Università Bocconi | Financial Reporting and Analysis (20214)

Solution to Question 1 (Investments)

a. Journal entry for the purchase transaction:

DR investment in Bulldog 50,000

CR cash 50,000

b. Goodwill is the amount of the purchase price that is not allocated to any identifiable asset
or liability.

Total 40% share

Assets, at book value $200,000 $80,000
Liabilities (100,000) (40,000)
Excess fair value of identifiable assets 10,000 4,000
Goodwill ?
Purchase price 50,000

The amount of goodwill therefore must be $6,000.

c. Tar Heel recognizes its share of 40% of Bulldog’s reported income, or $4,000, as
investment income on its own balance sheet. In addition, Tar Heel depreciates the excess
fair value of $4,000 over 10 years, which means an income reduction of $400. The
journal entry therefore records net investment income from Bulldog of $3,600.

DR investment in Bulldog 3,600

CR income from equity-method investees 3,600

Tar Heel’s share of the investee’s dividend of $2,000 (40% of $5,000) is recognized as a
reduction in the investment balance.

DR cash 2,000
CR investment in Bulldog 2,000

d. The ending balance of the investment account it:

investment in Bulldog (12/31) = investment in Bulldog (1/1) + income – dividends

= 50000 + 3600 – 2000 = 51600

e. The liquidation of the investment is recorded as:

DR cash 45,000
DR loss on sale of investment 6,600
CR investment in Bulldog 51,600
 Università Bocconi | Financial Reporting and Analysis (20214)

Solution to Question 2 (Revenue Recognition)

a. Calculations are shown in the table below.

2014 2015 2016 2017

hours incurred, current 6,000 8,000 10,000 7,000
hours incurred, cumulative previously 0 6,000 14,000 24,000
total hours incurred to date 6,000 14,000 24,000 31,000
estimated remaining hours 24,000 18,000 6,000 0
% of completion 20% 44% 80% 100%
total revenue to date 3,200,000 7,000,000 12,800,00 16,000,000
0
cumulative revenue, last period 0 3,200,000 7,000,000 12,800,000
revenue this period 3,200,000 3,800,000 5,800,000 3,200,000
cost of sales 2,400,000 3,200,000 4,000,000 2,800,000
gross profit 800,000 600,000 1,800,000 400,000
payment received 0 4,000,000 5,000,000 7,000,000
cumulative payments received 0 4,000,000 9,000,000 16,000,000
net contract asset (liability) 3,200,000 3,000,000 3,800,000 0

b. The net contract asset or liability is the difference between the cumulative revenue earned
to date and the cumulative payments received to date. If revenues exceed (are less than)
payments received, the difference is shown as an asset (liability). The values are shown in
the table above. The numbers are the same in the alternative scenario in part b, except that
the 2015 balance is $2,400,000 instead of $3,000,000. (You can use either scenario to
answer this part.)

c. The changed estimate would not affect the aggregate profit because the actual costs and
revenues are the same as before. The revised estimate would, however, reduce the
percentage of completion in 2015 to 40% and therefore shift gross profit from 2015 into
2016. The new profit figures are $0 in 2015 and $2,400,000 in 2016.
 Università Bocconi | Financial Reporting and Analysis (20214)

Solution to Question 3 (Revenue Recognition)

a. The joint IFRS and US GAAP revenue recognition standard requires the identification of
the distinct performance obligations in any given revenue transaction, the allocation of
the total revenue across these performance obligations, and the recognition of the revenue
allocated to an obligation if and when that obligation is fulfilled. The allocation is based
on the stand-alone selling price of each performance obligation. In the case of the
cupcake sales, there are two distinct performance obligations: the sale of the cupcakes and
the $1 voucher. The $5,000 of revenue needs to be allocated between these two
performance obligations. The first obligation (sale of the cupcake) is satisfied when the
cupcakes are sold. The second obligation (the voucher) will only be satisfied when
customers redeem the vouchers in the future (or when the voucher expires). Hence,
Jessica should defer the recognition of whatever portion of the $5,000 sales proceeds is
allocated to the vouchers until 2015.

b. To compute the revenue allocation between the cupcakes and the vouchers:
value of cupcakes = $5000
value of vouchers = 1000*(90%*$1) = $900
cupcake revenue to be recognized in 2014 = (5000/(5000+900))*$5000 = $4237
Journal entry for the 2014 cupcake sales:

DR cash 5000
CR deferred revenue 763
CR sales revenue 4237

c. The value of the voucher will now depend on the prices of the items that are expected to
be redeemed.
value of cupcakes = $5000
value of vouchers = 1000*(20%*50%*$2 + 40%*50%*$6) = $1400
cupcake revenue to be recognized in 2014 = (5000/(5000+1400))*$5000 = $3906
 Università Bocconi | Financial Reporting and Analysis (20214)

Solution to Question 4 (Accounts Receivable)

a. According to table (c), bad debt expense for all receivables is S/9,717, but, as both table
(a) and the text disclosure in (c) indicate, S/9,034 pertain to receivables in non-financial
assets, so only the remaining S/683 should be included in the answer. The journal entry
for bad debt expense (additions) is therefore:

DR bad debt expense 683

CR allowance for doubtful accounts 683

There are no write-offs in non-financial receivables, so we can use the amounts from
table (c) without further adjustments. The journal entry for write-offs is:

DR allowance for doubtful accounts 11

CR accounts receivable 11

Only the bad debt expense of S/683 appears on the income statement.

b. According to table (a), the allowance for doubtful accounts pertaining to receivables in
financial assets is S/2,295 at the end of 2018. The probability that a financial receivable
ends up in default is therefore:

allowance for doubtful accounts ÷ gross receivables = 2,295 ÷ [ 97,210 + 923 +2,295 ] = 0.0229

The gross amount of financial receivables is the sum of the current and non-current net
balances of S/97,210 and S/923 in table (a), plus the allowance of S/2,295 added back.
Making the analogous calculation using the 2017 amounts yields:

allowance for doubtful accounts ÷ gross receivables = 1,685 ÷ [ 97,299 + 3,221 +1,685 ] = 0.0165

The default probability has therefore increased by 0.64 percentage points, or a factor of
1.39, between 2017 and 2018.

c. At the end of 2017, about half of all past-due receivables were past due for more than 60
days, whereas most of the past-due receivables at the end of 2018 are past due for 60 days
or less. Since the probability of default tends to increase with the age of the receivable,
the average default rate amount past-due receivables should therefore be less in 2018. By
contrast, the overall default probability (for current and past-due balances combined) has
risen from 1.7% in 2017 to 2.3% in 2018, as calculated above. The reason is that past due
balances, in percent of total receivables, increased about threefold between 2017 and
2018. Hence, even though the past-due receivables in 2018 are, on average, fewer days
past their due date than the past-due balances of 2017, the overall expected default rate is
higher in 2018.