Reading 32: Understanding the Income Statement LOS B习题精选 2010, accounting, principles, following

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LOS b, (Part 1): Explain the general principles of revenue recognition and accrual accounting.

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

A) Cash must have been received.

B) Earning activities are substantially completed.

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

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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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LOS b, (Part 3): Discuss the implications of revenue recognition principles for financial analysis.

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) neither of these statements.

C) only one 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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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) recognizes revenue later.

B) results in less leverage on the balance sheet.

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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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) Neither statement is correct.

C) Both statements are 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) Percentage-of-completion method.

B) Installment sales 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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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) $30 million.

B) $0.

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.

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When a reliable estimate of costs exists, ultimate payment is assured, and revenue is earned as costs are incurred, which of the following revenue recognition methods should be used?

A) Percentage-of-completion method.

B) Cost recovery method.

C) Installment sales method.

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The installment sales method recognizes revenue and associated cost of goods sold only when cash is received. Gross profit (sales – cost of goods sold) reflects the proportion of cash received.

The cost recovery method is similar to the installment sales method but is more conservative. Sales are recognized when cash is received, but no gross profit is recognized until all of the cost of goods sold is collected.

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When an unreliable estimate of costs exists and ultimate payment is assured, which of the following revenue recognition methods should be used?

A) Completed contract method.

B) Percentage-of-completion method.

C) Cost recovery method.

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The key word is "unreliable." The completed contract method is used when cost estimates are unreliable. The percentage-of-completion method recognizes profit corresponding to the percentage of cost incurred to total estimated costs associated with long-term construction contracts. Percent-of-completion is used where contracts and cost estimates are reliable.

The cost recovery method is similar to the installment sales method but is more conservative. Sales are recognized when cash is received, but no gross profit is recognized until all of the cost of goods sold is collected.