Revenue Recognition
Practice as You Learn
Financial Accounting
Revenue Recognition
Practice as You Learn
Practice Problem 1: Revenue Recognition Process
Determine the correct order of the following steps:
Step ___: Identify the performance obligations in the contract: single or multiple
Step ___: Recognize revenue when each performance obligation is satisfied
Step ___: Identify the contract with the customer (legal rights of the seller & customer)
Step ___: Record revenue when the seller receives the cash
Step ___: Determine the transaction price: entitled to receive from the customer
Step ___: Allocate the transaction price to each performance obligation
Answer
Step 1: Identify the contract with the customer (legal rights of the seller & customer)
Step 2: Identify the performance obligations in the contract: single or multiple
Step 3: Determine the transaction price: entitled to receive from the customer
Step 4: Allocate the transaction price to each performance obligation
Step 5: Recognize revenue when each performance obligation is satisfied
The receipt of cash has no impact on when revenue is reported
Practice Problem 2: Franchisor Revenue
Rolly Polly Sandwiches, Inc. sells franchises for a total fee of $20,000. Half the fee is for site selection and assistance establishing operations at the restaurant site (completed in 3 months). Half the fee is for monthly business consulting and on-going training over the 5-year franchise agreement. The company sold 5 franchisee rights during the first half of the current year and the franchisees all began operations in July.
B. Determine the price of each performance obligation.
C. Record the transactions for the franchisor for the first year.
Answer
A. Performance Obligations:
Site selection
Assist with establishing operations at the restaurant site
Monthly business consulting and ongoing training
B. Determine the price of each performance obligation:
5 franchise rights x $20,000 each = $100,000 total initial fees
For site selection and establishing the restaurant site
Earn 50% x $100,000 = $50,000 at the end of 3 months
For ongoing consulting and training over the agreement period
50% x $100,000 = $50,000 / 5 years = $10,000 each year for 5 years
Earn ½ the year in the current year $10,000 x ½ = $5,000
C. Record transactions related to revenue
Site selection and establish operations at the site:
Cash 100,000
Unearned Franchise Fee Revenue 100,000
Unearned Franchise Fee Revenue 50,000
Franchise Fee Revenue 50,000
Monthly consulting and training
Cash 5,000
Franchise Fee Revenue 5,000
Practice Problem 3: Multiple Distinct Performance Obligations
On January 1st, Gemini, Inc. sold software with a one-year service plan for a total price of $1,000. The software and service plan have stand-alone prices of $600 and $900, respectively.
A. Make the entry to record revenue on the date the customer accepts the software.
B. Make the entry at the end of the year, given Gemini, Inc. prepares annual financial statements only.
Answer
1st: Allocate the total price to the two separate performance obligations:
| Stand-alone price | % of Total | Allocated Revenue | |
|---|---|---|---|
| Software: | $600 | 40% | $400 |
|
Services: |
$900 |
60% |
$600 |
| Total | $1500 | 100% | $1000 |
Recognize $400 software sales revenue upon delivery and acceptance
Recognize $600 service revenue allocated to each month as time passes
A. On the date the customer accepts the software:
Cash $1,000
Sales Revenue $400
Deferred Revenue $600
Sales revenue is revenue when delivered
Deferred revenue will become revenue as time passes
B. At the end of the year:
Deferred Revenue $600
Service Revenue $600
or, each month:
Deferred Revenue $50
Service Revenue $50