Exercise 18

E18.1 (LO1) (Fundamentals of Revenue Recognition) Presented below are five

different situations. Provide an answer to each of these questions.
a. The Kawaski Jeep dealership sells both new and used Jeeps. Some of the
Jeeps are used for demonstration purposes; after 6 months, these Jeeps
are then sold as used vehicles. Should Kawaski Jeep record these sales of
used Jeeps as revenue or as a gain?
b. One of the main indicators of whether control has passed to the customer is
whether revenue has been earned. Is this statement correct?
c. One of the five steps in determining whether revenue should be recognized
is whether the sale has been realized. Do you agree?
d. One of the criteria that contracts must meet to apply the revenue standard
is that collectibility of the sales price must be reasonably possible. Is this
correct?
e. Many believe the distinction between revenue and gains is important in the
financial statements. Given that both revenues and gains increase net
income, why is the distinction important?

EXERCISE 18.1 (10–15 minutes)

(1) Kawaski is in the business of buying and selling both new and used Jeeps and this
activity should be considered part of its ordinary activities. Customers have entered
into a contract to purchase these Jeeps and sales revenue should be recognized by
Kawaski. Conversely, if Kawaski is selling its corporate headquarters to another party,
the transaction would not be a contract with a customer because selling real estate is
not an ordinary activity of Kawaski. In this case a gain or loss on sale should be
recognized on the transaction.
(2) This statement is not correct. In the new standard, indicators that control has passed to
the customer include having (1) a present obligation to pay, (2) physical possession, (3)
legal title, (4) risks and rewards of ownership, and (5) acceptance of the asset.
(3) Again this statement is not correct. See additional answer related to number 2.
(4) This statement is not correct. For a valid contract to exist, the collection of revenue
must be probable.
(5) The distinction between revenue and gains is important because it is useful to
understand how these increases in net income occurred. Sales revenue results from
the normal operating activities of the business, and therefore, is generally considered
a better measure for predicting the amount, timing, and uncertainty of future cash
flows. Gains on the other hand are often incidental to the business and therefore do
not provide as much predictive information.
E18.4 (LO2) (Determine Transaction Price) Jupiter Company sells goods to
Danone Inc. by accepting a note receivable on January 2, 2019. The goods have
a sales price of $610,000 (cost of $500,000). The terms are net 30. If Danone
pays within 5 days, however, it receives a cash discount of $10,000. Past history
indicates that the cash discount will be taken. On January 28, 2019, Danone
makes payment to Jupiter for the full sales price.
Instructions
a. Prepare the journal entry(ies) to record the sale and related cost of goods
sold for Jupiter Company on January 2, 2019, and the payment on January
28, 2019. Assume that Jupiter Company records the January 2, 2019,
transaction using the net method.
b. Prepare the journal entry(ies) to record the sale and related cost of goods
sold for Jupiter Company on January 2, 2019, and the payment on January
28, 2019. Assume that Jupiter Company records the January 2, 2019,
transaction using the gross method.

EXERCISE 18.4 (20–25 minutes)

(a) The journal entry to record the sale and related cost of goods sold are as follows:

January 2, 2019

Notes Receivable..................................................................... 600,000

Sales Revenue ($610,000 − $10,000)......................... 600,000
Cost of Goods Sold................................................................... 500,000
Inventory.................................................................... 500,000

The journal entry to record the collection of the note is as follows:

January 28, 2019

Cash........................................................................................ 610,000
Notes Receivable........................................................ 600,000
Sales Discounted Forfeited........................................

(b) January 2, 2019

Notes Receivable..................................................................... 610,000

Sales Revenue............................................................ 610,000
Cost of Goods Sold................................................................... 500,000
Inventory.................................................................... 500,000
 January 28, 2019
Cash........................................................................................ 610,000
Notes Receivable........................................................ 610,000

Note that the time value of money is not considered because the contract is less than
a year. Also, if payment occurs within 5 days, under the net method, the entry would
be:

Cash........................................................................................ 600,000
Notes Receivable........................................................ 600,000
EXERCISE 18.4 (continued)

If payment occurs within 5 days, under the gross method, the entry would be

Cash........................................................................................ 600,000
Sales Discounts....................................................................... 10,000
Notes Receivable........................................................ 610,000

E18.7 (LO2) (Determine Transaction Price) Blair Biotech enters into a licensing
agreement with Pang Pharmaceutical for a drug under development. Blair will
receive a payment of \10,000,000 if the drug receives regulatory approval.
Based on prior experience in the drug-approval process, Blair determines it is
90% likely that the drug will gain approval and a 10% chance of denial.
Instructions
a. Determine the transaction price of the arrangement for Blair Biotech.
b. Assuming that regulatory approval was granted on December 20, 2019, and
that Blair received the payment from Pang on January 15, 2020, prepare the
journal entries for Blair. The license meets the criteria for point-in-time
revenue recognition.

Because the arrangement only has two possible outcomes (regulatory approval is achieved
or not), Blair determines the transaction price based on the most likely approach.
Thus, the best measure for the transaction price is ¥10,000,000.

(b) December 20, 2019

Accounts Receivable................................................................ 10,000,000

License Revenue............................................................ 10,000,000

January 15, 2020

Cash .....................................................................10,000,000
Accounts Receivable...................................................... 10,000,000
E18.8 (LO2, 3) (Determine Transaction Price) Aaron's Agency sells an insurance
policy offered by Capital Insurance Company for a commission of $100 on
January 2, 2019. In addition, Aaron will receive an additional commission of $10
each year for as long as the policyholder does not cancel the policy. After selling
the policy, Aaron does not have any remaining performance obligations. Based
on Aaron's significant experience with these types of policies, it estimates that
policyholders on average renew the policy for 4.5 years. It has no evidence to
suggest that previous policyholder behavior will change.
Instructions
a. Determine the transaction price of the arrangement for Aaron, assuming
100 policies are sold.
b. Determine the revenue that Aaron will recognize in 2019.

a. Aaron determines that the transaction price for the 100 policies is $14,500 [($100 X
100) + ($10 X 4.5 X 100)].

(b) Aaron will recognize revenue of $3,222 ($14,500 X 12/54), because on average,
customers renew for 4.5 years, Aaron includes that amount in its estimate for the
transaction price. As circumstances change, Aaron updates its estimate of the
transaction price and recognizes revenue (or a reduction of revenue) for those
changes in circumstances.

E18.26 (LO3) (Warranty Arrangement) On January 2, 2019, Grando Company

sells production equipment to Fargo Inc. for $50,000. Grando includes a 2-year
assurance warranty service with the sale of all its equipment. The customer
receives and pays for the equipment on January 2, 2019. During 2019, Grando
incurs costs related to warranties of $900. At December 31, 2019, Grando
estimates that $650 of warranty costs will be incurred in the second year of the
warranty.
Instructions
a. Prepare the journal entry to record this transaction during 2019 (assuming
financial statements are prepared on December 31, 2019).
b. Repeat the requirements for (a), assuming that in addition to the assurance
warranty, Grando sold an extended warranty (service-type warranty) for an
additional 2 years (2021–2022) for $800.

(a) January 2, 2019

Cash ..........................................................................................50,000
Sales Revenue.............................................................................. 50,000

During 2019
Warranty Expense.................................................................................. 900
Cash, Labor, Parts......................................................................... 900

December 31, 2019

Warranty Expense.................................................................................. 650
 Warranty Liability......................................................................... 650

(b) January 2, 2019

Cash ($50,000 + $800)........................................................................... 50,800

Sales Revenue.............................................................................. 50,000
Unearned Warranty Revenue (Service-type)............................... 800

During 2019
Warranty Expense.................................................................................. 900
Cash, Labor, Parts......................................................................... 900

December 31, 2019

Warranty Expense.................................................................................. 650
Warranty Liability......................................................................... 650

Grando recognizes $400 of revenue on the service type warranty in 2021 and 2022. Warranty
costs in the extended warranty period will be expensed as incurred.

E18.27 (LO3) (Warranties) Celic SA manufactures and sells computers that

include an assurance- type warranty for the first 90 days. Celic offers an optional
extended coverage plan under which it will repair or replace any defective part
for 3 years from the expiration of the assurance-type warranty. Because the
optional extended coverage plan is sold separately, Celic determines that the 3
years of extended coverage represents a separate performance obligation. The
total transaction price for the sale of a computer and the extended warranty is
€3,600 on October 1, 2019, and Celic determines the standalone selling price of
each is €3,200 and €400, respectively. Further, Celic estimates, based on
historical experience, it will incur €200 in costs to repair defects that arise within
the 90-day coverage period for the assurance-type warranty. The cost of the
computer is €1,440. Assume that the €200 in costs to repair defects in the
computer occurred on October 25, 2019.
Instructions
a. Prepare the journal entry(ies) to record the October transactions related to
sale of the computer.
b. Briefly describe the accounting for the service-type warranty after the 90-
day assurance-type warranty period.
EXERCISE 18.27 (15–20 minutes)

(a) October 1, 2019

To record sales revenue, warranties, and related cost of goods sold

Cash (or Accounts Receivable)............................................................... 3,600

Sales Revenue.............................................................................. 3,200
Unearned Warranty Revenue (Service-type)............................... 400
Cost of Goods Sold................................................................................. 1,440
Inventory...................................................................................... 1,440

To record warranty expense on October 25, 2019

Warranty Expense.................................................................................. 200

Cash, Parts, Labor.........................................................................

(b) Celic recognizes warranty expenses associated with the assurance-type warranty as
actual warranty costs are incurred during the first 90 days after the customer receives
the computer. Celic recognizes the Unearned Service Revenue associated with the
service-type warranty as revenue during the extended warranty period and recognizes
the costs associated with providing the service-type warranty as they are incurred.

E18.29 (LO4) (Contract Modification) In September 2019, Gaertner Corp.

commits to selling 150 of its iPhone-compatible docking stations to Better Buy
Co. for $15,000 ($100 per product). The stations are delivered to Better Buy over
the next 6 months. After 90 stations are delivered, the contract is modified and
Gaertner promises to deliver an additional 45 products for an additional $4,275
($95 per station). All sales are cash on delivery.
Instructions
a. Prepare the journal entry for Gaertner for the sale of the first 90 stations.
The cost of each station is $54.
b. Prepare the journal entry for the sale of 10 more stations after the contract modification,
assuming that the price for the additional stations reflects thestandalone selling price at the
time of the contract modification. In addition,
the additional stations are distinct from the original products as Gaertner
regularly sells the products separately.
c. Prepare the journal entry for the sale of 10 more stations (as in (b)),
assuming that the pricing for the additional products does not reflect the
standalone selling price of the additional products and the prospective
method is used.

(a) Cash ..............................................................................9,000

Sales Revenue (90 X $100)............................................

Cost of Goods Sold.................................................................. 4,860

Inventory (90 X $54)......................................................

(b) Cash ..............................................................................1,000

Sales Revenue (10 X $100)............................................

Cost of Goods Sold.................................................................. 540

Inventory (10 X $54)......................................................

In this situation, the contract modification for the additional 45 products is, in effect, a
new and separate contract for future products that does not affect the accounting for
the previously existing contract.

(c) In this case, because the new price does not reflect a stand-alone selling price,
Gaertner allocates a modified transaction price (less the amounts allocated to
products transferred at or before the date of the modification) to all remaining
products to be transferred.
EXERCISE 18.29 (continued)

Under the prospective approach, Gaertner determines the transaction price for
subsequent sales ($97.86) as follows.

Consideration for products not yet delivered

   under original contract ($100 X 60)
Consideration for products to be delivered
   under the contract modification ($95 X 45)
Total remaining revenue
Revenue per remaining unit ($10 ,275 ¸ 105) = $97.86.

As indicated, the numerator includes products not yet transferred under original
contract ($100 X 60) plus products to be transferred under the contract modification
($95 X 45), which is divided by the remaining 105 products.

The journal entries to record subsequent sales and related cost of goods sold for 10
units is as follows.

Cash (10 X $100).............................................................1,000

Unearned Revenue........................................................ 21.40
Sales Revenue (10 X $97.86)......................................... 978.60

Cost of Goods Sold.......................................................540.00

Inventory....................................................................... 540.00