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E3-20. Breakage
The following analysis shows the amount of breakage revenue Ashley recognizes in
each year.
At the end of 2019, Ashley estimates that $300 of gift cards will not be redeemed.
Gift card redemptions to date have totaled $12,000 out of the $30,000 – $300 =
At the end of 2020, a similar analysis is done, but on cumulative amounts and based
on a revised estimate of breakage. Total breakage revenue that may be
Requirement 2:
The following is an analysis of the amount of gift card liability to be reported at each
balance sheet date:
E3-21. Allocating the transaction price
The bike and the tune-ups are separate performance obligations. Under the residual
E3-22. Allocating the transaction price
The bike and the tune-ups are separate performance obligations. The standalone
Financial Reporting and Analysis (7th Edition)
Chapter 3 Solutions
Revenue Recognition
Problems
Problems
P3-1. Determining royalty revenue
(AICPA adapted)
Revenue recognition does not depend on when cash is collected. Royalty
revenue should be recognized as goods are transferred to the customer.
Royalties to be recognized in 2019 are as follows:
P3-2. Revenue recognition over time and at a point in time under ASC Topic 606
Requirement 1:
At the end of 2019, the project is 1/3 complete in terms of costs incurred ($8
million out of a current estimate of $24 million (8+16) in total costs). Given the
assumption that costs incurred measures the extent to which the performance
Requirement 2:
If revenue is measured at a point in time (i.e. upon completion of the project
Requirement 3:
Cornwell must evaluate the contract and determine whether any of the
following criteria are met:
The customer simultaneously receives and consumes the goods and
services as the performance obligation is satisfied.
Given the information provided, it is unlikely that either of the first two criteria
would be met. Cornwell is providing new construction, so the customer is
unlikely to be able to benefit from partial completion. Further, the customer
probably does not control the asset during the construction process. The third
criterion allows firms to recognize revenue over time even when the customer
P3-3. Revenue recognition over time and at a point in time under ASC Topic 606
(AICPA adapted)
Requirement 1:
Revenue recognition over time
Year 2019
CR Construction revenue
$350,000
Revenue earned during the period: ($290,000/$435,000) x $525,000 = $350,000
Year 2020
CR Construction revenue
$175,000
Revenue earned during the period: ($440,000/$440,000) x $525,000 - $350,000
= $175,000
DR Billings on contract
$ 525,000
CR Cash, payables, materials, etc. $290,000
Because the project is incomplete, no revenue is recognized for the year
2019.
Year 2020
A comparison of amounts recognized under each method:
Recognition over time Recognition at a point in
time
Total 2019 2020 2019 2020
P3-4. Combining multiple contracts
Requirement 1:
Teuvo must combine the two contracts and treat them as a single contract
because they were entered into around the same time and serve a single
Requirement 2:
Teuvo now identifies the performance obligations. There are two performance
obligations: the goods from Contract A and the goods from Contract B. These
performance obligations have standalone selling prices of $85,000 and
Requirement 3:
Revenue should be recognized for each of the performance obligations when
P3-5. Combining multiple contracts
Requirement 1:
Panarin must combine the two contracts and treat them as a single contract
Requirement 2:
Panarin now identifies the performance obligations. There are two performance
obligations: the goods from Contract A and the goods from Contract B. These
Requirement 3:
Revenue should be recognized for each of the performance obligations when
P3-6. Multiple performance obligations
Requirement 1:
Quenneville must allocate the $500,000 transaction price to the two
the service contract and the remainder, or $410,000, to the equipment. (This
approach is appropriate if the price of the equipment is highly variable.) In
Requirement 2:
Quenneville expenses the $300,000 cost to manufacture the equipment,
resulting in earnings before taxes (EBT) related to the equipment of $500,000 –
$300,000 = $200,000. For the service contract, Quenneville expenses
P3-7. Warranty; Revenue recognition over time
Requirement 1:
Ladd first determines the standalone price of the extended warranty to be
$10,000 x 140% = $14,000. Then Ladd applies the residual approach. It
Requirements 2 and 3:
Revenue on the extended warranty must be recognized over time, as the
customer obtains the benefits. Further, the pattern of revenue recognition
should reflect the transfer of benefits to the customer, which is not necessarily
The following analysis determines the amount of warranty revenue Ladd should
recognize in Year 1 and Year 2. The analysis determines for each year the
Ladd recognizes $420 of revenue in Year 1, resulting in Year 1 profit on the
warranty in of $420 – $300 = $120. In Year 2, revenue is $1,348 for profit of
$1,348 – $900 = $448. Note that revenue is more than proportionally greater in
Year 2 than Year 1. Although costs incurred were three times as great in Year 2
as Year 1, revenue was about 3.2 times greater ($1,348/$420), because it also
P3-8. Significant financing component
Requirement 1:
This transaction involves a significant financing component, with Zahava
providing its customer (Ari) with financing. The present value of Ari’s payments
Requirement 2:
Requirement 3:
In 2021, Zahava accrues additional interest income on the note. At the beginning
These two entries could be combined into a single entry with a credit to Notes
receivable of $571,429.
P3-9. Significant financing component
Requirement 1:
This transaction involves a significant financing component, with the customer
(Ari) providing Zahava with financing. The future value of Ari’s payments as of
Requirement 2:
5% = $30,000).
Requirement 3:
In 2021, Zahava accrues additional interest expense on the contract liability. At
the beginning of the year, the balance was $600,000 + $30,000 = $630,000, so
interest expense in 2021 is $630,000 x 5% = $31,500, bringing the contract
liabilty balance to $661,500. Combined with the $100,000 to be paid on
December 31, 2021, the total is the $761,500 to be recognized as sales revenue.
These two entries could be combined into a single entry with a debit to Contract
liability of $630,000.
P3-10. Principal vs. agent
Requirement 1:
OAC is clearly an agent, not a principal. Every one of the indicators provided in
ASC Topic 606 that an entity is an agent are present: OAC does not have
Requirement 2:
Altering the legal form of the transaction does not change the underlying
economics. All of the indicators, which relate to the underlying economics, not the
bear inventory risk. It does not control pricing of goods. Although legally
