Revenue Recognition Flashcards
Challenge Questions
In 2020, Boeing entered into a long-term contract to manufacture a fleet of aircraft for the U.S. Air Force over five years. Which revenue recognition method should Boeing use, and what key factor determines this method under converged standards?
A. Recognize revenue when each aircraft is delivered; this is because each delivery is a distinct performance obligation.
B. Recognize revenue evenly over the contract duration because long-term contracts require evenly spread recognition.
C. Recognize revenue based on the percentage of completion, as Boeing’s performance obligation is satisfied over time and enhances the Air Force’s assets.
D. Recognize revenue only upon contract completion to avoid potential reversals due to the uncertainties of contract fulfillment.
Answer: C. Recognize revenue based on the percentage of completion, as Boeing’s performance obligation is satisfied over time and enhances the Air Force’s assets.
Explanation: Under IFRS and U.S. GAAP converged standards, revenue for long-term contracts like Boeing’s should be recognized over time if the performance obligation meets criteria such as enhancing an asset that the customer controls. Here, the percentage of completion method is appropriate because it reflects Boeing’s ongoing progress toward fulfilling its obligations.
Option A is incorrect because each aircraft delivery is not a separate obligation; the contract is for the entire fleet.
Option B is incorrect because revenue recognition is not evenly spread unless specifically required by contract terms.
Option D is incorrect as recognizing revenue only upon contract completion does not reflect the standard practices for long-term contracts under the converged standards.
Netflix offers both subscription-based streaming services and individual licensing deals for content with other distributors. Which aspect of the five-step revenue recognition process directly impacts how Netflix recognizes revenue from these licensing deals?
A. Identifying the separate performance obligations related to both subscriptions and licensing agreements.
B. Allocating revenue from all activities equally to smooth reported income over fiscal periods.
C. Recognizing revenue only when cash is received, regardless of the service provided.
D. Capitalizing all licensing revenues as long-term assets and recognizing them over a ten-year period.
Answer: A. Identifying the separate performance obligations related to both subscriptions and licensing agreements.
Explanation: Netflix must identify the distinct performance obligations for subscriptions versus licensing, which are separate deliverables under the revenue recognition standards. This step ensures accurate allocation of transaction prices and appropriate revenue timing.
Option B is incorrect because revenue is allocated based on the nature of each performance obligation, not evenly or arbitrarily.
Option C is incorrect; revenue recognition is not strictly tied to cash receipt but to satisfying performance obligations.
Option D is incorrect because licensing revenue is not capitalized as long-term assets but recognized based on performance obligation satisfaction.
A construction company based in Germany enters into a contract to build a custom-designed headquarters for a tech startup. Under IFRS 15, what conditions must be met for the construction firm to recognize revenue progressively over the contract term rather than at completion?
A. The startup receives benefits as the building is constructed, the asset is controlled by the startup, and there is no alternative use for the building.
B. The construction firm has the ability to alter the building design at any point without consulting the startup.
C. Revenue can only be recognized upon completion of each significant milestone as defined by the construction contract.
D. The construction company is allowed to recognize revenue when the full cost of materials is incurred.
Answer: A. The startup receives benefits as the building is constructed, the asset is controlled by the startup, and there is no alternative use for the building.
Explanation: Under IFRS 15, revenue can be recognized over time if the customer receives benefits as work is performed, controls the asset during construction, and the asset being created has no alternative use. This is typical for custom constructions where the customer gains control progressively.
Option B is incorrect because unilateral design changes do not directly affect revenue recognition.
Option C is incorrect as milestones are just one method; continuous control and benefit receipt by the customer drive recognition.
Option D is incorrect because recognizing revenue upon incurring costs is inconsistent without measuring progress toward fulfilling obligations.
Uber’s revenue model includes acting as an agent between riders and drivers, retaining a portion of the fare as a service fee. How should Uber recognize its revenue, and what implication does this have for its financial analysis compared to if it acted as a principal?
A. Recognize the entire fare as revenue and record the driver’s share as an expense, reflecting Uber’s role as a principal.
B. Recognize only its service fee as revenue, reflecting its role as an agent, leading to a much higher gross profit margin than if acting as a principal.
C. Recognize revenue when cash is collected from riders, matching the timing of service delivery.
D. Capitalize all fees as deferred income and amortize over the expected service period with drivers.
Answer: B. Recognize only its service fee as revenue, reflecting its role as an agent, leading to a much higher gross profit margin than if acting as a principal.
Explanation: As an agent, Uber reports only its service fee as revenue, leading to a higher gross profit margin because the revenue base is much lower compared to acting as a principal. This approach reflects Uber’s lack of inventory or service fulfillment responsibility directly, distinguishing it from a principal’s broader obligations.
Option A is incorrect because Uber does not act as a principal; it only facilitates the transaction.
Option C is incorrect as recognition timing focuses on performance obligations, not strictly cash receipt.
Option D is incorrect because service fees are not deferred but recognized as earned through transaction facilitation.
Under the converged revenue recognition standards, how should Microsoft recognize revenue from its Office 365 subscription service, which provides continuous software updates and support?
A. Recognize revenue upfront when the subscription is sold, as the license is immediately transferred to the customer.
B. Defer revenue recognition until the subscription period ends, ensuring no reversals.
C. Recognize revenue over the subscription period, reflecting the continuous obligation to provide updates and support.
D. Recognize revenue only if the software is physically installed on the customer’s devices.
Answer: C. Recognize revenue over the subscription period, reflecting the continuous obligation to provide updates and support.
Explanation: Microsoft’s Office 365 subscription involves continuous service, updates, and support, fitting the criteria for revenue recognition over the contract period. This aligns with IFRS and U.S. GAAP guidance for performance obligations that are fulfilled continuously rather than at a single point in time.
Option A is incorrect because the revenue is linked to ongoing service, not an immediate, one-time delivery.
Option B is incorrect as revenue recognition should coincide with service provision, not delayed until the end.
Option D is incorrect as the delivery model (cloud-based or installed) does not alter the recognition timing for subscriptions with ongoing obligations.
Tesla enters into a contract to deliver 100 electric vehicles (EVs) to a corporate client over two years. The contract price is $10 million, and Tesla estimates total costs at $6 million. By the end of the first year, Tesla has delivered 40 vehicles and incurred $2.4 million in costs. What amount of revenue should Tesla recognize at the end of the first year under the percentage of completion method?
A. $4 million
B. $4.8 million
C. $6 million
D. $5 million
Answer: B. $4.8 million
Explanation: Tesla recognizes revenue based on the percentage of costs incurred relative to total estimated costs, consistent with the percentage of completion method for long-term contracts.
Percentage of completion = $2.4 million / $6 million = 40%
Recognized revenue = 40% × $10 million = $4.8 million
Option A is incorrect as it represents 40% of the contract price, but without the correct application of the cost ratio.
Option C is incorrect as it incorrectly assumes recognition based on total costs, not percentage completion.
Option D incorrectly assumes a 50% completion rate, ignoring actual costs incurred.
Microsoft offers a software package sold as a license for $2 million upfront, with an additional $200,000 annually for support and updates. According to IFRS, how should Microsoft recognize the total revenue over a 5-year period if the license grants immediate software access but the updates are separate?
A. Recognize $2 million upfront and $200,000 per year as incurred.
B. Recognize $2.2 million evenly over 5 years.
C. Recognize $1 million upfront and defer $1 million over the license period.
D. Recognize the entire $3 million at the start of the contract.
Answer: A. Recognize $2 million upfront and $200,000 per year as incurred.
Explanation: The $2 million is for the immediate use of the software, which is recognized upfront. The $200,000 annual fee is a separate obligation for ongoing updates, recognized as incurred each year.
Option B incorrectly spreads the entire revenue over the contract term, misrepresenting the upfront license revenue.
Option C splits the license fee incorrectly without a basis for deferring half the initial amount.
Option D improperly recognizes the entire revenue at the outset, failing to separate the performance obligations.
A construction company is building a bridge for the city of San Francisco under a $50 million contract. By year-end, the company has incurred $20 million in costs, with an estimated total cost of $40 million. How much revenue should the company recognize at year-end?
A. $10 million
B. $20 million
C. $25 million
D. $30 million
Answer: C. $25 million
Explanation: Revenue is recognized using the percentage of completion method.
Percentage of completion = $20 million / $40 million = 50%
Recognized revenue = 50% × $50 million = $25 million
Option A represents half of the costs rather than revenue recognition.
Option B only accounts for costs, not revenue.
Option D assumes a higher percentage completion than achieved.
Apple offers a 3-year software subscription at $120,000 with annual software updates and technical support. If Apple recognizes $60,000 upfront for initial software delivery, how much should it recognize each year for updates and support?
A. $20,000
B. $40,000
C. $30,000
D. $60,000
Answer: C. $30,000
Explanation: Apple’s total subscription fee is $120,000. $60,000 is recognized upfront for the initial software, leaving $60,000 to be recognized evenly over three years for updates and support.
Annual recognition for updates and support = $60,000 / 3 years = $30,000 per year.
Option A underestimates the annual recognition, missing the correct allocation.
Option B allocates twice the correct amount per year.
Option D reflects a misunderstanding, assuming the entire balance is recognized annually.
A tech startup enters a 4-year contract with a customer for cloud-based software services, receiving $800,000 upfront. If the company recognizes revenue on a straight-line basis due to continuous service obligations, what is the amount of revenue recognized each year?
A. $100,000
B. $200,000
C. $400,000
D. $800,000
Answer: B. $200,000
Explanation: Revenue recognition on a straight-line basis distributes the upfront payment evenly over the 4-year contract period due to the continuous service nature of cloud-based solutions.
Annual recognized revenue = $800,000 / 4 years = $200,000 per year.
Option A is incorrect as it divides by an incorrect period.
Option C incorrectly suggests a 2-year recognition period.
Option D mistakenly assumes full recognition at once, contrary to the nature of the service provided.
A software company, TechSolutions, sells a software license for $600,000 and provides annual updates and technical support for $100,000 per year over a 3-year contract. According to the five-step revenue recognition process, how much revenue should TechSolutions recognize at the start of the contract and each year for the updates?
A. $600,000 upfront; $33,333 each year for updates.
B. $300,000 upfront; $200,000 each year for updates.
C. $400,000 upfront; $100,000 each year for updates.
D. $600,000 upfront; $100,000 each year for updates.
Answer: D. $600,000 upfront; $100,000 each year for updates.
Explanation: TechSolutions recognizes the license revenue of $600,000 at the start because the license is distinct and provides immediate benefit. The updates and support, which are separate performance obligations, are recognized as services are rendered each year.
Option A incorrectly spreads the license revenue, misinterpreting the nature of distinct performance obligations.
Option B incorrectly allocates revenue between the license and updates without appropriate criteria.
Option C underestimates the initial recognition, misaligning with distinct obligations.
A company, BuildPro, is contracted to construct a high-rise building over four years for $20 million. The total estimated cost is $15 million. In the first year, BuildPro incurs $3 million in costs. How much revenue should BuildPro recognize at the end of the first year using the percentage of completion method?
A. $5 million
B. $4 million
C. $3 million
D. $6 million
Answer: B. $4 million
Explanation: Revenue is recognized based on the proportion of costs incurred to total estimated costs.
Percentage of completion = $3 million / $15 million = 20%.
Recognized revenue = 20% × $20 million = $4 million.
Option A incorrectly assumes a 25% completion rate, not supported by costs incurred.
Option C reflects the costs, not the revenue.
Option D miscalculates completion percentage.
TravelMax acts as an agent, booking luxury vacations. A customer books a package for $50,000, and TravelMax earns a commission of $5,000. How much revenue should TravelMax report under the revenue recognition rules for agents?
A. $50,000
B. $5,000
C. $45,000
D. $0
Answer: B. $5,000
Explanation: As an agent, TravelMax recognizes revenue only equal to its commission, not the full transaction value.
Option A is incorrect as it represents the gross transaction, not applicable to agents.
Option C reflects the balance but does not align with agent-specific guidance.
Option D erroneously assumes no revenue recognition without understanding the commission aspect.
A franchisor, FastEats, grants a franchise to a new operator for a fee of $150,000 plus ongoing royalties of 3% of sales. If the franchisee’s sales in the first year are $2 million, how much revenue does FastEats recognize in the first year?
A. $150,000
B. $60,000
C. $210,000
D. $180,000
Answer: C. $210,000
Explanation: The revenue recognized includes the upfront franchise fee and the royalties from sales.
Royalty revenue = 3% of $2 million = $60,000.
Total revenue recognized = $150,000 + $60,000 = $210,000.
Option A overlooks ongoing royalties.
Option B miscalculates royalties only, ignoring the initial fee.
Option D underestimates total revenue, misrepresenting the franchise terms.
A company, SecureStorage, offers a 5-year data storage service for $250,000, paid upfront. According to revenue recognition standards, if the service obligation is performed evenly, how much revenue should SecureStorage recognize annually?
A. $50,000
B. $250,000
C. $25,000
D. $100,000
Answer: A. $50,000
Explanation: The revenue is recognized on a straight-line basis due to the even performance of the service over the contract term.
Annual recognized revenue = $250,000 / 5 years = $50,000.
Option B incorrectly assumes immediate recognition of the entire fee, contrary to service obligations.
Option C misinterprets the allocation, dividing by an incorrect period.
Option D doubles the correct amount, misunderstanding the service period.
