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Intermediate Accounting exam 2.

realization principle

requires that two criteria be satisfied before revenue can be recognized:The earnings process is judged to be complete or virtually complete.There is reasonable certainty as to the collectibility of the asset to be received (usually cash)

2. Revenue recognition for most installment sales occurs at the point of delivery of the product or service. Under what circumstances would a seller delay revenue recognition for installment sales beyond the delivery date

If the installment sale creates a situation where there is significant uncertainty concerning cash collection and it is not possible to make an accurate assessment of future bad debts, revenue and cost recognition should be delayed beyond the point of delivery.

3. Distinguish between the installment sales method and the cost recovery method of accounting for installment sales

The installment sales method recognizes gross profit by applying the gross profit percentage on the sale to the amount of cash actually received each period. The cost recovery method defers all gross profit recognition until cash has been received equal to the cost of the item sold.

4. Service revenue is recognized either at one point in time or over extended periods. Explain the rationale for recognizing revenue using these two approaches

For service revenue, if there is one final service that is critical to the earnings process, revenues and costs are deferred and recognized after this service has been performed. On the other hand, in many instances, service revenue activities occur over extended periods and recognizing revenue at any single date within that period would be inappropriate. Instead, it's more meaningful to recognize revenue over time in proportion to the performance of the activity.

5. Distinguish between the percentage- of- completion and completed contract methods of accounting for long- term contracts with respect to income recognition. Under what circumstances should a company use the completed contract method?

The completed contract method of recognizing revenues and costs on long-term construction contracts is equivalent to recognizing revenue at point of delivery, i.e., when the construction project is complete. The percentage-of-completion method assigns a fair share of the project's expected revenues and costs to each period in which the earnings process takes place, i.e., the construction period. The "fair share" typically is estimated as the project's costs incurred each period as a percentage of the project's total estimated costs. The completed contract method should only be used when the lack of dependable estimates or inherent hazards cause forecasts of future costs to be doubtful.

6. Periodic billings to the customer for a long- term construction contract are recorded as billings on construction contract. How is this account reported in the balance sheet?

The billings on construction contract account is a contra account to the construction in progress asset. At the end of each reporting period, the balances in these two accounts are compared. If the net amount is a debit, it is reported in the balance sheet as an asset. Conversely, if the net amount is a credit, it is reported as a liability.

7. When is an estimated loss on a long- term contract recognized using the percentage- of- completion method? The completed contract method?

An estimated loss on a long-term contract must be fully recognized in the first period the loss is anticipated, regardless of the revenue recognition method used.

8. Briefly describe the guidelines for recognizing revenue from the sale of software and other multiple- deliverable arrangements.

This guidance requires that if an arrangement includes multiple elements, the revenue from the arrangement should be allocated to the various elements based on the relative fair values of the individual elements. If part of an arrangement does not qualify for separate accounting, revenue recognition is delayed until revenue is recognized for the other parts.

guidelines provided by GAAP: substantial performance for recognition of revenue for a franchiser for an initial franchise fee

requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue. The term "substantial" requires professional judgment on the part of the accountant. In situations when the initial franchise fee is collectible in installments, even after substantial performance has occurred, the installment sales or cost recovery method should be used for profit recognition, if a reasonable estimate of uncollectibility cannot be made.

1. Define cash equivalents

Cash equivalents usually include negotiable instruments as well as highly liquid investments that have a maturity date no longer than three months from date of purchase.

2. Explain the primary functions of internal controls procedures in the accounting area. What is meant by separation of duties?

Internal control procedures involving accounting functions are intended to
improve the accuracy and reliability of accounting information and to safeguard the company's assets. The separation of duties means that employees involved in recordkeeping should not also have physical responsibility for assets.

3. Explain the difference between a trade discount and a cash discount.

Trade discounts are reductions below a list price and are used to establish a final price for a transaction. The reduced price is the starting point for initial valuation of the transaction. A cash discount is a reduction, not in the selling price of a good or service, but in the amount to be paid by a credit customer if the receivable is paid within a specified period of time.

4. Distinguish between the gross and net methods of accounting for cash discounts.

The gross method of accounting for cash discounts considers discounts not taken as part of sales revenue. The net method considers discounts not taken as interest revenue, because they are viewed as compensation to the seller for allowing the buyer to defer payment.

5. Briefly explain the accounting treatment for sales returns

When returns are material and a company can make reasonable estimates of
future returns, an allowance for sales returns is established. At a financial reporting date, this provides an estimate of the amount of future returns for prior sales, and involves a debit to sales returns and a credit to allowance for sales returns for the estimated amount. Allowance for sales returns is a contra account to accounts receivable. When returns actually occur in the future reporting period, the allowance for sales returns is debited.

6. Explain the typical way companies account for uncollectible accounts receivable ( bad debts). When is it permissible to record bad debt expense only at the time when receivables actually prove uncollectible?

Even when specific customer accounts haven't been proven uncollectible by the end of the reporting period, bad debt expense properly should be matched with sales revenue on the income statement for that period. Likewise, since it's not expected that all accounts receivable will be collected, the balance sheet should report only the expected net realizable value of that asset. So, to record the bad debt expense and the related reduction of accounts receivable when the amount hasn't been determined, an estimate is needed. In an adjusting entry, we record bad debt expense and reduce accounts receivable for an estimate of the amount that eventually will prove uncollectible. If uncollectible accounts are immaterial or not anticipated, or it's not possible to reliably estimate uncollectible accounts, an allowance for uncollectible accounts is not appropriate. In these few cases, any bad debts that do arise simply are written off as bad debt expense at the time they prove uncollectible.

7. Briefly explain the difference between the income statement approach and the balance sheet approach to estimating bad debts.

The income statement approach to estimating bad debts determines bad debt
expense directly by relating uncollectible amounts to credit sales. The balance sheet approach to estimating future bad debts indirectly determines bad debt expense by estimating the net realizable value for accounts receivable that exist at the end of the period. In other words, the allowance for uncollectible accounts at the end of the period is estimated and then bad debt expense is determined by adjusting the allowance account to reflect net realizable value.

8. Explain any possible differences between accounting for an account receivable factored with recourse compared with one factored without recourse

The accounting treatment of receivables factored with recourse depends on
whether certain criteria are met. If the criteria are met, the factoring is accounted for as a sale. If they are not met, the factoring is accounted for as a loan. In addition, note disclosure may be required. Accounts receivable factored without recourse are accounted for as the sale of an asset. The difference between the book value and the fair value of proceeds received is recognized as a gain or a loss

What is meant by the discounting of a note receivable? Describe the four- step process used to account for discounted notes

1. Accrue any interest revenue earned since the last payment date (or date of the note).
2. Compute the maturity value.
3. Subtract the discount the bank requires (discount rate times maturity value
times the remaining length of time from date of discounting to maturity date)
from the maturity value to compute the proceeds to be received from the bank (maturity value less discount). Compute the difference between the proceeds and the book value of the note and related interest receivable. The treatment of the difference will depend on whether the discounting is accounted for as a sale or as a loan. If it's a sale, the difference is recorded as a loss or gain on the sale; if it's a loan, the difference is viewed as interest expense or interest revenue.

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