Deck 8: Revenue Recognition

Question 1

How should the balances of Progress Billings and Construction in Progress be shown at reporting dates prior to the completion of a long-term contract?

A) Progress Billings as income, Construction in Progress as inventory
B) Net, as income from construction if credit balance, and loss from construction if debit balance
C) Progress Billings as deferred income, Construction in Progress as a current asset
D) Net, as a current asset if debit balance and current liability if credit balance

Answer 1

D

Question 2

Franchise fees are properly recognized as revenue

A) when received in cash.
B) when a contractual agreement has been signed.
C) after the franchise business has begun operations.
D) after the franchiser has substantially performed its service.

Answer 2

D

Question 3

The theoretical support for using the percentage-of-completion method of accounting for long-term construction projects is that it

A) is more conservative than the completed-contract method.
B) reports a lower Net Income figure than the completed-contract method.
C) more closely conforms to the cost principle.
D) produces a realistic matching of expenses with revenues.

Answer 3

D

Question 4

When comparing the percentage-of-completion and completed-contract methods of accounting for long-term construction contracts, both methods will report the same

A) balances each period in the Progress Billings account.
B) expense for cost of construction each year.
C) amount of income in the year of completion.
D) inventory carrying value each year during the construction period.

Question 5

Which of the following is not a difference between the percentage-of completion and completed-contract methods of accounting for long-term construction contracts?

A) They report different amounts for inventory during the construction period.
B) They report different amounts for progress billings during the construction period.
C) They cause a different cash inflow during the construction period.
D) They report different amounts for accounts receivable during the construction period.

Question 6

If the completed-contract method is used, what is the basis for determining the income to be recognized in the second year of a three-year contract?

A) Cumulative actual costs incurred only
B) Incremental cost for the second year only
C) Latest available estimated costs
D) No income would be recognized in year 2

Question 7

If the percentage-of-completion method is used, what is the basis for determining the gross profit to be recognized in the second year of a three-year contract?

A) Cumulative actual costs incurred only
B) Incremental cost for the second year only
C) Cumulative actual costs and estimated costs to complete
D) No gross profit would be recognized in year 2

Question 8

The installment method of recognizing revenue

A) should be used only in cases in which no reasonable basis exists for estimating the collectibility of receivables.
B) is not a generally accepted accounting principle under any circumstances.
C) should be used for book purposes only if it is used for tax purposes.
D) is an acceptable alternative accounting principle for a firm that makes installment sales.

Question 9

When using the installment sales method,

A) gross profit is deferred until all cash is received, but revenues and costs are recognized in proportion to the cash collected from the sale.
B) gross profit is recognized only after the amount of cash collected exceeds the cost of the item sold.
C) revenue, costs, and gross profit are recognized proportionally as the cash is received from the sale of product.
D) total revenues and costs are recognized at the point of sale, but gross profit is deferred in proportion to the cash that is uncollected from the sale.

Question 10

Goods on consignment should be included in the inventory of

A) the consignor but not the consignee.
B) both the consignor and the consignee.
C) the consignee but not the consignor.
D) neither the consignor nor the consignee.

Question 11

If a company uses the completed-contract method of accounting for long-term construction contracts, then during the period of construction, financial information related to a long-term contract will

A) appear on both the income statement and balance sheet during the construction period.
B) appear only on the income statement during the period of construction.
C) appear only on the balance sheet during the period of construction.
D) not appear on the financial statements.

Question 12

The completed-contract method of accounting for long-term construction-type contracts is preferable when

A) a contractor is involved in numerous projects.
B) the contracts are of a relatively long duration.
C) estimates of costs to complete and extent of progress toward completion are reasonably dependable.
D) there are inherent uncertainties in the contract beyond normal business risks.

Question 13

Assume the percentage-of-completion method of revenue recognition is used on a long-term construction contract. Under this method, revenues that are earned but unbilled at the balance sheet date should be disclosed

A) as a long-term receivable in the noncurrent assets section of the balance sheet.
B) only as a footnote disclosure until the customer is billed for the percentage of work completed.
C) as construction in progress in the current assets section of the balance sheet.
D) as construction in progress in the noncurrent assets section of the balance sheet.

Question 14

The cost recovery method is

A) used only when circumstances surrounding a sale are so uncertain that earlier recognition is impossible.
B) the most common method of accounting for real estate sales.
C) similar to percentage-of-completion accounting.
D) never acceptable under generally accepted accounting principles.

Question 15

Which of the following is not an element identified by the AICPA as being necessary in order to use percentage-of-completion accounting?

A) The construction period can be reasonably estimated.
B) The buyer can be expected to satisfy obligations under the contract.
C) Dependable estimates can be made of the extent of progress toward completion.
D) Dependable estimates can be made of contract costs.

Question 16

Which of the following types of service transactions is most likely to require the proportional performance method of revenue recognition based on the seller's direct costs to perform each act?

A) Processing of monthly mortgage payments by a mortgage banker
B) Providing lessons, examinations, and grading by a correspondence school
C) Providing maintenance services on equipment for a fixed periodic fee
D) Delivering freight (by a trucking firm)

Question 17

A company providing maintenance services on equipment for a fixed periodic fee would recognize

A) an equal amount of service revenue for each act.
B) service revenue over the fixed period by the straight-line method.
C) service revenue in proportion to the direct costs to the provider of the services to perform each act.
D) service revenue only when the fixed period has ended.

Question 18

Dilla Construction Company's projects extend over several years and collection of receivables is reasonably certain. Each project has a contract that specifies a price and the rights and obligations of all parties. Both the contractor and the customer are expected to fulfill their contractual obligations on each project. Reliable estimates can be made of the extent of progress and cost to complete each project. The method that the company should use to account for construction revenue is

A) installment sales.
B) percentage-of-completion.
C) completed-contract.
D) cost recovery.

Question 19

Which of the following best describes the condition(s) that must be present for the recognition of revenue?

A) The revenue must be earned, measurable, and collected.
B) The revenue must be earned, measurable, and collectible.
C) The revenue must be earned and collectible.
D) The revenue must be measurable and collectible.

Question 20

When the percentage-of-completion method of accounting for long-term construction projects is used, why is Construction in Progress increased by the annual recognized gross profit on long-term construction contracts?

A) The cost of the contract has increased.
B) The project's value has increased above cost.
C) The economy experiences inflation over the construction period.
D) Construction in Progress is not increased by the annual recognized profit.

Question 21

For a construction firm using the completed-contract method, if costs exceed billings on some contracts by $1,000,000 and billings exceed costs by $800,000 on others, the contracts should ordinarily be reported as a

A) current asset of $200,000.
B) current liability of $200,000.
C) current asset of $1,000,000 less a contra-current asset of $800,000.
D) current asset of $1,000,000 and a current liability of $800,000.

Question 22

Leno Distributing, which began operating on January 1, appropriately uses the installment method of accounting. The following information pertains to Leno's operations for the first year:

The balance in the deferred gross profit account at December 31 should be

A) $400,000.
B) $320,000.
C) $240,000.
D) $200,000.

Question 23

A company uses the percentage-of-completion method to account for a four-year construction contract. Progress billings sent in the second year that were collected in the third year would

A) be included in the calculation of the income recognized in the second year.
B) be included in the calculation of the income recognized in the third year.
C) be included in the calculation of the income recognized in the fourth year.
D) not be included in the calculation of the income recognized in any year.

Question 24

The following data relate to a construction job started by Worthington Co. during 2011:

See Worthington Co. information above. Under the completed-contract method, how much should Worthington recognize as gross profit for 2011?

A) $0
B) $30,000
C) $40,000
D) $90,000

Question 25

In accounting for a long-term construction contract for which there is a projected profit, the balance in the Construction in Progress account at the end of the first year of work using the percentage-of-completion method would be

A) zero.
B) the same as the completed-contract method.
C) higher than the completed-contract method.
D) lower than the completed-contract method.

Question 26

Brown Construction Company uses the percentage-of-completion method for long-term construction contracts. A specific job was begun in 2011 and completed in 2013. The contract price was $1,400,000 and cost information as of each year-end is given below:

Assuming Brown correctly recorded gross profit in 2011, how much gross profit should the company record in 2012?

A) $0
B) $20,000
C) $300,000
D) $320,000

Question 27

In 2011, Aldous Corp. began construction work under a three-year contract. The contract price is $800,000. Aldous used the percentage-of-completion method for financial accounting purposes. The income to be recognized each year is based on the proportion of costs incurred to total estimated costs for completing the contract. The financial presentations relating to this contract at December 31, 2011, appear below.

How much cash was collected in 2011 on this contract?

A) $32,000
B) $35,000
C) $47,000
D) $50,000

Question 28

Lake Construction Company uses the completed-contract method for long-term construction contracts. The information for a specific contract as of January 1, 2011, is shown below.

$600,000 of cost was incurred during 2011 and on December 31, 2011, the estimated remaining cost to complete was still $800,000. The correct balance for the Construction in Progress at December 31, 2011 is

A) $600,000.
B) $700,000.
C) $1,200,000.
D) $1,300,000.

Question 29

Shepard Construction Company has consistently used the percentage-of- completion method. On January 10, 2011, Shepard began work on a $3,000,000 construction contract. At the inception date, the estimated cost of construction was $2,250,000. The following data relate to the progress of the contract:

How much gross profit should Shepard recognize for the year ended December 31, 2012?

A) $150,000
B) $262,500
C) $300,000
D) $450,000

Question 30

Paral Company began operations on January 2, 2011, and appropriately used the installment sales method of accounting. The following data are available for 2011 and 2012:

The realized gross profit for 2012 is

A) $1,440,000.
B) $1,040,000.
C) $920,000.
D) $780,000.

Question 31

The following data relate to a construction job started by Worthington Co. during 2011:

See Worthington Co. information above. Under the percentage-of-completion method, how much should Worthington recognize as gross profit for 2011?

A) $0
B) $40,000
C) $80,000
D) $100,000

Question 32

Wedtec Enterprises, which began operations on January 1, appropriately uses the installment method of accounting. The following information is available for its first year:

What is the total amount of Wedtec's installment sales for the first year?

A) $300,000
B) $345,000
C) $425,000
D) $525,000

Question 33

On May 1, 2011, Green Construction Company entered into a fixed-price contract to construct an apartment building for $3,000,000. Green appropriately accounts for this contract under the percentage-of-completion method. Information relating to the contract is as follows:

What is the amount of contract costs incurred during the year ended December 31, 2012?

A) $600,000
B) $960,000
C) $990,000
D) $1,440,000

Question 34

Jessup Construction, Inc. has consistently used the percentage-of-completion method of recognizing income. During 2011, Jessup started work on a $1,500,000 fixed-price construction contract. The accounting records disclosed the following data for the year ended December 31, 2011:

How much loss should Jessup have recognized in 2011?

A) $15,000
B) $35,000
C) $50,000
D) $115,000

Question 35

C & J Construction, Inc. has consistently used the percentage-of-completion method of recognizing income. Last year C & J started work on a $4,500,000 construction contract, which was completed this year. The accounting records disclosed the following data for last year:

How much income should C & J have recognized on this contract last year?

A) $105,000
B) $150,000
C) $300,000
D) $350,000

Question 36

Salmon Construction Company uses the percentage-of-completion method of accounting. In 2011, Salmon began work on a project which had a contract price of $1,600,000 and estimated costs of $1,200,000. Additional information is as follows:

The amount of gross profit Salmon should recognize on this contract during 2011 is

A) $40,000.
B) $80,000.
C) $100,000.
D) $200,000.

Question 37

In accounting for sales on consignment, sales revenue and the related cost of goods sold should be recognized by the

A) consignor when the goods are shipped to the consignee.
B) consignee when the goods are shipped to the third party.
C) consignor when notification is received the consignee has sold the goods.
D) consignee when cash is received from the customer.

Question 38

Lake Construction Company uses the percentage-of-completion method for long-term construction contracts. The company has a project with a contract price of $7,000 on which $600 of gross profit has been recognized in prior years. Information for the current year is as follows:

What is the loss that Lake should recognize in the current year?

A) $600
B) $800
C) $1,400
D) No loss should be recognized.

Question 39

Brooke Company began operations on January 1, 2011, and uses the installment sales method of accounting. The company has the following information available for 2011 and 2012:

The realized gross profit for 2012 would be

A) $1,680,000.
B) $2,760,000.
C) $3,120,000.
D) $4,320,000.

Question 40

Rainbow Construction Company uses the percentage-of-completion method for long-term construction contracts. The company started a project with a contract price of $2,750 in 2011. Given the following data, what is the balance in Construction in Progress for this contract at the end of 2011?

A) $150
B) $400
C) $550
D) $1,750

Question 41

Hillson Company began operations on January 1, 2011, and appropriately uses the installment method of accounting. The following data are available for 2011 and 2012:

The realized gross profit for 2012 is

A) $240,000.
B) $390,000.
C) $440,000.
D) $600,000.

Question 42

Seahawks, Inc. had the following consignment transactions during December:

No sales of consigned goods were made through December 31. Seahawks' December 31 balance sheet should include consigned inventory at

A) $18,900.
B) $18,000.
C) $12,500.
D) $12,000.

Question 43

Bywater Construction contracted to build a ship over a two year period. The contract price was $21,000,000 with an estimate total cost of $18,400,000. The following cost data relate to the construction period.

Prepare the necessary journal entries for 2011, 2012, and 2013 assuming Bywater uses the percentage-of-completion method.

Question 44

When progress billings are made by a contractor on a long-term contract, what account is credited?

A) Contract Revenue, a revenue account
B) Contract Billings, a contra-asset account
C) Contract Receivable, an asset account
D) Contract Billings, a contra-revenue account

Question 45

Layton Construction Company has consistently used the percentage-of completion method of recognizing income. During 2011, Layton entered into a fixed-price contract to construct an office building for $10,000,000. Information relating to the contract is as follows:

Contract costs incurred during 2012 were

A) $3,200,000.
B) $3,300,000.
C) $3,500,000.
D) $4,800,000.

Question 46

Ajax Dry Cleaners, Inc. charges an initial franchise fee of $195,000. When the agreement is signed, a payment of $75,000 is due, followed by four annual payments of $30,000 at the end of each period. Ajax's normal borrowing rate is 12%. Prepare the entries to record the initial franchise fee on the books of Ajax under each of the following circumstances.

Question 47

Summit Electronics Company sends appliances to dealers on a consignment basis. The selling price per unit is $920 and the dealer earns a 30% commission. The manufacturing cost of the appliance to Summit Electronics is $570. Assume that in 2011, 800 units were sent on consignment to Farley Hardware. Four hundred of these units were sold for cash, and by December 31, 2011, remittance had been made to Summit Electronics for 380 units.
Prepare the required journal entries on the books of Summit Electronics Company and Farley Hardware for the transactions in 2011.

Question 48

A construction company uses the percentage-of-completion method for long-term construction contracts. A particular job was begun in 2010 and completed in 2012. During 2011, it appeared that the project would cost 25 percent more than originally expected. Data at the end of each year are given below:

The contract price was $700,000. Assuming the company properly recorded income in 2010, how much income should be recorded in 2011?

A) $10,000
B) $42,000
C) $160,000
D) $192,000

Question 49

In 2011, Johnson Builders began construction work under a three-year contract at a price of $7,525,000. The firm uses the percentage-of-completion method for financial accounting purposes. The income to be recognized each year is based on the proportion of cost incurred to the total estimated costs for completing the contract. The financial statement presentations relating to this contract on December 31, 2011, are:

Determine the

Question 50

Measuring progress toward completion of long-term construction projects can be accomplished in a number of ways. Nonetheless, all of these measurements can be classified into two basic groups: input measures and output measures. Input measures attempt to measure the effort devoted to a project to date compared to the total effort expected to be required in order to complete the project. A common input measure is the ratio of costs incurred to date to total estimated costs for the project. Output measures attempt to measure the results to date compared to total results when the project is completed. A common output measure would be the number of stories of a building completed compared to the total number of stories to be built.
Identify the general problems associated with input and output measures in determining the level of completion of a long-term construction project.

Question 51

Tappan Industrial sells machinery on the installment plan. On September 1, 2011, Tappan entered into an installment sale contract with Western Productions for a six-year period. Equal annual payments under the installment sale are $187,500 and are due on August 31 of each year beginning in 2012.
Additional information:

Compute the income or loss before taxes that Tappan should record for the year ended December 31, 2011, as a result of the above transaction, assuming that circumstances are such that the collection of the installments due under the contract

Question 52

Assume the Randall Corporation sold $30,000 worth of merchandise on the installment basis. The cost of the merchandise was $24,000, and collectibility of the receivable is uncertain. Collection in the current year on the account is $8,000. How much gross profit should be reported as realized?

A) $1,600
B) $2,000
C) $6,000
D) $8,000

Question 53

The importance of revenue to a business enterprise has caused much discussion among accountants as to how the term "revenue" should be defined. The FASB in Statement of Financial Accounting Concepts No. 6, "Elements of Financial Statements," defines revenue as "inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations."
Evaluate the soundness of the definition of the term "revenue" provided by the FASB in Statement of Financial Accounting Concepts No. 6.

Question 54

On January 3, 2011, Lincoln Services, Inc., signed an agreement authorizing Lisa Company to operate as a franchisee over a 20-year period for an initial franchise fee of $100,000 received when the agreement was signed. Lisa commenced operations on July 1, 2011, at which date all of the initial services required of Lincoln had been performed. The agreement also provides that Lisa must pay a continuing franchise fee equal to 5% of the revenue from the franchise annually to Lincoln. Lisa's franchise revenue for 2011 was $800,000. For the year ended December 31, 2011, how much should Lincoln record as revenue from franchise fees from the Lisa franchise?

A) $140,000
B) $90,000
C) $45,000
D) $42,500

Question 55

Knudsen Company sold $300,000 to customers on account during 2011, and collected $187,500 during the year. The company properly uses the installment sales method of revenue recognition due to the uncertainty of collection of these installment receivables. The company has determined that cost of sales for the $300,000 of sales was $240,000.
What is the correct balance of the company's Deferred Gross Profit account at the end of 2011, after the recognition of revenue for that year?

A) $22,500
B) $0
C) $60,000
D) $112,000

Question 56

On January 1, 2011 Rose Enterprises obtained a contract to construct a building. It was estimated at the beginning of the contract that it would take three years to complete the project at an expected cost of $200,000. The contract price was $250,000. The following information describes the status of the job at the close of production each year:

Compute the items listed below for each year assuming the use of the percentage-of-completion cost-to-cost method. (Round all percentages to two decimals).

Question 57

Superior Builders has a fixed -price contract providing $120,000 of revenue. Construction on the contract was begun in 2010 and was completed in 2011. Information relating to the contract is as follows:

What amount of income should Superior recognize in 2011 assuming that the company appropriately uses the percentage-of-completion method of income recognition?

A) $9,286
B) $15,000
C) $17,000
D) $7,000

Question 58

Under which of the following circumstances is the installment sales method appropriate for the recognition of revenue in the income statement?

A) For any sales where collection is spread over a reasonable long period of time.
B) In any situation where management wishes to delay the recognition of revenue in order to smooth its income.
C) For sales where collection is spread over a reasonable long period of time and significant doubt exists about the ultimate collection of the receivables.
D) For sales where collection is spread over a reasonable long period of time and no significant doubt exists concerning ultimate collection of the receivables.

Question 59

Grover, Inc., appropriately uses the installment sales method of revenue recognition. The company sold $1,500,000 on installment accounts during 2011. The cost of items sold was $900,000. At December 31, 2011, Grover reported a balance of $100,000 in the Deferred Gross Profit account. How much cash did Grover collect on installment contracts during 2011?

A) $600,000
B) $500,000
C) $250,000
D) $1,250,000

Question 60

The completed-contract method (as opposed to the percentage-of-completion method) of accounting for revenue from long-term construction contracts should be used in which of the following circumstances?

A) The contractor has been in business for many years and has completed many contracts in the past.
B) The contracts are of a relatively long duration.
C) Reasonable accurate estimates of the degree of completion can be made based on past experience.
D) Reasonably accurate estimates of the degree of completion cannot be made due to the lack of experience with similar types of contracts.

Question 61

Revenue is measured in terms of the value of the products or services exchanged in an "arms-length" transaction. This value represents either the net cash equivalent or the present discounted value of the money received or to be received in exchange for the products or services that an enterprise transfers to its customer.
Required:
Explain how this concept of the measurement of revenue might be used to determine the proper treatment of sales discounts and bad debt losses.

Question 62

CellMate, a cellular phone company, conducts a promotion in which new customers who sign a two-year contract receive a free phone. The contract requires the customer to pay a cancellation fee of $250 if the customer cancels the contract. CellMate charges a one-time activation fee of $60 and a monthly fee of $42 for ongoing service. The monthly fee is the same regardless of whether a free phone is provided. The phone costs CellMate $105, and CellMate sells the phone separately for $125. CellMate is not required to refund any portion of the fees paid for any reason. The customer has no obligation to CellMate if phone service is not provided. CellMate is a profitable business and has no reason to believe that the two-year service requirement will not be met.
Required:
1. Are the phone and the phone service (airtime) separate deliverables under this agreement?
2. What is the amount of revenue to be recognized upon signing of the agreement and delivery of the phone to the customer?

Question 63

Sand Company, a publicly traded company, delivers twenty truckloads of sand to Gravel Company prior to December 31, 2011, the end of Sand's fiscal year. Sand normally enters into a written sales agreement with customers similar to Gravel Company. The written sales agreement must be signed by both companies in order to be binding. Although the purchasing department of Gravel has orally agreed to the sale, Gravel management cannot sign the agreement until it is approved by the legal department of Gravel. Personnel of the legal department of Gravel will be on vacation until January 5, 2012.
Can Sand recognize on its income statement for the year ending December 31, 2011, the revenue related to the twenty truckloads delivered to Gravel? Explain.

Question 64

You are an accounting major who recently completed your masters degree in accounting and began working in public accounting as of September 1, 2011. Your younger brother currently is enrolled in a principles of accounting course. Your brother calls you at your firm's offices one day to congratulate you on the purchase of your new stereo system for your apartment. In the course of the conversation, your brother tells you that his accounting instructor discussed the installment sales method of recognition in class recently. Since your brother knows that you are paying for the stereo by making monthly payments, your brother (in an attempt to impress with his new-found knowledge) begins to describe the process for accounting under the installment sales method of revenue recognition. Your brother finds it particularly curious that the store that sold you the stereo system will be deferring revenue on the sale until cash is collected.
Required:
How would you respond to your younger brother's comments?

Question 65

Roberts Company sold inventory to Peterson Incorporated and recorded the sale as revenue. Part of the agreement of the sale is that Roberts will repurchase the merchandise at a specified price over a specified period of time. Meanwhile, Peterson uses the inventory purchased from Roberts as collateral for a loan. Peterson uses the proceeds from the loan to pay Roberts for the inventory purchased. Roberts ultimately repurchases the inventory from Peterson. Peterson then uses the proceeds of the repayment to pay its loan obligation.
Required:

Question 66

The Buford Corporation introduced a new line of product the profitability of which is quite uncertain. This uncertainty has resulted in Buford choosing to use the cost recovery method to account for this product.
The following information relating to the new product line is available for the year 2011:

Required:

Question 67

The collection of credit sales is usually predictable and reasonably assured as a result of credit approval, collections procedures, and historical evidence. In such cases, revenue is appropriately recognized at the point of sale. If a company makes credit sales to customers of relatively poor credit risk, however, recognition of revenue at the point of sale may be inappropriate. Although revenue may have been earned and is measurable, ultimate collection of the proceeds on the sale are highly uncertain. The creditor in such circumstances may defer the recognition of revenue until the amount due is collected. The installment sales method thus may be used. Under the installment sales method, both sales and cost of sales are recognized in the period of sale, but the related gross margin is deferred to those periods in which cash is collected. The gross margin rate for the installment sales is computed and multiplied times the cash collection to determine the portion of deferred gross margin to be recognized.
Required:
Evaluate the conceptual soundness of the installment sales method.

Question 68

The percentage-of-completion method is used to recognize revenue and gross profit for construction and other types of projects that extend beyond one accounting period. A problem similar to long-term construction projects exists in accounting for service revenue that is earned for more than one performance act where such activity extends beyond one accounting period.
Provide examples of service activities that might extend beyond one accounting period and propose means of recognizing revenues for such activities.

Question 69

Marvel System Services provides its customers with computer-based services over an extended period. Customers are required to prepay the entire fee for the extended service. Marvel performs initial setup activities to enter a customer into its system. The initial setup allows the customer to receive automated services from Marvel from that point forward in the service agreement.
The management of Marvel plans to recognize the revenue over the life of the service contract, but plans to recognize a disproportionate amount of revenue at the beginning of the contract as a result of the completion of the setup activities and the cost incurred in connection with the completion of the setup activities.
Required:
Do you agree with the proposal by the management of Marvel regarding revenue recognition related to the setup activities? How should revenue be recognized for an agreement such as this?

Question 70

Assume that a company receives $500 cash from a customer as the initial sign-up fee for a service. In addition to the sign-up fee, the customer also is required to pay $25 per month for the service. The expected economic life of the service agreement is 50 months. The company providing the service could subcontract with a third party to provide the service for 100 months for $100, which is also the cost to the company of providing the service.
Current professional standards regarding revenue recognition would require that the sign-up fee be recognized over the 50 months the service is provided. Nonetheless, you have heard that the FASB is considering another approach to revenue recognition called the asset-and-liability approach.
Required:
Explain how this transaction would be accounted for under the FASB's asset-and-liability approach and evaluate this new approach.

Question 71

Clarity Communications manufactures and sells audio and video conferencing equipment. The company sells its products through a nationwide network of distributors complemented by a direct sales force. The distributors had a written agreement with Clarity requiring the distributors to pay Clarity within 90 days of receiving Clarity products. The agreement also required distributors to take title to Clarity products at the time the products left Clarity's warehouse.
Through early 2011, Clarity experienced robust growth and increased product sales every quarter. In early 2011, it became apparent to Clarity's CEO, Melinda Waters, that the company would not meet its sales and revenue projections for the quarter ended March 31, 2011. At the end of March 2011, Waters instructed Phillip Potts, Clarity's Director of Manufacturing, to assemble enough products to ship to distributors in order to meet Clarity's sales projections. Waters entered into an agreement with one of Clarity's distributors, Star Marketing, to accept these products. The management of Star Marketing was assured that the transaction posed no risk to them. Waters also informed Star management that Star would not be required to pay for the merchandise until it was sold. Meanwhile, Clarity recorded an account receivable and revenue for this sale. These same procedures were followed at the end of each quarter for which Clarity anticipated falling short of its sales projections, including the recognition of revenue by Clarity.
During this same time period, Clarity, whose stock was publicly traded, was planning a private placement of additional shares of stock totaling $25.5 million. Accordingly, the stock price needed to remain high in order for the private placement to be attractive to investors.
Required:
Does the plan effected by Waters conform with Generally Accepted Accounting Principles (GAAP)?

Question 72

The percentage-of-completion method is a generally accepted accounting procedure that allows revenue to be recognized prior to the completion of a project or product. Revenues and gross profit are recognized each period based upon the progress of the construction. Construction costs plus gross profit earned to date are accumulated in an inventory account (Construction in Progress) and progress billings are accumulated in a contra-inventory account (Billings on Construction in Progress).
Required:
Explain the effect on shareholders and managers if an enterprise did not use the percentage-of-completion method to account for long-term contracts and projects.

Question 73

Bill's Club is a discount retailer subject to SEC regulation. Bill's Club charges its customers an annual membership fee. Although the fee is collected in advance, a customer can cancel and receive a full refund at any time during the year of membership.
Should Bill's Club recognize the entire initial membership fee at the beginning of the year or on a straight-line basis over the course of the membership year? Explain.
What journal entry should be made to record the initial receipt of the membership fees?

Question 74

On December 31, 2011, Wheeler Furniture (a retailer) sells a television and a three-year warranty to a customer. Wheeler would normally sell the television and warranty separately for $2,000 and $400, respectively. The cost of the television to Wheeler is $1,500. As part of a year-end promotion, Wheeler sells the television and warranty together for a reduced price of $2,300. The customer pays in full at the point of sale on the contract-signing.date.
Required:
1. Prepare the journal entry required at the contract-signing date.
2. Prepare the entry required when the television is delivered to the customer.
Wheeler will allocate the transaction price to the two performance obligations on the basis of the standalone selling prices of $2,000 and $400 for the television and the warranty, respectively, as follows: