Chapter 4: Revenue Recognition and Statement of Income

Question 1

Income is composed of two elements:

Answer 1

revenue and gains

Question 2

Ordinary activities

Answer 2

A company’s normal, ongoing major business activities

Question 3

Revenues

Answer 3

defined as increases in economic benefits from a company’s ordinary operating activities

Question 4

gains

Answer 4

result in increases in economic benefits from activities that are outside the course of ordinary operating activities.

Question 5

Revenue is often referred to with other terms

Answer 5

such as sales, fees, interest, dividends, royalties, or rent.

Question 6

economic benefit

Answer 6

there does not have to be a receipt of cash in order for a company to recognize revenue. This is why the term economic benefit is used when defining revenue.

Question 7

company reports net income

Answer 7

When total revenues exceed total expenses

Question 8

if total expenses exceed total revenues

Answer 8

a company reports a net loss.

Question 9

When assessing revenues, financial statement users evaluate

Answer 9

both quantity and quality

Question 10

Quantity

Answer 10

the amount of revenue and whether or not the trend shows an increase or decrease over a number of accounting periods.

Question 11

Quality

Answer 11

refers to the source(s) of revenue and the company’s ability to sustain the revenue over the longer term.

Question 12

higher quality earnings

high quality, high-quality

Answer 12

If these two amounts are moving together (both up or both down) and if the cash flow from operating activities is greater than the net income,

(cash flow from operations (from the statement of cash flows) with net income (or net earnings))

Question 13

lower quality earnings

Answer 13

If the two amounts do not move together and if the cash flow from operating activities is less than the net income

Question 14

The revenue recognition approach also differs depending on whether a company is using

Answer 14

IFRS or ASPE

Question 15

There are two revenue recognition approaches

Answer 15

1) the contract-based approach (which is also known as the asset-liability approach)
2) the earnings-based approach

Question 16

Companies preparing their financial statements using IFRS must use:

Answer 16

the contract-based approach

Question 17

companies preparing their financial statements using ASPE must use:

Answer 17

the earnings-based approach

Question 18

Contract-Based Approach

Answer 18

the contract-based approach focuses on the contracts a company has with its customers

Question 19

Contract

Answer 19

an agreement between two or more parties that creates a combination of rights (the right to be paid by customers, which is also known as the right to receive consideration) and performance obligations (the requirement to provide goods or services to customers).

Question 20

Net position in a contract

Answer 20

An entity’s position in a contract that it is party to. Determined by comparing the entity’s rights under the contract with its performance obligations under the contract. May result in a contract asset, contract liability, or net nil position

Question 21

Under the contract-based approach revenues are recognized when:

Answer 21

a company’s net position in the contract increases; that is, when a company’s rights under the contract increase or when its performance obligations under the contract decrease.

Question 22

5 step model of Revenue Recognition

Answer 22

1) Identify the contract.
2) Identify the performance obligations.
3) Determine the transaction price.
4) Allocate the transaction price to performance obligations.
5) Recognize revenue when each performance obligation is satisfied.

Question 23

Identify the contract

Answer 23

A contract exists when all five of the following criteria are met:

There is a legally enforceable agreement between two or more parties.
It has been approved and the parties are committed to their obligations.
Each party’s rights to receive goods or services or payment for those goods and services can be identified.
The contract has commercial substance, meaning that the risk, timing, or amount of the company’s future cash flows is expected to change as a result of the contract.
Collection is considered probable.

Question 24

Commercial substance

Answer 24

meaning that the risk, timing, or amount of the company’s future cash flows is expected to change as a result of the contract.

Question 25

Identify the performance obligations

Answer 25

The contract must be analyzed to determine the performance obligation(s) contained in it.

These are the goods and/or services to be delivered to the customer and are sometimes referred to as the contract deliverables.

There may be a single performance obligation to provide goods or services, or multiple performance obligations in which goods or services will be delivered over a period of time.

Question 26

Distinct good or services

Answer 26

Goods or services are considered to be distinct if both of the following criteria are met:

The customer can benefit from the good or service (by using, consuming, or selling it) on its own or with other resources it possesses or can obtain from a third party.
The promise to transfer the goods or services is separate from other promised goods or services in the contract. That is, these goods or services are being purchased as separate items under the contract, rather than forming part of a larger good or service.

Question 27

Determine the transaction price

Answer 27

The transaction price is the amount of consideration the company expects to receive in exchange for providing the goods or services.

Question 28

Variable consideration

Answer 28

can result if there are discounts, refunds, rebates, price concessions, incentives, performance bonuses, penalties, and so on.

Question 29

sales discounts (or prompt payment discounts):

Answer 29

which provide the customer with a discount off the purchase price if they pay within a shorter period of time

Question 30

A typical sales discount is “2/10, n/30,”

Answer 30

which means that the customer could take a 2% discount if they paid within 10 days of purchase or, if this was not done, the net (or full) amount of the account would be due within 30 days.

Question 31

Allocate the transaction price to performance obligations.

Answer 31

If, in Step 2, only a single performance obligation was identified, then this step is not required. However, if multiple performance obligations were identified, then a portion of the transaction price determined in Step 3 must be allocated to each of them.

Question 32

stand-alone selling price

Answer 32

This is the price that the company would sell each good or service (that is, each performance obligation) for separately.

Question 33

Recognize revenue when each performance obligation is satisfied.

Answer 33

As each performance obligation is satisfied, the company recognizes revenue equal to the portion of the transaction price that has been allocated to it in Step 4.

Question 34

Performance obligations are satisfied when _______ of the goods or services are transferred to the customer.

Answer 34

control

Question 35

Control is transferred

Answer 35

if the customer has the ability to direct the use of the asset and obtain substantially all of the remaining benefits from it through its use, consumption, sale, and so on.

Question 36

Indicators that control has been transferred include the customer having:

Answer 36

physical possession
legal title
the risks and rewards of ownership
accepted the goods or received the services
an obligation to pay

Question 37

Private companies using ASPE to prepare their financial statements use an earnings-based approach rather that the contract-based approach to determine when revenue should be recognized.

Answer 37

Under the earnings-based approach, revenue is recognized when the earnings process is substantially complete.

Question 38

Revenue recognition criteria: Sale of goods

Answer 38

Revenue from the sale of goods can be recognized when all of the following criteria are met:

1. The risks and rewards of ownership have been transferred to the customer.
2. The seller has no continuing involvement or control over the goods.
3. The amount of consideration to be received can be measured with reasonable assurance.
4. Collection is reasonably assured.

Question 39

Revenue recognition criteria: Provision of services

Answer 39

Revenue from the provision of services can be recognized when all of the following criteria are met:

1. The service has been performed.
2. The amount of consideration to be received can be measured with reasonable assurance.
3. Collection is reasonably assured.

Question 40

The contract-based approach focuses on the

Answer 40

statement of financial position,

Question 41

Right of Returns

Answer 41

Many companies provide a period in which customers can return goods for a variety of reasons (such as they were the wrong goods or they arrived damaged).

If a company makes sales with a right of return, management must estimate the extent of expected returns because they affect the estimated transaction price (Step 3 of the five-step model).

Question 42

Types of Warranties

Answer 42

Assurance warranty

Service warranty

Question 43

Assurance warranty

Answer 43

Sometimes warranty coverage is included in the price of the product

Question 44

Service warranty

Answer 44

Customers may also be given the option to purchase separate warranty coverage

Question 45

Key points to warranties

Answer 45

Assurance warranties are not considered to be a separate performance obligation.

Service warranties are considered to be a separate performance obligation.

Service warranties are purchased separately, generally have a long term, and the seller is not legally required to provide them.

Question 46

Factors that indicate that the warranty is a service warranty include:

Answer 46

The warranty is priced or negotiated separately.

The warranty coverage period is longer. The longer it is, the more likely the warranty is a service warranty.

The warranty is not required by law.

Question 47

Consignment

Answer 47

The selling of goods on behalf of another party, usually for comission

Question 48

Consignor

Answer 48

The owner of goods sold on consignment by a consignee

Question 49

Consignee

Answer 49

A entity that sells goods on commission on behalf of consignors, receiving a commission when the goods are sold

Question 50

Factors that would indicate a consignment arrangement include:

Answer 50

The company transferring the goods continues to control them until a future sale occurs.
The company transferring the goods is able to require them to be returned.
The company receiving the goods does not have an obligation to pay for them until a future sale occurs.

Question 51

Third-Party Sales

Answer 51

Sometimes a company is involved in third-party sales, either selling goods on behalf of a third party or using a third party to sell its goods. Travel sites like Expedia are an example of this.

Question 52

Principal

Answer 52

The initial amount lent or borrower

Question 53

Agent

Answer 53

A company that arranges for a third party to provide a good or service to its customer. Agents receive a commission or fee for arranging the sale

Question 54

If the company is considered to be a principal,

Answer 54

then the transaction price (Step 3 of the five-step model) would be the gross amount.

Question 55

If the company is considered to be an agent

Answer 55

then the transaction price (Step 3 of the five-step model) would be the net amount.

Question 56

Factors that would indicate that a company is serving as agent rather than principal include:

Answer 56

A third party is responsible for providing the goods or services.
The company receives consideration in the form of a commission.
The company does not establish the prices of the goods or services.
The company has no risk related to holding inventory.

Question 57

There are two main formats that can be used to prepare a statement of income:

Answer 57

the single-step format and the multi-step format

Question 58

single-step format

Answer 58

A statement of income in which all revenues are listed in one section and all expense (except income tax) are listed in as second section
Order: Revenue, expenses,

Question 59

Multi-step statement of income

Answer 59

A statement of income in which revenues and expenses from different sources are shown in separate sections

Question 60

The Five Steps of the Multi-Step Statement of Income

Answer 60

1) Sales revenue (or revenue)
2) Gross profit (or gross margin)
3) Profit from operations (or operating income)
4) Profit before income tax expense
5) Net income (loss) or profit

Question 61

Statements of income prepared using a multi-step format present key measures

Answer 61

including gross profit and profit from operating activities, making analysis easier for decision makers.

Question 62

Comprehensive income

Answer 62

is the total change in the shareholders’ equity (or net assets) of the enterprise from non-owner sources. It is equal to net income plus other comprehensive income.

Question 63

Statement of comprehensive income

Answer 63

Financial statement showing net income plus other components of other comprehensive income, combined to produce the total comprehensive income

Question 64

Other comprehensive income

Answer 64

Changes in net asset values representing unrealized gains and losses, which are not included in net earnings but are included in comprehensive income

Question 65

Comprehensive income = Net income + other comprehensive income

Answer 65

Equation

Question 66

Comprehensive income includes gains and losses from revaluing financial statement items to fair value or from changes in foreign exchange rates.

Answer 66

Stated again

Question 67

Accounting standards offer companies the choice of presenting their expenses

Answer 67

by function or by nature

Question 68

Function

Answer 68

A method of organizing expenses on the statement of income by way of the activity (business function) for which they were incurred (such as cost of goods sold, administrative, and selling)
If chosen, must include the nature in notes to financial statements

Question 69

Nature

Answer 69

A method of organizing expenses on the statement of income by way of their natural classification (such as salaries, transportation, depreciation, and advertising)

Question 70

Earnings per share (EPS)

Answer 70

A ratio calculated by dividing the earnings for the period by the average number of shares outstanding during the period.

Question 71

basic earnings per share ratio

Answer 71

Net income−Preferred dividends
_________________________
Weighted average number of
common shares outstanding

Question 72

Gross margin

Answer 72

Sales revenue - cost of goods sold = Gross margin

Question 73

Operating expense

Answer 73

Things such as utilities expense, insurance expense, administration expense, distribution expense (do not include interest expense or interest revenue, or financing activities)

Question 74

Operating income =

Answer 74

Gross margin - operating expense

Question 75

In a single-step statement of income, interest collected on investments is reported as a non-operating revenue. True or flase?

Answer 75

False

Question 76

Which statement of income format(s) do/does accounting standards allow?

Answer 76

Both ASPE and IFRS allow either format.

Question 77

Under the ________, accounting revenues are recognized when they are earned regardless of whether the related cash was received by the company.

Answer 77

accrual basis

Question 78

Financial statement users can find information about a company’s approach to revenue recognition in the ________ to its financial statements

Answer 78

Notes