Essay
Instructions:
The following answers point out the key phrases that should appear in students’ answers. They are not
intended to be examples of complete student responses. It might be helpful to provide detailed
instructions to students on how brief or in-depth you want their answers to be.
322. Silica Corporation constructs highly specialized communication satellites. A customer in
Hong Kong recently placed an order for a cable TV satellite at a price of $20 million. The
order was placed in April 2016, and the satellite is to be delivered in one year. The customer
has guaranteed to pay in full at the end of 2016, regardless of progress or cancellation. Silica
uses “proportion of time” as its measure of progress toward completion.
Required: When should Silica recognize revenue: at completion, or as the construction is
performed?
Answer:
323. Hans Cars & Trucks sells various types of used vehicles with a one-year warranty that
covers any defects. When customers make a purchase, they also receive a coupon for 10 free
engine oil changes and an option to change all of the tires for $50 after 30,000 miles.
Typically, customers pay $25 for an oil change and $250 for a new set of tires.
Required:
(a) Given the information above, how many performance obligations exist in the contract to
purchase a vehicle?
(b) Assume the same contract but that it offers customers an option to change all of the tires for
$250 after 30,000 miles. How many performance obligations exist in the contract to purchase a
vehicle?
324. Lexikon Pianos sells customized concert pianos throughout the U.S. Its grand concert
piano sells for $200,000, which includes delivery and installation. The product comes with a
two-year warranty that covers any product defects, and customers can choose to add an
extended three-year warranty for maintenance and repair at a price of $2,000. Customers also
get an option to upgrade traditional plastic keys to bone ones for an additional $20,000. The
extended warranty would normally sell for $3,500, and the installation of bone keys carries a
standalone price of $30,000.
Required:
(a) Given the information above, how many performance obligations exist in the contract to
purchase a grand concert piano?
(b) Now, assume that the standalone price of the extended warranty is $2,000, and that of the
bone key upgrade is $20,000. How many performance obligations exist in the contract to
purchase a grand concert piano?
325. Summerhill Construction builds luxury houses in remote areas. On June 1, 2016, the
company signed a contract to build a house in an undeveloped section of a mountainside, and
received $2 million in advance for the job. To complete the project, the company must
construct a pathway leading to the building lot, clear a large hillside, and construct a wooden
house. Normally, the company would charge $400,000, $1,400,000, and $500,000,
respectively, for each of these tasks if done separately.
Required: Given the information above, how many performance obligations are included in this
contract?
326. Optimus Pools, Inc. constructs outdoor swimming pools for wealthy individuals.
Recently it obtained an order to build a three-lane swimming pool of 25 yards in length in the
customer’s backyard. Under the contract, Optimus is also obligated to install a water heater
and a filtration system, which are necessary to make a swimming pool fully functional. Total
price for the construction was $55,000. Each of these smaller components would typically
cost $40,000, $10,000, and 20,000 if installed separately.
Required: Given the information above, how many performance obligations are included in this
contract?
327. FlexMotors, Inc. manufactures a variety of electronic drills and grass cutters. Recently, it
introduced a new line of handheld drills that generates much less noise and consumes much
less energy, but carries a much higher price tag. The company is currently considering
whether it should record $1.2 million of revenue upon shipment. Under the contract,
FlexMotors is obligated to accept any products from the distributors if they are not sold
within 6 months. The company is confident that the new model will sell, but is unable to
accurately estimate returns, because it has never sold anything quite like it.
Required: How much revenue should FlexMotors recognize upon shipment to distributors?
328. Horowitz Paint Shop sold $3,000 of paint to a local construction company for cash on
June 25, 2016. Because of a flood in the area, the customer requested that Horowitz not ship
the items from its warehouse until July 3, 2016, so Horowitz set aside the paint on June 25,
packaged and ready to ship on July 3.
Required: For the second quarter ending on June 30, how much revenue should Horowitz
recognize for the sale to the local construction company? Explain your answer.
329. On December 28, 2016, Omega Steel, Inc. sold $100,000 of steel sheets to a car
manufacturer. Due to holidays, Omega was unable to find a truck driver to deliver the
product. Delivery was finally made on January 5, 2017.
Required: How much revenue should Omega recognize in 2016 for the sale to the car
manufacturer? Explain your answer.
Chapter 5 Revenue Recognition and Profitability Analysis
330. The following disclosure note appeared in a recent annual report to stockholders of
Dell Inc., the computer manufacturer: “Net revenue includes sales of hardware, software
and peripherals, and services (including extended service contracts and professional
services). These products and services are sold either separately or as part of a multiple–
element arrangement. Dell allocates fees from multiple-element arrangements to the
elements based on the relative fair value of each element, which is generally based on the
relative list price of each element. For sales of extended warranties with a separate
contract price, Dell defers revenue equal to the separately stated price. Revenue associated
with undelivered elements is deferred and recorded when delivery occurs. Product revenue
is recognized, net of an allowance for estimated returns, when both title and risk of loss
transfer to the customer, provided that no significant obligations remain. Revenue from
extended warranty and service contracts, for which Dell is obligated to perform, is
recorded as deferred revenue and subsequently recognized over the term of the contract or
when the service is completed. Revenue from sales of third-party extended warranty and
service contracts, for which Dell is not obligated to perform, is recognized on a net basis
at the time of sale.”
Briefly explain why Dell Computer recognizes revenue at different times for (a) product sales,
(b) extended warranty and service contracts for which Dell is obligated to perform, and (c)
extended warranty and service contracts for which a third party is obligated to perform.
331. Are the following separate performance obligations: prepayments, quality-assurance
warranty, extended warranty, right of return? For each, indicate yes or no, and explain.
Answer:
332. Explain two approaches a seller can use to estimate variable consideration, and when
each approach is likely to be more appropriate.
333. Are sellers ever constrained from including variable consideration in the transaction
price used to estimate revenue? Explain, providing indicators of circumstances that could
require that constraint.
334. Briefly describe at least two indicators that can be used to distinguish whether a seller
is a principal or an agent according to GAAP.
335. Explain the differences between how a principal and agent would show a sale of a
product that has gross revenues of $1,000, cost of goods sold of $750, and a commission
paid by the principle of 10% of gross sales on their respective income statements.
336. Explain briefly how a company who sells to distributors with a right of return might
manage earnings if the company was falling short of profit projections. What sort of
ethical problems could result from that earnings management?
337. Many high-tech companies sell products with the opportunity for retailers to return the
merchandise if it is unsold after a certain period. This reduces the retailer’s risk of
inventory obsolescence. Explain the implications on revenue recognition under this kind
of policy. Include a specific example.
338. Briefly explain the circumstances in which license revenue is recognized over time
versus at a point in time. Provide an example of each.
Chapter 5 Revenue Recognition and Profitability Analysis
339. Briefly explain the circumstances that indicate the seller has a bill-and-hold sale and a
consignment sale, and how that affects the timing of revenue recognition for each.
340. Briefly explain the difference between an account receivable, a contract asset, and a
contract liability.
341. What is the objective of disclosures about revenue recognition? Indicate at least two
common types of important revenue recognition disclosures.
342. Imagine that the Ace Construction Company (ACC) concludes that it must switch
from recognizing revenue on long-term contracts over time according to percentage of
completion to recognizing revenue upon completion of each contract. Assume that none of
their construction projects are going to produce a loss. Is it possible that, in a particular
year, ACC will show higher gross profit under the new approach (recognizing revenue
upon contract completion) than they did under the old approach (recognizing revenue over
time according to percentage of completion)? Explain.
343. Briefly explain how a company that recognized revenue over time by estimating
percentage of completion using a cost-to-cost ratio could manage earnings upward to meet
a profit projection. What sort of ethical problems could result from that earnings
management?
344. Briefly explain how gross profit is recorded when revenue on long-term construction
projects is recognized over time according to percentage of completion.
345. Under what circumstances can revenue on long-term construction contracts be
recognized over time according to percentage of completion?
346. Briefly explain how you can determine if a company is effectively using leverage.
Use the following to answer questions 347-350:
The following table presents a summary of ratio analysis for McDonald’s and averages for their peer
group:
McDonald’s
Industry
Peer Group
Profit margin
8.0%
7.0%
Inventory turnover
114.5
99.6
Asset turnover
0.75
1.22
Equity multiplier
2
2.5
Return on shareholders’ equity
12.0%
21.3%
Chapter 5 Revenue Recognition and Profitability Analysis
347. Using the information provided above, use the DuPont framework to briefly summarize
the operating performance of McDonald’s relative to its benchmark competitors.
348. Are differences between McDonald’s and the industry likely driven by differences in size
between McDonald’s and the average company in their industry peer group? Explain
briefly.
349. Besides size differences, what other differences between McDonald’s and its industry peer
group could limit your ability to make meaningful comparisons about the performance of
McDonald’s from the data above?
350. Based on this information, if you were going to advise McDonald’s about how it could
enhance return on shareholders’ equity, what would you suggest? Be as specific as
possible in the operational or financial changes you would recommend.
Use the following to answer questions 351-352:
The following table presents a summary of ratio analysis for Uncle Joe’s Coffee, based on the most
recent 12 months and five-year comparisons of Uncle Joe’s with averages in the restaurant industry
and the services sector, respectively.
Company
Industry
Sector
Return on assets
10.68%
9.04%
5.09%
Return on assets- 5 yr. avg.
8.23%
8.37%
6.78%
Return on equity
13.94%
17.55%
10.97%
Return on equity- 5 yr. avg.
11.28%
15.69%
15.76%
Receivable turnover
34.15
27.99
16.11
Inventory turnover
11.88
34.73
15.94
Asset turnover
1.58
1.30
1.22
351. Using the information provided above, briefly summarize the operating performance of
Uncle Joe’s relative to its benchmark competitors.
Chapter 5 Revenue Recognition and Profitability Analysis
352. What limitations exist in drawing meaningful comparisons about the performance of
Uncle Joe’s from the data above?