All questions
Question 1
TravelSite.com operates a website that allows customers to book hotel rooms from various hotel chains. TravelSite.com facilitates the booking and processes the customer's payment. The hotel is responsible for providing the accommodation and is liable for the quality of the service. TravelSite.com earns a 12% commission on the booking price. A customer books a room for $500 through the website.
In this transaction, TravelSite.com is acting as an agent. How much revenue should TravelSite.com recognize from this booking?
- $60 (correct answer)
- $440
- $500
- $560
Explanation: An entity is an agent if its performance obligation is to arrange for another party to provide the good or service. The agent does not control the good or service before it is transferred to the customer. Here, TravelSite.com arranges the booking but the hotel provides the service. Therefore, TravelSite.com should recognize revenue in the net amount it expects to retain, which is its commission. Revenue = 500∗1260.
Question 2
On January 1, Year 1, Tech Corp. enters into a non-cancellable contract to provide services to a customer for $100,000. The customer is experiencing significant financial distress, and after assessing the customer's ability and intention to pay, Tech Corp. concludes that it is not probable that it will collect substantially all of the consideration. How should Tech Corp. account for this arrangement?
- Recognize the $100,000 as revenue on January 1 and record a corresponding allowance for credit losses.
- Not recognize any revenue until cash is received, provided the other criteria for revenue recognition are met. (correct answer)
- Recognize revenue on a straight-line basis over the service period, regardless of collection probability.
- Record the $100,000 as deferred revenue and recognize it when collection becomes probable.
Explanation: According to ASC 606, one of the criteria for identifying a contract with a customer is that the collectibility of substantially all of the consideration is probable. Since collection is not probable, a contract does not exist for accounting purposes. No revenue should be recognized until cash is received and the performance obligation has been satisfied, or the contract has been terminated and the consideration received is nonrefundable.
Question 3
Builder Co. enters into a contract to construct a commercial building for a total price of 5,000,000.Thecontractincludesaperformancebonusof200,000 that will be paid if the building is completed by a specific date. Builder Co. estimates it has a 70% probability of earning the full bonus and a 30% probability of earning no bonus. Builder Co. has extensive experience with similar projects and has concluded that the expected value method is the most predictive approach.
What is the total transaction price for this contract?
- $5,000,000
- $5,100,000
- $5,140,000 (correct answer)
- $5,200,000
Explanation: The transaction price includes fixed consideration plus an estimate of variable consideration. Using the expected value method, the variable consideration is calculated as the sum of probability-weighted amounts. The expected bonus is (70% * 200,000)+(300) = 140,000.Thetotaltransactionpriceisthefixedpriceplustheexpectedbonus:5,000,000 + 140,000=5,140,000.
Question 4
Gadget Co. sells two products, a smartphone and a smartwatch, in a bundled package for a total price of 1,050.Onastandalonebasis,thesmartphonesellsfor800 and the smartwatch sells for $600.
How much of the transaction price should be allocated to the smartphone?
- $525.00
- $600.00 (correct answer)
- $700.00
- $800.00
Explanation: The transaction price should be allocated to each performance obligation based on their relative standalone selling prices. The total standalone selling price is 800(smartphone)+600 (smartwatch) = 1,400.Theallocationpercentageforthesmartphoneis800 / 1,400=57.141,050 * (800/1,400) = $600.
Question 5
A telecommunications company offers a 24-month mobile phone plan for 70permonth.Theplanincludesanewsmartphonethatthecustomerreceivesatthebeginningofthecontract.Thestandalonesellingpriceofthesmartphoneis600, and the standalone price for the 24-month service is $50 per month.
Upon inception of the contract, how much revenue should be recognized for the transfer of the smartphone?
- $0
- $420
- $560 (correct answer)
- $600
Explanation: First, determine the total transaction price: 24 months * 70/month=1,680. Second, determine the total standalone selling prices: 600(phone)+(24months∗50/month) = 600+1,200 = 1,800.Third,allocatethetransactionpricebasedonrelativestandalonevalues.Theallocationtothesmartphoneis(600 / 1,800)∗1,680 = $560. This amount is recognized as revenue when control of the phone transfers to the customer at inception.
Question 6
On October 1, Year 1, a company paid a $10,000 sales commission to an employee for securing a 4-year service contract with a new customer. The commission is an incremental cost of obtaining the contract and is expected to be recovered. The service period begins on October 1, Year 1.
What is the amount of amortization expense related to this contract cost that the company should recognize for the year ended December 31, Year 1?
- $208
- $625 (correct answer)
- $2,500
- $10,000
Explanation: Incremental costs of obtaining a contract, such as sales commissions, should be capitalized as an asset and amortized on a systematic basis consistent with the transfer of services to the customer. The 10,000costshouldbeamortizedoverthe4−year(48−month)contractterm.ForYear1,theamortizationcovers3months(October,November,December).Amortizationexpense=(10,000 / 48 months) * 3 months = $625.
Question 7
A manufacturer enters into a non-cancellable contract to produce a specialized machine for a customer. The machine has no alternative use to the manufacturer. The contract requires the customer to make progress payments, and if the customer were to cancel, the manufacturer has an enforceable right to payment for all work performed to date plus a reasonable profit.
Which of the following best describes the appropriate timing for revenue recognition for this contract?
- At the point in time when the machine is delivered to the customer.
- At the point in time when the final payment is received from the customer.
- Over time, as the manufacturer produces the machine. (correct answer)
- Over time, but only after the machine is 50% complete.
Explanation: Revenue should be recognized over time if any of the three criteria in ASC 606 are met. In this case, two criteria are met: (1) The entity's performance creates an asset that the customer controls as it is created (implied by progress payments and customization), and (2) The asset created has no alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date. Therefore, revenue should be recognized over the production period, typically using a cost-to-cost or other input/output method.
Question 8
A company sells a product with a performance-based bonus. The company determines that the bonus is a form of variable consideration. However, the bonus is highly susceptible to market factors outside the company's control, and there is a high probability of a significant revenue reversal if the full estimated bonus is recognized. The company cannot make a reliable estimate.
According to the constraint on variable consideration, how much of the bonus should be included in the transaction price at the inception of the contract?
- The maximum possible bonus amount.
- The expected value of the bonus.
- The most likely amount of the bonus.
- Zero, until the uncertainty is resolved. (correct answer)
Explanation: ASC 606 includes a constraint on variable consideration: an entity should only include variable consideration in the transaction price to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is resolved. Given the high probability of a significant revenue reversal, the variable consideration is constrained, and none of it should be included in the transaction price until the uncertainty is resolved.
Question 9
An electronics retailer sells a television for 1,000.Thesaleincludesthemanufacturer′sstandardone−yearwarrantyagainstdefects,whichallcustomersreceive.Theretaileralsoofferscustomerstheoptiontopurchaseaseparatetwo−yearextendedwarrantyforanadditional150. The extended warranty covers repairs beyond the standard warranty period.
Which of these warranties represents a separate performance obligation under ASC 606?
- The one-year standard warranty only.
- The two-year extended warranty only. (correct answer)
- Both the standard and extended warranties.
- Neither of the warranties.
Explanation: A warranty is a separate performance obligation (a service-type warranty) if the customer has the option to purchase it separately. The two-year extended warranty is sold separately and provides a service beyond assuring the product complies with agreed-upon specifications. The one-year standard warranty is an assurance-type warranty, which is not a separate performance obligation but rather a guarantee of product quality, and its cost is accrued as a warranty expense.
Question 10
On December 15, Year 1, a retailer sells merchandise for 50,000cash.Themerchandisehasacostof30,000. The retailer provides customers with a 30-day right of return. Based on historical experience, the retailer estimates that 4% of sales will be returned. The company has a December 31 year-end.
What is the net revenue the retailer should recognize from this transaction for the year ended December 31, Year 1?
- $50,000
- $48,000 (correct answer)
- $30,000
- $18,000
Explanation: When a right of return exists, an entity should recognize revenue for the consideration it expects to be entitled to. The transaction price should be reduced by the expected returns. Net revenue = Total Sales * (1 - Expected Return Rate) = 50,000∗(1−0.04)=50,000 * 0.96 = 48,000.Arefundliabilityfor2,000 and an asset for the right to recover returned goods would also be recognized.
Question 11
A fitness center offers a 12-month membership contract. The contract requires a nonrefundable initiation fee of 100andamonthlyfeeof40. The fitness center's activities to initiate a membership are administrative tasks that do not transfer a separate good or service to the customer. The center determines the membership is a single performance obligation satisfied over the 12-month period.
How much revenue should the fitness center recognize in the first month of the contract?
- $40
- $48.33 (correct answer)
- $100
- $140
Explanation: The nonrefundable initiation fee is not a separate performance obligation. It is an advance payment for the future service of providing access to the fitness center. Therefore, the total transaction price must be calculated and recognized over the service period. Total price = 100fee+(12months∗40/month) = 100+480 = 580.Themonthlyrevenuerecognizedonastraight−linebasisis580 / 12 months = $48.33.
Question 12
A company provides consulting services to a start-up entity. In lieu of cash, the company agrees to accept 5,000 shares of the start-up's common stock as payment. The services are performed during the month of May. The fair value of the shares was 10pershareatthecontractinceptiononMay1and12 per share when the services were completed on May 31.
What is the transaction price of this contract?
- $50,000 (correct answer)
- $55,000
- $60,000
- The cost incurred by the company to provide the services.
Explanation: For noncash consideration, the transaction price is measured at the fair value of the noncash consideration at contract inception. The fair value at contract inception (May 1) was 10pershare.Therefore,thetransactionpriceis5,000shares×10/share = $50,000. The change in fair value during the contract period does not affect the transaction price unless the noncash consideration is variable consideration.
Question 13
A company sells Product A and Product B together in a bundle for 180.ThestandalonesellingpriceofProductAis150 and for Product B is $50. The company has observable evidence that when it sells Product A in other bundled arrangements, the price is always discounted, but the price of Product B is never discounted.
How much of the $180 transaction price should be allocated to Product A?
- $130 (correct answer)
- $135
- $140
- $150
Explanation: The total standalone price is 150+50 = 200.Thebundlepriceis180, resulting in a 20discount.Whenthereisobservableevidenceabouthowadiscountshouldbeallocated,theentityshouldallocateittothespecificperformanceobligation(s).SinceProductBisneverdiscounted,itsallocatedpriceremains50. The entire 20discountisallocatedtoProductA.Therefore,therevenueallocatedtoProductAis150 - 20=130.
Question 14
An entity installs complex equipment at a customer's facility. The contract includes a clause requiring customer acceptance, which is contingent on the equipment passing a series of performance tests that can only be conducted after installation is complete. The entity has determined that control of the equipment does not transfer to the customer until these tests are successfully passed.
When should the entity recognize revenue for the equipment?
- On a straight-line basis over the installation period.
- When the equipment is delivered to the customer's site.
- When the customer formally accepts the equipment after successful testing. (correct answer)
- When the final payment for the equipment is received.
Explanation: Revenue is recognized when a performance obligation is satisfied by transferring control of a good or service to the customer. If a contract includes customer acceptance clauses, the entity must determine when control transfers. If control transfers only upon acceptance (as is the case here, where acceptance is substantive), revenue should not be recognized until that acceptance occurs.
Question 15
A company is engaged in a long-term project to build a custom asset for a client, with revenue recognized over time. During the period, the company purchased $100,000 of specialized materials that were delivered to the job site. These materials have not yet been installed, and control of them has not yet transferred to the client. The cost of these materials is significant relative to the total estimated contract costs.
How should the revenue associated with these uninstalled materials be recognized in the current period under the cost-to-cost input method?
- Revenue should be recognized equal to the cost of the materials ($100,000) with no profit margin. (correct answer)
- No revenue should be recognized until the materials are installed.
- Revenue and profit should be recognized based on the overall project's percentage of completion applied to the materials.
- The cost of the materials should be expensed immediately with no corresponding revenue.
Explanation: When using a cost-based input method, if incurred costs are not proportionate to the entity's progress in satisfying the performance obligation, an adjustment is needed. For significant costs of uninstalled materials where control has not transferred, recognizing revenue based on the overall profit margin would overstate progress. Therefore, ASC 606 allows an entity to recognize revenue equal to the cost incurred for those materials, effectively recognizing zero profit on them until they are installed and contribute to progress.
Question 16
A company sells a machine and a 1-year maintenance plan as a single bundled product. The company determines this bundle contains two distinct performance obligations. To allocate the transaction price, the company needs the standalone selling prices of both the machine and the maintenance plan. The company has not sold either item separately and has no directly observable prices.
Which of the following would be an appropriate method for the company to estimate the standalone selling prices?
- The contractually stated price method.
- The completed contract method.
- The expected cost plus a margin approach. (correct answer)
- The percentage-of-completion method.
Explanation: When standalone selling prices are not directly observable, an entity must estimate them. ASC 606 suggests several methods, including: (1) Adjusted market assessment approach, (2) Expected cost plus a margin approach, and (3) Residual approach (in limited circumstances). The expected cost plus a margin approach involves forecasting the costs to satisfy the performance obligation and adding an appropriate profit margin. The other choices are not valid estimation methods for standalone selling prices.
Question 17
A food manufacturer pays a supermarket chain a nonrefundable fee of $200,000 for prominent placement of its products on store shelves for one year. The manufacturer has determined that this shelf placement does not represent a distinct service transferred from the supermarket to the manufacturer.
How should the manufacturer account for the $200,000 payment?
- As a marketing expense in the period paid.
- As a reduction of revenue recognized from sales to that supermarket. (correct answer)
- As an intangible asset amortized over one year.
- As a component of cost of goods sold.
Explanation: Consideration payable to a customer (such as slotting fees, cooperative advertising, etc.) is accounted for as a reduction of the transaction price, and therefore a reduction of revenue, unless the payment is in exchange for a distinct good or service that the customer transfers to the entity. Since the shelf placement is not a distinct service, the payment reduces the revenue from that customer.
Question 18
On November 1, Year 1, an entity sells inventory to a customer for 50,000cash.Aspartofthesalesagreement,theentitygivesthecustomertherighttorequiretheentitytorepurchasetheinventoryonMay1,Year2,for53,000.
How should this transaction be accounted for on November 1, Year 1?
- As a sale with a right of return.
- As a financing arrangement. (correct answer)
- As a lease.
- As a sale of a financial instrument.
Explanation: When an entity has an obligation to repurchase an asset (a forward or call option) for an amount that is more than the original selling price, the transaction is accounted for as a financing arrangement. The entity continues to recognize the asset, and the cash received is recognized as a financial liability. The difference between the repurchase price (53,000)andtheoriginalsellingprice(50,000) is recognized as interest expense over the contract term.
Question 19
A construction company has a contract to build a dam for 20million.Thecompanyrecognizesrevenueovertimeusingthecost−to−costinputmethod.InYear1,thecompanyincurredcostsof4 million. The total estimated cost to complete the dam is $16 million.
How much revenue should the construction company recognize in Year 1?
- $4,000,000
- $5,000,000 (correct answer)
- $16,000,000
- $20,000,000
Explanation: The cost-to-cost method measures progress based on the ratio of costs incurred to date to the total estimated costs. The percentage of completion is calculated as: Costs Incurred to Date / Total Estimated Costs = 4,000,000/16,000,000 = 25%. Revenue to be recognized in Year 1 is the percentage of completion multiplied by the total transaction price: 25% * 20,000,000=5,000,000.
Question 20
A company has a contract to sell 200 widgets to a customer for 100perwidget.Afterthecompanyhasdelivered120widgets,thecontractismodified.Thepriceoftheremaining80widgetsisreducedto90 per widget. The standalone selling price of the widgets at the time of the modification is $90. The remaining widgets are distinct from those already delivered.
How should this contract modification be accounted for?
- As a prospective modification, creating a blended price for the remaining 80 units.
- As a cumulative catch-up adjustment affecting revenue already recognized.
- As the termination of the old contract and the creation of a new one. (correct answer)
- As a separate new contract for the additional goods at the new price.
Explanation: Under ASC 606, this modification should be accounted for as a termination of the old contract and creation of a new contract. This treatment applies when: (1) the remaining goods are distinct from those already transferred, AND (2) the modification does not represent the addition of distinct goods at their standalone selling price. Here, the modification changes the price of originally promised goods (the remaining 80 widgets) rather than adding new distinct goods. The new price ($90) equals the standalone selling price, but these are not additional goods - they are the remaining goods from the original contract at a revised price.