Reading 32: Understanding the Income Statement-LOS b 习题精选 2011, accounting, principles, including, specific

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Session 8: Financial Reporting and Analysis: The Income Statement, Balance Sheet, and Cash Flow Statement
Reading 32: Understanding the Income Statement

LOS b: Explain the general principles of revenue recognition and accrual accounting, demonstrate specific revenue recognition applications (including accounting for long-term contracts, installment sales, barter transactions, and gross and net reporting of revenue), and discuss the implications of revenue recognition principles for financial analysis.

 

 

Which of the following is NOT a requirement for revenue recognition to occur?

A) Earning activities are substantially completed.

B) Transactions giving rise to revenue should be arms-length.

C) Cash must have been received.

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Revenue from credit sales may be recognized when sales are on account.

Other conditions when revenues are also considered earned include when: revenue can be measured with reasonable accuracy, transactions are not subject to revocation, it is possible to measure the cost of provided goods (no significant contingent obligation), and there is assurance of payment (cash) or collectability.

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Information about a company’s revenue recognition policies is most likely disclosed in:

A) the standard auditor’s report.

B) the financial statement notes.

C) Management’s Discussion and Analysis.

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Revenue recognition policies are disclosed in the footnotes to the financial statements.

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When evaluating the differences between two revenue recognition policies, an analyst should view the policy as more conservative which:

A) results in less leverage on the balance sheet.

B) recognizes revenue later.

C) is more dependent on management estimates.

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Recognizing revenue later rather than sooner is considered more conservative. More aggressive (less conservative) revenue recognition can result in less leverage by increasing assets.

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The Better Building Company has a contract to build a building for $100 million. The estimate of the cost of the project is $75 million. In the first year of the project, BB had costs of $30 million. The Better Building Company’s reported profit for the first year of the contract, using the percentage-of-completion method, is:

A) $0.

B) $20 million.

C) $10 million.

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Reported profit (in millions) = ($30 / $75)($100 ? 75) = $10.

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Which, if any, of the following statements about the installment sales method and cost recovery method is correct?

Statement 1: The cost recovery method recognizes revenue and associated costs of goods sold only when cash is received, based on gross profit margin.

Statement 2: The installment sales method recognizes sales when cash is received, but no gross profit is recognized until all of the cost of goods sold is collected.

A) Only one of these statements is correct.

B) Both statements are correct.

C) Neither statement is correct.

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Neither statement is correct because the definitions are reversed.

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An oil exploration company has been contracted to dig 100 exploratory holes for $200,000. The cost to complete this job is estimated to be $150,000, but the company doesn’t recognize any of the $50,000 profit until the job is completed. Which revenue recognition method is being used?

A) Cost recovery method.

B) Completed contract method.

C) Percentage-of-completion method.

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The completed contract method doesn't recognize revenue and expense until the contract is completed. The percentage-of-completion method would have recognized a portion of the $50,000 profit prior to completion.

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Which revenue recognition method is used when the payment is assured and revenue is earned as costs are incurred?

A) Installment sales method.

B) Percentage-of-completion method.

C) Cost recovery method.

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The installment sales method is used when the assurance of payment and estimated bad debts does not exist before cash is collected. Sales revenue and COGS are recognized only when cash is received.

The cost recovery method is used when future cash collections are not assured even after receipt of partial payments. Gross profit is not recognized until all of the cost of goods sold is collected.

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Jerry Krome, CFA, is an equity analyst. The head of research at Krome’s firm composes a memo that contains the following statements:

• To the extent that management has discretion over the firm’s revenue recognition, an analyst should consider policies that recognize revenue later to be more conservative than policies that recognize revenue sooner.
• When comparing the performance of companies, an analyst can use the information in the financial statement disclosures to adjust the financial statements for differences in revenue recognition policies.

With regard to the implications of revenue recognition policies for financial analysis, Krome should agree with:

A) both of these statements.

B) only one of these statements.

C) neither of these statements.

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Because revenue recognition often relies on judgment and estimates from management, it is not always possible to calculate the appropriate adjustments that would account for the differences between companies’ revenue recognition policies. An analyst should use the policies disclosed in companies’ financial statement footnotes to understand the degree to which their revenue recognition is conservative or aggressive. In general, recognizing revenue sooner is considered aggressive and recognizing revenue later is considered conservative.

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An analyst has gathered the following data pertaining to Hegel Company’s construction projects, which began during 2002:

	Project 1	Project 2
Contract price	$420,000	$300,000
Costs incurred in 2002	240,000	280,000
Estimated costs to complete	120,000	40,000
Billed to customers during 2002	150,000	270,000
Received from customers during 2002	90,000	250,000

If Hengel used the completed contract method, what amount of gross profit (loss) would Hengel report in its 2002 income statement for:

Project 1

Project 2

A) $0 ($20,000)

B) $0 $0

C) ($20,000) $0

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No profit is recognized until the completion of the project, however losses are recognized. Project 2 has an expected loss of $20,000.

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If Hengel used the percentage-of-completion method, what amount of gross profit (loss) would Hengel report in its 2002 income statement?

A) $20,000.

B) $22,500.

C) $(20,000).

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Under the percentage of completion method, $40,000 of profit is recognized for project 1. 120,000 + 240,000 = 360,000 total costs; 240,000 / 360,000 × 60,000 estimated profit = $40,000 profit.

Project 2 is running at a $20,000 loss. If the loss can be estimated the loss must be recognized at the time it is estimated. Total revenue for project 2 = 300,000 contract price ? 320,000 total costs = -$20,000 estimated loss

40,000 (project 1) ? 20,000 (project 2) = $20,000 gross profit in 2002

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Football Contractors, Inc. has contracted to build a stadium for the City of Washburn. The contract price is $100 million and costs are estimated at $60 million. Costs are not assured, however, because there is a material risk, which Football Contractors has assumed, that ground water problems might slow construction and increase costs by as much as $40 million. In 2004, the first year of the agreement, Football Contractors, Inc. billed $30 million, received a $20 million payment, and incurred $15 million in costs. For 2004 Football Contractors, Inc. should recognize revenue from the City of Washburn transaction in the amount of:

A) $0.

B) $30 million.

C) $20 million.

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The completed contract method is used when a reliable estimate of the total costs cannot be determined until the contract is finished. Because of the significant uncertainty surrounding the ground water costs, the completed contract method should be used in this transaction, and no revenue should be recognized in 2004 or any later year until the contract is completed or the cost uncertainty is resolved.