Chapter 18 In-Class Questions (with blanks) ACG4123

Multiple-Deliverable Arrangements
Cyber Samurai, Inc. has sold a bundled software package to Naive Company to
improve their network security for $200,000 on 12/20/2008. The bundle includes
software, installation, training, and customer support. The performance obligation
will be met for the software and installation when it is installed on 1/1/09, the
training will consist of two 8-hour sessions – one occurring on 1/2/09 and the other
occurring on 1/2/10. The customer support will be for five years beginning on
1/1/09. Given the following market values of each of these products included in
the bundle, how much revenue can Cyber Samurai, Inc recognize in 2009?
Value
Software $160,000
Installation $20,000
Training $120,000
Customer Support $100,000

160k + 20k +120K + 100K = 400k value individually, packaged for $200k. So
each product is allocated half of its individual value. (80k, 10k, 60k, and 50k,
respectively)

2009: 100% of software, 100% of installation, 50% of training, 20% of customer

support…….. 80k + 10k + 30k + 10k = 130k revenue in 2009

What is the journal entry that Cyber Samurai, Inc. will record on 12/20/2008?
Debit Cash 200k, Credit Unearned revenue 200k
Chapter 18 In-Class Questions (with blanks) ACG4123

Assuming that Cyber Samurai, Inc. adjusts their unearned revenue balances at year
end, what journal entry will they record on 12/31/2009?
Debit unearned revenue, Credit revenue for 130k each

Volume and Cash Discounts

On January 1, 2012 Cellar sells 10,000 units of inventory to Baeur. The list price
of each unit of inventory sold is $20 (assume the cost of each unit is $12). Due to
the high volume of inventory purchased by Baeur, Cellar offs a 10% trade discount
on this purchase price. In addition, Cellar offers a cash discount with the terms
2/10, n/30 to encourage a faster collection….
Scenario 1: Baeur pays for the inventory on January 9th…
How will Cellar record the sale and collections under the net method?

January 1st:
A/R $176,400
Revenue $176,400

COGS $120,000
Inventory $120,000

January 9th:
Cash $176,400
A/R $176,400

How will Cellar record this sale and collection under the gross method?
January 1st:
A/R $180,000
Revenue $180,000

COGS $120,000
Inventory $120,000

January 9th:
Cash $176,400
A/R $180,000
Sales Discount $3,600
Chapter 18 In-Class Questions (with blanks) ACG4123

On January 1, 2012 Cellar sells 10,000 units of inventory to Baeur. The list price
of each unit of inventory sold is $20 (assume the cost of each unit is $12). Due to
the high volume of inventory purchased by Baeur, Cellar offs a 10% trade discount
on this purchase price. In addition, Cellar offers a cash discount with the terms
2/10, n/30 to encourage a faster collection….
Scenario 2: Baeur pays for the inventory on January 30th…

How will Cellar record this sale and collection under the net method?
January 1st:
A/R $176,400
Revenue $176,400

COGS $120,000
Inventory $120,000

January 9th:
Cash $180,000
A/R $176,400
Interest Revenue $3,600
(would also accept credit to Sales Discounts Forfeited for $3,600 instead)

How will Cellar record this sale and collection under the gross method?
January 1st:
A/R $180,000
Revenue $180,000

COGS $120,000
Inventory $120,000

January 9th:
Cash $180,000
A/R $180,000

What is the annual percentage rate that Cellar enjoys if Baeur misses the discount
window?
Discount % divided by (1-discount percentage) times 365 divided by (end of
collection period – end of discount period)
.02 / (1-.02) * 365 / (30-10) = 37.24%
Chapter 18 In-Class Questions (with blanks) ACG4123

Contingent Consideration
On 10/1/2012 Cellar Inc. contracts to build a house for Baeur, Inc. for $300,000
that is to be completed within 6 months (end of March 2013). The contract
includes a $30,000 bonus if the house is built within 5 months. If the house is not
built within five months than the bonus is forfeited. Based on past experience,
Cellar, Inc. is 60% confident that the house will be built within 5 months. What is
the contract amount that Cellar, Inc. should use in determining revenue
recognition?

If >50% confident, $330,000

How much revenue would they record in 2012, assuming that Cellar has
determined that revenue is earned over time and evenly over the construction
period?

$330,000 / 5 months (expected duration based on above) = $66k per month

Start in October, so 3 months worked/earned in 2012:
66k x 3 = $198,000

What would the contract amount be if instead of providing an all or nothing bonus,
the bonus was $7,500 for every week that the house is delivered prior to six-
months up to a maximum of $30,000?

Cellar, Inc. expects the following outcomes:

Built within 5 months: 60%

Built after 5 months but before 5 months and one week: 10%
Built after 5 months and one week but before 5 months and two weeks: 10%
Built after 5 months and two week but before 5 months and three weeks: 10%
Built after 5 months and three week but before 6 months: 10%

“weighted average” approach if more than 2 possible outcomes:

.6 x 330k + .1 x 322.5k + .1 x 315k + .1 x 307.5k + .1 x 300k = $322,500
Chapter 18 In-Class Questions (with blanks) ACG4123

Principal/Agent Relationship - Consignment

5. Recognize revenue when (or as) the entity satisfies a performance obligation

Second Hand Toys Inc. begins operations on 1/1/2014. The primary business of
Second Hand Toys Inc. is to sell used baby/toddler toys brought in by consignors
and retain 40% of the sales price as a commission. In January of 2014 they receive
used toys from consignors and estimate the toys will ultimately sell for $10,000.
They do not sell any used toys in January, but in February they sell used toys for
$6,000 and receive more used toys that have an estimated sales price of $8,000.
They remit the net proceeds from the $6,000 in early March to satisfied consignors.
What entry(ies) should Second Hand Toys, Inc. record in January of 2014?

None

What entry(ies) should Second Hand Toys, Inc. record in February?

Cash $6,000
Commission Revenue $2,400
Payable to Consignor $3,600

What entry(ies) should Second Hand Toys, Inc. record in March?

Payable to Consignor $3,600

Cash $3,600
Chapter 18 In-Class Questions (with blanks) ACG4123

Revenue Recognition before Delivery-Percentage of Completion

Ybor City Construction has agreed to build a new bridge across Tampa Bay for a
price of $60,000,000. It takes three years to complete the project, and Ybor City
Construction uses the Percentage of Completion Method to account for long-term
contracts. Information on the cost for those three years is as follows:
Year 1 Year 2 Year 3
Cash Cost incurred to date $12,000,000 $27,000,000 $41,000,000
Estimated future costs $24,000,000 $9,000,000 $ 0
Current year Billings $18,000,000 $20,000,000 $22,000,000
Current year Cash coll $16,000,000 $17,000,000 $27,000,000

Year 1
What is the Year 1 income statement impact of this contract for Ybor City
Construction?

Revenue: 12mil costs incurred of 36 mil costs expected (12 mil+24 mil) = 33% of
total expected costs incurred. 33.3% x total revenue contracted (60 mil) =
$20,000,000 revenue in Year 1

Expenses: Project is profitable, so we figure out this year’s costs incurred. Year 1,
zero costs incurred previously, so the full $12 mil is our Year 1 expense

20 mil less 12 mil = 8 mil profit for Year 1

What will the Year 1 balance sheet report related to this contract for Ybor City
Construction?
Unbilled (but earned) revenues of $2 million: 20 mil earned as revenue less 18 mil
billed (current year billings). Account would be a current asset, unbilled revenue
or “revenues in excess of billings”.
Chapter 18 In-Class Questions (with blanks) ACG4123

Year 1 Year 2 Year 3

Cash Cost incurred to date $12,000,000 $27,000,000 $41,000,000
Estimated future costs $24,000,000 $9,000,000 $ 0
Current year Billings $18,000,000 $20,000,000 $22,000,000
Current year Cash coll $16,000,000 $17,000,000 $27,000,000

Year 2
What is the Year 2 income statement impact of this contract for Ybor City
Construction?
Same general process for revenue, with the wrinkle that we’ve been at this for a
year: 27 mil expenses incurred to date, 9 mil more expected. 27/36 = 75% of
expected costs incurred. 75% x 60 mil = 45 mil revenue earned IN TOTAL over
Years 1 and 2. So Year 2 revenue is 45 mil less Year’s 1s revenue of 20 mil = 25
mil

Expense is again the amount of current year costs incurred (27 mil less 12 mil),
since the project is still profitable.

Profit is 25 mil minus 15 mil = 10 mil

What will the Year 2 balance sheet report related to this contract for Ybor City
Construction?
7 million unbilled revenue (current asset)

45 mil in revenue recognized less 38 mil (18 mil Y1, 20 mil Y2) billed.
Chapter 18 In-Class Questions (with blanks) ACG4123

Year 1 Year 2 Year 3

Cash Cost incurred to date $12,000,000 $27,000,000 $41,000,000
Estimated future costs $24,000,000 $9,000,000 $ 0
Current year Billings $18,000,000 $20,000,000 $22,000,000
Current year Cash coll $16,000,000 $17,000,000 $27,000,000
Year 3
What is the Year 3 income statement impact of this contract for Ybor City
Construction?

Revenue….. the project is over, we recognized 20 mil in Y1, and 25 mil in Y2. 60
mil in total revenue over the entire project less the 45 we recognized in Y1 and Y2.
15 million

Expenses…. The project was profitable, so the difference between last year’s cash
cost incurred to date and this year’s. 41 mil less 27 mil = 14 mil

Profit = 1 mil (15 mil revenue less 14 mil expense)

What will the Year 3 balance sheet report related to this contract for Ybor City
Construction?
Subtract total revenue on the project (60 mil) from the addition of Y1 current year
billings to Y2 current year billings to Y3 current year billings.

60 mil less 18 mil less 20 mil less 22 mil…..zero.

Chapter 18 In-Class Questions (with blanks) ACG4123

How would the income statement impact for Year 2 and Year 3 change if, due
to some unforeseen circumstance, the estimated cost to complete the project
increased in year 2, resulting in the following costs (estimates)?

Year 1 Year 2 Year 3

Cash Cost incurred to date $12,000,000 $27,000,000 $41,000,000
Estimated future costs $24,000,000 $35,000,000 $20,000,000
Current year Billings $18,000,000 $20,000,000 $22,000,000
Current year Cash coll $16,000,000 $17,000,000 $27,000,000

Year 2:
Critical point: In year 2 we flip from expecting some profit (i.e. 24 million) to
expecting a 2 million dollar loss!! Total expected costs of 27 mil plus 35 mil = 62
mil…… that’s more than we are going to get in revenue (still 60 mil).

Revenue is the same process whether in loss or gain….. in Y2, we’ve incurred 27
mil in costs while expecting a total of 62 mil. 27/62 = 43.54%. 60 mil x .4354 =
26,129,032 total recognized revenue through Y2. Since we recognized 20 mil in
Y1, Y2’s revenue is 6,129,032.

Once we expect a loss, we go ahead and recognize the full loss (-2 million), AND
“clawback” any previously recognized profit. In Y1, we recognized an 8 million
dollar profit, so our total loss in Y2 needs to be 10 million (-2 for the loss, -8 to
“back out” or “offset” the previously recognized profit that we are no longer on
track to get).

Knowing revenue is 6,129,032 and we are “forcing” a loss of 10 million, so we

recognize expense of 16,129,032 in Y2.

Year 3:
Still in a loss condition, slightly better (1 mil expected loss versus 2 mil). Revenue
process is same as before: we’ve incurred 41 million out of an expected 61 million,
or 67.2%. 67.2% of 60 million is 40,327,869. That is the TOTAL revenue we
should recognize over years 1, 2, & 3 combined. So back out our Y1 & Y2
revenue:
40,327,869 – 6,129,032 – 20,000,000 = 14,198,137
Chapter 18 In-Class Questions (with blanks) ACG4123

Expense…… we “frontloaded” some expense last year to force the loss, now we
want to “get back on track” to match incurred cash expenses. As of Y3, we have
incurred total cash costs of 41mil. 16,129,032 was Y2’s portion, and 12 mil was
Y1’s portion. 41 mil less 12 mil less 16,129,032 = 12,870,968 expense in Y3.

Y3 profit = 14,198,137 less 12,870,968 = 1,327,169

(this is positive for two reasons……. We “frontloaded” future expenses in Y2 to

anticipate a loss, and the loss is looking like it is smaller than we
expected/anticipated in Y2)
Chapter 18 In-Class Questions (with blanks) ACG4123

Assuming that they instead used the completed contract method,

Year 1 Year 2 Year 3
Cash Cost incurred to date $12,000,000 $27,000,000 $41,000,000
Estimated future costs $24,000,000 $9,000,000 $ 0
Current year Billings $18,000,000 $20,000,000 $22,000,000
Current year Cash coll $16,000,000 $17,000,000 $27,000,000
Year 1
What is the Year 1 income statement impact of this contract for Ybor City
Construction?

zero

Year 2
What is the Year 2 income statement impact of this contract for Ybor City
Construction?

zero

Year 3
What is the Year 3 income statement impact of this contract for Ybor City
Construction?
Revenue of 60 mil, Expense of 41mil, profit of 19 mil
Chapter 18 In-Class Questions (with blanks) ACG4123

How would the income statement impact for Year 2 and Year 3 change if, due
to some unforeseen circumstance, the estimated cost to complete the project
increased in year 2, resulting in the following costs (estimates)?

Year 1 Year 2 Year 3

Cash Cost incurred to date $12,000,000 $27,000,000 $41,000,000
Estimated future costs $24,000,000 $35,000,000 $20,000,000
Current year Billings $18,000,000 $20,000,000 $22,000,000
Current year Cash coll $16,000,000 $17,000,000 $27,000,000

Year 2, we recognize a 2 million dollar loss.

Year 3, we do nothing because we already recognized a loss greater than the loss
we now expect (2 mil loss in Y2, expecting it to be 1 mil in Y3, but we ARE NOT
DONE with the project)

If the expected loss had gotten worse in Y3 (i.e. estimated future costs were 25
mil), we would recognize a loss of 4 mil in Y3.