Questions and Practice Exercises



Questions and Practice Exercises

Questions:

1. What are the two general revenue recognition criteria?

2. What four revenue recognition factors are identified in AICPA Statement of Position (SOP) 97-2, and how do these four factors relate to the two general revenue recognition criteria?

3. Why did the SEC issue Staff Accounting Bulletin (SAB) 101?

4. Why does Question 1 in SAB 101 emphasize the proper signing of a sales agreement?

5. What types of side agreements can turn a sale into a consignment?

6. What is a bill-and-hold arrangement? Under what circumstances may a seller recognize revenue before shipment on a bill-and-hold arrangement?

7. What is the significance of customer acceptance provisions?

8. In general, why are upfront, non-refundable fees not recognized as revenue immediately?

9. Why shouldn’t revenue be recognized until the transaction price can be definitely determined?

10. Under what circumstances can a refundable fee be recognized as revenue month-by-month before the refund period is over?

11. Why can’t contingent rents be estimated and recognized on a straight-line basis over the course of a year?

12. Under what circumstances can a company reliably estimate product returns?

13. Why would a company prefer gross revenue reporting over net revenue reporting?

Practice Exercises:

PRACTICE 1 BASIC JOURNAL ENTRIES FOR REVENUE RECOGNITION

The company collected $1,000 cash in advance from a customer for services to be rendered. Subsequently, the company rendered the services. Make the journal entries necessary to record (1) the receipt of the cash and (2) the subsequent completion of the services.

PRACTICE 2 JOURNAL ENTRIES FOR A CONSIGNMENT

Company S shipped goods costing $10,000 to Company C on consignment. The sales agreement states that Company C has 90 days to either sell the goods and pay Company S $16,000 for them or to return the goods to Company S. Make the journal entries necessary on the books of Company S to record (1) the original shipment of the goods to Company C and (2) the expiration of the 90-day period without the goods being returned by Company C. Company S uses a perpetual inventory system.

PRACTICE 3 JOURNAL ENTRIES FOR A LAYAWAY

On January 1, the company received layaway payments from two customers. Each customer paid $50. On December 24, the layaway period expired. On that date, the company received $300 from Customer 1 and delivered the promised merchandise (costing $200). Customer 2 did not return to make the final payment and thus forfeited the initial $50 layaway payment. Make the journal entries necessary to record (1) the receipt of the initial layaway payments, (2) the receipt of the final layaway payment and the delivery of the goods to Customer 1, and (3) the forfeit of the layaway payment by Customer 2. The company uses a perpetual inventory system.

PRACTICE 4 JOURNAL ENTRIES FOR AN UPFRONT, NON-REFUNDABLE FEE

The company sells satellite phone service. Customers are required to pay an initial fee of $360, followed by continuing service fees of $50 per month. The initial fee is not refundable. The company’s best estimate is that the average customer will continue the service for three years. On January 1, the company signed up 200 new customers. Make the journal entries necessary to record (1) the receipt of the initial fees from these 200 customers, (2) the receipt of the first monthly payment from the 200 customers, and (3) the partial recognition of the initial fees as revenue after the first month.

PRACTICE 5 JOURNAL ENTRIES FOR AN UPFRONT, REFUNDABLE FEE

The company operates a travel club through which subscribers can access low rates for air fares, hotel rooms, and rental cars. Each year, subscribers pay a refundable fee of $1,000 that allows them access to the company’s services for that year. A customer may receive a full refund of this fee at any time during the year with no questions asked. The cost to service a customer’s account for a year is $120; these costs are incurred in cash evenly throughout the year. The company can reliably estimate that 30 percent of customers will ask for a full refund of their subscription fee. On January 1, the company received payments from 1,500 subscribers. Make the journal entries necessary to record (1) the receipt of the subscription fees from these 1,500 customers, (2) the partial recognition of the subscription fees as revenue after the first month (with the associated service cost for the first month), and (3) final recognition of revenue (and associated service cost) for the month of December as well as the payment of full refunds to 30 percent of the customers (as expected).

PRACTICE 6 JOURNAL ENTRIES FOR CONTINGENT RENT

On January 1, Owner Company signed a one-year rental for a total of $480,000, with monthly payments of $40,000 due at the end of each month. In addition, the renter must pay contingent rent of two percent of all sales in excess of $50 million. The contingent rent is paid in one payment on December 31. On January 31, Owner Company received the first rental payment. At that time, sales for the renter had reached $10 million. On May 31, Owner Company received the regular monthly rental payment; by the end of May, the renter had reached a sales level of $55 million. On December 31, Owner received the final monthly rental payment as well as the contingent rental payment. The renter’s sales for the year totaled $80 million, of which $12 million occurred in December. Make the journal entries necessary on the books of Owner Company on (1) January 31, (2) May 31, and (3) December 31.

PRACTICE 7 REPORTING REVENUE GROSS AND NET

Online Company operates a Web grocer. Customers submit their orders online to Online Company; Online then forwards the orders to a national grocery chain. The grocery chain arranges for assembly and shipment of the order. Online Company receives two percent of the retail value of all orders it takes. During January, Online Company received orders for groceries with a retail selling price of $300,000. These groceries cost the grocery store chain $210,000. The grocery store chain collected cash of $300,000 from the customers and paid the appropriate commission in cash to Online Company. Based on this information, make all journal entries necessary in January (1) on the books of Online Company and (2) on the books of the grocery store chain. Assume that the grocery store chain uses a perpetual inventory system.

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