Professional Documents
Culture Documents
39 42 51
LO7 Appendix 6A – Describe and
illustrate the reporting for
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 6 6-1
nonrecurring items.
Q6-1. Revenue should be the amount of consideration that a firm expects to receive
for the performance obligations to the customer that it fulfilled during the period.
The revenue rules describe a five-step process. First, the contract (i.e.,
agreement) with the customer myst be identified. Then the firm’s distinct
performance obligations under the contract must be determined. Next, the
amount of consideration the the firm expects to receive must be estimated. If
there are multiple performance obligations, then the consideration must be
allocated to them based on their stand-alone selling prices. These steps are
completed at the commencement of the contract with the customer. Then, as
the firm fulfills a performance obligation, it should recognize as revenue the
amount that was allocated to the performance obligation..
For retailers, like Abercrombie & Fitch, revenue is generally earned when title
to the merchandise passes to the buyer (e.g., when the buyer takes possession
of the merchandise), because returns can be estimated. For companies
operating under long-term contracts, the performance obligation (e.g., to
construct an office building) is usually fulfilled over the period of construction.
Many such companies use the amount of cost incurred as a measure of the
fulfillment of the performance obligation. See the examples of The Gap and
Fluor in the chapter.
Q6-2. Financial statement analysis is usually conducted for purposes of forecasting
future financial performance of the company. Discontinued operations are, by
definition, not expected to continue to affect the profits and cash flows of the
company. Accordingly, the financial statements separately report discontinued
operations from continuing operations to provide more useful measures of
financial performance and financial income. For example, yielding an income
measure that is more likely to persist into the future, and a net assets measure
absent discontinued items.
Q6-3. Restructuring costs typically consist of two general categories: asset write-
downs and accruals of liabilities. Asset write-downs reduce assets and are
recognized in the income statement as an expense that reduces income and,
thus, equity. Liability accruals create a liability, such as for anticipated
severance costs and exit costs, and yield a corresponding expense that
reduces income and equity.
Q6-4. Big bath refers to an event in which a company records a nonrecurring loss in a
period of already depressed income. By deliberately reducing current period
earnings, the company removes future costs from the balance sheet or creates
‘reserves’ that can be used to increase future period earnings.
Q6-7. Estimates are necessary in order to accurately measure and report income on
a timely basis. For example, in order to record periodic depreciation of long-
lived assets, one must estimate the useful life of the asset. Estimates allow
accountants to match revenues and expenses incurred in different periods. For
example, accountants estimate warranty costs so that the warranty expense is
matched against the corresponding sales revenue. If the accounting process
waited until no estimates were necessary, there would be a significant delay in
the reporting of financial results.
Q6-8. When analysts publish earnings forecasts, these forecasts become a
benchmark against which some investors evaluate the company’s
performance. A company that fails to meet analysts’ forecasts may suffer a
stock price decline, even though earnings are higher than previous years’
earnings and overall performance is good. Consequently, management may
feel pressure to meet or slightly exceed analysts’ forecasts of earnings.
The Unlimited can only recognize revenues once they have transferred the products to
the customer and the amount of returns can be estimated with sufficient accuracy.
Assuming that happens at the time of sale, it must estimate the proportion of product
that is likely to be returned and deduct that amount from gross sales for the period. In
this case, it would report $4.9 million in net revenue (98% of $5 million) for the period. If
The Unlimited does not have sufficient experience to estimate returns, then one would
question whether there is a substantive contract with the customer, and it should wait to
recognize revenue until the right of return period has elapsed.
a. A.J. Smith should recognize the warranty revenue as it is earned. Since the
warranties provide coverage for three years beginning in 2020, one-third of the
revenue should be recognized in 2020, one-third in 2021, and the remaining third in
2022.
b.
Year 2020 2021 2022 Total
Revenue $566,666 $566,667 $566,667 $1,700,000
Warranty expenses 166,666 166,667 166,667 500,000
Gross profit $400,000 $400,000 $400,000 $1,200,000
c. Total revenue from sales of the camera packages is $79,800 ($399 x 200). The
revenue is allocated among the three elements of the sale (camera, printer and
warranty) as follows:
Using these proportions, the revenue is allocated among the three elements and
recognized for each element as it is earned. In this case, the portion of the revenue
allocated to the camera and printer are recognized immediately, while the revenue
allocated to the warranty is deferred and recognized over the three-year warranty
coverage period.
Year Revenue
2020 $67,830 ($79,800 x 0.6) + ($79,800 x 0.25)
2021 3,990 ($79,800 x 0.15) / 3
2022 3,990
2023 3,990
Total $79,800
a. To bring the allowance to the desired balance of $2,100, the company will need to
increase the allowance account by $1,600, resulting in bad debts expense of that
same amount.
c.
- Allowance for Doubtful Accounts (XA) + + Bad Debts Expense (E) -
500 Balance (a) 1,600
1,600 (a)
2,100 Balance Balance 1,600
a. Credit losses are incurred in the process of generating sales revenue. Specific
losses may not be known until many months after the sale. A company sets up an
allowance for uncollectible accounts to place the expense of uncollectible accounts
in the same accounting period as the sale and to report accounts receivable at its
estimated realizable value at the end of the accounting period.
b. The balance sheet presentation shows the gross amount of accounts receivable, the
allowance amount, and the difference between the two, the estimated net realizable
value. The balance sheet, thus, reports the net amount that we expect to collect.
That is the amount that is the most relevant to financial statement users.
c. The rule for expense recognition is that expenses are recognized when assets are
diminished (or liabilities increased) as a result of earning revenue or supporting
operations, even if there is no immediate decrease in cash. This dictates the use of
the allowance method. Recognition of expense only upon the write-off of the account
would delay the reporting of our knowledge that losses are likely and, thereby,
reduce the informativeness of the income statement. Accountants believe that
providing more timely information justifies the use of estimates that may not be as
precise as we would like.
a.
($ millions) 2018 2017
Accounts receivable (net)..............................................$421.4 $450.2
Allowance for returns and uncollectible
222.2 214.4
accounts.....................................................................
Gross accounts receivable............................................$643.6 $664.6
Percentage of uncollectible accounts to gross
accounts receivable.................................................... 3.1% 1.7%
($19.7/$643.6 ) ($11.6/$664.6)
Bad debts expense of $2,400 ($120,000 × 0.02) would cause the allowance for
uncollectibles to increase by the same amount. If the allowance increased by only
$2,100 for the period, Sloan Company must have written off accounts totaling $300. In
computing accounts receivable, sales revenue increased the account by $120,000, and
the write-offs would decrease it by $300. If there was a net increase of $15,000 for the
period, Sloan Company must have collected $104,700 in cash. ($104,700 = $120,000 -
$300 - $15,000.)
a.
Accounts Receivable Turnover Average Collection Period
Procter & $66,832/ [($4,686 +$4,594)/2] 365 / 14.4 = 25.3 days
Gamble = 14.4 times
b. P&G turns its accounts receivable faster than Colgate-Palmolive. Receivable turns
typically evolve to an equilibrium level for each industry that arises from the general
business models used by industry competitors. Differences can arise due to
variations in the product mix of competitors, the types of customers they sell to, their
willingness to offer discounts for early payment, and their relative strength vis-à-vis
the companies or individuals owing them money.
Also, the size of the firm may affect the ability of a company to exert bargaining
power over major suppliers or customers. For instance, both of these companies sell
a significant amount of their product to Walmart. P&G is a sizable company, and
may have greater bargaining power over Walmart than does the smaller Colgate-
Palmolive.
One other possibility is that the difference is due to the companies’ differing fiscal
year-ends. If the receivable balance is not constant during the year due to some
seasonality, then the receivable turnover ratio will depend on the choice of fiscal
year.
a.
i. Accounts receivable (+A) ……………………………………… 3,200,000
Sales revenue (+R, +SE) …………………………..…… 3,200,000
b. Besides the $12,000 in recovery, the collections from customers can be summarized
in the following entry:
(This amount includes payment of the recovered receivable for $12,000. The
allowance increases by $15,000 over the period, so the fact that net receivables
increased by $220,000 means that gross receivables must have increased by
$235,000. That fact allows us to “back out” the cash received.)
d.
Balance Sheet Income Statement
Cash Noncash Contra Liabil- Contrib. Earned Net
Transaction Asset + Assets - Assets = ities + Capital + Capital Revenues - Expenses = Income
i. Sales on +3,200,000 - = +3,200,000 +3,200,000 - = +3,200,000
account. Accounts Retained Sales
Receivable Earnings Revenue
ii. Bad debts - +42,000 = -42,000 - +42,000 = -42,000
expense. Allowance for Retained Bad Debts
Uncollectible Earnings Expense
Accounts
iii. Write-off of -39,000 - -39,000 = - =
uncollectibl Accounts Allowance for
e accounts. Receivable Uncollectible
Accounts
iv. Reinstate +12,000 - +12,000 - =
account Accounts Allowance for
previously Receivable Uncollectible
written off. Accounts
v. Collect +12,000 -12,000 - - =
reinstated Cash Accounts
account. Receivable
vi. Collect +2,926,000 -2,926,000 - = - =
cash on Cash Accounts
sales. Receivable
a.
Fiscal Year Revenue Revenue Growth
2018 $48,000
2019 55,000 14.6%
2020 62,000 12.7%
2021 62,000 0.0%
b.
Unearned Customer Purchases = Growth in
Fiscal Revenue Liability Revenue + Change in Customer
Year Revenue (end of year) Unearned Revenue Liability Purchases
2018 $48,000 $20,000
2019 55,000 24,000 55,000 + 4,000 = 59,000
2020 62,000 26,000 62,000 + 2,000 = 64,000 8.5%
2021 62,000 25,000 62,000 - 1,000 = 61,000 -4.7%
c. In both fiscal year 2020 and 2021, the growth in customer purchases is lower than
the growth in reported revenues. The practice of deferring revenue recognition
implies that reported revenues in a given period are the result of customer
purchases over many periods, resulting in a smoothing of revenues. In the case of
Finn Publishing, revenues in any given year are the result of newsstand and
bookstore purchases during that year, plus part of the subscriptions from that year,
plus part of the subscriptions from the previous year. That means that growth in
annual revenues is a composite of growth in customer purchases over an even
longer period of time.
For 2020 and 2021, Finn’s growth in revenues exceeds the growth in customer
purchases because the revenues are still reflecting growth from prior periods.
Purchases are a “leading indicator” of revenues, and thus, calculating customer
purchase behavior can be useful in forecasting future revenue and identifying
changes in customers’ attitudes about a company’s current offerings.
This question is based on an actual situation, in which the accounting rules were
influencing the product decisions. The rules for revenue deferral when there are
multiple deliverables (i.e., multiple performance obligations) deterred the company from
providing enhancements and upgrades that were available. If Commtech’s customers
(the wireless companies) had been willing to pay for the upgrades to their customers’
phones, that would have been allowed. (It’s not clear what the wireless companies’
incentives would be, because they may want to encourage users to purchase new
phones – with a new service contract – rather than improving their existing phones.)
The question can generate a discussion about whether accounting should drive
decisions. Whether it should or not, it does, so the question should evolve into what top
management should do about this type of situation. Does the situation described in the
problem require some managerial action, or not. Is the company foregoing sales
because of its accounting? Within Commtech, the finance staff was skeptical of
marketing’s predictions that the upgrades and enhancements would increase the sales
of existing phone models. If the upgrades and enhancements are delivered, Commtech
will have to change its accounting for revenue, with a resulting decrease in near-term
profitability. How might the company communicate that change in a way that the
investing public will understand as a net benefit to the company?
a. Verdi Co. would report stable sales because extending sales to lower credit quality
customers broadens the customer pool and thus Verdi Co. can sell the same
number of computers year over year.
b. Verdi Co. should have disclosed that is was selling to higher credit risk customers.
At a minimum, Verdi Co. should have estimated a larger expected bad debts
expense related to these customers. (If the credit quality was so poor, Verdi Co. may
even consider not reporting the revenue on the grounds that the agreement with the
customer lacked commercial substance).
c. In future periods when it is revealed that customers cannot pay for the computers,
Verdi Co. will have to write off the related accounts receivable. If these bad debts
were not reserved for early via the bad debts expense and allowance for doubtful
accounts, then Verdi Co. will have to record bad debts expense when the debt goes
bad. This will result in an expense in a year different than the reported revenue and
will supress future earnings, potentially significantly.
e. Wells Fargo Interest is earned by the passage of time. Each period, Wells
Fargo accrues income on each of its loans and establishes an
account receivable on its balance sheet.
On May 31, Haskins is entitled to payment of $50,000, but it has earned revenue of
$120,000. That is, it expects to receive consideration of $120,000 for the 120 units that
it has delivered to Skaife. The contract asset represents consideration that Haskins has
earned, but which is contingent on future events (i.e., delivery of the remaining 80
units).
c. Any ratios involving revenues (Profit margin or Accounts receivable turnover would
be affected. Ratios based on any measure of profit would show more variation in
the method in part (b), The cumulative effect on net income would cause retained
earnings to be higher (or at least never lower) under the method in part (a), affecting
the debt-to-equity ratio and the return on shareholders’ equity.
Design/Engineerin
a. g Year Cost incurred % Completed Revenue Margin Margin %
1 7.00 70.0% 10.50 3.50 33.3%
2 2.00 20.0% 3.00 1.00 33.3%
3 1.00 10.0% 1.50 0.50 33.3%
10.00 100.0% 15.00 5.00
Sum Year
1 7.00 10.50 3.50 33.3%
2 17.00 21.00 4.00 19.0%
3 11.00 13.50 2.50 18.5%
35.00 45.00 10.00
b. Combined Year
1 7.00 20.0% 9.00 2.00 22.2%
2 17.00 48.6% 21.87 4.87 22.3%
3 11.00 31.4% 14.13 3.13 22.2%
Total 35.00 100.0% 45.00 10.00
b. The total revenue for the “bundle” is $200. However the Fire, if sold alone sells for
$110 and the Amazon Prime membership sells for $120, which brings the total
“value” to $230. Thus, the Fire tablet represents 47.83% of the total value of the
bundle ($110/$230). Amazon should recognize $95.65 at the time of the sale
(47.83% of the $200 sale price) and defer the remaining $104.35. Over the
remainder of the quarter, Amazon would recognize one-fourth of this amount as
revenue from the Amazon Prime membership.
c.
Balance Sheet Income Statement
Cash Noncash Contrib. Earned Net
Transaction + = Liabilities + + Revenues - Expenses =
Asset Assets Capital Capital Income
To record bundled sale +200 + = +104.35 + + +95.65 +95.62 - = +95.65
transaction on July 1 Unearned
revenue Retained Sales
earnings revenue
a. There is not yet a contract with the customer that meets the company’s normal
business practice,” so revenue would not be recognized.
b. The performance obligation – to deliver customized units to the customer – has not
yet been fulfilled. The product has been shipped, but not to the customer and not
with the specified customizations that are required by the customer.
d. The distributor does not have the means to pay for the items delivered, so
collectability cannot be reasonably assured (until the distributor sells the product to
an end customer). Again, there would be a question as to whether a contract exists
with the distributor.
a. Prior to the aging of accounts, the balance in the Allowance for Uncollectible
Accounts would be a credit of $520 (the opening balance of $4,350 less the amounts
written off of $3,830).
c.
+ Bad Debts Expense (E) - - Allowance for Uncollectible Accounts (XA) +
(a) 4,180 4,350 Balance
Write-offs 3,830
4,180 (a)
4,700 Balance
d. If the write-offs had been $1000 higher, so too would be the bad debt expense. And,
if the write-offs had been $1000 lower, the bad debt expense would have been
$1000 lower. The aging of accounts determines the end-of-period balance sheet
value, which is combined with the beginning-of-period value and the write-offs during
the period to determine the bad debt expense. Any difference between the bad debt
expectations and the actual bad debt experience is corrected in this process.
The provision for doubtful accounts (bad debts expense) has the effect of
decreasing Steelcase’s reported income by $206 million for the year. The write-off
of $2.5 million of uncollectible accounts has no direct effect on income.
b.
2018 2017
Accounts receivable, net 300.3 307.6
Allowance for doubtful accounts 11.1 11.2
Computations
Accounts Allowance for
Receivable Uncollectible Accounts
Beginning balance $ 122,000 $ 7,900
Sales 1,173,000
Collections (1,150,000)
Write-offs ($3,600 + $2,400 +$900) (6,900) (6,900)
Provision for uncollectibles ($1,173,000 0.8%) _________ 9,384
$ 138,100 $ 10,384
b. Current Assets
Accounts receivable $375,000
Less: Allowance for uncollectible accounts 11,540
$363,460
c.
+ Bad Debts Expense (E) - - Allowance for Uncollectible Accounts (XA) +
(a) 7,340 4,200 Balance
7,340 (a)
11,540 Balance
a.
Year Sales Collections Accounts Written Off
2018 $ 751,000 $ 733,000 $ 5,300
2019 876,000 864,000 5,800
2020 972,000 938,000 6,500
Total $2,599,000 $2,535,000 $17,600
There isn’t any indication that the 1% rate is incorrect. If the rate is too high, we would
expect the allowance to grow at a faster rate than receivables. If the rate is too low, the
opposite would occur. In this case, the allowance percentage of receivables is 17%,
27% and 18% at the end of 2018, 2019 and 2020, respectively. So, there is no clear
direction that would indicate an inappropriate estimate.
a.
Earnings
from Return on
Operation End. Beg. Avg. Capital
s Assets Assets Assets Employed
Personal Systems $1,213 $12,156 $ 10,686 $11,421.0 10.6%
Printing 3,161 10,548 9,959 10,253.5 30.8%
Corporate
Investments (87) 3 1 2 (4,350.0)%
b. The most profitable group is Printing, which represents HP’s traditional strength.
However, it is not growing (based on a small sales percentage increase in 2017). The
Personal Systems (commercial and personal PCs, workstations, calculators, etc.) also
has a good return on capital employed. Corporate Investments is described by the
company as including HP Labs and cloud-related business incubation projects. The
negative return makes sense as this sounds like new businesses and R&D within HP.
c. The activities in Corporate Investments are reducing profits in the present, but they are
vital to the long-run competitive health of the company. An operating manager might
have a short-term horizon and be tempted to reduce the resources devoted to these
b. This entry is simplified by the fact the fiscal year-end is after the end of the current
season and by assuming that all of The Metropolitan Opera’s deferred revenue
relates to the following season (and none to any years after the following season).
(As a not-for-profit, The Metropolitan Opera does not have shareholders’ equity, but
rather “net assets.” Therefore, the recognition of revenue increases net assets (NA)
on the balance sheet.)
c. The Metropolitan Opera usually operates close to seating capacity. And, in a typical
year, more than one-half of its seats are sold before the season. The quantity of
unsold seats will affect The Metropolitan Opera’s marketing efforts for subscribers
who have not yet renewed, outreach to new potential subscribers and promotions for
individual tickets which go on sale shortly before the season. Those efforts can be
scaled up or down depending on the experience with advance sales.
b.
Cash (+A) 142.1
Deferred membership fees (+L) 142.1
The latter entry can be inferred from the information on membership fee revenue in
the income statement. The former entry can be inferred by noting that the Deferred
membership fee liability increased by $3.7 million over the period. Therefore, the
sales of memberships exceeded the revenue from memberships by $3.7 million.
c. When a customer spends $100 in the rewards program, they are entitled to $2 in
cash back. This reduces the value of the consideration that BJ’s receives from the
customer’s purchase from $100 to $98. The $2 would be provided to the member in
electronic awards in $20 increments. So, the entry would be the following:
Cash 100
Revenue 98
Payable to member 2
Once the member reaches the $20 mark, the payable would be debited and cash
would be credited.