Question 1

Why is there risk of earnings overstatement in accounting for construction contracts?

Accepted Answer

A) The long term nature of such contracts makes them a low risk area. 
B) Allocation of revenue and expenses between two or more periods simplifies the accounting. 
C) Significant professional judgment is required to make estimates used in the calculations. 
D) Percentage of completion method reduces the potential for earnings management, manipulation and errors.

Question 2

WestCoast Co. started a contract in June 2020 to build a bridge at a fixed price of $14 million. The bridge was to be completed by October 2022. Total cumulative costs incurred by the end of December 2020 and 2021 were $2 million and $6 million, respectively. WestCoast Co. is unable to estimate the total costs of the project prior to completion. Final costs at the end of the project totaled $11 million.
Required:
Determine the amount of revenue, cost of sales, and gross profit WestCoast Co. would report in 2020, 2021, and 2022.
 $$\begin{array} { | r | r | r | r | } 
\hline & 2020 & 2021 & 2022 \
\hline \text { Revenue } & & & \
\hline \text { Cost of sales } & & & \
\hline \text { Gross profit } & & & \
\hline
\end{array}$$

Accepted Answer

The answer of WestCoast Co. started a contract in June...

Question 3

Soorya Manufacturing makes educational toys that are sold to retailers on the following contractual terms: Each type of toy has a fixed wholesale price, is shipped F.O.B. shipping point, and payment is due 45 days after the shipment. The retailer may return a maximum of 45% of an order at the retailer's expense up to 6 months after delivery. Sales are made only to retailers that have a good credit rating.
Required:
a)Identify at least four different revenue recognition points that Soorya could use for its sales.
b)What revenue recognition criteria should Soorya use to determine when revenue should be recorded?

Accepted Answer

The answer of Soorya Manufacturing makes educational toys that are...

Question 4

Which statement is correct about unintentional errors on construction contracts?

Accepted Answer

A) Unintentional underestimates or overestimates may not be errors. 
B) Errors are misstatements that should not have been made based on the information available at the time. 
C) Both statements are correct. 
D) Neither statement is correct.

Question 5

Community Apartments Inc. (CA Inc.)is building a luxury condominium for a contract price of $68,000,000. This is estimated to be a three-year project with an estimated cost of $54,000,000. CA Inc. uses the percentage-of-completion method of revenue recognition, using the cost-to-cost method of estimating the percentage complete. The following is the best available information at the end of each year:
 $$\begin{array} { | l | l | l | l | } 
\hline & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } \
\hline \text { Eosts incurred each year } & 9,000 & 31,500 & 20,000 \
\hline \text { Estimated costs to complete } & 51,000 & 27,000 & 9 \
\hline \text { Gilling } & 8,000 & 34,500 & 25,500 \
\hline \text { Follections } & 7,000 & 28,500 & 32,500 \
\hline
\end{array}$$ Required:
a. Compute the amount of gross profit to be recognized in Year 1, Year 2, and Year 3. Show computations in tabular form provided below:
 $$\begin{array} { | l | l | l | l | } 
\hline & \underline { \text { Year 1 } } & \underline { \text { Year 2 } } & \underline { \text { Year 3 } } \
\hline \text { Cost incurred to date } & & & \
\hline \text { Estimated cost to complete } & & & \
\hline \text { Estimated total cost } & & & \
\hline \text { Contract price } & & & \
\hline \text { Estiruated grass prafit } & & & \
\hline \text { Eramplete } & & & \
\hline \text { Grass prafit ta date } & & & \
\hline \text { Current previess prafit } & & & \
\hline
\end{array}$$ b. Determine the performance that would be reported under the cash basis and accrual basis of accounting for Year 1 of this company. Explain how revenues are matched with expenses when the percentage of completion basis is used.
c. Complete the PARTIAL Balance Sheet for Year 1
Current assets
  Current Liabilities

Accepted Answer

The answer of Community Apartments Inc. (CA Inc.)is building a...

Question 6

Which statement is correct about the impact of estimation errors on construction contracts?

Accepted Answer

A) Underestimating future costs decreases the percentage complete ratio. 
B) Overestimating future costs increases the percentage complete ratio. 
C) Underestimating future costs increases the profit recognized in future periods. 
D) Underestimating future costs increases the profit recognized in the current period.

Question 7

A city transit authority issues 200,000 monthly passes at $80 each for sale at various retailers. Retailers act as consignees for these passes. Identify why the transit authority cannot recognize revenue at time of distribution.

Accepted Answer

A) The retailers have not taken physical possession of the asset. 
B) A contract has not been entered into. 
C) The transaction price is not known. 
D) The retailers do not bear the significant risks and rewards of ownership.

Question 8

On March 1, Pendant Textbook Publications delivered 100 copies of one of its accounting textbooks to the First University bookstore. The bookstore can return all unsold copies to Pendant. The retail price of each copy is $110, while the price charged to the bookstore is $80. Each book costs Pendant $40 to produce. On April 15, the distributor returns 30 unsold copies to Pendant. Based on these facts, how much revenue would Pendant recognize on April 15?

Accepted Answer

A) $2,800 
B) $5,600 
C) $7,700 
D) $2,400

Question 9

Briefly explain the following terms:
a)Non-monetary exchange transaction
b)Consignment transaction
c)Franchise
d)Installment sale

Accepted Answer

The answer of Briefly explain the following terms:
a)Non-monetary exchange transaction
b)Consignment...

Question 10

How is the prudence principle applied to the accounting for construction contracts?

Accepted Answer

A) If a loss is expected on the contract, all of this loss is immediately recognized. 
B) Only a proportional amount of revenue and expenses are recorded each year. 
C) If a loss is expected on the contract, a loss is recognized in the current year based on the degree of completion. 
D) Under this principle, good news is reflected earlier than bad news.

Question 11

On June 1, Electronics Distribution ships 100 TVs to TV World on consignment. Electronic Distribution's pays its wholesaler $500 for each TV. It then sells each TV for $800 to its retail customers including TV World. At the end of June, TV World sold 50 units. How much revenue should be recorded by Electronics Distribution for the month of June?

Accepted Answer

A) $80,000 
B) $50,000 
C) $40,000 
D) $25,000

Question 12

Shear Company sells computer equipment with a 2-year warranty. Prior experience indicates that costs associated with this warranty average 1% in the first year and 2% in the second year. In 2021, Shear had sales of $1,800,000. It paid $250,000 for materials and labour to make warranty-related repairs in 2021. What amount should the warranty expense for 2021 be?

Accepted Answer

A) $18,000 
B) $36,000 
C) $54,000 
D) $250,000

Question 13

Which of the following is correct about the value creation process?

Accepted Answer

A) The value creation process is the same for all entities. 
B) The value creation process is the same for all industries. 
C) Any point on the value creation process is acceptable for revenue recognition. 
D) The value creation process is specific to each entity.

Question 14

The publisher of Accounting Digest received the following 12-month subscriptions during 2021. Each subscription is $100. The company has a December 31 year end. Each subscription becomes effective in the calendar month after the company receives the subscription. What amount of revenue will the company record in 2021 for the subscriptions received between January-March? (Round your response to the nearest dollar). $$\begin{array} { | l | l | } 
\hline { \text { Month } } & \text { Subscription Received } \
\hline \text { Tanuary } & 4,300 \
\hline \text { February } & 4,200 \
\hline \text { March } & 4,100 \
\hline \text { April } & 4,400 \
\hline \text { May } & 6,100 \
\hline
\end{array}$$

Accepted Answer

A) $315,000 
B) $779,167 
C) $1,051,667 
D) $1,260,000

Question 15

McNicols started selling franchise locations in April 2021. The franchisee pays continuing fees based on annual sales. The initial fee relates to finding a store location and training the franchisee at McNicols' training facility over a 2-year period.
 $$\begin{array} { | l | r | r | } 
\hline & \text { Fiscal 2021 } &  { \text { Fiscal 2022 } } \
\hline \text { Initial franchise fee } & 85,000 & 95,000 \
\hline \text { Contionuing franchise fees } & 4 \% & 3 \% \
\hline \text { Franchise sold } & 5 & 3 \
\hline \text { Franchisees' reported sales } & 1,500,000 & 2,000,000 \
\hline
\end{array}$$ Required:
a)Explain how McNicols should account for the initial fee. Ignore the time value of money.
b)Assume that management estimates that 40% of the value of services related to the initial fee is fulfilled in the first year of signing the franchise agreement. Provide the journal entries to record this revenue in fiscal 2021 and in 2022.
c)Explain how McNicols should account for the ongoing fees.
d)Provide the journal entries to record the ongoing fees in fiscal 2021 and 2022.

Accepted Answer

The answer of McNicols started selling franchise locations in April...

Question 16

ACME is investing in a new heavy oil rig operation in northern Alberta. ACME has hired Max Contractors to construct the facilities. The contract price is $4,450 million to be completed over four years. The following information pertains to this construction contract.
$\begin{array} { | l | r | r | r | r | } 
\hline \text { (all amounts in \$millions) } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } \
\hline \text { Cumulative costs incurred to date } & 1,170 & 1,600 & 2,760 & 4,500 \
\hline \text { Estimated additional costs to complete } & 2,730 & 2,400 & 1,840 & 0 \
\hline \text { Billings on construction in progress } & 1,175 & 1,575 & 1,675 & 25 \
\hline \text { Cash collected in the year } & 1,145 & 1,555 & 1,685 & 65 \
\hline & & & & \
\hline
\end{array}$
Required: (Show all dollar amounts in millions.):
a. Calculate the amount of revenue, expense and gross profit to be recognized in the accounts of Max Contractors in each of the four years.
b. If Max were to underestimate the cost to complete to be $1,690 million instead of $1,840 in Year 3, how much gross profit or loss would be recognized in each year? How much more or less gross profit or loss would be reported in that year? How much more or less gross profit or less would be reported in Year 4, and in total for all four years?
c. Explain how Max would account for this project if there were significant uncertainty over the outcome of the contract, such that Max could not clearly identify or measure the construction costs.
d. Explain what the completed contract method is, and which entities can use this approach.

Accepted Answer

The answer of ACME is investing in a new heavy...

Question 17

Simple Inc. had sales of $1,500,000, including: •$30,000 of goods sold that were on consignment from an unrelated company on December 28, 2021
•$10,000 of goods shipped F.O.B shipping point on December 28, 2021.
•$20,000 of goods shipped F.O.B. destination point on December 31, 2021.
On its income statement, what amount of net sales should Simple Inc. record for 2021?

Accepted Answer

A) $1,440,000 
B) $1,470,000 
C) $1,480,000 
D) $1,490,000

Question 18

Coral Corporation builds large cruise ships on a contract basis. The company uses the percentage of completion method of revenue recognition. The following information pertains to the construction contracts it had in place as of its December 31, 2021 year-end.
 $$\begin{array} { | l | r | r | } 
\hline & 2020 & 2021 \
\hline \text { Cost incurred to date } & 200 \text { million } & 400 \text { million } \
\hline \text { Costs to complete contracts } & 800 \text { million } & 600 \text { million } \
\hline \text { Total price of contracts outstanding at December } & & \
\hline 1,2021 & 2,000 \text { million } & 2,500 \text { million } \
\hline \text { Revenue } & ? ? ? ? & ? ? ? \
\hline
\end{array}$$ Required:
a. Calculate the revenue to be recognized in 2020 and in 2021.
b. While examining the Coral financial statements, the auditors noted that there was an error in the estimate of costs to complete the contracts in 2020. The cost to complete should have been $600 million instead of $800 million. Explain how this would be accounted for in the financial statements.
c. In light of the evidence noted in (b), how much revenue should be recognized in 2021?

Accepted Answer

The answer of Coral Corporation builds large cruise ships on...

Question 19

In July, Telly-Rental sells a home theatre for $1,000 on an installment basis. The cost of goods sold is $400. How much deferred gross profit is recorded by Telly-Rental in July?

Accepted Answer

A) $0 
B) $400 
C) $600 
D) $1,000

Question 20

Superior Cars sold a car for $35,000 cash. In addition, the company will provide 4 oil changes per year for 5 years and an extended warranty for 5 years. The normal observable stand-alone selling prices are as follows:
 $$\begin{array} { | l | l | } 
\hline \text { Car } & \$ 35,000 \
\hline \text { Bil change } & \$ 50 \text { per oil change } \
\hline \text { service- type warranty } & \$ 4,000 \
\hline
\end{array}$$ a. Determine how revenue should be allocated to the various performance obligations in this transaction.
b. Apply the appropriate revenue recognition criteria to determine when revenue should be recognized to the components in this transaction.

Accepted Answer

The answer of Superior Cars sold a car for $35,000...

Exam 4: Revenue and Recognition