Intermediate Accounting, 8/e 5–1
Chapter 5 Revenue Recognition and Profitability Analysis
QUESTIONS FOR REVIEW OF KEY TOPICS
Question 5–1
The five key steps in applying the core revenue recognition principle are:
2. Identify the performance obligation(s) in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the performance obligations.
5. Recognize revenue when (or as) each performance obligation is satisfied.
Question 5–2
A performance obligation is satisfied at a single point in time when control is
transferred to the buyer at a single point in time. This often occurs at delivery. Five
key indicators are used to decide whether control of a good or service has passed
from the seller to the buyer. The customer is more likely to control a good or service
if the customer has:
1. An obligation to pay the seller.
3. Physical possession of the asset.
4. Assumed the risks and rewards of ownership.
5. Accepted the asset.
Management should evaluate these indicators individually and in combination to
decide whether control has been transferred.
Question 5–3
A performance obligation is satisfied over time if at least one of the following
three criteria is met:
1. The customer consumes the benefit of the seller’s work as it is performed,
3. The seller is creating an asset that has no alternative use to the seller, and
the seller can receive payment for its progress even if the customer
cancels the contract.
Answers to Questions (continued)
Question 5–4
Services typically qualify for revenue recognition over time because the customer
consumes the benefit of the seller’s work as it is performed. However, for
convenience, even if the service qualifies for recognition of revenue over time, the
Question 5–5
Sellers account for a promise to provide a good or service as a performance
obligation if the good or service is distinct from other goods and services in the
1. Capable of being distinct. The customer could use the good or service on its
2. Separately identifiable from other goods or services in the contract. The good
Answers to Questions (continued)
Question 5–6
If an arrangement has multiple performance obligations, the seller allocates the
Question 5–7
A contract specifies the legal rights and obligations of the seller and the customer.
For a contract to exist for purposes of revenue recognition, it must:
2. Be approved by both the seller and the customer, indicating commitment to
fulfilling their obligations,
4. Specify payment terms.
5. Be probable that the seller will collect the amount it is entitled to receive.
We normally think of a contract as being specified in a written document, but
Question 5–8
If a seller grants a customer the option to acquire additional goods or services,
that option gives rise to a performance obligation only if the option provides a
Answers to Questions (continued)
Question 5–9
Variable consideration is included in the contract’s transaction price when the
Question 5–10
A seller is constrained to recognize only the amount of revenue for which the
Question 5–11
A right to return unsatisfactory merchandise is not a performance obligation.
Rather, it represents a potential inability to satisfy the original performance
Answers to Questions (continued)
Question 5–12
A principal has primary responsibility for delivering a product or service and
Question 5–13
In general, the “time value of money” refers to the fact that money to be received
in the future is less valuable than the same amount of money received now. If you
have the money now, you can invest it to earn a return so the money can grow to a
Question 5–14
If a seller purchases distinct goods or services from their customer and pays more
than fair value for those goods or services, the excess payments are viewed as a
Answers to Questions (continued)
Question 5–15
1. Adjusted market assessment approach: Under this approach, the seller
estimates what it could sell the product or services for in the market in which it
2. Expected cost plus margin approach: Under this approach, the seller estimates
the performance obligation.
3. Residual approach: Under this approach, the seller subtracts from the total
Question 5–16
Some licenses transfer a right to use the seller’s intellectual property as it exists
when the license is granted. For these licenses, subsequent activity by the seller
Answers to Questions (continued)
Question 5–17
In franchise arrangements, the franchisor typically has multiple performance
obligations. The franchisor grants to the franchisee a right to sell the franchisor’s
Question 5–18
A bill–and–hold arrangement exists when a customer purchases goods but requests
that the seller not ship the product until a later date. The key indicator of whether
Answers to Questions (continued)
Question 5–19
Sometimes a company arranges for another company to sell its product under
consignment. The “consignor” physically transfers the goods to the other company
Question 5–20
Sometimes companies receive non–refundable prepayments from customers for
Question 5–21
Question 5–22
If the customer makes payment to the seller before the seller has satisfied
performance obligations, the seller records a contract liability. If the seller satisfies a
Intermediate Accounting, 8/e 5–9
Answers to Questions (continued)
Question 5–23
If a long-term contract qualifies for revenue recognition over time, the seller
Question 5–24
The billings on construction contract account is a contra account to the
Question 5–25
Question 5–26
Receivables turnover ratio = Net sales
Average accounts receivable (net)
Answers to Questions (continued)
Question 5–27
Profit margin on sales = Net income
Net sales
Question 5–28
Return on equity
=
Profit margin
X
Asset turnover
X
Equity multiplier
Question 5–29
The realization principle requires that two criteria be satisfied before revenue
can be recognized:
1. The earnings process is judged to be complete or virtually complete.
Question 5–30
At the time production is completed, there usually exists significant uncertainty
Question 5–31
If the installment sale creates a situation where there is significant uncertainty
Question 5–32
The installment sales method recognizes gross profit by applying the gross
Question 5–33
Deferred gross profit is a contra installment receivable account. The balance in
APPENDIX QUESTIONS FOR REVIEW OF KEY
TOPICS
Answers to Questions (continued)
Question 5–34
The completed contract method recognizes revenue, cost of construction, and
gross profit at the end of the contract, after the contract has been completed. The cost
Question 5–35
This guidance requires that if an arrangement includes multiple elements, the
Question 5–36
IFRS has less specific guidance for recognizing revenue for multiple–
Intermediate Accounting, 8/e 5–13
Answers to Questions (concluded)
Question 5–37
Specific guidelines for revenue recognition of the initial franchise fee are
provided by FASB ASC 952–605–25–1. A key to these guidelines is the concept
BRIEF EXERCISES
Brief Exercise 5–1
In 2016 Apache has transferred the land, and the construction company has an
obligation to pay Apache. Apache’s performance obligation has been satisfied, and
Brief Exercise 5–2
A performance obligation is satisfied over time if at least one of the following
three criteria is met:
2. The customer controls the asset as it is created, or
3. The seller is creating an asset that has no alternative use to the seller, and the
seller can receive payment for its progress even if the customer cancels the
Intermediate Accounting, 8/e 5–15
Brief Exercise 5–3
This contract qualifies for revenue recognition over time, because the
performance obligation (to provide technology consulting services upon request) is
consumed by the customer as the seller’s work is performed. Therefore, Varga
should recognize revenue of $4,000 ($6,000 × 8/12 months) in 2016.
Journal entries (not required):
May 1, 2016
Cash 6,000
Brief Exercise 5–4
Based on relative stand-alone selling prices, the software comprises 70% of the
total fair values ($70,000 ÷ [$30,000 + 70,000]), and the technical support comprises
30% ($30,000 ÷ [$30,000 + 70,000]). Therefore, Sarjit would recognize
Brief Exercise 5–5
Number of performance obligations in the contract: 1.
Access to eLean services is one performance obligation. Registration on the
website is not a performance obligation, but rather is part of the activity eLean must
Intermediate Accounting, 8/e 5–17
Brief Exercise 5–6
Number of performance obligations in the contract: 1.
We need to consider three aspects of the vacuum contract: delivery of the
vacuum, the one-year quality-assurance warranty, and the option to purchase the
three-year extended warranty. Delivery of the vacuum cleaner is a performance
Brief Exercise 5–7
Number of performance obligations in the contract: 2.
We need to consider three aspects of the vacuum contract: delivery of the
vacuum, the one-year quality-assurance warranty, and the option to purchase the
three-year extended warranty. Delivery of the vacuum cleaner is a performance
obligation. The one-year warranty that is included as part of the purchase (the
Brief Exercise 5–8
Number of performance obligations in the contract: 2.
In addition to the subscription, the renewal option is a performance obligation
Brief Exercise 5-9
Number of performance obligations in the contract: 1.
Brief Exercise 5-10
Number of performance obligations in the contract: 1.
Intermediate Accounting, 8/e 5–19
Brief Exercise 5-11
Number of performance obligations in the contract: 1.
A right of return is not a performance obligation. Instead, the right of return
represents a potential failure to satisfy the original performance obligation to deliver
Brief Exercise 5–12
The expected value would be calculated as follows:
Possible Amounts Probabilities Expected Amounts
$35,000 ($25,000 fixed fee + 10,000 bonus) × 50% = $17,500
Brief Exercise 5-13
When a contract includes variable consideration, sellers are constrained to
recognize only the amount of revenue they believe is probable that they won’t have
Brief Exercise 5–14
Finerly should recognize $0 of revenue upon delivery to distributors. Given the
Brief Exercise 5–15
Amazon will recognize revenue of $150, its commission on the sale. In this