Spiceland 10e CH 06 SM

Chapter 6 Revenue Recognition
QUESTIONS FOR REVIEW OF KEY TOPICS

Question 6–1
The five key steps in applying the core revenue recognition principle are:
1. Identify the contract with a customer.
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 6–2
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.
2. Legal title to the asset.
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 6–3
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,
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 contract.
Solutions Manual, Vol.1, Chapter 6 6–1
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Answers to Questions (continued)
Question 6–4
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
seller might wait to recognize revenue until the service has been completed because
it is more convenient to account for it that way. For example, if a service is
delivered over days or even weeks, the seller might just wait to recognize revenue
until delivery is complete rather than bothering with a more precise recognition of
revenue over time. This departure from GAAP is appropriate only if the amount of
revenue recognized under the departure is not materially different from the amount
of revenue that would be recognized if revenue was recognized over time.
Question 6–5
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
contract. The idea is to separate contracts into parts that can be viewed on a stand-
alone basis. That way the financial statements can better reflect the timing of the
transfer of separate goods and services and the profit earned on each one.
Performance obligations that are not distinct are combined and treated as a single
performance obligation.
A performance obligation is distinct if it is both:
1. Capable of being distinct. The customer could use the good or service on its
own or in combination with other goods and services it could obtain
elsewhere, and
2. Separately identifiable from other goods or services in the contract. The good
or service is not highly interrelated with other goods and services in the
contract.
6–2 Intermediate Accounting, 10/e

Question 6–6
If an arrangement has multiple performance obligations, the seller allocates the
transaction price in proportion to the stand-alone selling prices of the goods or
services underlying those performance obligations. If the seller can’t observe actual
stand-alone selling prices, the seller should estimate them.
Question 6–7
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:
1. Have commercial substance, affecting the risk, timing or amount of the seller’s future cash flows,
2. Be approved by both the seller and the customer, indicating commitment to fulfilling their obligations,
3. Specify the seller and customer’s rights regarding the goods or services to be transferred, and
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

contracts can be oral rather than written. Contracts also can be implicit based on the
typical business practices that a company follows. The key is that, implicitly or
explicitly, the arrangement be substantive and specify the legal rights and
obligations of a seller and a customer.
Question 6–8
Under U.S. GAAP, “probable” is defined as “likely to occur” or as “reasonably
be expected or believed on the basis of available evidence or logic but is neither
certain nor proved,” which implies a relatively high likelihood of occurrence. Under
IFRS “probable” is defined as a likelihood that is greater than 50%, which is lower
than the definition in U.S. GAAP. Therefore, some contracts might not meet this
threshold under U.S. GAAP that do meet it under IFRS.

Question 6–9
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
material right to the customer that the customer would not receive without entering
into the contract. If the option provides a material right, the customer in effect pays
the seller in advance for future goods or services, and the seller recognizes revenue
when those future goods or services are transferred or when the option expires.
Question 6–10
Variable consideration is included in the contract’s transaction price when the
seller believes it is probable that it won’t have to reverse (adjust downward) a
significant amount of revenue in the future because of a change in that variable
consideration. The seller estimates the variable consideration as either the expected
value or the most likely amount to be received, and includes that amount in the
contract’s transaction price.
Question 6–11
A seller is constrained to recognize only the amount of revenue for which the
seller believes it is probable that a significant amount of revenue won’t have to be
reversed (adjusted downward) in the future because of a change in that variable
consideration. Indicators that variable consideration should be constrained include
limited other evidence on which to base an estimate, dependence of the variable
consideration on factors outside the seller’s control, and a long delay between when
the estimate must be made and when the uncertainty is resolved.

Question 6–12
A right to return merchandise is not a performance obligation. Rather, it
represents a potential failure to satisfy the original performance obligation. We view
a right of return as a particular type of variable consideration. A seller usually can
estimate the returns that will result for a given volume of sales based on past
experience. Accordingly, the seller usually recognizes revenue upon delivery, but
then reduces revenue by the estimated returns. The seller reports net sales revenue in
the income statement, and also reports a refund liability in the balance sheet for any
additional amounts it expects to refund to customers who make returns.
However, if the seller lacks sufficient information to be able to accurately
estimate returns, the constraint on variable consideration applies, and the seller
should recognize revenue only to the extent it is probable that a significant revenue
reversal will not occur later if the estimate of returns changes. The seller might
instead postpone recognizing any revenue until the uncertainty about returns is
resolved.
Question 6–13
A principal has primary responsibility for delivering a product or service and
obtains control of the goods or services before they are transferred to the customer.
A principal recognizes as revenue the amount received from a customer. An agent
doesn’t primarily deliver goods or services, but acts as a facilitator that earns a
commission for helping sellers to transact with buyers, and recognizes as revenue
only the commission it receives for facilitating the sale.
Question 6–14
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
larger amount in the future.
If payment occurs either before or after delivery, conceptually the arrangement
includes a financing component. Prepayments include an element of interest
expense (the seller is borrowing from the buyer between payment and delivery),

while receivables include an element of interest revenue (the buyer is borrowing
from the seller between payment and delivery). When delivery and payment occur
relatively near each other, the financing component is not significant and can be
ignored. As a practical matter, sellers can assume the financing component is not
significant if the period between delivery and payment is less than a year.

Question 6–15
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
refund of part of the price of the goods and services that the customer purchased
from the seller. The excess payments are subtracted from the amount the seller is
entitled to receive from the customer when calculating the transaction price of the
sale to the customer.
Question 6–16
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
normally sells products. The seller likely would consider prices charged by
competitors for similar products.
2. Expected cost plus margin approach: Under this approach, the seller estimates
its costs of satisfying the performance obligation and then adds an appropriate
profit margin to determine the revenue it would anticipate receiving for satisfying
the performance obligation.
3. Residual approach: Under this approach, the seller subtracts from the total
transaction price the sum of the known or estimated stand-alone selling prices of
the other performance obligations that are included in the contract to arrive at an
estimate of an unknown or highly uncertain stand-alone selling price.

Question 6–17
For licenses of symbolic intellectual property (IP), like trademarks, logos, brand
names and franchise rights, sellers recognize revenue over time, because the license
provides the customer with the right of access to the seller’s IP with the
understanding that the seller will undertake ongoing activities during the license
period that benefit the customer.
For licenses of functional IP, sellers typically recognize revenue at the point in
time that the customer can first use the IP. Functional IP has significant standalone
functionality that is not affected by the seller’s ongoing activity. Examples include
software, drug formulas, and media content.
However, even for functional IP, sometimes sellers have to recognize revenue
over time, because the seller is expected to change the functionality over the license
period and the customer is required to use the updated version. In that case, even
though the license involves functional IP, we view the license as transferring a right
of access, and revenue must be recognized over the license period.
Question 6–18
In franchise arrangements, the franchisor typically has multiple performance
obligations. The franchisor grants to the franchisee a right to sell the franchisor’s
products and services and use its name for a specified period of time. The franchisor
also usually provides initial start-up services (such as identifying locations,
remodeling or constructing facilities, and selling equipment and training to the
franchisee). The franchisor also may provide ongoing products and services (such as
franchise-branded products and advertising and administrative services). So, a
franchise involves a license to use the franchisor’s intellectual property, but also
involves initial sales of products and services as well as ongoing sales of products
and services.

Question 6–19
A bill-and-hold arrangement exists when a customer purchases goods but requests
that the seller retain physical possession until a later date. The key indicator of
whether control has passed from the seller to the customer for bill-and-hold
arrangements is whether the customer has control of the asset. Since the customer
doesn’t have physical possession of the goods in a bill-and-hold arrangement, the
customer isn’t normally viewed as controlling the goods. However, if the customer
goods are specifically identified as the customer’s, and are ready for physical
transfer, and the seller can’t use the goods or sell them to another customer, then
revenue would be recognized despite the customer not having taken physical
possession of the goods.
Question 6–20
Under U.S. GAAP, intellectual property (IP) is categorized as either functional or
symbolic, and symbolic IP is viewed as providing an access right that requires
revenue recognition over time. IFRS does not require revenue recognition over time
for symbolic IP if the seller is not affecting the usefulness of the IP to the customer
during the license period.
Question 6–21
Sometimes a company arranges for another company to sell its product under
consignment. The “consignor” physically transfers the goods to the other company
(the consignee), but the consignor retains legal title. If the consignee can’t find a
buyer within an agreed-upon time, the consignee returns the goods to the consignor.
However, if a buyer is found, the consignee remits the selling price (less commission
and approved expenses) to the consignor.
Because the consignor retains the risks and rewards of ownership of the product
and title does not pass to the consignee, the consignor does not record revenue (and
related costs) until the consignee sells the goods and title passes to the eventual
customer.

Question 6–22
Sometimes companies receive non-refundable prepayments from customers for
some future good or service. That is what occurs when a company sells a gift card.
The seller does not recognize revenue at the time the gift card is sold to the
customer. Instead, the seller records a deferred revenue liability in anticipation of
recording revenue when the gift card is redeemed. If the gift card isn’t redeemed,
the seller recognizes revenue when it expires or when, based on past experience, the
seller has concluded that customers will not redeem it.
Question 6–23
Bad debt expense must be reported clearly either on its own line in the income
statement or in the notes to the financial statements.
Question 6–24
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 performance obligation before the customer has paid for it, the seller records either
a contract asset or a receivable. The seller recognizes an accounts receivable if the
seller has an unconditional right to receive payment, which is the case if only the
passage of time is required before the payment is due. If instead the seller satisfies a
performance obligation but its right to payment depends on something other than the
passage of time (for example, the seller satisfying other performance obligations),
the seller recognizes a contract asset.
Question 6–25
If a long-term contract qualifies for revenue recognition over time, the seller
recognizes a portion of the project’s expected revenues and costs to each period in
which construction occurs, according to the percentage of the project completed to
date. If the contract does not qualify for revenue recognition over time, the seller
recognizes revenue and costs when the project is complete.
Question 6–26
The billings on construction contract account is a contra account to the
construction in progress asset. At the end of each reporting period, the balances in
these two accounts are compared. If the net amount is a debit, it is reported in the
balance sheet as a contract asset. Conversely, if the net amount is a credit, it is
reported as a contract liability.

Question 6–27
An estimated loss on a long-term contract must be fully recognized in the first
period the loss becomes evident, regardless of the revenue recognition method used.

SUPPLEMENT QUESTIONS FOR REVIEW OF KEY TOPICS
Question 6–28
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.
2. There is reasonable certainty as to the collectibility of the asset to be
received (usually cash).
Question 6–29
At the time production is completed, there usually exists significant uncertainty
as to the collectibility of the asset to be received. We don’t know if the product will
be sold, nor the selling price, nor the buyer if eventually the product is sold. Because
of these uncertainties, revenue recognition usually is delayed until the point of
product delivery.
Question 6–30
If the installment sale creates a situation where there is significant uncertainty
concerning cash collection and it is not possible to make an accurate assessment of
future bad debts, revenue and cost recognition should be delayed beyond the point of
delivery.
Question 6–31
The installment sales method recognizes gross profit by applying the gross
profit percentage on the sale to the amount of cash actually received each period.
The cost recovery method defers all gross profit recognition until cash has been
received equal to the cost of the item sold.

Question 6–32
Deferred gross profit is a contra installment receivable account. The balance in
this account is subtracted from gross installment receivables to arrive at installment
receivables, net. The net amount of the receivables represents the portion of
remaining payments that represent cost recovery.
Question 6–33
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 recovery method will recognize an amount of revenue equal to the amount of
cost that can be recovered, which typically is an amount that exactly offsets costs
until all costs have been recovered, and then will recognize the remaining revenue
and gross profit. Therefore, revenue and cost are recognized earlier under the cost
recovery method than under the completed contract method, but gross profit
recognition is delayed until late in the contract for both approaches. Assuming that
the final costs are incurred just prior to completion of the contract, both approaches
should recognize gross profit at the same time.
Question 6–34
This guidance requires that if an arrangement includes multiple elements, the
revenue from the arrangement should be allocated to the various elements based on
the relative fair values of the individual elements. If part of an arrangement does not
qualify for separate accounting, revenue recognition is delayed until revenue is
recognized for the other parts.
Question 6–35
IFRS has less specific guidance for recognizing revenue for multiple-
deliverable arrangements. IAS No. 18 simply states that: “…in certain
circumstances, it is necessary to apply the recognition criteria to the separately
identifiable components of a single transaction in order to reflect the substance of
the transaction” and gives a couple of examples, whereas U.S. GAAP provides more
restrictive guidance concerning how to allocate revenue to various components and
when revenue from components can be recognized.

Answers to Questions (concluded)
Question 6–36
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
of substantial performance. It requires that substantially all of the initial services of
the franchisor required by the franchise agreement be performed before the initial
franchise fee can be recognized as revenue. The term “substantial” requires
professional judgment on the part of the accountant. In situations when the initial
franchise fee is collectible in installments, even after substantial performance has
occurred, the installment sales or cost recovery method should be used for profit
recognition, if a reasonable estimate of uncollectibility cannot be made.

BRIEF EXERCISES
Brief Exercise 6–1
In 2021 Apache has transferred the land, and the construction company has an
obligation to pay Apache. Apache’s performance obligation has been satisfied, and
revenue and a related account receivable of $3,000,000 can be recognized.
Under accrual accounting, revenue is recorded when goods or services are
transferred to customers (2021), not necessarily when cash changes hands in future
periods.

A performance obligation is satisfied over time if at least one of the following
three criteria is met:
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.
Under Estate’s construction agreement with CyberB, if for any reason

Estate can’t complete construction, CyberB would own the partially completed
building. Therefore, criterion 2 is satisfied, and revenue should be recognized as the
building is being constructed.

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 2021.
Journal entries (not required):
May 1, 2021
Cash 6,000
Deferred revenue 6,000
December 31, 2021 adjusting entry

Service revenue ($6,000 x 8/12) 4,000

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
$56,000 (equal to $80,000  70%) in revenue when the software is delivered and
defer the remaining $24,000 (equal to $80,000  30%) to be recognized evenly over
the next six months as the technical support service is provided.
$80,000
Transaction Price
70% 30%
$56,000 $24,000
Software Technical Support Service
The journal entry is recorded as follows:
Cash 80,000
Sales revenue (for software) 56,000
Deferred revenue (for tech support) 24,000
$0. Under U.S. GAAP, “probable” is defined as “likely to occur” or as

“reasonably expected or believed on the basis of available evidence or logic but is
neither certain nor proved,” which implies a relatively high likelihood of occurrence.
Therefore, this contract would not qualify for revenue recognition under U.S.
GAAP.

$100,000. Under IFRS “probable” is defined as a likelihood that is greater than

50%. Therefore, this contract would qualify for revenue recognition under IFRS.
(However, Tulane also would recognize a large bad debt expense associated with the
contract, given concern that it might not be paid.)

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
provide to satisfy its performance obligation of providing access to eLean’s on-line
services. The $50 payment is an upfront payment that is part of the total transaction
price associated with the service, and the monthly payments are the other
component.

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
quality-assurance warranty) is not a performance obligation, but rather is part of the
obligation to deliver a vacuum of appropriate quality. The option to purchase a
three-year extended warranty is not a performance obligation within the contract to
purchase a vacuum, because customers can purchase that warranty for the same
amount at other times, so the opportunity to buy it at the same time that they buy the
vacuum does not present a material right.

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
quality-assurance warranty) is not a performance obligation, but rather it is part of
the obligation to deliver a vacuum of appropriate quality. The option to purchase the
extended warranty, though, is a performance obligation within the contract to
purchase a vacuum. Customers can purchase that warranty at a 20% discount if they
do so when they buy the vacuum, so the opportunity to buy the extended warranty
constitutes a material right. Also, the option is capable of being distinct, as it could
be sold or provided separately, and it is separately identifiable, as the vacuum could
be sold without the option to purchase an extended warranty, so the option is
distinct, and qualifies as a performance obligation.

In addition to the subscription, the renewal option is a performance obligation

because it provides a material right that allows the customer to renew at a better
price than could be obtained without the right. The renewed protection is capable of
being distinct, as it could be sold or provided separately, and it is separately
identifiable, as the customer can use the renewed protection on its own. Therefore,
the renewed protection is distinct, and qualifies as a performance obligation.

Brief Exercise 6-11
The separate goods and services that Precision Equipment has agreed to provide
(equipment, customized software package, and consulting services) might be
capable of being distinct, but they are not separately identifiable. In the context of
the contract, the goods and services are highly dependent on and interrelated with
each other. The contractor’s role is to integrate and customize them to create one
automated assembly line.
Brief Exercise 6-12

Lego enters into a contract to design and construct a specific building. Each
smaller component of the construction contract, though capable of being distinct, is
not separately identifiable because each component is highly interrelated with each
other, and providing them to the customer requires the seller to integrate the
components into a combined item (garage).
Brief Exercise 6-13

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
goods to the customer. Because the total amount of cash received from the customer
depends on the amount of returns, a right of return is a type of variable
consideration.
Aria should estimate sales returns and reduce revenue by that amount in order to
arrive at “net revenue,” which would be the transaction price (the amount to be
recorded as revenue on the seller’s books). The total net revenue in this situation is
$280,233:
Revenue $288,900 ($90 × 3,210 units)
Sales returns 8,667 ($288,900 × 3%)
Net revenue $280,233

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
$25,000 ($25,000 fixed fee + $0 bonus) × 50% = 12,500
Expected contract price at inception $30,000
Or, alternatively:
$25,000 + ($10,000 × 50%) = $30,000
Brief Exercise 6-15

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
to reverse (adjust downward) in the future if the variable consideration changes. In
this case, factors outside the seller’s control (stock market volatility) make the
seller’s estimate of variable consideration very uncertain, so the amount of revenue
that Continental will recognize during the year is limited to the fixed annual
management fee, which is $1.5 million (1% of the client’s $150 million total assets
under management). Therefore, Continental would use $1.5 million as its estimate
of the transaction price. Any performance bonus earned by Continental will be
recognized as revenue if and when it is earned.

Finerly should recognize $0 of revenue upon delivery to distributors. Given the
uncertainty about estimated returns, Finerly can’t argue that it is probable that it
won’t have to reverse (adjust downward) a significant amount of revenue in the
future because of a change in returns. Therefore, Finerly won’t recognize revenue
until it either can better estimate returns or sales to end consumers occur.
Essentially, because Finerly can’t estimate returns, it treats this transaction as if it is
placing those goods on consignment with independent distributors.

Amazon will recognize revenue of $150, its commission on the sale. In this
transaction, Amazon never has primary responsibility for delivering a product or
service, and it is not vulnerable to risks associated with holding inventory or
delivering the product or service. Therefore, Amazon serves as an agent, and will
only recognize revenue on the transaction equal to the amount of the commission it
receives.

If payment occurs after delivery, conceptually the arrangement includes a
financing component. When the financing component is deemed to be significant,
receivables, like those of Wooten, we include an element of interest revenue (the
buyer is borrowing from the seller between payment and delivery). So, to determine
the component of the $10,000 that represents sales, we must remove the interest
component:
Sales revenue = present value of the amount to be paid on December 31, 2021
= $10,000 × 0.92593¥
= $9,259
¥ Present value of $1: n = 1, i = 8% (Table 2)

If payment occurs before delivery, conceptually the arrangement includes a
financing component. When the financing component is deemed to be significant,
prepayments, like those to Hodge, we include an element of interest revenue (the
buyer is borrowing from the seller between payment and delivery), So, to determine
the component of the $8,000 that represents sales we must remove the interest
component:
Sales revenue = present value of the amount to be paid on December 31, 2021
= $8,000 × 0.91743¥
= $7,339


If a seller is purchasing distinct goods or services from a customer at the fair value
of those goods or services, we account for that purchase as a separate transaction.
Otherwise, excess payments by the seller are treated as a refund of the customer’s
purchase. If the payments are made (or are expected to be made) at the time of the
original sale, the transaction price of the customer’s purchase is reduced
immediately by the refund. If payment is not expected at the time of the sale,
revenue is recorded based on the full transaction price, and any subsequent payment
by the seller above fair value results in a reduction of the transaction price at that
time.
There is no indication that Lewis’ payment to AdCo for $10,000, which is $2,500
more than the fair value of those services ($7,500), was expected at the time of the
original sale. Therefore, the original sale would be recorded based on the full
transaction price of $60,000. The overpayment of $2,500 reduces the $60,000
transaction price of the goods sold by Lewis to AdCo at the time the $10,000 is paid,
resulting in a downward adjustment of revenue of $2,500 at that time and net
revenue over the period of $60,000 – $2,500 = $57,500.

Under the adjusted market assessment approach, O’Hara would base its estimate
of the stand-alone selling price of the club-fitting services on the prices charged by
other vendors for those services, adjusted as necessary. Because O’Hara typically
charges 10% more than what other vendors charge, O’Hara would estimate the
stand-alone selling price of the club-fitting service to be $110 × 110% = $121.

Under the expected cost plus margin approach, O’Hara would base its estimate
of the stand-alone selling price of the club-fitting service on the $60 cost it incurs to
provide the services, plus its normal margin of $60 × 30% = $18. Therefore, O’Hara
would estimate the stand-alone selling price of the club-fitting services to be $60 +
$18 = $78.

Under the residual approach, O’Hara would base its estimate of the stand-alone
selling price of the club-fitting services on the total selling price of the contract
($1,500) minus the observable stand-alone selling price of clubs ($1,400).
Therefore, O’Hara would estimate the stand-alone selling price of the club-fitting
services to be $1,500 – $1,400 = $100.

The software is functional intellectual property and the license transfers a right
of use, since Saar’s activities during the license period (which for this software does
not have an end date) will not affect the value of the software to Kim. Therefore,
Saar can recognize the entire $100,000 upon transfer of the right. However, the
SAAR Associates name is symbolic intellectual property, so the license to use the
Saar name is an access right, with Saar’s ongoing activity affecting the benefit that
Kim receives, so Saar should recognize revenue as that access is consumed over 36
months. Since Kim uses the Saar name for four months in 2021 (September through
December), Saar should recognize revenue of 4 ÷ 36 = 1/9 of $90,000, or $10,000,
for that access right in 2021. In total, Saar recognizes revenue of $100,000 +
$10,000 = $110,000 in 2021.

$110,000. The software is functional intellectual property and the license
transfers a right of use, since Saar’s activities during the license period (which for
this software does not have an end date) will not affect the value of the software to
Kim. Therefore, Saar can recognize the entire $100,000 upon transfer of the right.
However, the Saar Associates name is symbolic intellectual property, so the license
to use the Saar name is an access right, with Saar’s ongoing activity affecting the
benefit that Kim receives, so Saar should recognize revenue as that access is
consumed over 36 months. Under U.S. GAAP it is not relevant that Saar will not
provide any services with respect to the access right over the license period – it only
matters that the license is classified as involving symbolic intellectual property.
Since Kim uses the Saar name for four months in 2021 (September through
December), Saar should recognize revenue of 4 ÷ 36 = 1/9 of $90,000, or $10,000,
for that access right in 2021. In total, Saar recognizes revenue of $100,000 +
$10,000 = $110,000 in 2021.
$190,000. The software is functional intellectual property and the license

transfers a right of use, since Saar’s activities during the license period (which for
this software does not have an end date) will not affect the value of the software to
Kim. Therefore, Saar can recognize the entire $100,000 upon transfer of the right.
The Saar Associates name would be classified as symbolic intellectual property
under U.S. GAAP, but under IFRS the focus is on whether the seller provides
benefit to the customer over the license period. Given that is not the case, Saar
would view this license as conveying a right of use, and could recognize $90,000 of
revenue for the license to use the Saar Associates name at the start of the license. In
total, Saar recognizes revenue of $100,000 + $90,000 = $190,000 in 2021.

Because Carlos had completed training and was open for business on August 1,
2021, TopChop apparently has satisfied its performance obligation with respect to
the initial training, equipment and furnishings, so it would recognize $50,000 of
revenue in 2021. In addition, since Carlos was a franchisee for the last six months of
2021, TopChop should recognize 6 ÷ 12 = 50% of a yearly fee of $30,000, or
$15,000. In total, TopChop recognizes revenue from Carlos of $50,000 + $15,000 =
$65,000 in 2021.

$0. Prior to delivery, Dowell maintains control of the inventory and should not
recognize revenue.

$250, equal to revenue for the sale of one painting. Kerianne has a
consignment arrangement with Holmstrom, so should not recognize transfer of
paintings to Holmstrom as sales. Kerianne would recognize Holmstrom’s
commission of $250 × 20% = $50 as an expense.

GoodBuy should not recognize revenue when it sells the $1,000,000 of gift
cards, because it has not yet satisfied its performance obligation to deliver goods
upon redemption of the cards. GoodBuy should recognize revenue of $840,000 for
redemptions, as well as $30,000 for gift cards that it estimates will never be
redeemed, totaling $870,000.

Contract asset: $0.
Contract liability: $2,000.
Accounts receivable: $0.
Holt has a contract liability, deferred revenue, of $2,000. It never has a contract
asset because it hasn’t satisfied a performance obligation for which payment
depends on something other than the passage of time. It does not have an accounts
receivable for the $3,000 until it delivers the furniture to Ramirez.

For long-term contracts, we view a company as having a contract asset if CIP >
Billings, so Cady has a contract asset for the first construction job of $6,000 (equal
to $20,000 CIP less $14,000 billings). For long-term contracts, we view a company
as having a contract liability if Billings > CIP, so Cady has a contract liability for the
second construction job of $2,000 (equal to $5,000 billings less $3,000 CIP).

Total estimated cost to complete = $6 million + $9 million = $15 million
% of completion = $6 million  $15 million = 40%
First year revenue = $20,000,000 x 40% = $8,000,000
First year gross profit = $8,000,000 – $6,000,000 = $2,000,000
Note: We can also determine first year gross profit as follows:

Total estimated gross profit ($20 million – $15 million) = $5,000,000
multiplied by the % of completion 40%
Gross profit recognized the first year $2,000,000

Assets:
Accounts receivable ($7 million – $5 million) $2,000,000
Cost plus profit ($6 million + $2 million*)
in excess of billings ($7 million) 1,000,000
* First year gross profit = $8,000,000 – $6,000,000 = $2,000,000

No revenue or gross profit recognized until project completed in year 2.
Year 2 revenue $20,000,000

Less: Costs in year 1 (6,000,000)
Costs in year 2 (10,000,000)
Year 2 gross profit $ 4,000,000

The anticipated loss of $3 million ($30 million contract price less total
estimated costs of $33 million) must be recognized in the first year applying either
method.

SUPPLEMENT BRIEF
EXERCISES
2021 Gross profit = $3,000,000 – $1,200,000 = $1,800,000
2021 Gross profit percentage = Gross profit  Sales:
$1,800,000
= 60%
$3,000,000
2021 gross profit = 2021 cash collection of $150,000 x 60% = $90,000

2022 gross profit = 2022 cash collection of $150,000 x 60% = $90,000

Initial deferred gross profit ($3,000,000 – $1,200,000) $1,800,000
Less gross profit recognized in 2021 ($150,000 x 60%) (90,000)
Less gross profit recognized in 2022 ($150,000 x 60%) (90,000)
Deferred gross profit at the end of 2022 $1,620,000

No gross profit will be recognized in either 2021 or 2022. Gross profit will not
be recognized until the entire $1,200,000 cost of the land is recovered. In this case, it
will take eight payments to recover the cost of the land ($1,200,000  $150,000 = 8),
so gross profit recognition will equal 100% of the cash collected beginning with the
ninth installment payment.

Year 1:
Revenue: $6 million
Cost: 6 million
Gross profit: $0
Year 2:
Revenue: $14 million ($20 million total – $6 million in year 1)
Cost: 10 million
Gross profit: $ 4 million

Orange has separate sales prices for the two parts of LearnIt-Plus, so that
vendor-specific objective evidence (VSOE) allows them to allocate revenue to those
parts according to their relative selling prices. LearnIt will be allocated $200 x [$150
÷ ($150 + $100)] = $120, and that revenue will be recognized upon delivery of the
LearnIt software. LearnIt Office Hours will be allocated $200 x [$100 ÷ ($150 +
$100)] = $80, and that revenue will be deferred and recognized over the life of the
one-year period in which the Office Hours are delivered.
If LearnIt were not sold separately, Orange would not have VSOE for all of the
parts of the contract. In that case, revenue would be delayed until the later part was
delivered. In this case, the $200 would be deferred and recognized over the life of
the one-year period in which the Office Hours are delivered.

Orange has separate sales prices for the two parts of LearnIt-Plus, so the
company can base its estimates of the fair value of those parts according to their
relative selling prices. LearnIt will be allocated $200 x [$150 ÷ ($150 + $100)] =
$120, and that revenue will be recognized upon delivery of the LearnIt software.
LearnIt Office Hours will be allocated $200 x [$100 ÷ ($150 + $100)] = $80, and
that revenue will be deferred and recognized over the life of the one-year period in
which the Office Hours are delivered.
If LearnIt were not sold separately, the accounting would be the same. Orange
would estimate the fair value of LearnIt Office Hours to be $100 and allocate
revenue in the same fashion as it did when that product was sold separately. (VSOE
is not required under IFRS).

Specific conditions for revenue recognition of the initial franchise fee are
provided by FASB ASC 952–605–25–1. A key to these conditions is the concept of
substantial performance. It requires that substantially all of the initial services of the
franchisor required by the franchise agreement be performed before the initial
franchise fee can be recognized as revenue. The term “substantial” requires
professional judgment on the part of the accountant. Often, substantial performance
is considered to have occurred when the franchise opens for business.
Continuing franchise fees are recognized over time as the services are
performed.

EXERCISES
Exercise 6–1
The FASB Accounting Standards Codification® represents the single source of
authoritative U.S. generally accepted accounting principles.
Requirement 1
Regarding the five steps used to apply the revenue recognition principle, the
appropriate citation is:
FASB ASC 606–10–05–04: “Revenue from Contracts with Customers–

Overall–Overview and Background–General.”
Requirement 2
Regarding indicators that control has passed from the seller to the buyer, such
that it is appropriate to recognize revenue at a point in time, the appropriate citation
is:

Overall––Recognition–Performance Obligations Satisfied at a Point in Time.”
Requirement 3
Regarding circumstances under which sellers can recognize revenue over time,
the appropriate citation is:

Overall––Recognition–Performance Obligations Satisfied Over Time.”

Exercise 6–2
Requirement 1
Ski West should recognize revenue over the ski season. Ski West fulfills its
performance obligation over time as it delivers the service to its pass holders by
providing access to its ski lifts.
Requirement 2
November 6, 2021 To record the cash collection.

Cash................................................................................ 450
Deferred revenue........................................................ 450
December 31, 2021 To recognize revenue earned in December (no

revenue earned in November, as season starts on December 1).
Deferred revenue ($450 x 1/5)............................................ 90
Service revenue........................................................... 90
Requirement 3
$90 is included in revenue in Ski West’s 2021 income statement. The $360
remaining balance in deferred revenue is included in the current liability section of
Ski West’s 2021 balance sheet.

Exercise 6–3
VP first must identify each performance obligation’s share of the sum of the
stand-alone selling prices of all performance obligations:
$1,700
TV: $1,700 + $100 + $200 = 85%
$100
Remote: $1,700 + $100 + $200 = 5%
$200
Installation: = 10%
$1,700 + $100 + $200
100%
VP would allocate the total selling price of the package ($1,900) based on stand-
alone selling prices, as follows:
TV: $1,900 × 85% = $1,615
Remote: $1,900 × 5% = 95
Installation: $1,900 × 10% = 190
$1,900
$1,900
Transaction Price
TV package
85% 5% 10%
$1,615 $95 $190

TV Remote Installation

Exercise 6–4
Requirement 1
Regarding the basis upon which a contract’s transaction price allocated to its
performance obligations, the appropriate citation is:
Overall–Measurement–Allocating the Transaction Price to Performance
Obligations.”
Requirement 2
Regarding indicators that a promised good or service is separately identifiable,
the appropriate citation is:
Overall–Recognition–Identifying Performance Obligations—Distinct Goods or
Services.”
Requirement 3
Regarding circumstances under which an option is viewed as a performance
obligation, the appropriate citation is:
Overall–Implementation Guidance and Illustrations–Customer Options for
Additional Goods or Services.”

Exercise 6-5
Requirement 1
Delivery of gold is one performance obligation. The additional insurance for

replacement of gold bars is a second performance obligation. The insurance service
is capable of being distinct because the bank could choose to receive similar services
from another insurance provider, and it is separately identifiable, as it is not highly
interrelated with the other performance obligation of delivering gold, and the seller’s
role is not to integrate and customize them to create one service or product. So, the
insurance qualifies as a performance obligation. The receipt of cash prior to delivery
is not a performance obligation, but rather gives rise to deferred revenue associated
with performance obligations to be satisfied in the future.
Requirement 2
Value of the gold bars:
$1,440/unit 100 units = $144,000
Stand-alone selling price of the insurance:
$60  100 units = 6,000
Total of stand-alone prices $150,000
Gold Examiner first identifies each performance obligation’s share of the sum of
the stand-alone selling prices of all deliverables:
$144,000
Gold bars delivered: $144,000 + $6,000 = 96%
$6,000
Insurance: = 4%
$144,000 + $6,000
100%

Exercise 6-5 (concluded)
Gold Examiner then allocates the total selling price based on stand-alone selling
prices, as follows:
$147,000
Transaction Price
Gold bars
96% 4%
$141,120 $5,880
Gold bars Insurance for
delivered replacement of gold bars
Entry on March 1, 2021:

Cash 147,000
Deferred revenue – insurance 5,880
Requirement 3
Entry on March 30, 2021:

Sales revenue 141,120
Gold Examiner recognizes only the portion of revenue associated with passing of
the legal title. The revenue associated with insurance coverage will be earned
only when that performance obligation is satisfied.
Requirement 4
Entry on April 1, 2021:
Deferred revenue – insurance 5,880
Service revenue 5,880

Exercise 6–6
Requirement 1
The delivery of SunBoots is one performance obligation. The option for discount
on additional future purchases is a second performance obligation because it
provides a material right to the customer that the customer would not receive
without the purchase of SunBoots. That material right to receive a discount is both
capable of being distinct, as it could be sold or provided separately, and it is
separately identifiable, as it is not highly interrelated with the other performance
obligation of delivering SunBoots, and the seller’s role is not to integrate and
customize them to create one product. So, the discount option represented by the
coupon is distinct and qualifies as a performance obligation.
Requirement 2
If Clarks can’t estimate the stand-alone selling price of SunBoots, it will use the
residual method to calculate that price as the amount of the total transaction price
minus the value of the discount.
Cash (1,000 x $70) 70,000

Sales revenue (to balance) 64,000
Deferred revenue – coupons (discount option) 6,000*
*(1,000 pairs  $100 average purchase price × 30% discount  20% of customers
estimated to redeem coupon)

Exercise 6–7
Requirement 1
The amount of revenue Manhattan Today should recognize upon receipt of the
subscription fee: $0.
Even though Manhattan Today received payments from customers for an annual
subscription, payment of the subscription activity does not transfer goods or services
to customers. Therefore, the annual fee is viewed as a prepayment for future delivery
of goods or services and would be recognized as deferred revenue – subscription (a
liability) when received. Later, when newspapers are delivered, deferred revenue –
subscription will be reduced and revenue recognized.
Requirement 2
Delivery of newspapers for one year is one performance obligation. The option
to receive a 40% discount on a carriage ride qualifies as a second performance
obligation. First, it is an option that conveys a material right to the recipient (as
opposed to just a general marketing offer). Second, it is both capable of being
distinct, as it could be sold or provided separately, and it is separately identifiable,
as it is not highly interrelated with the other performance obligation of delivering
newspapers, so the discount, as represented by the coupon, is distinct and qualifies
as a performance obligation. The seller’s role is not to integrate and customize them
to create one product. The seller will record deferred revenue – coupons for that
performance obligation and recognize revenue when either the coupons are
exercised or Manhattan Today estimates that they will not be redeemed.

Exercise 6–7 (concluded)
Requirement 3
Value of the coupon: 40% discount  $125 carriage fee = $ 50
Estimated redemption  30%
Stand-alone selling price of coupon $ 15
Stand-alone selling price of a normal subscription 135
Total of stand-alone prices $150
Manhattan Today must identify each performance obligation’s share of the sum
of the stand-alone selling prices of all deliverables:
$15
Coupon: $15 + $135 = 10%
$135
Subscription: = 90%
$15 + $135
100%
Manhattan Today allocates the total selling price based on stand-alone selling
prices, as follows:
$130
Transaction Price
New subscription
90% 10%
$117 $13
Delivery of subscription Discount on
newspapers carriage ride
Upon receiving the fee for 10 new subscriptions, the journal entry should be:
Cash ($130  10) 1,300

Deferred subscription revenue ($117  10) 1,170
Deferred revenue – coupons ($13  10) 130

Exercise 6-8
Requirement 1
Delivery of keyboards is one performance obligation. The option to receive a
special discount is a second performance obligation, as it provides a material right
that the customer would not receive had it not bought the keyboards. In this
particular instance, the customer has the right to receive a 25% discount for any
purchases in the next six months, which is a 20% discount in addition to the normal
5% discount offered to other customers. The option to receive the discount,
represented by the coupon, is both capable of being distinct, as it could be sold or
provided separately, and it is separately identifiable, as it is not highly interrelated
with the other performance obligation of delivering keyboards, and the seller’s role
is not to integrate and customize them to create one product. So, it is distinct and
qualifies as a performance obligation.
Requirement 2
When two or more performance obligations are associated with a single
transaction price, the transaction price must be allocated to the performance
obligations on the basis of respective stand-alone selling prices (estimated if not
directly available).
Meta’s estimated stand-alone selling price of the discount option is:
Value of the discount coupon:
(25% discount – 5% normal discount)  $20,000 = $ 4,000
Stand-alone selling price of discount coupon: $ 2,000
Stand-alone selling price of the keyboards:
$19.60  5,000 keyboards = 98,000

Exercise 6–8 (continued)
Meta first must identify each performance obligation’s share of the sum of the
stand-alone selling prices of all deliverables:
$2,000
Discount: $2,000 + $98,000 = 2%
$98,000
Keyboards: = 98%
$2,000 + $98,000
100%
Meta then allocates the total selling price based on stand-alone selling prices, as
follows:
$95,000
Transaction Price
Keyboards
98% 2%
$93,100 $1,900
Delivery of Discount on
keyboards future purchases
The journal entry to record the sale is:
Cash 95,000
Deferred revenue – coupons 1,900
The deferred revenue for the keyboards will become recognized as revenue on
June 1st.
The deferred revenue for the option to exercise the discount coupon is
recognized when the coupon either is exercised or expires in six months.

Requirement 3
All customers are eligible for a 5% discount on all sales. Therefore, the 5%
discount option issued to Bionics, Inc. does not give any material right to the
customer, so it is not a performance obligation in the contract, and Meta would
account for both (a) the delivery of keyboards and (b) the 5% coupon as a single
Cash 95,000

Exercise 6–9
Requirement 1
The expected value would be calculated as follows:

$70,000 ($50,000 fixed fee + $20,000 bonus) × 20% = $14,000
$50,000 ($50,000 fixed fee + $0 bonus) × 80% = 40,000
Expected contract price at inception $54,000
Or, alternatively: $50,000 + ($20,000 × 20%) = $54,000
Requirement 2
The most likely amount is the flat fee of $50,000, because there is a greater
chance of not qualifying for the bonus than of qualifying for the bonus, so that is the
transaction price.
Requirement 3
Because Thomas is very uncertain of its estimate, Thomas can’t argue that it is
probable that it won’t have to reverse (adjust downward) a significant amount of
revenue in the future because of a change in returns. Therefore, Thomas would not
include the bonus estimate in the transaction price, and the transaction price would
be the flat fee of $50,000.

Exercise 6-10
Requirement 1
During the July 1 – July 15 period, Rocky estimates a less than 50% chance it
will earn the bonus, so using the “most likely amount” approach, it assumes no
bonus, and estimates its revenue as $1,000 per day × 10 days = $10,000
Accounts receivable 10,000

Service revenue ($1,000 × 10 days) 10,000
Requirement 2
During the July 16 – July 31 period, Rocky earns guide revenue of another 15
days × $1,000 per day = $15,000. In addition, because Rocky estimates a greater
than 50% chance it will earn the bonus, using the “most likely amount” approach, it
estimates a bonus receivable of $100 per day × (10 days + 15 days) = $2,500.
Accounts receivable ($1,000 ×15 days) 15,000

Bonus receivable ($100 × 25 days) 2,500
Service revenue (to balance) 17,500
Requirement 3
On August 5, Rocky learns that it won’t receive a bonus, and receives only the
$25,000 balance in accounts receivable. Rocky must reduce its bonus receivable to
zero and record the offsetting adjustment in revenue.
Cash ($1,000 × 25 days) 25,000

Service revenue ($100 × 25 days) 2,500

Bonus receivable 2,500

Exercise 6-11
Requirement 1
Rocky’s normal guide revenue is 10 days × $1,000 per day = $10,000. Rocky
also estimates that there is a 30% chance it will earn the bonus, so its estimate of the
expected value of the bonus revenue earned to date is:

$1,000 ($100 bonus × 10 days) × 30% = $300
$0 ($0 bonus × 10 days) × 70% = -0-
Expected bonus as of July 15 $300
Or, alternatively: $100 × 10 days × 30% = $300.
Rocky’s July 15 journal entry would be:

Accounts receivable ($1,000 ×10 days) 10,000
Bonus receivable ($100 × 30% × 10 days) 300
Requirement 2
During the July 16 – July 31 period, Rocky earns another 15 days × $1,000/day
= $15,000 of its normal guiding revenue. In addition, because Rocky now believes
there is an 80% chance it will earn the bonus, its estimate of the expected value of
the bonus revenue earned to date (based on all 25 days guided during July) is:

$2,500 ($100 bonus × 25 days) × 80% = $2,000
$0 ($0 bonus × 25 days) × 20% = -0-
Expected bonus as of July 31 $2,000
Or, alternatively: $100 × 25 days × 80% = $2,000.

With $300 of bonus receivable and revenue already recognized, Rocky must
recognize an additional $2,000 – $300 = $1,700 of bonus receivable and bonus
revenue. Rocky’s July 31 journal entry would be:
Accounts receivable ($1,000 × 15 days) 15,000

Bonus receivable ([$100 × 80% × 25 days] – $300) 1,700
Service revenue (to balance) 16,700
Requirement 3
On August 5, Rocky learns that it won’t receive a bonus, and receives only the
$25,000 balance in accounts receivable. Rocky also must reduce its bonus
receivable to zero and record the offsetting adjustment in revenue.
Cash ($1,000 × 25) 25,000

Service revenue ($100 × 80% × 25 days) 2,000


Exercise 6–12
Requirement 1
If payment occurs after delivery, conceptually the arrangement includes a
financing component (the buyer is borrowing from the seller between payment and
delivery). Therefore, when the financing component is deemed to be significant, the
seller must account for interest revenue. To determine the component of the
$40,000 that represents sales revenue, we must remove the interest component:
January 1, 2021:
Notes receivable (given) 40,000
Discount on notes receivable (to balance) 2,963
Sales revenue (calculated below) 37,037
Revenue = present value of the amount to be paid on December 31, 2021

= $40,000 × 0.92593¥
= $37,037
Requirement 2
December 31, 2021:
Cash (given) 40,000
Discount on notes receivable (from requirement 1) 2,963
Interest revenue (to balance) 2,963
Requirement 3
January 1, 2021:
Discount on notes receivable (to balance) 5,706
Sales revenue (calculated below) 34,294
Revenue = present value of the amount to be paid on December 31, 2022

= $40,000 × 0.85734¥
= $34,294
Requirement 4
If the financing component is deemed to be insignificant, we can ignore the
interest component:
January 1, 2021:

Exercise 6–13
Requirement 1
January 1, 2021:
If payment occurs before delivery, conceptually the arrangement includes a
financing component (the seller is borrowing from the buyer between payment and
delivery). Therefore, when the financing component is deemed to be significant, the
seller must account for interest expense. However, at the time the prepayment
occurs, the entire amount received is viewed as deferred revenue:
Cash (calculated below) 37,037

Deferred revenue (to balance) 37,037
Deferred revenue = amount received on January 1, 2021 = present value of

the fair value of the goods to be delivered on December 31, 2021
= $40,000 × 0.92593¥
= $37,037
Requirement 2
December 31, 2021:
Interest expense ($37,037 × 8% ) 2,963
Deferred revenue (from requirement 1) 37,037
Sales revenue (given) 40,000
Requirement 3
January 1, 2021:
Cash (calculated below) 34,294
Deferred revenue = amount received on January 1, 2021 = present value of

the fair value of the goods to be delivered on December 31, 2022
= $40,000 × 0.85734¥
= $34,294

Requirement 4
If the financing component is deemed to be insignificant, we can ignore the
interest component:
January 1, 2021:
Cash (from requirement 1) 37,037

Exercise 6–14
Requirement 1
Record revenue upon sale:
Requirement 2
Because the advertising services have a fair value ($5,000) that is less than the
amount paid by Furtastic to Willett ($12,000), the remaining amount ($7,000) is
viewed as a refund, reducing revenue by that amount.
Advertising expense 5,000

Sales revenue 7,000
Cash 12,000
Requirement 3
Record receipt of cash:
Cash 150,000
Requirement 4
It is probable that Willett will pay Furtastic, so the relatively low likelihood of
bad debts does not affect Furtastic’s recognition of revenue on the Willet sale. If
Furtastic had considered it less than probable that it would collect its receivable from
Willet, it would not have a contract on June 1 for purposes of revenue recognition,
and would not recognize revenue until payment actually occurred on June 30.

Exercise 6–15
Requirement 1
Under the adjusted market assessment approach, VP would base its estimate of
the stand-alone selling price of the installation service on the prices charged by other
vendors for that service, adjusted as necessary. Given that the other vendors are
similar to VP, no adjustment is necessary. Therefore, VP would estimate the stand-
alone selling price of the installation service to be $150, the amount charged by
competitors for that service.
Requirement 2
Under the expected cost plus margin approach, VP would base its estimate of the
stand-alone selling price of the installation service on the $100 cost it incurs to
provide the service, plus its normal margin of 40% × $100 = $40. Therefore, VP
would estimate the stand-alone selling price of the installation service to be $100 +
$40 = $140.
Requirement 3
Under the residual approach, VP would base its estimate of the stand-alone
selling price of the installation service on the total selling price of the package
($1,900) less the observable stand-alone selling prices of the TV ($1,750) and
universal remote ($100). Therefore, VP would estimate the stand-alone selling price
of the installation service to be $1,900 – ($1,750 + $100) = $50.

Exercise 6–16
Requirement 1
Regarding the alternative approaches that can be used to estimate variable
consideration, the appropriate citation is:
Overall–Measurement–Variable Consideration.”
Requirement 2
Regarding the alternative approaches that can be used to estimate the stand-
alone selling price of performance obligations that are not sold separately, the
Overall–Measurement–Allocation Based on Standalone Selling Prices.”
Requirement 3
Regarding the timing of revenue recognition with respect to licenses, the
Overall–Implementation Guidance and Illustrations–Determining the Nature of
the Entity’s Promise.”
Requirement 4
Regarding indicators for assessing whether a seller is a principal, the
Overall–Implementation Guidance and Illustrations–Principal versus Agent
Considerations.”

Exercise 6–17
Requirement 1
Total amount of franchise agreement $600,000
Less: stand-alone selling price of training (15,000)
Less: stand-alone selling price of building and equip. (450,000)
Stand-alone selling price of five-year right $135,000
Requirement 2
As of July 1, 2021, Monitor has not fulfilled any of its performance obligations,
so the entire $600,000 franchise fee is recorded as deferred revenue.
Cash 75,000
Notes receivable 525,000
Requirement 3
On September 1, 2021, Monitor has satisfied its performance obligations with
respect to training and certifying Perkins and delivering an equipped Monitor
Muffler building. Therefore, Monitor should recognize revenue of $15,000 +
$450,000 = $465,000 on that date. In addition, by December 31, 2021, Monitor
should recognize 4 months of revenue (September – December) associated with the
five-year right it granted to Perkins, so Monitor should recognize revenue of
$135,000 × (4 ÷ (5 × 12)) = $9,000 associated with that right. Total revenue
recognized for the year ended December 31, 2021, is $465,000 + $9,000 = $474,000.

Exercise 6–18
Requirement 1
Regarding disclosures that are required with respect to performance obligations
that the seller is committed to satisfying but that are not yet satisfied, the appropriate
citation is:
Overall–Disclosure–Performance Obligations.”
Requirement 2
Regarding disclosures that are required with respect to uncollectible accounts
receivable, also called impairment losses on receivables, the appropriate citation is:
FASB ASC 606–10–50–4: “Revenue from Contracts with Customers–Overall–
Disclosure–Contracts with Customers.”
Requirement 3
Regarding disclosures that are required with respect to contract assets and
contract liabilities, the appropriate citation is:
Overall–Disclosure–Contract Balances.”

Exercise 6–19
Requirement 1
2021 2022
Contract price $2,000,000 $2,000,000
Actual costs to date 300,000 1,875,000
Estimated costs to complete 1,200,000 -0-
Total estimated costs 1,500,000 1,875,000
Gross profit (estimated in 2021) $ 500,000 $ 125,000
Revenue recognition:
2021: $ 300,000
= 20% × $2,000,000 = $400,000
$1,500,000
2022: $2,000,000 – $400,000 = $1,600,000
Gross profit recognition:
2021: $400,000 – $300,000 = $100,000
2022: $1,600,000 – $1,575,000 = $25,000
Note: We also can calculate gross profit directly using the percentage of
completion:
2021: $ 300,000
= 20% × $500,000 = $100,000
$1,500,000
2022: $125,000 – $100,000 = $25,000
Requirement 2
2021: $0 (contract not yet completed)
2022: $2,000,000 – $1,875,000 = $125,000

Requirement 3
Balance Sheet
At December 31, 2021
Current assets:
Accounts receivable $ 130,000
Costs and profit ($400,000*) in excess
of billings ($380,000) 20,000
* Costs ($300,000) + profit ($100,000)
Requirement 4
Balance Sheet
Current assets:
Current liabilities:
Billings ($380,000) in excess of costs and profit $ 80,000
($300,000)

Exercise 6–20
Requirement 1
($ in millions) 2021 2022 2023
Contract price $220 $220 $220
Actual costs to date 40 120 170
Estimated costs to complete 120 60 -0-
Total estimated costs 160 180 170
Estimated gross profit (actual in 2023) $ 60 $ 40 $ 50
2021: $40
= 25% × $220 = $55
$160
2022: $120
= (66.67% × $220) – $55 = $91.67
$180
2023: $220 – ($55 + $91.67) = $73.33
Gross profit (loss) recognition:

2021: $55 – $40 = $15
2022: $91.67 – $80 = $11.67
2023: $73.33 – $50 = $23.33
Note: We also can calculate gross profit directly using the percentage of
completion:
2021: $40
= 25% × $60 = $15
$160
2022: $120
= 66.67% × $40 = $26.67 – $15 = $11.67
$180
2023: $220 – $170 – ($15 + $11.67) = $23.33

Requirement 2
Year Revenue Gross profit (loss)

recognized recognized
2021 -0- -0-
2022 -0- -0-
2023 $220 $50
Requirement 3
2022 Revenue recognition:

$120
= (60% × $220) – $55 = $77
$200
2022 Gross profit (loss) recognition:

$77 – $80 = $(3)
Note: Also can calculate gross profit directly using the percentage of
completion:
$120
= 60% × $20* = $12 – $15 = $(3) loss
$200
*$220 – ($40 + $80 + $80) = $20

Exercise 6–21
Requirement 1
2021 2022 2023
Contract price $8,000,000 $8,000,000 $8,000,000
Actual costs to date 2,000,000 4,500,000 8,300,000
Estimated costs to complete 4,000,000 3,600,000 -0-
8,300,000
Estimated gross profit (loss)
(actual in 2023) $2,000,000 $ (100,000) $ (300,000)
2021: $2,000,000
= 33.3333% × $8,000,000 = $2,666,667
$6,000,000
2022: $4,500,000
= (55.5556% × $8,000,000) – $2,666,667 = $1,777,778
$8,100,000
2023: $8,000,000 – ($2,666,667 + $1,777,778) = $3,555,555
2021: $2,666,667 – $2,000,000 = $666,667
2022: $(100,000) – $666,667 = $(766,667)
2023: $(300,000) – $(100,000) = $(200,000)

Requirement 2
2021 2022
Construction in progress 2,000,000 2,500,000
Various accounts 2,000,000 2,500,000
To record construction costs
Accounts receivable 2,500,000 2,750,000

Billings on construction contract 2,500,000 2,750,000
To record progress billings
Cash 2,250,000 2,475,000

To record cash collections
Construction in progress 666,667

Cost of construction 2,000,000
Revenue from long-term contracts 2,666,667
To record gross profit
Cost of construction (1) 2,544,445

Revenue from long-term contracts 1,777,778
To record expected loss
(1) Revenue recognized in 2022 $1,777,778

Plus: Loss recognized in 2022 (from previous page) 766,667
Cost of construction, 2022 $2,544,445

Requirement 3
2021 2022
Balance Sheet
Current assets:
Accounts receivable $250,000 $525,000
Costs and profit ($2,666,667*) in
excess of billings ($2,500,000) 166,667
Billings ($5,250,000) in excess
of costs less loss ($4,400,000**) $850,000
* Costs ($2,000,000) + profit ($666,667)

** Costs ($2,000,000 + $2,500,000) – loss ($100,000 = $766,667 – $666,667)

Exercise 6–22
Requirement 1
2021 -0- -0-
2022 -0- $(100,000)
2023 $8,000,000 (200,000)
Total $8,000,000 $(300,000)
Requirement 2
2021 2022
Construction in progress 2,000,000 2,500,000
Various accounts 2,000,000 2,500,000

Billings on construction contract 2,500,000 2,750,000
Cash 2,250,000 2,475,000

Loss on long-term contract 100,000

To record expected loss

Requirement 3
Balance Sheet 2021 2022

Current assets:
Accounts receivable $250,000 $525,000
Billings ($2,500,000) in excess of costs
($2,000,000) $500,000
Billings ($5,250,000) in excess of costs less

loss ($4,400,000*) $850,000
* Costs ($2,000,000 + $2,500,000) – loss ($100,000)
Note: Billings in excess of costs is a contract liability, similar to deferred

profit.

Exercise 6–23
SUMMARY
Gr. Profit Recognized Over Time Gr. Profit Recognized Upon
Completion
Situation 2021 2022 2023 2021 2022 2023
1 $166,667 $233,333 $100,000 $0 $0 $500,000
2 $166,667 $(66,667) $100,000 $0 $0 $200,000
3 $166,667 $(266,667) $(100,000 $0 $(100,000) $(100,000)
)
4 $125,000 $375,000 $0 $0 $0 $500,000
5 $125,000 $(125,000) $200,000 $0 $0 $200,000
6 $(100,000) $(100,000) $(100,000 $(100,000) $(100,000) $(100,000)
)
Situation 1 - Revenue Recognized Over Time
2021 2022 2023
Contract price $5,000,000 $5,000,000 $5,000,000
Estimated costs to complete 3,000,000 900,000 -0-
Total estimated costs 4,500,000 4,500,000 4,500,000
Estimated gross profit
(actual in 2023) $ 500,000 $ 500,000 $ 500,000
Gross profit (loss) recognized:
2021:
Revenue = $1,500,000
= 33.3333% × $5,000,000 = $1,666,667
$4,500,000
Gross Profit = 1,666,667 – $1,500,000 = $166,667
Note: We can calculate gross profit directly as
$1,500,000
= 33.3333% × $500,000 = $166,667
$4,500,000
2022:
Revenue = $3,600,000
= 80.0% × $5,000,000 = $4,000,000 – $1,666,667
$4,500,000 = $2,333,333
Gross Profit = 2,333,333 – $2,100,000 = $233,333

Note: We can calculate gross profit directly as:
$3,600,000
= 80.0% × $500,000 = $400,000 – $166,667 = $233,333
$4,500,000
2023:
Revenue = $5,000,000 – $4,000,000 = $1,000,000
Gross Profit = $1,000,000 – $900,000 = $100,000
Situation 1 - Revenue Recognized Upon Completion
Year Gross profit recognized

2021 -0-
2022 -0-
2023 $500,000
Total gross profit $500,000
2021 2022 2023

Contract price $5,000,000 $5,000,000 $5,000,000
(actual in 2023) $ 500,000 $ 200,000 $ 200,000

2021:
Revenue = $1,500,000
= 33.3333% × $5,000,000 = $1,666,667
$4,500,000
Gross Profit = $1,666,667 – $1,500,000 = $166,667
Note: We can calculate gross profit directly as
$1,500,000
= 33.3333% × $500,000 = $166,667
$4,500,000
2022:
Revenue = $2,400,000
= 50.0% × $5,000,000 = $2,500,000 – $1,666,667
$4,800,000
= $833,333
Gross Profit = $833,333 – $900,000 = $(66,667)
Note: We can calculate gross profit directly as:

$2,400,000
= 50.0% × $200,000 = $100,000 – $166,667 = $(66,667)
$4,800,000
2023:
Revenue = $5,000,000 – $2,500,000 = $2,500,000
Gross Profit = $2,500,000 – $2,400,000 = $100,000
2021 -0-
2022 -0-
2023 $200,000

2021 2022 2023
Contract price $5,000,000 $5,000,000 $5,000,000
(actual in 2023) $ 500,000 $ (100,000) $ (200,000)
2021:
Revenue = $1,500,000
= 33.3333% × $5,000,000 = $1,666,667
$4,500,000
Gross Profit = $1,666,667 – $1,500,000 = $166,667
Note: can calculate gross profit directly as
$1,500,000
= 33.3333% × $500,000 = $166,667
$4,500,000
2022:
Overall loss of $5,000,000 – $5,100,000 = $(100,000)
Gross profit = $(100,000) – $166,667 = $(266,667)
2023:
Overall loss of $5,000,000 – $5,200,000 = $(200,000)
Gross profit = $(200,000) – $(100,000) = $(100,000)

Year Gross profit (loss) recognized
2021 -0-
2022 $(100,000)
2023 (100,000)
Total project loss $(200,000)

2021 2022 2023
Contract price $5,000,000 $5,000,000 $5,000,000
Actual costs to date 500,000 3,500,000 4,500,000
Estimated costs to complete 3,500,000 875,000 -0-
(actual in 2023) $1,000,000 $ 625,000 $ 500,000
2021:
Revenue = $ 500,000
= 12.5% × $5,000,000 = $625,000
$4,000,000
Gross Profit = $625,000 – $500,000 = $125,000
$500,000
= 12.5% × $1,000,000 = $125,000
$4,000,000
2022:
Revenue = $3,500,000
= 80% × $5,000,000 = $4,000,000 – $625,000
$4,375,000 = $3,375,000
Gross Profit = $3,375,000 – $3,000,000 = $375,000

$3,500,000
= 80.0% × $625,000 = $500,000 – $125,000 = $375,000
$4,375,000
2023:
Revenue = $5,000,000 – $4,000,000 = $1,000,000
Gross Profit = $1,000,000 – $1,000,000 = $ - 0 –

2021 -0-
2022 -0-
2023 $500,000

2021 2022 2023
Contract price $5,000,000 $5,000,000 $5,000,000
(actual in 2023) $1,000,000 $ -0- $
200,000

2021:
Revenue = $ 500,000
= 12.5% × $5,000,000 = $625,000
$4,000,000
Gross Profit = $625,000 – $500,000 = $125,000
$500,000
= 12.5% × $1,000,000 = $125,000
$4,000,000
2022: $0 – $125,000 = $(125,000)
2023: $200,000 – 0 = $200,000

2021 -0-
2022 -0-
2023 $200,000

2021 2022 2023
Contract price $5,000,000 $5,000,000 $5,000,000
Estimated costs to complete 4,600,000 1,700,000 - 0 -
(actual in 2023) $ (100,000) $ (200,000) $ (300,000)
2021: $(100,000)
2022: $(200,000) – $(100,000) = $(100,000)
2023: $(300,000) – $(200,000) = $(100,000)

2021 $(100,000)
2022 (100,000)
2023 (100,000)

Exercise 6–24
Requirement 1
Construction in progress = Costs incurred + Profit recognized
$100,000 = ? + $20,000
Actual costs incurred in 2021 = $80,000
Requirement 2
Billings = Cash collections + Accounts receivable
$94,000 = ? + $30,000
Cash collections in 2021 = $64,000
Requirement 3
Let A = Actual cost incurred + Estimated cost to complete
Actual cost incurred

× (Contract price – A) = Profit recognized
A
$80,000
($1,600,000 – A) = $20,000
A
$128,000,000,000 – $80,000A = $20,000A
$100,000A = $128,000,000,000
A = $1,280,000
Estimated cost to complete = $1,280,000 – $80,000 = $1,200,000

Requirement 4
$80,000
= 6.25%
$1,280,000
Alternatively, Requirement 4 can be answered as follows:

Contract price $1,600,000
Less: Total estimated cost 1,280,000
Estimated gross profit $ 320,000
Proportion of gross profit recognized to date:

$20,000
= 6.25%
$320,000

SUPPLEMENT EXERCISES
Exercise 6–25
Requirement 1
2021 cost recovery %:
$234,000
= 65% (gross profit % = 35%)
$360,000
$245,000
= 70% (gross profit % = 30%)
$350,000
2021 gross profit:

Cash collection from 2021 sales of $150,000 x 35% = $52,500
2022 gross profit:

Cash collection from 2021 sales of $100,000 x 35% = $35,000
+ Cash collection from 2022 sales of $120,000 x 30% = 36,000
Total 2022 gross profit $71,000

Requirement 2
2021 deferred gross profit balance:
2021 initial gross profit ($360,000 – $234,000) $126,000
Less: Gross profit recognized in 2021 (52,500)
Balance in deferred gross profit account $ 73,500
2022 deferred gross profit balance:

2021 initial gross profit ($360,000 – $234,000) $126,000
Gross profit recognized in 2022 (35,000)
2022 initial gross profit ($350,000 – $245,000) 105,000

Balance in deferred gross profit account $107,500

Exercise 6–26
2021
Installment receivables................................................... 360,000
Inventory..................................................................... 234,000
Deferred gross profit................................................... 126,000
To record installment sales
2021
Cash................................................................................ 150,000
Installment receivables............................................... 150,000
To record cash collections from installment sales
2021
Deferred gross profit....................................................... 52,500
Realized gross profit................................................... 52,500
To recognize gross profit from installment sales
2022
Inventory..................................................................... 245,000
2022
Cash................................................................................ 220,000
2022

Exercise 6–27
Requirement 1
Year Income recognized
2021 $180,000 ($300,000 – $120,000)
2022 -0-
2023 -0-
2024 -0-
Total $180,000
Requirement 2
Cost recovery %:
$120,000
------------- = 40% (gross profit % = 60%)
$300,000
Year Cash Collected Cost Recovery(40%) Gross Profit(60%)

2021 $ 75,000 $ 30,000 $ 45,000
2022 75,000 30,000 45,000
2023 75,000 30,000 45,000
2024 75,000 30,000 45,000
Totals $300,000 $120,000 $180,000
Requirement 3
Year Cash Collected Cost Recovery Gross Profit

2021 $ 75,000 $ 75,000 -0-
2022 75,000 45,000 $ 30,000
2023 75,000 -0- 75,000
2024 75,000 -0- 75,000
Totals $300,000 $120,000 $180,000

Exercise 6–28
Requirement 1
July 1, 2021
Sales revenue.............................................................. 300,000
To record installment sale
Cost of goods sold.......................................................... 120,000

Inventory..................................................................... 120,000
To record cost of installment sale
Cash................................................................................ 75,000
To record cash collection from installment sale
July 1, 2022
Cash................................................................................ 75,000

Requirement 2
July 1, 2021
Inventory..................................................................... 120,000
Cash................................................................................ 75,000

To recognize gross profit from installment sale
July 1, 2022
Cash................................................................................ 75,000


Requirement 3
July 1, 2021
Inventory..................................................................... 120,000
Cash................................................................................ 75,000
July 1, 2022
Cash................................................................................ 75,000


Exercise 6–29
Requirement 1
Cost of goods sold ($1,000,000 – $600,000) $400,000
Add: Gross profit if using cost recovery method 100,000
Cash collected $500,000
Requirement 2
Gross profit percentage = $600,000 ÷ $1,000,000 = 60%
Cash collected × Gross profit percentage = Gross profit recognized
$500,000 × 60% = $300,000 gross profit

Exercise 6–30
October 1, 2021
Installment receivables..................................................... 4,000,000
Inventory..................................................................... 1,800,000
Deferred gross profit................................................... 2,200,000
To record the installment sale
Cash................................................................................ 800,000
To record the cash down payment from installment sale
Deferred gross profit ($800,000 x 55%*)....................... 440,000
October 1, 2022
Repossessed inventory (fair value) ................................ 1,300,000
Deferred gross profit (balance)....................................... 1,760,000
Loss on repossession (difference) .................................. 140,000
Installment receivable (balance)................................. 3,200,000
To record the default and repossession
*$2,200,000  $4,000,000 = 55% gross profit percentage

Exercise 6–31
Requirement 1
April 1, 2021
Installment receivables................................................... 2,400,000
Land............................................................................ 480,000
Gain on sale of land.................................................... 1,920,000
April 1, 2021
Cash................................................................................ 120,000
April 1, 2022
Cash................................................................................ 120,000
Requirement 2
April 1, 2021
Installment receivables................................................... 2,400,000
Land............................................................................ 480,000
Deferred gain.............................................................. 1,920,000

When payments are received, gain on sale of land is recognized, calculated by

applying the gross profit percentage ($1,920,000 ÷ $2,400,000 = 80%) to the cash
collected (80% x $120,000).
April 1, 2021
Cash................................................................................ 120,000
Deferred gain.................................................................. 96,000

Gain on sale of land (80% × $120,000).......................... 96,000
To recognize profit from installment sale
April 1, 2022
Cash................................................................................ 120,000
Deferred gain.................................................................. 96,000

Gain on sale of land (80% × $120,000).......................... 96,000
To recognize profit from installment sale

Exercise 6–32
The FASB Accounting Standards Codification represents the single source of
authoritative U.S. generally accepted accounting principles. Regarding
circumstances indicating when the installment method or cost recovery method is
appropriate for revenue recognition, the appropriate citation is:
FASB ASC 605–10–25–04: “Revenue Recognition–Overall–Recognition–

Installment and Cost Recovery Methods of Revenue Recognition.” (Note: ASC
605–10–25–03 also provides some guidance, as it indicates when installment
method is not acceptable).

Exercise 6–33
2021:
Revenue: $40
Cost: 40
Gross profit: $0
2022:
Revenue: $80
Cost: 80
Gross profit: $0
2023:
Revenue: $100 ($220 contract price – $40 – $80)
Cost: 50
Gross profit: $ 50

Exercise 6–34
As written, the question implies that there is no VSOE (vendor specific sales price
evidence), because the question refers to the prices as estimated. Under the
assumption that there is no VSOE, the correct answer to this problem is as follows:
Requirement 1
Revenue should be recognized at date of shipment of the upgrade, which
occurs on January 1, 2022, because there is no vendor-specific evidence with which
to allocate transaction price to the various software deliverables.
Requirement 2
July 1, 2021
Cash................................................................................ 243,000
Deferred revenue........................................................ 243,000
To record sale of software
If instead the Exercise had said that Easywrite sold each of those components
separately for the amounts listed, Easywrite would have VSOE for each component,
and the correct answer would be:
Requirement 1
Revenue should be recognized as follows:
Software – date of shipment, July 1, 2021
Technical support – evenly over the 12 months of the agreement
Upgrade – date of shipment, January 1, 2022
The amounts are determined by an allocation of total contract price in

proportion to the individual fair values of the components if sold separately:
Software $210,000 ÷ $270,000 × $243,000 = $189,000
Technical support $ 30,000 ÷ $270,000 × $243,000 = 27,000
Upgrade $ 30,000 ÷ $270,000 × $243,000 = 27,000
Total $243,000

Requirement 2
July 1, 2021
Cash................................................................................ 243,000
Revenue...................................................................... 189,000
Deferred revenue ($27,000 + $27,000)........................... 54,000
To record sale of software

Exercise 6–35
Requirement 1
Conveyer ($20,000 ÷ 50,000) × $45,000 = $18,000

Labeler ($10,000 ÷ 50,000) × $45,000 = 9,000
Filler ($15,000 ÷ 50,000) × $45,000 = 13,500
Capper ($5,000 ÷ 50,000) × $45,000 = 4,500
Total $45,000
Requirement 2
All $45,000 of revenue is delayed until installation of the conveyer,

because the usefulness of the other elements of the multi-part arrangement
is contingent on its delivery.

Exercise 6–36
Requirement 1
Conveyer ($20,000 ÷ 50,000) × $45,000 = $18,000

Labeler ($10,000 ÷ 50,000) × $45,000 = 9,000
Filler ($15,000 ÷ 50,000) × $45,000 = 13,500
Capper ($5,000 ÷ 50,000) × $45,000 = 4,500
Total $45,000
Requirement 2
Under IFRS, it’s likely that Richardson would recognize revenue the same
as in Requirement 1, because (a) revenue for each part can be estimated
reliably and (b) the receipt of economic benefits is probable.

Exercise 6–37
October 1, 2021
Cash (10% × $300,000)...................................................... 30,000
Notes receivable.............................................................. 270,000
Deferred revenue ........................................................ 300,000
To record franchise agreement and down payment
January 15, 2022

Deferred revenue............................................................ 300,000
Franchise fee revenue................................................. 300,000
To recognize franchise fee revenue

PROBLEMS
Problem 6-1
Requirement 1
a. Number of performance obligations in the contract: 2.
The unlimited access to facilities for one year is one performance obligation.
Because the discount voucher provides a material right to the customer (a 25%
discount for yoga classes rather than a 10% discount) and that right is not one the
customer would receive had it not bought the one-year new membership, the
option to buy yoga classes at a discount is a second performance obligation. The
discount voucher is capable of being distinct because it could be sold or provided
separately, and it is separately identifiable, as it is not highly interrelated with the
other performance obligation of providing access to Fit & Slim’s facilities, and
the seller’s role is not to integrate and customize them to create one product or
service. So, the discount coupon qualifies as a performance obligation.
b. To allocate the contract price to the performance obligations, we should first

consider that Fit & Slim would offer a 10% discount on the yoga classes to all
customers as part of its normal promotion strategy. So, a 25% discount provides a
customer with an incremental value of 15% (25% – 10%). Thus, the estimated
stand-alone selling price of the voucher provided by Fit & Slim is $30 ($500
initial price of the classes  15% incremental discount  40% likelihood of
exercising the option).
F&S’s estimated stand-alone selling price of the discount option is:

Value of the yoga discount voucher:
(25% discount – 10% normal discount)  $500 = $ 75
Stand-alone selling price of yoga discount voucher: $ 30
Stand-alone selling price of new gym membership: 720
Total of stand-alone prices $750

Problem 6-1 (continued)
F&S must identify each performance obligation’s share of the sum of the stand-
alone selling prices of all deliverables:
$30
Yoga discount voucher: $30 + $720 = 4%
$720
Facilities access: = 96%
$30 + $720
100%
F&S then allocates the total selling price based on stand-alone selling prices, as
follows:
$700
Transaction Price
New membership
96% 4%
$672 $28
Access to facilities Discount on
yoga classes
Cash 700
Deferred revenue 672
Deferred revenue – coupons 28

Problem 6-1 (concluded)
Requirement 2
a. Number of performance obligations in the contract: 1.
The access to the gym for 50 visits is one performance obligation. The option
to pay $15 for additional visits does not constitute a material right because it
requires the same fee as would normally be paid by nonmembers. Therefore,
it is not a performance obligation in the contract.
(Note: It could be argued that the coupon book actually includes 50 performance
obligations – one for each visit to the gym. That would end up producing a very
similar accounting outcome, as the $500 cost of the book would be allocated to
the 50 visits with revenue recognized for each visit.)
b. Since the option to visit on additional days is not a performance obligation, F&S
should not allocate any of the contract price to the option. Therefore, the entire
$500 payment is allocated to the 50 visits associated with the coupon book
(“coupons”).
c. Cash 500
Deferred revenue – coupons 500

Problem 6–2
Requirement 1
Delivery of a Protab computer is one performance obligation.
The option to purchase a Probook at a 50% discount is a second performance
obligation because it provides a material right to the customer that the customer
would not receive had it not bought the Protab. The option, represented by the
coupon, is capable of being distinct because it could be sold or provided separately,
and it is separately identifiable, as it is not highly interrelated with the other
performance obligation of delivering a Protab computer, and the seller’s role is not
to integrate and customize them to create one product. So, the discount coupon
The 6-month quality assurance warranty is not a performance obligation. It is not
sold separately and is simply a cost to assure that the product is of good quality. The
seller will estimate and recognize an expense and related contingent warranty
liability in the period of sale. Accounting for warranties is covered in Chapter 13.
The coupon providing an option to purchase an extended warranty does not
provide a material right to the customer because the extended warranty costs the
same whether or not it is purchased along with the Protab. Therefore, that option
does not constitute a performance obligation within the contract to purchase a Protab
package.

Requirement 2
Allocation of purchase price to performance obligations:
Allocation of
Percentage of the sum total
Stand-alone of the stand-alone transaction
selling price of selling prices of the price to each
Performance the performance performance performance
obligation: obligation: obligations: obligation:
Protab tablet $76,000,0001 95%3 $74,100,0005
Option to
purchase a 4,000,0002 5%4 3,900,0006
Probook
Total $80,000,000 100.00% $78,000,000
1
$76,000,000 = $760/unit × 100,000 units.
$4,000,000 = 50% discount × $400 normal Probook price × 100,000 discount
2
coupons issued × 20% probability of redemption.

3
95% = $76,000,000 ÷ $80,000,000
4
5% = $4,000,000 ÷ $80,000,000
5
$74,100,000 = 95.00% × ($780 × 100,000 units)
6
$3,900,000 = 5.00% × ($780 × 100,000 units)

Requirement 3
Creative then allocates the total selling price based on stand-alone selling prices,
as follows:
$78,000,000
Transaction Price
Protab package
95% 5%
$74,100,000 $3,900,000
Protab computers Probook discount

Cash ($780 × 100,000 units) 78,000,000
Sales revenue 74,100,000
Deferred revenue – coupons 3,900,000

Problem 6–3
Requirement 1
Delivery of a Protab computer is one performance obligation.
The option to purchase a Probook at a 50% discount is a second performance
obligation because it provides a material right to the customer that the customer
would not receive had it not bought the Protab. The option, represented by the
coupon, is capable of being distinct because it could be sold or provided separately,
and it is separately identifiable, as it is not highly interrelated with the other
performance obligations in the contract, so the discount coupon qualifies as a
The 6-month quality assurance warranty is not a performance obligation. It is not
sold separately and is simply a cost to assure that the product is of good quality. The
seller will estimate and recognize an expense and related contingent warranty
liability in the period of sale. Accounting for warranties is covered in Chapter 13.
The option to purchase the extended warranty provides a material right to the
customer, as the extended warranty costs less when purchased with the coupon that
was included in the Protab Package ($50) than it does when purchased separately
($75), so it is a third performance obligation. The option is capable of being distinct
because it could be sold or provided separately, and it is separately identifiable, as it
is not highly interrelated with the other performance obligations in the contract, and
the seller’s role is not to integrate and customize them to create one product or
service. So, the discount option qualifies as a performance obligation.

Requirement 2
Allocation of purchase price to performance obligations:
Percentage of the Allocation of

sum of the stand- total transaction
Stand-alone alone selling prices price to each
selling price of of the performance performance
Performance the performance obligations (to two obligation:
obligation: obligation: decimal places):
Protab tablet $76,000,0001 93.83%4 $73,187,4007
Option to purchase
Probook 4,000,0002 4.94%5 3,853,2008
Option to purchase
extended warranty 1,000,0003 1.23%6 959,4009
Total $81,000,000 100.00% $78,000,000
1
$76,000,000 = $760/unit × 100,000 units.
$4,000,000 = 50% discount × $400 normal Probook price × 100,000 discount
2
coupons issued × 20% probability of redemption.

$1,000,000 = ($75 price of warranty sold separately minus $50 price of warranty
3
sold at time of software purchase) × 100,000 units sold × 40% probability of

exercise of option.
4
93.83% = $76,000,000 ÷ $81,000,000
5
4.94% = $4,000,000 ÷ $81,000,000
6
1.23% = $1,000,000 ÷ $81,000,000
7
$73,187,400 = 93.83% × ($780 × 100,000 units)
8
$3,853,200 = 4.94% × ($780 × 100,000 units)
9
$959,400 = 1.23% × ($780 × 100,000 units)

Requirement 3
Creative then allocates the total selling price based on stand-alone selling prices,
as follows:
$78,000,000
Transaction Price
Protab Package
93.83% 4.94% 1.23%
$73,187,400 $3,853,200 $959,400

Protab computers Probook discount Extended warranty

Cash ($800 × 100,000 units) 78,000,000
Sales revenue 73,187,400
Deferred revenue – coupons 3,853,200
Deferred revenue – extended warranties 959,400

Problem 6-4
Requirement 1
The delivery of Supply Club’s normal products is one performance obligation.
The promise to redeem loyalty points for discounts on purchases represents a
material right to customers that they would not receive had they not bought Supply
Club’s products, so that the discount provided upon redemption of loyalty points
represents a second performance obligation. The loyalty program provides
customers with a discount option on future purchases. That option is capable of
being distinct because it could be sold or provided separately, and it is separately
identifiable, as it is not highly interrelated with the other performance obligation of
delivering products under normal sales agreements (the customer can redeem loyalty
points for future purchases). Therefore, the promise to redeem loyalty points
Because there are two performance obligations associated with a single
transaction price ($135,000), the transaction price must be allocated between the two
performance obligations on the basis of stand-alone prices.
Supply Club’s estimated stand-alone selling price of the loyalty points is:
Value of the loyalty points:
125,000 points  $0.20 discount per point = $ 25,000
Stand-alone selling price of loyalty points: $ 15,000
Stand-alone selling price of purchased products: 135,000
Supply Club must identify each performance obligation’s share of the sum of the
stand-alone selling prices of all deliverables:
$15,000
Loyalty points: $15,000 + $135,000 = 10%
$135,000
Purchased products: = 90%
$15,000 + $135,000
100%

Supply Club then allocates the total selling price based on stand-alone selling
prices, as follows:
$135,000
Transaction Price
Loyalty program
90% 10%
$121,500 $13,500
Purchased products Loyalty points discount
The journal entry to record July sales would be:
Cash ($135,000 × 80%) 108,000

Accounts receivable ($135,000 × 20%) 27,000
Deferred revenue – loyalty points 13,500
Requirement 2
Cash ($60,000 × 75% × 80%)* 36,000
Accounts receivable ($60,000 × 25% × 80%)* 12,000
Deferred revenue – loyalty points** 10,800
*
Sales are discounted by 20% when points are redeemed, so only 80% of each
dollar sold is received. 75% of sales are for cash, and 25% are on credit.
**
Supply Club expected that 60% of the 125,000 awarded points would
eventually be redeemed. 60% × 125,000 = 75,000. Therefore, the 60,000
August redemptions constitute 60,000 ÷ 75,000 = 80% of total redemptions
expected. Because Supply Club assigned $13,500 of deferred revenue to the
July loyalty points, Supply Club should recognize revenue of $13,500 × 80% =
$10,800.
When deferred revenue associated with the loyalty points was first recognized, a
total of $13,500 was assigned to the points, given an expectation that 75,000
points would be redeemed. Therefore, each redeemed point results in recognition
of $13,500/75,000 or $0.18/point.
When 60,000 points are redeemed, they reduce the cash collected (now or in the
future) by 20%. Thus, total cash collected will be $60,000 x 80% = $48,000.
75%, or $36,000, is collected immediately, and another $12,000 is collected
when the receivable is collected. Thus, total revenue recognized upon sale is
$36,000 (associated with cash sales) + $12,000 (associated with A/R) + $10,800
(deferred revenue associated with loyalty point redemption), totaling $58,800.

Problem 6–5
Requirement 1
The contract requires 6 payments of $20,000, plus or minus $10,000 at the end of
the contract. So the contract will provide either [(6  $20,000) + $10,000] =
$130,000, or [(6  $20,000) – $10,000] = $110,000.
Revis would estimate the expected value of the transaction price as follows:
Possible Expected
Prices Probability Consideration
$130,000 ([$20,000  6] + $10,000) 80% $104,000

$110,000 ([$20,000  6] – $10,000) 20% 22,000
Expected value of contract price at inception $126,000
Each month Revis will recognize $21,000 (equal to $126,000 ÷ 6) of revenue,

recording the following journal entry:
Cash 20,000
Requirement 2
After six months the bonus receivable will have accumulated to $6,000 (equal to
6  $1,000). If Revis receives the bonus, it will record the following entry:
Cash 10,000

Requirement 3
If Revis pays the penalty, it will record the following entry:

Cash 10,000

Problem 6–6
Requirement 1
Cash 80,000
Because Super Rise believes that unexpected delays are likely and that it will not
earn the $40,000 bonus, Super Rise is not likely to receive the bonus. Thus, the
$40,000 is not included in the transaction price, and only the fixed payment of
$80,000 is recognized as deferred revenue.
Requirement 2
Deferred revenue ($80,000 ÷ 10) 8,000

Bonus receivable ($40,000 ÷ 10) 4,000
Super Rise recognizes revenue of $12,000 associated in the month of January.
Because Super Rise believes it is likely to receive the bonus, it will estimate the
transaction price to be $120,000 (equal to $80,000 fixed payment + $40,000 bonus),
and will recognize 1/10 of that amount each month.
Requirement 3

Bonus receivable [($40,000 ÷ 10) × 5] 20,000
Super Rise recognizes revenue of $8,000 in each month, including May, based on
the original transaction of $80,000 (equal to $80,000 ÷ 10 months). However, no
bonus receivable had been recognized prior to May because unexpected delays were
considered likely and thus no bonus was expected. In May, Super Rise concludes it
is likely to receive the bonus, so it will revise the transaction price to $120,000
(equal to $80,000 fixed payment + $40,000 contingent bonus). This means Super
Rise must record additional revenue of $20,000 to adjust revenue to the appropriate
amount [($40,000 bonus receivable ÷ 10 months) × 5 months], and recognize a
receivable for that amount.

Problem 6–7
Requirement 1
Cash 80,000
Because Super Rise has high uncertainty about its bonus estimate, it can’t argue
that it is probable that it won’t have to reverse (adjust downward) a significant
amount of revenue in the future because of a change in its estimate. Therefore, the
$40,000 is not included in the transaction price, and only the fixed payment of
$80,000 is recognized as deferred revenue.
Requirement 2

Bonus receivable [($40,000 ÷ 10) × 5] 20,000
Super Rise recognizes revenue of $8,000 in the month of May based on the
original transaction of $80,000 (equal to $80,000 ÷ 10 months). In addition, now that
Super Rise can make an accurate estimate, it can argue that it is probable that it
won’t have to reverse (adjust downward) a significant amount of revenue in the
future because of a change in its estimate. Therefore, Super Rise will revise the
transaction price to $120,000 (equal to $80,000 fixed payment + $40,000 contingent
bonus). This means Super Rise must record additional revenue of $20,000 to adjust
revenue to the appropriate amount [($40,000 bonus receivable ÷ 10 months) × 5
months], and recognize a receivable for that amount.

Problem 6-8
Requirement 1
At the contract’s inception, Velocity calculates the transaction price to be the
expected value of the two possible eventual prices:
Possible Expected
Prices Probabilities Consideration
$500,000 ([$60,000  8] + $20,000) 80% $400,000

$460,000 ([$60,000  8] – $20,000) 20% 92,000
Expected value at contract inception: $492,000
Because its consulting services are provided evenly over the eight months,
Velocity will recognize revenue of $61,500 (equal to $492,000 ÷ 8 months).
Because Velocity is guaranteed to receive only $60,000 per month ($1,500 less than
the revenue recognized), it will recognize a bonus receivable of $1,500 in each
month to reflect the expected value of the bonus amount to be received at the end of
the contract. Therefore, Velocity’s journal entry to record the revenue each month
for the first four months is as follows:
Cash 60,000

Problem 6–8 (continued)
Requirement 2
By the end of the fourth month, the bonus receivable account would have a
balance of $6,000 (equal to 4  $1,500), equal to half of the expected value of the
bonus of $12,000 (equal to $492,000 – [8  $60,000]). At the start of the fifth month,
the estimated likelihood of receiving the bonus is revised so the estimated
transaction price decreases:
Possible Expected
Prices Probabilities Consideration
$500,000 ([$60,000  8] + $20,000) 60% $300,000

$460,000 ([$60,000  8] – $20,000) 40% 184,000
Transaction price as start of fifth month: $484,000
So, after four months, the bonus receivable account should have a balance of
$2,000, which is half of the new expected value of the bonus of $4,000 (equal to
$484,000 – [8  $60,000]). Because the bonus receivable account was increased to
$6,000 in the first four months, an adjustment of $4,000 is needed to reduce the
bonus receivable down to $2,000:

This entry reduces the bonus receivable from $6,000 to $2,000, with the
offsetting debit being a reduction in revenue. Over the remaining four months, the
bonus receivable will increase by $500 each month, accumulating to $4,000 by the
end of the contract.

Problem 6–8 (concluded)
Requirement 3
Because services are provided evenly over the eight months, Velocity would
recognize revenue of $60,500 (equal to $484,000 ÷ 8 months) in each of months five
through eight. Because Velocity received $60,000 per month ($500 less than the
revenue recognized), Velocity would recognize a bonus receivable of $500 each
month to reflect the additional service revenue in excess of its unconditional right to
$60,000. The journal entry would be:
Cash 60,000
Bonus receivable 500
Requirement 4
At the end of contract, Velocity learns that it will receive the bonus of $20,000. It
already has recognized revenue of $4,000 associated with the bonus. Therefore,
when Velocity receives the cash bonus, it will recognize additional revenue of
$16,000.
Cash 20,000

Problem 6-9
Requirement 1
authoritative U.S. generally accepted accounting principles. Regarding accounting
for sales-based royalties from licenses, the appropriate citation is:
Overall–Implementation Guidance and Illustrations–Sales-Based or Usage-
Based Royalties.”
That citation requires that both of the following two events have occurred:
1. The sales that utilize the intellectual property have occurred.
2. The performance obligation to which the royalty has been allocated has been
satisfied.
Therefore, Tran can’t recognize revenue for sales-based royalties on the Lyon
license until sales have actually occurred.
Requirement 2
If Tran accounts for the Lyon license of functional intellectual property as a right
of use that is conveyed on April 1, 2021, Tran can recognize revenue of $500,000 on
that date, because that is the date upon which Tran transfers to Lyon the right to use
its intellectual property. The journal entry would be:
Cash 500,000
License revenue 500,000
Requirement 3
Tran recognizes revenue for sales-based royalties in the period in which
uncertainty is resolved. Tran is due $1,000,000 of royalties on Lyon’s sales in 2021,
so it should recognize revenue in that amount. The journal entry would be:
Cash 1,000,000
License revenue 1,000,000

Requirement 4
If Tran accounts for the Lyon license of symbolic intellectual property as an
access right for the period from April 1, 2021, through March 31, 2023, Tran cannot
recognize any revenue on April 1, 2021, because it fulfills its performance obligation
over the access period and no time has yet passed. Instead, Tran must recognize
deferred revenue of $500,000. The journal entry would be:
Cash 500,000
As of December 31, 2021, Tran has partially fulfilled its performance obligation
to provide access to its symbolic intellectual property. Given that the access right
covers a five-year period (from April 1, 2021, through March 31, 2026), and Tran
provided access for nine months of 2021 (from April 1, 2021, through December 31,
2021), Tran has provided 15% [equal to 9 ÷ (5 × 12)] of the access right during
2021, and should recognize 15% × $500,000 = $75,000 of revenue. Tran also
should recognize revenue for the $1,000,000 of royalties arising from Lyon’s sales
in 2021. So, total revenue recognized in 2021 is $75,000 + $1,000,000 =
$1,075,000. The journal entry would be:
Cash 1,000,000
License revenue 1,075,000

Problem 6–10
Requirement 1
2021 2022 2023
Contract price $10,000,000 $10,000,000 $10,000,000
(actual in 2023) $ 2,000,000 $ 2,000,000 $ 1,800,000
2021: $2,400,000
= 30.0% × $10,000,000 = $3,000,000
$8,000,000
2022: $6,000,000
= 75.0% × $10,000,000 – $3,000,000 = $4,500,000
$8,000,000
2023: $10,000,000 – $7,500,000 = $2,500,000

2021: $3,000,000 – $2,400,000 = $600,000
2022: $4,500,000 – $3,600,000 = $900,000
2023: $2,500,000 – $2,200,000 = $300,000
Note: Also can calculate gross profit directly using the percentage of completion:
2021: $2,400,000
= 30.0% × $2,000,000 = $600,000
$8,000,000
2022: $6,000,000
= 75.0% × $2,000,000 = $1,500,000 – $600,000 = $900,000
$8,000,000
2023: $1,800,000 – $1,500,000 = $300,000

Requirement 2
2021 2022 2023
Construction in progress 2,400,000 3,600,000 2,200,000

Cash, materials, etc. 2,400,000 3,600,000 2,200,000
Accounts receivable 2,000,000 4,000,000 4,000,000

Billings on construction 2,000,000 4,000,000 4,000,000
contract
Cash 1,800,000 3,600,000 4,600,000

Construction in progress 600,000 900,000 300,000

(gross profit)
Cost of construction 2,400,000 3,600,000 2,200,000
(cost incurred)
Revenue from long-term 3,000,000 4,500,000 2,500,000
contracts

Requirement 3
Current assets:
Accounts receivable $ 200,000 $600,000
Construction in progress $3,000,000 $7,500,000
Less: Billings (2,000,000) (6,000,000)
Costs and profit in excess
of billings 1,000,000 1,500,000
Note: Construction in progress in excess of billings is a contract asset; Billings

in excess of construction in progress is a contract liability.

Requirement 4
2021 2022 2023
Costs incurred during the year $2,400,000 $3,800,000 $3,200,000
Estimated costs to complete
as of year-end 5,600,000 3,100,000 -
2021 2022 2023
Contract price $10,000,000 $10,000,000
$10,000,000
(actual in 2023) $ 2,000,000$ 700,000 $ 600,000
2021: $2,400,000
= 30.0% × $10,000,000 = $3,000,000
$8,000,000
2022: $6,200,000
= 66.6667% × $10,000,000 – $3,000,000 = $3,666,667
$9,300,000
2023: $10,000,000 – $6,666,667 = $3,333,333
2021: $3,000,000 – $2,400,000 = $600,000
2022: $3,666,667 – $3,800,000 = $(133,333)
2023: $3,333,333 – $3,200,000 = $133,333

Note: Also can calculate gross profit directly using the percentage of completion:
2021: $2,400,000
= 30.0% × $2,000,000 = $600,000
$8,000,000
2022: $6,200,000
= 66.6667% × $700,000 = $466,667 – $600,000 = $(133,333)
$9,300,000
2023: $600,000 – $466,667 = $133,333
Requirement 5
2021 2022 2023
as of year-end 5,600,000 4,100,000 -
2021 2022 2023
Contract price $10,000,000 $10,000,000 $10,000,000
(actual in 2023) $ 2,000,000 $ (300,000) $ (100,000)
2021: $2,400,000
= 30.0% × $10,000,000 = $3,000,000
$8,000,000
2022: $6,200,000
= 60.19417% × $10,000,000 – $3,000,000 = $3,019,417
$10,300,000
2023: $10,000,000 – $6,019,417 = $3,980,583

2021: $3,000,000 – $2,400,000 = $600,000
2022: $(300,000) – $600,000 = $(900,000)

2023: $(100,000) – $(300,000) = $200,000

Problem 6–11
Requirement 1
Year Revenue Gross profit

2021 -0- -0-
2022 -0- -0-
2023 $10,000,000 $1,800,000
Total $10,000,000 $1,800,000
Requirement 2
2021 2022 2023


contract
Cash 1,800,000 3,600,000 4,600,000

Construction in progress 1,800,000

(gross profit)
Cost of construction 8,200,000
(costs incurred)
Revenue from long-term 10,000,000
contracts (contract price)

Requirement 3

Current assets:
Accounts receivable $ 200,000 $ 600,000
Less: Billings (2,000,000) (6,000,000)
Costs in excess of billings 400,000 -0-
Note: Construction in progress in excess of billings is a contract asset.
Requirement 4
2021 2022 2023
as of year-end 5,600,000 3,100,000 -
Year Revenue Gross profit
2021 -0- -0-
2022 -0- -0-
2023 $10,000,000 $600,000
Total $10,000,000 $600,000
Requirement 5
2021 2022 2023
as of year-end 5,600,000 4,100,000 -

2021 -0- -0-
2022 -0- $(300,000)
2023 $10,000,000 200,000
Total $10,000,000 $(100,000)

Problem 6–12
Requirement 1
2021 2022 2023
Contract price $4,000,000 $4,000,000 $4,000,000
(actual in 2023) $ 500,000 $ (200,000) $ (250,000)
2021 -0-
2022 $(200,000)
2023 (50,000)
Requirement 2
2021: Revenue: (10% × $4,000,000) – $350,000 cost = $50,000
2022: $(200,000) – $50,000 = $(250,000)
2023: $(250,000) – $(200,000) = $(50,000)
Requirement 3

Current assets:
Costs less loss ($2,300,000*) in
excess of billings ($2,170,000) $ 130,000
Billings ($720,000) in excess
of costs and profit ($400,000) $ 320,000
*Cumulative costs ($2,500,000) less cumulative loss recognized ($200,000) = $2,300,000

Problem 6–13
Requirement 1
Recognizing revenue upon completion of long-term construction contracts is
equivalent to recognizing revenue at the point in time at which delivery occurs.
Recognizing revenue over time requires assigning a share of the project’s expected
revenues and costs to each construction period. The share is estimated based on the
project's costs incurred each period as a percentage of the project's total estimated
costs.
Requirement 2
2021 2022
Contract price $20,000,000 $20,000,000
Actual costs to date 4,000,000 13,500,000
Estimated costs to complete 12,000,000 4,500,000
Estimated gross profit $ 4,000,000 $ 2,000,000
a. Revenue recognition: If revenue is recognized upon project completion,

Citation would not report any revenue in the 2021 or 2022 income statements.
b. Gross profit recognition:

If revenue is recognized upon project completion, Citation would not report
gross profit until the project is completed. Citation would have to report an
overall gross loss on the contract in whatever period it first revises the estimates
to determine that an overall loss will eventually occur. Citation never estimates
the Altamont contract will earn a gross loss, so never has to recognize one.

c.
Balance Sheet
Current assets:
Costs ($4,000,000*) in excess
of billings ($2,000,000) 2,000,000
* If revenue is recognized upon project completion, this account would only

include costs of $4,000,000
Requirement 3
2021 2022
Contract price $20,000,000 $20,000,000
Estimated gross profit $ 4,000,000 $ 2,000,000
a. Revenue recognition:
2021:
$ 4,000,000
Revenue: = 25% × $20,000,000 = $5,000,000
$16,000,000
2022:
$13,500,000
Revenue: = 75% × $20,000,000 = $15,000,000
$18,000,000
Less: 2021 revenue 5,000,000
2022 revenue $10,000,000
2021: Gross Profit: $5,000,000 – $4,000,000 = $1,000,000
2022: Gross Profit: $10,000,000 – $9,500,000 = $500,000

c.
Balance Sheet
Current assets:
Costs and profit ($5,000,000*) in excess
of billings ($2,000,000) 3,000,000
* Costs ($4,000,000) + profit ($1,000,000)
Requirement 4
2021 2022
Contract price $20,000,000 $20,000,000
Estimated gross profit $ 4,000,000 ($ 2,500,000)
a. Revenue recognition:
Total revenue recognized to date = (percentage complete)(total revenue)

= ($13,500,000 ÷ $22,500,000) x ($20,000,000)
= (60%) x ($20,000,000)
= $12,000,000
Revenue recognized in 2022 = total – revenue recognized in prior periods
= $12,000,000 – $5,000,000 = $7,000,000

2022: Overall loss of ($2,500,000) – previously recognized gross profit of
$1,000,000 = $3,500,000.

c.
Balance Sheet
Current assets:
Accounts receivable $ 1,600,000
Billings ($12,000,000) in excess of costs
and profit ($11,000,000*) 1,000,000
* 2021 costs ($4,000,000) + 2021 profit ($1,000,000) + 2022 costs

($9,500,000) – 2022 loss ($3,500,000)
Requirement 5
Citation should recognize revenue at the time of delivery, when the homes are
completed and title is transferred to the buyer. Recognizing revenue over time is not
appropriate in this case, because the criteria for revenue recognition over time are
not met. Specifically, the customers are not consuming the benefit of the seller’s
work as it is performed (criterion 1 in Illustration 5-5), the customer does not control
the asset as it is created (criterion 2), and the homes have an alternative use to the
seller and seller does not have the right to receive payment for progress to date
(criterion 3). Until completion of the home, transfer of title does not occur and the
full sales price is not received, so control of the homes has not passed from Citation
to the buyers.
Requirement 6
Income statement:
Sales revenue (3 x $600,000) $1,800,000
Cost of goods sold (3 x $450,000) 1,350,000
Gross profit $ 450,000
Balance sheet:
Current assets:
Inventory (work in process) $2,700,000
Customer deposits (or deferred revenue) $ 300,000*
*$600,000 x 10% = $60,000 x 5 = $300,000

SUPPLEMENT PROBLEMS
Problem 6–14
REAGAN CORPORATION
Income Statement
For the Year Ended December 31, 2021
Income before income taxes..........................
[1] $3,680,000
Income tax expense ....................................... 1,472,000
Net income..................................................... 2,208,000
Earnings per share 2.21
[1] Income from continuing operations before income taxes:

Unadjusted $4,200,000
Add: Gain from sale of equipment 50,000
Deduct: Loss on inventory write-down (400,000)
Depreciation expense (2021) (50,000)
Overstated profit on installment sale (120,000) *
Adjusted $3,680,000
*Profit recognized ($400,000 – $240,000) $160,000
Profit that should have been recognized
(gross profit ratio of 40% x $100,000) (40,000)
Overstated profit $120,000

Problem 6–15
Requirement 1
2021 cost recovery % :
$180,000
= 60% (gross profit % = 40%)
$300,000
$280,000
= 70% (gross profit % = 30%)
$400,000
2021 gross profit:
Cash collection from 2021 sales = $120,000 x 40% = $48,000
2022 gross profit:
Cash collection from 2021 sales = $100,000 x 40% = $40,000
+ Cash collection from 2022 sales = $150,000 x 30% = 45,000
Total 2022 gross profit $85,000
Requirement 2
2021
Inventory..................................................................... 180,000
Cash ................................................................ 120,000



2022
Inventory..................................................................... 280,000
Cash................................................................................ 250,000

Requirement 3
Date Cash Collected Cost Recovery Gross Profit
2021
2021 sales $120,000 $120,000 -0-
2022
2021 sales $100,000 $ 60,000 $40,000
2022 sales 150,000 150,000 -0-
2022 totals $250,000 $210,000 $40,000

2021
Inventory..................................................................... 180,000
Cash................................................................................ 120,000
To record cash collection from installment sales
2022
Inventory..................................................................... 280,000
Cash................................................................................ 250,000
To record cash collection from installment sales


Problem 6–16
Requirement 1
Total profit = $500,000 – $300,000 = $200,000
Installment sales method: Gross profit % = $200,000 ÷ $500,000 = 40%
8/31/19 8/31/20 8/31/21 8/31/22 8/31/23
Cash collections $100,000 $100,000 $100,000 $100,000 $100,000
a. Point of delivery method $200,000 -0- -0- -0- -0-
b. Installment sales method

(40% x cash collected) $ 40,000 $ 40,000 $ 40,000 $ 40,000 $40,000
c. Cost recovery method -0- -0- -0- $100,000 $100,000

Requirement 2
Point of Installment
Delivery Sales Cost Recovery
Installment receivables 500,000
Cost of goods sold 300,000
Inventory 300,000
To record sale on 8/31/19
Installment receivables 500,000 500,000

Inventory 300,000 300,000
Deferred gross profit 200,000 200,000
To record sale on 8/31/19
Cash 100,000 100,000 100,000

Installment receivables 100,000 100,000 100,000
(Entry made each Aug. 31)
Deferred gross profit 40,000

Realized gross profit 40,000
(Entry made each Aug. 31)
Deferred gross profit 100,000

Realized gross profit 100,000
(Entry made 8/31/22 &
8/31/23)

Requirement 3
Point of Installment Cost

Delivery Sales Recovery
December 31, 2021
Assets
Less: Deferred gross profit (160,000) (200,000)
Installment receivables, net 240,000 200,000
December 31, 2022

Assets
Less: Deferred gross profit (120,000) (200,000)
Installment receivables, net 180,000 100,000

Problem 6–17
Requirement 1
All jobs consist of four equal payments: one payment when the job is completed and
three payments over the next three years.
Bluebird:
Job completed in 2019, so down payment made in 2019, another payment in 2020,
and two payments remain. $400,000 gross receivable at 1/1/2021 implies
payments of ($400,000  2) = $200,000 in 2021 and 2022. Four payments of
$200,000 implies total revenue of 4 × $200,000 = $800,000 on the job. Twenty-
five percent gross profit ratio implies cost of 75% × $800,000 = $600,000.
Cost recovery method gross profit: Payments in 2019 and 2020 have already
recovered $400,000 of cost, so cost remaining to be recovered as of 1/1/2021 is
$600,000 total – $400,000 already recovered = $200,000. Therefore, the entire
2021 payment of $200,000 will be applied to cost recovery, and no gross profit is
recognized in 2021.
Installment sales method gross profit: $200,000 payment × 25% gross profit ratio
= $50,000 of gross profit recognized in 2021.
PitStop:
Job completed in 2018, so down payment made in 2018, another payment in 2019,
another in 2020, and one payment remains. $150,000 gross receivable at 1/1/2021
implies a single payment of $150,000 in 2021. Four payments of $150,000 implies
total revenue of 4 × $150,000 = $600,000 on the job. Thirty-five percent gross
profit ratio implies cost of 65% × $600,000 = $390,000.
Cost recovery method gross profit: Payments in 2018, 2019, and 2020 of a total of
$450,000 have already recovered the entire $390,000 of cost and allowed
recognition of $60,000 of gross profit. Therefore, the entire 2021 payment of
$150,000 will be applied to gross profit.
Installment sales method gross profit: $150,000 payment × 35% gross profit ratio
= $52,500 of gross profit recognized in 2021.

Totals:
Cost recovery method: $0 (Bluebird) + $150,000 (PitStop) = $150,000.
Installment sales method: $50,000 (Bluebird) + $52,500 (PitStop) = $102,500.
Requirement 2
If Dan is focused on 2021, he would not be happy with a switch to the installment
sales method, because that would produce gross profit of only $102,500, which is
$47,500 less than he would show under the cost recovery method. It is true that
the installment sales method recognizes gross profit faster than does the cost
recovery method, but the installment sales method also recognizes gross profit
more evenly than does the cost recovery method. The timing of these jobs is such
that 2021 is a year in which almost all of the gross profit associated with the
PitStop job gets recognized, so 2021 looks more profitable under the cost recovery
method.

Problem 6–18
Requirement 1

2021 -0-
2022 -0-
2023 $1,800,000
Total gross profit $1,800,000
Requirement 2
2021 2022 2023


contract
Cash 1,800,000 3,600,000 4,600,000

Construction in progress 1,800,000

(gross profit)
Cost of construction 2,400,000 3,600,000 2,200,000
(costs incurred)
Revenue from long-term 2,400,000 3,600,000 4,000,000
contracts (contract price)

Requirement 3

Current assets:
Accounts receivable $ 200,000 $ 600,000
Less: Billings (2,000,000) (6,000,000)
Costs in excess of billings 400,000 -0-
Requirement 4
2021 2022 2023
as of year-end 5,600,000 3,100,000 -

2021 -0-
2022 -0-
2023 $600,000
Requirement 5
2021 2022 2023
as of year-end 5,600,000 4,100,000 -

2021 -0-
2022 $(300,000)
2023 200,000

Problem 6–19
Requirement 1
a. January 30, 2021
Cash ............................................................................... 200,000

Notes receivable ............................................................. 1,000,000
Deferred revenue........................................................ 1,200,000
b. September 1, 2021
Deferred revenue............................................................ 1,200,000

Franchise fee revenue ................................................ 1,200,000
c. September 30, 2021
Accounts receivable ($40,000 x 3%) ................................. 1,200

Service revenue .......................................................... 1,200
d. January 30, 2022
Cash................................................................................ 100,000
Notes receivable ......................................................... 100,000

Requirement 2
a. January 30, 2021
Cash ............................................................................... 200,000

Notes receivable ............................................................. 1,000,000
Deferred revenue........................................................ 1,200,000
b. September 1, 2021

Franchise fee revenue (cash collected)........................... 200,000
c. September 30, 2021
Accounts receivable ($40,000 x 3%) ................................. 1,200

Service revenue .......................................................... 1,200

d. January 30, 2022
Cash................................................................................ 100,000
Notes receivable ......................................................... 100,000

Franchise fee revenue ................................................ 100,000
Requirement 3
Balance Sheet
Current assets:
Notes receivable ($1,000,000) less $ -0-
deferred revenue ($1,000,000)
Deferred revenue $200,000
Explanation: Revenue recognition on the entire note receivable is deferred. In

addition, $200,000 of deferred revenue must be shown as a liability.

DECISION MAKERS’ PERSPECTIVE
CASES
Research Case 6–1
(Note: This case requires the student to reference a journal article.)
1.
Abuse Explanation
1. Cutoff The company either closes its books early (so some
manipulation current-year revenue is postponed until next year) or
leaves the books open too long (so some next-year
revenue is included in the current year).
2. Deferring too The company has an arrangement under which
much or too revenue should be deferred, but it doesn’t defer the
little revenue revenue. Or, a company could defer too much
revenue to shift income into future periods.
3. Bill-and-hold The company records sales even though it hasn’t yet
sale delivered the goods to the customer.
4. Right-of-return The company sells to distributors or other customers
sale and can’t estimate returns with sufficient accuracy
due to the nature of the selling relationship.
2. Manipulating estimates of percentage complete in order to manipulate gross

profit recognition.
3. These abuses tended to increase income (75% of the time), consistent with
management generally having an incentive to increase income.
4. Yes, auditors tended to require adjustment (56% of the time), consistent with
auditors being concerned about income-increasing earnings management.

Judgment Case 6–2
Determining whether Toys4U satisfies the performance obligation requires the
company to consider indicators of whether McDonald’s has obtained control of the
dolls. Management should evaluate these indicators individually and in combination
to decide whether control has been transferred. The indicators include, but are not
limited to the following:
1. The customer has accepted the asset. There is no acceptance provision
indicated, but given that McDonald’s returns unsold dolls to Toys4U, it does
not appear that McDonald’s has irrevocably accepted the dolls.
2. The customer has legal title. The facts do not state whether title transfers.
3. The customer has physical possession of goods. McDonald’s has possession

of the dolls.
4. The customer has the risks and rewards of ownership. Given that
McDonald’s returns unsold dolls to Toys4U, McDonald’s does not appear to
be holding the risks of ownership.
5. The customer has an obligation to pay the seller. In this case, McDonald’s
does not pay Toys4U until the dolls are sold, so McDonald’s is conditionally
(not unconditionally) obliged to pay for the toys.
In this case, Toys4U has not transferred control upon delivery because
McDonald’s has not accepted the asset, does not have the risks and rewards of
ownership, and does not have an obligation to pay Toys4U unless the dolls are sold.
Therefore, the answer is “no”. Toys4U has not satisfied its performance obligation.
This is essentially a consignment arrangement, and Toys4U should not recognize
revenue until McDonald’s sells dolls to customers.

Judgment Case 6–3
Level 1: Kerry obtained the access code for Level I on December 1, meaning that
Kerry has obtained the control of the right to use the software for Level I on that
date. On December 1 Cutler should recognize $50 of revenue for Level I.
Level II: Tom passed the Level I test on December 10 and Kerry purchased
access to Level II on the same day. However, Kerry received the access code for
Level II on December 20, so control over the Level II software was not transferred
to Kerry until December 20. Cutler should recognize $30 of revenue for Level II on
December 20.

Ethics Case 6–4
Discussion should include these elements.
Facts:
Horizon Corporation, a computer manufacturer, reported profits from 2016
through 2019, but reported a $20 million loss in 2020 due to increased competition.
The chief financial officer (CFO) circulated a memo suggesting the shipment of
computers to J.B. Sales, Inc., in 2021 with a subsequent return of the merchandise to
Horizon in 2022. Horizon would record a sale for the computers in 2021 and avoid
an inventory write-off that would place the company in a loss position for that year.
The CFO is clearly asking Jim Fielding to recognize revenue in 2021 that he
knows will be reversed as a sales return in 2022.
Ethical Dilemma:
Is Jim's obligation to challenge the memo of the CFO and provide useful
information to users of the financial statements greater than the obligation to prevent
a company loss in 2021 that may lead to bankruptcy?
Who is affected?
Jim Fielding
CFO and other managers
Other employees
Shareholders
Potential shareholders
Creditors
Auditors

Judgment Case 6-5
Scenario 1: Recognize revenue over time. The terms of the contract and all the
related facts and circumstances indicate that Star controls the room as it is built.
Crown is entitled to receive payments throughout the contract as evidenced by the
required progress payments (with no refund of payment for any work performed
to date) and by the requirement to pay for any partially completed work in the
event of contract termination. Consequently, Crown’s performance obligation is to
provide Star with construction services, and Crown would recognize revenue over
time throughout the construction process.
Scenario 2: Recognize revenue upon contract completion. The terms of the
contract and all the related facts and circumstances indicate that Star does not
obtain control of the gym until it is delivered. If the contract is terminated prior to
completion, Crown retains the equipment, suggesting that Crown retains control
of the equipment throughout the job. Consequently, Crown’s performance
obligation is to provide Star with a completed gym, and Crown would recognize
revenue upon contract completion.
Scenario 3: Recognize revenue over time. The terms of the contract and all the
related facts and circumstances indicate that Coco has the ability to direct the use
of, and receive the benefit from, the consulting services as they are performed.
The restaurant has an unconditional obligation to pay throughout the contract as
evidenced by the nonrefundable progress payments, and the right to a report
regardless of contract termination. Also, the report has no alternate use to
CostDriver. Therefore, the CostDriver Company’s performance obligation is to
provide the restaurant with services continuously during the three months of the
contract, and CostDriver should recognize revenue over the life of the contract.
Scenario 4: Recognize revenue upon contract completion. The terms of the
contract and all the related facts and circumstances indicate that Edwards, the
customer, obtains control of the apartment upon completion of the contract.
Edwards obtains title and physical possession of the apartment only on completion
of the contract. Consequently, Tower’s performance obligation is to provide the
customer with a completed apartment, and Tower should not recognize revenue
until delivery of the apartment.

Trueblood Accounting Case 6–6
A solution and extensive discussion materials can be obtained from the Deloitte
Foundation.
Judgment Case 6-7

No, the license and R&D development services are not separate performance
obligations. The license granted by Pfizer is for functional intellectual property, so
you might be tempted to recognize revenue upon the date of transfer. However, the
license is not a performance obligation, because it is not separately identifiable. The
only way to exploit the license is by utilizing ongoing R&D services from Pfizer.
The license does not provide utility on its own or together with other goods or
services that HealthPro has received previously from Pfizer or that are available
from other entities. Rather, the license requires Pfizer’s R&D services and
proprietary expertise to be valuable. Therefore, Pfizer would combine the license
with the R&D services to HealthPro and account for them as a single performance
obligation, with revenue recognized over time as Pfizer provides R&D services.

Communication Case 6–8
The critical question that student groups should address is how to account for
punches in the punch card and the option to possibly receive a free ice cream cone
that it provides. Students should benefit from participating in the process, interacting
first with other group members, then with the class as a whole.
The preferred solution should include the idea that the sale of an ice cream cone
to a person who has a card involves two performance obligations:
1. Providing the ice cream cone
2. Eventually providing an additional ice cream cone, if and when a customer
reaches 10 punches on a card and redeems the card for the free cone.
Students should recognize that each punch on the punch card contributes to an
option to receive a future ice cream cone. That option is capable of being distinct
because it could be sold or provided separate from selling a cone, and it is
separately identifiable, as it is not highly interrelated with selling a cone (for
example, cones certainly could be sold without offering the punch card program, and
in fact that is how Jerry’s currently does business). Therefore, each punch on the
punch card is distinct from the cone that is sold at the same time, and each punch
Students also should recognize that not all cards will be redeemed for ice cream
cones. Some may be lost, and some may never fill up with the required 10 punches.
Therefore, Jerry must estimate the chance that a punch results in a future ice cream
cone. He likely would come up with some estimate. For example, he might
conclude that half of all punches end up unused, such that a punch on average leads
to Jerry providing 1/20 of a free future cone. In that case, the revenue for each cone
should be allocated to the two performance obligations based on their stand-alone
selling prices, and a journal entry is recorded upon sale of a cone as follows:
Cash xxx
Sales Revenue xxx
Deferred revenue xxx

Case 6–8 (concluded)
In the future, when a card is redeemed, the deferred revenue account would be
reduced and revenue recognized for deferred revenue related to ten punches.
Sales of ice cream cones to people who do not have cards have only a single
performance obligation – to deliver the ice cream cone – and so can be accounted for
in the same manner as they were previously.
Other solutions that are likely to emerge:
1. Treat providing the occasional free cone as a cost of doing business and
don’t view provision of that cone as a separate performance obligation. The
idea here is that the deferral of revenue associated with the free cones is
time-consuming and is not likely to provide a material amount of additional
information to financial statement users. This approach would be an
immaterial departure from GAAP.
2. Ignore revenue recognition and instead accrue an estimated cost. This

solution views the free ice cream cone as a promotional expense. The
estimated cost of the free cone should be expensed as the 10 required cones
are sold. A corresponding liability is recorded which should increase to an
amount equal to the cost of the free cone. When the free cone is awarded, the
liability and inventory are reduced. This approach ignores the idea that there
is a revenue-recognition aspect to the promise of free cones, so is not
correct.
It’s important that each student actively participate in the process. Domination by
one or two individuals should be discouraged. Students should be encouraged to
contribute to the group discussion by (a) offering information on relevant issues, and
(b) clarifying or modifying ideas already expressed, or (c) suggesting alternative
direction.

Judgment Case 6-9
When other parties are involved in providing goods or services to a seller’s

customer, the seller must determine whether its performance obligation is to provide
the goods or services, making the seller a principal, or the seller arranges for another
party to provide those goods or services, making the seller an agent. That
determination affects whether the seller recognizes revenue in the amount of
consideration received in exchange for those goods or services (if principal) or in the
amount of any fee or commission received in exchange for arranging for the other
party to provide the goods or services (if agent).
Requirement 1
AuctionCo is a principal because it obtained control of the used bicycle before
the bicycle was sold. Therefore, AuctionCo should recognize revenue of $300 at the
time of the sale to the customer.
Requirement 2
AuctionCo is an agent because it never controlled the product before it was sold.
Therefore, AuctionCo should recognize revenue for the commission fees of $100
received upon sending $200 to the original owner at the time of the sale to the
customer.
Requirement 3
If AuctionCo must pay the bicycle owner the $200 price regardless of whether
the bicycle is sold, then AuctionCo would appear to have purchased the bicycle and
should be treated as a principal. Therefore, AuctionCo should recognize revenue of
$300 at the time of the sale to the customer.

Real World Case 6–10
Requirements 1 and 2
Excerpt from Expedia’s 2017 Annual Report:
Merchant Hotel. Our travelers pay us for merchant hotel transactions prior to
departing on their trip, generally when they book the reservation. We record the
payment in deferred merchant bookings until the stay occurs, at which point we
record the revenue. In certain nonrefundable, nonchangeable transactions where we
have no significant post-delivery obligations, we record revenue when the traveler
completes the transaction on our website, less a reserve for chargebacks and
cancellations based on historical experience. Amounts received from customers are
presented net of amounts paid to suppliers.
Excerpt from Booking Holding’s (Priceline) 2017 Annual Report:
Merchant revenues are derived from services where the Company facilitates
payments for the travel services provided. Name Your Own Price® travel
reservation services are presented in the income statement on a gross basis so
merchant revenue and cost of revenues include the reservation price to the customer
and the cost charged by the service provider, respectively (see "Recent Accounting
Pronouncements" described later in this footnote for accounting changes that are
effective January 1, 2018). For all other merchant transactions, the Company
presents merchant revenue on a net basis in the income statement.

Case 6–10 (continued)
Requirement 3
a) Expedia’s “merchant hotel” revenues:
This is reported net: “Amounts received from customers are presented net of
amounts paid to suppliers...”
b) Priceline’s “‘Name Your Own Price®’ services”:
This is reported gross: “Name Your Own Price® travel reservation services
are presented in the income statement on a gross basis so merchant revenue
and costs of revenues include the reservation price to the customer and the
cost charged by the service provider, respectively.”
c) Priceline’s “Merchant Retail Services”:
This is reported net: “The Company records the difference between the
reservation price to the consumer and the travel service provider cost to the
Company of its merchant retail reservation services on a net basis in
merchant revenue.”
Requirement 4
Students might argue this point both ways, as Priceline’s “Name your own
Price®” service has characteristics that differ from Expedia’s merchant hotel model.
Yet, both services are fundamentally offering hotel reservations, so it appears that
relatively similar services can be accounted for as gross or net depending on how
they are structured. Priceline’s “Name your own Price®” service appears similar to
services that Expedia might offer under its merchant hotel model, yet Priceline
would recognize revenue gross and Expedia would recognize revenue net. If similar
items are treated differently, comparability is reduced.

Foundation.

Research Case 6–12
Requirement 1
Considerations.”
Requirement 2
Considerations.”
The Codification lists the following indicators that the entity is a principal:
1. The entity is primarily responsible for fulfilling the contract.
2. The entity has inventory risk before or after the goods have been ordered by
a customer, during shipping, or on return.
3. The entity has discretion in establishing prices for the goods or services.
Requirements 3 and 4
Yes. Alphabet’s 2017 10K states: “For ads placed on Google Network
Members’ properties, we evaluate whether we are the principal (i.e., report revenues
on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report
advertising revenues for ads placed on Google Network Members’ properties on a
gross basis, that is, the amounts billed to our customers are recorded as revenues,
and amounts paid to Google Network Members are recorded as cost of revenues.
Where we are the principal, we control the advertising inventory before it is
transferred to our customers. Our control is evidenced by our sole ability to monetize
the advertising inventory before it is transferred to our customers, and is further
supported by us being primarily responsible to our customers and having a level of
discretion in establishing pricing. ” That is consistent with the indicators listed
above, so Alphabet’s reasoning appears appropriate.

Requirement 1
A bill and hold strategy accelerates the recognition of revenue. In this case,
sales that would normally have occurred in 1998 were recorded in 1997. Assuming a
positive gross profit on these sales, earnings in 1997 is inflated.
Requirement 2
A customer would probably not be expected to pay for goods purchased using
this bill and hold strategy until the goods were actually received. Receivables would
therefore increase.
Requirement 3
Sales that would normally have been recorded in 1998 were recorded in 1997.
This bill and hold strategy shifted sales revenue and therefore earnings from 1998 to
1997.
Requirement 4
Earnings quality refers to the ability of reported earnings (income) to predict a
company’s future earnings. Sunbeam’s earnings management strategy produced a
1997 earnings figure that was not indicative of the company’s future profit-
generating ability.

Judgment Case 6–14
Bill’s argument is that recognizing revenue upon project completion is
preferable because it is analogous to point of delivery revenue recognition. That is,
no revenue is recognized until the completed product is delivered. John’s argument
is that the important factor is the process of satisfying the performance obligation
and that revenue should be recognized as the process takes place.
John’s argument is correct. In situations when the earnings process takes
place over long periods of time, like long-term construction contracts, it is preferable
to recognize revenue over time, rather than to wait until the contract has been
completed.

Communication Case 6–15
Suggested Grading Concepts and Grading Scheme:
Content (70%)
_________ 25 Income differences.
 Revenue recognition over time recognizes gross profit during construction
based on an estimate of percent complete.
 If a project doesn’t qualify for revenue recognition over time, no gross
profit is recognized until project completion.
 Estimated losses are fully recognized in the first period an overall loss is
anticipated.
_________ 20 Balance sheet differences.
 The two approaches are similar. However, for profitable projects, the
construction in progress account during construction will have a higher
balance when revenue is recognized over time due to the inclusion of gross
profit.
__________ 25 According to generally accepted accounting principles, revenue should be
recognized over time if:
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.
The second and third of these situations likely apply to Willingham’s construction
contracts, so those contracts probably require revenue recognition over time.
_________
70 points
Writing (30%)
_________ 6 Terminology and tone appropriate to the audience of a company
controller.
_________ 12 Organization permits ease of understanding.
 Introduction that states purpose.
 Paragraphs that separate main points.
_________ 12 English
 Sentences grammatically clear and well organized, concise.
 Word selection.
 Spelling.
 Grammar and punctuation.
_________
30 points_

DATA ANALYTICS case
Your Tableau analysis should produce the following combination chart:

Data Analytics Case (continued)
Move your cursor to hover above various data points in the chart. Notice that an
information box appears to reveal the pertinent sales and return measures for that
company in that year.
Requirement 1
Which company exhibited more favorable receivables management, as measured
by sales return percentage, in 2012, Big Store or Discount Goods? What percent
of that company’s customer purchases were returned?
Big Store exhibited more favorable receivables management, as measured by

sales return percentage, in 2012. The sales return percentage for Big Store in
2012 was 6.3%. The sales return percentage for Discount Goods in 2012 was
9.1%.
Requirement 2
During the period 2013-2016, did Big Store’s sales return percentage become (a)
more favorable or (b) less favorable?
During the period 2013-2016, Big Store’s sales return percentage became more
favorable, decreasing steadily from 7.73% to 7%.

Data Analytics Case (concluded)
Requirement 3
During the period 2013-2016, did Discount Goods’ sales return percentage
become (a) more favorable or (b) less favorable?
During the period 2013-2016, Discount Goods’ sales return percentage became
less favorable, increasing steadily from about 8% to 9.6%.
Requirement 4
Which company exhibited more favorable receivables management, as measured
by sales return percentage, in 2021, Big Store or Discount Goods? What percent
of that company’s customer purchases were returned?
Big Store exhibited more favorable receivables management, as measured by

sales return percentage, in 2021. The sales return percentage for Big Store in
2021 was 9.38%. The sales return percentage for Discount Goods in 2021 was
14.93%.

Target Case
Requirement 1
Target reports Sales revenue of $71,879 million for the 2017 fiscal year, which
ended February 3, 2018.
Requirement 2
Recording revenue at the point of sale indicates that Target records revenue at the
point in time that customers receive goods or services. That is the point in time that
Target has fulfilled its performance obligation to deliver goods to customers.
Requirement 3
Target estimates returns as a percentage of sales based on historical return patterns,
and only includes net sales (reduced for estimated returns) in its income statement.
Therefore, estimated returns reduce revenue and net income. Those estimates
will be adjusted to reflect actual returns over time.
Requirement 4
It appears likely that Target is accounting for those arrangements as an agent,
because it is including “commissions earned on sales generated by leased
departments” within sales. If Target were accounting for those arrangements as a
principal, it would include gross revenue for those arrangements in sales.
Requirement 5
When a gift card is sold, Target recognizes a deferred revenue liability rather
than revenue, because it has not yet delivered goods or services to a customer.
Target will reduce the deferred revenue liability and recognize revenue either
when the gift card is redeemed or when, based on historical experience, Target
judges it to be “broken”, meaning that Target does not believe the gift card will
ever be redeemed.

Target Case (concluded)
Requirement 6
Target indicates that “Vendor income reduces either our inventory costs or SG&A
expenses based on the provisions of the arrangement. Under our compliance
programs, vendors are charged for merchandise shipments that do not meet our
requirements (violations), such as late or incomplete shipments. These allowances
are recorded when violations occur. Substantially all consideration received is
recorded as a reduction of cost of sales.” Thus, vendor income is really a refund of
some of the amount that Target is paying for goods or services. It reduces
Target’s costs, and so does not affect Target’s revenue. Likewise, because
Target’s cost is the same as the vendor’s revenue, these refunds serve to reduce
vendors’ revenue.

Air France–KLM Case
Requirement 1
a. AF’s balance sheet indicates current deferred revenue on ticket sales of
€2,889 million as of December 31, 2017.
b. The journal entry would be:

Sales revenue 2,889
c. This seems consistent with U.S. GAAP. A liability for deferred revenue is
recognized when tickets are purchased, and then the deferred revenue is
reduced and revenue is recognized when the transportation service is
provided.
Requirement 2
a. From note 4.7: “In accordance with the IFRIC 13, these ‘miles’ are
considered as distinct elements from a sale with multiple elements and one
part of the price of the initial sale of the airfare is allocated to these ‘miles’
and deferred until the Group’s commitments relating to these ‘miles’ has
been met.
The deferred amount due in relation to the acquisition of miles by members

is estimated:
- According to the fair value of the miles, defined as the amount at which
the benefits can be sold separately.
- After taking into account the redemption rate, corresponding to the
probability that the miles will be used by members, using a statistical
method.”
b. Per the balance sheet, AF has a liability for “Frequent flyer programs” of
€819 million.
c. AF’s approach is consistent with ASU No. 2014-09, in that the transaction
price for airfare is allocated to the performance obligations of (1) providing
the airfare and (2) providing future airfare or other goods and services upon
redemption of miles. The revenue associated with AF miles is deferred and
recognized separately from the revenue associated with the flights that
customers use to earn the miles.
SUPPLEMENT CASES
Judgment Case 6–16
Requirement 1
The three methods that could be used to recognize revenue and costs for this
situation are (1) point of delivery, (2) the installment sales method, and (3) the
cost recovery method.
2021 gross profit under the three methods:
(1) point of delivery:
$80,000 – $40,000 = $40,000
(2) installment sales method:
$40,000
= 50% = gross profit %
$80,000
50% x $30,000 (cash collected) = $15,000
(3) cost recovery method:
$0. No gross profit recognized since cost ($40,000) exceeds cash

collected ($30,000).

Case 6-16 (concluded)
Requirement 2
Customers sometimes are allowed to pay for purchases in installments over

long periods of time. Uncertainty about collection of a receivable normally increases
with the length of time allowed for payment. In most situations, the increased
uncertainty concerning the collection of cash from installment sales can be
accommodated satisfactorily by estimating uncollectible amounts. In these
situations, point of delivery revenue recognition should be used.
If, however, the installment sale creates a situation where there is significant
uncertainty concerning cash collection making it impossible to make an accurate
assessment of future bad debts, revenue and cost recognition should be delayed. The
installment sales method and the cost recovery method are available to handle such
situations. These methods should be used only in situations involving exceptional
uncertainty. The cost recovery method is the more conservative of the two.

IFRS Case 6–17
Vodafone’s revenue recognition policies for products and services are similar to
revenue recognition policies in the U.S. Sales of products are recorded when goods
have been put at the disposal of the customers in accordance with agreed terms of
delivery and when the risks and rewards of ownership have been transferred to the
buyer. Sales of services are recognized as the services are provided. Revenue for
multiple-deliverable contracts is allocated to separate deliverables based on relative
fair values. The terminology is somewhat different, but the end results, as compared
to U.S. policies, should be similar in most cases.
IFRS Case 6–18

Requirement 1
Per the revenue recognition section of ThyssenKrupp’s annual report for the
fiscal year ended September 30, 2015, note 1: Summary of Significant Accounting
Policies:
Revenue recognition
…Construction contract revenue and expense are accounted for using the
percentage-of-completion method, which recognizes revenue as performance of the
contract progresses. The contract progress is determined based on the percentage of
costs incurred to date to total estimated cost for each contract after giving effect to
the most recent estimates of total cost.
…Where the income of a construction contract cannot be estimated reliably,
contract revenue that is probable to be recovered is recognized to the extent of
contract costs incurred. Contract costs are recognized as expenses in the period in
which they are incurred.
Requirement 2
Similar accounting would be used under U.S. GAAP.

Foundation.

Foundation.

Requirement 3
The following is from the 2017 10-K of Jack in the Box, Inc. The responses to
the question will vary if the company has since changed its revenue recognition
policy.
 Initial franchise license fee revenue: Franchise development and license fees
are recorded as deferred revenue until we have substantially performed all of
our contractual obligations and the restaurant has opened for business.
 Continuing fees revenue: Franchise royalties are recorded in revenues on an
accrual basis. Among other things, a franchisee may be provided the use of
land and building, generally for a period of 20 years, and is required to pay
negotiated rent, property taxes, insurance and maintenance. Franchise rents
based on fixed rental payments are recognized as revenue over the term of the
lease. Certain franchise rents, which are contingent upon sales levels, are
recognized in the period in which the contingency is met.
Requirement 4
Answers to this question will, of course, vary because students will research
financial statements of different companies. Likely candidates for comparison
include most of the fast-food chains such as McDonald’s, and Wendy’s, and Arby’s.


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Chapter 6 Revenue Recognition

QUESTIONS FOR REVIEW OF KEY TOPICS

6–2 Intermediate Accounting, 10/e

We normally think of a contract as being specified in a written document, but

Solutions Manual, Vol.1, Chapter 6 6–3

6–4 Intermediate Accounting, 10/e

Solutions Manual, Vol.1, Chapter 6 6–5

6–6 Intermediate Accounting, 10/e

Solutions Manual, Vol.1, Chapter 6 6–7

6–8 Intermediate Accounting, 10/e

Solutions Manual, Vol.1, Chapter 6 6–9

Answers to Questions (continued)

Solutions Manual, Vol.1, Chapter 6 6–11

6–12 Intermediate Accounting, 10/e

Solutions Manual, Vol.1, Chapter 6 6–13

6–14 Intermediate Accounting, 10/e

Brief Exercise 6–2

Under Estate’s construction agreement with CyberB, if for any reason

Solutions Manual, Vol.1, Chapter 6 6–15

Journal entries (not required):

December 31, 2021 adjusting entry

6–16 Intermediate Accounting, 10/e

The journal entry is recorded as follows:

Brief Exercise 6–5

$0. Under U.S. GAAP, “probable” is defined as “likely to occur” or as

Solutions Manual, Vol.1, Chapter 6 6–17

$100,000. Under IFRS “probable” is defined as a likelihood that is greater than

Brief Exercise 6–7

Access to eLean services is one performance obligation. Registration on the

Brief Exercise 6–8

We need to consider three aspects of the vacuum contract: delivery of the

6–18 Intermediate Accounting, 10/e

We need to consider three aspects of the vacuum contract: delivery of the

Brief Exercise 6–10

In addition to the subscription, the renewal option is a performance obligation

Solutions Manual, Vol.1, Chapter 6 6–19

Brief Exercise 6-12

Brief Exercise 6-13

A right of return is not a performance obligation. Instead, the right of return

6–20 Intermediate Accounting, 10/e

Possible Amounts Probabilities Expected Amounts

Brief Exercise 6-15

Brief Exercise 6–16

Solutions Manual, Vol.1, Chapter 6 6–21

Brief Exercise 6–18

Brief Exercise 6–19

6–22 Intermediate Accounting, 10/e

Solutions Manual, Vol.1, Chapter 6 6–23

Brief Exercise 6–21

6–24 Intermediate Accounting, 10/e

Brief Exercise 6–23

Brief Exercise 6–24

Solutions Manual, Vol.1, Chapter 6 6–25

Brief Exercise 6–26

$190,000. The software is functional intellectual property and the license

6–26 Intermediate Accounting, 10/e

Brief Exercise 6–28

Brief Exercise 6–29

Brief Exercise 6–30

Solutions Manual, Vol.1, Chapter 6 6–27