires a current period adjustment of excess gross profit recognized on the project in prior periods. d. No current period adjustment is required. *78. All revenue for franchise companies is derived from a. assistance for site selection and negotiating lease. b. bookkeeping and advisory services. c. sale of initial franchise and continuing fees. d. advertising and promotion. 18 - 12 Test Bank for Intermediate Accounting, IFRS Edition, 2e *79. Franchise fees should be recognized a. on the date the contract was signed. b. on the date the franchise is opened for business. c. on the date the franchise fee is paid to franchisor. d. when performance obligations are satisfied. *80. Revenue for sales-based royalty payments should be recognized a. when the amount of sales can be determined. b. on the date payment is received by the franchisor. c. on the date the performance obligation is satisfied. d. on the date the contract was signed. *81. Franchise revenue are recognized over time if a. franchise rights are transferred at a point in time. b. the franchisor is providing access to the right rather than transferring control. c. performance obligations regarding franchise rights are completed when the franchise opens. d. the franchisee fee is payable upon signing of contract. *82. Types of franchising arrangements include all of the following except a. service sponsor-retailer. b. wholesaler-service sponsor. c. manufacturer-wholesaler. d. wholesaler-retailer. *83. Continuing franchise fees should be recorded by the franchisor a. as revenue when uncertainty related to the variable consideration is resolved. b. as revenue when received. c. in accordance with the accounting procedures specified in the franchise agreement. d. as revenue only after the balance of the initial franchise fee has been collected. *84. Occasionally a franchise agreement grants the franchisee the right to make future bargain purchases of equipment or supplies. When recording the initial franchise fee, the franchisor should a. increase revenue recognized from the initial franchise fee by the amount of the expected future purchases. b. record a portion of the initial franchise fee as unearned revenue which will increase the selling price when the franchisee subsequently makes the bargain purchases. c. defer recognition of any revenue from the initial franchise fee until the bargain purchases are made. d. None of these answer choices are correct. *85. Franchise revenues are recognized over time if a. franchise rights are transferred at a point in time. b. the franchisee fee is payable upon signing of contract. c. performance obligations regarding franchise rights are completed when the franchise opens. d. None of these answer choices are correct. Revenue Recognition 18 - 13 Multiple Choice Answers—Conceptual Item Ans. 26. 27. 28. 29. 30. 31. 32. 33. 34. d c b d a c b b d Item 35. 36. 37. 38. 39. 40. 41. 42. 43. Ans. Item a c d b c a d a b 44. 45. 46. 47. 48. 49. 50. 51. 52. Ans. d a c c b a d b a Item Ans. Item Ans. Item Ans. Item Ans. c b d a b d d c d 62. 63. 64. 65. 66. 67. *68. *69. *70. d a c b d c a b c *71. *72. *73. *74. *75. 76. 77. *78. *79. b c a c a c b c d *80. *81. *82. *83. *84. *85. a b b a b d 53. 54. 55. 56. 57. 58. 59. 60. 61. MULTIPLE CHOICE—Computational 86. Marle Construction enters into a contract with a customer to build a warehouse for $850,000 on March 30, 20155 with a performance bonus of $50,000 if the building is completed by July 31, 2015. The bonus is reduced by $10,000 each week that completion is delayed. Marle commonly includes these completion bonuses in its contracts and, based on prior experience, estimates the following completion outcomes: Completed by July 31, 2015 August 7, 2015 August 14, 2015 August 21, 2015 Probability 65% 25% 5% 5% The transaction price for this transaction is a. b. c. d. 87. $895,000 $850,000 $552,500 $585,000 On June 1, 2015, Johnson & Sons sold equipment to James Landscaping Services. In exchange for a zero-interest bearing note with a face value of $55,000, with payment due in 12 months. The fair value of the equipment on the date of sale was $50,000. The amount of revenue to be recognized on this transaction in 2015 is a. $55,000. b. $5,000 c. $50,000 d. $50,000 sales revenue and $2,917 interest revenue. 18 - 14 Test Bank for Intermediate Accounting, IFRS Edition, 2e 88. P & G Auto Parts sells parts to AAA Car Repair during 2015. P&G offers rebates of 2% on purchases up to $30,000 and 3% on purchases above $30,000 if the customer’s purchases for the year exceed $100,000. In the past, AAA normally purchases $150,000 in parts during a calendar year. On March 25, 2015, AAA Car Repair purchased $37,000 of parts. The journal entry to record the sale includes a a. debit to Accounts Receivable for $37,000. b. debit to Accounts Receivable for $36,260. c. credit to Sales Revenue for $35,890. d. credit to Sales Revenue for $36,260. 89. Roche Pharmaceuticals entered into a licensing agreement with Zenith Lab for a new drug under development. Roche will receive $6,750,000 if the new drug receives FDA approval. Based on prior approval, Roche determines that it is 85% likely that the drug will gain approval. The transaction price of this arrangement should be a. $6,750,000. b. $5,737,500. c. $1,012,500. d. $0 until approval is received. 90. Meyer & Smith is a full-service technology company. They provide equipment, and installation services as well as training. Customers can purchase any product or service separately or as a bundled package. Container Corporation purchased computer equipment, installation and training for a total cost of $120,000 on March 15, 2014. Estimated standalone fair values of the equipment, installation, and training are $75,000, $50,000, and $25,000 respectively. The transaction price allocated to equipment, installation and training is a. $75,000, $50,000, $25,000 respectively b. $40,000, $40,000, $40,000 respectively c. $120,000 for the entire bundle. d. $60,000, $40,000 and $20,000 respectively. 91. Meyer & Smith is a full-service technology company. They provide equipment, and installation services as well as training. Customers can purchase any product or service separately or as a bundled package. Container Corporation purchased computer equipment, installation and training for a total cost of $120,000 on March 15, 2014. Estimated standalone fair values of the equipment, installation and training are $75,000, $50,000 and $25,000 respectively. The journal entry to record the transaction on March 15, 2014 will include a a. credit to Sales Revenue for $120,000. b. debit to Unearned Service Revenue of $25,000. c. credit to Unearned Service Revenue of $20,000. d. credit to Service Revenue of $50,000. 92. Bella Pool Company sells prefabricated pools that cost $100,000 to customers for $180,000. The sales price includes an installation fee, which is valued at $25,000. The fair value of the pool is $160,000. The installation is considered a separate performance obligation and is expected to take 3 months to complete. The transaction price allocated to the pool and the installation is a. $155,676 and $24,324 respectively b. $160,000 and $25,000 respectively c. $180,000 and $25,000 respectively d. $138,378 and $21,622 respectively Revenue Recognition 18 - 15 93. Botanic Choice sell natural supplements to customers with an unconditional right of return if they are not satisfied. The right of returns extends 60 days. On February 10, 2014, a customer purchases $3,000 of products (cost $1,500). Assuming that based on prior experience, estimated returns are 20%. The journal entry to record the sale and cost of goods sold includes a a. debit to Cash and a credit to Sales Revenue of $3,000. b. credit to Refund Liability of $600 and a credit to Sales Revenue of $2,400. c. debt to Cost of Goods Sold and credit to Inventory for $1,500. d. credit to Estimated Inventory Returns of $300 94. Botanic Choice sells natural supplements to customers with an unconditional right of return if they are not satisfied. The right of returns extends 60 days. On February 10, 2014, a customer purchases $3,000 of products (cost $1,500). Assuming that based on prior experience, estimated returns are 20%. The journal entry to record the return of $200 of merchandise includes a a. credit to Refund Liability for $200. b. credit to Returned Inventory for $100. c. credit to Estimated Inventory Returns for $100. d. debit to Estimated Inventory Returns for $100. 95. On August 5, 2015, Famous Furniture shipped 20 dining sets on consignment to Furniture Outlet, Inc. The cost of each dining set was $350. The cost of shipping the dining sets amounted to $1,800 and was paid for by Famous Furniture. On December 30, 2014, the consignee reported the sale of 15 dining sets at $850 each. The consignee remitted payment for the amount due after deducting a 6% commission, advertising expense of $300, and installation and setup costs of $390. The amount cash received by Famous Furniture is a. $12,750 b. $11,985 c. $11,295 d. $11,685 96. On August 5, 2015, Famous Furniture shipped 20 dining sets on consignment to Furniture Outlet, Inc. The cost of each dining set was $350 each. The cost of shipping the dining sets amounted to $1,800 and was paid for by Famous Furniture. On December 30, 2015, the consignee reported the sale of 15 dining sets at $850 each. The consignee remitted payment for the amount due after deducting a 6% commission, advertising expense of $300, and installation and setup costs of $390. The total profit on units sold for the consignor is a. $11,295 b. $4,695 c. $6,045 d. $9,945 18 - 16 Test Bank for Intermediate Accounting, IFRS Edition, 2e 97. On November 1, 2015, Green Valley Farm entered into a contract to buy a $75,000 harvester from John Deere. The contract required Green Valley Farm to pay $75,000 in advance on November 1, 2015. The harvester (cost of $55,000) was delivered on November 30, 2014. The journal entry for John Deere to record the contract on November 1, 2015 includes a a. credit to Accounts Receivable for $75,000. b. credit to Sales Revenue for $75,000. c. credit to Unearned Sales Revenue for $75,000. d. debit to Unearned Sales Revenue for $75,000. 98. On November 1, 2015, Green Valley Farm entered into a contract to buy a $75,000 harvester from John Deere. The contract required Green Valley Farm to pay $75,000 in advance on November 1, 2015. The harvester (cost of $55,000) was delivered on November 30, 2015. The journal entry for John Deere to record the delivery of the equipment includes a a. debit to Unearned Sales Revenue for $75,000. b. credit to Unearned Sales Revenue for $75,000. c. credit to Cost of Goods Sold for $55,000. d. debit to Inventory for $55,000. 99. Arizona Communications contracted to set up a call center for the City of Phoenix. Under the terms of the contract, Arizona Communications will design and set-up a call center with the following costs: Design of call center Computers, servers, telephone equipment Software Installation and testing of equipment Selling commission Annual service contract $10,000 $275,000 $85,000 $15,000 $25,000 $50,000 In addition, Arizona Communications will maintain and service the equipment and software to ensure smooth operations of the call center for an annual fee of $90,000. Ownership of equipment installed remains with the City of Phoenix. The contract costs that should be capitalized is a. $460,000 b. $410,000 c. $360,000 d. $370,000 Use the following information for questions 100-103: Seasons Construction is constructing an office building under contract for Cannon Company. The contract calls for progress billings and payments of $1,240,000 each quarter. The total contract price is $14,880,000 and Seasons estimates total costs of $14,200,000. Seasons estimates that the building will take 3 years to complete, and commences construction on January 2, 2015. Revenue Recognition 18 - 17 *100. At December 31, 2015, Seasons estimates that it is 30% complete with the construction, based on costs incurred. What is the total amount of Revenue from Long-Term Contracts recognized for 2015 and what is the balance in the Accounts Receivable account assuming Cannon Company has not yet made its last quarterly payment? Revenue Accounts Receivable a. $4,960,000 $4,960,000 b. $4,260,000 $ 1,240,000 c. $4,464,000 $ 1,240,000 d. $4,260,000 $4,960,000 *101. At December 31, 2015, Seasons Construction estimates that it is 75% complete with the building; however, the estimate of total costs to be incurred has risen to $14,400,000 due to unanticipated price increases. At December 31, 2014, Seasons estimated it was 30% complete. What is the total amount of Construction Expenses that Seasons will recognize for the year ended December 31, 2015? a. $10,800,000 b. $6,300,000 c. $6,390,000 d. $6,540,000 *102. At December 31, 2015, Seasons Construction estimates that it is 75% complete with the building; however, the estimate of total costs to be incurred has risen to $14,400,000 due to unanticipated price increases. What is reported in the balance sheet at December 31, 2015 for Seasons as the difference between the Construction in Process and the Billings on Construction in Process accounts, and is it a debit or a credit? Difference between the accounts Debit/Credit a. $3,380,000 Credit b. $1,240,000 Debit c. $880,000 Debit d. $1,240,000 Credit *103. Seasons Construction completes the remaining 25% of the building construction on December 31, 2016, as scheduled. At that time the total costs of construction are $15,000,000. At December 31, 2015, the estimates were 75% complete and total costs of $14,400,000. What is the total amount of Revenue from Long-Term Contracts and Construction Expenses that Seasons will recognize for the year ended December 31, 2016? Revenue Expenses a. $14,880,000 $15,000,000 b. $3,720,000 $ 3,750,000 c. $3,720,000 $ 4,200,000 d. $3,750,000 $ 3,750,000 18 - 18 Test Bank for Intermediate Accounting, IFRS Edition, 2e The following information relates to questions 104 and 105. Cooper Construction Company had a contract starting April 2015, to construct a $18,000,000 building that is expected to be completed in September 2017, at an estimated cost of $16,500,000. At the end of 2015, the costs to date were $7,590,000 and the estimated total costs to complete had not changed. The progress billings during 2015 were $3,600,000 and the cash collected during 2015 was 2,400,000. *104. For the year ended December 31, 2015, Cooper would recognize gross profit on the building of: a. $632,500 b. $690,000 c. $810,000 d. $0 *105. At December 31, 2015 Cooper would report Construction in Process in the amount of: a. $690,000 b. $7,590,000 c. $8,280,000 d. $7,080,000 *106. Hayes Construction Corporation contracted to construct a building for $4,500,000. Construction began in 2015 and was completed in 2016. Data relating to the contract are summarized below: Year ended December 31, 2015 2016 Costs incurred $1,800,000 $1,350,000 Estimated costs to complete 1,200,000 — Hayes uses the percentage-of-completion method as the basis for income recognition. For the years ended December 31, 2015, and 2016, respectively, Hayes should report gross profit of a. $810,000 and $540,000. b. $2,700,000 and $1,800,000. c. $900,000 and $450,000. d. $0 and $1,350,000. *107. Monroe Construction Company uses the percentage-of-completion method of accounting. In 2015, Monroe began work on a contract it had received which provided for a contract price of $25,000,000. Other details follow: 2015 Costs incurred during the year $12,000,000 Estimated costs to complete as of December 31 8,000,000 Billings during the year 11,000,000 Collections during the year 6,500,000 What should be the gross profit recognized in 2015? a. $1,000,000 b. $13,000,000 c. $3,000,000 d. $5,000,000 Revenue Recognition 18 - 19 Use the following information for questions 108 and 109. In 2015, Fargo Corporation began construction work under a three-year contract. The contract price is €4,800,000. Fargo uses the percentage-of-completion method for financial accounting purposes. The income to be recognized each year is based on the proportion of costs incurred to total estimated costs for completing the contract. The financial statement presentations relating to this contract at December 31, 2015, follow: Statement of Financial Position Accounts receivable—construction contract billings Construction in progress Less contract billings Costs and recognized profit in excess of billings €200,000 €600,000 480,000 Income Statement Income (before tax) on the contract recognized in 2015 120,000 €120,000 *108. How much cash was collected in 2015 on this contract? a. €200,000 b. €280,000 c. €40,000 d. €480,000 *109. What was the initial estimated total income before tax on this contract? a. €600,000 b. €640,000 c. €800,000 d. €960,000 *110. Adler Construction Co. uses the percentage-of-completion method. In 2015, Adler began work on a contract for £6,600,000 and it was completed in 2016. Data on the costs are: Year Ended December 31 2015 2016 Costs incurred £2,340,000 £1,680,000 Estimated costs to complete 1,560,000 — For the years 2015 and 2016, Adler should recognize gross profit in 2015 and 2016 of a. b. c. d. 2015 £0 £1,548,000 £1,620,000 £1,620,000 2016 £2,580,000 £1,032,000 £960,000 £2,580,000 Use the following information for questions 111 and 112. Gomez, Inc. began work in 2015 on contract #3814, which provided for a contract price of €14,400,000. Other details follow: 2015 2016 Costs incurred during the year €2,400,000 €7,350,000 Estimated costs to complete, as of December 31 7,200,000 0 Billings during the year 2,700,000 10,800,000 Collections during the year 1,800,000 11,700,000 18 - 20 Test Bank for Intermediate Accounting, IFRS Edition, 2e *111. Assume that Gomez uses the percentage-of-completion method of accounting. The portion of the total gross profit to be recognized as income in 2015 is a. €900,000. b. €1,200,000. c. €3,600,000. d. €4,800,000. *112. Assume that Gomez uses the cost-recovery method of accounting. The portion of the total gross profit to be recognized as income in 2016 is a. €1,800,000. b. €2,700,000. c. €4,650,000. d. €14,400,000. Use the following information for questions 113 and 114. Kiner, Inc. began work in 2015 on a contract for $16,800,000. Other data are as follows: 2015 2016 Costs incurred to date $7,200,000 $11,200,000 Estimated costs to complete 4,800,000 — Billings to date 5,600,000 16,800,000 Collections to date 4,000,000 14,400,000 *113. If Kiner uses the percentage-of-completion method, the gross profit to be recognized in 2015 is a. $2,880,000. b. $3,200,000. c. $4,320,000. d. $4,800,000. *114. If Kiner uses the cost-recovery method, the gross profit to be recognized in 2016 is a. $2,720,000. b. $5,600,000. c. $2,800,000. d. $11,200,000. Use the following information for questions 115 and 116. *115. Horner Construction Co. uses the percentage-of-completion method. In 2015, Horner began work on a contract for €16,500,000; it was completed in 2016. The following cost data pertain to this contract: Year Ended December 31 2015 2016 Cost incurred during the year €5,850,000 €4,200,000 Estimated costs to complete at the end of year 3,900,000 — The amount of gross profit to be recognized on the income statement for the year ended December 31, 2016 is a. €2,400,000. b. €2,580,000. c. €2,700,000. d. €6,450,000. Revenue Recognition 18 - 21 *116. If the cost-recovery method of accounting was used, the amount of gross profit to be recognized for years 2015 and 2016 would be a. b. c. d. 2015 €6,750,000. €6,450,000. €0. €0. 2016 €0. €(300,000). €6,450,000. €6,750,000. *117. Remington Construction Company uses the percentage-of-completion method. During 2015, the company entered into a fixed-price contract to construct a building for Sherman Company for $24,000,000. The following details pertain to the contract: Percentage of completion Estimated total cost of contract Gross profit recognized to date At December 31, 2015 25% $18,000,000 1,500,000 At December 31, 2016 60% $20,000,000 2,400,000 The amount of construction costs incurred during 2016 was a. $12,000,000. b. $7,500,000. c. $4,500,000. d. $2,000,000. Use the following information for questions 118 and 119. Eilert Construction Company had a contract starting April 2015, to construct a €21,000,000 building that is expected to be completed in September 2016, at an estimated cost of €19,250,000. At the end of 2015, the costs to date were €8,855,000 and the estimated total costs to complete had not changed. The progress billings during 2015 were €4,200,000 and the cash collected during 2015 was €2,800,000. Eilert uses the percentage-of-completion method. *118. For the year ended December 31, 2015, Eilert would recognize gross profit on the building of a. €0. b. €737,917. c. €805,000. d. €945,000. *119. At December 31, 2015, Eilert would report Construction in Process in the amount of a. €9,660,000. b. €8,855,000. c. €8,260,000. d. €805,000. 18 - 22 Test Bank for Intermediate Accounting, IFRS Edition, 2e *120. Douglas Diners Inc. charges an initial franchise fee of $90,000 broken down as follows: Rights to trade name, market area, and proprietary know-how Training services Equipment (cost of $10,800) Total initial franchise fee $40,000 11,500 38,500 $90,000 Upon signing of the agreement, a payment of $40,000 is due. Thereafter, two annual payments of $30,000 are required. The credit rating of the franchisee is such that it would have to pay interest of 8% to borrow money. The franchise agreement is signed on August 1, 2014, and the franchise commences operation on November 1, 2014. Assuming that no future services are required by the franchisor once the franchise begins operations, the entry on November 1, 2014 would include a. a credit to Unearned Franchise Revenue for $40,000. b. a debit to Service Revenue for $11,500. c. a debit to Sales Revenue for $38,500. d. a debit to Unearned Franchise Revenue for $40,000. *121. Douglas Diners Inc. charges an initial franchise fee of $90,000 broken down as follows: Rights to trade name, market area, and proprietary know-how Training services Equipment (cost of $10,800) Total initial franchise fee $40,000 11,500 38,500 $90,000 Upon signing of the agreement, a payment of $40,000 is due. Thereafter, two annual payments of $30,000 are required. The credit rating of the franchisee is such that it would have to pay interest of 8% to borrow money. The franchise agreement is signed on August 1, 2015, and the franchise commences operation on November 1, 2015. Assume that the total training fees includes training services for the period leading up to the franchise opening ($5,500 value) and for 3 months following opening. The journal entry on August 1, 2015 would include a. a credit to Unearned Service Revenue for $11,500. b. a credit to Unearned Service Revenue for $6,000. c. a debit to Sales Revenue for $38,500. d. a debit to Unearned Franchise Revenue for $40,000. Revenue Recognition 18 - 23 *122. On January 1, 2015 Dairy Treats, Inc. entered into a franchise agreement with a company allowing the company to do business under Dairy Treats's name. Dairy Treats had performed substantially all required services by January 1, 2015, and the franchisee paid the initial franchise fee of $840,000 in full on that date. The franchise agreement specifies that the franchisee must pay a continuing franchise fee of $72,000 annually, of which 20% must be spent on advertising by Dairy Treats. What entry should Dairy Treats make on January 1, 2015 to record receipt of the initial franchise fee and the continuing franchise fee for 2015? a. Cash.................................................................................... 912,000 Franchise Fee Revenue........................................... 840,000 Revenue from Franchise Fees................................. 72,000 b. Cash.................................................................................... 912,000 Unearned Franchise Fees........................................ 912,000 c. Cash.................................................................................... 912,000 Franchise Fee Revenue........................................... 840,000 Revenue from Franchise Fees................................. 57,600 Unearned Franchise Fees........................................ 14,400 d. Prepaid Advertising.............................................................. 14,400 Cash.................................................................................... 912,000 Franchise Fee Revenue........................................... 840,000 Revenue from Franchise Fees................................. 72,000 Unearned Franchise Fees........................................ 14,400 *123. Wynne Inc. charges an initial franchise fee of $1,840,000, with $400,000 paid when the agreement is signed and the balance in five annual payments. The present value of the future payments, discounted at 10%, is $1,091,744. The franchisee has the option to purchase $240,000 of equipment for $192,000. Wynne has substantially provided all initial services required and collectibility of the payments is reasonably assured. The amount of revenue from franchise fees is a. $ 400,000. b. $1,443,744. c. $1,491,744. d. $1,840,000. Multiple Choice Answers—Computational Item 86. 87. 88. 89. 90. 91. 92. Ans. a d c b d c a Item 93. 94. 95. 96. 97. 98. 99. Ans. b c c c c a b Item *100. *101. *102. *103. *104. *105. *106. Ans. c d b c b c c Item *107. *108. *109. *110. *111. *112. *113. Ans. c b d c b c a Item *114. *115. *116. *117. *118. *119. *120. Ans. Item Ans. b a c b c a d *121. *122. *123. a c b 18 - 24 Test Bank for Intermediate Accounting, IFRS Edition, 2e MULTIPLE CHOICE—CPA Adapted 124. Green Construction Co. has consistently used the percentage-of-completion method of recognizing revenue. During 2015, Green entered into a fixed-price contract to construct an office building for $24,000,000. Information relating to the contract is as follows: At December 31 2015 2016 Percentage of completion 15% 45% Estimated total cost at completion $18,000,000 $19,200,000 Gross profit recognized (cumulative) 1,200,000 2,880,000 Contract costs incurred during 2016 were a. $5,760,000. b. $5,940,000. c. $6,300,000. d. $8,640,000. 125. Bruner Constructors, Inc. has consistently used the percentage-of-completion method of recognizing income. In 2015, Bruner started work on a €42,000,000 construction contract that was completed in 2016. The following information was taken from Bruner's 2014 accounting records: Progress billings Costs incurred Collections Estimated costs to complete €13,200,000 12,600,000 8,400,000 25,200,000 What amount of gross profit should Bruner have recognized in 2015 on this contract? a. €4,200,000 b. €2,800,000 c. €2,100,000 d. €1,400,000 126. During 2015, Gates Corp. started a construction job with a total contract price of $14,000,000. The job was completed on December 15, 2015. Additional data are as follows: Actual costs incurred during the year Estimated remaining costs Billed to customer Received from customer 2015 $5,400,000 5,400,000 4,800,000 4,000,000 2016 $6,100,000 — 9,200,000 9,600,000 Under the cost-recovery method, what amount should Gates recognize as gross profit for 2016? a. $900,000 b. $1,250,000 c. $1,900,000 d. $2,500,000 Multiple Choice Answers—CPA Adapted Item *124. Ans. b Item *125. Ans. d Item *126. Ans. d Revenue Recognition 18 - 25 DERIVATIONS — Computational No. Answer Derivation 86. a ($900,000 .65) + ($890,000 .25) + ($880,000 .05) + ($870,000 .05) = $895,000. 87. d ($55,000 $50,000) 7/12 = $2,917. 88. c $37,000 ($37,000 .03) = $35,890. 89. b $6,750,000 .85 = $5,737,500. 90. d $75,000 + $50,000 + $25,000 = $150,000 $75,000/ $150,000 $120,000 = $60,000 $50,000/ $150,000 $120,000 = $40,000 $25,000/ $150,000 $120,000 = $20,000. 91. c $75,000 + $50,000 + $25,000 = $150,000 ($25,000/ $150,000) $120,000 = $20,000. 92. a $160,000 + $25,000 = $185,000. $160,000/ $185,000 $180,000 = $155,676 $25,000/ $185,000 $180,000 = $24,324. 93. b $3,000 .2 = $600; $3,000 $600 = $2,400. 94. c $1,500/ $3,000 = 5; $200 .5 = $100. 95. c (15 x $850) ($12,750 .06) $300 $390 = $11,295. 96. c $11,295 (15 $350) = $6,045. 97. c 98. a 99. b $10,000 + $275,000 + $85,000 + $15,000 + $25,000 = $410,000. *100. c $14,880,000 .30 = $4,464,000. *101. d ($14,400,000 .75) – ($14,200,000 .30) = $6,540,000. *102. b ($14,880,000 .75) – ($1,240,000 8) = $1,240,000 debit. *103. c $14,880,000 .25 = $3,720,000 $15,000,000 – ($14,400,000 .75) = $4,200,000. *104. b ($18,000,000 – $16,500,000) ($7,590,000 ÷ $16,500,000) = $690,000. 18 - 26 Test Bank for Intermediate Accounting, IFRS Edition, 2e Revenue Recognition *105. c $7,590,000 + $690,000 = $8,280,000. *106. c $1,800,000 ———————————— ×($4,500,000 – $3,000,000) = $900,000 $1,800,000 + $1,200,000 18 - 27 ($4,500,000 – $3,150,000) – $900,000 = $450,000. *107. c $12,000,000 ——————————— ×($25,000,000 – $20,000,000) = $3,000,000. $12,000,000 + $8,000,000 *108. b €480,000 – €200,000 = €280,000. *109. d €600,000 – €120,000 = €480,000 €480,000 ————————— ×(€4,800,000 – Total estimated cost) = €120,000 Total estimated cost Total estimated cost = €3,840,000 €4,800,000 – €3,840,000 = €960,000. *110. c £2,340,000 —————- ×(£6,600,000 – £3,900,000) = £1,620,000 £3,900,000 (£6,600,000 – £4,020,000) – £1,620,000 = £960,000. *111. b €2,400,000 ————— ×(€14,400,000 – €9,600,000) = €1,200,000. €9,600,000 *112. c $14,400,000 – $9,750,000 = $4,650,000. DERIVATIONS — Computational (cont.) No. Answer Derivation *113. a $7,200,000 ————— ×($16,800,000 – $12,000,000) = $2,880,000. $12,000,000 *114. b $16,800,000 – $11,200,000 = $5,600,000. *115. a 2014: [€5,850,000 ÷ (€5,850,000 + €3,900,000)] × €6,750,000 = €4,050,000 2015: (€16,500,000 – €10,050,000) – €4,050,000 = €2,400,000. 18 - 28 Test Bank for Intermediate Accounting, IFRS Edition, 2e *116. c 2016: €16,500,000 – €10,050,000 = €6,450,000. *117. b ($20,000,000 × .60) – ($18,00,000 × .25) = $7,500,000. *118. c (€8,855,000 ÷ €19,250,000) × €1,750,000 = €805,000. *119. a (€8,855,000 ÷ €19,250,000) × €1,750,000 = €805,000. €8,855,000 + €805,000 = €9,660.000. *120. d *121. a *122. c Cash = $840,000 + $72,000 = $912,000 Franchise Fee Revenue = $840,000 Unearned Franchise Fees = $72,000 ×20% = $14,400 Revenue from Franchise Fees = $72,000 – $14,400 = $57,600. *123 b $400,000 + $1,091,744 – $48,000 = $1,443,744. DERIVATIONS — CPA Adapted No. Answer Derivation *124. b ($19,200,000 ×45%) – ($18,000,000 ×15%) = $5,940,000. *125. d $12,600,000 —————— ×($42,000,000 – $37,800,000) = $1,400,000. $37,800,000 *126. d €14,000,000 – €5,400,000 – €6,100,000 = €2,500,000. Revenue Recognition 18 - 29 EXERCISES Ex. 18-127—Allocate transaction price. Windsor Windows manufactures and sells custom storm windows for enclosed porches. Windsor also provides installation service for the windows. The installation process does not involve changes in the windows, so this service can be provided by other vendors. Windsor enters into the following contract on June 1, 2015, with a local homeowner. The customer purchases windows for a price of $3,500 and chooses Windsor to do the installation. Windsor charges the same price for the windows irrespective of whether it does the installation or not. The price of the installation service is estimated to have a fair value of $900. The customer pays Windsor $3,000 (which equals the fair value of the windows, which have a cost of $1,700) upon delivery and the remaining balance upon installation of the windows. The windows are delivered on August 1, 2015, Windsor completes installation on September 15, 2015, and the customer pays the balance due. Prepare the journal entries for Windsor in 2015. (Round amounts to nearest dollar.) Solution 18-127 June 1, 2015 No entry – neither party has performed under the contract. On August 1, 2015, Windsor has two performance obligations: (1) the delivery of the windows and (2) the installation of the windows. Windows Installation Total $3,000 900 $3,900 Allocation Windows ($3,000 $3,900) X $3,500 $2,692 Installation ($900 $3,900) X $3,500 808 Revenue recognized $3,500 (round to nearest dollar) Windsor makes the following entries for delivery and installation. August 1, 2015 Cash.................................................................................... Accounts Receivable........................................................... Unearned Service Revenue......................................... Sales Revenue............................................................. 3,000 500 Cost of Goods Sold.............................................................. Inventory...................................................................... 1,700 808 2,692 (Windows delivered, performance obligation for installation recorded) 1,700 18 - 30 Test Bank for Intermediate Accounting, IFRS Edition, 2e Solution 18-127 (cont.) September 15, 2015 Cash........................................................................................................... Unearned Service Revenue........................................................................ Service Revenue (Installation)............................................................. Accounts Receivable........................................................................... 500 808 808 500 Ex. 18-128—Sales with discounts. On July 2, 2015, Lake Company sold to Sue Black merchandise having a sales price of $6,000 (cost $3,600) with terms of 2/10, n/30, f.o.b. shipping point. Lake estimates that merchandise with a sales value of $600 will be returned. An invoice totaling $120, terms n/30, was received by Black on July 6 from Pacific Delivery Service for the freight cost. Upon receipt of the goods, on July 3, Black notified Lake that $250 of merchandise contained flaws. The same day, Lake issued a credit memo covering the defective merchandise and asked that it be returned at Lake’s expense. Lake estimates the returned items to have a fair value of $100. The freight on the returned merchandise was $20 paid by Lake on July 7. On July 12, the company received a check for the balance due from Black. Instructions (a) Prepare journal entries for Lake Company to record all the events noted above assuming sales and receivables are entered at gross selling price. (b) Prepare the journal entry assuming that Sue Black did not remit payment until August 5. Solution 18-128 (a) July 2 Accounts Receivable.................................................................... Refund Liability................................................................. Sales Revenue................................................................. 6,000 Estimated Inventory Returns........................................................ Cost of Goods Sold...................................................................... Inventory........................................................................... *($3,600 $6,000) X $600 360* 3,240 600 5,400 3,600 July 3 Refund Liability............................................................................. Accounts Receivable........................................................ 250 Returned Inventory....................................................................... Estimated Inventory Returns............................................. 100 250 100 Revenue Recognition 18 - 31 Solution 18-128 (cont.) The journal entry to record delivery cost is as follows. July 7 Delivery Expense.......................................................................... Cash................................................................................. 20 20 The journal entry to record payment within the discount period is as follows. July 12 Cash .......................................................................................... Sales Discounts (2% X $5,750).................................................... Accounts Receivable........................................................ (b) 5,635 115 5,750 August 2, 2015 Cash .......................................................................................... Accounts Receivable........................................................ 5,750 5,750 Ex. 18-129—Allocate transaction price. The Appliance Store is an experienced home appliance dealer. Appliance Store also offers a number of services together with the home appliances that it sells. Assume that Appliance Store sells dishwashers on a standalone basis. Appliance Store also sells installation services and maintenance services for dishwashers. However, Appliance Store does not offer installation or maintenance services to customers who buy dishwashers from other vendors. Pricing for dishwashers is as follows. Dishwasher only Dishwasher with Installation service Dishwasher with maintenance services Dishwasher with installation and maintenance services $ 950 1,050 1,150 1,200 In each instance in which maintenance services are provided, the maintenance service is separately priced within the arrangement at $200. Additionally, the incremental amount charged by Appliance Store for installation approximates the amount charged by independent third parties. Dishwashers are sold subject to a general right of return. If a customer purchases a dishwashers with installation and/or maintenance services, in the event Appliance Store does not complete the service satisfactorily, the customer is only entitled to a refund of the portion of the fee that exceeds $800. Instructions (a) Assume that a customer purchases a dishwasher with both installation and maintenance services for $1,200. Based on its experience, Appliance Store believes that it is probable that the installation of the equipment will be performed satisfactorily to the customer. Assume that the maintenance services are priced separately. Identify the separate performance obligations related to the Appliance Store revenue arrangement. 18 - 32 Test Bank for Intermediate Accounting, IFRS Edition, 2e Ex. 18-129 (cont.) (b) Indicate the amount of revenue that should be allocated to the dishwasher the installation, and to the maintenance contract. (c) Prepare the necessary journal entry for the Appliance Store. Solution 18-129 (a) The separate performance obligations are the dishwasher, installation, and maintenance service, since each item has standalone value to the customer. (b) Dishwasher Installation Maintenance Total (c) Cash Sales Revenue Service Revenue Unearned Service Revenue $ 950/$1,250 X $1,200 = $ 912 $ 100/$1,250 X $1,200 = $ 96 $ 200/$1,250 X $1,200 = $ 192 $1,250 1,200 912 96 192 Ex. 18-130—Warranty arrangement. On December 31, 2015, Dieker Company sells equipment to Tabor Inc. for $62,500. Dieker includes a 1-year assurance warranty service with the sale of all its equipment. The customer receives and pays for the equipment on December 31, 2015. Dieker estimates the prices to be $61,000 for the equipment and $1,500 for the cost of the warranty. Instructions (a) Prepare the journal entry to record this transaction on December 31, 2015. (b) Repeat the requirements for (a), assuming that in addition to the assurance warranty, Dieker sold an extended warranty (service type warranty) for an additional 2 years (2017–2018) for $1,000. Solution 18-130 (a) (b) Cash............................................................................................. Warranty Expense........................................................................ Warranty Liability.............................................................. Sales Revenue................................................................. 62,500 1,500 1,500 62,500 Dieker should recognize $500 of warranty revenue in 2017 and 2018. Cash............................................................................................. Warranty Expense........................................................................ Warranty Liability.............................................................. Sales Revenue................................................................. Unearned Service Revenue (Warranty)............................ 63,500 1,500 1,500 62,500 1,000 Revenue Recognition 18 - 33 Ex. 18-131—Existence of a contract. On July 1, 2015, Ellsbury Inc. entered into a contract to deliver one of its specialty machines to Kickapoo Landscaping Co. The contract requires Kickapoo to pay the contract price of $2,500 in advance on July 15, 2015. Kickapoo pays Ellsbury on July 15, 2015, and Ellsbury delivers the machine (with cost of $1,600) on July 31, 2015. Instructions (a) Prepare the journal entry on July 1, 2015, for Ellsbury. (b) Prepare the journal entry on July 15, 2015, for Ellsbury. (c) Prepare the journal entry on July 31, 2015, for Ellsbury. Solution 18-131 (a) July 1, 2015 No entry – neither party has performed on July 1, 2014. (b) July 15, 2015 Cash............................................................................................. Unearned Sales Revenue................................................. (c) 2,500 2,500 July 31, 2015 Unearned Sales Revenue............................................................ Sales Revenue...................................................................... 2,500 Cost of Goods Sold...................................................................... Inventory................................................................................ 1,600 2,500 1,600 *Ex. 18-132—Journal entries—percentage-of-completion. Dixon Construction Company was awarded a contract to construct an interchange at the junction of U.S. 94 and Highway 30 at a total contract price of $12,000,000. The estimated total costs to complete the project were $9,000,000. Instructions (a) Make the entry to record construction costs of $5,400,000, on construction in process to date. (b) Make the entry to record progress billings of $3,000,000. (c) Make the entry to recognize the profit that can be recognized to date, on a percentage-ofcompletion basis. *Solution 18-132 (a) (b) Construction in Process................................................................ 5,400,000 Materials, Cash, Payables................................................ 5,400,000 Accounts Receivable.................................................................... 3,000,000 Billings on Construction in Process................................... 3,000,000 18 - 34 Test Bank for Intermediate Accounting, IFRS Edition, 2e *Solution 18-132 (cont.) (c) Construction Expenses................................................................. 5,400,000 Construction in Process (60% complete)...................................... 1,800,000 Revenue from Long-Term Contracts................................. 7,200,000 *Ex. 18-133—Percentage-of-completion method. Dalton Construction Co. contracted to build a bridge for $8,000,000. Construction began in 2015 and was completed in 2016. Data relating to the construction are: 2015 $2,640,000 2,160,000 Costs incurred during the year Estimated costs to complete 2016 $2,200,000 — Dalton uses the percentage-of-completion method. Instructions (a) How much revenue should be reported for 2015? Show your computation. (b) Make the entry to record progress billings of $3,300,000 during 2015. (c) Make the entry to record the revenue and gross profit for 2015. (d) How much gross profit should be reported for 2016? Show your computation. *Solution 18-133 (a) (b) (c) (d) $2,640,000 ————— × $8,000,000 = $4,400,000 $4,800,000 Accounts Receivable.................................................................... 3,300,000 Billings on Construction in Process .................................. 3,300,000 Construction Expenses................................................................. 2,640,000 Construction in Process................................................................ 1,760,000 Revenue from Long-Term Contracts................................. 4,400,000 Revenue Costs Total gross profit Recognized in 2015 Recognized in 2016 Or Total revenue Recognized in 2015 Recognized in 2016 Costs in 2016 Gross profit in 2016 $8,000,000 4,840,000 3,160,000 (1,760,000) $ 1,400,000 $8,000,000 (4,400,000) 3,600,000 (2,200,000) $ 1,400,000 Revenue Recognition 18 - 35 *Ex. 18-134—Percentage-of-completion method. Penner Builders contracted to build a high-rise for $28,000,000. Construction began in 2015 and is expected to be completed in 2018. Data for 2015 and 2016 are: 2015 2016 $3,600,000 $10,400,000 14,400,000 9,600,000 Costs incurred to date Estimated costs to complete Penner uses the percentage-of-completion method. Instructions (a) How much gross profit should be reported for 2015? Show your computation. (b) How much gross profit should be reported for 2016? (c) Make the journal entry to record the revenue and gross profit for 2016. *Solution 18-134 (a) $3,600,000 ————— × $10,000,000 = $2,000,000 $18,000,000 (b) $10,400,000 —————— × $8,000,000 = $4,160,000 $20,000,000 Less 2014 gross profit Gross profit in 2015 (c) 2,000,000 $2,160,000 Construction in Process................................................................ 2,160,000 Construction Expenses................................................................. 6,800,000 Revenue from Long-Term Contracts................................. 8,960,000 *Ex. 18-135—Percentage-of-completion and cost-recovery methods. On February 1, 2015, Marsh Contractors agreed to construct a building at a contract price of €5,800,000. Marsh estimated total construction costs would be €4,000,000 and the project would be finished in 2017. Information relating to the costs and billings for this contract is as follows: Total costs incurred to date Estimated costs to complete Customer billings to date Collections to date 2015 €1,500,000 2,500,000 2,200,000 2,000,000 2016 €2,640,000 1,760,000 4,000,000 3,500,000 2017 €4,600,000 -05,600,000 5,500,000 Instructions Fill in the correct amounts on the following schedule. For percentage-of-completion accounting and for cost-recovery accounting, show the gross profit that should be recorded for 2015, 2016, and 2017. 18 - 36 Test Bank for Intermediate Accounting, IFRS Edition, 2e *Ex. 18-135 (cont.) Percentage-of-Completion Gross Profit Cost-Recovery Gross Profit 2015 ____________ 2015 ____________ 2016 ____________ 2016 ____________ 2017 ____________ 2017 ____________ 2015 2016 2017 Cost-Recovery Gross Profit — — €1,200,000d *Solution 18-135 2015 2016 2017 Percentage-of-Completion Gross Profit €675,000a €165,000b €360,000c a €1,500,000 ————— × €1,800,000 = €675,000 €4,000,000 b €2,640,000 ————— × €1,400,000 = €840,000 €4,400,000 2015 gross profit 2016 gross profit (675,000) €165,000 c €5,800,000 4,600,000 1,200,000 (840,000) € 360,000 d €5,800,000 4,600,000 €1,200,000 Total revenue Total costs Total gross profit Recognized to date 2017 gross profit Total revenue Total costs Total gross profit Revenue Recognition 18 - 37 *Ex. 18-136—Franchises. Pasta Inn charges an initial fee of $1,600,000 for a franchise, with $320,000 paid when the agreement is signed and the balance in four annual payments. The present value of the annual payments, discounted at 10%, is $1,014,000. The franchisee has the right to purchase $60,000 of kitchen equipment and supplies for $50,000. An additional part of the initial fee is for advertising to be provided by Pasta Inn during the next five years. The value of the advertising is $1,000 a month. Collectibility of the payments is reasonably assured and Pasta Inn has performed all the initial services required by the contract. Instructions Prepare the entry to record the initial franchise fee. Show supporting computations in good form. *Solution 18-136 Total fee Amount due Present value of payments Bargain purchase Advertising ($1,000 × 60) Revenue from franchise fees $1,600,000 $1,280,000 (1,014,000) Cash.......................................................................................... 320,000 Notes Receivable...................................................................... 1,280,000 Discount on Notes Receivable ...................................... Revenue from Franchise Fees ...................................... Unearned Franchise Fees ............................................. (266,000) (10,000) (60,000) $1,264,000 266,000 1,264,000 70,000 18 - 38 Test Bank for Intermediate Accounting, IFRS Edition, 2e PROBLEMS Pr. 18-137—Allocate Transaction Price, Discounts, Time Value. Master Grill Company sells outdoor grilling products, providing gas and charcoal grills, accessories, and installation services for custom patio grilling stations. Instructions Respond to the requirements related to the following independent revenue arrangements for Master Grill products and services. (a) Master Grill offers contract MG100 which is comprised of a free-standing gas grill for small patio use plus installation to a customer’s gas line for a total price $700. On a standalone basis, the grill sells for $600 (cost $350), and Master Grill estimates that the fair value of the installation service (based on cost-plus estimation) is $150. Master Grill signed 15 MG100 contracts on May 30, 2015, and customers paid the contract price in cash. The grills were delivered and installed on June 15, 2015. Prepare journal entries for Master Grill for MG100 in May and June 2015. (b) Master Grill sells its specialty combination gas/wood-fired grills to local restaurants. Each grill is sold for $900 (cost $500) on credit with terms 2/20, net/60. Prepare the journal entries for the sale of 20 grills on August 1, 2015, and upon payment, assuming the customer paid on (1) August 20, 2015, and (2) September 29, 2015. Assume the company records sales net. Solution 18-137 (a) The total revenue of $10,500 ($700 X 15) should be allocated to the two performance obligations based on their relative fair values. In this case, the fair value of the grills is considered $9,000 ($600 X 15) and the fair value of the installation fee is $2,250 ($150 X 15). The total fair value to consider is therefore $11,250 ($9,000 + $2,250). The allocation is as follows. Equipment ($9,000 / $11,250) X $10,500 = $8,400 Installation ($2,250 / $11,250) X $10,500 = $2,100 Master Grill makes the following entries. May 30, 2015 Cash.......................................................................................... Unearned Service Revenue (Installation)....................... Unearned Service Revenue (Equipment)....................... 10,500 2,100 8,400 June 15, 2015 Unearned Service Revenue (Installation).................................. Unearned Service Revenue (Equipment).................................. Service Revenue (Installation)....................................... Service Revenue (Equipment)....................................... 2,100 8,400 Cost of Goods Sold................................................................... Inventory ($350 X 15).................................................... 5,250 2,100 8,400 5,250 Revenue Recognition 18 - 39 Solution 18-137 (cont.) (b) 1. August 1, 2015 Accounts Receivable [$18,000 – (2% X $18,000)]......................................... Sales Revenue......................................................... Cost of Goods Sold.......................................................... Inventory ($500 X 20)............................................... August 20, 2015 Cash................................................................................ Accounts Receivable................................................ 2. 17,640 17,640 10,000 10,000 17,640 17,640 August 1, 2015 Accounts Receivable [$18,000 – (2% X $18,000)]......................................... Sales Revenue......................................................... Cost of Goods Sold.......................................................... Inventory ($500 X 20)............................................... September 29, 2015 Cash................................................................................ Accounts Receivable................................................ Sales Discounts Forfeited (2% X $18,000)...................................................... 17,640 17,640 10,000 10,000 18,000 17,640 360 Pr. 18-138—Long-term construction project accounting. Dobson Construction specializes in the construction of commercial and industrial buildings. The contractor is experienced in bidding long-term construction projects of this type, with the typical project lasting fifteen to twenty-four months. The contractor uses the percentage-of-completion method of revenue recognition since, given the characteristics of the contractor's business and contracts, it is the most appropriate method. Progress toward completion is measured on a costto-cost basis. Dobson began work on a lump-sum contract at the beginning of 2015. As bid, the statistics were as follows: Lump-sum price (contract price) Estimated costs Labor Materials and subcontractor Indirect costs Estimated Gross Profit $4,000,000 $ 850,000 1,750,000 400,000 3,000,000 $1,000,000 18 - 40 Test Bank for Intermediate Accounting, IFRS Edition, 2e Pr. 18-138 (cont.) At the end of the first year, the following was the status of the contract: Billings to date Costs incurred to date Labor Materials and subcontractor Indirect costs Latest forecast total cost $2,250,000 $ 464,000 648,000 193,000 1,305,000 3,000,000 It should be noted that included in the above costs incurred to date were standard electrical and mechanical materials stored on the job site, but not yet installed, costing $105,000. These costs should not be considered in the costs incurred to date. Instructions (a) Compute the percentage of completion on the contract at the end of 2015. (b) Indicate the amount of gross profit that would be reported on this contract at the end of 2015. (c) Make the journal entry to record the income (loss) for 2015 on Dobson's books. (d) Indicate the account(s) and the amount(s) that would be shown on the balance sheet of Dobson Construction at the end of 2015 related to its construction accounts. Also indicate where these items would be classified on the balance sheet. Billings collected during the year amounted to $1,900,000. (e) Assume the latest forecast on total costs at the end of 2015 was $4,060,000. How much income (loss) would Dobson report for the year 2015? Solution 18-138 (a) Costs to date Less materials on job site $1,305,000 (105,000) $1,200,000 Costs Incurred to Date —————————— = Percentage of Completion Total Estimated Costs $1,200,000 ————— = 40% $3,000,000 (b) Revenue 40% × $4,000,000 = Costs incurred Gross profit $1,600,000 1,200,000 $ 400,000 (c) Construction Expenses................................................................. 1,200,000 Construction in Process................................................................ 400,000 Revenue from Long-Term Contracts................................. 1,600,000 Revenue Recognition 18 - 41 Solution 18-138 (cont.) (d) (e) Current Assets Accounts receivable $350,000 ($2,250,000 – $1,900,000) Current Liability Billings in excess of contract costs and recognized profit $650,000 ($2,250,000 – $1,600,000) Total loss reported in 2015 Contract price Estimated cost to complete Amount of loss to be reported $4,000,000 4,060,000 $ (60,000) Pr. 18-139—Accounting for long-term construction contracts. The board of directors of Ogle Construction Company is meeting to choose between the costrecovery method and the percentage-of-completion method of accounting for long-term contracts in the company's financial statements. You have been engaged to assist Ogle's controller in the preparation of a presentation to be given at the board meeting. The controller provides you with the following information: 1. 2. Ogle commenced doing business on January 1, 2015. Construction activities for the year ended December 31, 2015, were as follows: Project A B C D E Project A B C D E 3. 4. Total Contract Price € 500,000 720,000 475,000 200,000 450,000 €2,345,000 Billings Through 12/31/15 € 340,000 210,000 475,000 100,000 400,000 €1,525,000 Contract Costs Incurred Through 12/31/15 € 424,000 195,000 350,000 123,000 320,000 €1,412,000 Estimated Additional Costs to Complete Contracts €101,000 455,000 -097,000 80,000 €733,000 Cash Collections Through 12/31/15 € 310,000 210,000 390,000 65,000 400,000 €1,375,000 Each contract is with a different customer. Any work remaining to be done on the contracts is expected to be completed in 2016. 18 - 42 Test Bank for Intermediate Accounting, IFRS Edition, 2e Pr. 18-139 (cont.) Instructions (a) Prepare a schedule by project, computing the amount of income (or loss) before selling, general, and administrative expenses for the year ended December 31, 2015, which would be reported under: (1) The cost-recovery method. (2) The percentage-of-completion method (based on estimated costs). (b) Prepare the general journal entry(ies) to record revenue and gross profit on project B (second project) for 2015, assuming that the percentage-of-completion method is used. (c) Indicate the balances that would appear in the statement of financial position at December 31, 2015 for the following accounts for Project D (fourth project), assuming that the percentage-of-completion method is used. Accounts Receivable Billings on Construction in Process Construction in Process (d) How would the balances in the accounts discussed in part (c) change (if at all) for Project D (fourth project), if the cost-recovery method is used? Solution 18-139 (a) (1) and (2) Projects Contract price Contract costs incurred Additional costs to complete Total cost Total gross profit or (loss) A €500,000 424,000 B €720,000 195,000 C €475,000 350,000 D €200,000 123,000 E €450,000 320,000 101,000 525,000 455,000 650,000 -0350,000 97,000 220,000 80,000 400,000 € 70,000 €125,000 € (20,000) € 50,000 € (25,000) The amount reported as income (loss) under the cost-recovery method for 2015 is: Project A B C D E €(25,000) -0125,000 (20,000) -0€ 80,000 The amount reported as income (loss) under the percentage-of-completion method for 2015 is: Project A B C D E €(25,000) 21,000 125,000 (20,000) 40,000 €141,000 €70,000 × (€195,000 ÷ €650,000) €50,000 × (€320,000 ÷ €400,000) Revenue Recognition 18 - 43 Solution 18-139 (cont.) (b) (c) (d) Construction in Process................................................................ Construction Expenses................................................................. Revenue from Long-term Contracts.................................. Billings Cash collections Accounts receivable Billings on Construction in Process €100,000 (65,000) € 35,000 100,000 Costs incurred Loss reported Construction in process €123,000 (20,000) €103,000 21,000 195,000 216,000 The account balances would be the same. Pr. 18-140—Long-term contract accounting (cost-recovery). Evans Construction, Inc. experienced the following construction activity in 2015, the first year of operations. Cash Cost Estimated Total Billings Collections Incurred Additional Contract through through through Costs to Contract Price 12/31/15 12/31/15 12/31/15 Complete X $260,000 $170,000 $155,000 $182,000 $ 63,000 Y 330,000 115,000 115,000 100,000 252,000 Z 233,000 233,000 198,000 158,000 -0$823,000 $518,000 $468,000 $440,000 $315,000 Each of the above contracts is with a different customer, and any work remaining at December 31, 2015 is expected to be completed in 2016. Instructions Prepare a partial income statement and a partial statement of financial position to indicate how the above contract information would be reported. Evans uses the cost-recovery method. Solution 18-140 Evans Construction, Inc. Income Statement For the Year 2015 Revenue from long-term contracts (contract Z) Cost of construction (contract Z) Gross profit Provision for loss (contract Y)* *Contract costs through 12/31/15 Estimated costs to complete Total estimated costs Total contract price Loss recognized in 2015 $233,000 158,000 $ 75,000 22,000 $100,000 252,000 352,000 330,000 $ 22,000 18 - 44 Test Bank for Intermediate Accounting, IFRS Edition, 2e Solution 18-140 (cont.) Evans Construction, Inc. Statement of Financial Position As of 12/31/15 Current assets: Accounts receivable ($518,000 – $468,000) Inventories Construction in process (contract X) Less: Billings Unbilled contract costs Current liabilities: Billings ($115,000) in excess of contract costs ($100,000) Estimated liability from long-term contracts $ 50,000 $182,000 170,000 12,000 15,000 22,000