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CA18-1 (Revenue Recognition—Alternative Methods) Peterson Industries has three operating divisions—Farber Mining, Glesen Paperbacks, and Enyart Protection Devices. Each division maintains its own accounting system and method of revenue recognition.

Farber Mining

Farber Mining specializes in the extraction of precious metals such as silver, gold, and platinum. During the fiscal year ended November 30, 2010, Farber entered into contracts worth $2,250,000 and shipped metals worth $2,000,000. A quarter of the shipments were made from inventories on hand at the beginning of the fiscal year, and the remainder were made from metals that were mined during the year. Mining totals for the year, valued at market prices, were: silver at $750,000, gold at $1,400,000, and platinum at $490,000. Farber uses the completion-of-production method to recognize revenue, because its operations meet the specified criteria—i.e., reasonably assured sales prices, interchangeable units, and insignificant distribution costs.

Enyart Paperbacks

Enyart Paperbacks sells large quantities of novels to a few book distributors that in turn sell to several national chains of bookstores. Enyart allows distributors to return up to 30% of sales, and distributors give the same terms to bookstores. While returns from individual titles fluctuate greatly, the returns from distributors have averaged 20% in each of the past 5 years. A total of $7,000,000 of paperback novel sales were made to distributors during the fiscal year. On November 30, 2010, $2,200,000 of fiscal 2010 sales were still subject to return privileges over the next 6 months. The remaining $4,800,000 of fiscal 2010 sales had actual returns of 21%. Sales from fiscal 2009 totaling $2,500,000 were collected in fiscal 2010, with less than 18% of sales returned. Enyart records revenue according to the method referred to as revenue recognition when the right of return exits, because all applicable criteria for use of this method are met by Enyart's operations.

Glesen Protection Devices

Glesen Protection Devices works through manufacturers' agents in various cities. Orders for alarm systems and down payments are forwarded from agents, and Glesen ships the goods f.o.b. shipping point. Customers are billed for the balance due plus actual shipping costs. The firm received orders for $6,000,000 of goods during the fiscal year ended November 30, 2010. Down payments of $600,000 were received, and $5,000,000 of goods were billed and shipped. Actual freight costs of $100,000 were also billed. Commissions of 10% on product price were paid to manufacturers' agents after the goods were shipped to customers. Such goods are warranted for 90 days after shipment, and warranty returns have been about 1% of sales. Revenue is recognized at the point of sale by Glesen.


  1. There are a variety of methods for revenue recognition. Define and describe each of the following methods of revenue recognition, and indicate whether each is in accordance with generally accepted accounting principles.

    1. Completion-of-production method.

    2. Percentage-of-completion method.

    3. Installment-sales method.

  2. Compute the revenue to be recognized in the fiscal year ended November 30, 2010, for

    1. Farber Mining.

    2. Enyart Paperbacks.

    3. Glesen Protection Devices.

    (CMA adapted)

CA18-2 (Recognition of Revenue—Theory) Revenue is usually recognized at the point of sale. Under special circumstances, however, bases other than the point of sale are used for the timing of revenue recognition.


  1. Why is the point of sale usually used as the basis for the timing of revenue recognition?

  2. Disregarding the special circumstances when bases other than the point of sale are used, discuss the merits of each of the following objections to the sales basis of revenue recognition:

    1. It is too conservative because revenue is earned throughout the entire process of production.

    2. It is not conservative enough because accounts receivable do not represent disposable funds, sales returns and allowances may be made, and collection and bad debt expenses may be incurred in a later period.

  3. Revenue may also be recognized (1) during production and (2) when cash is received. For each of these two bases of timing revenue recognition, give an example of the circumstances in which it is properly used and discuss the accounting merits of its use in lieu of the sales basis.

    (AICPA adapted)

CA18-3 (Recognition of Revenue—Theory) The earning of revenue by a business enterprise is recognized for accounting purposes when the transaction is recorded. In some situations, revenue is recognized approximately as it is earned in the economic sense. In other situations, however, accountants have developed guidelines for recognizing revenue by other criteria, such as at the point of sale.


(Ignore income taxes.)

  1. Explain and justify why revenue is often recognized as earned at time of sale.

  2. Explain in what situations it would be appropriate to recognize revenue as the productive activity takes place.

  3. At what times, other than those included in (a) and (b) above, may it be appropriate to recognize revenue? Explain.

CA18-4 (Recognition of Revenue—Bonus Dollars) Griseta & Dubel Inc. was formed early this year to sell merchandise credits to merchants who distribute the credits free to their customers. For example, customers can earn additional credits based on the dollars they spend with a merchant (e.g., airlines and hotels). Accounts for accumulating the credits and catalogs illustrating the merchandise for which the credits may be exchanged are maintained online. Centers with inventories of merchandise premiums have been established for redemption of the credits. Merchants may not return unused credits to Griseta & Dubel.

The following schedule expresses Griseta & Dubel's expectations as to percentages of a normal month's activity that will be attained. For this purpose, a "normal month's activity" is defined as the level of operations expected when expansion of activities ceases or tapers off to a stable rate. The company expects that this level will be attained in the third year and that sales of credits will average $6,000,000 per month throughout the third year.

Griseta & Dubel plans to adopt an annual closing date at the end of each 12 months of operation.


  1. Discuss the factors to be considered in determining when revenue should be recognized in measuring the income of a business enterprise.

  2. Discuss the accounting alternatives that should be considered by Griseta & Dubel Inc. for the recognition of its revenues and related expenses.

  3. For each accounting alternative discussed in (b), give balance sheet accounts that should be used and indicate how each should be classified.

    (AICPA adapted)

CA18-5 (Recognition of Revenue from Subscriptions) Cutting Edge is a monthly magazine that has been on the market for 18 months. It currently has a circulation of 1.4 million copies. Negotiations are underway to obtain a bank loan in order to update the magazine's facilities. They are producing close to capacity and expect to grow at an average of 20% per year over the next 3 years.

After reviewing the financial statements of Cutting Edge, Andy Rich, the bank loan officer, had indicated that a loan could be offered to Cutting Edge only if it could increase its current ratio and decrease its debt to equity ratio to a specified level.

Jonathan Embry, the marketing manager of Cutting Edge, has devised a plan to meet these requirements. Embry indicates that an advertising campaign can be initiated to immediately increase circulation. The potential customers would be contacted after the purchase of another magazine's mailing list. The campaign would include:

  1. An offer to subscribe to Cutting Edge at 3/4 the normal price.

  2. A special offer to all new subscribers to receive the most current world atlas whenever requested at a guaranteed price of $2.

  3. An unconditional guarantee that any subscriber will receive a full refund if dissatisfied with the magazine.

Although the offer of a full refund is risky, Embry claims that few people will ask for a refund after receiving half of their subscription issues. Embry notes that other magazine companies have tried this sales promotion technique and experienced great success. Their average cancellation rate was 25%. On average, each company increased its initial circulation threefold and in the long run increased circulation to twice that which existed before the promotion. In addition, 60% of the new subscribers are expected to take advantage of the atlas premium. Embry feels confident that the increased subscriptions from the advertising campaign will increase the current ratio and decrease the debt to equity ratio.

You are the controller of Cutting Edge and must give your opinion of the proposed plan.


  1. When should revenue from the new subscriptions be recognized?

  2. How would you classify the estimated sales returns stemming from the unconditional guarantee?

  3. How should the atlas premium be recorded? Is the estimated premium claims a liability? Explain.

  4. Does the proposed plan achieve the goals of increasing the current ratio and decreasing the debt to equity ratio?

CA18-6 (Long-Term Contract—Percentage-of-Completion) Widjaja Company is accounting for a long-term construction contract using the percentage-of-completion method. It is a 4-year contract that is currently in its second year. The latest estimates of total contract costs indicate that the contract will be completed at a profit to Widjaja Company.


  1. What theoretical justification is there for Widjaja Company's use of the percentage-of-completion method?

  2. How would progress billings be accounted for? Include in your discussion the classification of progress billings in Widjaja Company financial statements.

  3. How would the income recognized in the second year of the 4-year contract be determined using the cost-to-cost method of determining percentage of completion?

  4. What would be the effect on earnings per share in the second year of the 4-year contract of using the percentage-of-completion method instead of the completed-contract method? Discuss.

    (AICPA adapted)

CA18-7 (Revenue Recognition—Real Estate Development) Lillehammer Lakes is a new recreational real estate development which consists of 500 lake-front and lake-view lots. As a special incentive to the first 100 buyers of lake-view lots, the developer is offering 3 years of free financing on 10-year, 12% notes, no down payment, and one week at a nearby established resort—"a $1,200 value." The normal price per lot is $15,000. The cost per lake-view lot to the developer is an estimated average of $3,000. The development costs continue to be incurred; the actual average cost per lot is not known at this time. The resort promotion cost is $700 per lot. The notes are held by Harper Corp., a wholly owned subsidiary.


  1. Discuss the revenue recognition and gross profit measurement issues raised by this situation.

  2. How would the developer's past financial and business experience influence your decision concerning the recording of these transactions?

  3. Assume 50 persons have accepted the offer, signed 10-year notes, and have stayed at the local resort. Prepare the journal entries that you believe are proper.

  4. What should be disclosed in the notes to the financial statements?

CA18-8 (Revenue Recognition) Nimble Health and Racquet Club (NHRC), which operates eight clubs in the Chicago metropolitan area, offers one-year memberships. The members may use any of the eight facilities but must reserve racquetball court time and pay a separate fee before using the court. As an incentive to new customers, NHRC advertised that any customers not satisfied for any reason could receive a refund of the remaining portion of unused membership fees. Membership fees are due at the beginning of the individual membership period. However, customers are given the option of financing the membership fee over the membership period at a 9% interest rate.

Some customers have expressed a desire to take only the regularly scheduled aerobic classes without paying for a full membership. During the current fiscal year, NHRC began selling coupon books for aerobic classes to accommodate these customers. Each book is dated and contains 50 coupons that may be redeemed for any regularly scheduled aerobics class over a one-year period. After the one-year period, unused coupons are no longer valid.

During 2008, NHRC expanded into the health equipment market by purchasing a local company that manufactures rowing machines and cross-country ski machines. These machines are used in NHRC's facilities and are sold through the clubs and mail order catalogs. Customers must make a 20% down payment when placing an equipment order; delivery is 60–90 days after order placement. The machines are sold with a 2-year unconditional guarantee. Based on past experience, NHRC expects the costs to repair machines under guarantee to be 4% of sales.

NHRC is in the process of preparing financial statements as of May 31, 2011, the end of its fiscal year. Marvin Bush, corporate controller, expressed concern over the company's performance for the year and decided to review the preliminary financial statements prepared by Joyce Kiley, NHRC's assistant controller. After reviewing the statements, Bush proposed that the following changes be reflected in the May 31, 2011, published financial statements.

  1. Membership revenue should be recognized when the membership fee is collected.

  2. Revenue from the coupon books should be recognized when the books are sold.

  3. Down payments on equipment purchases and expenses associated with the guarantee on the rowing and cross-country machines should be recognized when paid.

Kiley indicated to Bush that the proposed changes are not in accordance with generally accepted accounting principles, but Bush insisted that the changes be made. Kiley believes that Bush wants to manage income to forestall any potential financial problems and increase his year-end bonus. At this point, Kiley is unsure what action to take.


    1. Describe when Nimble Health and Racquet Club (NHRC) should recognize revenue from membership fees, court rentals, and coupon book sales.

    2. Describe how NHRC should account for the down payments on equipment sales, explaining when this revenue should be recognized.

    3. Indicate when NHRC should recognize the expense associated with the guarantee of the rowing and cross-country machines.

  1. Discuss why Marvin Bush's proposed changes and his insistence that the financial statement changes be made is unethical. Structure your answer around or to include the following aspects of ethical conduct: competence, confidentiality, integrity, and/or objectivity.

  2. Identify some specific actions Joyce Kiley could take to resolve this situation.

    (CMA adapted)

CA18-9 (Revenue Recognition—Membership Fees) Midwest Health Club offers one-year memberships. Membership fees are due in full at the beginning of the individual membership period. As an incentive to new customers, MHC advertised that any customers not satisfied for any reason could receive a refund of the remaining portion of unused membership fees. As a result of this policy, Richard Nies, corporate controller, recognized revenue ratably over the life of the membership.

MHC is in the process of preparing its year-end financial statements. Rachel Avery, MHC's treasurer, is concerned about the company's lackluster performance this year. She reviews the financial statements Nies prepared and tells Nies to recognize membership revenue when the fees are received.


Answer the following questions.

  1. What are the ethical issues involved?

  2. What should Nies do?

*CA18-10 (Franchise Revenue) Amigos Burrito Inc. sells franchises to independent operators throughout the northwestern part of the United States. The contract with the franchisee includes the following provisions.

  1. The franchisee is charged an initial fee of $120,000. Of this amount, $20,000 is payable when the agreement is signed, and a $20,000 non-interest-bearing note is payable at the end of each of the 5 subsequent years.

  2. All of the initial franchise fee collected by Amigos is to be refunded and the remaining obligation canceled if, for any reason, the franchisee fails to open his or her franchise.

  3. In return for the initial franchise fee, Amigos agrees to (a) assist the franchisee in selecting the location for the business, (b) negotiate the lease for the land, (c) obtain financing and assist with building design, (d) supervise construction, (e) establish accounting and tax records, and (f) provide expert advice over a 5-year period relating to such matters as employee and management training, quality control, and promotion.

  4. In addition to the initial franchise fee, the franchisee is required to pay to Amigos a monthly fee of 2% of sales for menu planning, receipt innovations, and the privilege of purchasing ingredients from Amigos at or below prevailing market prices.

Management of Amigos Burrito estimates that the value of the services rendered to the franchisee at the time the contract is signed amounts to at least $20,000. All franchisees to date have opened their locations at the scheduled time, and none have defaulted on any of the notes receivable.

The credit ratings of all franchisees would entitle them to borrow at the current interest rate of 10%. The present value of an ordinary annuity of five annual receipts of $20,000 each discounted at 10% is $75,816.


  1. Discuss the alternatives that Amigos Burrito Inc. might use to account for the initial franchise fees, evaluate each by applying generally accepted accounting principles, and give illustrative entries for each alternative.

  2. Given the nature of Amigos Burrito's agreement with its franchisees, when should revenue be recognized? Discuss the question of revenue recognition for both the initial franchise fee and the additional monthly fee of 2% of sales, and give illustrative entries for both types of revenue.

  3. Assume that Amigos Burrito sells some franchises for $100,000, which includes a charge of $20,000 for the rental of equipment for its useful life of 10 years; that $50,000 of the fee is payable immediately and the balance on non-interest-bearing notes at $10,000 per year; that no portion of the $20,000 rental payment is refundable in case the franchisee goes out of business; and that title to the equipment remains with the franchisor. Under those assumptions, what would be the preferable method of accounting for the rental portion of the initial franchise fee? Explain.

    (AICPA adapted)


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