module 5

Question 1

general revenue recognition rules

Answer 1

Recognize revenue when the company transfers the good or service to
the customer
▪ When the customer obtains control of the good or service
▪ It is not necessary to receive cash to recognize revenue

Question 2

performance obligation

Answer 2

Every sale involves a contract (express or implied)
between the customer and the company whereby the
company agrees to transfer a good or service to the
customer and the customer agrees to pay for it.
▪ All that is necessary for the company to recognize
revenue is for the good to be transferred or the service
performed.
▪ It is at that point the company’s performance
obligation under the contract is satisfied and revenue
can be recognized.

Question 3

Sales on Credit

Answer 3

Many sales are on credit, meaning the customer has agreed
to pay the company in the future
▪ The company recognizes revenue when the good or service is
transferred to the customer, and records an account
receivable to be collected later
▪ Revenue recognition is unaffected by the delayed receipt of
cash if the company has fulfilled its performance obligation

Question 4

5 Steps of Revenue Recognition

Answer 4

1) Identify the contract(s) with the customer
2)Identify the performance obligation(s) in the contract
3) Determine the transaction price
4)Allocate the transaction price to the performance obligation(s)
5)Recognize revenue as/when each performance obligation is
satisfied

Question 5

Evidence that the performance obligation has been
satisfied occurs when the customer has …

Answer 5

Legal title to the good or has received the service.
▪ Physical possession of the good.
▪ Assumed the risks and rewards of owning the good or
receiving the service.
▪ Accepted the good or service and has an obligation to pay
the company.

Question 6

Nonrefundable up-front fees. (when revenue is recongnized)

Answer 6

Recognize as revenue when the
goods or services are provided (per contract terms)

Question 7

bill- and-hold arrangements

Answer 7

Recognize when control of the
goods transfers to the customer

Question 8

Consignment sales

Answer 8

Recognize commission when goods are
sold.

Question 9

Franchises

Answer 9

Recognize as the as the goods or services are
delivered.

Question 10

Variable Consideration

Answer 10

Recognize the expected amount to be
received when goods or services are provid

Question 11

Cost-to-Cost Method

Answer 11

Recognize revenue as a proportion of total costs incurred
to fulfill the contract

Question 12

prepayments by customer

Answer 12

When a company receives cash in advance of incurring costs
under the contract, it records a liability that represents the
obligation to deliver the product for which it has been paid.

Question 13

Costs paid in excess of billings

Answer 13

When a company incurs costs in excess of the amount it bills
the customer, it recognizes that excess as a current asset.

Question 14

Sales Allowences

Answer 14

Many companies offer customers a variety of sales
allowances, including
▪ Rights of return,
▪ Sales discounts for volume purchases, and
▪ Retailer promotions (point-of-sale price markdowns, and other
promotions).

Question 15

Three metrics to analyze sales allowances (slide 23)

Answer 15

1. Additions charged to Gross Sales
2. Allowance as Percentage of Gross Sales
3. Adequacy of the allowance amount

Question 16

Unearned deferred revenue

Answer 16

In some industries, it is common to receive cash before
recording revenue
▪ This creates a liability (Unearned Revenue) for the company’s
obligation to deliver a good or perform a service at a future date
▪ When the good is provided or the service rendered, the
unearned revenue liability is reduced and revenue is recognized

Question 17

Analysis of Unearned Revenue

Answer 17

If deferred revenue liabilities decrease, we infer the company’s
current reported revenue was collected from customers in a
prior accounting period and there have been fewer new
prepayments for which revenue will be recognized in the future

Question 18

The magnitude of accounts receivable is measured with the
following two ratios:

Answer 18

Accounts receivable turnover = Sales/
Average A/R
2) Days sales outstanding (DSO)= 365/
A/R Turnover

Question 19

When accounts receivable have grown more quickly than
sales, we observe:

Answer 19

▪ Lower accounts receivable turnover ratio
▪ Higher percentage of accounts receivable to sales
▪ Lengthening of the DSO
▪ Generally, such a trend is not favorable for two possible
reasons
▪ The company is becoming more lenient in granting credit to its
customers
▪ Credit quality is deteriorating

Question 20

Discontinued Operations

Answer 20

Companies often divest of business segments
▪ When this occurs, the company reports the event at the bottom
of the income statement by segregating income from continuing
versus discontinued operations
▪ The discontinued operations line item has two components
▪ Net income (or loss) from the segment’s business activities prior to the
divestiture
▪ Any gain (or loss) on the sale of the business

Question 21

transitory

Answer 21

Transitory items won’t recur and thus, they are largely
irrelevant to predicting future performance.
▪ Investors tend to focus on income from continuing
operations because that is the level of profitability that is
likely to persist (continue) into the future.