Accounting John Hault's Case

Electric utility bills.

When an electric utility customer uses electricity, the electric company has earned revenues. It is obviously impossible, however, for the company to read all of its customers’ meters on the evening of December 31. How does the electric company know its revenue for a given year? Explain. According to historical data, the electricity usage usually tended to be fairly constant from month to month. The company can estimate the revenues for each month, by using historical data. Generally high fluctuation will not occur in electricity usage.

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We can easily estimate the monthly usage by the data of the same month last year. In this situation, if there is any inaccuracy we can adjust its estimation. Usually, the electricity usage is quite constant over time. Therefore, the company can estimate its revenues based on the data from the last year. If there is any inaccuracy, we can make adjustment in the following month. Retainer fee. A law firm received a “retainer” of $10,000 on July 1, 2006, from a client. In return, it agreed to furnish general legal advice upon request for one year.

In addition, the client would be billed for regular legal services such as representation in litigation. There was no way of knowing how often, or when, the client would request advice, and it was quite possible that no such advice would be requested. How much of the $10,000 should be counted as revenue in 2006? Why? Only half of the “retainer” should be recognized. This is because, according to the Revenue Recognition Principle, we recognize the revenue when the service is rendered. At the end of the year, only six months of the services have been provided.Even when the client would request advice in a particular month, we still recognize the revenue because our service has always been ready due to our responsibility.

In other words, we have been provided the service throughout the year constantly. Half of the “retainer” which is $5,000 should be counted as revenue in 2006, the rest $50,00 should be recorded as unearned revenue. We consider “retainer” as a 1 year service contract no matter when the customer will request advice. Actually, we are always stand by for any request from the customer, which mean we are providing service throughout the year constantly.Once you may argue that there may not be any service provided during the rest year. Like the unearned revenue of rent, once they paid an unearned revenue will be recorded, and during the rest period, revenue will be record according to time, no matter the customer “use” the room or not.

For example, in the next month, there will be a decreasing of $1/12X10,000 in unearned revenue and the same amount of increasing in revenue. Contract based on period. Standing-by service: how to recognize? Cruise. Raymond’s, a travel agency, chartered a cruise ship for two weeks beginning January 23, 2007, for $200,000.In return, the ship’s owner agreed to pay all costs of the cruise. In 2006, Raymond’s sold all available space on the ship for $260,000. It incurred $40,000 in selling and other costs in doing so.

All the $260,000 was received in cash from passengers in 2006. Raymond’s paid $50,000 as an advance payment to the ship owner in 2006. How much, if any, of the $260,000 was revenue to Raymond’s in 2006? Why? Does the question of whether passengers were entitled to a refund in 2007 if they canceled their reservations make any difference in the answer?Why? According to the Revenue Recognition Principle, no revenue should be recognized in year 2006 because Raymond’s services started from January 23, 2007; revenue is recognized only when the company provides the service to its customers. The $260,000 is recognized as unearned revenue. If the customer cancel the reservations, both of the unearned revenue and the cash account of the company will be reduced. None of the revenue should be reported in 2006. Revenue should be recognized when the service is being received by customers.According to this case, customers received service after January 23, 2007, so the $260,000 is under unearned revenue account, but not revenue.

If customer canceled their reservations, there will be a decreasing on both unearned revenue and cash, at a same amount. Accretion. A nursery owner had one plot of land containing Christmas trees that were four years old on November 1, 2006. The owner had incurred costs of $3 per tree up to that time. A wholesaler offered to buy the trees for $4 each and to pay in addition all costs of cutting and bundling, and transporting them to market.The nursery owner declined this offer, deciding that it would be more profitable to let the trees grow for one more year. Only a trivial amount of additional cost would be involved. The price of Christmas trees varies with their height.

Should the nursery owner recognize any revenue from these trees in 2006? Why? According to the Revenue Recognition Principle, no revenue should be recognized in year 2006 because there was no transaction during the yaer 2006. No revenue should be recognized in 2006. Because the transaction did not happen during the year 2006. Unbilled” receivables. The balance sheet of an architectural firm shows a significant asset labeled Unbilled Receivables. The firm says this represents in-process projects, valued at the rates at which the customers will be charged for the architects’ time. Why would a firm do this instead of valuing projects in process at their cost, the same as a manufacturing firm would value its in-process inventory? Does it make any difference in the reported owners’ equity for the architectural firm to report such in-process work as receivables rather than as inventory?Why? For construction projects, it involves a long term process and accidents are so common in construction , which brings extra material cost and wages.

So,it is hard to ascertain its cost until the project is finished. If such in-process work is reported as receivables, both revenue and expenses incurred are reported consistently,implying that the reported owner’s equity will increase consistently. However,if it is reported as inventory,the inventory used changes a lot across the construction time,owner’s equity will subsequently increases inconsistently.

Because construction is a long term process and there is a written contract between an architectural firm and the customer, its revenue should be recognized according to percentage of completion. For an architectural firm, it won’t use the costs to represent the percentage of completion. Actually, it is very difficult to estimate total costs needed in the construction. During the progress, the total costs probably enhance because of lack of time or wrong use of material. The firm needs to fix the problem and therefore higher costs.

As such a case is frequently happened in the progress, it makes estimating the costs difficult. Therefore, it would be better for the architectural firm to recognize revenue by the rates at which the customers will be charged for the architects’ time. And by using this method, the revenue and expense will be consistent during the architect’s time. Therefore, owners’ equity will increase fixed amount in the architect’s time . If the firm report such in-process work as inventory, as inventory used change a lot during the architect’s time, owners’ equity will not increase consistently.Premium coupons. A manufacturer of coffee enclosed a premium coupon with each $2.

50 (at wholesale) jar of coffee that it sold to retailers. Customers could use this coupon to apply to $0. 50 of the price of a new type of instant tea that the manufacturer was introducing and that sold for $2. 00 wholesale. The manufacturer reimbursed retail stores $0.

60 for each such coupon they submitted. The extra $0. 10 was to pay the grocer for coupon handling costs.

Past experience with similar premium offers indicated that approximately 20 percent of such coupons are eventually redeemed.At the end of 2006, however, only about 10 percent of the coupons issued in 2006 had been redeemed. In recording the revenues for the company for 2006, what allowance, if any, should be made for these coupons? Why? If an allowance should be made, should it apply to all the sales revenue of coffee or to the sales revenue of tea? Why? Only 10percent of the coupons redeemed should be recorded as allowance (contra-revenue) which deducts the gross sales of tea. No allowance is needed to be applied to the sales revenue of coffee because the coupons only redeem for buying tea. Traveler’s checks.

A bank sells a customer $500 of American Express traveler’s checks, for which the bank collects from the customer $505. (The bank charges a 1 percent fee for this service. ) How does the bank record this transaction? How does the transaction affect American Express’s balance sheet? $500 payment should be recognized as account payable because it is the liability we should pay to American Express. On the other hand, $5 should be recognized as revenue, for the bank provided the service. The cash account will be increased by $505 and the liability will be increased by $500.Like wisely, the retained earnings is increased by $5. First of all the bank purchases amount of traveler’s checks from American Express. It will increase both the inventory (under assets) and the account payable(under liability).

Then the bank sell it at $505, we will record revenue of $505 and COGS of $500, it will also increase the cash by $505 and decrease the inventory by $500. American Express records the transaction as a $500 account receivable until the Bank sells the Traveler’s Checks for cash.Once the customer paid, bank will pay their payable by this amount of cash. American Express will reduce the account receivable, and increasing cash. Product repurchase agreement. In December 2006, Manufacturer A sold merchandise to Wholesaler B.

B used this inventory as collateral for a bank loan of $100,000 and sent the $100,000 to A. Manufacturer A agreed to repurchase the goods on or before July1, 2007, for $112,000, the difference representing interest on the loan and compensation for B’s services. Does Manufacturer A have revenue in 2006? Why?The revenue should be recognized by the manufacturer A because the risk and reward of the ownership is transferred to the manufacturer B. For the reason that the manufacturer use this inventory as collateral for bank loan which implies the risk and the reward of the owner ship has been transferred to the wholesaler B. For a sale and repurchase agreement on an asset other than a financial asset, the terms of the agreement need to be analyzed to ascertain whether, in substance, the seller has transferred the risks and reward of ownership to the buyer and hence revenue is recognized.

When the seller has retained the risks and rewards of ownership, even though legal title has been transferred, the transaction is a financing arrangement and does not give rise to revenue. In this case, company B used this inventory as collateral for a bank loan, and take risks of those merchandise, so the Manufacturer A have revenue in 2006. (Hong Kong Accounting Standard 18 Revenue) Franchises. A national real estate brokerage firm has become highly successful by selling franchises to local real estate brokers.

It charges $10,000 for the initial franchise fee and a service fee of 6 percent of the broker’s revenue thereafter. For this it permits use of its well-known name, and provides a one-week initial training course, a nationwide referral system, and various marketing and management aids. Currently, the franchise fee accounts for 25precent of the national firm’s receipts, but it expects that the United States market will be saturated within the next three years, and thereafter the firm will have to depend on the service fee and new sources of revenues that it may develop.Should it recognize the $10,000 as revenue in the year in which the franchise agreement is signed? Why? If it dose, what will happen to its profits after the market has become saturated? Why? In the year in which the franchise agreement is signed , the$10,000 should not be recognized as revenue because no service is provided. The recognition of the revenue should be matched with the expenses of providing services . If the $10,000 is recognized as revenue, the firm’s profit will drop greatly after the market has become saturated.

As the franchise fee accounts for 25 percent of the national firm’s receipts, the saturation of the market and the recognition of the whole franchise fee in which the franchise agreement is signed implies that the profit after year 3 will drop by 25 percent . If it does recognize the $10,000 as revenue in the year in which the franchise agreement is signed, the profits after the market has become saturated will be lower than the past three years suddenly.In the past three years, the company had franchise fee as revenue, which accounts for 25precent of the revenue. After these three years, however, the market will be saturated, which mean the company won’t receive any franchise fee.

Revenue will only be 75precent of the past three years. We can expect there will be a huge decrease of profits between year3 and year4. Therefore, we can say that the profit is not consistent if franchise fee is recognized in the year in which the agreement is signed. Computer systems.In the early 2006, the sales vice president of Tech-Logic reached agreement to deliver several computer systems with a total price of $570,000 to an organization in one of the newly independent countries established following the dissolution of the former Soviet Union.

Tech-Logic management was very excited about this contract. The countries that were part of the former Soviet Union represented a major market that was just opening up for trade, and these countries especially needed the kinds of high-technology products that Tech-Logic sold. Tech-Logic manufactured and shipped the entire $570,000 order during 2006.

Tech-Logic normally recognized revenue on the sale of its products when they were shipped. However, Tech-Logic’s controller wondered whether the same revenue recognition policy should apply to this contract. First, contract law in these countries was evolving and it was hard to know if certain laws existed or what they were. In addition, the controller was uncertain when Tech-Logic would receive the $570,000 in cash. He had heard that in many of these countries needed for foreign exchange, although the customer kept assuring Tech-Logic that they would receive cash shortly.

The controller pondered whether to recognize the entire $570,000 as revenue in 2006. If not, then when should this revenue be recognized? Why? The $570,000 should not be recognized as revenue in 2006 as the payment is not reasonably assured. Although the customer kept assuring Tech-Logic that they would receive cash shortly, no evidence can sure the payment, in addition to the lack of foreign exchange. Since revenue should be recognized only when the payment is assured, the revenue should be recognized when the payment is received or when it is sured that there is the contract law to guarantee the payment in this case.If it is confirmed that no payment can be received,a loss of inventory should be recorded. The revenue should not be recognized when they shipped. In revenue principle, is says that we generally considers revenue to be realized and earned when collectibility of the sale proceeds is reasonably assured. (Securities and Exchange Commission).

In this case, the customer’s country did not have any contract law to protect this deal and lacking foreign exchange, all of these indicate that we are not sure whether we can receive cash or not.We cannot record revenue when the goods are delivered, because the risk of loss has has not passed to the customer, even it has been shipped. We suggest recognize the revenue when the cash receive, or the contract become legitimated. If we confirm that the cash will never receive, that means the company suffer a loss of value of shipped inventory. STEP1(when goods shipped) STEP2(if we receive cash or other valid note) Dr.

Cash/Receivable570,000 Cr. Revenue570,000 or STEP2(if we confirm that we will not receive the money) Dr. Loss X Cr. Inventory X

Author: Leonard Warren


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