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Intermediate Accounting, Vol 1, 3e (Lo/Fisher)

Chapter 4 Revenue and 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 Type: MC
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 Type: MC
Skill: Conceptual
132
© 2017 Pearson Canada Inc.
alternatives.
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.
D) Permitting too much choice in accounting policies impairs comparability of financial
statements.
Answer: B
Diff: 3 Type: MC
Skill: Conceptual
alternatives.
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 Type: ES
Skill: Conceptual
alternatives.
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 Type: ES
Skill: Conceptual
133
alternatives.
134
1) On March 1, Pendant Textbook Publications delivered 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 Type: MC
Skill: Computational
Objective: 4.2 Apply the general revenue and expense recognition criteria to a variety of
contexts.
2) Which statement is correct about multiple performance obligation 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 Type: MC
Skill: Conceptual
contexts.
3) Which statement is correct about multiple performance obligation arrangements?

A) The residual method must normally be used.
B) The relative stand-alone selling price method must normally be used.
C) There is no specific method that must be used.
D) The adjusted market assessment approach is an acceptable residual approach that may be
used.
Answer: B
Diff: 2 Type: MC
Skill: Conceptual
contexts.
135
4) Discuss when it is acceptable to use the residual approach to allocate the transaction price to
performance obligations.
Answer: The residual approach may only be used if either (i) the good or service in question
have a highly variable selling price, or (ii) the entity has not yet established a price for that good
or service.
Diff: 2 Type: ES
Skill: Conceptual
contexts.
5) List the five key steps in the revenue recognition process.

Answer:
1) Identify the contract
2) Identify the performance obligation
3) Determine the transaction price
4) Allocate the transaction price to performance obligations
5) Recognize income in accordance with performance
Diff: 1 Type: ES
Skill: Conceptual
contexts.
6) 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 in accordance with IFRS 15 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. IFRS requires that revenue be
recognized at: either a point in time or over time as the performance obligations are satisfied. An
example of the first alternative is recognizing revenue when the drug is delivered to the
customer;. An example of the second alternative is recognizing revenue as performance is
achieved in accordance with the benchmarks established in the contract e.g. regulatory approval.
Diff: 1 Type: ES
Skill: Conceptual
contexts.
136
7) Explain how the transaction price should be allocated to the performance obligations in a
multiple performance obligation sales arrangement.
Answer: IFRS 15 requires that enterprises allocate the transaction price to the various
performance obligations in a multiple performance obligation sales arrangement based on the
observable stand-alone selling prices of the components. If this is not possible paragraph 79 of
IFRS 15 identifies three alternatives noting that other approaches may also be suitable. The three
alternatives identifies in paragraph 79 are:
1) The adjusted market assessment approach which involves estimating what a customer would
be willing to pay for the good or service or what competitors charge for a similar good or
service.
2) The expected cost plus margin approach which involves estimating expected costs to provide
the good or service and adding a profit margin typical for that good or service.
3) The residual approach which computes the stand-alone selling price as the transaction price
less the total of the observable stand-alone selling prices of other goods services in the
transaction. This approach is only acceptable if either (i) the good or service in question has a
highly variable selling price, or (ii) the entity has not yet established a selling price for that good
or service.
Diff: 2 Type: ES
Skill: Conceptual
contexts.
8) Explain how the timing of revenue recognition is affected by multiple performance

obligations in the arrangement. Explain how revenue is ultimately recognized in a multiple
performance obligations sales arrangements.
Answer: Clearly, it is inappropriate to record all the revenue upon delivery of simply one
product or service 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 Type: ES
Skill: Conceptual
contexts.
137
9) Explain why a company should allocate revenue to multiple performance obligations 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 Type: ES
Skill: Conceptual
contexts.
10) Simply Manufacturers has signed an order to supply 10,000 chairs at a price to be
determined sixty days after delivery. Payment is due at that time. The price per chair may range
from $0 to $100 depending on a series of events, the outcome of which cannot be accurately
predicted. Which of the following factors is most likely to precludes Simply from recognizing
revenue at time of delivery.
A) The purchaser bears the significant risks and rewards of ownership.
B) The revenue is variable in nature.
C) The purchaser is not obligated to pay for the goods at time of delivery.
D) Simply had not paid its suppliers for the materials used to manufacture the chairs.
Answer: B
Diff: 1 Type: MC
Skill: Conceptual
contexts.
138
11) Fancy Cars sold a used car for $35,000 cash. The company will also provide 4 oil changes
per year for 5 years and an extended service-type warranty for 5 years. This is the first time that
Fancy has offered an extended warranty. They intend to offer it to customers on a stand-alone
basis but have not yet established a sales price. The observable selling prices of the car and oil
changes follow:
Car $30,000
Oil change $50 each oil change
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 for the various components of this transaction.
Answer:
a. The residual method is appropriate since the fair value of the warranty is not determinable as a
stand-alone price has not yet been established for the service-type warranty.
Value
Car $30,000
Oil change
(50 × 4/yr × 5 yrs) $1,000
Total transaction price less the observable stand-
alone selling price of the car and oil changes.
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 Type: ES
contexts.
12) 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 why the transit authority cannot
recognize revenue at time of distribution.
A) The retailers have not taken physical possession of the asset.
B) A contract has not been entered into.
C) The transaction price is not known.
D) The retailers do not bear the significant risks and rewards of ownership.
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
contexts.
139
13) Hedley Corporation sold hardware and software for $70,000 cash. In addition, the company
will provide support on the software for 1 year and maintenance on the hardware for 3 years. The
observable stand-alone selling prices are as follows:
Hardware $60,000
Software $15,000
Hardware
Maintenance $5,000
Answer:
a. The relative stand-alone selling price method is appropriate since the stand-alone sales prices
of all components are observable.
Stand-alone % of total Transaction Amount allocated

selling price selling pice price to PO
Hardware $60,000 75% $70,000 $52,500
Software $15,000 18.75% $70,000 $13,125
Hardware
Maintenance $5,000 6.25% $70,000 $4,375
$80,000 100% $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 Type: ES
contexts.
14) An insurance company receives annual premiums for fire insurance on June 25 for coverage
beginning July 1. Identify why the insurance company cannot recognize revenue when the
premium is received.
A) The insurance company has not transferred to the buyer the significant risks and rewards of
ownership of the service.
B) The customer has not taken possession of the asset.
C) The insurance company earns the revenue over time, rather than at a point of time (time of
sale).
D) The customer does not control the asset.
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
contexts.
140
15) Superior Cars sold a car for $35,000 cash. In addition, the company will provide 4 oil
changes per year for 5 years and an extended warranty for 5 years. The normal observable stand-
alone selling prices are as follows:
Car $35,000
Oil change $50 per oil change
service- type warranty $4,000
a. Determine how revenue should be allocated to the various performance obligations in this
transaction.
recognized to the components in this transaction.
Answer:
a. The relative stand-alone sales price method is appropriate since the stand-alone sales price for
all components is determinable.
Stand-alone
selling price 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 Type: ES
contexts.
141
16) The publisher of TV Weekly received the following 52-week subscriptions during the first
quarter of fiscal 2018. 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 2018 for the subscriptions received in January? (Round
your response to the nearest dollar).
Subscription
Month 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 Type: MC
contexts.
142
17) Harris Corporation sold hardware and software for $70,000 cash. In addition, the company
will provide support on the software for 1 year and maintenance on the hardware for 3 years. The
observable stand-alone selling prices are as follows:
Hardware $60,000
Software $8,900
Hardware
Maintenance $4,000
Answer:
a. The relative stand-alone selling price method is appropriate since the stand-alone sales prices
of all components are observable.
Stand-alone
sales price 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 Type: ES
contexts.
143
18) The publisher of Accounting Digest received the following 12-month subscriptions during
2018. 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 2018 for the subscriptions received between
January-March? (Round your response to the nearest dollar).
Subscription
Month 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 Type: MC
contexts.
19) On June 1, Electronics Distribution ships 100 TVs to TV World on consignment. Electronic
Distribution's pays its wholesaler $500 for each TV. It then sells each TV for $800 to its retail
customers including TV World. 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 Type: MC
contexts.
144
20) 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 Type: MC
contexts.
21) Which of the following is TRUE when goods are sold on consignment?
A) The customer has taken physical possession of the asset.
B) The selling entity has the present right to payment for the asset.
C) The significant risks and rewards of ownership have been transferred.
D) The customer has accepted the asset.
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
contexts.
22) Which of the following is TRUE when goods are sold on on an installment basis?
A) Revenue is recognized at time of the initial sale.
B) Cost of goods sold is debited for the cost of the merchandise sold.
C) Revenue is not recognized until all monies due under the contract have been collected.
D) The deferred gross profit liability is debited as cash is collected.
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
contexts.
145
23) 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 Type: MC
contexts.
24) 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) $125
B) $250
C) $500
D) $1,000
Answer: C
Diff: 1 Type: MC
contexts.
25) 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 Type: MC
contexts.
146
26) 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 Type: MC
Skill: Conceptual
contexts.
27) 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 Type: MC
contexts.
28) On December 1, 2018, 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, 2018 financial statements?
A) Sales of $5,000 should only be recognized in 2019 when the return privilege expires.
B) Sales of $5,000 should be recognized in 2018 as long as there is a reserve for returns.
C) Sales of $5,000 should be recognized in 2018, with future costs accrued as an estimated
liability.
D) Sales should only be recognized as the related cash is collected.
Answer: A
Explanation: A) The right of return means that the revenue to be recognized is variable in
nature. Given the uncertainty, revenue cannot be recognized until the amount of variable
consideration is known which is when the right of return expires.
Diff: 2 Type: MC
contexts.
147
29) On September 1, 2018, 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, 2018 financial statements?
A) Sales of $75,000 should only be recognized after 120 days when the return privilege expires.
B) Sales of $74,250 should be recognized and a provision for refund liability of $750 established
in September.
C) Sales of $75,000 should be recognized in September 2018.
D) Sales should only be recognized as the related cash is collected.
Answer: B
Diff: 2 Type: MC
contexts.
30) 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 Type: MC
Skill: Conceptual
contexts.
31) RU FIT Centre opened for business on April 5, 2018. 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 Type: MC
contexts.
148
32) 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 2018, Shear had sales of $1,800,000. It paid $250,000 for materials and labour to make
warranty-related repairs in 2018. What amount should the warranty expense for 2018 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 Type: MC
contexts.
33) YMN had sales of $1,500,000, including:

• $25,000 of goods shipped on consignment to an unrelated company on December 28, 2018
and received by that company on December 31, 2018
• $20,000 of goods shipped F.O.B. shipping point to a different unrelated party on December
31, 2018 and received on January 2, 2019.
On its income statement, what amount of net sales should YMN record for 2018?
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 Type: MC
contexts.
149
34) 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, 2018
• $10,000 of goods shipped F.O.B shipping point on December 28, 2018.
• $20,000 of goods shipped F.O.B. destination point on December 31, 2018.
On its income statement, what amount of net sales should Simple Inc. record for 2018?
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 Type: MC
contexts.
35) Philips Corp. is unsure how to record the following transactions:

• $60,000 of goods shipped F.O.B shipping point on December 28, 2018.
• $50,000 of goods shipped F.O.B. destination point on December 31, 2018.
What amount of sales related to these two transactions should Philips Corp. record in fiscal
2018?
A) $0
B) $50,000
C) $60,000
D) $110,000
Answer: C
Diff: 2 Type: MC
contexts.
150
36) Here are some financial records for Accounting Plus Magazine which started operations in
October 2018. 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 2018? (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 Type: MC
contexts.
37) Here are some financial records for Accounting Plus Magazine which started operations in
October 2018. 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, 2018? (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 Type: MC
contexts.
151
38) 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 Type: MC
Skill: Conceptual
contexts.
39) Based on the note disclosure provided below for XYZ 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 contracts, revenues are generally recognized in accordance
with IFRS 15 (Revenue) 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
performance obligation 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 Type: ES
Skill: Conceptual
contexts.
152
40) 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 Type: ES
Skill: Conceptual
contexts.
41) On January 1, 2018 Sukhi's Cycles Inc. sells a motorcycle for $24,000. Terms offered are
$1,000 per month first due February 1, 2018. The market interest rate for transactions of this type
is 0.25% per month. What is the amount of revenue that Sukhi should record at time of sale?
Answer: There is a significant financing component in the contract. As the contract exceeds one
year, the transaction price must be adjusted to reflect the time value of money. The amount of
revenue to be recorded is $23,266 (PMT = 1,000; N = 24; I = 0.25; PV - ? = -$23,266).
Diff: 1 Type: ES
contexts.
153
$10,000 cash; $7,000 due on January 1, 2019, and $7,000 due on January 1, 2020. The market
interest rate for transactions of this type is 4.0% per annum. What is the amount of revenue that
Sukhi should record at time of sale?
revenue to be recorded is $23,203 (PMT = 7,000; N = 2; I = 4 PV - ? = -$13,203; $13,203 +
$10,000 = $23,203).
Diff: 1 Type: ES
contexts.
$10,000 cash with the balance of $14,000 due on January 1, 2020. The market interest rate for
transactions of this type is 5% per annum. What is the amount of revenue that Sukhi should
record at time of sale?
revenue to be recorded is $22,698 (FV = 14,000; N = 2; I = 5 PV - ? = -$12,698; $12,698 +
$10,000 = $22,698).
Diff: 1 Type: ES
contexts.
154
44) In the chart below, identify the revenue recognition method that you feel is most appropriate
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. Note that Sale of goods: significant risk and
this contract price is rewards transferred; remaining indemnity
variable, rather than fixed. risk is small and estimable.
If material, period end
revenue must be adjusted
to reflect this.
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 Type: ES
Skill: Conceptual
contexts.
155
45) In the chart below, identify the expense recognition method that you feel is most appropriate
Expense recognition
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:
Why?
Transaction Expense recognition method
Matching with the benefits received
A Over time over time.
Matching with the benefits of
B Based on units of production production and subsequent sales.
At point of sale (as an adjusting
entry to the previous year's Matching delivery costs with the
C financial statements related sales.
Diff: 2 Type: ES
Skill: Conceptual
contexts.
46) Compare and contrast the revenue recognition criteria for a transaction involving the sale of
goods with a transaction involving the provision of services.
Answer: The five-step revenue recognition process detailed in IFRS 15 is largely the same for
the sale of goods and services.
Diff: 1 Type: ES
Skill: Conceptual
contexts.
156
47) 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 2018, 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 2017. In January 2019, the company received 27,000 unsold copies for magazines
published in the last weeks of December 2018.
Required:
Determine the amount of revenue from non-subscriptions TV Weekly should recognize in 2018.
Answer: Copies distributed and sold in 2018 × Newsstand price per copy less 50% = 2018 non-
subscription revenue
= [1,654,000 - (390,000 - 30,000 + 27,000)] ∗ $4
= 1,267,000 × $4 = $5,068,000
Diff: 1 Type: ES
contexts.
48) 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 2018, 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 2018 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 2018
Installment accounts receivable 39,000
Inventory 30,420
Deferred gross profit 8,580
JE for installment sales in Jan 2018
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 2018, Sept 2018 and Jan 2019
Diff: 2 Type: ES
Skill: Conceptual
contexts.
157
49) 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 2018, 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 and ignoring the time value of money
a) Determine the balance of installment accounts receivable at December 31, 2018.

b) Determine the amount of deferred gross profit as at December 31, 2018. (Round to the nearest
whole dollar.)
c) Determine the sales revenue to recognize in 2018 for installment sales made in the year.
158
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

Sales Payment(s) O/S at at year end
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, 2018 is $63,600. (424,000 ∗ 15%).
c) Sales revenue for installment sales made in 2018 is $656,000. (1,080,000 - 424,000).
Diff: 2 Type: ES
contexts.
159
50) Aurora Gold Company produced 650,000 ounces of gold in 2018. 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.
2017 2018
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 2018 balance
sheet.
Answer:
a)
2017 2018
591,600,000
Revenue $546,000,000 (870 ∗ (650 + 50 - 20))
Cost of goods 399,840,000
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 Type: ES
contexts.
160
51) McNicols started selling franchise locations in April 2018. 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 2018 Fiscal 2019

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. Ignore the time value of money.
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 2018 and in 2019.
c) Explain how McNicols should account for the ongoing fees.
d) Provide the journal entries to record the ongoing fees in fiscal 2018 and 2019.
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 2018. 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 2018

sold 255,000
sold 255,000
Fiscal 2019
Cash 285,000
sold 114,000
sold 171,000
c) The ongoing fees should be recorded annually based on the percentage in the agreement.
Revenue earned as time elapses.
161
d) Journal entries
Cash or Accounts receivable (4% ∗ 1,500,000) 60,000
Franchise revenue 60,000
Fiscal 2018
Cash or Accounts receivable (3% ∗ 2,000,000) 60,000

Franchise revenue 60,000
Fiscal 2019
Diff: 2 Type: ES
contexts.
52) 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 at least 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 31 of IFRS 15 provides the following revenue recognition criteria for the sale of
goods or services: ¶18. An entity shall recognize revenue when (or as) the entity satisfies a
performance obligation by transferring a promised good or service (ie an asset) to a customer.
An asset is transferred when (or as) the customer obtains control of that asset. Paragraph 34 then
establishes that: ¶34 When evaluating whether a customer obtains control of an asset, an entity
shall consider any agreement to repurchase the asset.
In this instance control is most likely transferred at time of shipping so option 3 is correct. Note,
however that the right of return means that the amount of consideration is variable. In accordance
with paragraphs 55 and B21 of IFRS 15 an entity shall recognize revenue only for the amount
that it expects to be entitled and establish a refund liability for the difference between this
amount and the amount of consideration received (or receivable).
Diff: 3 Type: ES
Skill: Conceptual
contexts.
162
53) 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 at least 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.
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 31 of IFRS 15 provides the following revenue recognition criteria for the sale of
goods or services: ¶18. An entity shall recognize revenue when (or as) the entity satisfies a
performance obligation by transferring a promised good or service (ie an asset) to a customer.
An asset is transferred when (or as) the customer obtains control of that asset. Paragraph 34 then
establishes that: ¶34 When evaluating whether a customer obtains control of an asset, an entity
shall consider any agreement to repurchase the asset.
163
c)
Pros Cons
Revenue would be recorded The company has NOT transferred
earlier than at the other stages of control of the asset to the purchaser.
the process. This would improve
Record the company's reported retained The company does NOT have any
revenues when earnings. receivable/asset due from the
manufactured customer at this point.
The company has NOT transferred
control of the asset to the purchaser.
Record While the contract is mutually
revenues at unexecuted, the purchaser has a The company does NOT have any
signing of legal obligation to fulfill the terms receivable/asset due from the
contract. of the contract. customer at this point.
Because the shipping terms are
FOB shipping point, the company
has transferred control of the asset
(i.e., customer is liable for the The customer can return up to 45%
goods if lost, damaged or of the items.
destroyed). The return period is significant (6
months).
While the returns can be Therefore, the consideration is
Record significant, the company has a variable. It is not known with
revenues at substantial operating history and certainty how much revenue will be
shipping point could establish a refund liability earned until after the return period
for the expected returns. expires.
This could be seen as a
"significant act" in the earnings
process: customer is legally liable The payment date is not critical for
for payment only on this date. accounting — as long as an
Record allowance can be established for any
revenues 45 The company has a substantial potential non-payment.
days after operating history and could
shipment when establish a reasonable provision
payment is due for bad debts when the revenue
entry is booked.
Unduly conservative
The information in the financial

Record statements using this method will be
revenues after reliable, but not relevant (i.e., users
6 months would tradeoff some reliability to get
(when the right more relevance through earlier
of customer The measurability of the revenue revenue recognition).
return expires) is the MOST RELIABLE at this
date. Bonus would be distributed later.
164
d) In this instance control is most likely transferred at time of shipping so option 3 is correct.
Note, however that the right of return means that the amount of consideration is variable. In
accordance with paragraphs 55 and B21 of IFRS 15 an entity shall recognize revenue only for
the amount that it expects to be entitled and establish a refund liability for the difference between
this amount and the amount of consideration received (or receivable)
Diff: 3 Type: ES
Skill: Conceptual
contexts.
1) Lagory Co. started a contract in June 2017 to build a bridge at a fixed price of $14 million.
The bridge was to be completed by October 2019. Total cumulative costs incurred by the end of
December 2017 and 2018 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 2018?
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)
2017 2018 2019

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 Type: MC
Objective: 4.3 Apply the specific revenue and expense recognition criteria for long-term
contracts, including the prospective treatment applicable to changes in estimates.
2) Which of the following statements is correct about the revenue recognition criteria for a
performance obligation satisfied over time?
A) The outcome of the performance obligation must be reasonably estimable before the
percentage of completion method can be used to record revenue.
B) The selling entity creates an asset that the selling asset controls..
C) The selling entity creates an asset with an alternative use to the selling entity
D) The selling entity does not have an enforceable right to payment for the performance
completed to date.
Answer: A
Diff: 2 Type: MC
Skill: Conceptual
165
3) Sunshine Contractors started a contract in January 2017 to build a bridge at a fixed price of
$14 million. The bridge was to be completed by October 2019. Total cumulative costs incurred
by the end of December 2017 and 2018 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 2019?
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)
2017 2018 2019

Revenue 2,000,000 4,000,000 8,000,000
Cost of sales 2,000,000 4,000,000 5,000,000
Diff: 2 Type: MC
4) 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, 2018 year-end.
2017 2018
Cost incurred to date 200 million 400 million
Costs to complete contracts 600 million 600 million
Total price of contracts outstanding
at December 31, 2018 1,300 million 1,300 million
How much revenue will Algae recognize in 2017?

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 Type: MC
166
5) 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 Type: MC
Skill: Conceptual
6) 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 Type: MC
Skill: Conceptual
7) 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 Type: MC
Skill: Conceptual
167
8) Ying Construction Company entered into a contract to build a new airport terminal for
$2,500,000. Construction commenced on August 1, 2017, with a planned completion date of
December 31, 2019. A summary of the costs, billings, and collections is provided below:
2017 2018 2019

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, 2018 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 Type: MC
168
9) Yang Construction Company entered into a contract to build a new airport terminal for
$2,500,000. Construction commenced on August 1, 2017, with a planned completion date of
December 31, 2019. A summary of the costs, billings, and collections is provided below:
2017 2018 2019

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 2018?
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 Type: MC
169
10) Early in 2018, 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 2018, 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 2018, 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 Type: MC
170
11) Pool Contractors (PC) entered into a contract to build a solar heated swimming complex for
$1,800,000. Construction commenced on July 1, 2017, with a planned completion date of
December 31, 2019. A summary of the related accounting information is provided below:
2017 2018 2019

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 2018 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 2017: $400,000 / ($400,000 + $1,200,000) × ($1,800,000 –
$1,600,000) = $50,000
% complete 2018: ($400,000 + $500,000) / ($400,000 + $500,000 + $600,000) = 60% complete
Gross profit 2018:
[($1,800,000 – $1,500,000) × 60%] - 2017 GP
= $180,000 – $50,000
= $130,000
Diff: 3 Type: MC
171
12) Nichols Construction Company (NCC) entered into a contract to build a shopping complex
for $1,900,000. Construction commenced on July 1, 2017, with a planned completion date of
2017 2018 2019

How much would the balance in accounts receivable be on the balance sheet of NCC at the end
of 2018 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 Type: MC
13) Nova Construction Company (NCC) entered into a contract to build a school for $1,800,000.
Construction commenced on May 1, 2017, with a planned completion date of December 31,
2019. A summary of the related accounting information is provided below:
2017 2018 2019

How much gross profit would be recognized in fiscal 2017 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 Type: MC
172
14) Tyco Ltd entered into a contract to build a sports arena for $1,800,000. Construction
commenced on August 1, 2017, with a planned completion date of December 31, 2019. A
summary of the related accounting information is provided below:
2017 2018 2019

How much would the balance in accounts receivable be on the balance sheet of Tyco at the end
of 2017 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 Type: MC
15) Nichols Construction Company (NCC) entered into a contract to build a shopping complex
for $1,900,000. Construction commenced on July 1, 2017, with a planned completion date of
2017 2018 2019

How much would the balance in accounts receivable be on the balance sheet of NCC at the end
of 2019 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 Type: MC
Skill: Conceptual
173
16) 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 Type: ES
Skill: Conceptual
17) Queensbridge Corp. started a contract in June 2017 to build a bridge at a fixed price of $45
million. The bridge was to be completed by October 2019 at a total estimated cost of $35
million. Total cumulative costs incurred by the end of December 2017 and 2018 were $7 million
and $24 million, respectively. Because of cost overruns in 2018, 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, 2017
and December 31, 2018.
Answer: Gross profit = (cost incurred to date / estimated total cost) × (estimated gross profit) -
(gross profit previously recognized)
2017: $2,000,000
(Percent complete × Estimated gross profit) - Gross profit previously recognized
= (7 million / 35 million) × 10 million - 0
= $2,000,000
2018: $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 Type: ES
174
18) WestCoast Co. started a contract in June 2017 to build a bridge at a fixed price of $14
million. The bridge was to be completed by October 2019. Total cumulative costs incurred by
the end of December 2017 and 2018 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
2017, 2018, and 2019.
2017 2018 2019

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.
2017 2018 2019
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 Type: ES
175
19) Jones Contractors Inc. agreed to construct a building for $500,000. Construction commenced
in 2017 and was completed in 2019.
2017 2018 2019

Costs incurred during the
year 159,300 217,405 103,295
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.
2017 2018 2019

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

year
Construction in process
inventory at end of year 0
176
Answer:
2017 2018 2019
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)
2017 2018 2019

Accounts receivable at end of
year
(Uncollected A/R from last year 7,500 8,500
+ Billings during the year — (0 + 90 - 82.5) (7.5 + 200 -
Collections during the year) 199) 11,500
Construction in process
inventory at end of year (Open 177,00
balance from last year + (0 + 159.3 +
Expenses + Gross profit) 17.7) 411,250 500,000
Diff: 2 Type: ES
177
20) On July 1, 2017, 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 2019, 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 2017, 2018,
and 2019.
2017 2018 2019

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, 2017, 2018, and 2019.
The company used the cost-to-cost method to estimate the percentage complete.
Answer:
2017 2018 2019
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 Type: ES
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.
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.
contract.
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
Objective: 4.4 Apply the accounting standards for long-term contracts when profitability is in
doubt.
178
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.
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 contract costs as incurred and an amount of revenue
equal to the costs that are expected to be recovered on the contract.
contract.
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
doubt.
3) Which accounting method is permitted under ASPE for construction contracts in limited
circumstances?
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.
contract.
Answer: B
Diff: 2 Type: MC
Skill: Conceptual
doubt.
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 Type: MC
Skill: Conceptual
doubt.
179
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 Type: MC
Skill: Conceptual
doubt.
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 Type: MC
Skill: Conceptual
doubt.
7) Smile Operators entered into a contract to build a swimming complex for $1,800,000.
Construction commenced on July 1, 2017, with a planned completion date of December 31,
2019. A summary of the related accounting information is provided below:
2017 2018 2019

Billings during the year 360,000 440,000 1,000,000
How much gross profit would be recognized in 2018 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 Type: MC
doubt.
180
8) Tradel Construction Company entered into a contract to build a condominium building for
$1,800,000. Construction commenced on July 1, 2017, with a planned completion date of
2017 2018 2019

Billings during the year 360,000 440,000 1,000,000
How much gross profit would be recognized in 2019 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 Type: MC
doubt.
181
9) Assume the following facts for a construction contract that was completed over four years.
The contract price is $5.1 million.
2017 2018 2019 2020

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
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.
Answer: The question only asks for the gross profit or loss, so we can simply apply the normal
formulas. Note: Normal circumstances (2017, 2019, 2020) and expected loss on the contract
(2018).
GP = (Estimated % Complete or 100% if expected loss) ×

(Estimated GP) - (GP previously recognized)
2017 [(750,000/3,000,000 × 100%] × (2,100,000) - (0) = $525,000
2018 100% × (250,000 loss) - 525,000 = (775,000)
[ (2,610,000 / 4,350,000) × 100% ] × 750,000 - (250,000 loss)
2019 = $700,000
2020 100% × 750,000 - 450,000 = 300,000
Diff: 2 Type: ES
doubt.
10) What are three 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 Type: ES
Skill: Conceptual
doubt.
182
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 Type: ES
doubt.
183
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 Type: MC
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
minimized?
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 Type: MC
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 Type: MC
Skill: Conceptual
184
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 Type: MC
Skill: Conceptual
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 Type: MC
Skill: Conceptual
6) 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 Type: MC
Skill: Conceptual
185
7) 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 Type: ES
Skill: Conceptual
186
8) 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 that the
entity reports its financial results in accordance with ASPE and all transactions are material.
Transaction Appropriate accounting

During the audit of the 2018 fiscal year,
the auditors learned that Soorya Mining
Inc. should have had used an average
price of $850/oz. for its fiscal 2018
reporting, not $840/oz.
the auditors learned that Everlast
Construction used the cost recovery
method to account for its long-term
contracts as it could not reasonable
estimate the outcome of its performance
obligations. Everlast has since improved
its estimating capabilities and has
adopted the percentage of completion
method.
the auditors learned that Everlast
Construction previously used the
completed contract method.During the
year Everlast adopted the percentage of
completion method.
187
Answer:
Transaction Appropriate accounting
During the audit of the 2018 fiscal
year, the auditors learned that Soorya
Mining Inc. should have had used an
average price of $850/oz. for its
fiscal 2018 reporting, not $840/oz. Error correction
This is the adoption of a new policy, rather
than a change in accounting policy. Paragraph
During the audit of the 2018 fiscal 16 of IAS 8 provides that it is not a change of
year, the auditors learned that accounting policy when a policy is applied for
Everlast Construction used the cost transactions, other events or conditions that
recovery method to account for its differ in substance from those previously
long-term contracts as it could not occurring. In this instance the entity previously
reasonable estimate the outcome of had a condition where it could not reliably
its performance obligations. Everlast estimate the out come of the performance
has since improved its estimating obligation. This has now changed and the
capabilities and has adopted the entity can reliably estimate the outcome of the
percentage of completion method. performance obligation.
During the audit of the 2018 fiscal
year, the auditors learned that Error correction. Changing from an incorrect
Everlast Construction previously policy (completed contract method) to an
used the completed contract allowable policy (percentage of completion) is
method.During the year Everlast an error correction, rather than a change in
adopted the percentage of policy as the company should not have used
completion method. the incorrect policy in the first place.
Diff: 3 Type: ES
Skill: Conceptual
188
Comprehensive Learning Objectives
1) Creation Construction Company (CCC) has contracted to build an office building for Property
Corp. The construction started on January 1, 2018, and the project was completed on July 1,
2021. 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.
2018 2019 2020 2021

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 2018, 2019, 2020, and 2021, assuming that the
percentage of completion method is used.
Answer:
GP = (Estimated % Complete or 100% if expected loss) ×
(Estimated GP) - (GP previously recognized). (000s)
[(16,500 / 66,000) *100%] × (4,500) - (0) = $ 1,125
[[$4,500 = (70,000 - 66,000) + [50% × (66,000 - 65,000)]
2018 ]]
100% × (1,500) - 1,125 = ($2,625) (Estimated costs =
$42,900 + $35,100 = $78,000. Estimated costs - originally
estimated costs = $78,000 - $65,000 = $13,000. customers
responsibility 50%. $13,000 × 50% = $6,500. Revised
contract amount is $70,000 + $6,500 = $76,500. $76,500 -
2019 $78,000 = $1,500 loss. )
[ (56,100 / 66,000) × 100% ] × 4,500 - (1,500 loss) = $
2020 5,325
100% × 3,000 - 3,825 = ($ 825) ($69,000 - $65,000 =
$4,000; $4,000 × 50% = $2,000; $70,000 + $2,000 =
$72,000; $75,000 - $72,000 = $3,000 overall profit for the
2021 contract). ($1,125 - $2,625 + $5,325 - $825 = $3,000).
Diff: 3 Type: ES
Objective: 4.3/ 4.4 Apply the specific revenue and expense recognition criteria for long-term
contracts, including the prospective treatment applicable to changes in estimates./Apply the
accounting standards for long-term contracts when profitability is in doubt.
189
2) 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?
190
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
C=A+
Estimated total cost 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
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 Type: ES
191
3) 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.
192
Answer:
a. Gross profit (loss)
GP = (Estimated % Complete or 100% if expected loss) ∗
(Estimated GP) - (GP previously recognized)
[(4,500,000/12,000,000 *100%] × (3,000,000) - (0) =
Year 1 $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
Cr. Billings on construction in
progress 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 Type: ES
193
4) In early 2015, 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
2021. 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, 2015.
1. How much gross profit (or loss) will Ecotravel record in the 2015 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 2015.
b. Assume that it is now early 2019 and you are preparing the adjusting entries for 2018. The
accounting records indicate that, by the end of 2017, 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 2018, 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 2018 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 2018.
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. *$758 - $680 = $78.
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 Type: ES
194
5) 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.
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)
195
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 Type: ES
Objective: 4.3/ 4.4/ 4.5 Apply the specific revenue and expense recognition criteria for long-
term contracts, including the prospective treatment applicable to changes in estimates./Apply the
accounting standards for long-term 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.
196
6) 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, 2018 year-end.
2017 2018
Cost incurred to date 200 million 400 million
Costs to complete contracts 800 million 600 million
Total price of contracts outstanding at
December 31, 2018 2,000 million 2,500 million
Revenue ???? ????
Required:
a. Calculate the revenue to be recognized in 2017 and in 2018.
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 2017. 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 2018?
Answer:
a.
2017: $400 million
(Percent complete × Contract revenue) - Revenue previously recognized
= (200/1,000) × 2,000
= 400 million
2018: $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 2017 error and then calculate 2018
2017 error correction:
= (200/800) × 2,000
= 500 million
2018 calculation:
= (400/1000) × 2,500 - 500
= 500 million
Diff: 1 Type: ES
contracts, including 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.
197
7) 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
recognized
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
198
Answer:
a. ( in $ thousands)
Notes 1 2 3
Estimated total cost C=A+B 60,000 67,500 60,500
Contract price D 68,000 68,000 68,000
% complete E = A/C 15% 60% 100%
Gross profit previously recognized G 0 1,200 300
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 Type: ES
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.
199
8) 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
recognized
c. Complete the PARTIAL Balance Sheet for Year 2.

Current assets
Accounts Receivable
Inventories
Current Liabilities
Unearned revenue
200
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 method (IFRS) or completed contract method (ASPE) would then be used.
b. ( in $ thousands)
Notes 1 2 3
Estimated total cost C=A+B 60,000 67,500 60,500
Contract price D 68,000 68,000 68,000
% complete E = A/C 15% 60% 100%
Gross profit previously recognized G 0 1,200 300
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
201
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 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
Diff: 3 Type: ES
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.
202

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Intermediate Accounting, Vol 1, 3e (Lo/Fisher)

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

2) Which statement is correct about multiple performance obligation arrangements?

3) Which statement is correct about multiple performance obligation arrangements?

5) List the five key steps in the revenue recognition process.

8) Explain how the timing of revenue recognition is affected by multiple performance

Stand-alone % of total Transaction Amount allocated

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

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

35) 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?

a) Determine the balance of installment accounts receivable at December 31, 2018.

Installment Numbers of Installment Sales O/S

b) $11,760,000 (20,000 ∗ 588)

Fiscal 2018 Fiscal 2019

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

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

The information in the financial

2017 2018 2019

2017 2018 2019

How much revenue will Algae recognize in 2017?

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

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

2017 2018 2019

2017 2018 2019

Contract price $3,500,000

Costs incurred to date $1,350,000

2017 2018 2019

2017 2018 2019

2017 2018 2019

2017 2018 2019

2017 2018 2019

2017 2018 2019

2017 2018 2019

2017 2018 2019

Accounts receivable at end of

2017 2018 2019

2017 2018 2019

1) Which statement best explains the completed contract method?

4) Which statement about the cost recovery method is correct?

2017 2018 2019

2017 2018 2019

2017 2018 2019 2020

GP = (Estimated % Complete or 100% if expected loss) ×

Year 1 Year 2 Year 3

Year 1 Year 2 Year 3 Total

1) Why is there risk of earnings overstatement in accounting for construction contracts?

5) Which statement is correct about the "winner's curse"?

6) What disclosures are required under IFRS for construction contracts?

Transaction Appropriate accounting

2018 2019 2020 2021

Year 1 Year 2 Year 3

Year 1 Year 2 Year 3

b. Prepare all the journal entries required in Year 2.

Revenue (income) recognition

d. GP = (Estimated % Complete or 100% if expected loss) × (Estimated GP) - (GP previously

Year 1 Year 2 Year 3

b. Revenue = % complete × estimated total revenue – revenue previously recognized