Exercise 18 [PDF]

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Exercise 18 E18.1 (LO1) (Fundamentals of Revenue Recognition) Presented below are five different situations. Provide an answer to each of these questions. a. The Kawaski Jeep dealership sells both new and used Jeeps. Some of the Jeeps are used for demonstration purposes; after 6 months, these Jeeps are then sold as used vehicles. Should Kawaski Jeep record these sales of used Jeeps as revenue or as a gain? b. One of the main indicators of whether control has passed to the customer is whether revenue has been earned. Is this statement correct? c. One of the five steps in determining whether revenue should be recognized is whether the sale has been realized. Do you agree? d. One of the criteria that contracts must meet to apply the revenue standard is that collectibility of the sales price must be reasonably possible. Is this correct? e. Many believe the distinction between revenue and gains is important in the financial statements. Given that both revenues and gains increase net income, why is the distinction important?



EXERCISE 18.1 (10–15 minutes) (1)



(2)



(3) (4) (5)



Kawaski is in the business of buying and selling both new and used Jeeps and this activity should be considered part of its ordinary activities. Customers have entered into a contract to purchase these Jeeps and sales revenue should be recognized by Kawaski. Conversely, if Kawaski is selling its corporate headquarters to another party, the transaction would not be a contract with a customer because selling real estate is not an ordinary activity of Kawaski. In this case a gain or loss on sale should be recognized on the transaction. This statement is not correct. In the new standard, indicators that control has passed to the customer include having (1) a present obligation to pay, (2) physical possession, (3) legal title, (4) risks and rewards of ownership, and (5) acceptance of the asset. Again this statement is not correct. See additional answer related to number 2. This statement is not correct. For a valid contract to exist, the collection of revenue must be probable. The distinction between revenue and gains is important because it is useful to understand how these increases in net income occurred. Sales revenue results from the normal operating activities of the business, and therefore, is generally considered a better measure for predicting the amount, timing, and uncertainty of future cash flows. Gains on the other hand are often incidental to the business and therefore do not provide as much predictive information.



E18.4 (LO2) (Determine Transaction Price) Jupiter Company sells goods to Danone Inc. by accepting a note receivable on January 2, 2019. The goods have a sales price of $610,000 (cost of $500,000). The terms are net 30. If Danone pays within 5 days, however, it receives a cash discount of $10,000. Past history indicates that the cash discount will be taken. On January 28, 2019, Danone makes payment to Jupiter for the full sales price. Instructions a. Prepare the journal entry(ies) to record the sale and related cost of goods sold for Jupiter Company on January 2, 2019, and the payment on January 28, 2019. Assume that Jupiter Company records the January 2, 2019, transaction using the net method. b. Prepare the journal entry(ies) to record the sale and related cost of goods sold for Jupiter Company on January 2, 2019, and the payment on January 28, 2019. Assume that Jupiter Company records the January 2, 2019, transaction using the gross method. EXERCISE 18.4 (20–25 minutes) (a)



The journal entry to record the sale and related cost of goods sold are as follows: January 2, 2019 Notes Receivable..................................................................... Sales Revenue ($610,000 − $10,000).........................



600,000 600,000



Cost of Goods Sold................................................................... Inventory....................................................................



500,000 500,000



The journal entry to record the collection of the note is as follows: January 28, 2019 Cash........................................................................................ Notes Receivable........................................................ Sales Discounted Forfeited........................................ (b)



610,000 600,000



January 2, 2019 Notes Receivable..................................................................... Sales Revenue............................................................



610,000 610,000



Cost of Goods Sold................................................................... Inventory....................................................................



500,000 500,000



January 28, 2019 Cash........................................................................................ Notes Receivable........................................................



610,000 610,000



Note that the time value of money is not considered because the contract is less than a year. Also, if payment occurs within 5 days, under the net method, the entry would be: Cash........................................................................................ Notes Receivable........................................................



600,000 600,000



EXERCISE 18.4 (continued) If payment occurs within 5 days, under the gross method, the entry would be Cash........................................................................................ Sales Discounts....................................................................... Notes Receivable........................................................



600,000 10,000 610,000



E18.7 (LO2) (Determine Transaction Price) Blair Biotech enters into a licensing agreement with Pang Pharmaceutical for a drug under development. Blair will receive a payment of \10,000,000 if the drug receives regulatory approval. Based on prior experience in the drug-approval process, Blair determines it is 90% likely that the drug will gain approval and a 10% chance of denial. Instructions a. Determine the transaction price of the arrangement for Blair Biotech. b. Assuming that regulatory approval was granted on December 20, 2019, and that Blair received the payment from Pang on January 15, 2020, prepare the journal entries for Blair. The license meets the criteria for point-in-time revenue recognition. Because the arrangement only has two possible outcomes (regulatory approval is achieved or not), Blair determines the transaction price based on the most likely approach. Thus, the best measure for the transaction price is ¥10,000,000. (b)



December 20, 2019 Accounts Receivable................................................................ License Revenue............................................................



10,000,000 10,000,000



January 15, 2020 Cash .....................................................................10,000,000 Accounts Receivable......................................................



10,000,000



E18.8 (LO2, 3) (Determine Transaction Price) Aaron's Agency sells an insurance policy offered by Capital Insurance Company for a commission of $100 on January 2, 2019. In addition, Aaron will receive an additional commission of $10 each year for as long as the policyholder does not cancel the policy. After selling the policy, Aaron does not have any remaining performance obligations. Based on Aaron's significant experience with these types of policies, it estimates that policyholders on average renew the policy for 4.5 years. It has no evidence to suggest that previous policyholder behavior will change. Instructions a. Determine the transaction price of the arrangement for Aaron, assuming 100 policies are sold. b. Determine the revenue that Aaron will recognize in 2019. a. Aaron determines that the transaction price for the 100 policies is $14,500 [($100 X 100) + ($10 X 4.5 X 100)]. (b)



Aaron will recognize revenue of $3,222 ($14,500 X 12/54), because on average, customers renew for 4.5 years, Aaron includes that amount in its estimate for the transaction price. As circumstances change, Aaron updates its estimate of the transaction price and recognizes revenue (or a reduction of revenue) for those changes in circumstances.



E18.26 (LO3) (Warranty Arrangement) On January 2, 2019, Grando Company sells production equipment to Fargo Inc. for $50,000. Grando includes a 2-year assurance warranty service with the sale of all its equipment. The customer receives and pays for the equipment on January 2, 2019. During 2019, Grando incurs costs related to warranties of $900. At December 31, 2019, Grando estimates that $650 of warranty costs will be incurred in the second year of the warranty. Instructions a. Prepare the journal entry to record this transaction during 2019 (assuming financial statements are prepared on December 31, 2019). b. Repeat the requirements for (a), assuming that in addition to the assurance warranty, Grando sold an extended warranty (service-type warranty) for an additional 2 years (2021–2022) for $800. (a)



January 2, 2019 Cash ..........................................................................................50,000 Sales Revenue..............................................................................



50,000



During 2019 Warranty Expense.................................................................................. Cash, Labor, Parts.........................................................................



900 900



December 31, 2019 Warranty Expense..................................................................................



650



Warranty Liability.........................................................................



(b)



650



January 2, 2019 Cash ($50,000 + $800)........................................................................... Sales Revenue.............................................................................. Unearned Warranty Revenue (Service-type)...............................



50,800 50,000 800



During 2019 Warranty Expense.................................................................................. Cash, Labor, Parts.........................................................................



900 900



December 31, 2019 Warranty Expense.................................................................................. Warranty Liability.........................................................................



650 650



Grando recognizes $400 of revenue on the service type warranty in 2021 and 2022. Warranty costs in the extended warranty period will be expensed as incurred.



E18.27 (LO3) (Warranties) Celic SA manufactures and sells computers that include an assurance- type warranty for the first 90 days. Celic offers an optional extended coverage plan under which it will repair or replace any defective part for 3 years from the expiration of the assurance-type warranty. Because the optional extended coverage plan is sold separately, Celic determines that the 3 years of extended coverage represents a separate performance obligation. The total transaction price for the sale of a computer and the extended warranty is €3,600 on October 1, 2019, and Celic determines the standalone selling price of each is €3,200 and €400, respectively. Further, Celic estimates, based on historical experience, it will incur €200 in costs to repair defects that arise within the 90-day coverage period for the assurance-type warranty. The cost of the computer is €1,440. Assume that the €200 in costs to repair defects in the computer occurred on October 25, 2019. Instructions a. Prepare the journal entry(ies) to record the October transactions related to sale of the computer. b. Briefly describe the accounting for the service-type warranty after the 90day assurance-type warranty period.



EXERCISE 18.27 (15–20 minutes) (a)



October 1, 2019



To record sales revenue, warranties, and related cost of goods sold Cash (or Accounts Receivable)............................................................... Sales Revenue.............................................................................. Unearned Warranty Revenue (Service-type)...............................



3,600 3,200 400



Cost of Goods Sold................................................................................. Inventory......................................................................................



1,440 1,440



To record warranty expense on October 25, 2019 Warranty Expense.................................................................................. Cash, Parts, Labor......................................................................... (b)



200



Celic recognizes warranty expenses associated with the assurance-type warranty as actual warranty costs are incurred during the first 90 days after the customer receives the computer. Celic recognizes the Unearned Service Revenue associated with the service-type warranty as revenue during the extended warranty period and recognizes the costs associated with providing the service-type warranty as they are incurred.



E18.29 (LO4) (Contract Modification) In September 2019, Gaertner Corp. commits to selling 150 of its iPhone-compatible docking stations to Better Buy Co. for $15,000 ($100 per product). The stations are delivered to Better Buy over the next 6 months. After 90 stations are delivered, the contract is modified and Gaertner promises to deliver an additional 45 products for an additional $4,275 ($95 per station). All sales are cash on delivery. Instructions a. Prepare the journal entry for Gaertner for the sale of the first 90 stations. The cost of each station is $54.



b. Prepare the journal entry for the sale of 10 more stations after the contract modification, assuming that the price for the additional stations reflects thestandalone selling price at the time of the contract modification. In addition, the additional stations are distinct from the original products as Gaertner regularly sells the products separately. c. Prepare the journal entry for the sale of 10 more stations (as in (b)), assuming that the pricing for the additional products does not reflect the standalone selling price of the additional products and the prospective method is used. (a)



Cash ..............................................................................9,000 Sales Revenue (90 X $100)............................................ Cost of Goods Sold.................................................................. Inventory (90 X $54)......................................................



(b)



4,860



Cash ..............................................................................1,000 Sales Revenue (10 X $100)............................................ Cost of Goods Sold.................................................................. Inventory (10 X $54)......................................................



540



In this situation, the contract modification for the additional 45 products is, in effect, a new and separate contract for future products that does not affect the accounting for the previously existing contract. (c)



In this case, because the new price does not reflect a stand-alone selling price, Gaertner allocates a modified transaction price (less the amounts allocated to products transferred at or before the date of the modification) to all remaining products to be transferred.



EXERCISE 18.29 (continued) Under the prospective approach, Gaertner determines the transaction price for subsequent sales ($97.86) as follows. Consideration for products not yet delivered    under original contract ($100 X 60) Consideration for products to be delivered    under the contract modification ($95 X 45) Total remaining revenue Revenue per remaining unit ($10 ,275 ¸ 105) = $97.86. As indicated, the numerator includes products not yet transferred under original contract ($100 X 60) plus products to be transferred under the contract modification ($95 X 45), which is divided by the remaining 105 products. The journal entries to record subsequent sales and related cost of goods sold for 10 units is as follows. Cash (10 X $100).............................................................1,000 Unearned Revenue........................................................ Sales Revenue (10 X $97.86).........................................



21.40 978.60



Cost of Goods Sold.......................................................540.00 Inventory.......................................................................



540.00