honeycfa

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) $10 million.

B) $0.

C) $20 million.

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

honeycfa

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.

honeycfa

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.

honeycfa

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.

honeycfa

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.

 

honeycfa

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.

honeycfa

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.