18–81
CA 18-4
(a) Income results from economic activity in which one entity furnishes goods or services to another.
To warrant revenue recognition, the earnings process must be substantially complete and there
must be a change in net assets that is capable of being objectively measured. Normally, this
involves an arm’s-length exchange transaction with a party external to the entity. The existence
and terms of the transaction may be defined by operation of law, by established trade practice, or
may be stipulated in a contract.
As a practical consideration, there must be a reasonable degree of certainty in measuring the
amount of revenue. Problems of measurement may arise in estimating the degree of completion
of a contract, the net realizable value of a receivable, or the value of a nonmonetary asset
received in an exchange transaction. In some cases, while the revenue may be readily measured,
it may be impossible to reasonably estimate the related expenses. In such instances, revenue
recognition must be deferred until the matching process can be completed.
be to recognize the revenue from the never–to–be-redeemed credits on a passage–of–time basis.
The principal expense, merchandise premium costs, should be matched with the revenue. If all
revenue is recognized when credits are sold, an accrual of the cost of the future premium
redemptions would be necessary. In such a case, when credit redemptions and related premium
issuances occurred, the costs of the premiums would be charged to the accrued liability account.
On the other hand, if credit sales were treated as an advance, the deferred revenue would be
recognized and the matching cost of the premiums issued would be recognized with the revenue
at the time of redemption.
18–82
CA 18-4 (Continued)
a premium, the types of customers who receive credits, and the ease of exchanging credits for
premiums will all affect the proportion of credits actually redeemed in relation to the potential
redemptions. The difference between the five percent initial estimate and the actual proportion of
unredeemed credits affects the accrual of a liability for redemption of credits issued under the
first method and the rate of transfer of revenue from the advances account under the second and
third methods.
(c) Under all of the alternatives, Griseta & Dubel’s major asset (in terms of data given in the question)
would be its inventory of premiums. The major account with a credit balance would be either an
estimated liability for cost of redeeming the outstanding credits under the first alternative or an
advance (deferred revenue) account under the second and third alternatives. In view of the
nature of the operation, the inventory account(s) would be included in the current asset classifica-
tion and the liability would be classified as current. The advances would be reported preferably
as a current liability.
CA 18-5
(a) Receipts based on subscriptions should be credited to unearned revenue. As each monthly issue
is distributed, the unearned revenue is reduced (Dr.) and earned revenue is recognized (Cr.).
A problem results because of the unqualified guarantee for a full refund. Certain companies
experience such a high rate of returns to sales that they find it necessary to postpone revenue
recognition until the return privilege has substantially expired. Cutting Edge is expecting a 25% return
rate and it will not expire until the new subscriptions expire. GAAP requires that transactions
should not be recognized currently as revenue unless all of the following conditions are met:
1. The seller’s price to the buyer is substantially fixed or determinable at the date of sale.
2. The buyer has paid the seller, or the buyer is obligated to pay the seller, and the obligation
Cutting Edge has met all of the above conditions. Consequently, revenue should be recognized
as each issue is distributed.
CA 18-5 (Continued)
This is necessary because the expense recognition principle requires that the expected return be
recognized at the same time revenue is recognized. The account entitled Sales Returns and
Allowances is a contra-revenue account. There is some controversy, however, over how the Allowance
for Sales Returns and Allowances is classified. As long as subscribers pay in cash, the
(c) Since the atlas premium may be accepted whenever requested, it is necessary for Cutting Edge
to record a liability for estimated premium claims outstanding. According to GAAP, the estimated
premium claims outstanding is a contingent liability which should be reported since it can be
readily estimated [60% of the new subscribers X (cost of atlas – $2)] and its occurrence is
probable. As the new subscription is obtained, Cutting Edge should record the estimated liability
as follows:
(d) The current ratio (Current Assets/Current Liabilities) will change, but not in the direction Embry
thinks. As subscriptions are obtained, current assets (cash or accounts receivable) will increase
and current liabilities (unearned revenue) will increase by the same amount. In addition, the
liabilities for estimated premium claims outstanding and the allowance for estimated sales returns
will increase with no change in current assets. Consequently, the current ratio will decrease
rather than increase as proposed. Naturally as the revenue is earned, these ratios will become
more favorable. Similarly, the debt to equity ratio will not be decreased due to the increase in
liabilities.
CA 18-6
(a) Widjaja Company should recognize revenue as it performs the work on the contract (the
percentage-of-completion method) because the right to revenue is established and collectibility is
reasonably assured. Furthermore, the use of the percentage-of-completion method avoids distor-
tion of income from period to period and provides for better recognition of expenses with the
related revenues.
18–84
CA 18-6 (Continued)
(c) The income recognized in the second year of the four-year contract would be determined using
the cost-to-cost method of determining percentage of completion as follows:
1. The estimated total income from the contract would be determined by deducting the estimated
total costs of the contract (the actual costs to date plus the estimated costs to complete) from
the contract price.
(d) Earnings per share in the second year of the four-year contract would be higher using the
percentage-of-completion method instead of the completed-contract method because income
would be recognized in the second year of the contract using the percentage-of-completion
method, whereas no income would be recognized in the second year of the contract using the
completed-contract method.
CA 18-7
(a) GAAP provides two criteria, both of which must be met; collectibility is assured and the seller is
not obligated to perform significant activities in the future. In this scenario, satisfaction of those
two criteria is questionable. First, the development is not completed; thus, the seller does have
significant activities to complete. If the developer fails to complete the development, it is very
reasonable to expect the buyers to stop making payment on their notes. In fact, they will probably
initiate legal proceedings (class action suit) against the seller. The seller does not receive cash at
the time of the “sale” and for all practical purposes is the holder of the notes.
(c) If the developer is financially sound and there is good reason to expect completion:
Notes Receivable………………………………………………………………………. 750,000
Sales Revenue (50 X $15,000) …………………………………………….. 750,000
Cost of Sales ……………………………………………………………………………. 150,000
Developed Land (50 X $3,000) …………………………..………………… 150,000
CA 18-7 (Continued)
CA 18-8
(a) 1. NHRC should recognize revenue on the following bases:
• The membership fees, which are paid in advance and sold with a money-back guarantee,
should be recognized as revenue over the life of the membership. Each month, NHRC
earns one-twelfth of the revenue. This results in a liability for the unearned and potentially
refundable portion of the fee. For those membership fees that are financed, interest is
recognized as time passes at the rate of 9 percent per annum.
period in which the sale is recorded.
(b) The Institute of Management Accountants structured its unofficial answer to this ethical question
around its “Standards of Ethical Conduct for Management Accountants” (Statement on Management
Accounting Number 1c):
• Competence
Bush has an obligation: (1) to perform his professional duties in accordance with relevant
technical standards and (2) to prepare complete and clear reports after appropriate analyses
of relevant and reliable information. Bush’s proposed changes to the financial statements
are not in accordance with generally accepted accounting principles and, therefore, will not
result in clear reports based on reliable information.
CA 18-8 (Continued)
• Objectivity
Bush’s proposals do not communicate information fairly and objectively nor will they disclose
all relevant information that could reasonably be expected to influence an intended user’s
understanding of the financial statements.
(c) Joyce Kiley may wish to speak to Bush again regarding the GAAP violations to ensure that she
understands his position. In order to resolve the situation, Kiley should follow the policies
established by NHRC for the resolution of ethical conflicts. If the company does not have such
a policy or the policy does not resolve the conflict, Kiley should consider the following course
of action:
1. Since her immediate supervisor is involved in the situation, Kiley should take the issue to the
next higher managerial level. Kiley need not inform Bush of this step because of his
involvement.
CA 18-9
(a) Honesty and integrity of financial reporting versus higher corporate profits are the ethical issues.
Nies’s position represents GAAP. The financial statements should be presented fairly and that
will not be the case if Avery’s approach is followed. External users of the statements such as
investors and creditors, both current and future, will be misled.
*CA 18-10
(a) Two primary criteria must be met before revenue is recognized: (1) the related earnings process
must be substantially completed (the revenue must be earned), and (2) there must be objective
evidence of the market value of the output—this often is interpreted to require that an exchange
has taken place—and is usually referred to as realization (often stated as realized or realizable).
18–87
*CA 18-10 (Continued)
or
1.
Cash …………………………………………………………
20,000
20,000
Notes Receivable ……………………………………….
100,000
75,816
or
2.
Cash …………………………………………………………
20,000
20,000
Notes Receivable ……………………………………….
100,000
75,816
Discount on Notes Receivable …………………
24,184
Unearned Franchise Fees ………………………
95,816
or
3.
Cash …………………………………………………………
20,000
20,000
Notes Receivable ……………………………………….
100,000
75,816
Discount on Notes Receivable …………………
24,184
Revenue from Franchise Fees …………………
20,000
20,000
Unearned Franchise Fees ………………………
75,816
75,816
4.
Cash …………………………………………………………
20,000
Revenue from Franchise Fees …………………
20,000
5.
Cash …………………………………………………………
20,000
Unearned Franchise Fees ………………………
20,000
The assumption underlying this procedure is that either the down payment is refundable or
Revenue from Franchise Fees …………………
95,816
95,816
18–88
*CA 18-10 (Continued)
6. Three additional alternatives would parallel the first three alternatives given above, except
that the notes would be reported at their face value. These alternatives would be appropriate
in situations where the notes bear interest or call for the payment of interest at the going rate.
(b) Because the initial cash collection of $20,000 must be refunded if the franchise fails to open, it is
not fully earned until the franchisee begins operations. Thus, Amigos Burrito should record the
initial franchise fee as follows:
When the franchisee begins operations, the $20,000 would be earned and the following entry
should be made:
Unearned Franchise Fee ……………………………….
20,000
Revenue from Franchise Fees …………………
20,000
or
Cash …………………………………………………………..
20,000
20,000
Notes Receivable ………………………………………….
100,000
75,816
Discount on Notes Receivable …………………
24,184
Unearned Franchise Fees ……………………….
75,816
75,816
(or Advances by Franchisees)
Revenue from Franchise Fees …………………
20,000
20,000
The notes receivable are properly recorded at their present value. No more than $75,816, the net
present value of the notes, should be reported as an asset. Interest at 10% should be accrued
each year by a debit to Discount on Notes Receivable (or Notes Receivable) and a credit to
Interest Revenue. Collections are recorded as debits to Cash and credits to Notes Receivable.
Each year as the services are rendered, an appropriate amount would be transferred from
Unearned Franchise Fees to Revenue from Franchise Fees. Since these annual payments are
not refundable, the Revenue from Franchise Fees might be recognized at the time the $20,000 is
collected, but this may result in the mismatching of costs and revenues.
or
Cash …………………………………………………………..
20,000
20,000
Notes Receivable ………………………………………….
100,000
75,816
Discount on Notes Receivable …………………
24,184
Unearned Franchise Fees ……………………….
95,816
95,816
(or Advances by Franchisees)
18–89
*CA 18-10 (Continued)
Second, it must wait until the end of each of the next five years so that it may collect each of the
$20,000 notes. Since collection has not been a problem, and since the advice may consist
largely of manuals and periodical service tip flyers, it could be maintained that a substantial
portion of the $75,816, the present value of the notes, should be recognized as revenue when a
The monthly fee of 2% of sales should be recorded as revenue at the end of each month. This
fee is for current services rendered and should be recognized as the services are performed.
(c) If the rental portion of the initial franchise fee, $20,000, represents the present value of monthly
rentals over a ten-year period, it should be recorded as Unearned Lease Revenue to be
recognized on an actuarially sound basis over the periods benefiting from the use of the leased
assets. This type of transaction does not necessarily represent a sale of the equipment and
immediate recognition of the entire rental as revenue may not be appropriate.
If the transaction could be considered to be a sale of equipment, the entire rental revenue of
$20,000 should be recognized immediately upon delivery of the equipment.
18–90
(a) 2009 Sales: $79,029 million.
(b) P&G’s revenues decreased from $81,748 million to $79,029 million
from 2008 to 2009, or 3.4%. Revenues increased from $74,832 million
to $81,748 million from 2007 to 2008, or 9.2%. Revenues increased
from $55.3 billion in 2005 to $79.0 billion in 2009—a 42.9% increase.
(d) Trade promotions, consisting primarily of customer pricing allowances,
merchandising funds and consumer coupons, are offered through
various programs to customers and consumers. Sales are recorded
net of trade promotion spending, which is recognized as incurred,
generally at the time of the sale. Most of these arrangements have
terms of approximately one year. Accruals for expected payouts under
these programs are included as accrued marketing and promotion in
the accrued and other liabilities line item in the Consolidated Balance
Sheets.
18–91
COMPARATIVE ANALYSIS CASE
(a) For the year 2009, Coca-Cola reported net operating revenues of
$30.990 billion and PepsiCo reported net revenue of $43.232 billion.
0.04% from 2008 to 2009.
(b) Revenue Recognition Policies
Coca-Cola provided the following revenue recognition note:
Our Company recognizes revenue when persuasive evidence of an
arrangement exists, delivery of products has occurred, the sales
Our customers can earn certain incentives including, but not
limited to, cash discounts, funds for promotional and marketing
activities, volume-based incentive programs and support for
infrastructure programs. The costs associated with these incentives
are included in deductions from revenue, a component of net
18–92
COMPARATIVE ANALYSIS CASE (Continued)
PepsiCo’s Revenue Recognition note is as follows:
We recognize revenue upon shipment or delivery to our customers
in accordance with written sales terms that do not allow for a right
of return. However, our policy for DSD and certain chilled products
The policies are similar but Coca-Cola does not discuss it policies with
respect to returns on direct store deliveries. This is likely due to the
company’s extensive equity bottling investees. That is, the direct store
deliveries are made by the bottlers, not by Coca-Cola.
FINANCIAL STATEMENT ANALYSIS CASE
WESTINGHOUSE ELECTRIC CORPORATION
(a) For product sales, Westinghouse Electric Corporation uses the date of
delivery, point of sale, basis for revenue recognition. For services ren-
(b) Point of sale or date of delivery is acceptable in ordinary product sale
transactions where the seller’s earning process is virtually complete,
no further obligations or costs remain, and the exchange transaction
has taken place (title passes).
For service transactions revenue is recognized as earned and realizable,
which is when services are rendered to the satisfaction of the customer
and become billable.
The percentage–of-completion method of revenue recognition is accept-
able on long-term projects, usually construction contracts exceeding
one year in length. Its application is required if the following conditions
exist:
1. A firm contract price with a high probability of collection exists.
can be made intermittently.
(c) WFSI is probably a wholly owned finance subsidiary of Westinghouse
that provides financing for customers of Westinghouse. The character
of the revenue being recognized by WFSI is interest revenue on notes