Accounting Chapter 18 Wiley Questions - Test 2

3. Describe the revenue recognition principle. - ANS 3. The revenue recognition principle indicates that revenue is recognized in the accounting period when a performance obligation is satisfied. That is, a company recognizes revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it receives, or expects to receive, in exchange for those goods or services. 4. Identify the five steps in the revenue recognition process. - ANS 4. The five steps in the revenue recognition process are: 1.Identify the contract(s) with customers. 2.Identify the separate performance obligations in the contract. 3.Determine the transaction price. 4.Allocate the transaction price to the separate performance obligations. 5.Recognize revenue when each performance obligation is satisfied. 5. Describe the critical factor in evaluating whether a performance obligation is satisfied. - ANS 5. Change in control is the deciding factor in determining when a performance obligation is satisfied. Control is transferred when the customer has the ability to direct the use of and obtain substantially all the remaining benefits from the asset or service. Control is also indicated if the customer has the ability to prevent other companies from directing the use of, or receiving the benefit, from the asset or service. 9. What is a performance obligation? Under what conditions does a performance obligation exist? - ANS 9. A performance obligation is a promise in a contract to provide a product or service to a customer. This promise may be explicit, implicit, or possibly based on customary business practice. To determine whether a performance obligation exists, the company must determine whether the customer can benefit from the good or service on its own or together with other readily available resources. 20. When does a company satisfy a performance obligation? Identify the indicators of satisfaction of a performance obligation. - ANS 20. A company satisfies its performance obligation when the customer obtains control of the good or service. Indications that the customer has obtained control are: 1.The company has a right to payment for the asset. 2.The company transferred legal title to the asset. 3.The company transferred physical possession of the asset. 4.The customer has significant risks and rewards of ownership. 5.The customer has accepted the asset. 21. Under what conditions does a company recognize revenue over a period of time? - ANS 21.Companies satisfy performance obligations either at a point in time or over a period of time. Companies recognize revenue over a period of time if one of the following three criteria is met: 1.The customer receives and consumes the benefits as the seller performs. 2.The customer controls the asset as it is created or enhanced (e.g., a builder constructs a building on a customer's property). 3.The company does not have an alternative use for the asset created or enhanced (e.g., an aircraft manufacturer builds specialty jets to a customer's specifications) and either (a) the customer receives benefits as the company performs and therefore the task would not need to be re-performed, or (b) the company has a right to payment and this right is enforceable. 22. How do companies recognize revenue from a performance obligation over time? - ANS 22. A company recognizes revenue from a performance obligation over time by measuring the progress toward completion. The method selected for measuring progress should depict the transfer of control from the company to the customer. The most common are the cost-to-cost and units-of-delivery methods. The objective of these methods is to measure the extent of progress in terms of costs, units, or value added. Companies identify the various measures (costs incurred, labor hours worked, tons produced, floors completed, etc.) and classify them as input or output measures. Input measures (costs incurred, labor hours worked) are efforts devoted to a contract. Output measures (with units of delivery measured as tons produced, floors of a building completed, miles of a highway completed) track results. Neither is universally applicable to all long-term projects. Their use requires the exercise of judgment and careful tailoring to the circumstances. The most popular input measure used to determine the progress toward completion is the cost-to-cost basis. Under this basis, a company measures the percentage of completion by comparing costs incurred to date with the most recent estimate of the total costs required to complete the contract. 23. Explain the accounting for sales with right of return. - ANS 23. To account for sales with rights of return, (and for some services that are provided subject to a refund), companies generally recognize all of the following:a.Revenue for the transferred products in the amount of consideration to which seller is reasonably assured to be entitled considering the products expected to be returned or allowances granted.b.An asset (and corresponding adjustment to cost of goods sold) for its right to recover inventory from the customer. If the company is unable to reliably estimate the level of returns, it should not report revenue until the returns are predictable. 26. Explain a *principal-agent relationship* and its significance to revenue recognition. - ANS 26. In a principal-agent relationship, the principal's performance obligation is to provide goods or perform services for a customer. The agent's performance obligation is to arrange for the principal to provide these goods or services to a customer. In a principal-agent relationship, amounts collected on behalf of the principal are not revenue of the agent. The revenue for the agent is the amount of the *commission* it receives (usually a percentage of the selling price or total revenue).LO 27. What is the nature of a sale on consignment? - ANS 27.A sale on consignment is the shipment of merchandise from a manufacturer (or wholesaler) to a dealer (or retailer) with title to the goods and the risk of sale being retained by the manufacturer who becomes the consignor. The consignee (dealer) is expected to exercise due diligence in caring for the merchandise and the dealer has full right to return the merchandise. The consignee receives a commission upon the sale and remits the balance of the cash collected to the consignor. The consignor recognizes a sale and the related revenue upon notification of sale from the consignee and receipt of the cash. The consigned goods are carried in the consignor's inventory, not the consignee's, until sold. consignee receives the commission 28. What are the two types of warranties? Explain the accounting for each type. - ANS 28.The two types of warranties are:a.Warranties that the product meets agreed-upon specifications in the contract at the time the product is sold. This type of warranty is included in the sale price of the company's product and is often referred to as an assurance-type warranty.b.Warranties that provide an additional service beyond the assurance-type warranty. This warranty is not included in the sale price of the product and is referred to as a service-type warranty. Companies do not record a separate performance obligation for assurance-type