Chapter 5

Question 1

Revenue recognition was previously based on the:

Answer 1

“realization principle”

Question 2

What is the core revenue recognition principle?

Answer 2

Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods or services.

Question 3

What are the five steps used to apply the Core Revenue Recognition Principle?

Answer 3

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

Question 4

What are performance obligations?

Answer 4

are promises to transfer goods or services to a customer.

Question 5

When are performance obligations satisfied?

Answer 5

They are satisfied when the seller transfers control of goods or services to the customer.

Question 6

What are the indicators that control has been transferred from the seller to the customer?

Answer 6

1. An obligation to pay the seller
2. Legal title to the asset
3. Physical possession of the asset
4. Assumed the risks and rewards of ownership
5. Accepted the asset

Question 7

What are the criteria for recognizing revenue over time?

Answer 7

1. The customer consumes the benefit of the seller’s work as it is performed (i.e. a company provides cleaning services to a customer for a period of time)
2. The customer controls the asset as it is created (i.e. when a contractor builds an extension onto a customer’s existing building)
3. The seller is creating an asset that has no alternative use to the seller, and the seller has the legal right to receive payment for progress to date (i.e. as when a company manufactures customized fighter jets for the U.S. Air Force)

Question 8

How is revenue recognized when a performance obligation is satisfied over time?

Answer 8

Revenue is recognized in proportion to the amount of the performance obligation that has been satisfied

Question 9

Most __________ qualify for revenue recognition over time.

Answer 9

long-term contracts

Question 10

__________ can be used to estimate progress towards completion when performance obligations are satisfied over time.

Answer 10

Input or output methods

Question 11

Promises to provide goods and services are performance obligations when the goods and services are __________.

Answer 11

distinct

Question 12

A good or service is distinct if it is both:

Answer 12

1. Capable of being distinct. (i.e. The customer could use the good or service on its own or in combination with other good and services it could obtain elsewhere)
2. Separately identifiable from other goods or services in the contract. (i.e. The good or service is distinct in the context of the contract because it is not highly interrelated with other goods and services in the contract)

Question 13

What is the transaction price?

Answer 13

is the amount the seller expects to be entitled to receive from the customer in exchange for providing goods and services

Question 14

If a contract includes more than one performance obligation, the seller allocates the transaction price to each one in proportion to _____________.

Answer 14

their stand-alone selling prices

Question 15

What is a stand-alone selling price?

Answer 15

is the amount at which the good or service is sold separately under similar circumstances.

Question 16

Revenue with respect to each performance obligation is recognized when (or as):

Answer 16

that performance obligation is satisfied.

Question 17

What is a contract?

Answer 17

an agreement that creates legally enforceable rights and obligations.

Question 18

A seller must believe __________ is probable for a contract to exist for the purposes of revenue recognition.

Answer 18

collectibility

Question 19

A contract does not exist if:

Answer 19

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

Question 20

A(n) __________ is not a performance obligation.

Answer 20

prepayment

(Why?) because they aren’t a promise to transfer a product or service to a customer.

Question 21

A(n) __________ warranty is not a performance obligation.

Answer 21

quality-assurance

(Why?) Rather, it is a cost of satisfying the performance obligation to deliver products of acceptable quality.

Question 22

What is a quality-assurance warranty?

Answer 22

warranty that obligates the seller to make repairs or replace products that later are found to be defective or unsatisfactory.

Question 23

A(n) __________ warranty is a separate performance obligation.

Answer 23

extended

(Why?) Because an extended warranty is priced and sold separately from the product, it constitutes a performance obligation and can be viewed as a separate sales transaction.

Question 24

What is an extended warranty?

Answer 24

offered as an additional service that covers new problems arising after the customer takes control of the product.

Question 25

An option for additional goods or services is a performance obligation if it confers a ________ ________ to the customer would not receive otherwise.

Answer 25

material right

Question 26

What are the specific situations that affect the transaction price?

Answer 26

1. Variable consideration 2. Sales with a right of return 3. Identifying whether the seller is acting as a principal or an agent 4. Time value of money 5. Payments by the seller to the customer

Question 27

What is variable consideration?

Answer 27

Is estimated as either the expected value or the most likely amount.

Question 28

If there are several outcomes, the ________________ will be more appropriate. On the other hand, if only two outcomes are possible, the ________________ will be more appropriate.

Answer 28

expected value | most likely amount

Question 29

Sellers are limited to recognizing variable consideration to the extent that it is probable that a significant __________ will not occur in the future.

Answer 29

revenue reversal

Question 30

What are the indicators that a significant revenue reversal could occur?

Answer 30

1. poor evidence on which to base an estimate 2. dependence of the estimate on factors outside the seller's control 3. a history of the seller changing payment terms on similar contracts 4. a broad range of outcomes that could occur 5. a long delay before uncertainty resolves

Question 31

Is a "right of return" considered a performance obligation?

Answer 31

No (Why?) Instead, it represents a potential failure to satisfy the original performance obligation to provide goods that the customer wants to keep.

Question 32

How do we calculate Net sales?

Answer 32

Sales revenue Less: Sales returns Net sales

Question 33

What is a principal?

Answer 33

controls goods and services and is responsible for providing them to the customer.

Question 34

What is an agent?

Answer 34

doesn't control goods or services, but rather facilitates transfers between sellers and customers.

Question 35

An agent only records its __________ as revenue.

Answer 35

commission

Question 36

Sellers must account for the __________ component of transactions when it is significant.

Answer 36

financing

Question 37

Identify the approaches used to estimate stand-alone selling prices:

Answer 37

1. Adjusted market assessment approach 2. Expected cost plus margin approach 3. Residual approach

Question 38

What is the adjusted market assessment approach?

Answer 38

The seller considers what it could sell the product or services for in the market in which it normally conducts business, perhaps referencing prices charged by competitors.

Question 39

What is the expected cost plus margin approach?

Answer 39

The seller estimates its cost of satisfying a performance obligation and then adds an appropriate profit margin.

Question 40

What is the residual approach?

Answer 40

used to estimate a stand-alone selling price that is very uncertain

Question 41

__________ allow the customer to use the seller's intellectual property.

Answer 41

Licenses

Question 42

If a seller's activities during the license period are not expected to affect the intellectual property being licensed to the customer, then:

Answer 42

the revenue is recognized at the START of the license period.

Question 43

If a seller's activities during the license period are expected to affect the intellectual property being licensed to the customer, then:

Answer 43

the revenue is recognized OVER the license period

Question 44

What is a franchise arrangement?

Answer 44

a franchisor (e.g. Subway) grants to the franchisee the right to sell the franchisor's products and use its name.

Question 45

What is a bill-and-hold arrangement?

Answer 45

exists when a customer purchases goods but requests that the seller not ship the product until a later date.

Question 46

Revenue recognition occurs at __________ for a bill-and-hold arrangement.

Answer 46

delivery

Question 47

What is a consignment arrangement?

Answer 47

Where a company arranges for another company to sell its product under consignment. The "consignor" physically transfers the goods to the other company (the consignee), but the consignor retains legal title. If a buyer is found, the consignee remits the selling price to the consignor. If the consignee can't find a buyer within an agreed-upon time, the consignee returns the goods to the consignor.

Question 48

Revenue recognition occurs upon __________ in a consignment arrangement.

Answer 48

sale to an end customer

Question 49

Sales of gift cards are recognized as __________.

Answer 49

deferred revenue

Question 50

The seller recognizes __________, __________, and __________ on separate lines of its balance sheet.

Answer 50

``` contract liabilities (deferred revenue) contract assets (before the customer has paid for it) accounts receivable (before the customer has paid for it) ```

Question 51

Companies provide detailed __________ about revenues.

Answer 51

disclosures

Question 52

What is the percentage-of-completion method?

Answer 52

recognized revenue in each year of the contract (long-term) according to the progress toward completion that occurred during that year.

Question 53

Long-term contracts that didn't qualify for revenue recognition over time were accounted for using an approach called the __________.

Answer 53

completed contract method (Why?) Because all revenue was recognized at a single point in time - upon completion of the contract.

Question 54

Construction in progress (CIP) is the contractor's __________ inventory.

Answer 54

work-in-process

Question 55

Accounting for costs, billings, and cash receipts does not depend on the __________ of revenue recognition.

Answer 55

timing

Question 56

The billings on construction account is a __________ to the CIP asset.

Answer 56

contra account

Question 57

The billings on construction contract account prevents __________ assets by reducing CIP whenever an account receivable is recognized.

Answer 57

"double counting" (having both the physical asset and the financial asset in the balance sheet at the same time constitutes double counting the same arrangement.)

Question 58

The same total amount of revenue is recognized whether it's over the term of the contract or only upon completion, but the __________ of recognition differs.

Answer 58

timing

Question 59

CIP includes __________ and __________ on the contract that have been recognized to date.

Answer 59

profits | losses

Question 60

If a contract doesn't qualify for revenue recognition over time, revenue is recognized when __________.

Answer 60

the project is completed

Question 61

If revenue is recognized upon completion of the contract, CIP is updated to include __________ at that point in time.

Answer 61

gross profit

Question 62

If a contract qualifies for revenue recognition over time, revenue is __________ as the project is completed.

Answer 62

recognized over time

Question 63

How do we calculate Revenue recognized this period?

Answer 63

Revenue recognized this period = (Total estimated revenue * Percentage completed to date) - Revenue recognized in prior periods

Question 64

How should progress to date be estimated?

Answer 64

1. Use output-based measures (i.e. number of units produced or delivered, achievement of milestones, and surveys or appraisals of performance completed to date) 2. Use seller's input, measured as the proportion of effort expended thus far relative to the total effort expected to satisfy the performance obligation (i.e. costs incurred, labor hours expended, machine hours used, time lapsed)

Question 65

When recognizing revenue over the term of the contract, CIP is updated each period to include _________.

Answer 65

gross profit

Question 66

The income statement includes:

Answer 66

1. revenue 2. cost of construction 3. gross profit

Question 67

What is the journal entry to close billing and CIP accounts upon contract completion whether revenue is recognized over time or upon completion?

Answer 67

Debit: Billings on construction contract Credit: Construction in progress (CIP)

Question 68

__________ of revenue recognition does not affect the total amount of profit or loss recognized.

Answer 68

Timing

Question 69

__________ contracts are subtracted from CIP to determine the balance sheet presentation.

Answer 69

Billings on construction

Question 70

CIP in excess of billings is treated as a __________ rather than an accounts receivable, whereas billings in excess of CIP is treated as a __________.

Answer 70

contract asset | contract liability

Question 71

Recognized losses on long-term contracts reduce the __________ account.

Answer 71

CIP

Question 72

An estimated loss on a long-term contract is fully recognized in the ____________, regardless of whether revenue is recognized over time or upon completion.

Answer 72

first period the loss is anticipated

Question 73

Revenue recognition criteria help ensure that an income statement reflects:

Answer 73

the actual accomplishments of a company for the period.

Question 74

Identify the methods of revenue recognition:

Answer 74

1. percentage-of-completion 2. completed contract 3. cost recovery 4. installment sales

Question 75

A company is considered an __________ if it has discretion in setting prices and identifying suppliers. a) principal b) agent

Answer 75

a) principal

Question 76

Identify the distinction between a principal and an agent:

Answer 76

If a company is a PRINCIPAL, it records revenue equal to that total sales prices paid by customers as well as cost of goods sold equal to the cost of the item to the company. If a company is an AGENT, it records as revenue only the commission it receives on the transaction.

Question 77

To record construction costs: (Debit/Credit)

Answer 77

Debit: CIP Credit: Various accounts

Question 78

To record progress billings: (Debit/Credit)

Answer 78

Debit: Accounts Receivable Credit: Billings on Construction

Question 79

To record cash collections: (Debit/Credit)

Answer 79

Debit: Cash Credit: Accounts receivable

Question 80

To record gross profit: (Debit/Credit)

Answer 80

Debit: CIP Debit: Cost of Construction Credit: Revenue from long-term contracts

Question 81

To record expected loss: (Debit/Credit)

Answer 81

Debit: Cost of Construction Credit: Revenue from long-term contracts Credit: CIP