CHAPTER 4
REVENUE RECOGNITION AND THE STATEMENT OF
INCOME
SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE
AND LEVEL OF DIFFICULTY
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True-False Statements
1.
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8.
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15.
2
H
22.
M
29.
5
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2.
1
E
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33.
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Multiple Choice Questions
34.
1
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43.
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M
52.
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61.
E
70.
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35.
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71.
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36.
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50.
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59.
2
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68.
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42.
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51.
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60.
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69.
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Exercises
77.
2
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79.
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81.
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E
83.
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78.
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H
80.
2,4
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82.
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Matching
85.
2–4,7
M
Short-Answer Essay
86.
2
H
87.
2
H
Essay
88.
2
H
Note: E = Easy M = Medium H = Hard
4 – 2 Test Bank for Understanding Financial Accounting, Canadian Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE
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Learning Objective 1
1.
TF
3.
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34.
MC
36.
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38.
MC
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TF
4.
TF
35.
MC
37.
MC
Learning Objective 2
5.
TF
12.
TF
42.
MC
49.
MC
56.
MC
63.
MC
80.
Ex
6.
TF
13.
TF
43.
MC
50.
MC
57.
MC
64.
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85.
Ma
7.
TF
14.
TF
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TF
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TF
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Es
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TF
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MC
78.
Ex
11.
TF
41.
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48.
MC
55.
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MC
79.
Ex
Learning Objective 3
16.
TF
19.
TF
22.
TF
67.
MC
70.
MC
73.
MC
85.
Ma
17.
TF
20.
TF
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TF
68.
MC
71.
MC
81.
Ex
18.
TF
21.
TF
24.
TF
69.
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72.
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82.
Ex
Learning Objective 4
25.
TF
26.
TF
27.
TF
74.
MC
80.
Ex
83.
Ex
85.
Ma
Learning Objective 5
28.
TF
29.
TF
75.
MC
76.
MC
Learning Objective 6
30.
TF
Learning Objective 7
31.
TF
32.
TF
33.
TF
84.
Ex
85.
Ma
Note: TF = True-False Ex = Exercise SAE = Short-Answer Essay
MC = Multiple Choice Ma = Matching Es = Essay
Revenue Recognition and the Statement of Income 4 – 3
CHAPTER LEARNING OBJECTIVES
1. Explain the nature of revenue and why revenue is of significance to users.
2. Identify and explain the general criteria for revenue recognition and the specific
revenue recognition criteria related to the sale of goods, the provision of services,
and the receipt of interest, royalties, and dividends.
3. Explain how revenues are measured.
4 – 4 Test Bank for Understanding Financial Accounting, Canadian Edition
4. Understand the difference between a single-step statement of income and a
multi-step statement of income.
5. Understand the difference between comprehensive income and net income.
6. Understand the difference between presenting expenses by function or by
nature of the item on the statement of income.
7. Calculate and interpret a company’s basic earnings per share.
Revenue Recognition and the Statement of Income 4 – 5
TRUE-FALSE STATEMENTS
1. There must be a receipt of cash in order for a company to recognize revenue.
2. The amount of revenue is one of the most significant amounts reported in the financial
statements.
3. Under the accrual basis, accounting revenues are recognized when they are earned
regardless of whether the related cash was received by the company.
4. Financial statement users can find information about a company’s revenue recognition
policies in the notes to the financial statements.
5. A company may choose numerous methods of recognizing revenue for different
revenue types.
6. If it is probable that economic benefits will flow to the company and the amounts can
be reliably measured, then revenue should be recognized.
7. In order to use the percentage of completion method, it is necessary to have
continuing involvement or control over the goods/services.
8. In retail stores revenue is normally recognized at the time of sale.
9. Part of the revenue recognition criteria includes reasonable assurance of collectability
of at least some portion of the amount earned.
10. Accounting standards identify two revenue recognition criteria that must be met
before a company selling goods can recognize revenue.
11. When the customer takes the goods away, the selling company no longer has
control over the goods.
12. At the time of sale, the selling price does not have to be determined in order for the
selling company to quantify the economic benefits of the transactions.
13. When making sales, there are costs that may be incurred in the future; an example
4 – 6 Test Bank for Understanding Financial Accounting, Canadian Edition
of a cost is bad debts.
14. Many service contracts require the seller to provide services for multiple periods. In
order to properly recognize revenue, you must use the percentage of completion
method.
15. In order to recognize revenue for interest, royalties, or dividends, all companies must
be able to determine the costs incurred to complete the transaction.
16. The incentive built in for prompt payment of cash by a customer for a credit sale is
called a cash discount.
17. When buyers request and receive an adjustment for products damaged during
shipping this is called a trade discount.
18. Revenue should be measured at the cost of the consideration received or receivable.
19. Bundling is a term used when companies sell both a product and a service.
20. A sales discount of 2/10 means the seller will receive 98% of the selling price.
21. Companies offering sales discounts must adjust the original amount of the sales
revenue.
22. If a customer receives goods that are damaged but does not want to return the
goods to the seller, the seller can offer a reduction in the selling price which is known as
an allowance.
23. Sales returns and allowances is a contra revenue account which is added to sales
revenue when determining net sales.
24. Estimated returns must be reported in the same period as the related sales, which
ensures that the company’s net sales revenues are fairly stated.
25. When a company uses a mutli step income statement, all revenues are presented
first regardless of the source.
26. A single-step income statement requires several steps to reach a company’s net
Revenue Recognition and the Statement of Income 4 – 7
profit or loss.
27. The multi-step income statement allows readers to easily identify gross profit and
profits earned from operating activities.
28. Private companies must report comprehensive income in their financial statements.
29. Comprehensive income must be reported on a separate statement called the
Statement of Comprehensive Income.
30. The choice of presenting expenses based on their nature or function rests with
management.
31. The earnings per share figure expresses net income, after deducting common
dividends, on a per-share basis.
32. EPS may be reported either on the statement of financial position or the statement of
income.
33. When there has been a change in the number of preferred shares during the period,
a weighted average number of shares must be determined for the EPS calculation.
4 – 8 Test Bank for Understanding Financial Accounting, Canadian Edition
ANSWERS TO TRUE-FALSE STATEMENTS
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Revenue Recognition and the Statement of Income 4 – 9
MULTIPLE CHOICE QUESTIONS
34. Which of the following would indicate high quality earnings for a company?
a) Increasing revenue while cash from operations is stable.
b) Increasing net income while cash from operations decreases.
c) Revenue and net income that move together.
d) Net income and cash flow from operations that move together.
35. In which of the following businesses would the delivery of the product and the
collection of cash occur at the same time?
a) a clothing retail store
b) a consulting firm
c) a home builder
d) an advertising firm
36. When a company reports net income, financial statement users see this as a sign
that
a) the company is viable.
b) the company has the ability to sustain itself.
c) the company has the ability to declare dividends.
d) all of the above.
37. Earnings are considered to be of higher quality if
a) cash flow from operating activities is greater than net earnings.
b) cash flow from operating activities is less than net earnings.
c) cash flow from investing activities is greater than net earnings.
d) cash flow from investing activities is less than net earnings.
38. Earnings are considered to be of lower quality if
a) cash flow from operating activities is greater than net earnings.
b) cash flow from financing activities is less than net earnings.
c) cash flow from operating activities is less than net earnings.
d) cash flow from investing activities is less than net earnings.
39. In the retail industry, when customers pay cash at the time of sale, revenue is
recognized
a) when the inventory is purchased.
b) at the time of sale.
c) when the time frame for returns has passed.
d) when the cash is deposited in the bank.
40. When revenue is earned from the sale of goods, all of the following criteria must be
met before revenue can be recognized EXCEPT
4 – 10 Test Bank for Understanding Financial Accounting, Canadian Edition
a) revenue must be earned.
b) the amount earned is measurable.
c) all sales returns and allowances have been recorded.
d) there is no continuing involvement or control over the goods.
41. When revenue is earned from the provision of services, all of the following are
necessary for revenue recognition EXCEPT
a) economic benefits from the transaction will flow to the seller.
b) the amount of revenue can be reliably measured.
c) the costs incurred to complete the transaction can be reliably measured.
d) the seller has no continuing involvement.
42. Certossi’s Spa sells gift certificates for future services. These gift certificate sales
should be recorded as
a) a credit to sales revenue.
b) a credit to cash.
c) a debit to sales revenue.
d) a credit to unearned revenue.
43. Frenzo Furniture Co. is a manufacturer of specialty furniture. Because each piece is
custom manufactured, the company requires a down payment of 40% of the estimated
cost of the finished piece before production begins. Frenzo Furniture Co. should record
the deposit as a
a) credit to sales revenue.
b) credit to unearned revenue.
c) credit to inventory.
d) credit to cost of goods sold.
44. Revenue may be recognized during production in which of the following types of
business?
a) retail sales
b) manufacturing for mass-production
c) construction
d) franchise operations
45. Duguay Designers took a $1,500 deposit from a customer when they signed the
contract to paint the customer’s residence. It took them three weeks to complete the job.
On completion the customer paid the $3,500 balance. How should Duguay Designers
recognize revenue for this job?
a) The $1,500 as revenue when it is received, and the $3,500 as revenue when it is
received.
b) The $1,500 as unearned revenue and the $3,500 as revenue when it is received.
c) $1,667 a week during the painting period.
d) $5,000 as revenue at the completion of the project.
Revenue Recognition and the Statement of Income 4 – 11
46. Duro Brothers Ltd. is a construction company located in Toronto. The company is
responsible for several large building complexes currently being constructed in the
Toronto area. Total revenue and costs can be readily estimated and each contract is
expected to take several years to complete. How is Duro most likely to recognize
revenue?
a) percentage of completion method
b) equally over the term of the contract
c) at the time of contract signing
d) all revenue at the end of the job
47. Bailey Consulting, a Winnipeg based Company, has just signed a contract to
complete a strategic plan for a local business. This plan will likely take 2 to 3 months to
complete. How should Bailey Consulting recognize revenue?
a) percentage of completion method
b) equally over the term of the contract
c) at the time of contract signing
d) all revenue at the end of the job
48. The revenue recognition method most often used for short-term construction projects
is to recognize revenue
a) during the construction process as a percentage of the costs completed.
b) at the completion of the project.
c) at the time the construction contract is signed.
d) as cash is received.
49. In order to apply the percentage of completion method the contractor must be able to
estimate all the following EXCEPT
a) the total cost of the project.
b) the total revenue for the project.
c) the collectability of all receivables.
d) the amount of revenue to be recognized each period.
50. The Carluccis decided to open a resort. In the first month of operation they collected
cash and credit card receipts of $1,800. All rooms rent out at $75 a night and during the
month they had 19 room rentals and had received non-refundable deposits of $37.50
each on another five nights of rentals. For two of those deposits the people had failed to
show up and the Carluccis did not refund the deposits, the other three deposits were for
future stays. The appropriate amount for them to recognize as revenue for their first
month is
a) $1,425.
b) $1,500.
c) $1,800.
d) $1,575.
Use the following information for questions 51–53.
4 – 12 Test Bank for Understanding Financial Accounting, Canadian Edition
Big Bump Mountain operates a ski resort in the Rocky mountains of Alberta. They sell
three types of ski tickets. Season tickets are sold throughout the year, and entitle the
holder to ski any day all season long. They are non-refundable. Daily tickets are sold at
the mountain and are only valid for the day they are sold. Corporate group tickets are
sold throughout the year. The buyer receives a package of 20 daily ticket coupons at a
discounted price and the coupons can be redeemed for a day of skiing any time during
the season. The skier needs to present the coupon for a ticket on the desired ski day.
Unused tickets (coupons) expire at the end of the season and are non-refundable.
51. When should Big Bump Mountain recognize revenue for the season tickets?
a) at the time of sale
b) on the day the mountain first opens for skiing
c) throughout the ski season
d) at the end of the ski season
52. When should Big Bump Mountain recognize revenue for the corporate tickets
redeemed?
a) at the time of sale
b) on the day they are redeemed for a ticket
c) throughout the ski season
d) at the end of the ski season
53. How should Big Bump Mountain account for the corporate tickets NOT redeemed?
a) They should estimate an amount at the time of sale and recognize it as revenue then.
b) They should estimate an amount at the time of sale and recognize it as revenue
evenly throughout the ski season.
c) They should estimate an amount at the time of sale and recognize it as revenue
proportionally every time a coupon is redeemed.
d) They should recognize it as revenue at the end of the ski season.
54. During the current year, First Flex Corporation sold $1,250,000 in goods that cost
$750,000. Cash sales were $500,000 and credit sales $750,000. First Flex collected
$500,000 of the credit sales during the year. What amount of revenue should Flex
recognize for the year under the revenue recognition principle?
a) $1,250,000
b) $ 500,000
c) $ 750,000
d) $ 1,000,000
55. On May 1, Yeung Enterprises paid rent for 3 months in advance. The total payment
was $1,200. How much rent expense should Yeung recognize for the month of May?
a) $1,200
b) $ 300
c) $ 600
d) $ 400
Revenue Recognition and the Statement of Income 4 – 13
56. Frozen Limited sold $1,750,000 worth of goods during the current year. The cost of
goods sold is $1,050,000. Credit sales were $1,575,000, of which 40% were still
outstanding. How much cash was collected by Frozen Ltd.?
a) $1,575,000
b) $1,120,000
c) $ 805,000
d) $ 175,000
Use the following information for questions 57–58.
Dinca Construction Co. agreed to build a bridge for Gotham City. The contract specifies
that construction will take three years and Dinca will receive $12,500,000. The company
expects annual costs to be $3,500,000; $2,750,000; and $1,800,000.
57. Assume Dinca uses the percentage of completion method. Profits for year one will
be
a) $0.
b) $1,483,333.
c) $1,934,783.
d) $4,450,000.
58. Assume Dinca uses the percentage of completion method. Revenue recognized in
year three will be
a) $1,800,000.
b) $2,795,030.
c) $4,166,667.
d) $12,500,000.
59. Khouri Construction agreed to build a shopping centre for $25,000,000 over the next
four years. Estimated cost for years one through four are: $7,500,000; $5,000,000;
$5,000,000; and $2,500,000. Estimated profit or loss for year one, assuming the
percentage of completion method, would be
a) $(1,250,000).
b) $0.
c) $1,250,000.
d) $1,875,000.
60. All of the following statements are true EXCEPT
a) a company that has multiple lines of business must consistently apply one revenue
recognition policy for all types of revenue.
b) a company that has multiple lines of business can use different methods of revenue
recognition for different products.
c) a company that has multiple lines of business must tell users what policies they are
using so that that they can make informed decisions.
d) A company that has multiple lines of business must choose revenue recognition
4 – 14 Test Bank for Understanding Financial Accounting, Canadian Edition
policies that are appropriate for their revenue streams.
61. All of the following categories have established revenue recognition criteria EXCEPT
a) sales of goods.
b) collection of accounts receivable.
c) provision of services.
d) receipt of interest, royalties, and dividends.
62. All of the following criteria must be satisfied in order to recognize revenue for the
sales of goods EXCEPT
a) the portion of total services can be reliably measured.
b) significant risks and rewards have been transferred to the buyer.
c) the seller has no continuing involvement.
d) the amount of revenue can be reliably measured.
63. Which of the following criteria must be satisfied in order to recognize revenue for the
receipt of interest, royalties, and dividends?
a) The portion of total services can be reliably measured.
b) Significant risks and rewards have been transferred to the buyer.
c) The seller has no continuing involvement.
d) The amount of revenue can be reliably measured.
64. All of the following criteria must be satisfied in order to recognize revenue for the
provision of services EXCEPT
a) the portion of total services can be reliably measured.
b) the costs incurred can be reliably measured.
c) the seller has no continuing involvement.
d) the amount of revenue can be reliably measured.
65. All of the following are examples of service revenues EXCEPT
a) cell phone, internet, or television services.
b) cargo revenues when airlines provide flight services to their customers.
c) textbook sales by universities and colleges.
d) service and maintenance revenue by vehicle manufacturers.
66. Tuition services when universities and college provide educational services are
considered revenue from
a) sale of goods.
b) provision of services.
c) receipt of interest.
d) none of the above.
67. If the goods sold to a customer are damaged in shipment, the buyer normally asks
for a(n)
Revenue Recognition and the Statement of Income 4 – 15
a) sales discount.
b) accounts receivable.
c) sales allowance.
d) purchase discount.
68. If a $12,500 sale is made on September 21 with terms 2/10 net 30 and collection is
made on October 2, the amount collected is
a) $12,250.
b) $10,000.
c) $12,750.
d) $12,500.
69. If a $6,750 sale is made on December 30 with terms of 2/10, net 30 and collection is
made on January 31, the amount collected is
a) $5,400.
b) $6,615.
c) $6,750.
d) $6,885.
70. A typical sales discount is “2/10, n/30″ which means that the customer
a) could take a 2% discount in 10 days.
b) could take a 10% discount in 2 days.
c) could take a 2% discount in 30 days.
d) will get no discount if paid in 10 days.
71. The difference between sales revenue and cost of goods sold is
a) sales revenue.
b) gross profit.
c) operating income.
d) net income.
72. The difference between gross profit and the company’s operating expenses is
a) sales revenue.
b) gross profit.
c) operating income.
d) net income.
73. The final step in preparing the multi-step income statement is
a) sales revenue.
b) gross profit.
c) operating income.
d) net income.
74. Operating expenses included all of the following EXCEPT
4 – 16 Test Bank for Understanding Financial Accounting, Canadian Edition
a) advertising.
b) depreciation.
c) rent.
d) loss on sale of equipment.
75. Comprehensive income is equal to
a) net income minus comprehensive income.
b) net income plus comprehensive income.
c) gross profit plus comprehensive income.
d) gross profit minus comprehensive income.
76. Examples of functional areas of the income statement are
a) sales, gross profit, and net income.
b) cost of sales, administrative activities, and selling activities.
c) wages expenses, depreciation, and rent expense.
d) gross profit, operating income, and net income.
Revenue Recognition and the Statement of Income 4 – 17
ANSWERS TO MULTIPLE CHOICE QUESTIONS
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
4 – 18 Test Bank for Understanding Financial Accounting, Canadian Edition
EXERCISES
77. Tabele Engineers signed a contract to develop a warehouse for a customer.
Development covers a four-year period. The following data pertain to the contract and
subsequent development:
Contract price: $1,750,000
Estimated costs: 1,500,000 (remained unchanged throughout contract
period)
Actual Results
Year Costs Receipts
1 $750,000 $205,000
2 $450,000 $537,000
3 $225,000 $600,000
4 $ 75,000 $408,000
Instructions
Calculate the revenue, expense, and profit for each of the four years using the
percentage of completion method.
Solution (5 min.)
78. Great Gossip publishes and sells magazines catering to teenage girls. Subscriptions
are sold for $36 for twelve monthly issues. The following chart indicates how many were
sold during 2015 and what payment they had received from subscribers by year-end.
The first magazine is delivered the same month the subscription is sold.
Date # subscriptions sold Cash Received
January 1 200 $ 7,200
May 1 350 12,600
September 1 800 28,800
December 1 650 23,400
Instructions
a) How much cash did Great Gossip collect in 2015?
b) What amount of revenue should Great Gossip report for the year ended December
31, 2015?
c) Are there differences between the amount of cash collected and the revenues
recognized? If so, explain why?
Solution (8 min.)
Revenue Recognition and the Statement of Income 4 – 19
79. Place an X for each criterion that must be met in order to recognize revenue in each
category.
Criteria
Sale of
Goods
Provision of
Services
Receipt of
Interest, royalties
and dividends
Significant risks and rewards
are transferred
Seller has no continuing
involvement
Amount of revenue can be
reliably measured
Economic benefits from the
transaction will flow to the seller
Cost incurred can be reliably
measured
Total services can be reliably
measured
Goods
Services
Interest, royalties
Significant risks and rewards are
transferred
involvement
Amount of revenue can be
reliably measured
Economic benefits from the
transaction will flow to the seller
Solution
4 – 20 Test Bank for Understanding Financial Accounting, Canadian Edition
80. Little Luxuries Day Spa’s cash receipts for the period ended December 31, 2015
were $1,175,000. The cost of sales are estimated at 60% of revenues, with gift
certificate sales representing 10% of all cash receipts. Since gift certificate sales are part
of a new marketing strategy that was not implemented until December, no gift
certificates were redeemed in 2015.
Instructions
a) Prepare Little Luxuries partial Statement of Income.
b) How should gift certificate sales be recorded and why?
Solution (10 min.)
81. On March 10, Roussi Marble Masters (RMM) recorded $45,000 in revenues related
to a project it was working on for Hiles Kitchen Krafts (HKK). The terms were 2/10, n/30.
Instructions
a) Record the journal entry at the date of the sales and collection date assuming HKK
paid on March 19. Compute the net sales at on March 19.
b) Record the journal entry at the date of the sale and collection date assuming HKK
paid on March 30. Compute the net sales on March 30.
Solution
Revenue Recognition and the Statement of Income 4 – 21
82. On November 2, Hartely Home Designers (HHD) sold products to one of its
customers for $75,000 on account, terms 2/10, n/45. Six days later, the customer
contacted HHD to report that a few goods were not the brand that they had ordered.
HHD sales manager negotiated with the customer and agreed to reduce the sales price
by $1,000 if the customer agreed to keep all the products. The customer paid their
account on November 11.
Instructions
a) Record the journal entries for the sale and payment of transactions.
b) Assume the customer paid on November 30; record the journal entries for the sale
and payment of transactions.
Solution
4 – 22 Test Bank for Understanding Financial Accounting, Canadian Edition
83.
Jackson’s Jamaican Jerky
Trial Balance
April 30, 2014
Cash $14,245
Accounts Receivable 2,540
Merchandise Inventory 9,780
Office Supplies 100
Store Supplies 200
Prepaid Rent 600
Office Equipment 3,000
Accumulated Depreciation—Office Equipment $600
Store Equipment 5,800
Accumulated Depreciation—Store Equipment 580
Accounts Payable 1,390
Notes Payable 5,000
Jackson Grun—Capital 3,023
Jackson Grun—Withdrawals 18,000
Sales 86,400
Sales Discounts 2,460
Sales Returns and Allowances 1,280
Cost of goods sold 18,200
Office Salaries Expense 6,825
Rent Expense 1,200
Office Supplies Expense 300
Advertising Expense 1,800
Interest Expense 263
Depreciation Expense 400
Totals $91,993 $91,993
Instructions
Prepare a multi-step Income Statement.
Revenue Recognition and the Statement of Income 4 – 23
84. Wamsley Ltd. reported net income of $750,000 for the year ended September 30,
2015. During the year, the company also declared and paid dividends of $45,000 on the
company’s preferred shares. At the beginning of the year, Wamsley had 350,000
common shares outstanding. No shares were issued or repurchased during the year.
Instructions
a) Calculate the basic earnings per share ratio.
b) Assume 200,000 common shares were issued on Oct 1, 2013 and an additional
150,000 common shares issued on June 1, 2014. Calculate the basic earnings per
share ratio.
Solution
4 – 24 Test Bank for Understanding Financial Accounting, Canadian Edition
MATCHING
85. Match the following terms to the descriptions by entering the appropriate letter in the
space provided.
TERMS
a) Sales Discount
b) Earnings per share
c) Revenue recognition at time of sale
d) Multi-Step Income Statement
e) Percentage of completion method
f) Trade discount
DESCRIPTIONS
____ 1. Earnings process is essentially completed and revenue has been realized.
____ 2. A negotiated or posted reduction to the selling price.
____ 3. Presents total earnings on a per share basis.
____ 4. Generally used on long–term construction projects.
____ 5. Provides a reduction in cash collected from the customer if an account is
paid within the specified time period.
____ 6. Requires several steps to reach a companies net profit or loss.
Solution (3 min.)
Revenue Recognition and the Statement of Income 4 – 25
SHORT-ANSWER ESSAY QUESTIONS
86. Describe the two general revenue recognition criteria and explain the logic behind
them.
Solution (7 min.)
Instructions
Discuss when all revenues should be recognized at Buff it Up. Support your discussion
with reference to the specific revenue recognition criteria.
Solution (12 min.)
4 – 26 Test Bank for Understanding Financial Accounting, Canadian Edition
Revenue Recognition and the Statement of Income 4 – 27
ESSAY QUESTIONS
88. Standard setters provide guidelines for recognizing revenue. It is generally
recognized at the time of sale; however, it is possible to recognize revenue at other
times.
Instructions
a) Explain why revenue is generally recognized at the time of sale.
b) Explain the method used to recognize revenue for long term contracts.
Solution (10 min.)
4 – 28 Test Bank for Understanding Financial Accounting, Canadian Edition
LEGAL NOTICE