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Kieso, Intermediate Accounting, 13/e, Solutions Manual 18-
CHAPTER 18
Revenue Recognition
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics Questions
Brief Exercises Exercises Problems
Concepts for Analysis
*1. Realization and recognition; sales transactions; high rates of return.
*2. Long-term contracts. 7, 8, 9, 10, 11, 12, 22
*3. Installment sales. 13, 14, 16, 17, 18, 19, 20, 21, 22
*4. Repossessions on installment sales.
*5. Cost-recovery method; deposit method.
*6. Franchising. 22, 28, 29, 30, 31
*7. Consignments. 22, 32 12 21
*This material is dealt with in an Appendix to the chapter.
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ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Brief Exercises Exercises Problems
- Apply the revenue recognition principle. 1 1, 2, 3
- Describe accounting issues for revenue recognition at point of sale.
- Apply the percentage-of-completion method for long-term contracts.
- Apply the completed-contract method for long-term contracts.
- Identify the proper accounting for losses on long-term contracts.
- Describe the installment-sales method of accounting.
- Explain the cost-recovery method of accounting.
*8. Explain revenue recognition for franchises and consignment sales.
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ASSIGNMENT CHARACTERISTICS TABLE (Continued)
Item Description
Level of Difficulty
Time (minutes)
P18-16 Revenue recognition methods—comparison. Complex 40– P18-17 Comprehensive problem—long-term contracts. Complex 50–
CA18-1 Revenue recognition—alternative methods. Moderate 20– CA18-2 Recognition of revenue—theory. Moderate 35– CA18-3 Recognition of revenue—theory. Moderate 25– CA18-4 Recognition of revenue—bonus dollars. Moderate 30– CA18-5 Recognition of revenue from subscriptions. Complex 35– CA18-6 Long-term contract—percentage-of-completion. Moderate 20– CA18-7 Revenue recognition—real estate development. Moderate 30– CA18-8 Revenue recognition, ethics Moderate 25– CA18-9 Revenue recognition—membership fees, ethics Moderate 20–
*CA18-10 Franchise revenue. Moderate 35–
Kieso, Intermediate Accounting, 13/e, Solutions Manual 18-
SOLUTIONS TO CODIFICATION EXERCISES
CE18-
Master Glossary
(a) Under the cost-recovery method, no profit is recognized until cash payments by the buyer, including principal and interest on debt due to the seller and on existing debt assumed by the buyer, exceed the seller’s cost of the property sold.
(b) A method of recognizing profit for time-sharing transactions under which the amount of revenue recognized (based on the sales value) at the time a sale is recognized is measured by the rela- tionship of costs already incurred to the total of costs already incurred and future costs expected to be incurred.
(c) Under the deposit method, the seller does not recognize any profit, does not record notes receivable, continues to report in its financial statements the property and the related existing debt even if it has been assumed by the buyer, and discloses that those items are subject to a sales contract.
(d) The installment-sales method apportions each cash receipt and principal payment by the buyer on debt assumed between cost recovered and profit. The apportionment is in the same ratio as total cost and total profit bear to the sales value.
CE18-
According to FASB ASC 605-10-25-3 (Revenue Recognition—Recognition):
Revenue should ordinarily be accounted for at the time a transaction is completed, with appropriate provi- sion for uncollectible accounts. Revenue and gains generally are not recognized until being realized or realizable and until earned. Accordingly, unless the circumstances are such that the collection of the sale price is not reasonably assured, the installment-sales method of recognizing revenue is not acceptable.
CE18-
According to FASB ASC 910-605-50-2 (Contractors—Revenue Recognition—Disclosure):
If the completed-contract method is used, the reason for selecting that method shall be indicated, for example, either of the following:
(a) Numerous short-term contracts for which financial position and results of operations reported on the completed-contract basis would not vary materially from those resulting from use of the percentage-of-completion method.
(b) Inherent hazards or undependable estimates that cause forecasts to be doubtful.
Kieso, Intermediate Accounting, 13/e, Solutions Manual 18-
ANSWERS TO QUESTIONS
- A series of highly publicized cases of companies recognizing revenue prematurely has caused the SEC to increase its enforcement actions in this area. In some of these cases, significant adjustments to previously issued financial statements were made. Some of these cases involved contingent sales where side agreements were in place or high rates of return occurred. In addition, in some cases, unfinished product was shipped to customers and counted as revenues or unauthorized product was shipped to customers and counted as revenues.
- Revenue is conventionally recognized at the date of sale. For revenue to be recognized at the date of sale, (1) the amount of the revenue should be reasonably measurable—that is, the collectibility of the sales price is reasonably assured or the amount uncollectible can be estimated reasonably (realized or realizable)—and (2) the earnings process is complete or virtually complete—that is, the seller is not obligated to perform significant activities after the sale to earn the revenue.
- Revenues are recognized generally as follows: (a) Revenue from selling products—date of delivery to customers. (b) Revenue from services rendered—when the services have been performed and are billable. (c) Revenue from permitting others to use enterprise assets—as time passes or as the assets are used. (d) Revenue from disposing of assets other than products—at the date of sale.
- Types of sales transactions: (1) Cash sale. (2) Credit sale. (3) C.O.D. sale. (4) Will-call or layaway sale. (5) Sale in advance of delivery (long-term construction). (6) Branch sale. (7) Intercompany sale. (8) Franchise sale. (9) Installment sale.
The student should identify for each type of sale a form of business which typically engages in that type of sale. Many of these sales transactions are not mentioned in this chapter, so the student will probably not identify all these transactions.
- The three alternatives available to a seller that is exposed to risks of ownership due to a return of the product are: (1) Not recording the sale until all return privileges have expired. (2) Recording the sale, but reducing sales by an estimate of future returns. (3) Recording the sale and accounting for the returns as they occur in the future.
- FASB Statement No. 48 requires that such sales transactions not be recognized as current revenue unless all of the following six conditions are met: (1) The seller’s price to the buyer is substantially fixed or determinable at the date of sale. (2) The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product. (3) The buyer’s obligation to the seller would not be changed in the event of theft, or physical destruction, or damage of the product. (4) The buyer acquiring the product has economic substance apart from that provided by the seller. (5) The seller does not have a significant obligation for future performance to directly bring about resale of the product by the buyer. (6) The amount of future returns can be reasonably estimated.
- The two basic methods of accounting for long-term construction contracts are: (1) the percentage- of-completion method and (2) the completed-contract method.
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Questions Chapter 18 (Continued)
The percentage-of-completion method is preferable when estimates of costs to complete and extent of progress toward completion of long-term contracts are reasonably dependable. The percentage-of-completion method should be used in circumstances when reasonably dependable estimates can be made and: (1) The contract clearly specifies the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement. (2) The buyer can be expected to satisfy all obligations under the contract. (3) The contractor can be expected to perform the contractual obligation.
The completed-contract method is preferable when the lack of dependable estimates or inherent hazards cause forecasts to be doubtful.
- Costs Incurred Total Estimated Cost
X Total Revenue = Revenue Recognized
$9 million $50 million
X $60,000,000 = $10,800,
Revenue Recognized – Actual Cost Incurred = Gross Profit Recognized $10,800,000 – $9,000,000 = $1,800,
- Under the percentage-of-completion method, income is reported to reflect more accurately the production effort. Income is recognized periodically on the basis of the percentage of the job completed rather than only when the entire job is completed. The principal disadvantage of the completed-contract method is that it may lead to distortion of earnings because no attempt is made to reflect current performance when the period of the contract extends into more than one accounting period.
- The methods used to determine the extent of progress toward completion are the cost-to-cost method and units-of-delivery method. Costs incurred and labor hours worked are examples of input measures, while tons produced, stories of a building completed, and miles of highway completed are examples of output measures.
- The two types of losses that can become evident in accounting for long-term contracts are: (1) A current period loss involved in a contract that, upon completion, is expected to produce a profit. (2) A loss related to an unprofitable contract.
The first type of loss is actually an adjustment in the current period of gross profit recognized on the contract in prior periods. It arises when, during construction, there is a significant increase in the estimated total contract costs but the increase does not eliminate all profit on the contract. Under the percentage-of-completion method, the estimated cost increase necessitates a current period adjustment of previously recognized gross profit; the adjustment results in recording a current period loss. No adjustment is necessary under the completed-contract method because gross profit is only recognized upon completion of the contract.
Cost estimates at the end of the current period may indicate that a loss will result upon completion of the entire contract. Under both methods, the entire loss must be recognized in the current period.
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Questions Chapter 18 (Continued)
- Year Cash Collected
X *Gross Profit Percentage
= Gross Profit Recognized
2006 $ 80,000 38% $ 30, 2007 320,000 38% 121, 2008 100,000 38% 38, $500,000 $190,
*[($500,000 – $310,000) ÷ $500,000]
- When interest is involved in installment sales, it should be separately accounted for as interest revenue distinct from the gross profit recognized on the installment sales collections during the period. The amount of interest recognized each period is dependent upon the installment payment schedule.
- With respect to the income statement, the degree of detail to be reported frequently will vary, depending upon the magnitude of installment sales revenues in relation to total sales. If installment sales are relatively insignificant in amount, they may be merged with regular sales with no separate designation. In this case the realized gross profit on installment sales normally is reported on the income statement as a separate item immediately below gross profit.
Alternatively, should installment sales represent a material amount of the total revenue of the business enterprise, additional detail may be required for a full and informative disclosure. In such cases it might be desirable to report on the income statement three columns as follows: (1) Total, (2) Regular Sales, and (3) Installment Sales. Obviously, many variations are possible and should be used to meet the necessities of information and full disclosure.
- (a) Income (gross profit) on certain installment sales may be recognized on a basis of:
Gross Profit Selling Price
X Collections.
In some cases where collection is uncertain, the cost-recovery method might be employed. (b) The income on sales for future delivery is not recognized until title has passed to the buyer. (c) When the consignee returns an “account sales” reporting the sale of the merchandise. (d) Under the percentage of completion method: Cost to Date
Estimated Total Cost
X Estimated Gross Profit
or when the contract is completed. (e) During the periods in which the publications are issued.
- Under the cost-recovery method, revenue is recognized (along with the relevant cost of goods sold) in the period of the sale. However, the gross profit is deferred and is not recognized in the income statement until cash payments received from the buyer exceed the cost of the merchandise sold.
In those periods in which the cash payments exceed the costs, the excess receipts (representing gross profits deferred) are reported as a separate item of revenue.
Kieso, Intermediate Accounting, 13/e, Solutions Manual 18-
Questions Chapter 18 (Continued)
*24. Under the deposit method, revenue is not recognized. The deposit method treats cash advances and other payments received as refundable deposits. The sales transaction is not considered complete and recognizable. Only after sufficient risks and rewards of ownership have been transferred and the sale is considered complete is one of the other revenue recognition methods discussed in the chapter applied to the sale transaction.
The major difference is that in the installment-sales and cost-recovery methods, it is assumed that the seller has performed on the contract but cash collection is highly uncertain. Under the deposit method, the seller has not performed and no legitimate claim exists.
*25. It is improper to recognize the entire franchise fee as revenue at the date of sale when many of the services of the franchisor are yet to be performed and/or uncertainty exists regarding collection of the entire fee.
*26. In a franchise sale, the franchisor may record initial franchise fees as revenue only when the franchisor makes “substantial performance” of the services it is obligated to perform. Substantial performance occurs when the franchisor has no remaining obligation to refund any cash received or excuse any nonpayment of a note and has performed all the initial services required under the contract.
*27. Continuing franchise fees should be reported as revenue when they are earned and receivable from the franchisee, unless a portion of them have been designated for a particular purpose. In that case, the designated amount should be recorded as revenue, with the costs charged to an expense account. Continuing product sales would be accounted for in the same manner as would any other product sales.
*28. (a) If it is likely that the franchisor will exercise an option to purchase the franchised outlet, the initial franchise fee should not be recorded as a revenue but as a deferred credit. When the option is exercised, the deferred amount would reduce the franchisor’s investment in the outlet. (b) When the franchise agreement allows the franchisee to purchase equipment and supplies at bargain prices from the franchisor, a portion of the initial franchise fee should be deferred. The deferred portion would be accounted for as an adjustment of the selling price when the franchisee subsequently purchases the equipment and supplies.
*29. A sale on consignment is the shipment of merchandise from a manufacturer (or wholesaler) to a dealer (or retailer) with title to the goods and the risk of sale being retained by the manufacturer who becomes the consignor. The consignee (dealer) is expected to exercise due diligence in caring for the merchandise and the dealer has full right to return the merchandise. The consignee receives a commission upon the sale and remits the balance of the cash collected to the consignor.
The consignor recognizes a sale and the related revenue upon notification of sale from the consignee and receipt of the cash. The consigned goods are carried in the consignor’s inventory, not the consignee’s, until sold.
BRIEF EXERCISE 18-
Current Assets
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BRIEF EXERCISE 18-7 (Continued)
Installment Sales................................................................ 150,
Cost of Installment Sales............................................... 102,
Deferred Gross Profit, 2010....................................... 48,
Deferred Gross Profit, 2010 .............................................. 17,
Realized Gross Profit on Installment Sales
(32% X $54,000) ..................................................... 17,
BRIEF EXERCISE 18-
Repossessed Merchandise............................................... 275
Loss on Repossession...................................................... 37*
Deferred Gross Profit ($520 X 40%) ................................. 208
Installment Accounts Receivable ............................. 520
*[$275 – ($520 – $208)]
BRIEF EXERCISE 18-
Current Assets
Installment accounts receivable due in 2011 .......... $ 65,
Installment accounts receivable due in 2012 .......... 110,
Current Liabilities
Deferred gross profit ($23,400 + $41,800) ................ $ 65,
BRIEF EXERCISE 18-
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SOLUTIONS TO EXERCISES
EXERCISE 18-1 (15–20 minutes)
(a) Uddin could recognize revenue at the point of sale based upon the time
of shipment because the books are sold f.o.b. shipping point. Because
of the return policy one might argue in favor of the cash collection basis.
Because the returns can be estimated, one could argue for shipping
point less estimated returns.
(b) Based on the available information and lack of any information indi-
cating that any of the criteria in GAAP were not met, the correct treatment
is to report revenue at the time of shipment as the gross amount less
the 12% normal return factor. This is supported by the legal test of
transfer of title and the criteria in GAAP. One could be very conservative
and use the 30% maximum return allowance.
(c) Accounts Receivable ...................................... 15,000,
Sales Revenue—Texts ............................ 15,000,
Sales Returns* ($15,000,000 X 12%) .............. 1,800,
Allowance for Sales Returns .................. 1,800,
(d) Sales Returns*................................................. 200,
Allowance for Sales Returns.......................... 1,800,
Accounts Receivable .............................. 2,000,
Cash ................................................................. 13,000,
Accounts Receivable .............................. 13,000,
*A debit to Sales Revenue—Texts or Sales Returns could be made here.
EXERCISE 18-2 (15–20 minutes)
(a) 1. 6/3 Accounts Receivable—Ann Mount.... 8,
Sales............................................ 8,
EXERCISE 18-2 (Continued)
- Kieso, Intermediate Accounting, 13/e, Solutions Manual 18-
- BRIEF EXERCISE 18-
- Construction in Process 1,700,
- Materials, Cash, Payables, etc............................. 1,700,
- Accounts Receivable 1,200,
- Billings on Construction in Process 1,200,
- Cash............................................................................... 960,
- Accounts Receivable............................................ 960,
- BRIEF EXERCISE 18-
- Accounts Receivable............................................ $240,
- Construction in process............................... $1,715, Inventories
- Less: Billings................................................ 1,000,
- of billings...................................................... 715, Costs and recognized profit in excess
- BRIEF EXERCISE 18-
- (a) Construction Expenses........................................ 278, - Revenue from Long-Term Contracts........... 258, Construction in Process (Loss)................... 20,000* - Construction in Process (Loss)................... 20, (b) Loss from Long-Term Contracts 20,000*
- BRIEF EXERCISE 18- *[$420,000 – ($278,000 + $162,000)]
- Installment Accounts Receivable, 2010 150,
- Cash............................................................................... 54,
- Installment Accounts Receivable, 2010.............. 54,
- Cost of Installment Sales............................................... 102,
- Inventory.................................................................. 102,
- Kieso, Intermediate Accounting, 13/e, Solutions Manual 18-
- *BRIEF EXERCISE 18-
- Cash.................................................................................... 25,
- Notes Receivable............................................................... 50,
- Discount on Notes Receivable 8,
- Unearned Franchise Fees ($25,000 + $41,402)........ 66,
- *BRIEF EXERCISE 18-
- Advertising Expense
- Commission Expense 2,
- Revenue from Consignment Sales........................... 21,
- Cost of Goods Sold 13, *[$21,500 – $500 – ($21,500 X 10%)]
- Inventory on Consignment 13, - Kieso, Intermediate Accounting, 13/e, Solutions Manual 18-
- 6/5 Sales Returns and Allowances................... - Accounts Receivable—Ann Mount.....
- 6/7 Transportation-Out - Cash
- 6/12 Cash 7, - Sales Discounts (2% X $7,400) - Accounts Receivable—Ann Mount..... 7,
- 6/3 Accounts Receivable—Ann Mount 7, - Sales [$8,000 – (2% X $8,000)] 7,
- 6/5 Sales Returns and Allowances................... - [$600 – (2% x $600)] Accounts Receivable—Ann Mount
- 6/7 Transportation-Out - Cash
- 6/12 Cash 7, - Accounts Receivable—Ann Mount..... 7,
- (b) 8/5 Cash 7, - Accounts Receivable—Ann Mount..... 7, - (2% X $7,400) Sales Discounts Forfeited
- (a) Cash (2010 slips) (300 X $800)....................................... 240, EXERCISE 18-3 (10–15 minutes) - Dock Rent Revenue 240,
- Cash (2011 slips) [200 X $800 X (1.00 – .05)] 152, - Unearned Revenue (current).................................. 152,
- Cash (2012 slips) [60 X $800 X (1.00 – .20)] 38, - Unearned Revenue (noncurrent) 38,
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EXERCISE 18-4 (Continued)
(b) Construction in Process ($825,000 – $400,000) .... 425,
Materials, Cash, Payables, etc. .................... 425,
Accounts Receivable ($900,000 – $300,000) ......... 600,
Billings on Construction in Process .............. 600,
Cash ($810,000 – $270,000)..................................... 540,
Accounts Receivable ....................................... 540,
Construction Expenses........................................... 425,
Construction in Process ......................................... 135,
Revenue from Long-Term Contracts.............. 560,000*
*$1,600,000 X (75% – 40%)
(c) Gross profit recognized in:
Gross profit $–0– $–0– $530,000*
EXERCISE 18-5 (10–15 minutes)
(a) Contract billings to date.......................................... $61,
Less: Accounts receivable 12/31/10 ..................... 18,
Portion of contract billings collected..................... $43,
(b)
(The ratio of gross profit to revenue recognized in 2010.)
$1,000,000 X .30 = $300,
(The initial estimated total gross profit before tax on the contract.)
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EXERCISE 18-6 (10–12 minutes)
DOUGHERTY INC.
Computation of Gross Profit to be
Recognized on Uncompleted Contract
Year Ended December 31, 2010
Total contract price
Estimated contract cost at completion
Fixed fee.............................................................................. 450,
Total ............................................................................. 2,450,
Total estimated cost .......................................................... 2,000,
Gross profit......................................................................... 450,
Percentage of completion ($800,000 ÷ $2,000,000) ......... 40%
Gross profit to be recognized ($450,000 X 40%) ............. $ 180,
EXERCISE 18-7 (25–30 minutes)
(a) 1. Gross profit recognized in 2010:
Contract price ................................................ $1,200,
Costs:
Costs to date .......................................... $280,
Estimated additional costs ................... 520,000 800,
Total estimated profit .................................... 400,
Percentage completion to date
Gross profit recognized in 2010................... $ 140,
Gross profit recognized in 2011:
Contract price ................................................ $1,200,
Costs:
Costs to date .......................................... $600,
Estimated additional costs ................... 200,000 800,
Total estimated profit .................................... 400,
Percentage completion to date
Total gross profit recognized ....................... 300,
Less: Gross profit recognized in 2010 ....... 140,
Gross profit recognized in 2011................... $ 160,
