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Questions and Answers
Revenue is recognized in the period when it is ________.
Revenue is recognized in the period when it is ________.
Which of the following is NOT an indicator of transferring control of goods or services to the buyer?
Which of the following is NOT an indicator of transferring control of goods or services to the buyer?
Revenue is recognized when it is highly probable it won't be reversed.
Revenue is recognized when it is highly probable it won't be reversed.
True (A)
What is the difference between expensing and capitalizing a cost?
What is the difference between expensing and capitalizing a cost?
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Which of the following costs is typically expensed as incurred, not capitalized?
Which of the following costs is typically expensed as incurred, not capitalized?
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What is the key difference between capitalization and expensing in terms of their impact on net income?
What is the key difference between capitalization and expensing in terms of their impact on net income?
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Capitalized interest is recorded in the CFO (cash flow from operations) as an outflow.
Capitalized interest is recorded in the CFO (cash flow from operations) as an outflow.
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Which of the following is NOT a key takeaway for understanding the impact of capitalized interest on a company's financial statements?
Which of the following is NOT a key takeaway for understanding the impact of capitalized interest on a company's financial statements?
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Research costs are typically capitalized under both IFRS and US GAAP.
Research costs are typically capitalized under both IFRS and US GAAP.
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What is the main purpose of a common-size income statement?
What is the main purpose of a common-size income statement?
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The tax rate on revenue is a better measure of a company's actual tax burden than the effective tax rate.
The tax rate on revenue is a better measure of a company's actual tax burden than the effective tax rate.
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Which of the following is NOT a factor that can affect a company's effective tax rate?
Which of the following is NOT a factor that can affect a company's effective tax rate?
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The gross profit margin is calculated by dividing gross profit by sales revenue.
The gross profit margin is calculated by dividing gross profit by sales revenue.
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The net profit margin is calculated by dividing net income by revenue.
The net profit margin is calculated by dividing net income by revenue.
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What is the key purpose of basic earnings per share (EPS)?
What is the key purpose of basic earnings per share (EPS)?
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Which of the following events would require a retrospective adjustment to prior periods' EPS?
Which of the following events would require a retrospective adjustment to prior periods' EPS?
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A company's accounting estimates are based on its current judgment and information, and are never subject to change.
A company's accounting estimates are based on its current judgment and information, and are never subject to change.
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What is the purpose of the Treasury Stock method?
What is the purpose of the Treasury Stock method?
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Diluted EPS assumes that all potentially dilutive securities will be converted to common stock. This is how it reflects a worst-case scenario for investors.
Diluted EPS assumes that all potentially dilutive securities will be converted to common stock. This is how it reflects a worst-case scenario for investors.
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The key takeaway for understanding the impact of a company's decision to capitalize vs expense construction interest is that:
The key takeaway for understanding the impact of a company's decision to capitalize vs expense construction interest is that:
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A company's discontinued operations are included in the calculation of its net income from continuing operations.
A company's discontinued operations are included in the calculation of its net income from continuing operations.
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Prior-period adjustments are only made when a company discovers that it has made a mistake in its accounting estimates.
Prior-period adjustments are only made when a company discovers that it has made a mistake in its accounting estimates.
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Changes in scope or exchange rates are typically the result of mergers and acquisitions, which are reported separately on the income statement.
Changes in scope or exchange rates are typically the result of mergers and acquisitions, which are reported separately on the income statement.
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A company's stock split is always reported in a retrospective manner, meaning that a company will go back and adjust prior periods' EPS to reflect the split.
A company's stock split is always reported in a retrospective manner, meaning that a company will go back and adjust prior periods' EPS to reflect the split.
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The Treasury Stock method is primarily used to calculate the number of shares that will be issued when convertible preferred shares are converted.
The Treasury Stock method is primarily used to calculate the number of shares that will be issued when convertible preferred shares are converted.
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Flashcards
Revenue Recognition
Revenue Recognition
Recognizing revenue when it is earned, not when cash is received.
Cash Sales
Cash Sales
Revenue recognized at the time of exchange for cash.
Credit Sales
Credit Sales
Revenue recognized at the time of sale; creates accounts receivable.
Unearned Revenue
Unearned Revenue
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Converged Standards
Converged Standards
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Performance Obligation
Performance Obligation
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Transaction Price
Transaction Price
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Allocating Transaction Price
Allocating Transaction Price
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Revenue Recognition Over Time
Revenue Recognition Over Time
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Matching Principle
Matching Principle
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Deferred Revenue
Deferred Revenue
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Expense Recognition
Expense Recognition
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Capitalization
Capitalization
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Amortization
Amortization
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Depreciation
Depreciation
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Expense Immediately
Expense Immediately
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Long-Term Contracts
Long-Term Contracts
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Bill-and-Hold Agreement
Bill-and-Hold Agreement
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Agent vs. Principal
Agent vs. Principal
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Franchise Fees
Franchise Fees
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Royalty Fees
Royalty Fees
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Service vs. License Revenue
Service vs. License Revenue
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Collectability
Collectability
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Revenue Reporting
Revenue Reporting
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Management Judgments
Management Judgments
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Net Income
Net Income
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Expense Recognition Policies
Expense Recognition Policies
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Cash Basis Accounting
Cash Basis Accounting
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Commissions for Long-Term Contracts
Commissions for Long-Term Contracts
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Collectibility Criteria
Collectibility Criteria
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Study Notes
Revenue Recognition
- Cash Sales: Revenue is recognized at the time of exchange, when cash is received, for goods or services with no returns allowed.
- Credit Sales: Revenue is recognized at the time of sale, creating accounts receivable on the balance sheet.
- Revenue Recognition: Revenues are recognized when they are earned, not necessarily when cash is collected.
- Revenue Reporting: Reported net of returns, allowances (e.g., warranty provisions, customer discounts) on the income statement, adhering to the matching principle (revenue is matched to related expenses).
- Unearned Revenue: Created when payment is received before goods/services are transferred to the customer, offsetting the asset (cash) increase on the balance sheet. Recognition involves crediting unearned revenue and debiting revenue as the goods/services are transferred.
Converged Standards
- Accounting standards (IASB/IFRS and FASB/US GAAP) aim for global consistency and comparability across countries and industries, through efforts like converged standards in revenue recognition.
- Standards identify a five-step process for recognizing revenue: identify contracts, identify performance obligations, determine transaction price, allocate transaction price, recognize revenue.
Performance Obligations
- Distinct Good or Service: A good or service is considered distinct when the customer can benefit from it independently, and the promise to transfer the good or service can be separately identified from other promises.
- Transaction Price: The amount a company expects to receive for delivering a good or service (fixed or variable, e.g., bonuses for early delivery)
- Recognition: Revenue is recognized when it's highly probable the revenue won't be reversed. If uncertain, record a liability for potential refunds, and an asset for expected returns.
Long-Term Contracts
- Revenue Recognition: Revenue is recognized based on progress towards fulfilling the performance obligation (using either input or output methods), in long-term contracts, rather than the timing of payment.
- Input Methods: Revenue recognition is based on costs incurred (as a percentage of total estimated costs).
- Output Methods: Revenue recognition is based on milestones achieved or the percentage of work completed.
- Example: If 50% of project costs are incurred in year 1 on a two-year project, 50% of the revenue is recognized in year 1.
Revenue Recognition Over Time
- Customer Benefits Over Time: Recognition occurs when customer continuously gains value as the service or product is provided. (example: cleaning services, car maintenance)
- Enhancing/Creating Customer Assets: Recognition occurs when value is added to an existing asset or something new is created for the customer. (example: house construction, car modifications)
- No Alternative Use with Enforceable Rights: Acknowledges custom-made assets held by a customer where no other use exists for the supplier. (example: custom machinery, furniture)
Costs to Secure Long-Term Contracts
- Capitalization: Costs to secure a long-term contract, such as sales commissions, must be capitalized and amortized over the contract's duration. This ensures the costs to secure the contract are matched with the revenue generated from the contract, consistent with the matching principle.
Agent vs. Principal
- Agent: Reports only the commission earned as revenue. Records cost of goods sold by the principal.
- Principal: Reports the gross sales price as revenue and the cost of the goods sold.
Revenue from Company-Owned/Franchise Royalties/Fees
- Company-Owned: Revenue is from direct sales at the company's own stores.
- Franchise Royalties/Fees: One-time fee and ongoing royalty payments from franchisees based on sales.
- Supplies Revenue from selling products or services to franchisees.
- Treatment: Franchise fees are initially recorded as deferred revenue and recognized over time, royalties are recognized when they are due.
Revenue from Company-Owned/License to Install Software
- Licensed Software with Updates: Revenue is recognized over the life of the contract as updates/improvements are provided.
- Licensed Software without Updates: Revenue is recognized upfront.
- Cloud-Based Software: Revenue is recognized over the life of the contract as a service, rather than as a license.
Bill-and-Hold Agreements
- Criteria: Customer request, identified goods, ready for delivery, no redirection allowed.
- Recognition: Revenue is recognized before shipping if conditions are met, and customer has control.
Expense Recognition
- Net Income: Calculated as revenue minus expenses.
- Expenses: Decreases in economic benefits (due to outflows, asset depletion, or liability incurrence) during a period and reduce equity (excluding distributions to owners).
- Matching Principle: Match expenses to the related revenue they help generate.
Capitalization vs. Expensing
- Capitalization: Costs that provide future economic benefits are recorded as assets and are expensed over a longer period (via depreciation, amortization, or depletion). Expenses are matched with the revenue they help generate
- Expensing: Costs that do not provide future economic benefits are recorded as immediate expenses in the current period. Costs are expensed if they don't offer long term value.
Income Statement Ratios
- Gross Profit Margin: Gross profit divided by revenue
- Net Profit Margin: Net income divided by revenue
- Operating Profit Margin: Operating profit divided by revenue
- Pretax Margin: Pretax accounting profit divided by revenue
- Effective Tax Rate: Income tax expense divided by pretax income
Earnings per Share (EPS)
- Definition: Earnings per share (EPS) estimates the earnings per share if all potentially dilutive securities are converted (basic EPS).
- Components: Income, Preferred dividends, Weighted average number of outstanding common shares
Nonrecurring Items
- Definition: Events unusual or infrequent in nature, material enough to affect financial statement users, and excluded from continuing operations.
- Examples: Gains/losses from the sale of assets, restructurings.
- Reporting: Disclosed separately and before tax.
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Description
This quiz covers key concepts of revenue recognition under accounting standards, focusing on cash and credit sales, unearned revenue, and revenue reporting. Understand how revenue is recognized and reported in financial statements, adhering to accounting principles and converged standards.
