CHAPTER 18

SOLUTIONS TO QUESTIONS

1. A major criticism of IFRS regarding revenue recognition is it lacks

guidance. IFRS has only one basic standard on revenue recognition.

2. The revenue recognition principle indicates that revenue is recognized

when it is probable that the economic benefits will flow to the
company and the benefits can be measured reliably.
3. Revenues are recognized generally as follows:
(a) Revenue from selling products—date of delivery to customers.
(b) Revenue from services rendered—when the services have been
performed and are billable.
(c) Revenue from permitting others to use enterprise assets—as
time passes or as the assets are used.
(d) Revenue from disposing of assets other than products—at the
date of sale.
4. Revenue should be measured at the fair value of consideration received
or receivable. Any trade discounts or volume rebates should reduce
consideration received or receivable and the related revenue.
5. The two basic methods of accounting for long-term construction
contracts are: (1) the percentage-of-completion method and (2) the
cost-recovery method. Companies must use the percentage-of-
completion method when the following conditions exist:
1. Total contract revenue can be measured reliably;
2. It is probable that the economic benefits associated with the
contract will flow to the company;
3. Both the contract costs to complete the contract and the stage of
contract completion at the end of the reporting period can be
measured reliably; and
4. The contract costs attributable to the contract can be clearly
identified and measured reliably so the actual contract costs
incurred can be compared with prior estimates.

Companies should use the cost-recovery method when they cannot

meet the conditions to use the percentage-of-completion method or
when there are inherent hazards in the contract beyond the normal,
recurring business risks.

6. The two types of losses that can become evident in accounting for
long-term contracts are:

(1) A current period loss involved in a contract that, upon

completion, is expected to produce a profit.
 (2) A loss related to an unprofitable contract.

The first type of loss results in an adjustment to cumulative gross profit

recognized on the contract. It arises when, during construction, there is
a significant increase in the estimated total contract costs but the
increase does not eliminate all profit on the contract. Under the
percentage-of-completion method, the estimated cost increase
necessitates a current period adjustment of cumulative gross profit,
thereby eliminating some amount of previously recognized gross profit.
The adjustment results in recording a current period loss. No
adjustment is necessary under the cost-recovery method because gross
profit is only recognized upon completion of the contract.

Alternatively, if the second type of loss situation, cost estimates at the

end of the current period indicate that a loss will result upon completion
of the entire contract. In this situation, under both methods
(percentage-of-completion or cost recovery), the entire loss must be
recognized in the current period.

7. Under the cost-recovery method, revenue is recognized up to the amount

of costs incurred in each period. However, no gross profit is recognized
in the income statement until the contract is complete. Thus, revenue
does not exceed costs until the period in which the contract is
completed.

8. A multiple deliverable arrangement provides multiple products or

services to customers as part of a single arrangement. The major
accounting issue related to this type of arrangement is how to allocate
the revenue to the various products and services.

9. Once the separate units of a multiple deliverable arrangement are

determined, the amount paid for the arrangement is allocated among
the separate units based on relative fair value. A company determines
fair value for each unit based on what the vendor could sell the
component for on a standalone basis. If the company’s standalone
prices are not available, third-party evidence can be used to determine
fair value. If third-party evidence is not available, fair value can be
determined based on the seller’s best estimate of what the unit would
sell for on a standalone basis.

BRIEF EXERCISES

BRIEF EXERCISE 18-1

Construction in Process.................................................. 1,700,000

Materials, Cash, Payables, etc................................
1,700,000
Accounts Receivable....................................................... 1,200,000
Billings on Construction in Process........................
1,200,000

Cash.................................................................... 960,000
Accounts Receivable............................................... 960,000

Construction in Process.................................................. 680,000

[($1,700,000 ÷ 5,000,000) X $2,000,000]
Construction Expenses................................................... 1,700,000
Revenue from Long-Term Contracts.......................
2,380,000
($7,000,000 X 34%)
BRIEF EXERCISE 18-2

Construction in Process...................................................... 1,700,000

Materials, Cash, Payables, etc....................................
1,700,000

Accounts Receivable........................................................... 1,200,000

Billings on Construction in Process............................
1,200,000

Cash....................................................................... 960,000
Accounts Receivable...................................................
960,000

Construction Expenses....................................................... 1,700,000

Revenue from Long-Term Contracts............................
1,700,000

BRIEF EXERCISE 18-3

Current Assets
Accounts Receivable.............................................. $ 240,000
Inventories
Construction in process.................................. $2,450,000
Less: Billings.................................................. 1,400,000
Costs and recognized profit in
excess of billings.................................. 1,050,000

BRIEF EXERCISE 18-4

(a) Construction Expenses............................................... 278,000

Construction in Process (Loss)..........................
20,000*
Revenue from Long-Term Contracts...................
258,000

(b) Construction Expenses............................................... 278,000

Revenue from Long-Term Contracts...................
278,000
Loss from Long-Term Contracts................................. 20,000*
 Construction in Process (Loss).......................... 20,000

*[$420,000 – ($278,000 + $162,000)]

 SOLUTIONS TO EXERCISES

EXERCISE 18-1 (20–25 minutes)

(a) Gross profit recognized in:

2010 2011 2012

Contract price $1,600,00 $1,600,00 $1,600,00
0 0 0
Costs:
Costs to $400,00 $825,000 $1,070,000
date 0
Estimated
costs to
complete 600,00 1,000,00 275,000 1,100,00 0 1,070,00
0 0 0 0
Total
estimated 600,000 500,000 530,000
profit
Percentage
completed to 40% 75%* 100
date * * %
Total gross
profit 240,000 375,000 530,000
recognized
Less: Gross
profit
recognized in 240,000 375,00
previous years 0 0
Gross profit
recognized in
current year $ $ 135,000 $
240,000 155,000

**$400,000 ÷ $1,000,000
**$825,000 ÷ $1,100,000

(b) Construction in Process ($825,000 – $400,000).......... 425,000

Materials, Cash, Payables, etc.................................
425,000

Accounts Receivable ($900,000 – $300,000)................. 600,000

Billings on Construction in Process......................
600,000
 Cash ($810,000 – $270,000)........................................... 540,000
Accounts Receivable.............................................
540,000

Construction Expenses.................................................. 425,000

Construction in Process................................................ 135,000
Revenue from Long-Term Contracts......................
560,000*

*$1,600,000 X (75% – 40%)

(c) Gross profit recognized in:

2010 2011 2012

Gross profit $–0– $–0– $530,000
($400,000 – ($825,000 – ($1,600,000 –
$400,000) $825,000) $1,070,000)

EXERCISE 18-2 (15–20 minutes)

$640,000
(a) 2010— X $2,200,000 = $880,000
$1,600,000

2011—$2,200,000 (contract price) minus $880,000 (revenue recognized

in 2010) = $1,320,000 (revenue recognized in 2011).

(b) $1,560,000 of the contract price is recognized as income in 2011

(2,200,000 – 640,000). $640,000 of the contract price was recognized as
income in 2010.

(c) Using the percentage-of-completion method, the following entries would

be made:

Construction in Process................................................ 640,000

Materials, Cash, Payables, etc..............................
640,000

Accounts Receivable..................................................... 420,000

 Billings on Construction in Process......................
420,000

Cash.................................................................. 350,000
Accounts Receivable............................................. 350,000

Construction in Process................................................ 240,000*

Construction Expenses................................................. 640,000
Revenue from Long-Term Contracts
[from (a)].............................................................
880,000

*[$2,200,000 – ($640,000 + $960,000)] X ($640,000 ÷ $1,600,000)

(Using the cost-recovery method, all the same entries are made except
for the last entry. No income is recognized until the total contract cost
is collected.)
EXERCISE 18-3 (10–15 minutes)

(a) The conditions for a multiple-deliverable arrangement exist for Appliance

Center since the delivered item has value to the customer on a stand-
alone basis, the agreement includes a general right of return, and per-
formance of the undelivered item (installation) is considered probable.

(b) Oven $ 800/$1,025 X $1,000 = $780

Installation $ 50/$1,025 X $1,000 = $ 49
Maintenance $ 175/$1,025 X $1,000 = $171
$1,025

SOLUTIONS TO PROBLEMS

PROBLEM 18-1

(a) Computation of Recognizable Profit/Loss

Percentage-of-Completion Method

2010

Costs to date (12/31/10)........................................................ € 300,000

Estimated costs to complete................................................ 1,200,000
Estimated total costs................................................... €1,500,000

Percent complete (€300,000 ÷ €1,500,000).......................... 20%

Revenue recognized (€1,900,000 X 20%).............................. € 380,000

Costs incurred....................................................................... 300,000
Profit recognized in 2010...................................................... € 80,000

2011

Costs to date (12/31/11)........................................................ €1,200,000

Estimated costs to complete................................................ 800,000
Estimated total costs................................................... 2,000,000
Contract price....................................................................... 1,900,000
Total loss............................................................................... € 100,000
 Total loss............................................................................... € 100,000
Plus gross profit recognized in 2010..................................... 80,000
Loss recognized in 2011........................................................ € 180,000

OR

Percent complete (€1,200,000 ÷ €2,000,000)....................... 60%

Revenue recognized in 2011

[(€1,900,000 X 60%) – €380,000] ...................................... € 760,000
Costs incurred in 2011
(€1,200,000 – €300,000) ................................................... 900,000
Loss to date.......................................................................... 140,000
Loss attributable to 2012*.................................................... 40,000
Loss recognized in 2011........................................................ € 180,000

*2012 revenue
(€1,900,000 – €380,000 – €760,000) ......... €760,000
2012 estimated costs.......................... 800,000
2012 loss.............................................. € (40,000)

2012

Costs to date (12/31/12)................................................ €2,100,000

Estimated costs to complete....................................... 0
2,100,000
Contract price.............................................................. 1,900,000
Total loss...................................................................... € (200,000)

Total loss...................................................................... € (200,000)

Less: Loss recognized in 2011.................................... €180,000
Gross profit recognized in 2010................................... (80,000)
(100,000)
Loss recognized in 2012............................................... € (100,000)
(b) Computation of Recognizable Profit/Loss
Cost-Recovery Method

2010—NONE

2011

Costs to date (12/31/11)................................................. €1,200,000

Estimated costs to complete........................................ 800,000
Estimated total costs............................................ 2,000,000
Deduct contract price................................................... 1,900,000
Loss recognized in 2011................................................ € (100,000 )

2012

Total costs incurred....................................................... €2,100,000

Total revenue recognized............................................... 1,900,000
Total loss on contract........................................... (200,000)
Deduct loss recognized in 2011..................................... (100,000)
Loss recognized in 2012................................................ € (100,000)

PROBLEM 18-2

(a) MONAT CONSTRUCTION COMPANY, INC.

Computation of Billings on Uncompleted Contract
In Excess of Related Costs
December 31, 2010

Partial billings on contract during 2010................................. £1,400,000

Deduct construction costs incurred during 2010................... 1,140,000
Balance, December 31, 2010.................................................. £ 260,000
 MONAT CONSTRUCTION COMPANY, INC.
Computation of Cost of Uncompleted Contract
In Excess of Related Billings
December 31, 2011

Balance, December 31, 2010—excess of

billings over costs............................................................... £ (260,000)
Add construction costs incurred during 2011
(£3,290,000 – £1,140,000) .................................................. 2,150,000
1,890,000
Deduct provision for loss on contract
recognized during 2011
(£3,290,000 + £1,410,000 – £4,400,000)............................. 300,000
1,590,000
Deduct partial billings during 2011
(£2,500,000 – £1,400,000)................................................... 1,100,000
Balance, December 31, 2011.................................................. £ 490,000

MONAT CONSTRUCTION COMPANY, INC.

Computation of Costs Relating to Substantially
Completed Contract in Excess of Billings
December 31, 2012

Balance, December 31, 2011—excess of costs

over billings........................................................................... £ 490,000
Add construction costs incurred during 2012
(£4,800,000 – £3,290,000) .................................................... 1,510,000
2,000,000
Deduct loss on contract recognized during 2012
(£4,800,000 – £4,400,000 – £300,000).................................. 100,000
1,900,000
Deduct partial billings during 2012
(£4,300,000 – £2,500,000)..................................................... 1,800,000
Balance, December 31, 2012.................................................... £ 100,000
(b) MONAT CONSTRUCTION COMPANY, INC.
Computation of Profit or Loss to be Recognized
On Uncompleted Contract
Year Ended December 31, 2010

Contract price........................................................ £4,400,000

Deduct contract costs:
Incurred to December 31, 2010............................. £1,140,000
Estimated costs to complete................................ 2,660,000
Total estimated contract cost............................... 3,800,000
Estimated gross profit on contract
at completion...................................................... £ 600,000
Profit to be recognized.......................................... £ 0

(The cost-recovery method recognizes income only after all costs are
incurred.)
MONAT CONSTRUCTION COMPANY, INC.
Computation of Loss to be Recognized
On Uncompleted Contract
Year Ended December 31, 2011

Contract price.................................................... £4,400,000

Deduct contract costs:
Incurred to December 31, 2011......................... £3,290,000
Estimated costs to complete............................ 1,410,000
Total estimated contract cost........................... 4,700,000
Loss to be recognized........................................ £ (300,000)

(The cost-recovery method requires that provision should be made for

an expected loss.)
MONAT CONSTRUCTION COMPANY, INC.
Computation of Loss to Be Recognized
On Substantially Completed Contract
Year Ended December 31, 2012

Contract price...................................................................... £4,400,000

Deduct contract costs incurred.......................................... 4,800,000
Loss on contract.................................................................. (400,000)
Deduct provision for loss booked
at December 31, 2011...................................................... 300,000
Loss to be recognized.......................................................... £ (100,000)
 FINANCIAL REPORTING PROBLEM

(a) 2008 Revenues: £9,022 million.

(b) M&S’s revenues increased from £8,588 million to £9,022 million from
2007 to 2008, or 5.1%. Revenues increased from £7,798 million to £8,588
million from 2006 to 2007, or 10.1%. Revenues increased from £7,798
million in 2006 to £9,022 million in 2008—a 15.7% increase.

(c) M&S’s revenue comprises sales of goods to customers outside the

company less an appropriate deduction for actual and expected returns,
discounts and loyalty scheme voucher costs, and is stated net of Value
Added Tax and other sales taxes. Sales of furniture and online sales are
recorded on delivery to the customer.

(d) Revenues are recorded with a deduction for expected discounts and
loyalty scheme vouchers. Thus, M&S, by establishing allowances for
expected returns, is following accrual accounting principles.

PROFESSIONAL RESEARCH PROBLEM

(a) IAS 18, paragraphs 15-19 addresses revenue recognition when right of
return exists.

(b) “Right of return” is a term/condition allowing customers to return

inventory.

“Bill and hold” refers to sales that the buyer is not yet ready to take
delivery but the buyer takes title and accepts billing.

(c) When there is a right of return, revenue is recognized at the time of sale
when the seller retains only an insignificant risk of ownership, and it can
reliability estimate future returns (IAS 18, para. 17).

(d)

Examples of factors that may impair the ability to make a reasonable estimate
of future returns include:

 A lack of experience with a particular customer or group of customer

  A lack of experience with the product sold
 Unusual economic conditions

(e) The seller recognises revenue when the buyer takes title, provided:

1. it is probable that delivery will be made;

2. the item is on hand, identified and ready for delivery to the buyer at
the time the sale is recognised;

3. the buyer specifically acknowledges the deferred delivery

instructions; and

4. the usual payment terms apply.

Revenue is not recognised when there is simply an intention to acquire

or manufacture the goods in time for delivery.

Note to instructor: IFRS has limited guidance regarding these conditions. As a

result, following the IFRS Hierarchy, companies commonly appeal to GAAP
literature for revenue recognition guidance.