Revenue Recognition Questions...


H

hi

Helpful commentsl only please...

1. A publishing company sends books in November totaling $10 million and
accepts any unsold books up to January 10th. Based on past experience, they
expect 20% to be returned. How much revenue should be recognized?

-I put $10 million. I figure the answer is 10, 8, or 0. Any thoughts?

2. A franchiser sold 5 franchises and collected cash. now, it is obligated
to help the franchisees to find a location, arrange financing, and train the
franchisees personel. Should the franchier recognize revenue?

- My group thinks no, but i'm not so sure. Any thoughts?

3. A low firm offers prepaid legal services where for a yearly premium that
is paid at the time of the sale the firm promises to provide specified
services as defined in the contract for no charge. During the current year,
cash of $40,000 was received and services (which would have been billed for
$18,000) rendered. Because the contracts were sold throughout the year, the
law firm estimates only 40% of the contracts have been filled. How much, if
any, revenue should be recognized?

- My group and I believe it's either $16,000 or $18,000.

4. A health insurance company sells polices and collects premiums during the
year totaling $100,000 and is now obligated to pay for the specified health
care costs. Should the company recognize revenue?

-We put yes.

Any (helpful) thoughts?
 
B

Bob

hi said:
Helpful commentsl only please...

1. A publishing company sends books in November totaling $10 million and
accepts any unsold books up to January 10th. Based on past experience, they
expect 20% to be returned. How much revenue should be recognized?

-I put $10 million. I figure the answer is 10, 8, or 0. Any thoughts?

2. A franchiser sold 5 franchises and collected cash. now, it is obligated
to help the franchisees to find a location, arrange financing, and train the
franchisees personel. Should the franchier recognize revenue?

- My group thinks no, but i'm not so sure. Any thoughts?

3. A low firm offers prepaid legal services where for a yearly premium that
is paid at the time of the sale the firm promises to provide specified
services as defined in the contract for no charge. During the current year,
cash of $40,000 was received and services (which would have been billed for
$18,000) rendered. Because the contracts were sold throughout the year, the
law firm estimates only 40% of the contracts have been filled. How much, if
any, revenue should be recognized?

- My group and I believe it's either $16,000 or $18,000.

4. A health insurance company sells polices and collects premiums during the
year totaling $100,000 and is now obligated to pay for the specified health
care costs. Should the company recognize revenue?

-We put yes.

Any (helpful) thoughts?
post your "tentative" solutions to the problems and we'll comment on your
answers
 
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H

Harry

hi said:
Helpful commentsl only please...

1. A publishing company sends books in November totaling $10 million and
accepts any unsold books up to January 10th. Based on past experience, they
expect 20% to be returned. How much revenue should be recognized?

-I put $10 million. I figure the answer is 10, 8, or 0. Any thoughts?
Revenue should only be recognized when realized or realizable AND earned.

It would be $8 mil for two reasons: first, revenue recognition requires
that revenue be realized or realizable.. clearly if they "expect" a 20%
return then that portion is not realizable. Also, the conservatism contraint
says that when in doubt choose the method that is least likely to overstate
income, which recognizing the 20% that you expect to be returned would
violate.
2. A franchiser sold 5 franchises and collected cash. now, it is obligated
to help the franchisees to find a location, arrange financing, and train the
franchisees personel. Should the franchier recognize revenue?

- My group thinks no, but i'm not so sure. Any thoughts?
Revenue should only be recognized when realized or realizable AND earned.

The key word here is "obligated", the franchiser has not yet provided
(earned) the service that it has been paid for, therfore it has a liablilty
and must therefore show it as unearned revenue.
3. A low firm offers prepaid legal services where for a yearly premium that
is paid at the time of the sale the firm promises to provide specified
services as defined in the contract for no charge. During the current year,
cash of $40,000 was received and services (which would have been billed for
$18,000) rendered. Because the contracts were sold throughout the year, the
law firm estimates only 40% of the contracts have been filled. How much, if
any, revenue should be recognized?

- My group and I believe it's either $16,000 or $18,000.
Revenue should only be recognized when realized or realizable AND earned.

If they were paid $40,000 and only performed 40% of the obligation then 60%
of the obligation remains unearned, therefore only 40% (or $16,000) should
be recognized.
4. A health insurance company sells polices and collects premiums during the
year totaling $100,000 and is now obligated to pay for the specified health
care costs. Should the company recognize revenue?

-We put yes.
Revenue should only be recognized when realized or realizable AND earned.

No, if this is cash collected for services not yet rendered (earned) then it
is a liability.
 
J

Janice Davis

hi said:
Helpful commentsl only please...

1. A publishing company sends books in November totaling $10 million and
accepts any unsold books up to January 10th. Based on past experience, they
expect 20% to be returned. How much revenue should be recognized?

-I put $10 million. I figure the answer is 10, 8, or 0. Any thoughts?
I say this is correct.
2. A franchiser sold 5 franchises and collected cash. now, it is obligated
to help the franchisees to find a location, arrange financing, and train the
franchisees personel. Should the franchier recognize revenue?

- My group thinks no, but i'm not so sure. Any thoughts?
Your group is correct. The only time revenue would be recognized here is if
the company makes its profits from selling companies. The profits from the
sale of franchises would be listed in the multi-step income statement under
Other Gains and Losses
3. A low firm offers prepaid legal services where for a yearly premium that
is paid at the time of the sale the firm promises to provide specified
services as defined in the contract for no charge. During the current year,
cash of $40,000 was received and services (which would have been billed for
$18,000) rendered. Because the contracts were sold throughout the year, the
law firm estimates only 40% of the contracts have been filled. How much, if
any, revenue should be recognized?

- My group and I believe it's either $16,000 or $18,000.
It seems to me that you have confusion over the recognition and realization
of revenues. Revenue is recognized at the point of sale. Revenue is realized
at or near cash ie notes receivable/ accounts receivable. Here $40,000 is
recognized and recorded in your books. At the end of the accounting period
only $18,000 can be realized.
4. A health insurance company sells polices and collects premiums during the
year totaling $100,000 and is now obligated to pay for the specified health
care costs. Should the company recognize revenue?

-We put yes.
Again correct
Any (helpful) thoughts?
Not to be redundant or insincere, but you and your group really need to
study the concepts of revenue recognition and revenue realization. Here's an
example that was given to me. I bought a house from a builder, but I can't
move into it yet. The house has not been built. The builder can recognize
the revenue from the sale, but cannot realize the revenue until the house is
substantially complete.
 
H

Harry

Janice Davis said:
Any (helpful) thoughts?
Not to be redundant or insincere, but you and your group really need to
study the concepts of revenue recognition and revenue realization. Here's an
example that was given to me. I bought a house from a builder, but I can't
move into it yet. The house has not been built. The builder can recognize
the revenue from the sale, but cannot realize the revenue until the house is
substantially complete.
Actually Janice you may want to go back and study the concepts yourself.
Recognition means including it as income on the financial statements.
Realizing it is something that must occur BEFORE it can be recognized, and
it must also be considered "earned" before it can be recognized as income.

Your example is actually backward. The builder can realize the sale (ie
recieve cash) but he cannot recognize it until it is earned (ie builds the
house).
 
P

Paul

hi said:
Helpful commentsl only please...
Why just the helpful ones?

1. A publishing company sends books in November totaling $10 million and
accepts any unsold books up to January 10th. Based on past experience, they
expect 20% to be returned. How much revenue should be recognized?
In what period? (This ~is~ helpful as you have to know what you are doing)

-I put $10 million. I figure the answer is 10, 8, or 0. Any thoughts?
If the publishing company "sends books", have they actually sold the books,
or are they just on consignment? It does make a difference.

2. A franchiser sold 5 franchises and collected cash. now, it is obligated
to help the franchisees to find a location, arrange financing, and train the
franchisees personel. Should the franchier recognize revenue?
As opposed to not recognizing the revenues? Look, revenue has to be
recognized. The terms of the franchise agreement may shed light on when the
revenue should be recognized.

- My group thinks no, but i'm not so sure. Any thoughts?

3. A low firm offers prepaid legal services where for a yearly premium that
is paid at the time of the sale the firm promises to provide specified
services as defined in the contract for no charge. During the current year,
cash of $40,000 was received and services (which would have been billed for
$18,000) rendered. Because the contracts were sold throughout the year, the
law firm estimates only 40% of the contracts have been filled. How much, if
any, revenue should be recognized?
Cash basis, it's all revenue when received.
 
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J

Janice Davis

Harry said:
Here's house

Actually Janice you may want to go back and study the concepts yourself.
Recognition means including it as income on the financial statements.
Realizing it is something that must occur BEFORE it can be recognized, and
it must also be considered "earned" before it can be recognized as income.

Your example is actually backward. The builder can realize the sale (ie
recieve cash) but he cannot recognize it until it is earned (ie builds the
house).
Egads! NEVER let be said that I can clearly explain things. :eek:) I understand
the concepts, but always seem to have a problem conveying them. Many thanks.
 
P

Paul

Harry said:
Revenue should only be recognized when realized or realizable AND earned.

The key word here is "obligated", the franchiser has not yet provided
(earned) the service that it has been paid for, therfore it has a liablilty
and must therefore show it as unearned revenue.

I disagree if the franchise fee isn't refundable. Otherwise the services
may never be performed. It's a long shot, but.....it happens.


Revenue should only be recognized when realized or realizable AND earned.

If they were paid $40,000 and only performed 40% of the obligation then 60%
of the obligation remains unearned, therefore only 40% (or $16,000) should
be recognized.
At best it should be recognized over the life of the contract. Each year
1/12th of the contracted price is booked as revenue.
 
H

Harry

Paul said:
Why just the helpful ones?
Because he is an accounting student and has been harassed already for not
"doing his own homework." It is clear by the nature of the questions that
these are textbook not practical questions, and while there are many a
pompous fool ready to pounce on the guy, he is only looking for legitimate
help from knowledgeable people in a subject that can be overwhelming for
those who are not exposed to it everyday.

H
 
H

hi

My accounting teacher told me that the answer is $10 million, not 8 million.
He said you'd recognized $10 million revenue and do another entry for $2
million of an expense. Why do so many people give me different answers?
 
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H

Harry

hi said:
My accounting teacher told me that the answer is $10 million, not 8 million.
He said you'd recognized $10 million revenue and do another entry for $2
million of an expense. Why do so many people give me different answers?
Because in the real world everything is not black and white, and while there
are standards many situations are either not covered or can and will be
interpreted differently. In text books examples, the questions that pertain
to a certain chapter are covered in the chapter and the answer that the
professor expects is the answer that the text describes or he has explained
in lecture. It really does not matter how someone else interprets the
question.. what matters is what your professor is expecting.

H
 

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