Deck 3: Additional Topics in Income Determination

Question 1

Under the percentage-of-completion method,the profit to be recognized in any year is based on the ratio of incurred contract costs divided by estimated total contract costs.

Answer 1

True

Question 2

Under GAAP,the completed contract method is an acceptable alternative to the percentage-of-completion method of accounting for any given long-term construction project.

Answer 2

False

Question 3

Interest payments are included when computing the recognized gross profit on installment sales.

Answer 3

False

Question 4

Deferred gross profit on installment sales is generally treated as a deduction from installment sales.

Question 5

Revenue is recognized at the earliest moment in time that the revenue is "earned" and "realized or realizable."

Question 6

At the end of a given long-term construction project,"retained earnings" will be the same regardless of whether the construction company uses the completed contract method or the percentage-of-completion method when accounting for the project.

Question 7

Revenue is recognized at the earliest moment that the critical event and measurability criteria are both satisfied.

Question 8

Extended time of completion of the project and accurate measurement of its progress towards completion are the only attributes necessary for the appropriate utilization of the percentage-of-completion method of revenue recognition.

Question 9

A sale should not be recognized as revenue by the seller at time of sale if payment is made by check.

Question 10

Construction contracts usually require purchasers to make progress payments to the contractor as construction progresses.

Question 11

Treating the "billings on construction in progress" account as an off-set (contra)to the construction inventory account avoids including certain costs and profits twice on the balance sheet.

Question 12

Producers of commodities have well-organized markets for their products,thus an established price is available for as many units as they choose to sell.

Question 13

When losses occur on long-term contracts using the completed contract method,they are recognized at the completion of the contract.

Question 14

The sale is itself the sole criterion for recognizing revenue.

Question 15

In both farming and mining there is general agreement that the critical event in adding value usually comes before the actual sale.

Question 16

The percentage of completion ratio is determined by dividing costs incurred to date by the contract price.

Question 17

The installment sales method recognizes revenue and income proportionately as cash is collected.

Question 18

Under the percentage-of-completion method,the amount debited to "construction expense" each period is the actual construction costs incurred in that period.

Question 19

Because a farmer's expenditures for seed,fertilizer and fuel yield uncertain future benefits (similar to expenditures on research and development),such expenditures are expensed as incurred.

Question 20

The amount of revenue recognized under the percentage-of-completion method is equal to the progress payments received during the reporting period.

Question 21

When it's highly uncertain whether customers will make the cash payments called for in a contract,then the sale itself is not the critical event in creating value.

Question 22

Selling,general,and administrative expenses relating to installment sales are deferred until the revenue is recognized.

Question 23

Initial franchise fee revenue should be recognized when all material services or conditions relating to the sale have been substantially performed by the franchisor.

Question 24

Authoritative guidance on bundled (multiple-element)software sales transactions states that if a software sales arrangement includes multiple,distinct elements,the revenue from the arrangement should be allocated to the various elements based on prevailing industry practices.

Question 25

Generally accepted accounting principles leave ample room for managers to manipulate earnings to their satisfaction.

Question 26

The key accounting issue related to bundled (multiple-element)sales transactions is the amount of revenue to be recognized over the contract period.

Question 27

The key issue in franchise fee accounting centers on when and how much of the initial franchise fee should be recognized up front as revenue by the franchisor.

Question 28

Under the "cost recovery method," after the cost of the merchandise sold on an installment basis has been recovered,any cash collected in excess of this amount is recorded as recognized gross profit on the seller's income statement.

Question 29

The account "Billings on Construction in Progress" is shown on the balance sheet as a liability account.

Question 30

Stringent rules do not exist for determining when revenue has been earned and is realizable thus leaving some flexibility for management to "manage earnings" within the confines of generally accepted accounting principles.

Question 31

Stringent rules exist for determining when revenue has been earned and is realizable thus leaving little flexibility for management to "manage earnings" within the confines of generally accepted accounting principles.

Question 32

Even though well-organized markets for agricultural commodities exist,GAAP requires that farmers use only the completed-transaction method of revenue recognition.

Question 33

The most important criteria related to revenue recognition when the right of return exists is that the amount of future returns can be reasonably estimated.

Question 34

The key accounting issue related to bundled (multiple-element)sales transactions is how much of the lump-sum contract price should be recognized up front when the product is delivered to the customer,and how much should be deferred and recognized as the seller satisfies its commitment for other deliverables specified in the contract.

Question 35

Costs incurred by the franchisor to provide initial and continuing services (for example,counseling by a registered dietician or advertising)are expensed in the same periods as the franchise revenue in accordance with the matching principle.

Question 36

In franchise arrangements,the franchisor gives the franchisee the exclusive right to sell a product or service in a given locale and to use the franchisor's name for a specified period of time.

Question 37

The installment sales method is considered more conservative than the cost recovery method because when using the installment sales method,a portion of gross profit is recognized on each dollar collected.

Question 38

A typical franchise agreement calls for only the payment of an initial franchise fee which is recorded as revenue in the period it is received.

Question 39

The installment sales method of recognizing profit for accounting purposes is acceptable if collection of the sales price is not reasonably assured.

Question 40

GAAP requires that the interest component of the periodic cash flows from installment sales be recorded separately.

Question 41

IFRS rules for revenue recognition and measurement are much more voluminous and detailed than those contained in U.S.GAAP.

Question 42

Research indicates that few managers would engage in real transaction management (e.g.,delaying research and development or advertising)in order to meet earnings targets.

Question 43

SAB 104,"Revenue Recognition," was not meant to change GAAP,but rather to close some loopholes and eliminate gray areas in how GAAP was being applied in practice.

Question 44

"Cookie jar reserves" refers to the practice of overreserving estimated obligations during good times and underestimating,or reversing previous charges,in bad times.

Question 45

A prior period adjustment results in an adjustment to the company's beginning retained earnings balance.

Question 46

The audit committee and the company's internal audit staff provide the first-line defense against accounting errors/irregularities.

Question 47

The SEC through its review of companies' filings sometimes identifies accounting irregularities that require correction.

Question 48

A seller may recognize revenue when the production of the goods is complete if the buyer requests that the transaction be on a "bill and hold" basis and has a substantial business purpose for such a request.

Question 49

In the context of revenue recognition,an "arrangement" means there is a final understanding between the parties as to the specific nature and terms of the agreed-upon transaction.

Question 50

With respect to revenue generated by selling goods,IFRS prescribes that revenue should be recognized using the percentage-of-completion method.

Question 51

"Cookie jar reserves" are required under GAAP.

Question 52

As per the SEC,nonrefundable up-front initiation fees to activate services contracts (e.g.,telecommunications services)may be immediately recognized as revenue as long as the fees are greater than the costs to activate the contracted services.

Question 53

Errors discovered after the year in which they occur are corrected through disclosure in notes to the financial statements.

Question 54

IFRS and U.S.GAAP rules for revenue recognition and measurement largely overlap.

Question 55

"Big bath" restructuring charges are believed to not adversely affect stock prices.

Question 56

The correction of an error causes previous year financial statements to be retroactively restated for comparative purposes.

Question 57

The SEC permits Internet resellers (i.e.,those that act as agents or brokers in a transaction)to report revenue on either a "gross" or "net" basis.

Question 58

Revenue recognition irregularities constitute the most frequently cited reason for restating financial statements during the past few years.

Question 59

Research indicates that fewer firms report slightly negative earnings than slightly positive earnings,suggesting that managers of firms that would otherwise report a slight loss are finding ways to prop up earnings.

Question 60

"Capacity swaps" have been used by telecommunications companies as a means to prematurely recognize revenue.

Question 61

Unlike U.S.GAAP,IFRS calls for revenue to be measured at the fair value of the consideration received or receivable.

Question 62

All of the following are examples of long-term construction projects except

A)military hardware.
B)oil tankers.
C)bridges.
D)residential swimming pools.

Question 63

Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project estimated to cost $4,000,000 and the following information is available:
$\begin{array}{llll}(\$ \text { in thousands) } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 }\\\text { Costs incurred } & \$ 1,000 & \$ 1,500 & \$ 1,250 \\\text { Estimated completion costs } & \$ 3,000 & \$ 1,500 & \$ 10 \\\text { Billings } & \$ 750 & \$ 1,750 & \$ 2,500 \\\text { Cash collected } & \$ 500 & \$ 1,500 & \$ 3,000\end{array}$

-Using the percentage-of-completion method of revenue recognition,how much income is recognized in Year 2?

A)$250,000
B)$375,000
C)$625,000
D)$3,125,000

Question 64

Under the percentage-of-completion method of revenue recognition,the percentage-of-completion ratio is computed by dividing

A)profits earned to date by estimated total profits.
B)costs incurred to date by estimated total costs.
C)costs incurred to date by the contract price.
D)profits earned to date by the contract price.

Question 65

When the outcome of a service contract can be reliably estimated,IFRS rules allow firms to recognize contract revenue and expenses using the percentage-of-completion method.

Question 66

When the outcome of a transaction for services cannot be reliably measured,IFRS rules call for entities to recognize revenue only up to the amount of recoverable costs incurred to that point.

Question 67

If the critical event and measurability conditions are not satisfied,revenue may be recognized after the sale

A)when legal ownership passes to the seller.
B)when cash is collected.
C)as the goods are shipped.
D)on the receipt of goods by the customer.

Question 68

When the risk of non-collection of installment payments is high or when there is no reasonable basis for estimating the proportion of installment accounts receivable likely to prove uncollectible,both IFRS and U.S.GAAP permit the use of the installment sales method.

Question 69

Under IFRS,when the cost recovery method is applied to installment sales,the seller will recognize gross profit only after the cumulative amount of cash collected exceeds the cost of sales.

Question 70

The earliest moment that the critical event and measurability are both satisfied for revenue recognition is usually

A)before the sale.
B)after the sale.
C)at the time of sale.
D)when payment is receiveD.

Question 71

Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project estimated to cost $4,000,000 and the following information is available:
$\begin{array}{llll}(\$ \text { in thousands) } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 }\\\text { Costs incurred } & \$ 1,000 & \$ 1,500 & \$ 1,250 \\\text { Estimated completion costs } & \$ 3,000 & \$ 1,500 & \$ 10 \\\text { Billings } & \$ 750 & \$ 1,750 & \$ 2,500 \\\text { Cash collected } & \$ 500 & \$ 1,500 & \$ 3,000\end{array}$

-Using the percentage-of-completion method of revenue recognition,how much income is recognized in Year 3?

A)$375,000
B)$625,000
C)$1,000,000
D)$1,250,000

Question 72

If the critical event and measurability conditions are satisfied,revenue may be recognized before the sale

A)as production takes place.
B)when the customer pays in advance.
C)if the seller legally owns the goods.
D)when the customer purchases on credit.

Question 73

Under the percentage-of-completion method,the profit to be recognized in any year is based on the ratio of

A)incurred contract costs divided by estimated total contract costs.
B)incurred contract costs multiplied by estimated total contract costs.
C)estimated total contract costs divided by incurred contract costs.
D)estimated total contract costs multiplied by incurred contract costs.

Question 74

When losses occur on long-term contracts using the percentage-of-completion method,they are recognized

A)in their entirety as soon as it becomes known that a loss will be suffered.
B)at the completion of the project.
C)proportionately over the contract period using costs incurred as a base.
D)evenly over the contract perioD.

Question 75

Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project estimated to cost $4,000,000 and the following information is available:
$\begin{array}{llll}(\$ \text { in thousands) } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 }\\\text { Costs incurred } & \$ 1,000 & \$ 1,500 & \$ 1,250 \\\text { Estimated completion costs } & \$ 3,000 & \$ 1,500 & \$ 10 \\\text { Billings } & \$ 750 & \$ 1,750 & \$ 2,500 \\\text { Cash collected } & \$ 500 & \$ 1,500 & \$ 3,000\end{array}$

-Which one of the following entries would be made in Year 1 to record the income recognized using the percentage-of-completion method of revenue recognition?

A) $\begin{array}{lr}\text { DR Inventory: Construction in progress } & 250,000 \\\text { DR Construction expense } & 1,000,000\\\text { CR Construction revenue }&1,250,000\end{array}$
B) DR Inventory: Construction in progress $\quad 375,000$
CR Billings on construction in progress \quad 375,000\C) DR Inventory: Construction in progress \(\quad 675,000
CR Billings on construction in progress $\quad$ 675,000
D) DR Income on long-term construction contract $\quad 3,125,000$
CR Accounts payable, cash, etc. $\quad$$3,125,000$

Question 76

When the outcome of a service contract cannot be reliably estimated,IFRS rules require firms to use the completed contract method.

Question 77

Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project estimated to cost $4,000,000 and the following information is available:
$\begin{array}{llll}(\$ \text { in thousands) } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 }\\\text { Costs incurred } & \$ 1,000 & \$ 1,500 & \$ 1,250 \\\text { Estimated completion costs } & \$ 3,000 & \$ 1,500 & \$ 10 \\\text { Billings } & \$ 750 & \$ 1,750 & \$ 2,500 \\\text { Cash collected } & \$ 500 & \$ 1,500 & \$ 3,000\end{array}$

-Which one of the following entries would be made in Year 3 to record the completion and acceptance of the project using the completed-contract method of revenue recognition?

A) DR Inventory: Construction in progress $\quad$$5,000,000$
CR Billings on construction in progress $\quad$$5,000,000$
B) DR Billings on construction in progress $\quad 5,000,000$
CR Inventory: Construction in progress $\quad$$3,750,000$
CR Income on long-term construction contract $\quad$$1,250,000$
C) DR Inventory: Construction in progress $\quad 3,750,000$
DR Income on long-term construction contract $\quad 1,250,000$
CR Billings on construction in progress $\quad$$5,000,000$
D) DR Billings on construction in progress $\quad$$\quad$$1,250,000$
CR Inventory: Construction in progress $\quad$$\quad$$1,250,000$

Question 78

Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project estimated to cost $4,000,000 and the following information is available:
$\begin{array}{llll}(\$ \text { in thousands) } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 }\\\text { Costs incurred } & \$ 1,000 & \$ 1,500 & \$ 1,250 \\\text { Estimated completion costs } & \$ 3,000 & \$ 1,500 & \$ 10 \\\text { Billings } & \$ 750 & \$ 1,750 & \$ 2,500 \\\text { Cash collected } & \$ 500 & \$ 1,500 & \$ 3,000\end{array}$

-Which one of the following entries would be made in Year 1 to record the costs incurred using the percentage-of-completion method of revenue recognition?

A) DR Inventory: Construction in progress $\quad$$\quad$$1,000,000$
CR Accounts payable, cash, etc. $\quad$$\quad$$1,000,000$
B) DR Inventory: Construction in progress $\quad 1,000,000$
CR Income on long-term construction contract $\quad 1,000,000$
C) DR Inventory: Construction in progress $\quad 1,000,000$
CR Billings on construction in progress $\quad 1,000,000$
D) DR Income on long-term construction contract $\quad 1,000,000$
CR Accounts payable, cash, etc. $\quad 1,000,000$

Question 79

When losses occur on long-term contracts using the completed-contract method,they are recognized

A)proportionately over the contract period using costs incurred as a base.
B)evenly over the contract period.
C)in their entirety as soon as it becomes known that a loss will be suffered.
D)at the completion of the project.

Question 80

Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project estimated to cost $4,000,000 and the following information is available:
$\begin{array}{llll}(\$ \text { in thousands) } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 }\\\text { Costs incurred } & \$ 1,000 & \$ 1,500 & \$ 1,250 \\\text { Estimated completion costs } & \$ 3,000 & \$ 1,500 & \$ 10 \\\text { Billings } & \$ 750 & \$ 1,750 & \$ 2,500 \\\text { Cash collected } & \$ 500 & \$ 1,500 & \$ 3,000\end{array}$

-Which one of the following entries would be made in Year 2 to record the customer billing using the percentage-of-completion method of revenue recognition?

A) DR Accounts receivable $\quad$$1,500,000$
CR Cash $\quad$$\quad$$1,500,000$
B) DR Accounts receivable $\quad$$\quad$$1,500,000$
CR Billings on construction in progress $\quad$$\quad$$1,500,000$
C) DR Accounts receivable $\quad$$\quad$$1,750,000$
CR Income on long-term construction contract $\quad$$\quad$$1,750,000$
D) DR Accounts receivable $\quad$$1,750,000$
CR Billings on construction in progress $\quad$$1,750,000$