Week 5 Exercises | Course Paper

5-1 Financial Accounting for MBAs, 7th Edition

Week 5 Home Exercises—Total 30 points

Topic: Revenue Recognition (4 points)

1. Identify when each of the following companies should recognize revenue.

a. Valero Energy – integrated petroleum company that sells crude oil, natural gas and petroleum and

chemical products under short-term agreements at prevailing market prices

The company is into selling fossil fuel in a short-term agreement, which indicates there is small

gap exist between placing order and shipping goods. The firm should recognize revenue on an

accrual basis, as the short-term agreement is generally last for less than a year or two.

b. Boeing – airplane manufacturer whose revenue is derived largely from long-term fixed-price

contracts with airlines

The company is into manufacturing airbus, which involves high investment and the project

generally last for several years based on the number of order placed per contract. Generally,

for a company that works on a contract basis, it recognizes revenues as well as cost on the

basis of percentage of completion method. The method help recognize income and expenses

annually as the work progresses over the period.

c. Wells Fargo – large commercial bank that earns interest on loans

Well Fargo should recognize its revenues on a cash basis, because there are every chances

that the loan is refinanced (in case the interest rate tumbles) or principal is paid before maturity.

d. Ford Motor Company – manufactures and retails automobiles, provides financing for dealers and

customers

The company is a mix of both goods (manufacturing, retailing) and services (financing). In this

case, the company should follow both cash and accrual method of recognizing revenues.

Accrual method for the revenues generated from goods and cash method for financing.

Topic: Risk Exposures to Revenue Recognition (4 points)

2. When should each of the following companies recognize revenue for the following operations? Identify

potential revenue recognition issues or risk exposures facing the company:

a. Costco Wholesale Corporation collects annual membership fees from customers.

Costco Wholesale Corp should record membership fees evenly over the year. A risk is that

they might record all the fees as revenue when the customer makes the initial payment. This

won’t really be a issue if Costco receives about the same membership fees over the year.

b. The New York Times receives advertising revenues in advance from Citigroup, for an ad campaign

that will run a full-page spread once a week for six months.

The New York Times should record the revenue as each ad appears (weekly). Although there

is a risk that the company could record all of the advance payment as revenue when Citigroup

pays it. There might be a issue if advance advertising revenues are not consistent during the

year.

c. Zappos is an online clothing and shoe retailer. It receives credit card payments when customers

place their orders and ships products from warehouses within 5-7 business days.

Credit cards are essentially cash, revenue should not be recognized until the product is

shipped. Until that time, the cash received is recognized as an asset on the balance sheet and

a liability is recorded to reflect an responsibility to deliver product. The revenue risk that

Zappos could record the cash receipts as revenue, before the product is delivered, to boost

current sales and profit. This risk is small however in that most shipments follow cash receipt

by only a few days.

d. Ticketmaster contracts with the producer of Blue Man Group to sell tickets online. Ticketmaster

charges each customer a fee of $7 per ticket and receives $12 per ticket from the producer.

Ticketmaster does not take control of the ticket inventory. Average ticket price for the event is $99.

Ticketmaster should record $19($7+$12) revenue each time it sells a ticket. Of that $7 will be

received in cash and $12 will be recorded as receivable from the Blue man group producers.

The risk exposure is that Ticketmaster could record $106($99+$7) for each ticket sold and

offset that with a cost of goods sold of $87 ($99-$12)(along with a $87 accounts payable) to

the Blue man group producer. This would increase the company’s sales figure but would not

have any effect on the profit because still the profit remains same (106-87=19)