Intermediate Accounting Vol 1 Canadian 2nd Edition Lo Test Bank Download

Intermediate Accounting, Volume 1, 2e
Chapter 4 – Revenue Recognition
Solution Manual for Intermediate Accounting Vol 1

Canadian 2nd Edition Lo Fisher 0133098648
9780133098648
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Chapter 4 Revenue Recognition
Learning Objective 1
1) Which of the following best explains what recognition means in financial reporting?
A) Recognition is the process of reporting an item that is due within 12 months in the current section of
the balance sheet.
B) Recognition is the process of reporting an item in the notes to the financial statements.
C) Recognition is the process of presenting an item in the financial statements.
D) Recognition refers to the choice between using fair value and historical cost in the financial statements.
Answer: C
Diff: 1
Skill: Conceptual
Objective: 4.1 Explain why there is a range of alternatives for revenue recognition that are conceptually valid and the
rationale for accounting standards to prescribe a smaller set of alternatives.
2) Which of the following is correct about the value creation process?

A) The value creation process is the same for all entities.
B) The value creation process is the same for all industries.
C) Any point on the value creation process is acceptable for revenue recognition.
D) The value creation process is specific to each entity.
Answer: D
Diff: 2
Skill: Conceptual
3) Which of the following statements about the value creation process is NOT correct?
A) The value creation process reflects the wide range of possible points at which revenue could be
recognized.
B) Recognizing revenue early in the value creation process is more conservative than waiting until cash is
received.
C) Recognizing revenue early in the value creation process involves more uncertainties and lower
reliability about cash flows.
4-1
Copyright © 2014 Pearson Canada Inc.
D) Permitting too much choice in accounting policies impairs comparability of financial statements.
Answer: B
Diff: 3
Skill: Conceptual
4-2
4) Explain why accounting standards generally prescribe a smaller set of alternatives for revenue
recognition.
Answer: Accounting standards prescribe revenue recognition at later stages of the value creation process
when the risks and uncertainties surrounding procurement, demand, price, credit, and indemnity risk are
sufficiently low. This enables revenue to be measurable.
Diff: 1
Skill: Conceptual
5) Discuss advantages and disadvantages of using the cash basis to recognize revenues. Provide three
valid reasons in your discussion.
Answer:
Advantages/Pros:
• The cash basis of revenue recognition would be more reliable since the cash receipt is readily
verifiable.
Disadvantages/Cons:
• This method usually delays the recognition of revenue, reducing its timeliness and relevance to users.
• Information from the cash method is generally less useful for making predictions about the future, as
they can fluctuate due to random events affecting the timing of payment.
• While more reliable, the cash basis does not eliminate judgment and overstatements.
• Restricting revenue recognition to the cash basis can have real consequences on business activities. For
instance, a company would be less willing to sell products on credit; and the supply of credit is essential
to the health of the economy.
Diff: 2
Skill: Conceptual
6) Here are the general definition and recognition criteria for assets. For each criterion, provide the
related revenue recognition criteria.
a. The entity gives up the future benefits embodied in the asset.
b. The entity gives up control of the resource and therefore removes the item as an asset.
c. The future inflows of resources (e.g., from accounts receivable) are reasonably measurable.
d. The future inflows of resources (e.g., from accounts receivable) are probable.
Answer: Revenue recognition criteria associated with each definition or recognition criteria of an asset:
a. The entity has transferred to the buyer the significant risks and rewards of ownership of the goods.
b. The entity retains neither continuing managerial involvement, to the degree usually associated with
ownership, nor effective control over the goods sold.
c. The amount of revenue can be measured reliably.
d. It is probable that the economic benefits associated with the transaction will flow to the entity.
Diff: 2
Skill: Conceptual
4-3
7) You are an accountant working at Phantastic Pharmaceutical Inc. and have been asked to explain to
your controller the possible points at which revenue could be recognized by your organization. Identify
two alternatives that are conceptually valid for recognizing revenue at Phantastic.
Answer: Value creation occurs during many different business processes: research and development of
the drugs, production of the drugs, signing of contract with the customer, delivery of drugs to the
customer, or collection from the customer. Conceptually, revenue could be recognized at any of these
points to correspond to the value added by these activities.
Diff: 1
Skill: Conceptual
1) On March 1, Pendant Textbook Publications delivers 100 copies of one of its accounting textbooks to
the First University bookstore. The bookstore can return all unsold copies to Pendant. The retail price of
each copy is $110, while the price charged to the bookstore is $80. Each book costs Pendant $40 to
produce. On April 15, the distributor returns 30 unsold copies to Pendant. Based on these facts, how
much revenue would Pendant recognize on April 15?
A) $2,800
B) $5,600
C) $7,700
D) $2,400
Answer: B
Explanation: B) ($80 ∗ 70 copies sold = $5,600)
Diff: 1
Skill: Computational
Objective: 4.2 Apply the general revenue and expense recognition criteria to a variety of contexts involving the sale
of goods and provision of services.
2) Which statement is correct about multiple deliverable sales arrangements?

A) The revenue recognition criteria no longer apply to these transactions.
B) The revenue must be allocated to the components of the sale evenly over the life of the contract.
C) The revenue must be recognized evenly over the life of the contract.
D) Identifying the different sources of revenue increases the representational faithfulness.
Answer: D
Diff: 2
Skill: Conceptual
4-4
3) Which statement is correct about multiple deliverable sales arrangements?

A) The residual value method must be used.
B) The relative fair value method must be used.
C) There is no specific method that must be used.
D) The relative fair value method increases moral hazard.
Answer: C
Diff: 2
Skill: Conceptual
4) Discuss where judgment needs to be applied in the residual value and relative fair value methods.
Answer: It is a matter of professional judgment how one chooses the order of the residual value
allocation and how one chooses between the relative fair value method and the residual fair value
method.
That judgment should take into consideration the reliability of the fair value estimates. If the fair values of
all the components were measured with about the same degree of reliability or accuracy, then it would
make more sense to apply the relative fair value method.
On the other hand, big differences in the reliability of the measurements suggests that it would make
sense to first allocate the price to those components that are measured with the greatest reliability, with
the least reliably measured component taking the remaining unallocated value.
Diff: 2
Skill: Conceptual
5) Explain how revenue should be allocated to the components in a multiple deliverable sales
arrangement.
Answer: While IAS 18 paragraph 13 makes it clear that enterprises should allocate revenue to the
components of arrangements with multiple deliverables, the standard does not specify HOW this
allocation should be made. Different methods can result in different amounts allocated to each
component and different timing of recognition.
In principle, there are two reasonable ways to make this allocation. The first is the relative fair value method
(also called the proportional method), meaning that we allocate revenue in proportion to the estimated
fair values of the components.
The second method is the residual value method, meaning that one of the components picks up the portion
of the sale price that remains after allocating to all the other components.
Diff: 2
Skill: Conceptual
4-5
6) Explain how the timing of revenue recognition is affected by multiple deliverables in the arrangement.
Explain how revenue is ultimately recognized in a multiple deliverable sales transaction.
Answer: Clearly, it is inappropriate to record all the revenue upon delivery of simply one product or
service car if some products or services are delivered at different points in time.
All products or services in such a sales transaction are taken into account.
To record revenue in a manner that reflects the timing of delivery for each product or service in the sales
arrangement, the sales price of the total arrangement is allocated to the individual components. Then the
normal revenue recognition criteria are applied to each component to determine when the revenue from
that element can be recorded by the company.
Diff: 2
Skill: Conceptual
7) Explain why a company should allocate revenue to multiple deliverables in a sales transaction even if
the company delivers all of the products or services in the same accounting period.
Answer: Proper allocation of revenue to the various revenue streams can make a difference to financial
statement readers. Identifying different sources of revenue increases the representational faithfulness of
the information and allows users to better understand the operations of the enterprise.
For example, knowing that a car company earns more from providing services than from the sale of a car
could be quite informative to users in the prediction of future revenues and cash flows. Users could
perceive some revenue sources as more sustainable than other sources.
This information will also reduce moral hazard and information asymmetry.
Diff: 2
Skill: Conceptual
8) Simply Manufacturers has signed an order to supply 10,000 chairs at a price to be determined in the
future. Identify which revenue recognition criteria is NOT met at the point of sale, preventing the
recognition of revenue at that time.
A) The entity has transferred to the buyer the significant risks and rewards of ownership of the goods.
B) It is probable that the economic benefits associated with the transaction will flow to the entity.
C) Stage of completion - either the coverage period has not yet begun or the period has not elapsed.
D) The amount of revenue can be measured reliably.
Answer: D
Diff: 1
Skill: Conceptual
4-6
9) Fancy Cars sold a car for $35,000. In addition, the company will provide 4 oil changes per year for 5
years and an extended warranty for 5 years. The normal selling prices are as follows:
Car 30,000
Oil change 50 each time
Warranty unknown
a. Determine how revenue should be allocated to the various components in this transaction.
b. Apply the appropriate revenue recognition criteria to determine when revenue should be recognized to
the components in this transaction.
Answer:
a. The residual value method is appropriate since the fair value for all components is not determinable.
Fair value
Car 30,000
Oil change
(50 × 4/yr × 5 yrs) 1,000
Total sales price less the known
values
Warranty 4,000 35,000 - 30,000 - 1,000
35,000
b. Revenue for the car should be recognized upon delivery. Revenue for the oil changes will recorded as
each of the 20 oil changes is performed (1,000/ (4/yr*5yrs) ). The revenue for the warranty would be
recognized over the 5 years.
Diff: 2
10) A city transit authority issues 200,000 monthly passes at $80 each for sale at various retailers. Retailers
act as consignees for these passes. Identify which revenue recognition criteria is NOT met at the point of
sale, preventing the recognition of revenue at that time.
Answer: A
Diff: 1
Skill: Conceptual
4-7
11) Hedley Corporation sold hardware and software for $70,000. In addition, the company will provide
support on the software for 1 year and maintenance on the hardware for 3 years. The normal selling
prices are as follows:
Hardware 60,000
Software 5,900
Hardware Maintenance unknown
Answer:
a. The residual value method is appropriate since the fair value for all components is not determinable.
Fair value
Hardware 60,000
Software 5,900
Total sales price less the known
values
Hardware Maintenance 4,100 70,000 - 60,000 - 5,900
70,000
b. Revenue for the Hardware should be recognized upon delivery/installation. Revenue for the software
should be recorded over the one-year support period being provided. Revenue for the maintenance
contract should be recognized over the 3-years.
Diff: 2
12) An insurance company receives annual premiums for fire insurance on June 25 for coverage
beginning July 1. Identify which revenue recognition criteria is NOT met at the point of sale, preventing
the recognition of revenue at that time.
Answer: C
Diff: 1
Skill: Conceptual
4-8
13) Superior Cars sold a car for $35,000. In addition, the company will provide 4 oil changes per year for 5
years and an extended warranty for 5 years. The normal selling prices are as follows:
Car 35,000
Oil change 50 each time
Warranty 4,000
Answer:
a. The relative fair value method is appropriate since the fair value for all components is determinable.
Fair value Allocated Value

Car 35,000 30,625 [35,000/40,000 × 30,000]
Oil change
(50 × 4/yr × 5 yrs) 1,000 875 [1,000/40,000 × 30,000]
Warranty 4,000 3,500 [4,000/40,000 × 30,000]
40,000 35,000
b. Revenue for the car should be recognized upon delivery. Revenue for the oil changes will recorded as
each of the 20 oil changes is performed (875/ (4/yr × 5yrs) ). The revenue for the warranty would be
recognized over the 5-years.
Diff: 2
14) An apartment owner receives a deposit of $1200 equal to one month's rent. Identify which revenue
recognition criteria is NOT met at the point of sale, preventing the recognition of revenue at that time.
Answer: B
Diff: 1
Skill: Conceptual
4-9
15) The publisher of TV Weekly received the following 52-week subscriptions during the first quarter of
fiscal 2012. Each subscription is $110, which is a 47% discount off the newsstand price of $4 per issue.
Each subscription becomes effective in the calendar month after the company receives the subscription.
The company has a December 31 fiscal year. What amount of revenue will the company record in 2012 for
the subscriptions received in January? (Round your response to the nearest dollar).
Month Subscription Received

January 4,300
February 4,200
March 4,100
A) $247,142
B) $250,690
C) $433,583
D) $1,279,500
Answer: C
Explanation: C) 4,300 ∗ 11/12 months ∗ 110 subscription price = $433,583.33
Diff: 2
4-10
16) Harris Corporation sold hardware and software for $70,000. In addition, the company will provide
support on the software for 1 year and maintenance on the hardware for 3 years. The normal selling
prices are as follows:
Hardware 60,000
Software 8,900
Hardware Maintenance 4,000
b. Apply the appropriate revenue recognition criteria to determine when revenue should be recognized
to the components in this transaction.
Answer:
a. The relative fair value method is appropriate since the fair value for all components is determinable.
Fair value Allocated Value

Hardware 60,000 57,613 [60,000/72,900 × 70,000]
Software 8,900 8,546 [8,900/72,900 × 70,000]
Hardware Maintenance 4,000 3,841 [4,000/72,900 × 70,000]
72,900 70,000
b. Revenue for the Hardware should be recognized upon delivery/installation. Revenue for the
software should be recorded over the one-year support period being provided. Revenue for the
maintenance contract should be recognized over the 3-years.
Diff: 2
4-11
17) The publisher of Accounting Digest received the following 12-month subscriptions during 2012. Each
subscription is $100. The company has a December 31 year end. Each subscription becomes effective in
the calendar month after the company receives the subscription. What amount of revenue will the
company record in 2012 for the subscriptions received between January-March? (Round your response to
the nearest dollar).
Month Subscription Received

January 4,300
February 4,200
March 4,100
April 4,400
May 6,100
A) $315,000
B) $779,167
C) $1,051,667
D) $1,260,000
Answer: C
Explanation: C) [(4,300 ∗ 11/12 months) + (4,200 × 10/12 months) + (4,100 ∗ 9/12 months)] ∗ $100
subscription price = $1,051,667
Diff: 3
18) Which condition is NOT necessary to recognize revenue from the sale of goods?
A) When the entity has transferred ownership to the buyer.
B) When the amount of revenue can be measured reliably.
C) When it is probable that the economic benefits will be flow to the entity.
D) When the entity retains no managerial control over the assets.
Answer: A
Diff: 1
Skill: Conceptual
19) Which of the following statements is correct about the revenue recognition criteria for the provision of
services?
A) The outcome of the transaction must be reliably estimable before the percentage of completion method
can be used to record revenue.
B) Ownership must pass to the buyer before revenue can be recorded.
C) Stage of completion does not need to be reliably measurable.
D) Control must pass to the buyer before revenue can be recorded.
Answer: A
Diff: 1
Skill: Conceptual
4-12
20) Which of the following statements about the revenue recognition criteria is NOT correct?
A) Ownership and control are applicable for the provision of services.
B) Revenue recognition criteria are the same for both sale of goods and provision of services.
C) Stage of completion should be reliably estimable in order to use the percentage of completion method.
D) Percentage of completion is an acceptable method of revenue recognition.
Answer: B
Diff: 2
Skill: Conceptual
21) On June 1, Electronics Distribution ships 100 TVs to TV World on consignment. The cost of each unit
is $500 and the unit selling price is $800. At the end of June, TV World sold 50 units. How much revenue
should be recorded by Electronics Distribution for the month of June?
A) $80,000
B) $50,000
C) $40,000
D) $25,000
Answer: C
Explanation: C) 50 units ∗ $800/unit = $40,000
Diff: 1
22) On June 1, Electronics Distribution ships 100 TVs to TV World on consignment. The cost of each unit
is $600 and the unit selling price is $750. At the end of June, TV World sold 50 units. How much cost of
sales should be recorded by Electronics Distribution for the month of June?
A) $37,500
B) $30,000
C) $60,000
D) $75,000
Answer: B
Explanation: B) 50 units ∗ 600/unit = $30,000
Diff: 1
23) Which revenue recognition criterion is NOT satisfied when goods are sold on consignment?
A) The stage of completion can be reliably measured.
B) The transfer of risks and rewards of ownership.
C) Costs incurred can be reliably measured.
D) Managerial control over the goods sold.
Answer: B
Diff: 1
Skill: Conceptual
4-13
24) Which revenue recognition criterion is not satisfied when goods are sold on an installment basis?
A) Transfer of risks and rewards of ownership.
B) Transfer of control over the goods sold.
C) Costs incurred or to be incurred can be reliably measured.
D) Probability that economic benefits will flow to the entity.
Answer: D
Diff: 1
Skill: Conceptual
25) In July, Telly-Rental sells a home theatre for $1,000 on an installment basis. The system costs Telly-
Rental $400. Telly-Rental generally earns a gross profit of 15%. How much revenue is recorded by Telly-
Rental in July?
A) $0
B) $150
C) $400
D) $1,000
Answer: A
Explanation: A) Revenue is deferred until cash is received.
Diff: 1
26) In July, Telly-Rental sells a home theatre for $1,000 on an installment basis. Telly-Rental generally
earns a gross margin of 25%. The customer pays $500 in December. How much revenue is recorded by
Telly-Rental in December?
A) $0
B) $125
C) $250
D) $500
Answer: D
Diff: 1
27) In July, Telly-Rental sells a home theatre for $1,000 on an installment basis. The cost of goods sold is
$400. How much deferred gross profit is recorded by Telly-Rental in July?
A) $0
B) $400
C) $600
D) $1,000
Answer: C
Explanation: C) 1000 - 400 = 600
Diff: 1
4-14
28) Which statement best describes a franchise arrangement?

A) An arrangement in which one party licenses its business practices to another party.
B) An arrangement in which one party exchanges goods or services with another party with little or no
consideration.
C) An arrangement in which one party provides goods to another party to sell on its behalf and will
accept all goods that are not sold.
D) An arrangement in which one party allows the purchaser to make payments over an extended period
of time.
Answer: A
Diff: 1
Skill: Conceptual
29) In September, Fast-Foods Inc. (FF) sells a franchise for an initial fee of $150,000 and ongoing fees
based on 3% of gross profit. FF estimates that 20% of the initial fee relates to initial training, store design
and opening activities; the remaining 80% relate to activities to be performed over 3 years. How much
revenue should be recorded in September?
A) $4,500
B) $30,000
C) $120,000
D) $150,000
Answer: B
Explanation: B) 20% ∗ 150,000 = $30,000
Diff: 1
30) What accounting issue arises for recognizing non-monetary transactions?

A) Determining when the risks and rewards are transferred.
B) Determining the stage of completion.
C) Determining the costs incurred or still to be incurred.
D) Determining the amount at which to record the transaction.
Answer: D
Diff: 1
Skill: Conceptual
4-15
31) On December 1, 2012, SuperTech sold 100 locks for laptop computers at $50 each with a 90-day
unconditional right of return. Since this is a new product for SuperTech, it has no past history regarding
estimated returns. Which of the following is true regarding SuperTech's December 31, 2012 financial
statements?
A) Sales of $5,000 should only be recognized in 2013 when the return privilege expires.
B) Sales of $5,000 should be recognized in 2012 as long as there is a reserve for returns.
C) Sales of $5,000 should be recognized in 2012, with future costs accrued as an estimated liability.
D) Sales should only be recognized as the related cash is collected.
Answer: A
Diff: 2
32) On September 1, 2012, Electric Depot sold 100 laptop computers at $750 each with a 120-day
unconditional right of return. Customers have 90 days to pay. Based on past experience, Electric Depot
estimates that approximately 1% will be returned. Which of the following is true regarding Electric
Depot's December 31, 2012 financial statements?
A) Sales of $75,000 should only be recognized after 120 days when the return privilege expires.
B) Sales of $75,000 should be recognized in September with a reserve for returns of $750.
C) Sales of $75,000 should be recognized in September 2012.
D) Sales should only be recognized as the related cash is collected.
Answer: B
Diff: 2
33) DB Inc. sells goods on a variety of terms to its customers, such as some sales on credit, some on
consignment, and some on an installment basis. Which of the following revenue recognition methods is
most applicable for a company like DB?
A) Installment sales method, if the credit risk is low.
B) Installment method, if credit risk is high.
C) At time of shipment to the consignee, for consignment sales.
D) At the point of sale, if credit risk is very high.
Answer: B
Diff: 2
Skill: Conceptual
4-16
34) Which of the following is an acceptable revenue-recognition method?

A) At time of shipment, if warranty uncertainty is not reliably measurable.
B) At time of shipment to the consignee, for consignment sales.
C) Installment method, if credit risk is high.
D) At the point of sale, if credit risk is very high.
Answer: C
Diff: 2
Skill: Conceptual
35) RU FIT Centre opened for business on April 5, 2012. For revenue recognition purposes, all
memberships are assumed to be issued at the beginning of the month, with 1-year memberships costing
$600 and 2-year memberships costing $960. During April, 32 1-year memberships and 25 2-year
memberships were sold. RU FIT Centre prepares monthly financial statements. Which of the following
statements is correct?
A) Revenue to be recognized as earned for the month of April is $2,600.
B) Revenue to be recognized as earned for the month of April is $3,600.
C) Revenue to be recognized as earned for the month of April is $43,200.
D) Deferred revenue at April 30 would be $43,200.
Answer: A
Explanation: A) (32 × $600 × 1/12) + (25 × $960 × 1/24) = $2,600
Diff: 2
36) Shear Company sells computer equipment with a 2-year warranty. Prior experience indicates that
costs associated with this warranty average 1% in the first year and 2% in the second year. In 2012, Shear
had sales of $1,800,000. It paid $250,000 for materials and labour to make warranty-related repairs in 2012.
What amount should the warranty expense for 2012 be?
A) $18,000
B) $36,000
C) $54,000
D) $250,000
Answer: C
Explanation: C) $1,800,000 × 3% = $54,000
Diff: 2
4-17
37) YMN had sales of $1,500,000, including:

• $25,000 of goods shipped on consignment to an unrelated company on December 28, 2012 and received
by that company on December 31, 2012
• $20,000 of goods shipped F.O.B. shipping point to a different unrelated party on December 31, 2012 and
received on January 2, 2013.
On its income statement, what amount of net sales should YMN record for 2012?
A) $1,455,000
B) $1,475,000
C) $1,525,000
D) $1,545,000
Answer: B
Explanation: B) $1,500,000 - $25,000 = $1,475,000
Diff: 3
38) Simple Inc. had sales of $1,500,000, including:

• $30,000 of goods sold that were on consignment from an unrelated company on December 28, 2012
• $10,000 of goods shipped F.O.B shipping point on December 28, 2012.
• $20,000 of goods shipped F.O.B. destination point on December 31, 2012.
On its income statement, what amount of net sales should Simple Inc. record for 2012?
A) $1,440,000
B) $1,470,000
C) $1,480,000
D) $1,490,000
Answer: C
Explanation: C) $1,500,000 - $20,000 = $1,480,000
Diff: 3
39) Philips Corp. is unsure how to record the following transactions:

• $60,000 of goods shipped F.O.B shipping point on December 28, 2012.
• $50,000 of goods shipped F.O.B. destination point on December 31, 2012.
What amount of sales related to these two transactions should Philips Corp. record in fiscal 2012?
A) $0
B) $50,000
C) $60,000
D) $110,000
Answer: C
Diff: 2
4-18
40) Here are some financial records for Accounting Plus Magazine which started operations in October
2012. Sales for its first month were as follows:
Price per Subscription start Subscription term

Subscriptions sold
subscription date (months)
16,400 25 Oct 1 6 months
11,800 40 Oct 1 12 months
What would be the subscription revenue to be recognized for the month of Oct 2012? (Round to the
nearest dollar).
A) $68,333
B) $107,667
C) $774,333
D) $882,000
Answer: B
Explanation: B) (16,400 ∗ 25 ∗ 1/6) + (11,800 ∗ 40 ∗ 1/12) = 107,667
Diff: 3
41) Here are some financial records for Accounting Plus Magazine which started operations in October
2012. Sales for its first month were as follows:
Price per Subscription start Subscription term

Subscriptions sold subscription date (months)
16,400 25 Oct 1 6 months
11,800 40 Oct 1 12 months
What would be the deferred revenue at Oct 31, 2012? (Round to the nearest dollar).
A) $107,667
B) $341,667
C) $774,333
D) $882,000
Answer: C
Explanation: C) (16,400 ∗ 25 ∗ 5/6) + (11,800 ∗ 40 ∗ 11/12) = 774,333
Diff: 3
4-19
42) Which of the following methods of revenue recognition would be selected when a vendor has another
firm acting as its selling agent?
A) Cost recovery method.
B) Returned goods method.
C) Installment sales method.
D) Consignment sales method.
Answer: D
Diff: 2
Skill: Conceptual
43) Based on the note disclosure provided below for BMW Group, when would the following types of
revenue be recognized?
a) Consignment sales of vehicles (Sales with repurchase commitments).
b) Financial services.
c) Lease rentals.
d) Post-sale services (Multiple-component contracts).
e) Sale of products.
Revenues from the sale of products are recognized when the risks and rewards of ownership of the goods
are transferred to the customer, the sales price is agreed or determinable and receipt of payment can be
assumed. Revenues are stated net of discounts, allowances, settlement discount and rebates. In the case of
long-term construction work, revenues are generally recognized in accordance with IAS 18 (Revenue)
and IAS 11 (Construction Contracts) on the basis of the stage of completion of work performed using the
percentage of completion method. Revenues also include lease rentals and interest income from financial
services. Revenues for the Financial Operations sub-group also include the interest income earned by
Group financing companies.
If the sale of products includes a determinable amount for subsequent services ("multiple-component
contracts") the related revenues are deferred and recognized as income over the period of the contract.
Amounts are normally recognized as income by reference to the expected pattern of related expenditure.
Profits arising on the sale of vehicles for which a Group company retains a repurchase commitment (buy-
back contracts) are not recognized until such profits have been realized. The vehicles are included in
inventories and stated at cost.
Answer:
a. Deferred until product is sold to consumer.
b. Interest income as time elapses.
c. As rental period expires.
d. Deferred and recognized as revenue over period of contract according to the pattern of expected costs.
e. Upon transfer of risks and rewards, price is agreed or determinable, and payment is likely.
Diff: 2
Skill: Conceptual
4-20
44) In the chart below, identify the revenue recognition method that you feel is most appropriate and also
explain why.
Revenue recognition
Transaction method Why?
A. An appliance store sells and delivers a fridge
with a two-year warranty.
B. An airplane manufacturer signs a contract to
supply two planes over four years for Air
Canada.
C. An insurance company issues a one-year
insurance policy.
Answer:
Revenue recognition
A At point of sale Sale of goods: risk and rewards
transferred.
B According to degree of Sale of goods: significant risk and
completion rewards transferred; remaining
indemnity risk is small and estimable.
C Over time Provision of services. Revenue earned as
time elapses.
Diff: 2
Skill: Conceptual
4-21
45) In the chart below, identify the revenue recognition method that you feel is most appropriate and also
explain why.
Transaction Revenue recognition Why?

method
A. An electronics store sells a computer with a
7-day lowest-price guarantee. (That is, if the
customer finds a lower price on the same
product offered by the company or a
competitor, the company will refund the
difference to the customer.)
B. A university receives students' course fees, in
full, at the start of the semester.
C. A company deposits funds into a three-year
term deposit that earns 3% per year.
Answer:
Revenue recognition
A At point of sale Sale of goods: significant risk and
rewards transferred; remaining
indemnity risk is small and estimable.
B According to degree of Provision of services. Revenue earned as
completion courses progress.
C Over time Provision of services: a deposit provides
funds to the bank to use for lending.
Diff: 2
Skill: Conceptual
4-22
46) In the chart below, identify the expense recognition method that you feel is most appropriate and also
explain why.
Expense recognition
Transaction method Why ?
A. A company purchases computers for its
marketing department.
B. A company purchases manufacturing
equipment that is expected to produce 25,000
units.
C. A company incurs delivery costs on January 2
for a shipment of products sold seven days
earlier (before the year-end).
Answer:
Expense recognition Why ?
Transaction method
Matching with the benefits received
A Over time over time.
Based on units of Matching with the benefits of
B production production and subsequent sales.
Matching delivery costs with the related
C At point of sale sales.
Diff: 2
Skill: Conceptual
47) Compare and contrast the revenue recognition criteria for a transaction involving the sale of goods
with a transaction involving the provision of services.
Answer:
• For both goods and services, the amount of revenue and costs must be reliably measured, and
collection be reasonably assured.
• Some differences include:
o For the sale of goods, there must be a transfer of risk and rewards of ownership to the buyer
and a relinquishment of managerial control over the goods.
o For the provision of services, the stage of completion must be reliably measured.
Diff: 1
Skill: Conceptual
4-23
48) Through non-subscription sales, TV Weekly provides retailers with a 50% margin (or 100% mark up)
on its magazines. The newsstand price is $8 per issue. During 2012, the company distributed 1,654,000
copies to retailers, not all of which were sold. Retailers sent a total of 390,000 unsold copies back to the
publisher, of which 30,000 copies were for last two issues published in 2011. In January 2013, the
company received 27,000 unsold copies for magazines published in the last weeks of December 2012.
Required:
Determine the amount of revenue from non-subscriptions TV Weekly should recognize in 2012.
Answer: Copies distributed and sold in 2012 × Newsstand price per copy less 50% = 2012 non-
subscription revenue
= [1,654,000 - (390,000 - 30,000 + 27,000)] ∗ $4
= 1,267,000 × $4 = $5,068,000
Diff: 1
49) Larimar Computers provides customers the option to purchase products with three installment
payments made over 12 months (equal payments at the end of the 4th, 8th, and 12th months). In January
2012, Larimar sold $39,000 of computers to one customer on this installment plan. The cost of these
computers is $30,420.
Required:
Using the installment sales method, record the journal entries for Larimar's installment sales made in
January 2012 and the subsequent payments received on each installment date. Assume all installment
payments are received, and ignore the time value of money.
Answer: Gross profit % = 22% (39,000 - 30,420)/39,000
Jan 2012
Installment accounts receivable 39,000
Inventory 30,420
Deferred gross profit 8,580
JE for installment sales in Jan 2012
Cash 13,000
Cost of goods sold 10,140
Deferred gross profit (22% × 13,000) or 8,580/3 2,860
Installment accounts receivable 13,000
Revenue 39,000/3 13,000
JE for May 2012, Sept 2012 and Jan 2013
Diff: 2
Skill: Conceptual
4-24
50) Jennifer Furnishings frequently has sales involving "no down payment and no payments for three
months." Three months after the purchase date, customers make four equal monthly payments (i.e., they
make equal payments 3, 4, 5, and 6 months after purchase). Each payment is one-quarter of the purchase
price. The company has a December 31 year-end. During 2012, the company made the following sales on
installment plans. Jennifer makes 15% gross profit on these sales.
Sales
January 63,000
February 104,000
March 100,000
April 69,000
May 100,000
June 69,000
July 135,000
August 65,000
September 69,000
October 100,000
November 84,000
December 122,000
Total $1,080,000
Required: Using the installment sales method
a) Determine the balance of installment accounts receivable at December 31, 2012.

b) Determine the amount of deferred gross profit as at December 31, 2012. (Round to the nearest whole
dollar.)
c) Determine the sales revenue to recognize in 2012 for installment sales made in the year.
4-25
Answer:
a) The installment accounts receivable are $424,000.
All of the installments sales from January to June would be fully collected by December 31.
Installment Numbers of Installment Sales O/S at year

Sales Payment(s) O/S end
at year end
(1) (2) [(1) ∗ (2) /4 payments
January 63,000 0
February 104,000 0
March 100,000 0
April 69,000 0
May 100,000 0
June 69,000 0
July 135,000 1 33,750
August 65,000 2 32,500
September 69,000 3 51,750
October 100,000 4 100,000
November 84,000 4 84,000
December 122,000 4 122,000
Total $1,080,000 424,000
b) The deferred gross profit at December 31, 2012 is $63,600. (424,000 ∗ 15%).
c) Sales revenue for installment sales made in 2012 is $656,000. (1,080,000 - 424,000).
Diff: 2
4-26
51) Aurora Gold Company produced 650,000 ounces of gold in 2012. Average sales price was $870/oz.
The price was $870/oz at the start of the year and $870/oz at the end of the year. Production cost averaged
$588/oz, which has been stable for several years. The company had 50,000 ounces in inventory at the
beginning of the year, and 20,000 ounces at the end of the year.
Required:
a) Calculate Aurora Gold's revenue, cost of goods sold, and gross profit, assuming the company
recognizes revenue at the point of sale/delivery.
2011 2012
Revenue $546,000,000
Cost of goods sold 382,200,000
Gross profit 163,800,000
b) Determine the amount that should be shown as ending inventory on Aurora's 2012 balance sheet.
Answer:
a)
2011 2012
591,600,000
Revenue $546,000,000 (870 ∗ (650 + 50 - 20))
399,840,000
Cost of goods sold 382,200,000 (588 ∗ (650 + 50 - 20))
Gross profit 163,800,000 191,760,000
b) $11,760,000 (20,000 ∗ 588)

Diff: 2
4-27
52) McNicols started selling franchise locations in April 2012. The franchisee pays continuing fees based
on annual sales. The initial fee relates to finding a store location and training the franchisee at McNicols'
training facility over a 2-year period.
Fiscal 2012 Fiscal 2013

Initial franchise fee 85,000 95,000
Continuing franchise fees 4% 3%
Franchise sold 5 3
Franchisees' reported sales 1,500,000 2,000,000
Required:
a) Explain how McNicols should account for the initial fee.
b) Assume that management estimates that 40% of the value of services related to the initial fee is fulfilled
in the first year of signing the franchise agreement. Provide the journal entries to record this revenue in
fiscal 2012 and in 2013.
c) Explain how McNicols should account for the ongoing fees.
d) Provide the journal entries to record the ongoing fees in fiscal 2012 and 2013.
4-28
Answer:
a) The $85,000 fee should be recorded based on the performance completed by McNicols. McNicols
should record the revenue associated with finding the store location in fiscal 2012. The revenue associated
with training the franchise should be recorded over 2 years as service is provided by McNicols.
b) Journal entries
Cash 425,000
Franchise revenue (40% ∗ 85,000) ∗ 5 franchises sold 170,000
Deferred revenue (60% ∗ 85,000) ∗ 5 franchises sold 255,000
Fiscal 2012

Fiscal 2013
Cash 285,000
c) The ongoing fees should be recorded annually based on the percentage in the agreement. Revenue
earned as time elapses.
d) Journal entries
Cash or Accounts receivable (4% ∗ 1,500,000) 60,000

Franchise revenue 60,000
Fiscal 2012
Cash or Accounts receivable (3% ∗ 2,000,000) 60,000

Franchise revenue 60,000
Fiscal 2013
Diff: 2
4-29
53) Soorya Manufacturing makes educational toys that are sold to retailers on the following contractual
terms: Each type of toy has a fixed wholesale price, is shipped F.O.B. shipping point, and payment is due
45 days after the shipment. The retailer may return a maximum of 45% of an order at the retailer's
expense up to 6 months after delivery. Sales are made only to retailers that have a good credit rating.
Required:
a) Identify four different revenue recognition points that Soorya could use for its sales.
b) What revenue recognition criteria should Soorya use to determine when revenue should be recorded?
Answer:
a)
1. Record revenues when manufactured
2. Record at signing of contract with retailer
3. Record revenues at shipping point
4. Record revenues 45 days after shipment when payment is due
5. Record revenues after 6 months (when the right of customer return expires)
b) Paragraph 14 of IAS 18 provides the following revenue recognition criteria for the sale of goods.
¶14. Revenue from the sale of goods shall be recognized when all the following conditions have been satisfied:
(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership
nor effective control over the goods sold;
(c) the amount of revenue can be measured reliably;
(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and
(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.
Diff: 2
Skill: Conceptual
4-30
54) Soorya Manufacturing makes educational toys that are sold to retailers on the following terms: Each
type of toy has a fixed wholesale price, is shipped F.O.B. shipping point, and payment is due 45 days
after the shipment. The retailer may return a maximum of 45% of an order at the retailer's expense up to 6
months after delivery. Sales are made only to retailers that have a good credit rating. In Soorya's 11 years
of existence, the company has experienced a return rate of approximately 15%, a bad debt expense of 5%
of sales and an average collection period of 90 days. Soorya provides a bonus to its senior managers
based on annual revenues, net of returns.
Required:
a. Identify three different revenue recognition points that Soorya could use to record revenue.
b. What revenue recognition criteria should Soorya use to determine when revenue should be recorded?
c. Discuss the pros and cons for 2 alternative recognition points mentioned in point (a). Remember to
support your reasoning with case facts.
d. Recommend the recognition point that Soorya should use in its financial statements.
4-31
Answer:
a)
1. Record revenues when manufactured
2. Record at signing of contract with retailer
3. Record revenues at shipping point
4. Record revenues 45 days after shipment when payment is due
5. Record revenues after 6 months (when the right of customer return expires)
b) Paragraph 14 of IAS 18 provides the following revenue recognition criteria for the sale of goods.
4-32
c)
Pros Cons
The company has NOT
transferred the risks and
The item has a fixed wholesale rewards of ownership (i.e.,
price so the measurability of the seller is still liable for the goods
revenue is assured. if damaged or destroyed).
Record revenues This would maximize bonus for The company does NOT have
when management. any receivable/asset due from
manufactured the customer at this point.
Because the shipping terms are
FOB shipping point, the
company has transferred the
risks and rewards of ownership
(i.e., customer is liable for the
goods if lost, damaged or
destroyed). The customer can return up to
45% of the items.
While the returns can be The return period is significant
significant, the company has a (6 months).
substantial operating history Therefore, the measurability of
and could establish a reasonable the revenue is NOT assured
Record revenues provision for returns when the measurability. (How much
at shipping point revenue entry is booked — revenue will there be after the
measurability is assured. returns?)
This could be seen as a
"significant act" in the earnings
process: customer is legally
liable for payment only on this
date.
Measurability likely best since a

customer who pays the amount
will not likely return items after
payment. The payment date is not critical
for accounting — as long as an
The company has a substantial allowance can be established for
Record revenues operating history and could any potential non-payment.
45 days after establish a reasonable provision
shipment when for bad debts when the revenue This is NOT the significant act.
payment is due entry is booked —
measurability is assured.
Record revenues Unduly conservative
after 6 months
(when the right The measurability of the The information in the financial
of customer revenue is the MOST statements using this method
return expires) RELIABLE at this date. will be reliable, but not relevant
4-33
(i.e., users would tradeoff some

reliability to get more relevance
through earlier revenue
recognition).
Bonus would be distributed

later.
d) Any valid recommendation that flows from the student's analysis.

Diff: 3
Skill: Conceptual
4-34
type of toy has a fixed wholesale price, is shipped f.o.b. shipping point, and payment is due 45 days after
the shipment. The retailer may return a maximum of 45% of an order at the retailer's expense up to 6
of sales and an average collection period of 90 days. Soorya provides a bonus to its senior managers
based on annual revenues, net of returns.
Required:
a. What revenue recognition criteria should Soorya use to determine when revenue should be recorded?
b. Discuss the pros and cons for recording revenue when the goods are manufactured by Soorya.
Remember to support your reasoning with case facts.
c. Discuss the pros and cons for recording revenue when the goods are shipped to the retailer.
Remember to support your reasoning with case facts.
d. Discuss the pros and cons for recording revenue 45 after shipment when payment is due. Remember
to support your reasoning with case facts.
e. Recommend the recognition point that Soorya should use in its financial statements.
Answer:
a) Paragraph 14 of IAS 18 provides the following revenue recognition criteria for the sale of goods.
4-35
b), c) and d)
Pros Cons
The company has NOT
The item has a fixed wholesale transferred the risks and
price so the measurability of the rewards of ownership (ie. Seller
revenue is assured. is still liable for the goods if
damaged or destroyed).
This would maximize bonus for
b) Record management. The company does NOT have
revenues when any receivable/asset due from
manufactured the customer at this point.
Because the shipping terms are
FOB shipping point, the
company has transferred the
risks and rewards of ownership
(ie. Customer is liable for the
goods if lost, damaged or The customer can return up to
destroyed). 45% of the items.
The return period is significant
While the returns can be (6 months).
significant, the company has a Therefore, the measurability of
substantial operating history the revenue is NOT assured
and could establish a reasonable measurability. (How much
c) Record provision for returns when the revenue will there be after the
revenues at revenue entry is booked — returns?)
shipping point measurability is assured.
This could be seen as a

"significant act" in the earnings
process: customer is legally
liable for payment only on this
date.

payment.
The payment date is not critical
The company has a substantial for accounting — as long as an
d) Record operating history and could allowance can be established for
revenues 45 establish a reasonable provision any potential non-payment.
days after for bad debts when the revenue
shipment when entry is booked — This is NOT the significant act.
payment is due measurability is assured.
4-36
e) Any valid recommendation that flows from the student's analysis.

Diff: 3
Skill: Conceptual
4-37
1) Lagory Co. started a contract in June 2011 to build a bridge at a fixed price of $14 million. The bridge
was to be completed by October 2013. Total cumulative costs incurred by the end of December 2011 and
2012 were $2 million and $6 million, respectively. Lagory Co. is unable to estimate the total costs of the
project prior to completion. Final costs at the end of the project totalled $11 million. How much revenue
will Lagory Co. report in 2012?
A) $2,000,000
B) $3,000,000
C) $4,000,000
D) $14,000,000
Answer: C
Explanation: C) (since Lagory cannot estimate total costs, use cost recovery method)
2011 2012 2013

Revenue 2,000,000 4,000,000 8,000,000
Cost of sales 2,000,000 4,000,000 5,000,000
Gross profit 0 0 3,000,000
Diff: 2
Objective: 4.3 Apply the specific revenue and expense recognition criteria for construction contracts, including the
prospective treatment applicable to changes in estimates.
2) Sunshine Contractors started a contract in January 2011 to build a bridge at a fixed price of $14 million.
The bridge was to be completed by October 2013. Total cumulative costs incurred by the end of December
2011 and 2012 were $2 million and $6 million, respectively. Sunshine is unable to estimate the total costs
of the project prior to completion. Final costs at the end of the project totaled $11 million. How much cost
of sales will Sunshine report in 2013?
A) $3,000,000
B) $5,000,000
C) $8,000,000
D) $11,000,000
Answer: B
Explanation: B) (since Lagory cannot estimate total costs, use cost recovery method)
2011 2012 2013

Revenue 2,000,000 4,000,000 8,000,000
Cost of sales 2,000,000 4,000,000 5,000,000
Diff: 2
4-38
3) Algae builds large ships and uses the percentage of completion method of revenue recognition. The
following information pertains to the construction contracts it had in place as of its December 31, 2012
year-end.
2011 2012
Cost incurred to date 200 million 400 million
Costs to complete contracts 600 million 600 million
Total price of contracts outstanding at
December 31, 2012 1,300 million 1,300 million
How much revenue will Algae recognize in 2011?

A) $260 million
B) $325 million
C) $433 million
D) $1,300 million
Answer: B
Explanation: B) (Percent complete × Contract revenue) – Revenue previously recognized
= (200/800) × 1,300 - 0
= 325 million
Diff: 1
4) Which statement best explains the percentage of completion method?

A) An accounting method that recognizes revenue and expenses on a contract only after it is completed.
B) An accounting method that recognizes revenue and expenses on a contract in proportion to the degree
of progress.
C) An accounting method that recognizes an amount of revenue equal to the costs that are expected to be
recovered on the contract.
D) An accounting method that recognizes revenue and expenses based on the fair value of the contract.
Answer: B
Diff: 1
Skill: Conceptual
5) How is revenue recognized on a cost plus 7% contract?

A) Revenue is recognized only after the contract is completed.
B) Revenue and expenses are recognized in proportion to the degree of progress.
C) Record an amount of revenue equal to the costs that are expected to be recovered on the contract.
D) Revenue equal to the cost plus 7% profit will be recorded each year.
Answer: D
Diff: 1
Skill: Conceptual
4-39
6) Which statement about the percentage of completion method is correct?

A) This method recognizes revenue on a straight-line basis.
B) This method can only be used if there are no uncertainties about how much the contract will cost or
how long it will take to complete.
C) This method allocates revenue, not construction costs.
D) This method allocates construction costs, not revenue.
Answer: C
Diff: 2
Skill: Conceptual
7) Ying Construction Company entered into a contract to build a new airport terminal for $2,500,000.
Construction commenced on August 1, 2011, with a planned completion date of December 31, 2013. A
summary of the costs, billings, and collections is provided below:
2011 2012 2013

Costs incurred during the year 500,000 700,000 1,100,000
Estimated costs to complete at year end 1,500,000 1,200,000 0
Billings during the year 440,000 1,000,000 1,060,000
Cash collections during the year 400,000 900,000 1,200,000
Ying uses the percentage of completion method. What amount would appear as accounts receivable on
Ying's December 31, 2012 balance sheet?
A) $100,000
B) $140,000
C) $1,000,000
D) $1,400,000
Answer: C
Explanation: C) $440,000 + $1,000,000 - $400,000 - $900,000 = $140,000
Diff: 2
4-40
8) Yang Construction Company entered into a contract to build a new airport terminal for $2,500,000.
Construction commenced on August 1, 2011, with a planned completion date of December 31, 2013. A
summary of the costs, billings, and collections is provided below:
2011 2012 2013

Costs incurred during the year 500,000 700,000 1,100,000
Estimated costs to complete at year end 1,500,000 1,200,000 0
Billings during the year 440,000 1,000,000 1,060,000
Yang uses the percentage of completion method. How much gross profit would Yang recognize in 2012?
A) $100,000 loss
B) $75,000 loss
C) $50,000 profit
D) $100,000 profit
Answer: B
Explanation: B) ($500,000 + $700,000) / ($500,000 + $700,000 + $1,200,000) × ($2,500,000 – $2,400,000) =
$50,000
$50,000 – [$500,000 / ($500,000 + $1,500,000) × ($2,500,000 – $2,000,000)] = $(75,000)
Diff: 3
9) Early in 2012, Forest Ltd. signed a contract to construct a warehouse. Forest's management estimated
the gross profit on the contract to be $740,000, as indicated by the following:
Contract price $3,500,000

Estimated costs 2,760,000
Estimated gross profit $ 740,000
At the end of 2012, the status of the work on the contract was as follows:
Costs incurred to date $1,350,000

Estimated costs to complete 1,650,000
How much revenue can be recognized on this contract for 2012, assuming that Forest uses the
percentage of completion basis for long-term construction contracts (round to nearest dollar)?
A) $333,000
B) $863,333
C) $1,575,000
D) $1,711,957
Answer: C
Explanation: C) 1,350,000 / (1,350,000 + 1,650,000) × 3,500,000 = 1,575,000
Diff: 3
4-41
10) Pool Contractors (PC) entered into a contract to build a solar heated swimming complex for
$1,800,000. Construction commenced on July 1, 2011, with a planned completion date of December 31,
2013. A summary of the related accounting information is provided below:
2011 2012 2013

Costs incurred during the year 400,000 500,000 650,000
Estimated costs to complete at year end 1,200,000 600,000 0
Billings during the year 560,000 640,000 600,000
Cash collections during the year 500,000 310,000 990,000
How much gross profit would be recognized in fiscal 2012 if PC uses the percentage of completion
method?
A) $50,000
B) $100,000
C) $130,000
D) $180,000
Answer: C
Explanation: C) Gross profit 2011: $400,000 / ($400,000 + $1,200,000) × ($1,800,000 – $1,600,000) = $50,000
% complete 2012: ($400,000 + $500,000) / ($400,000 + $500,000 + $600,000) = 60% complete
Gross profit 2012:
[($1,800,000 – $1,500,000) × 60%] - 2011 GP
= $180,000 – $50,000
= $130,000
Diff: 3
4-42
11) Nichols Construction Company (NCC) entered into a contract to build a shopping complex for
2011 2012 2013

How much would the balance in accounts receivable be on the balance sheet of NCC at the end of 2012 if
NCC uses the percentage of completion method?
A) $130,000
B) $390,000
C) $790,000
D) $1,100,000
Answer: B
Explanation: B) ($560,000 + $640,000) - ($500,000 + $310,000) = $390,000
Diff: 3
12) Nova Construction Company (NCC) entered into a contract to build a school for $1,800,000.
Construction commenced on May 1, 2011, with a planned completion date of December 31, 2013. A
summary of the related accounting information is provided below:
2011 2012 2013

How much gross profit would be recognized in fiscal 2011 if NCC uses the percentage of completion
method?
A) $50,000
B) $100,000
C) $130,000
D) $180,000
Answer: A
Explanation: A) $400,000 / ($400,000 + $1,200,000) × ($1,800,000 - $1,600,000) = $50,000
Diff: 2
4-43
13) Tyco Ltd entered into a contract to build a sports arena for $1,800,000. Construction commenced on
August 1, 2011, with a planned completion date of December 31, 2013. A summary of the related
accounting information is provided below:
2011 2012 2013

How much would the balance in accounts receivable be on the balance sheet of Tyco at the end of 2011 if
Tyco uses the percentage of completion method?
A) $110,000
B) $60,000
C) $500,000
D) $660,000
Answer: B
Explanation: B) $560,000 - $500,000 = $60,000
Diff: 2
14) Nichols Construction Company (NCC) entered into a contract to build a shopping complex for
2011 2012 2013

How much would the balance in accounts receivable be on the balance sheet of NCC at the end of 2013 if
NCC uses the percentage of completion method?
A) $0
B) $250,000
C) $290,000
D) $800,000
Answer: C
Explanation: C) ($440,000 + $660,000+800,000) - ($310,000 + $500,000 + 800,000) = $290,000
Diff: 2
Skill: Conceptual
4-44
15) Explain how a company records revenue and expenses for a long-term contract under IFRS. Include
an explanation of how changes in estimates are accounted for under this method.
Answer:
• IFRS prescribes the percentage of completion method to account for construction contracts.
• The percentage of completion method recognizes revenue in proportion to the degree of progress on
the contracted project.
• Enterprises may obtain estimates of the percentage complete from engineering estimates, the cost-to-
cost approach, or other sources.
• Enterprises apply prospective treatment for changes in estimates for costs and percentage complete.
• The cost-to-cost approach expresses the fraction complete as the ratio of cost incurred divided by the
estimated total cost.
Diff: 1
Skill: Conceptual
16) Queensbridge Corp. started a contract in June 2011 to build a bridge at a fixed price of $45 million.
The bridge was to be completed by October 2013 at a total estimated cost of $35 million. Total cumulative
costs incurred by the end of December 2011 and 2012 were $7 million and $24 million, respectively.
Because of cost overruns in 2012, it is now expected that the project will cost $5,000,000 more than
originally estimated. Final costs at the end of the project totaled $36 million. Queensbridge Corp. follows
the guidance in IFRS.
Required:
Determine the amount of gross profit to be recognized for the years ended December 31, 2011 and
December 31, 2012.
Answer: Gross profit = (cost incurred to date / estimated total cost) × (estimated gross profit) - (gross
profit previously recognized)
2011: $2,000,000
(Percent complete × Estimated gross profit) - Gross profit previously recognized
= (7 million / 35 million) × 10 million - 0
= $2,000,000
2012: $1,000,000
(Percent complete × Estimated gross profit) - Gross profit previously recognized
= [(31 million / 40 million) × 5 million] - 2 million
= $1,875,000
Diff: 2
4-45
17) WestCoast Co. started a contract in June 2011 to build a bridge at a fixed price of $14 million. The
bridge was to be completed by October 2013. Total cumulative costs incurred by the end of December
2011 and 2012 were $2 million and $6 million, respectively. WestCoast Co. is unable to estimate the total
costs of the project prior to completion. Final costs at the end of the project totaled $11 million.
Required:
Determine the amount of revenue, cost of sales, and gross profit WestCoast Co. would report in 2011,
2012, and 2013.
2011 2012 2013

Revenue
Cost of sales
Gross profit
Answer: Remember that the company is unable to estimate the total costs and must use the cost recovery
method.
2011 2012 2013

Revenue (= cost of sales) 2,000,000 4,000,000 8,000,000
Cost of sales 2,000,000 4,000,000 5,000,000
Diff: 1
4-46
18) Jones Contractors Inc. agreed to construct a building for $500,000. Construction commenced in 2011
and was completed in 2013.
2011 2012 2013

Estimated costs to complete 290,700 81,295 0
Collections during the year 82,500 199,000 207,000
Required:
For each of the three years, determine the following amounts relating to the above contract: revenue,
expenses, gross profit, accounts receivable balance, and construction-in-process inventory balance.
2011 2012 2013

Revenue
Expenses
Gross profit (loss)
Accounts receivable at end of year

Construction in process inventory at
end of year 0
Answer:
2011 2012 2013
Revenue — current year
(Percent complete × Contract 177,000 234,250 88,750
revenue) - Revenue previously
recognized [(159.3/450 × [(376.705/458 × [500 - 177 -
500) - 0] 500) - 177] 234.250]
Expenses 159,300 217,405 103,295
Gross profit (loss) 17,700 16,845 (14,545)
2011 2012 2013

Accounts receivable at end of year
(Uncollected A/R from last year + 7,500
Billings during the year — (0 + 90 - 82.5) 8,500
Collections during the year) (7.5 + 200 -199) 11,500
Construction in process inventory at 177,00
end of year (Open balance from last (0 + 159.3 +
year + Expenses + Gross profit) 17.7) 411,250 500,000
Diff: 2
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19) On July 1, 2011, Cusak Construction Company Inc. contracted to build an office building for Candy
Lane Corp. for a total contract price of $2,150,000. On July 1, Cusak estimated that it would take between
two and three years to complete the building. In October 2013, the building was deemed substantially
completed. Following are accumulated contract costs incurred, estimated costs to complete the contract,
and accumulated billings to Candy Lane in 2011, 2012, and 2013.
2011 2012 2013

Costs incurred to date 340,000 1,150,000 2,400,000
Estimated costs to complete 1,360,000 1,150,000 0
Billings to Candy Lane 590,000 1,000,000 2,100,000
Required:
Using the percentage of completion method, calculate the revenue and profit or loss to be recognized as a
result of this contract for the years ended December 31, 2011, 2012, and 2013. The company used the cost-
to-cost method to estimate the percentage complete.
Answer:
2011 2012 2013
Revenues — current year 430,000 645,000 1,075,000
Expenses 340,000 810,000 1,250,000
Gross profit (loss) before prudence
adjustment 90,000 (165,000) (175,000)
Prudence adjustment for expected
loss/reversal 0 (75,000) 75,000
Gross profit (loss) 90,000 (240,000) (100,000)
Diff: 2
4-48
1) Which statement best explains the completed contract method?

A) An accounting method that defers revenue and expense recognition until the date when the contractor
completes the project.
of progress.
C) An accounting method that recognizes an amount of revenue equal to the costs that are expected to be
recovered on the contract.
Answer: A
Diff: 1
Skill: Conceptual
Objective: 4.4 Apply the accounting standards for construction contracts when profitability is in doubt.
2) Which statement best explains the cost recovery method?

A) An accounting method that recognizes revenue and expenses on a contract only after it is completed.
of progress.
C) An accounting method that recognizes contract costs as incurred and an amount of revenue equal to
the costs that are expected to be recovered on the contract.
Answer: C
Diff: 1
Skill: Conceptual
3) Which accounting method is permitted under ASPE for construction contracts?

A) An accounting method that recognizes revenue and expenses on a cash basis.
B) An accounting method that recognizes revenue and expenses only after it is completed.
C) An accounting method that recognizes costs as incurred and an amount of revenue equal to the costs
that are expected to be recovered on the contract.
Answer: B
Diff: 2
Skill: Conceptual
4) Which statement about the cost recovery method is correct?

A) The method recognizes contract revenues on a cash basis.
B) The method recognizes revenue and expenses in proportion to the degree of progress.
C) This method recognizes defers any profit until the contract is completed.
D) This method is the preferred method for recognizing revenue.
Answer: C
Diff: 2
Skill: Conceptual
4-49
5) How is the prudence principle applied to the accounting for construction contracts?
A) If a loss is expected on the contract, all of this loss is immediately recognized.
B) Only a proportional amount of revenue and expenses are recorded each year.
C) If a loss is expected on the contract, a loss is recognized in the current year based on the degree of
completion.
D) Under this principle, good news is reflected earlier than bad news.
Answer: A
Diff: 1
Skill: Conceptual
6) Which formula explains how gross profit is recognized when an overall loss is expected on the contract
under the percentage completion method?
A) Cost incurred / Estimated total cost.
B) (Cost incurred / Estimated total cost) × Contract revenue - Revenue previously recognized.
C) (Cost incurred / Estimated total cost) × Estimated total cost - Cost of sales previously recognized.
D) 100% × (Estimated gross loss) - (Gross profit/loss previously recognized).
Answer: D
Diff: 2
Skill: Conceptual
7) Smile Operators entered into a contract to build a swimming complex for $1,800,000. Construction
commenced on July 1, 2011, with a planned completion date of December 31, 2013. A summary of the
related accounting information is provided below:
2011 2012 2013

Billings during the year 360,000 440,000 1,000,000
How much gross profit would be recognized in 2012 if the company uses the completed contract method
under ASPE?
A) $0
B) $120,000
C) $220,000
D) $250,000
Answer: A
Diff: 2
4-50
8) Tradel Construction Company entered into a contract to build a condominium building for $1,800,000.
Construction commenced on July 1, 2011, with a planned completion date of December 31, 2013. A
summary of the related accounting information is provided below:
2011 2012 2013

Billings during the year 360,000 440,000 1,000,000
How much gross profit would be recognized in 2013 if Tradel uses the completed contract method?
A) $0
B) $120,000
C) $220,000
D) $250,000
Answer: D
Explanation: D) $1,800,000 - ($400,000 + $500,000 + $650,000) = $250,000
Diff: 3
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9) Assume the following facts for a construction contract that was completed over four years. The
contract price is $5.1 million.
2011 2012 2013 2014

Costs incurred to date 750,000 2,033,000 2,610,000 4,350,000
Estimated costs to complete 2,250,000 3,317,000 1,740,000 0
Required:
a. Using the percentage of completion method, calculate the gross profit or loss to be recognized as a
result of this contract for each of the four years. The company used the cost-to-cost method to estimate
the percentage complete.
b. If this company were permitted to use guidance in the CICA Handbook, and the company chose to apply
the completed contract method, what would be the gross profit or loss in each of the four years?
Answer:
a. The question only asks for the gross profit or loss, so we can simply apply the normal formulas. Note:
Normal circumstances (2011, 2013, 2014) and expected loss on the contract (2012).
GP = (Estimated % Complete or 100% if expected loss) × (Estimated

GP) - (GP previously recognized)
2011 [(750,000/3,000,000 × 100%] × (2,100,000) - (0) = $525,000
2012 100% × (250,000 loss) - 525,000 = (775,000)
2013 [ (2,610,000 / 4,350,000) × 100% ] × 750,000 - (250,000 loss) = $700,000
2014 100% × 750,000 - 450,000 = 300,000
b. For the completed contract method, no profit is recognized until the end of the contract. However, any
expected losses are recognized in their entirety in the year anticipated. The gross profits (losses) for the
four years are shown in the following table. It is important to note that the loss is not reversed in 2013
when the project becomes profitable again–all profits are deferred to the date of contract completion.
Year 2011 2012 2013 2014 Total

Gross profit (loss) 0 (250,000) 0 1,000,000 750,000
Diff: 2
10) What are some exceptions to the use of the percentage of completion method for construction
contracts?
Answer:
• When the enterprise expects a loss on a contract, prudence requires that 100% of the loss be recognized
immediately.
• The cost recovery method should be used when the enterprise cannot reasonably estimate the outcome
of the construction contract.
• Enterprises eligible to use guidance in ASPE may use the completed contract method.
Diff: 1
Skill: Conceptual
4-52
11) Southtel is a builder of large digital networks. In the midst of the high-tech euphoria, the company bid
and won a $48,000,000 contract to build a network for the country of Elbonia. Details on the project over
the last three years are as follows:
Year 1 Year 2 Year 3

Cumulative costs incurred 16,500 36,000 54,000
Additional costs to complete as estimated at
year end 49,500 12,000 0
Amounts invoiced to customer in the year 13,500 26,000 21,000
Cash collected in the year from the customer 10,500 25,000 12,500
Required:
Calculate the amount of revenue, cost of goods sold (COGS), and gross profit (or loss) to be recognized in
each of the three years. The company uses the percentage of completion method to account for long-term
contracts. Record your answer in the following table.
Year 1 Year 2 Year 3 Total

Revenue 48,000
Less: Cost of goods sold 16,500 54,000
Less: Expected loss (recovery) (13,500) 0
Gross profit (loss) (6,000)
Answer:
Year 1 Year 2 Year 3 Total
Revenue 12,000 24,000 12,000 48,000
(Percent complete × Contract
revenue) — Revenue previously
recognized
Less: Cost of goods sold 16,500 19,500 18,000 54,000
(Cumulative costs of current
year — cumulative costs of
prior year)
Less: Expected loss (recovery) 13,500 (13,500) 0 0
Cost overrun in year 1, then cost
containment in year 2
Gross profit (loss) (18,000) 18,000 (6,000) (6,000)
Diff: 2
4-53
1) Why is there risk of earnings overstatement in accounting for construction contracts?

A) The long term nature of such contracts makes them a low risk area.
B) Allocation of revenue and expenses between two or more periods simplifies the accounting.
C) Significant professional judgment is required to make estimates used in the calculations.
D) Percentage of completion method reduces the potential for earnings management, manipulation and
errors.
Answer: C
Diff: 1
Skill: Conceptual
Objective: 4.5 Evaluate the risks of revenue misstatements and the appropriateness of revenue recognition policies in
specific circumstances by applying professional judgment.
2) What are some ways in which earnings management on construction contracts can be prevented?
A) Determining the degree of completion in a manner that best represents the underlying performance of
the project.
B) Judiciously making estimates for the cost-to-cost approach that maximize earnings in the current year.
C) Underestimating future costs.
D) Not using engineering estimates or the cost-to-cost approach.
Answer: A
Diff: 2
Skill: Conceptual
3) Which statement is correct about the impact of estimation errors on construction contracts?
A) Underestimating future costs decreases the percentage complete ratio.
B) Overestimating future costs increases the percentage complete ratio.
C) Underestimating future costs increases the profit recognized in future periods.
D) Underestimating future costs increases the profit recognized in the current period.
Answer: D
Diff: 3
Skill: Conceptual
4) Which statement is correct about unintentional errors on construction contracts?

A) Unintentional underestimates or overestimates may not be errors.
B) Errors are misstatements that should not have been made based on the information available at the
time.
C) Both statements are correct.
D) Neither statement is correct.
Answer: C
Diff: 2
Skill: Conceptual
4-54
5) Which statement is correct about the "winner's curse"?

A) Misstatements from the winner's curse are unintentional under-estimates or over-estimates.
B) Misstatements from the winner's curse result from the unavailability of correct information.
C) The winner's curse means a contract is usually awarded to the highest bidder.
D) The winner's curse means that a contract will tend to be awarded to the contractor who
underestimates costs the most.
Answer: D
Diff: 2
Skill: Conceptual
6) How is income and expense recognized for biological assets under IFRS?
A) Changes in fair value.
B) Percentage of completion method.
C) Completed contract method.
D) Cash basis.
Answer: A
Diff: 1
Skill: Conceptual
7) What disclosures are required under IFRS for construction contracts?

A) Method used to determine the percentage complete in the period.
B) Contract revenue recognized in the period.
C) Method of revenue recognition.
D) All of the above are required.
Answer: D
Diff: 2
Skill: Conceptual
4-55
8) Briefly explain the following terms:

a) Non-monetary exchange transaction
b) Consignment transaction
c) Franchise
d) Installment sale
Answer:
a) Non-monetary exchange transactions: The exchange of goods or services with little or no monetary
consideration.
b) Consignment: An arrangement where one party (the consignor) provides goods to a second party to
sell; however, the second party (the consignee) has the right to return all or a portion of the goods to the
first party if the goods are not sold.
c) Franchise: A commercial arrangement in which one party (the franchisor) licenses its trademarks,
business practices, and so on to another (the franchisee).
d) Installment sale: An arrangement whereby the seller allows the buyer to make payments over an
extended period of time while the buyer receives the product at the beginning of the installment period.
Diff: 1
Skill: Conceptual
4-56
9) Explain whether each of the following transactions would be accounted for as a change in accounting
policy, change in accounting estimate or as an error correction. Assume all transactions are material.
Transaction Appropriate accounting

During the audit of the 2012 fiscal year,
the auditors learned that Soorya Mining
Inc. should have had used an average
price of $850/oz. for its fiscal 2012
reporting, not $840/oz.
the auditors learned that Everlast
Construction used the completed
contract method. It would now like to
use the percentage of completion
method.
Inc. had hedged the sales price for all its
production in the year. In other words,
the price for all of the 2012 production
was guaranteed to be $850/ oz. As a
result, the auditors determined that it
would be more appropriate for the
company to recognize revenue when
production was complete. Soorya had
not previously engaged in hedging of
the price on its production.
4-57
Answer:
Transaction Appropriate accounting
Inc. should have had used an average
price of $850/oz. for its fiscal 2012
reporting, not $840/oz. Error correction
the auditors learned that Everlast
Construction used the completed
contract method. It would now like to
use the percentage of completion
method. Change in accounting policy
Inc. had hedged the sales price for all its
production in the year. In other words,
the price for all of the 2012 production
was guaranteed to be $850/ oz. As a
result, the auditors determined that it
would be more appropriate for the
company to recognize revenue when
production was complete. Soorya had
not previously engaged in hedging of
the price on its production. Change in estimate
Diff: 1
Skill: Conceptual
4-58
Comprehensive Learning Objectives
type of toy has a fixed wholesale price, is shipped F.O.B. shipping point, and payment is due 45 days
after the shipment. The retailer may return a maximum of 45% of an order at the retailer's expense up to 6
of sales and an average collection period of 90 days.
Soorya provides a bonus to its senior managers based on annual revenues, net of returns.
Required:
a) Identify four different points in Soorya's value creation process that could be used for recording
revenue.
b) What are the basic revenue recognition criteria under IFRS?
c) Discuss the pros and cons for two alternative recognition points mentioned in point (a). Remember to
d) Recommend the recognition point that Soorya should use in its financial statements.
e) Explain why this is or this is not a consignment sales transaction.
f) Explain why this is or this is not an installment sales transaction.
Answer:
a) Here are some common ones (student could raise other valid points)
• manufacturing
• shipment
• collection period: 45 days after shipment when payment is due
• at end of contract life: 6 months when the right of customer return expires
b) Revenue recognition criteria for sale of goods. Based on IAS 18:
Revenue from the sale of goods shall be recognized when all the following conditions have been satisfied:
(b) the entity retains neither continuing managerial involvement to the degree usually associated with
ownership nor effective control over the goods sold;
4-59
c) Discuss the pros and cons for two alternative recognition points mentioned in point (a). Remember to
Pros Cons
Record The item has a fixed wholesale The company has NOT
revenues when price so the measurability of the transferred the risks and
manufactured revenue is assured. rewards of ownership (i.e.,
seller is still liable for the goods
This would maximize bonus for if damaged or destroyed).
management.
Record Because the shipping terms are The customer can return up to
revenues at FOB shipping point, the 45% of the items.
shipping point company has transferred the The return period is significant
risks and rewards of ownership (6 months).
(i.e., customer is liable for the Therefore, the measurability of
goods if lost, damaged or the revenue is NOT assured
destroyed). measurability. (How much
revenue will there be after the
While the returns can be returns?)
significant, the company has a
substantial operating history
and could establish a reasonable
provision for returns when the
revenue entry is booked —
Record This could be seen as a The payment date is not critical
revenues 45 "significant act" in the earnings for accounting — as long as an
days after process: customer is legally allowance can be established for
shipment when liable for payment only on this any potential non-payment.
payment is due date.
/ collected This is NOT the significant act.
payment.
The company has a substantial

operating history and could
establish a reasonable provision
for bad debts when the revenue
entry is booked —
d) Recommend the recognition point that Soorya should use.

Any point as indicated in the table above is acceptable.
4-60
e) This is NOT a consignment sales transaction. Risk of ownership is transferred from Soorya to the
customer. Note: Consignment sale is an arrangement where one party (the consignor) provides goods to a
second party to sell; however, the second party (the consignee) has the right to return all or a portion of
the goods to the consignor if the goods are not sold.
f) This is NOT an installment sales transaction. The customer is NOT making payments to Soorya over an
extended period of time. Note: Installment sale is an arrangement whereby the seller allows the buyer to
make payments over an extended period of time while the buyer receives the product at the beginning of
the installment period.
Diff: 2
Skill: Conceptual
Objective: 4.1/ 4.2 Explain why there is a range of alternatives for revenue recognition that are conceptually valid and
the rationale for accounting standards to prescribe a smaller set of alternatives./Apply the general revenue and
expense recognition criteria to a variety of contexts involving the sale of goods and provision of services.
2) Creation Construction Company (CCC) has contracted to build an office building for Property Corp.
The construction started on January 1, 2012, and the project was completed on July 1, 2015. The contract
price was $70 million. Due to uncertainties in the construction process, the two parties to the project
agreed to a risk-sharing arrangement whereby Property Corp. covers 50% of all cost overruns in excess of
the originally estimated cost of $65 million (e.g., if estimated total costs are $69 million, then CCC would
receive an additional $2 million for the contract). The following data relate to the construction period.
2012 2013 2014 2015

Costs incurred to date 16,500 42,900 56,100 69,000
Estimated costs to complete 49,500 35,100 9,900 0
Billings during the year 24,000 38,600 61,600 ????
Collections during the year 19,000 35,100 58,100 68,500
Required:
Calculate the estimated gross profit (loss) for 2012, 2013, 2014, and 2015, assuming that the percentage of
completion method is used.
Answer:
GP = (Estimated % Complete or 100% if expected loss) ×
(Estimated GP) - (GP previously recognized)
[(16,500 / 66,000) *100%] × (4,500) - (0) = $ 1,125 [[$4,500 = (70,000
2012 - 66,000) + [50% × (66,000 - 65,000)] ]]
2013 100% × (1,500) - 1,125 = ($2,625)
2014 [ (56,100 / 66,000) × 100% ] × 4,500 - (1,500 loss)= $ 5,325
2015 100% × 3,000 - 3,825 = ($ 825)
Diff: 2
Objective: 4.3/ 4.4 Apply the specific revenue and expense recognition criteria for construction contracts, including
the prospective treatment applicable to changes in estimates./Apply the accounting standards for construction
contracts when profitability is in doubt.
4-61
3) Apartment King (AK) is building a luxury condominium for a contract price of $68,000,000. This is
estimated to be a three-year project with an estimated cost of $54,000,000. AK uses the percentage of
completion method of revenue recognition, using the cost-to-cost method of estimating the percentage
complete. The following is the best available information at the end of each year:

Costs incurred each year 9,000 31,500 20,000
Billings 13,000 29,500 25,500
Collections 9,000 26,500 32,500
Required:
a. Calculate the amount of gross profit to be recognized in Year 1, Year 2, and Year 3. Show computations
in tabular form provided below.

Cost incurred to date
Estimated cost to complete
Estimated total cost
Contract price
Estimated gross profit
% complete
Gross profit to date
Gross profit previously recognized
Current gross profit
b. Prepare all the journal entries required in Year 2.

c. Prepare the journal entry required in Year 3 to close the accounts related to the project.
d. At the end of Year 2, if the estimated cost to complete is $28 million (instead of $27 million), how much
gross profit would be recognized in Year 2?
4-62
Answer:
a. ( in $ thousands)
Notes 1 2 3
Cost incurred to date A 9,000 40,500 60,500
Estimated cost to complete B 51,000 27,000 0
Estimated total cost C=A+B 60,000 67,500 60,500
Contract price D 68,000 68,000 68,000
Estimated gross profit D-C 8,000 500 7,500
% complete E = A/C 15% 60% 100%
Gross profit to date F = DE 1,200 300 7,500
Gross profit previously recognized G 0 1,200 300
Current gross profit F-G 1,200 (900) 7,200
b. (Year 2 - in $ thousands)
Costs incurred
Dr. CIP 31,500
Cr. Cash, A/P 31,500
Billings
Dr. A/R 29,500
Cr. Billings on construction in progress 29,500
Collections
Dr. Cash 26,500
Cr. A/R 26,500
Revenue (income) recognition

Dr. COGS 31,500
Cr. Revenue 30,600
Cr. CIP 900
c.
Dr. Billings on construction in progress 68,000
Cr. CIP 68,000
d.
GP = (Estimated % Complete or 100% if expected loss) × (Estimated GP) - (GP previously recognized)
(500 loss) × 100% - 1,200 = 1,700 loss
Diff: 3
4-63
4) Buildings Ltd. is constructing a residential building in downtown Vancouver for a contract price of
$15,000,000. Costs for this contract were initially estimated to be $12,000,000. The company uses the
percentage of completion method of revenue recognition, using the cost-to-cost method of estimating the
percentage complete. The following information is available:

Additional costs to complete estimated at year end 7,500 5,000 0
Billings 6,000 6,000 3,000
Collections 5,000 6,500 3,500
Required:
a. Calculate the amount of gross profit to be recognized in each year. Show computations in good form.
b. Calculate the amount of revenue to be recognized in Year 2.
c. Prepare all the journal entries required in Year 2.
d. Prepare the journal entry required in Year 3 to acknowledge completion and acceptance of the project.
4-64
Answer:
a. Gross profit (loss)
GP = (Estimated % Complete or 100% if expected loss) ∗
(Estimated GP) - (GP previously recognized)
Year 1 [(4,500,000/12,000,000 *100%] × (3,000,000) - (0) = $1,125,000
Year 2 100% × (3,000,000 loss) - 1,125,000 = (4,125,000)
Year 3 100% × 0 - (3,000,000 loss)= $3,000,000
b. Revenue = % complete × estimated total revenue – revenue previously recognized

= (13,000 / 18,000) × 15,000 - 5,625 = $5,208k
c. (in $ thousands)
Costs incurred
Dr. Construction in progress (CIP) 8,500
Cr. Cash, A/P 8,500
Billings
Dr. A/R 6,000
Collections
Dr. Cash 6,500
Cr. A/R 6,500
Revenue and expense recognition

Dr. COGS 8,500
Cr. Revenue 5,208
Dr. Expected loss on LT contract 833
Cr. CIP 4,125
d.
Project completion
Dr. Billings on construction 15,000
Cr. CIP 15,000
Diff: 3
4-65
5) In early 2009, Ecotravel Corp. won a contract to build a rapid transit line connecting downtown
Vancouver to the airport and the suburb of Richmond (the RAV line). The contract was for $2.2 billion to
be received over the construction period of six years, ending in November 2015. Ecotravel has a
December 31 year-end and uses the percentage of completion method to account for long-term contracts.
Required:
a. Ecotravel's management expects the gross profit on the total project to be 20%, and that $352 million
would be incurred on the project by December 31, 2009.
1. How much gross profit (or loss) will Ecotravel record in the 2009 fiscal year if management's estimates
are accurate?
2. Provide the journal entry to record revenue, cost of goods sold, and expected loss (if applicable) for
fiscal 2009.
b. Assume that it is now early 2013 and you are preparing the adjusting entries for 2012. The accounting
records indicate that, by the end of 2011, a total of $758 million in revenue and $680 million in cost of
goods sold had been recorded. You also know that $372 million in costs were incurred on the project in
2012, and management's best estimates indicate another $1,208 million in costs will be required to
complete the project.
1. How much gross profit (or loss) should Ecotravel record in the 2012 fiscal year if management's
estimates are accurate?
2. Provide the journal entry to record revenue, cost of goods sold, and expected loss (if applicable) for
fiscal year 2012.
Answer:
a.
1. GP = (Estimated % Complete or 100% if expected loss) × (Estimated GP) - (GP previously recognized) =
(440) × 20% - 0 = 88 million
2. Journal Entry
Dr. COGS 352 million

Dr. CIP 88 million
Cr. Revenue 440 million
b.
1. GP = (Estimated % Complete or 100% if expected loss) × (Estimated GP) - (GP previously recognized) =
(60 loss) × 100% - 78 = (138) million loss
Since a loss is projected, record 100% of loss.
2. Journal entry
Dr. COGS 372

Dr. Expected loss 32
Cr. CIP 138
Cr. Revenue 266
Diff: 3
4-66
6) ACME is investing in a new heavy oil rig operation in northern Alberta. ACME has hired Max
Contractors to construct the facilities. The contract price is $4,450 million to be completed over four years.
The following information pertains to this construction contract.
(all amounts in $millions) Year 1 Year 2 Year 3 Year 4

Cumulative costs incurred to date 1,170 1,600 2,760 4,500
Estimated additional costs to complete 2,730 2,400 1,840 0
Billings on construction in progress 1,175 1,575 1,675 25
Cash collected in the year 1,145 1,555 1,685 65
Required: (Show all dollar amounts in millions.):
a. Calculate the amount of revenue, expense and gross profit to be recognized in the accounts of Max
Contractors in each of the four years.
b. If Max were to underestimate the cost to complete to be $1,690 million instead of $1,840 in Year 3, how
much gross profit or loss would be recognized in each year? How much more or less gross profit or loss
would be reported in that year? How much more or less gross profit or less would be reported in Year 4,
and in total for all four years?
c. Explain how Max would account for this project if there were significant uncertainty over the outcome
of the contract, such that Max could not clearly identify or measure the construction costs.
d. Explain what the completed contract method is, and which entities can use this approach.
4-67
Answer:
a.
Revenue - current year (*) 1,335 445 890 1,780
Expenses 1,170 430 1,160 1,740
Gross profit(loss) before prudence 165 15 (270) 40
Price adjustment for expected loss
accrual/reversal 0 0 (60) 60
Gross profit/loss 165 15 (330) 100
Revenue Yr 1: (1,170/ (1170 +2730) × 4,450 - (previous revenue recognized) = 1,335

b.
Revenue - current year 1,335 445 979 1,691
Expenses 1,170 430 1,160 1,740
Gross profit(loss) before prudence 165 15 (181) (49)
Price adjustment for expected loss
accrual/reversal 0 0 0 0
Gross profit/loss 165 15 (181) (49)
Underestimating the cost to complete the project in Year 3 results in

∙ no change to Year 1 profits
∙ an increase of 149 million to Year 3 profits
∙ a decrease of 149 million to Year 4 profits
∙ no change to cumulative profits over the 4-years.
c) If Max cannot reliably estimate the contract costs, it must use the cost recovery method.
The cost recovery method recognizes (1) contract costs incurred in the period as expenses, and (2) an
amount of revenue equal to the costs that are expected to be recoverable as part of the contract. Thus, this
method defers any profit on the contract to the completion date. In addition,
the prudence principle continues to apply, so that any expected losses will be recognized immediately.
d) The completed contract is permitted under ASPE for private enterprises. This method defers revenue
and expense recognition until the date when the contractor completes the project, instead of periodically
over the life of the contract under the percentage of completion method. The prudence principle still
applies, such that any losses are still recognized in the period first anticipated. In short, profits are
deferred but losses are not.
Diff: 2
Objective: 4.3/ 4.4/ 4.5 Apply the specific revenue and expense recognition criteria for construction contracts,
including the prospective treatment applicable to changes in estimates./Apply the accounting standards for
construction contracts when profitability is in doubt./Evaluate the risks of revenue misstatements and the
appropriateness of revenue recognition policies in specific circumstances by applying professional judgment.
4-68
7) Coral Corporation builds large cruise ships on a contract basis. The company uses the percentage of
completion method of revenue recognition. The following information pertains to the construction
contracts it had in place as of its December 31, 2012 year-end.
2011 2012
Cost incurred to date 200 million 400 million
Costs to complete contracts 800 million 600 million
Total price of contracts outstanding at December
31, 2012 2,000 million 2,500 million
Revenue ???? ????
Required:
a. Calculate the revenue to be recognized in 2011 and in 2012.
b. While examining the Coral financial statements, the auditors noted that there was an error in the
estimate of costs to complete the contracts in 2011. The cost to complete should have been $600 million
instead of $800 million. Explain how this would be accounted for in the financial statements.
c. In light of the evidence noted in (b), how much revenue should be recognized in 2012?
Answer:
a.
2011: $400 million
(Percent complete × Contract revenue) - Revenue previously recognized
= (200/1,000) × 2,000
= 400 million
2012: $600 million
= (400/1000) × 2,500 - 400
= 600 million
b. This will be retrospectively accounted for as an error correction. This is not a change in estimate that is
accounted for prospectively.
c. Must first correct 2011 error and then calculate 2012

2011 error correction:
= (200/800) × 2,000
= 500 million
2012 calculation:
= (400/1000) × 2,500 - 500
= 500 million
Diff: 1
the prospective treatment applicable to changes in estimates./Evaluate the risks of revenue misstatements and the
appropriateness of revenue recognition policies in specific circumstances by applying professional judgment.
4-69
8) Community Apartments Inc. (CA Inc.) is building a luxury condominium for a contract price of
$68,000,000. This is estimated to be a three-year project with an estimated cost of $54,000,000. CA Inc. uses
the percentage-of-completion method of revenue recognition, using the cost-to-cost method of estimating
the percentage complete. The following is the best available information at the end of each year:
Billings 8,000 34,500 25,500
Collections 7,000 28,500 32,500
Required:
a. Compute the amount of gross profit to be recognized in Year 1, Year 2, and Year 3. Show computations
in tabular form provided below:
Year 1 Year 2 Year3
Contract price
% complete
b. Determine the performance that would be reported under the cash basis and accrual basis of
accounting for Year 1 of this company. Explain how revenues are matched with expenses when the
percentage of completion basis is used.
c. Complete the PARTIAL Balance Sheet for Year 1
Current assets
Accounts Receivable
Inventories
Current Liabilities
Unearned revenue
4-70
Answer:
a. ( in $ thousands)
Notes 1 2 3
Contract price D 68,000 68,000 68,000
% complete E=A/C 15% 60% 100%
Gross profit to date F=DE 1,200 300 7,500
b.
Under the cash basis of accounting, cash flow from operations would consist of the cash inflows less the
cash outflows: 7,000 - 9,000 = net outflow of 2,000 (ie. Performance loss)
Under the accrual basis of accounting, net income (loss) would be 1,200 as determined above under the
percentage of completion basis.
Under the percentage of completion method, gross profit is recorded for the percent that the project is
complete. By definition, gross profit is revenue - costs; as such, to record revenues under this method, the
corresponding costs associated with the revenue must also be recorded/accrued.
c.Partial Balance Sheet — Year 1
Current assets
Accounts Receivable
[ (8,000-7,000) ] 1,000
Inventories 0
CIP
Costs incurred Year 1 + GP recognized Year 1
(9,000) + (1,200)
10,200
Less: Billings
8,000 2,200
3,200
Current Liabilities
Unearned revenue 0
Diff: 3
Objective: 1.2/ 1.3/ 2.2./ 2.3/ 3.3/ 3.5/ 4.3/ 4.4 Apply the concepts of information asymmetry, moral hazard, conceptual
framework, accrual accounting, and the articulation of financial statements to the accounting principles for
construction contracts.
4-71
9) Destiny Apartments Inc. (DA Inc.) is building a luxury condominium for a contract price of
$68,000,000. This is estimated to be a three-year project with an estimated cost of $54,000,000. DA Inc. uses
the percentage of completion method of revenue recognition, using the cost-to-cost method of estimating
the percentage complete. The following is the best available information at the end of each year:

Billings 13,000 29,500 25,500
Collections 9,000 26,500 32,500
Required:
a. Explain how the percentage completion method reduced information asymmetry and guards against
moral hazard.
b. Compute the amount of gross profit to be recognized in Year 1, Year 2, and Year 3. Show computations
in tabular form provided below:
Year 1 Year 2 Year3
Contract price
% complete
c. Complete the PARTIAL Balance Sheet for Year 2
Current assets
Accounts Receivable
Inventories
Current Liabilities
Unearned revenue
4-72
Answer:
a. Using the percentage of completion method reduces information asymmetry for the investor. The
financial statements provide information on the revenue and costs of the project annually over the life of
the project. Having this information increases the predictive and feedback value of financial statements
and hence, is more relevant information.
This method guards against moral hazard since the most recent cost estimates are used in the calculation;
if management attempts to manipulate income in one year, the percentage for the following year will be
adjusted and the previous year's overstatement will be revealed to the investors. The ratios and margins
would be askew and alert investors of the manipulation attempts.
Additionally, this method cannot be used if management is not able to reasonably estimate the costs to be
incurred or the stage of completion on a rational or systematic basis. The cost recovery or completed
contract method would then be used.
b. ( in $ thousands)
Notes 1 2 3
Contract price D 68,000 68,000 68,000
% complete E=A/C 15% 60% 100%
Gross profit to date F=DE 1,200 300 7,500
c.Partial Balance Sheet — Year 2

Current assets
Accounts Receivable
Year 1 AR + Year 2 AR
[ (13,000-9,000) + (29,500-26,500) ] 7,000
Inventories 0
7,000
Current Liabilities
Unearned revenue
CIP
Costs incurred Year 1 and Year 2 + GP recognized Year 1
& Year 2
(9,000+31,500) + (1,200-900)
40,800
Less: Billings
Year 1 + Year 2
13,000 + 29,500
42,500 1,700
4-73
JE for Year 2 ( in $ thousands) — helps with partial BS calculations

Costs incurred
Dr. CIP 31,500
Cr. Cash, A/P 31,500
Billings
Dr. A/R 29,500
Collections
Dr. Cash 26,500
Cr. A/R 26,500
Revenue (income) recognition

Dr. COGS 31,500
Cr. Revenue 30,600
Cr. CIP 900
Diff: 3
Objective: 1.2/ 1.3/ 2.2./ 2.3/ 3.3/ 3.5/ 4.3/ 4.4 Apply the concepts of information asymmetry, moral hazard, conceptual
framework, accrual accounting, and the articulation of financial statements to the accounting principles for
construction contracts.
4-74

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Intermediate Accounting, Volume 1, 2e

Chapter 4 – Revenue Recognition

Solution Manual for Intermediate Accounting Vol 1

Solution manual: https://testbankpack.com/p/solution-manual-for-intermediate-

Test bank: https://testbankpack.com/p/test-bank-for-intermediate-accounting-

Chapter 4 Revenue Recognition

2) Which of the following is correct about the value creation process?

2) Which statement is correct about multiple deliverable sales arrangements?

3) Which statement is correct about multiple deliverable sales arrangements?

Fair value Allocated Value

Month Subscription Received

Fair value Allocated Value

Month Subscription Received

28) Which statement best describes a franchise arrangement?

30) What accounting issue arises for recognizing non-monetary transactions?

34) Which of the following is an acceptable revenue-recognition method?

37) YMN had sales of $1,500,000, including:

38) Simple Inc. had sales of $1,500,000, including:

39) Philips Corp. is unsure how to record the following transactions:

Price per Subscription start Subscription term

Price per Subscription start Subscription term

Transaction Revenue recognition Why?

Required: Using the installment sales method

a) Determine the balance of installment accounts receivable at December 31, 2012.

Installment Numbers of Installment Sales O/S at year

Cost of goods sold 382,200,000

Gross profit 163,800,000

b) $11,760,000 (20,000 ∗ 588)

Fiscal 2012 Fiscal 2013

Deferred revenue (60% ∗ 85,000) ∗ 5 franchises sold 255,000

Cash or Accounts receivable (4% ∗ 1,500,000) 60,000

Cash or Accounts receivable (3% ∗ 2,000,000) 60,000

Measurability likely best since a

(i.e., users would tradeoff some

Bonus would be distributed

d) Any valid recommendation that flows from the student's analysis.

This could be seen as a

Measurability likely best since a

e) Any valid recommendation that flows from the student's analysis.

2011 2012 2013

2011 2012 2013

How much revenue will Algae recognize in 2011?

4) Which statement best explains the percentage of completion method?

5) How is revenue recognized on a cost plus 7% contract?

6) Which statement about the percentage of completion method is correct?

2011 2012 2013

2011 2012 2013

Contract price $3,500,000

Costs incurred to date $1,350,000

2011 2012 2013

2011 2012 2013

2011 2012 2013

2011 2012 2013

2011 2012 2013

2011 2012 2013

2011 2012 2013

2011 2012 2013

2011 2012 2013

Accounts receivable at end of year

2011 2012 2013

2011 2012 2013

1) Which statement best explains the completed contract method?

2) Which statement best explains the cost recovery method?

3) Which accounting method is permitted under ASPE for construction contracts?