2 - Revenues and Its Relationship To Current Assets

4/26/24, 8:08 PM Part_2 - Dashboard - Revenues and Its Relationship to Current Assets
Overview
Revenues and Its Relationship to Current Assets
The selling process results in transactions that change both the income statement and the balance sheet. Sales revenue and accounts receivable or cash are used to
recognize the revenue. Cost of goods sold and inventory are used to record the movement of inventory to the customer. Understand the criteria for recognizing
revenue to determine when these entries would be recorded.
Upon completion of this lesson, candidates should be able to:
Demonstrate an understanding of the relationship between revenue and receivables and revenue and inventory (2.A.3.e).
Determine and analyze the effect on revenue of changes in revenue recognition and measurement methods (2.A.3.f).
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Study Guide
I. Revenues and accounts receivable, as well as cost of sales and inventory, are related to each other through the sales process.
A. When inventory is sold and transferred to the customer, the sale is recorded as a sale on account. This means that accounts receivable, and not cash, will
be increased. When the perpetual inventory method is used the journal entry to reduce inventory and increase cost of sales will be made at the same
time as the recording of the sale. Let's assume that the selling price is higher than the cost of inventory, so there is gross profit. The two required journal
entries are:
Debit: Accounts Receivable xxx
Credit: Sales XXX

Debit: Cost of Sales xxx
Credit: Inventory XXX

B. When these entries are made the dollar amount of sales minus cost of sales will create gross profit. There will be an increase to both gross profit and
operating income for the amount of the gross profit.
C. At the same time, assets will increase by the amount of the gross profit as well. This is true because there is a reduction in the inventory account and an
increase in the accounts receivable account. The change in assets is the same as the change on the income statement.
D. The increase in income from this transaction is higher in percentage terms than the increase in assets will be. Therefore, each sale will increase the return
on assets, all things being equal.
II. Aspects of Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606)
A. Revenue is recognized to show the transfer(s) of promised goods or services to the customer in an amount that reflects the consideration the company
expects to be entitled to for the transfer(s). This means that revenue is equal to the amount of consideration. There are five steps to be followed:
1. Identify the contract(s) with the customer
2. Identify the contract’s performance obligation(s)
3. Determine the transaction price
4. Allocate the transaction price to the performance obligation(s) in the contract
5. Recognize revenue as the performance obligation is satisfied
B. It is the transfer of control of the promised goods or services to the customer that triggers the recognition of revenue.
C. The transfer of control to the customer can be:
1. At a point in time, or
2. Over time
D. When transferred over time, there are two methods than can be used to allocate revenues:
1. Output methods:
i. Performance completed to date
ii. Appraisals of results achieved
iii. Units produced or delivered
iv. Time elapsed
2. Input methods:
i. Resources consumed
ii. Labor hours expended
iii. Costs incurred
iv. Time elapsed
v. Machine hours used
E. Once a method is chosen, it is used for the term of the contract. There may be differences in recognized revenue from year to year, only to the extent of
the changes in the activity from year to year. For example, when the actual labor hours in year 1 are different from the hours in year 2.
F. There are no longer industry differences that were used in the past for construction, software, real estate, and telecommunications.
G. A contract based on the transfer of control over time will create a contract asset on the balance sheet of the seller. The contract asset will be classified as
current or long term based on the terms of the contract.
Summary
Focusing on understanding the relationships between the income statement and the balance sheet will increase your ability to analyze these statements.
Remember: If the entity makes sales on account (credit sales), there will be accounts receivable; if they are a merchandiser or manufacturer, they will have
inventory that, when sold, moves to cost of sales. A basic understanding of the Accounting Standards Update can give insight into the current and future
recognition of revenues, and therefore cost of sales.
Slides
Flashcards
1
FC.rev.current.FC001_1709
Difficulty: N/A
Revenues are related to current assets through the sales process.

When inventory is sold, the sale is recorded on account and inventory
How are revenues related to current assets? is reduced.
Debit: Accounts Receivable XXX

Credit: Sales XXX
Debit: Cost of Sales XXX
Credit: Inventory XXX
The dollar amount of sales minus cost of sales will create gross profit.
Assets will increase by the same amount as gross profit.
2
FC.rev.current.FC002_1709
Will ROA increase, decrease, or remain the same after a sale that All things being equal, each sale will increase the return on assets
generates gross profit is made? because the increase in income from a sale that generates profit is
higher in percentage terms than the increase in assets will be.
Notes
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Test Bank Questions
Question 1
2.A.3.e
cma11.p2.t1.me.0022_0820
Deutsche Bearings has total sales of $9,745,923, inventories of $2,237,435, cash and equivalents of $755,071, and days sales outstanding of 49 days. If the firm's
management wanted its days sales outstanding (DSO) to be 35 days, by how much will the accounts receivable have to change? Round your final answer to two
decimal places.
$373,816.23
−$373,816.23
−$934,540.57
$934,540.57
Question 2
2.A.3.e
rev.current.tb.011_2104
When inventory is sold for more than its carrying value:
Gross profit will increase and operating income will decrease.
Gross profit will decrease and operating income will decrease.
Gross profit will increase and operating income will increase.
Gross profit will decrease and operating income will increase.
Question 3
2.A.3.e
Morris Equipment sold three dozen switzenhoppers to Patterson Industries for $1,000 each on credit. Morris had purchased the switzenhoppers for $740 each. All of
the following statements are true except:
Morris Equipment made a profit on the sale.
Morris Equipment’s accounts receivable will increase by the same amount as inventory will decrease.
Morris Equipment’s cost of goods sold will increase by the same amount that its inventory will decrease.
All things being equal, this sale will increase the return on assets for Morris Equipment.
Question 4
2.A.3.e
Nunez Inc. had sales of $350,000 on September 9th. Products were delivered on the same day of the sales. Their gross profit from those sales was $100,000. Eighty
percent of the gross sales had terms of net 30; the remaining 20% paid on delivery. Because of the industry, all inventory sold must be paid for on the day that it is
sold. At the beginning of the day, Nunez has an accounts receivable balance of $2,625,000 and a cash balance of $475,000. Assuming no payments for past sales were
received and only inventory was paid on the 9th, what is its accounts receivable and cash balance, respectively, first thing on September 10th?
$2,905,000; $545,000
$2,975,000; $545,000
$2,905,000; $295,000
$2,975,000; $295,000
Question 5
2.A.3.f
Under the old revenue recognition guidelines, Quixote Aeronautics recognized 100% of revenue when planes were delivered. When management analyzed their
contracts using the five steps in Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customer (Topic 606), they determined that revenue
should be recognized over time using performance completed to date. Which method is Quixote Aeronautics using to recognize revenue and what will be the impact
on its revenue recognition going forward as compared to its previous revenue recognition method?
Output method; revenue will be recognized earlier in the sales process moving forward
Input method; revenue will be recognized earlier in the sales process moving forward
Output method; revenue will be recognized later in the sales process moving forward
Input method; revenue will be recognized later in the sales process moving forward
Question 6
2.A.3.f
Richmond Industries discovered that Division A has been incorrectly recognizing revenue over the past year. Division A sells printing equipment to print shops. The
contract for each piece of equipment is made up of three parts: Equipment with a stand-alone price of $750, three years of supplies valued at $150 which are
delivered as used, and a three-year service plan worth $150. When sold together, Division A has a contract price of $900.
Division A has been recognizing revenue of $850 at the time of the sale. During the period that Division A was incorrectly recognizing revenue, it sold 12 units. How
much did Division A under- or overstate revenue during this period? (Round your answer to the nearest dollar.)
Revenue was $2,484 understated.
Revenue was $2,484 overstated.
Question 7
2.A.3.e
The GKW Company completed a sale on credit of a product costing $25 at a selling price of $45. What is the impact on total assets from this sale?
Increase of $20
Increase of $45
Increase of $70
Decrease of $20
Question 8
2.A.3.e
Which of the following statements is correct?
When a credit sale is made the asset “cash” increases by the selling price and the asset “inventory” decreases by the cost of goods sold.
When a credit sale is made the asset “accounts receivable” increases by the selling price and the asset “inventory” decreases by the cost of goods sold.
When a credit sale is made the asset “accounts receivable” increases by the selling price and the asset “inventory” increases by the cost of goods sold.
When a credit sale is made the asset “accounts receivable” increases by the selling price and the asset “inventory” decreases by the selling price.
Question 9
2.A.3.f
The NUH Company has one contract with a single performance obligation and a transaction price of $50,000 and a second contract with two performance obligations
and a transaction price of $90,000. Which contract will NUH record more revenue from in the year the contracts are signed?
The single performance contract as NUH will record $50,000 in the year the contract is signed and $45,000 on the two-performance contract in the year the
contract is signed.
The two-performance contract as NUH will record $90,000 on that contract in the year the contract is signed and $50,000 on the single performance contract in
the year the contract is signed.
More information is needed about both contracts to determine how much revenue will be recognized from both contracts in the year they are signed.
NUH will record $50,000 on the single performance contract but more information is needed about the two-performance contract.
Question 10
2.A.3.f
Which of the following events triggers the recording of revenue?
Collection of cash from the customer.
The signing of a binding contract with the customer.
When a collection of cash from the customer is probable and cannot reasonably be estimated.
Transfer of control of goods and services to the customer.
Question 11
2.A.3.f
Which of the following is not an example of an “input method” to measure the transfer of control of goods and services?
Performance completed to date
Costs incurred
Labor hours expended
Machine hours used
Question 12
2.A.3.e
The IMY Company completed a sale on credit of a product costing $40 at a selling price of $100. What is the impact on total assets from this sale?
Increase of $60
Increase of $140
Decrease of $60
Increase of $100
Question 13
2.A.3.e
When a company sells a product on credit, total assets increase by the sales price.
When a company sells a product on credit, total assets increase by the sale’s gross profit.
When a company sells a product on credit, total assets increase by the cost of goods sold.
When a company sells a product on credit, total assets increase by the sale’s net profit.
Question 14
2.A.3.f
The LSG Company signs two contracts with a total transaction price of $70,000 in the same year. Contract 1 has one performance obligation for $70,000 while
Contract 2 has one performance obligation for $65,000 and another for $5,000. Which statement accurately describes how revenue will be recorded the year the
contracts are signed?
LSG will recognize $70,000 in revenue for Contract 1 and $70,000 in revenue for Contract 2 in the year the contract is signed.
LSG will recognize $70,000 in revenue for Contract 1 and $0 in revenue for Contract 2 in the year the contract is signed.
More information is needed about both contracts to determine how much revenue will be recognized in the year they are signed.
Question 15
2.A.3.f
Which of the following statements is correct concerning transfer of control of goods and services to customers?
Transfer of control must be identified as a specific point in time.
Transfer of control must be determined using an output method.
Transfer of control is used to determine if a contract exists for revenue recognition purposes.
Companies must use the same method for determining transfer of control for the life of a contract.
Question 16
2.A.3.f
Which of the following is not an example of an “output method” to measure the transfer of control of goods and services?
Resources consumed
Units produced
Appraisal of results achieved
Question 17
2.A.3.e
tb.rev.current.003_1809
Hill Company sells a 2-year warranty and TV combo for $900. The warranty sells for $150 alone, and the TV sells for $850 alone. Hill sells the package to a customer on
January 1st. How much revenue will it recognize in Year 1?
$833
$900
$765
$1000
Question 18
2.A.3.e
If a company sells inventory and records a profit, what impact does this have on the quick ratio?
The quick ratio will decrease.
The quick ratio will increase.
There will be no effect on the quick ratio.
Unable to determine from information provided.
Question 19
2.A.3.f
On December 31st, Year 1, James, Inc. sells a motorcycle to Wilson for $10,000. 60% of the money is collected on the date of sale, and the other 40% is collected on
December 31st, Year 2. How much revenue should James recognize in the Year 1 financial statements?
$10,000
$6,000
$4,000
$0
Question 20
2.A.3.e
If a company purchases inventory and then sells it at a loss, what effect will this have on the current ratio?
The current ratio would decrease.
The current ratio would increase.
There would be no effect on the current ratio.
Unable to determine from information provided
Question 21
2.A.3.e
Bear Co. began operations on 1/1/20X0. The information shown here is available for 20X1.
Sales $1,400,000
Accounts Receivable Collections to Date $240,000
Gross Profit Margin for All Sales 40%
Beginning of Year Accounts Receivable $150,000
1/1/20X1 Allowance for Doubtful Accounts $30,000
Bad Debt Expense $70,000
For the year ended 12/31/20X1, what amount should Bear report as ending Accounts Receivable?
$840,000
$1,310,000
$1,160,000
$1,235,000
Question 22
2.A.3.e
aq.bnchmk.perf.0001_1708
All of the following ratios will increase as a result of inventory being sold at a profit except :
Return on Assets.
Current Ratio.
Debt to Equity Ratio.
Inventory Turnover.
Question 23
2.A.3.f
Which of the following criteria must be met when identifying a contract with a customer for revenue recognition?
I. Each party has the unilateral right to terminate the contract without compensating the other party.
II. The contract must be approved by all parties and can be written, oral, or simply implied by normal business practice.
III. Relevant rights and obligations of each party (generally the seller's performance obligations and the buyer's payment terms) are clear.
IV. The contract has commercial substance.
II, III, and IV
I, II, and IV only
I and II only
II and III only
Question 24
2.A.3.f
All of the following are steps of the revenue recognition process except:
Recognize revenue for each performance obligation
Determine the transaction price
Identify the contract with a customer
Ensure all performance obligations are explicit in the contract
Answered Question 1
2.A.3.e
cma11.p2.t1.me.0022_0820
Deutsche Bearings has total sales of $9,745,923, inventories of $2,237,435, cash and equivalents of $755,071, and days sales outstanding of 49 days. If the firm's
management wanted its days sales outstanding (DSO) to be 35 days, by how much will the accounts receivable have to change? Round your final answer to two
decimal places.
$373,816.23
−$373,816.23
−$934,540.57
$934,540.57
Sales = $9,745,923; Inventory = $2,237,435; Cash and equivalents = $755,071; DSO = 49 days
365 365
DSO = =
Accounts recievable turnover Net sales/Accounts recievable
365×Accounts recievables
DSO =
Net sales
49×$9, 745, 923

DSO×Net sales
Accounts recievables = =
365 365
= $1, 308, 356.79
Target DSO = 35 Days
DSO×Net sales 35×9,745,923

New accounts recievables = =
365 365
= $934, 540.56
δ Accounts recievables = $1, 308, 356.79 − $934, 540.56
−$373, 816. 23
Answered Question 2
2.A.3.e
When inventory is sold for more than its carrying value:
Gross profit will increase and operating income will decrease.
Gross profit will decrease and operating income will decrease.
Gross profit will increase and operating income will increase.
Gross profit will decrease and operating income will increase.
This answer is correct. When inventory is sold for more than its carrying value, the company will make a profit on that sale. Gross profit and operating income
will move in tandem. If one increases, the other will also increase, if all other things are equal.
Answered Question 3
2.A.3.e
Morris Equipment sold three dozen switzenhoppers to Patterson Industries for $1,000 each on credit. Morris had purchased the switzenhoppers for $740 each. All of
the following statements are true except:
Morris Equipment made a profit on the sale.
Morris Equipment’s accounts receivable will increase by the same amount as inventory will decrease.
Morris Equipment’s cost of goods sold will increase by the same amount that its inventory will decrease.
All things being equal, this sale will increase the return on assets for Morris Equipment.
This answer is correct because this statement is false. Inventory will decrease by the $26,640 ($740 × 36) purchase and carrying price. Accounts receivable will
increase by $36,000 ($1,000 × 36).
Answered Question 4
2.A.3.e
Nunez Inc. had sales of $350,000 on September 9th. Products were delivered on the same day of the sales. Their gross profit from those sales was $100,000. Eighty
percent of the gross sales had terms of net 30; the remaining 20% paid on delivery. Because of the industry, all inventory sold must be paid for on the day that it is
sold. At the beginning of the day, Nunez has an accounts receivable balance of $2,625,000 and a cash balance of $475,000. Assuming no payments for past sales were
received and only inventory was paid on the 9th, what is its accounts receivable and cash balance, respectively, first thing on September 10th?
$2,905,000; $545,000
$2,975,000; $545,000
$2,905,000; $295,000
$2,975,000; $295,000
This answer is correct. Ending accounts receivable = Beginning accounts receivable + Credit sales − Payments received = $2,625,000 + ($350,000 × 80%) =
$2,905,000.
Ending cash balance = Beginning cash balance + Cash receipts − Cash disbursements.
Cash disbursements for Nunez on the 9th were for inventory. Inventory = Cost of goods sold = Sales − Gross profit = $350,000 − $100,000 = $250,000.
Ending cash balance = $475,000 + ($350,000 × 20%) − $250,000) = $295,000.
Answered Question 5
2.A.3.f
Under the old revenue recognition guidelines, Quixote Aeronautics recognized 100% of revenue when planes were delivered. When management analyzed their
contracts using the five steps in Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customer (Topic 606), they determined that revenue
should be recognized over time using performance completed to date. Which method is Quixote Aeronautics using to recognize revenue and what will be the impact
on its revenue recognition going forward as compared to its previous revenue recognition method?
Output method; revenue will be recognized earlier in the sales process moving forward
Input method; revenue will be recognized earlier in the sales process moving forward
Output method; revenue will be recognized later in the sales process moving forward
Input method; revenue will be recognized later in the sales process moving forward
This answer is correct. Performance completed to date is an output method used to allocate revenues. Since revenues will be allocated as production occurs
based on performance meeting performance measures rather than waiting until the airplane is completed, smaller amounts of revenue will be recognized
over time rather than all of it being recognized at a later date.
Answered Question 6
2.A.3.f
Richmond Industries discovered that Division A has been incorrectly recognizing revenue over the past year. Division A sells printing equipment to print shops. The
contract for each piece of equipment is made up of three parts: Equipment with a stand-alone price of $750, three years of supplies valued at $150 which are
delivered as used, and a three-year service plan worth $150. When sold together, Division A has a contract price of $900.
Division A has been recognizing revenue of $850 at the time of the sale. During the period that Division A was incorrectly recognizing revenue, it sold 12 units. How
much did Division A under- or overstate revenue during this period? (Round your answer to the nearest dollar.)
This answer is correct. The contract has three performance obligations: the equipment, the supplies, and the service. The transaction price is $900. This price
is allocated to the performance obligations based on their individual values or stand-alone prices:
$750 + $150 + $150 = $1,050. Using the percentage of each to the total value, their allocated transaction price would be [($750 × (750 ÷ 1,050)) + ($150 × (150 ÷
1,050)) + ($150 × (150 ÷ 1,050))] = $643 + $128.50 + $128.50 = $900.
The full equipment revenue allocation would be recognized at the time of the sale. Because the supplies and service are for three years, only one-third of that
revenue would be recognized in the current year. Revenue to be recognized would be $643 + ($128.50 ÷ 3) + ($128.50 ÷ 3) = $729. Division A was recognizing
$850. The difference of $121 per unit × 12 units = $1,452 that revenue was overstated by Division A.
Answered Question 7
2.A.3.e
The GKW Company completed a sale on credit of a product costing $25 at a selling price of $45. What is the impact on total assets from this sale?
Increase of $20
Increase of $45
Increase of $70
Decrease of $20
Correct. When a company sells a tangible product, two asset accounts are impacted. Accounts receivable (if it is a credit sale) or cash (if it is a cash sale)
increase to reflect the sales revenue generated. Inventory decreases to reflect the cost of goods sold. For GKW, accounts receivable increases by $45, and
inventory decreases by $25, resulting in a net increase in total assets of $20.
Answered Question 8
2.A.3.e
When a credit sale is made the asset “cash” increases by the selling price and the asset “inventory” decreases by the cost of goods sold.
When a credit sale is made the asset “accounts receivable” increases by the selling price and the asset “inventory” decreases by the cost of goods sold.
When a credit sale is made the asset “accounts receivable” increases by the selling price and the asset “inventory” increases by the cost of goods sold.
When a credit sale is made the asset “accounts receivable” increases by the selling price and the asset “inventory” decreases by the selling price.
Correct. When a company sells a tangible product on credit, two asset accounts are impacted. Accounts receivable increases to reflect the sales revenue
generated and inventory decreases to reflect the cost of goods sold.
Answered Question 9
2.A.3.f
The NUH Company has one contract with a single performance obligation and a transaction price of $50,000 and a second contract with two performance obligations
and a transaction price of $90,000. Which contract will NUH record more revenue from in the year the contracts are signed?
The single performance contract as NUH will record $50,000 in the year the contract is signed and $45,000 on the two-performance contract in the year the
contract is signed.
The two-performance contract as NUH will record $90,000 on that contract in the year the contract is signed and $50,000 on the single performance contract in
the year the contract is signed.
More information is needed about both contracts to determine how much revenue will be recognized from both contracts in the year they are signed.
NUH will record $50,000 on the single performance contract but more information is needed about the two-performance contract.
Correct. Performance obligations are the basis for recognizing revenue. As part of the revenue recognition process, companies must determine how many
performance obligations are contained in a contract, the amount of the contract’s transaction price assigned to each obligation, and the basis for
determining when performance obligations are satisfied. Revenue can only be recognized when the obligations are satisfied. This information is needed
about the performance obligations in both contracts to determine how much revenue will be recognized in the year the contracts are signed.
Answered Question 10
2.A.3.f
Which of the following events triggers the recording of revenue?
Collection of cash from the customer.
The signing of a binding contract with the customer.
When a collection of cash from the customer is probable and cannot reasonably be estimated.
Transfer of control of goods and services to the customer.
determining when performance obligations are satisfied. Revenue can only be recognized when the obligations are satisfied. Performance obligations are
satisfied as a company transfers control of goods and services to the customer. This can happen at a single point or over time.
2.A.3.f
Which of the following is not an example of an “input method” to measure the transfer of control of goods and services?
Costs incurred
Labor hours expended
Machine hours used
Correct. To record revenue, a company must transfer control of goods or services to the customer. This can happen at a particular point in time or over a
period of time. When done over a period, it is necessary to estimate the amount of control transferred each period. A company can use an “input method” or
an “output method” to make this estimate. Companies have discretion over the method chosen, but once it is chosen the same method should be used
throughout the contract. Typical “input methods” include costs incurred, labor hours expended, or machine hours used as all three of these measure inputs
in the production process. Performance completed to date is an output method as it measures the output of a process, not inputs into the process.
2.A.3.e
The IMY Company completed a sale on credit of a product costing $40 at a selling price of $100. What is the impact on total assets from this sale?
Increase of $60
Increase of $140
Decrease of $60
Increase of $100
Correct. When a company sells a tangible product, two asset accounts are impacted. Accounts receivable (if it is a credit sale) or cash (if it is a cash sale)
increase to reflect the sales revenue generated. Inventory decreases to reflect the cost of goods sold. For IMY, accounts receivable increases by $100 and
inventory decreases by $40, resulting in a net increase in total assets of $60.
2.A.3.e
When a company sells a product on credit, total assets increase by the sales price.
When a company sells a product on credit, total assets increase by the sale’s gross profit.
When a company sells a product on credit, total assets increase by the cost of goods sold.
When a company sells a product on credit, total assets increase by the sale’s net profit.
Correct. When a company sells a product on credit, two asset accounts are impacted. Accounts receivable increases to reflect the sales revenue generated
and inventory decreases to reflect the cost of goods sold. The difference between these two amounts is the sale’s gross profit.
2.A.3.f
The LSG Company signs two contracts with a total transaction price of $70,000 in the same year. Contract 1 has one performance obligation for $70,000 while
Contract 2 has one performance obligation for $65,000 and another for $5,000. Which statement accurately describes how revenue will be recorded the year the
contracts are signed?
LSG will recognize $70,000 in revenue for Contract 1 and $0 in revenue for Contract 2 in the year the contract is signed.
More information is needed about both contracts to determine how much revenue will be recognized in the year they are signed.
determining when performance obligations are satisfied. Revenue can only be recognized when the obligations are satisfied. This information is needed
about the performance obligations in both contracts to determine how much revenue will be recognized in the year the contracts are signed.
2.A.3.f
Which of the following statements is correct concerning transfer of control of goods and services to customers?
Transfer of control must be identified as a specific point in time.
Transfer of control must be determined using an output method.
Transfer of control is used to determine if a contract exists for revenue recognition purposes.
Companies must use the same method for determining transfer of control for the life of a contract.
determining when performance of obligations are satisfied. Revenue can only be recognized when the obligations are satisfied. Performance obligations are
satisfied as a company transfers control of goods and services to the customer. This can happen at a single point or over time. When transfer occurs over
time, companies can base revenue recognition on output methods or input methods. Once a method is chosen, the company must use that method for the
life of the contract.
2.A.3.f
Which of the following is not an example of an “output method” to measure the transfer of control of goods and services?
Resources consumed
Units produced
Appraisal of results achieved
Correct. To record revenue, a company must transfer control of goods or services to the customer. This can happen at a particular point in time or over a
period of time. When done over a period of time, it is necessary to estimate the amount of control transferred each period. A company can use an “input
method” or an “output method” to make this estimate. Companies have discretion over the method chosen, but once it is chosen the same method should
be used throughout the contract. Typical “output methods” include performance completed to date, appraisals of results achieved, and units produced or
delivered as all three of these measure outputs of a production process. Resources consumed is an input method as it measures the inputs used in a process,
not outputs of a process.
2.A.3.e
Hill Company sells a 2-year warranty and TV combo for $900. The warranty sells for $150 alone, and the TV sells for $850 alone. Hill sells the package to a customer on
January 1st. How much revenue will it recognize in Year 1?
$833
$900
$765
$1000
This answer is correct. Using the standalone selling prices to allocate the transaction price of $900 to the performance obligations identified in the contract,
the revenue allocated to the TV is $765. This is calculated as {$900 × [$850 ÷ ($850 + $150)]}. The standalone warranty revenue is $135 ($900 − $765). The TV
revenue is recognized in Year 1, as is half of the warranty revenue [$765 + ($135 ÷ 2)] = $833.
2.A.3.e
If a company sells inventory and records a profit, what impact does this have on the quick ratio?
The quick ratio will decrease.
The quick ratio will increase.
There will be no effect on the quick ratio.
Unable to determine from information provided.
This answer is correct. The quick ratio excludes inventory. Selling the inventory will increase accounts receivable or cash, which are included in the
numerator of the quick ratio. Therefore, the quick ratio will increase.
2.A.3.f
On December 31st, Year 1, James, Inc. sells a motorcycle to Wilson for $10,000. 60% of the money is collected on the date of sale, and the other 40% is collected on
December 31st, Year 2. How much revenue should James recognize in the Year 1 financial statements?
$10,000
$6,000
$4,000
$0
This answer is correct. We can assume that the performance obligation was satisfied because control of the motorcycle transferred from James, Inc. to
Wilson on December 31st, Year 1. Therefore, even though only $6,000 is collected on the date of sale, and $4,000 is in Accounts Receivable, the revenue to be
recognized is $10,000.
2.A.3.e
If a company purchases inventory and then sells it at a loss, what effect will this have on the current ratio?
The current ratio would decrease.
The current ratio would increase.
There would be no effect on the current ratio.
Unable to determine from information provided
This answer is correct. The current ratio would decrease, because the Current Assets received for the inventory are worth less than the inventory.
2.A.3.e
Bear Co. began operations on 1/1/20X0. The information shown here is available for 20X1.
Sales $1,400,000
Accounts Receivable Collections to Date $240,000
Gross Profit Margin for All Sales 40%
Beginning of Year Accounts Receivable $150,000
Bad Debt Expense $70,000
For the year ended 12/31/20X1, what amount should Bear report as ending Accounts Receivable?
$840,000
$1,310,000
$1,160,000
$1,235,000
This answer is correct. First, Accounts Receivable written off should be determined as follows:
Beginning allowance for doubtful accounts + Bad debt expense – Ending allowance for doubtful accounts = Accounts Receivable written off
$30,000 + $70,000 − $25,000 = $75,000
Then, solve for ending Accounts Receivable as follows:
Beginning Accounts Receivable + Sales – Accounts Receivable written off – Accounts Receivable collections to date = ending Accounts Receivable
$150,000 + $1,400,000 – $75,000 – $240,000 = $1,235,000.
2.A.3.e
aq.bnchmk.perf.0001_1708
All of the following ratios will increase as a result of inventory being sold at a profit except :
Return on Assets.
Current Ratio.
Debt to Equity Ratio.
Inventory Turnover.
This answer is correct. The debt to equity ratio would decrease. Selling the inventory at a profit would generate revenue, which increases equity. This
increases the denominator in the debt to equity ratio, decreasing the ratio.
2.A.3.f
Which of the following criteria must be met when identifying a contract with a customer for revenue recognition?
I. Each party has the unilateral right to terminate the contract without compensating the other party.
II. The contract must be approved by all parties and can be written, oral, or simply implied by normal business practice.
III. Relevant rights and obligations of each party (generally the seller's performance obligations and the buyer's payment terms) are clear.
IV. The contract has commercial substance.
II, III, and IV
I, II, and IV only
I and II only
II and III only
Before revenue can be recognized, the organization must determine if a contract exists. The following should be considered in identifying a contract with a
customer: (A) The contract must be approved by all parties and can be written, oral, or simply implied by normal business practice. (B) Relevant rights and
obligations of each party (generally the seller's performance obligations and the buyer's payment terms) are clear. (C) The contract has commercial
substance.
Some situations may indicate that no contract exists for purposes of revenue recognition. In these cases, revenue would not be recognized before it is
determined that a contract does exist. (1) If each party has the unilateral right to terminate the contract without compensating the other party, then no
contract exists until either the entity has transferred goods or services to the customer or the entity has received or is entitled to receive consideration for
goods or services. (2) If collectability of substantially all of the consideration for goods or services is not probable, then no contract exists, and revenue would
not be recognized until nonrefundable consideration is received and the organization has satisfied its performance obligations.
2.A.3.f
All of the following are steps of the revenue recognition process except:
Recognize revenue for each performance obligation
Determine the transaction price
Identify the contract with a customer
Ensure all performance obligations are explicit in the contract
The revenue recognition process uses the following steps: (1) Identify the contract with a customer. (2) Identify separate performance obligations in the
contract. (3) Determine the transaction price. (4) Allocate the transaction price to the performance obligation(s) identified in the contract. (5) Recognize
revenue for each performance obligation.
Identification of performance obligations should be done from the perspective of the customer. As a result, performance obligations could be explicit in the
contract or simply implied by normal business practices if those practices create reasonable expectation on the part of the customer.

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4/26/24, 8:08 PM Part_2 - Dashboard - Revenues and Its Relationship to Current Assets

Upon completion of this lesson, candidates should be able to:

Credit: Sales XXX

Credit: Inventory XXX

Revenues are related to current assets through the sales process.

Debit: Accounts Receivable XXX

You haven’t made any notes or highlights yet.

Test Bank Questions

Revenues and Its Relationship to Current Assets

Gross profit will decrease and operating income will decrease.

Gross profit will increase and operating income will increase.

Gross profit will decrease and operating income will increase.

Revenue was $2,484 understated.

Revenue was $2,484 overstated.

Revenue was $1,452 understated.

Revenue was $1,452 overstated.

The signing of a binding contract with the customer.

Transfer of control of goods and services to the customer.

Labor hours expended

Machine hours used

Transfer of control must be determined using an output method.

Appraisal of results achieved

Performance completed to date

The quick ratio will increase.

There will be no effect on the quick ratio.

Unable to determine from information provided.

The current ratio would increase.

There would be no effect on the current ratio.

Unable to determine from information provided

Debt to Equity Ratio.

II, III, and IV

I, II, and IV only

II and III only

Determine the transaction price

Identify the contract with a customer

Ensure all performance obligations are explicit in the contract

49×$9, 745, 923

= $1, 308, 356.79

Target DSO = 35 Days

DSO×Net sales 35×9,745,923

δ Accounts recievables = $1, 308, 356.79 − $934, 540.56

Gross profit will decrease and operating income will decrease.

Gross profit will increase and operating income will increase.

Gross profit will decrease and operating income will increase.

Ending cash balance = $475,000 + ($350,000 × 20%) − $250,000) = $295,000.

Revenue was $2,484 understated.

Revenue was $2,484 overstated.

Revenue was $1,452 understated.

Revenue was $1,452 overstated.

The signing of a binding contract with the customer.

Transfer of control of goods and services to the customer.

Labor hours expended

Machine hours used

Transfer of control must be determined using an output method.

Appraisal of results achieved

Performance completed to date

The quick ratio will increase.

There will be no effect on the quick ratio.