Financial Reporting and Analysis (7th Edition)
Chapter 3 Solutions
Revenue Recognition
Exercises
Note: Exercises E3-1 through E3-4 deal with when a contract subject to the
revenue recognition rules exists. In order for a contract to exist that is subject to
ASC Topic 606, the following conditions must all have been met:
All parties to the contract have approved the contract and are legally
obligated to perform their obligations under the contract.
Payment terms can be identified, although consideration may include a
variable component.
Collection is probable. Assessment of collectibility “is based on whether the
E3-1. Existence of a contract
Note: See the beginning of this chapter’s solutions for the criteria for existence of a
contract.
In scenario 1, no legally binding contract has been entered into as of the end of the
year. Even though the customer usually places an order by the end of the
In scenario 2, again there is no contract until the order is received by fax. It is
In scenario 3, there is a contract upon receipt of the order by phone. This situation
creates an oral contract, which is legally binding on the two parties. The fact
In situation 4, there is a contract when Amiel and the customer agree. The price
need not be certain in order for there to be a contract subject to the revenue
E3-2. Existence of a contract
Note: See the beginning of this chapter’s solutions for the criteria for existence of a
contract.
There is no contract subject to the revenue recognition rules until Latter receives
payment for two reasons. First, Latter has specifically stated that it will not ship
the goods until a cashier’s check is received, indicating that Latter has not
E3-3. Existence of a contract
Note: See the beginning of this chapter’s solutions for the criteria for existence of a
contract.
In scenario 1, once it is determined the patient is insured with one of Riff’s preferred
In scenario 2, Riff may recognize revenue when it determines the patient is insured.
In scenario 3, Riff may recognize revenue when it determines the patient is insured.
So, Riff may recognize $11,000 of revenue, subject to the constraint that it must be
probable that a significant reversal will not be necessary. If that amount of
revenue is recognized, there is a 50% chance that a reversal will be required.
In scenario 4, Riff may recognize revenue once it comes to a financial agreement
with the patient. Until that time, Riff cannot assert that the other party to the
transaction intends to perform its obligations. Once the agreement is reached,
E3-4. Existence of a contract
Note: See the beginning of this chapter’s solutions for the criteria for existence of a
contract.
In scenario 1, Lemon has a contract with Morley that is subject to ASC Topic 606. In
Note the contrast in scenario 2. In this scenario, Lemon and Morley have formed a
joint venture because they have agreed that each will supply certain resources
E3-5. Principal vs. agent
The following are indicators that a firm is an agent, not a principal, to the transaction:
Another party has primary responsibility for fulfilling the contract terms.
The firm does not bear any inventory risk.
In scenario 1, Van Allen is an agent. In addition to being compensated through
commission, it is likely (because Van Allen is a broker) that it is not responsible
In scenario 2, Van Allen is again an agent. It is still compensated via commission
In scenario 3, Van Allen is a principal. Van Allen controls pricing and bears inventory
E3-6. Deposits
Requirement 1:
At this point, there is no contract subject to ASC Topic 606 and no revenue may be
recognized, so Pogrund records a Customer deposit:
Requirement 2:
At this point, there is a contract subject to ASC Topic 606, but Pogrund has not yet
transferred any goods or services to the customer, so it may not recognize any
revenue. The additional deposit increases the Customer deposit liability.
Requirement 3:
The contract has been terminated and Pogrund is entitled to retain the deposit with
no further obligations to David. It may now recognize revenue:
E3-7. Warranties
Requirement 1:
The standard warranty is not a separate performance obligation because it clearly is
intended to assure the equipment was defect free at the time of sale. So,
Kruger recognizes revenue in the amount of the sale.
In addition to recording cost of goods sold (DR Cost of goods sold; CR Inventory),
Kruger recognizes Warranty expense in the same period as Sales revenue:
Requirement 2:
The extended warranty is a separate performance obligation because it provides
goods and services beyond assuring the equipment is defect free at the time of
the sale. The total consideration must be allocated to the two performance
obligations. The revenue related to the sale of the equipment is recognized
Given that the equipment and the extended warranty have standalone prices of
$50,000 and $3,000, respectively, and assuming the total consideration
Again Kruger records cost of goods sold (DR Cost of goods sold; CR Inventory) and
also Warranty expense for the standard warranty.
E3-8. Contract modification
From the facts given, it is clear that the second transaction was negotiated
separately from the first and therefore the increment to the contract price
E3-9. Contract modification
From the facts given, the additional goods are distinct, but the increment to the
transaction price is not commensurate with the standalone price of the
additional goods. Therefore, the original contact is considered cancelled and
E3-10. Volume discount and variable consideration
A volume discount creates variable consideration when there is uncertainty about
the likelihood the volume discount will be taken. Revenue should be recognized
Requirement 1:
At the end of the first quarter, Glick assesses the likelihood Newman will reach the
volume discount threshold. The assessment is that Newman is very unlikely to
reach that threshold. So, the most likely outcome is that ultimately Glick will be
Requirement 2:
At the end of the second quarter, Glick reassesses the likelihood Newman will reach
the volume discount threshold. The new assessment is that Newman is very
likely to reach that threshold. So, the most likely outcome is that ultimately Glick
will be entitled to collect (from sales to Newman to date) (1,200 + 4,500) x $30
x 90% = $153,900 from Newman. Glick records $153,900 – $36,000 =
E3-11. Revenue recognition at a point in time or over time
In scenario 1, revenue recognition should be over time. The service is transferred to
In scenario 2, Kleymenova is creating an asset that has no alternative use and has
In scenario 3, the consulting work improves or enhances the collection system,
In scenario 4, none of the three criteria that result in revenue recognition over time
are met. The client does not receive and consume the services over time. The
client does not control an asset that is being improved. The asset Kleymenova
E3-12. Allocation of transaction price and revenue recognition
Gerakos allocates 2/3 ($60,000/$90,000) of the $80,000 transaction price, or
$53,333, to the software and 1/3 ($30,000/$90,000) of the $80,000 transaction
price, or $26,667 to the technical support. All the revenue allocated to the
So, total revenue in 2019 is $53,333 + ($26,667 x 1/3) = $62,222. Revenue in 2020
E3-13. Allocation of transaction price and revenue recognition
Gerakos allocates $60,000 of the $80,000 transaction price to the software and the
residual of $20,000 to the technical support. All the revenue allocated to the
software is recognized when it is sold, which is in 2019. The revenue allocated
So, total revenue in 2019 is $60,000 + ($20,000 x 1/3) = $66,667. Revenue in 2020
E3-14. Allocation of transaction price and revenue recognition
Gerakos allocates $30,000 of the $80,000 transaction price to the technical support
and the residual of $50,000 to the software. All the revenue allocated to the
So, total revenue in 2019 is $50,000 + (30,000 x 1/3) = $60,000. Revenue in 2020 is
E3-15. Allocation of transaction price and revenue recognition
Requirement 1:
First Ginzel must assess whether there the data extraction is a distinct performance
obligation. To be distinct, goods or services must be of benefit to the customer
separately. The data extraction is not separately beneficial. The purpose of
Therefore, there is a single performance obligation consisting of the marketing
reports, and the performance obligation is satisfied over time as each report is
delivered. Therefore, the $110,000 transaction price is all associated with the
Requirement 2:
Costs to fulfill a contract should be capitalized and then recognized in the income
statement in a pattern that is consistent with the pattern in which revenue is
E3-16. Determining liability for unperformed obligation under ASC Topic 606
As of December 31, 2019, Jerry’s has a liability for unperformed obligations for the
E3-17. Determining liability for unperformed obligation under ASC Topic 606
Initially, Regal records a $250,000 liability for the gift certificates. It expects $250,000
x 10% + $25,000 of breakage, which may be recognized as revenue in
proportion to the redemption of the gift certificates. As of December 31, 2019,
The entries for the gift certificate activity for the year are:
The liability reported in the December 31, 2019 balance sheet is $250,000 –
$200,000 – $22,222 = $27,778.
E3-18. Determining when to recognize revenue
Requirement 1:
Bullseye entered into a contract calling for the sale of 250,000 gallons of fuel. There
is one performance obligation, but the obligation is being satisfied over time
Note also that it would be equivalent for Bullseye to treat each gallon as one of
250,000 separate performance obligations (or, for that matter, each half gallon
Requirement 2:
Bullseye recognizes revenue over time, with the proportion of fuel transferred as the
best measure of the extent to which the customer has benefited. The
E3-19. Breakage
For each $105 club purchase, Cassidy has 5 possible oil changes that may be
redeemed. Each is a performance obligation, and the transaction price is
allocated in proportion to the standalone values of the performance obligations.
Cassidy may also recognize breakage revenue and reduce its liability in proportion
to the actual redemptions. For each club purchase, Cassidy expects 4.5 of the
Therefore, with each oil change, Cassidy recognizes revenue of $21 + $2.33 =
$23.33.
Suppose, for example, Cassidy sells 100 club memberships and, as expected, 450
of the 500 possible oil changes are redeemed. Cassidy receives cash of $105 x