Chapter 17 Flashcards
Leno Computers manufactures tablet computers for sale to retailers such as Fallon Electronics. Recently, Leno sold and delivered 200 tablet computers to Fallon for $20,000 on January 5, 2025. Fallon has agreed to pay for the 200 tablet computers within 30 days. Fallon has a good credit rating and should have no difficulty in making payment to Leno. (a) Explain whether a valid contract exists between Leno Computers and Fallon Electronics. (b) Assuming that Leno Computers has not yet delivered the tablet computers to Fallon Electronics, what might cause a valid contract not to exist between Leno and Fallon?
a) Apply the 5-step process:
- The contract has commercial substance–Fallon Electronics has agreed to pay cash fro the computers.
- The parties have approved the contract and are committed to perform–Fallon Electronics has made a commitment to purchase the computers and Leno has approved the selling of the computers. In fact, Leno has delivered the computers to Fallon.
- The identification of the rights of the parties–Fallon has the right to the computers and Leno has the right to payment.
- The identification of payment terms–Fallon has agreed to pay $20,000 within 30 days for the computers.
- it is probable that the consideration will be collected–although no cash has yet been paid by Fallon, Fallon has a good credit rating which indicates that the consideration will be collected.
b)
The contract may not be valid if the contract is wholly unperformed and each party can unilaterally terminate the contract without consideration. In addition, if Fallon has a poor credit rating and it is not probable that the consideration will be collected on the contract, a valid contract does not exist.
On May 10, 2025, Cosmo Co. enters into a contract to deliver a product to Greig Inc. on June 15, 2025. Greig agrees to pay the full contract price of $2,000 on July 15, 2025. The cost of the goods is $1,300. Cosmo delivers the product to Greig on June 15, 2025, and receives payment on July 15, 2025. Prepare the journal entries for Cosmo related to this contract. Either party may terminate the contract without compensation until one of the parties performs.
5/10/25: No entry, because neither party has performed under the contract and either party may terminate the contract without compensatory damages.
6/15/25:
D - Accounts Receivable: 2,000
C - Sales Revenue: 2,000
D - Cost of Goods Sold: 1,300
C - Inventory: 1,300
7/15/25:
D - Cash: 2,000
C - Accounts Receivable: 2,000
Hillside Company enters into a contract with Sanchez Inc. to provide a software license and 3 years of customer support. The customer-support services require specialized knowledge that only Hillside Company’s employees can perform. How many performance obligations are in the contract?
There is one performance obligation in this situation, which is providing of the licensed software and custom support together.
Destin Company signs a contract to manufacture a new 3D printer for $80,000. The contract includes installation which costs $4,000 and a maintenance agreement over the life of the printer at a cost of $10,000. The printer cannot be operated without the installation. Destin Company as well as other companies could provide the installation and maintenance agreement. What are Destin Company’s performance obligations in this contract?
Three performance obligations exist in this contract:
1) Manufacture of the 3-D-printer
2) Installation services
3) Maintenance Services
Ismail Construction enters into a contract to design and build a hospital. Ismail is responsible for the overall management of the project and identifies various goods and services to be provided, including engineering, site clearance, foundation, procurement, construction of the structure, piping and wiring, installation of equipment, and finishing. Does Ismail have a single performance obligation to the customer in this revenue arrangement? Explain.
Ismail accounts for the bundle of goods and services as a single performance obligation because the goods or services in the bundle are highly interrelated.
On May 1, 2025, Richardson Inc. entered into a contract to deliver one of its specialty mowers to Kickapoo Landscaping Co. The contract requires Kickapoo to pay the contract price of $900 in advance on May 15, 2025. Kickapoo pays Richardson on May 15, 2025, and Richardson delivers the mower (with cost of $575) on May 31, 2025.
a) Prepare the journal entry on May 1, 2025, for Richardson.
b) Prepare the journal entry on May 15, 2025, for Richardson.
c) Prepare the journal entry on May 31, 2025, for Richardson.
a) 5/1
No entry - neither party has performed on 5/1.
b) 5/15
D - Cash: 900
C - Unearned Sales Revenue: 900
c) 5/31
D - Unearned Sales Revenue: 900
C - Sales Revenue: 900
D - Cost of Goods Sold: 575
C - Inventory: 575
Nair Corp. enters into a contract with a customer to build an apartment building for $1,000,000. The customer hopes to rent apartments at the beginning of the school year and provides a performance bonus of $150,000 to be paid if the building is ready for rental beginning August 1, 2026. The bonus is reduced by $50,000 each week that completion is delayed. Nair commonly includes these completion bonuses in its contracts and, based on prior experience, estimates the following completion outcomes:
Completed by August 1, 2026: 70%
Completed by August 8, 2026: 20%
Completed by August 15, 2026: 5%
After August 15, 2026: 5%
Determine the transaction price for this contract.
8/1: 70% chance of 1,150,000 = 805,000
8/8: 20% chance of 1,100,000 = 220,000
8/15: 5% chance of 1,050,000 = 52,500
After 8/15: 5% chance of 1,000,000 = 50,000
805,000 + 220,000 + 52,500 + 50,000 =
The total transaction price is 1,127,500.
Nair Corp. enters into a contract with a customer to build an apartment building for $1,000,000. The customer hopes to rent apartments at the beginning of the school year and provides a performance bonus of $150,000 to be paid if the building is ready for rental beginning August 1, 2026. The bonus is reduced by $50,000 each week that completion is delayed. Nair commonly includes these completion bonuses in its contracts and, based on prior experience, estimates the following completion outcomes:
Completed by August 1, 2026: 70%
Completed by August 8, 2026: 20%
Completed by August 15, 2026: 5%
After August 15, 2026: 5%
Determine the transaction price for this contract.
Referring to the revenue arrangement in the above problem, determine the transaction price for the contract, assuming (a) Nair is only able to estimate whether the building can be completed by August 1, 2026, or not (Nair estimates that there is a 70% chance that the building will be completed by August 1, 2026), and (b) Nair has limited information with which to develop a reliable estimate of completion by the August 1, 2026, deadline.
a) In this situation, Nair uses the most likely amount as the estimate = 1,150,000.
b) When there is limited information with which to develop a reliable estimate of completion, then no revenue related to the incentive should be recognized until the uncertainty is resolved. Therefore, no revenue is recognized until the completion of the contract, with a transaction price of $1,000,000.
Presented below are three revenue recognition situations:
a) Groupo sells goods to MTN for $1,000,000, payment due at delivery.
b) Groupo sells goods on account to Grifols for $800,000, payment due in 30 days.
c) Groupo sells goods to Magnus for $500,000, payment due in two installments, the first installment payable in 18 months and the second payment due 6 months later. The present value of the future payments is $464,000.
Indicate the transaction price for each of these situations and when revenue will be recognized.
a) Groupo would recognize revenue of 1,000,000 at delivery.
b) Groupo would recognize revenue of 800,000 at the point of sale.
c) Groupo would recognize revenue of 464,000 at the point of sale and recognize interest revenue of 36,000 (500,000 - 464,000) over the payment period.
On July 10, 2025, Amodt Music sold CDs to retailers on account and recorded sales revenue of $700,000 (cost $560,000). Amodt grants the right to return CDs that do not sell in 3 months following delivery. Past experience indicates that the normal return rate is 15%. By October 11, 2025, retailers returned CDs to Amodt and were granted credit of $78,000. Prepare Amodt’s journal entries to record (a) the sale on July 10, 2025, and (b) $78,000 of returns on October 11, 2025, and on October 31, 2025. Assume that Amodt prepares financial statements on October 31, 2025.
a) 7/10
D - Accounts Receivable: 700,000
C - Sales Revenue: 700,000
D - Cost of Goods Sold: 560,000
C - Inventory: 560,000
b) 10/11
D - Sales Returns and Allowances: 78,000
C - Accounts Receivable: 78,000
D - Returned Inventory: 62,400
C - Cost of Goods Sold ((560,000 / 700,000) x 78,000): 62,400
c) 10/31
No entries are needed as the return period has expired.
