Revenue Recognition Paper 2

Answer (D) is correct. GAAP require that revenue be recognized when it is realized or realizable and earned. Under the completed-contract method, revenue recognition is appropriate only at the completion of the contract. Neither the recording nor the collection of progress billings affects this recognition.

Answer (B) is correct. Under the percentage-of-completion method, revenues and expenses are recognized based on the stage of completion at the balance sheet date if the outcome of the contract can be estimated reliably. For a fixed-price contract, the outcome can be estimated reliably if (1) total revenue can be measured reliably, (2) it is probable that the economic benefits of the contract will flow to the enterprise, (3) contract costs to complete and stage of completion can be measured reliably, and (4) contract costs can be clearly identified and measured reliably so that actual and estimated costs can be compared.

Answer (D) is correct. Under a consignment arrangement, the consignor ships goods to the consignee, who acts as sales agent for the consignor. The goods are in the physical possession of the consignee but remain the property of the consignor and are included in the consignor’s inventory. Revenue and the related cost of goods sold from consigned goods are recognized by the consignor only when the merchandise is sold and delivered to the final customer. Accordingly, recognition occurs when notification is received that the consignee has sold the goods

Answer (A) is correct. One condition for recognition of revenue from the sale of goods is the transfer of the significant risks and rewards of ownership. Retention of significant risk may occur when, for example, the buyer may rescind the purchase for a reason stipulated in the contract, and the buyer is uncertain about the probability of return. However, if the entity can reliably estimate future returns and recognizes a liability for returns based on experience and other pertinent information, revenue may be recognized at the time of sale if the other conditions for revenue recognition also are met.

Answer (B) is correct. Unrealized holding gains and losses on trading securities are included in earnings and are therefore reported in the income statement.

Answer (C) is correct. When the outcome of a transaction involving the rendering of services (e.g., a construction project) cannot be estimated reliably, revenue must be recognized only to the extent of the expenses recognized that are recoverable. If it is probable that the entity will recover the transaction costs incurred, revenue is recognized only to the extent of those costs that are expected to be recoverable. Thus, $100,000, 10% of the $1,000,000 contract, should be recognized as revenue compared with $0 of revenue recognized under the completed contract method, since the contract is not fully completed.