5 | Income Measurement & Profitability Analysis Flashcards
1
Q
The Balance Sheet is a statement of…
A
financial position that reports the assets, liabilities, and stockholder’s equity of a business enterprise at a specific date.
2
Q
Liquidity refers to the…
A
amount of time that is expected to elapse until an asset is realized or otherwise converted into cash or until a liability has to be paid.
How quickly an asset can be turned into cash to cover current obligations
3
Q
Solvency refers to the…
A
…ability of a company to pay it’s debts as they mature.
4
Q
Revenue Recognition
Which 2 criterias has to be satisfied before revenue can be recognized/recorded?
A
- The earnings process is judged complete or virtually complete.
- There is reasonable certainty as to the collectability of the asset to be received (usually cash)
5
Q
Revenue Recognition
According to the FASB, “Revenues are…
A
…inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
6
Q
Revenue Recognition
Give the Staff Accounting Bulletin (SAB) No. 101 and later 104 that provides 4 additional criteria for judging whether or the realization principle is satisfied.
A
- Persuasive evidence of an arrangement exists
- Delivery has occurred or services have been rendered
- The seller’s price to the buyer is fixed or determinable
- Collectibility is reasonably assured.
7
Q
Revenue Recognition
What is the difference between cost & expense?
A
When you buy an asset - it is a cost.
When you use the benefit of the asset - it is an expense.
7
Q
Revenue Recognition Methods
At delivery during delivery cycle use…
A
…completed contract method
8
Q
Revenue Recognition Methods
Prior to delivery during production cycle use…
A
…Percentage of Completion Method
9
Q
Revenue Recognition Methods
After delivery during collection cycle use…
A
…installment or cost recovery method.
10
Q
Revenue Recognition Methods
If collectibility is an issue, we defer revenue recognition until…
A
…we can reasonably estimate the amount to be received.
11
Q
Revenue Recognition Methods | IFRS vs GAAP
Revenue Recognition Concepts
A
Definition of revenue is very similar.
Condition to recognize revenue is different but typically leads to recognition at the same time & amount.
Exceptions occur, such as multiple-deliverable contracts since IFRS has less industry specific guidance
12
Q
Revenue Recognition | Product
The point of delivery refers to the date…
A
…legal title to the product passes from seller to buyer.
13
Q
Revenue Recgonition
Revenue is earned throughout the earnings process. The critical event is…
A
…the point in time when the realization principle is satified.
14
Q
Revenue Recognition | Product
List the 4 significant uncertainties that remain after the product is produced
A
1) Will it be sold
2) For how much will it be sold
3) To whom will it be sold
4) Collectability of assets
15
Q
Revenue Recognition | Product
Because of significant uncertainties after product production - revenue recognition is usually delayed until….
A
…point of sale, at product delivery.
16
Q
Revenue Recognition | Product
Product delivery date occurs when legal title to the goods passes from seller to buyer, which depends on…
A
…the terms of the agreement (f.o.b. shipping point / f.o.b. destination)
17
Q
Revenue Recognition | Product
f.o.b. shipping point means…
A
Free On Board Shipping Point
Legal Title to the goods changes hands at poing of shipment
Purchaser is responsible for shipping costs & transit insurance
18
Q
Revenue Recognition | Product
f.o.b. destination means…
A
Free On Board Destination
Legal Title to the goods changes hands at the customer’s location
Seller is responsible for shipping costs & transit insurance
19
Q
Revenue Recognition | Product
At product delivery date, we know the product has been sold, the price, and the buyer. The only remaining uncertainty at the time of delivery involves…
A
…the ultimate cash collection or and product return.
20
Q
Revenue Recognition | Service
Service revenue is often recognized at a point in time if there is…
A
…one final activity that is deemd critical to the earnings process, in this calse, all revenue is deferred until this final activity is performed.
21
Q
Revenue Recognition | Service
Give an example of a service company that recognizes revenue until the completion of a act critical to the earnings process.
A
A moving company does not recognize revenue until the goods have been delivered.
22
Q
Revenue Recognition | Service
Give an example of a service company that recognizes revenue over time as service is performed.
A
Renting an office space.
24
Q
Revenue Recognition | Principal vs Agent
An agent doesn’t control goods or services, but rather…
A
…facilitates transfers between sellers and buyers for a commission.
25
Revenue Recognition | Principal vs Agent
A principal...
... has primary responsibility of goods/services
- for delivering
- associated risks
- for collecting payment
26
Revenue Recognition | Principal vs Agent
What amount of revenue does a principal company recognize?
The gross(total) amount received from the customer.
27
Revenue Recognition | Principal vs Agent
What amount of revenue does an agent company recognize?
The net commission amount received for facilitating the sale.
28
Revenue Recognition | Principal vs Agent
Give 3 additional indicators for determining 'principal' status. The Company...
1) ...has primary responsibiity for providing product/service
2) ...owns inventory prior to order & after customer returns it.
3) ...has discretion in price-setting and identifying suppliers
29
Revenue Recognition | After Delivery
What are 'Installment Sales'?
When customers are allowed to pay for purchases in installments over a long period of time.
30
Revenue Recognition | After Delivery
Uncertainty concerning cash collection can be accomodated satisfactorily by...
...estimating uncollectible amounts.
31
Revenue Recognition | After Delivery
If there is significant uncertainty concerning cash collection, making bad debt estimate impossible,...
...revenue/expense recognition should be delayed.
32
Revenue Recognition | After Delivery
Give an example of an Installment Sale
Real Estate Sales
33
Revenue Recognition | After Delivery
GAAP requires the installment sales method to be applied to a...
...retail land sale that meets certain criteria.
34
Revenue Recognition | After Delivery
When extreme uncertainty exists regarding cash collection, delay revenue/expense recognition by using one of these 2 methods.
1) Installment Sales Method
| 2) Cost Recovery Method
35
Revenue Recognition | After Delivery
Name the 2 components 'The Installment Sales Method' divides each payment into.
1) Partial recovery of cost
| 2) Partial recovery of gross profit
36
Revenue Recognition | After Delivery
'The Installment Sales Method' divides each payment using the...
'Gross Profit Percentage' (Gross Profit / Sales) applicable to the sale.
37
Revenue Recognition | After Delivery
The initial journal entry of an 'Installment Sale"
DB Intallment Receivables (full sale amount)
CR Inventory (full COGS amount)
CR Deferred Gross Profit (Difference)
38
Revenue Recognition | After Delivery
When using 'The Installment Sale Method' - 'deferred gross profit' is a contra account to ...
... 'installment receivables'
39
Revenue Recognition | After Delivery
Payments received using "The Instalmment Sale Method' are recorded ...
DB Cash (full amount)
CR Installment Receivables (full amount)
DB Deferred Gross Profit (profit %)
CR Realized Gross Profit (profit %)
Cost is not realized incrementally.
40
Revenue Recognition | After Delivery
Sales and COGS associated with Installment Sales are not usually reported in the Income Statement under the Installment Method, just...
...the resulting gross profit.
41
Revenue Recognition | After Delivery
A company uses the installment method when it can't reliably...
...estimate bad debts
42
Revenue Recognition | After Delivery
The Installement Method does not account for Bad Debt and ...
defers gross profit until cash is collected.
43
Revenue Recognition | After Delivery
The 'Cost Recovery Method' defers all gross profit recognition until...
....cash equal to the cost of the item sold has been received.
44
Revenue Recognition | After Delivery
Under the 'Cost Recovery Method' the journal entry to record the sale is the same as the 'Installement Sales Method' - what is it?
DB Installment receivables (sale amount)
CR Inventory (COGS)
CR Deferred Gross Profit (the diff.)
45
Revenue Recognition | After Delivery
Under the 'Cost Recovery Method' the journal entry to record payments until COGS is covered is?
```
DB Cash (full amount)
CR Installment Receivables (full amount)
```
No revenue is recognized until COGS is covered.
46
Revenue Recognition | After Delivery
Under the 'Cost Recovery Method' the journal entry to record payments once COGS is covered is?
```
DB Cash (full amount)
CR Installment Receviables (full Amount)
```
DB Deferred gross profit (amount after COGS)
CR Realized gross profit (amount after COGS)
47
Revenue Recognition | After Delivery
Retailers who give the 'right to return' can recognize revenues/expenses at 'point of delivery' as long as...
...they estimate (based on history) returns for a given volume of sales and meet specific criteria.
48
Revenue Recognition | After Delivery
Estimates of Returns are used to...
... reduce sales and COGS in anticipation of returns in order to
- avoid overstating gross profit in period of sale
- avoid understating gross profit in period of return
49
Revenue Recognition | After Delivery
What is an important part of the agreement between buyer and seller?
Customer acceptance.
50
Revenue Recognition | After Delivery
Anytime a company recognizes revenue at a point other than 'point of delivery', ...
...the revenue recognition method used is disclosed in the summary of significant accounting policies.
51
Revenue Recognition | Consignment Sales
The Consignor is the?
Company that retains legal rights / owns the product.
52
Revenue Recogntion | Consignment Sales
The Consignee is the?
Company that sells another companie's product for a commission.
53
Revenue Recognition | Consignment Sales
Consigned inventory stays in the balance sheet of?
The Consignor (company that owns the product)
54
Revenue Recognition | Consignment Sales
The Consignor does not record a sale unless/until the...
...consignee sells the goods and title passes to eventual customer.
55
Revenue Recognition | Prior to Delivery
The 'Completed Contract Method' recognizes revenue...
...at a point in time when the earnings process is complete.
56
Revenue Recognition | Prior to Delivery
The 'Percentage of Completion Method" recognizes revenue...
...by allocating a share of the project's revenues/expenses to each reporting period as construction occurs.
57
Revenue Recognition | Prior to Delivery
IFRS & GAAP both require the percentage-of-completioin method unless...
Estimates of the following are not possible:
1. Revenues
2. Expenses
3. Progress towards completion
58
Revenue Recognition | Prior to Delivery
US GAAP requires the percentage-of-completion method be used whenever (3)...
1) Estimats can be made of revenues/costs
2) Contract specifies parties' rights, consideration to be pid, & payment terms.
3) Purchaser & seller have ability & expectation to fulfill obligations under contract
59
Revenue Recognition | Prior to Delivery
Which method allows for earlier recognition of revenue and profits, percentage-of-completion of completed-contract method?
Percentage-of-completion
60
Revenue Recognition | Prior to Delivery
All costs incurred in the construction process are initially recorded in an asset account called....
...'Construction in Protress'
The equivalent to Work-In-Progress in Manufacturing.
The Construction Project is an inventory item in process
61
Revenue Recognition | Prior to Delivery
Accounting for costs, billings, and cash receipts are the same for both...
...percentage-of-completion and completed contract method.
62
Revenue Recognition | Prior to Delivery
Periodc billings are credited to...
..."billings on construction contract"
A contra account to 'Construction In Progress"
63
Revenue Recognition | Prior to Delivery
'Billings on Construction Contract' prevents "double counting" assets by...
...reducing 'Construction In Progress" whenever an 'Accounts Receivable' is recognized.
64
Revenue Recognition | Prior to Delivery
At the end of each period, the balances of which two accounts are compared?
'Billings on Construction' and 'Construction in Progress'
65
Revenue Recognition | Prior to Delivery
If the net of 'Billings on Construction' and 'Construction in Progress' is a debit, it is reported in the Balance Sheet as an...
...asset.
66
Revenue Recognition | Prior to Delivery
If the net of 'Billings on Construction' and 'Construction in Progress' is a credit, it is reported in the Balance Sheet as an...
...liability. (you've billed for more than you've built so far)
67
Revenue Recognition | Prior to Delivery
'Billings on Construction Contract' is also known as?
'Billings'
68
Revenue Recognition | Prior to Delivery
On a Short-Term Sale - the Physical Asset (Goods) is removed from the Balance Sheet when...
...the Financial Asset (Revenue) is recognized.
69
Revenue Recognition | Prior to Delivery
On aLong-Term Comntract - the Physical Asset (Goods)...
...remains on the Balance Sheet when the Financial Asset (Revenue) is recognized. 'Billings' solves this 'double counting' problem.
70
Revenue Recognition | Prior to Delivery
Journal entries for for costs, billings, & cash receipts are the same for the 'Completed Contract' and the 'percentage-of-completion'.
What is the journal entry for construction costs?
DB Construction In Progress
| CR Cash, Materials, etc
71
Revenue Recognition | Prior to Delivery
Journal entries for for costs, billings, & cash receipts are the same for the 'Completed Contract' and the 'percentage-of-completion'.
What is the journal entry for construction billing?
DB Accounts Receivable
| CR Billing On Construction Contract
72
Revenue Recognition | Prior to Delivery
Journal entries for for costs, billings, & cash receipts are the same for the 'Completed Contract' and the 'percentage-of-completion'.
What is the journal entry for cash collected?
DB Cash
| CR Accounts Receivable
73
Revenue Recognition | Prior to Delivery
Journal entries for revenue recognition are the same for the 'Completed Contract' and the 'percentage-of-completion' (only the timing & amounts differ).
What are the journal entries for revenue recognition?
DB Construction In Progress
DB Cost of Construction
CR Revenue from long-term contracts
74
Revenue Recognition | Prior to Delivery
Journal entries to close 'Billings' and 'Construction In Progress' (and transfer title to customer) are the same for the 'Completed Contract' and the 'percentage-of-completion'.
What is the journal entry to close these two accounts?
DB Billings On Construction
| CR Construction In Progress
75
Revenue Recognition | Prior to Delivery
Why do both, the 'Completed Contract' and 'Percentage-of-Completion' Methods add 'Gross Profit' to 'Construction In Porgress'?
In essence, the company sold a portion of the asset, by adding the revenue to the inventory - updates the current value of the asset.
(cost + gross profit = sale price)
76
Revenue Recognition | Prior to Delivery
Under the 'Completed Contract Method' - profit is recognized...
...when the project is completed.
77
Revenue Recognition | Prior to Delivery
Under the 'Percentage-of-Completion Method' - profit is recognized...
...over the life of the project as the project is completed.
78
Revenue Recognition | Prior to Delivery
What is the most common measure of progress used under the 'Percentage-of-Completion Method'?
Cost-to-cost ratio
79
Revenue Recognition | Prior to Delivery
What is the cost-to-cost ratio?
Measures progress as the rato of total estimated costs vs costs incurred to date.
80
Revenue Recognition | Prior to Delivery
How do you calculate Gross Profit?
Total Est. Gross Profit x % Completed - Prior Gross Profit
81
Revenue Recognition | Prior to Delivery
Under the 'Percentage-of-Completion Method, 'Construction In Progress' is updated each period to include...
...Gross Profit.
82
Revenue Recognition | Prior to Delivery
In the Balance Sheet, 'Construction in Progress' (CIP) (containing costs and profit) is offset against...
'Billings on Construction'.
83
Revenue Recognition | Prior to Delivery
When 'Construction in Progress' (CIP) is greater than 'Billings' - it is reported on the Balance Sheet as...
...an Asset.
84
Revenue Recognition | Prior to Delivery
When 'Construction in Progress' (CIP) is less than 'Billings' - it is reported on the Balance Sheet as...
...a Liability.
85
Revenue Recognition | Prior to Delivery
When 'Construction in Progress' (CIP) is greater than 'Billings' - companies report in on the Balance Sheet as...
...a component of A/R, Inventory, or on its own.
86
Revenue Recognition | Prior to Delivery
The method used to account for long-term contracts must be dsiclosed in...
...the 'Summary of Significant Accounting Policies'
87
Revenue Recognition | Prior to Delivery
Whether you use the 'Percentage-of-Completion' method or the Completed Contract Method - once an overall loss on the project is porjected...
...the total loss amount must be recognized in the period that projection occurs.
88
Revenue Recognition | Prior to Delivery
When using the 'percentage-of-completion method' a periodic loss for a profitable project - revenue is determined...
...the same as in profitable years.
89
Revenue Recognition | IFRS vs GAAP
Both require the use of this method for Revenue recognition for long-term contracts when reliable estimates are avaialbe.
Percentage-of-Completion Method
90
Revenue Recognition | IFRS vs GAAP
When reliable estimates are not available for revenue recognition on long-term contracts - what does GAAP require and what does IFRS require?
GAAP requires the Completed Contract Method
| IFRS requires the Cost Recovery Method
91
Revenue Recognition | Industry-Specific Revenue Issues
GAAP indicates that if a software arrangement includes multiple elements, the revenue from the arrangement should be allocated to the various elements based on...
..."vendor-specific objective evidence" (VSOE) of fair values of the individual elements.
92
Revenue Recognition | Industry-Specific Revenue Issues
VSOE stands for
Vendor Specific Objective Evidence
93
Revenue Recognition | Industry-Specific Revenue Issues
VSOE pertains to which industry?
Software and Other Multiple-Element Arrangements
94
Revenue Recognition | Industry-Specific Revenue Issues
The VSOE of fair values are the...
...sales prices of the leements when sold separately by that vendor.
95
Revenue Recognition | Industry-Specific Revenue Issues
If VSOE doesn't exsit, for Software and Other Multiple Deliverable Arrangements, revenue recognition...
...is deferred until VSOE is available or until all elements of the arrangement is delivered.
96
Revenue Recognition | GAAP vs IFRS
Multiple-Deliverable Arrangements
GAAP - VSOE
IFRS - little guidance. IAS No. 18 states "...in certain circustances, it is necessary to apply the recognition criteri to the separately idenfiable components of a single transaction in order to reflect the substance of the transaction"
97
Revenue Recognition | Franchise Sales
The Franchisor is...
...the corporation that sell's the right to use its name/product to the franchisee.
98
Revenue Recognition | Franchise Sales
The Franchisee is...
...the individual that buys the right to use the frinchisor's name/product.
99
Revenue Recognition | Franchise Sales
Give the two common Franchise Fees
1) Initial Franchise Fee
| 2) Continuing Franchise Fees
100
Revenue Recognition | Franchise Sales
List 4 services commonly included for the Initial Franchise Fee.
1) the right to use name/product
2) assistance in finding location
3) constructing facilities
4) training employees
101
Revenue Recognition | Franchise Sales
The Initial Franchise Fee is usually a...
...fixed amount that can be made in installments.
102
Revenue Recognition | Franchise Sales
FASB states that franchise fee revenue shall be recognized,...
with appropriate provision for bad debt, when all material services/conditions have been performed.
103
Revenue Recognition | Franchise Sales
If uncollectibility of the Initial Franchise Fee due in installments can not be estimated, even after substantial performance occurred, revenue is recognized using...
Installment Sales or Cost Recovery Method.
104
Profitability Analysis | Actiity Ratios
Activity Ratios measure a company's...
...efficiency in managing its assets.
105
Profitability Analysis | Activity Ratios
Given that a company incurs cost to finance assets, the greater the number of times an asset turns over,
the fewer assets are required to maintain a given level of activity/revenue.
High turnovers are ususally attractive.
106
Profitability Analysis | Activity Ratios
Asset Turnover Ratio =
Net Sales
_________________
Average Total Assets
(Beg & End Bal) / 2
107
Profitability Analysis | Activity Ratios
Receivables Turnover Ratio =
Net Sales
_______________________________________
Average Accounts Receivables
(Gross A/R - Allow/ for Bad Debts) Beg & End / 2
108
Profitability Analysis | Activity Ratios
The Receivables Turnover Ratio shows..
...how quickly a company is able to collect its accounts receivable. The higher the ratio, the shorter the average time between sale and cash.
109
Profitability Analysis | Activity Ratios
Average Collection Period =
365
_______________________
Receivables Turnover Ratio
110
Profitability Analysis | Activity Ratios
The Average Collection Period is the...
...approximate number of days the average accounts receivable balance is outstanding.
111
Profitability Analysis | Activity Ratios
The Inventory Turnover Ratio shows...
...the number of times the average inventory balance is sold during a particular period. How quickly inventory is sold.
112
Profitability Analysis | Activity Ratios
Inventory Turnover Ratio =
COGS
_______________
Average Inventory
113
Profitiability Analysis | Activity Ratios
The Average Days in Inventory indicates...
...the number of days it normally takes to sell inventory.
114
Profitabiity Analysis | Activity Ratios
Average days in inventory =
365
___________________
Inventory turnover ratio
115
Profitability Analysis | Profitabiity ratios
Profitability ratios assist in evaluating...
...various aspects of the company's proft-making activities.
116
Profitability Analysis | Profitability ratios
What are the 3 common profitability measures
1) Profit margin on sales
2) Return on Assets
3) Return on Shareholder's Equity
117
Profitability Analyis | Profitability ratios
The Profit Margin on Sales Ratio measures..
...the amount of net income achieved per sales dollar.
118
Profitability Analysis | Profitability ratios
Profit Margin on Sales =
Net Income
__________
Net Sales
119
Profitability Analysis | Profitability ratios
Return on Total Assets (ROA) expresses...
income as a percentage of the average total assets available to generate that income.
120
Profitabiity Analysis | Profitability ratios
ROA stands for?
Return On Assets
121
Profitability Analysis | Profitability ratios
Return on Assets (ROA) =
Net Income
______________
Avg Total Assets
122
Profitability Analysis | Profitability ratios
Return on shareholder's equity measures...
the return to suppliers of equity capital.
123
Profitability Analysis | Profitability ratios
ROE stands for?
Return on sharehoder's Equity
124
Profitability Analysis | Profitability ratios
Return on Equity (ROE) =
Net Income
_____________________
Avg. Shareholders' Equity
125
Profitability Analysis | Profitability ratios
What does the DuPont framework show?
It shows that return on equity depends on profitabiity, activity, and financial leverage.
