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CHAPTER 4

Income Measurement and the Objectives of Financial Reporting

QUESTIONS

Q4-1.
No, it’s rarely possible for one set of financial statements to satisfy all objectives of financial
reporting, since most companies have many objectives, some of which that are contradictory.
The pursuit of tax minimization, which is of some importance to all companies, necessarily
sacrifices most other objectives, particularly the evaluation of management performance, income
maximization, or income smoothing, which usually are important for a publicly traded company.
For private companies higher net income might be desirable if financial statements have to be
provided to bankers whereas minimizing taxes would be served by legitimately reporting a lower
net income.

Q4-2.
There is no “most important” objective of financial reporting. This question must be assessed in
the context of each individual entity. For a small private company with few external stakeholders
demanding information therefore income tax minimization is probably the most important
objective. For a company urgently requiring a loan the most important objective is providing
information that increases the likelihood of obtaining the loan—perhaps by reporting higher net
income or providing detailed cash flow forecasts. For senior managers with a net income-based
bonus plan the most important objective might be receiving a large bonus. From a stakeholder’s
perspective the most important objective is the one that satisfies that stakeholder’s information
needs.

Q4-3.
Product costs can be reasonably attached to the specific revenues they helped generate and are
expensed as cost of goods sold when the revenue is recognized. Period costs can’t be readily
matched to specific revenues and is expensed in the period when the cost occurs. In theory, the
matching concept requires that all costs be matched to the revenue they help generate. This is one
of the goals of accrual accounting. In practice, it can be very difficult to match many costs to the
revenues they helped earn. For example, for many entities it can be difficult to match costs like
utilities, administrative salaries, depreciation, and advertising to specific revenues.

Q4-4.
Revenue recognition refers to choosing the time period when the revenue is recorded on the
income statement and included in the calculation of income.

Q4-5.
The recognition of revenue either increases an asset or decreases a liability. If a sale is made on
credit, accounts receivable is increased (debited) when the revenue is recognized. If a cash sale is
made then cash is increased (debited) when the revenue is recognized. If the customer paid in
advance for the good or service and an unearned revenue liability was set up when the payment
was received, when the revenue is recognized the unearned revenue liability is decreased

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(debited). In all cases, recognition of revenue will result in an increase in retained earnings
(credit). When an entity recognizes revenues its net assets (assets – liabilities) increase.

Q4-6.
Receipt of cash isn’t always the last or most important critical event to occur and thus in some
instances it doesn’t trigger revenue recognition. Cash may be received before a product is
produced or before it’s delivered (or a service performed). An example provided in the text is one
of an airline in which customers often pay for flights months in advance but revenue isn’t
recognized until the flight takes place (as this is the point in time when performance is achieved).
Prior to the flight, the payment would be recorded as a liability (unearned revenue) and this
liability would be reduced upon performance by the company (the provision of the flight). Under
IFRS revenue recognition occurs at the earliest time the revenue recognition criteria are met. The
criteria don’t require cash to be collected; only that collection is probable.

Q4-7.
The benefit of the flexibility is that the management of the entity is able to select the accounting
policy that is most appropriate, a method that best reflects the economic activity of the entity.
This flexibility is valuable because the economic activities of the Canadian and world economies
are too complex to precisely define accounting rules to suit every situation. Flexibility also
allows management to use methods that best serve the needs of the entity’s stakeholders. The
disadvantage is that managers can use the flexibility to pursue their own interests at the expense
of the users of financial statements who receive information that is either biased, incomplete, or
not as reflective of the entities underlying economic activity.

Q4-8.
When given the option for revenue recognition there is two ways revenue can be recognized; the
gradual approach or the critical event approach. For long-term service contracts using the critical
event approach would delay the recognition of revenue until all five revenue recognition criteria
are met:
1. Significant risks and rewards of ownership have been transferred from the seller to the buyer.
2. The seller has no involvement or control over the goods sold.
3. Collection of payment is probable.
4. The amount of revenue can be reasonably measured.
5. Costs of earning the revenue can be reasonably measured.
In this case criterion 1 & 2 which are performance driven could delay the recognition of revenue
in later periods resulting in financial statements that aren’t relevant to the users of the financial
statements. In addition, with a continuous service the revenue is being earned on a continuous
basis so it makes sense to capture the economic activity on a continuous basis rather than at a
single critical event. Therefore using the percentage-of-completion method will allow revenues
and expenses to be recognized as performance occurs for long-term contracts making the
financial statements more relevant.

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Q4-9.
There can be considerable latitude for when to recognize revenue, even within the IFRS/ASPE
standards and the specific facts of the situation. If alternatives exist after considering the
constraints and the facts the objectives of the managers would influence how they choose to
recognize revenue. A firm might prefer to recognize revenue as late as permitted, if postponing
income taxes is the most important accounting objective. Alternatively, if a significant portion of
management’s compensation was a bonus based on income, revenue recognition at an earlier
point would be preferred. In general, given the latitude and flexibility available, the objective
would influence when managers choose to recognize revenue.

Q4-10.
Constraints are formal limitations on the range of choices available with regard to accounting
alternatives for a particular event or transaction, such as those imposed by IFRS/ASPE, laws,
contracts, and so on. Facts are the economic circumstances that surround an event. The facts may
lead strongly to a conclusion that only one alternative would be acceptable to a knowledgeable
observer. For example, if a barber shop provides a haircut for cash, the only credible revenue
recognition policy is when the service is provided. In other cases, when the facts are more
ambiguous and subject to interpretation, more than one reasonable alternative might exist.
Objectives arise from the purposes that the preparers of the financial statements have for the
statements. They arise from a consideration of the most important users of the statements and the
anticipated decisions that may be influenced by the financial statements. Constraints, facts, and
objectives must be considered when making an accounting choice because they each may serve
to limit or guide the choice. They must be considered in order, with constraints being considered
first, then facts, and only if more than one alternative exists after consulting the facts can
objectives be considered.

Q4-11.
Matching is the process of recording and reporting expenses in the same period as the revenues
those expenses helped earn are recorded and reported. Examples of matching include
depreciation of property, plant, and equipment, the cost of inventory sold, the cost of labour,
estimated warranty costs, bad debts (many other examples could be provided). Matching is
important when income is determined for purposes such as measuring performance, evaluating
management or predicting future profitability because performance requires the association of
the economic benefits and costs an entity incurs. Matching can be difficult because the
contribution a particular expenditure makes to earning revenues in a period can sometimes be
very difficult to determine. For example, it’s not clear how a delivery vehicle contributes to the
earning of revenue.

Q4-12.
Accounting is a representation of the economic activity of an entity, not the economic activity
itself. Economic events and transactions, such as delivery of products or services to customers,
payment or receipt of cash, signing of contracts, or changes in the values of assets, aren’t
affected by how an entity does its accounting. All that’s affected is how those economic events
are reported. However, while accounting doesn’t affect the economic activity of an entity, it can
have economic consequences. That is, the decisions and wealth of stakeholders, including the

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Copyright © 2013 McGraw-Hill Ryerson Ltd.
entity itself, can be affected by how an entity does its accounting. Analogously, alternative
presentations of a resume don’t change the actual work and education experience of a person;
they only affect how that experience is presented. However, the perceptions that readers of the
resume have of the qualifications of the applicant may be influenced by the way in which they
are presented on the resume.

Q4-13.
Under accrual accounting revenue represents an economic benefit earned by an entity. To
recognize revenue, it’s necessary to specify when that economic benefit has been achieved.
Economic benefits are often not easily observable so accountants have to interpret the economic
events to determine when to recognize revenue. Accountants (under IFRS/ASPE) created the
revenue recognition criteria to assist in the determination of when to recognize revenue.
However, while the criteria offer guidance, they don’t always identify an unambiguous moment
for when to recognize revenue. As a result, managers will have to choose a time to recognize
revenue and that choice may be one of a set of possible points in the earnings process at which to
recognize the economic benefit. The interpretation of the revenue recognition criteria isn’t only
affected by the interpretation of the facts or economic circumstances, but also by the objectives
of financial reporting of the managers of the entity.

Q4-14.
Under cash accounting, there is no ambiguity around when revenue should be recognized
because revenue is recognized when cash is received. The point at which cash is received is clear
and unambiguous. In contrast, under accrual accounting revenue represents an economic benefit,
not simply the receipt of cash. It can be difficult to specify the precise time when revenue is
earned because it’s necessary to specify when an economic benefit is achieved. Economic
benefits are often not easily observable so accountants have to interpret the economic events to
determine when to recognize revenue.

Q4-15.
With the percentage-of-completion method, revenue is recognized gradually over the term of the
contract, based on some definition of progress in completing the work being done. With the zero-
profit method revenues are recognized in a period up to the point where they equal costs incurred
in the period (so profit is zero in each period). The remaining revenue (the amount not
recognized in previous periods) is recognized in the last period of the contract along with the
remaining expenses. The percentage-of-completion method requires more judgment because it’s
necessary to determine the percentage of the project that has been completed in each period.
With the zero-profit method, it’s only necessary to determine costs incurred in each period of the
contract.

Q4-16.
Managers of an entity are the people best equipped to make decisions about the entity, including
decisions about financial reporting to stakeholders. The managers are (should be) the people with
the most information about the entity and therefore their decisions will be the most informed
ones. However, managers don’t always or necessarily look out for the interests of the
stakeholders they report to; sometimes they pursue their own interests. Engaging independent
third parties to prepare financial statements would mitigate the self-interested behaviour of the

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Copyright © 2013 McGraw-Hill Ryerson Ltd.
managers, but it would come at the expense of less informed people preparing the financial
statements. Oversight of financial statement preparation might help mitigate the self-interested
behaviour of managers. For example, audits of financial statements by independent third parties
could serve this purpose provided the auditors carry out their functions properly. However, there
is clear evidence that auditors don’t always do that. For example, Arthur Andersen’s demise in
the early 2000s and controversies surrounding the independence of auditors call this approach
into question.

Q4-17.
Allowing the use of a single revenue recognition point would eliminate uncertainty and
judgement about when revenue is recognized. In that sense the statement would be more reliable
because there would be no confusion about how an entity was recognizing revenue. However,
requiring a universal revenue recognition point wouldn’t make financial statements more useful
of more relevant for decision making. How useful and relevant financial statements are depends
on who the user is and the decision he or she has to make. Flexibility in an accounting system
can make financial statements more relevant by allowing managers to select accounting methods
most suitable for the situation. Similarly, financial statements are intended to reflect the financial
position and economic activity of an entity. A universal method of revenue recognition may not
universally capture the economic activity of an entity. Different methods can be appropriate for
different circumstances. On the other hand, by specifying when revenue must be recognized, the
ability of managers to exercise their self-interest through the accounting choices they make is
mitigated.

Q4-18
1. Significant risks and rewards of
ownership have been transferred This is a performance criterion which means the buyer now
from seller to buyer bears the risk and enjoys the rewards associated with
receiving or owning the product or service.
This is also a performance criterion in that the seller is no
2. The seller has no involvement or longer involved in the management or decision of how the
control over the goods sold goods are being used.
3. The amount of revenue can be It’s necessary to know the amount of revenue that will be
reasonably measured. earned. That is, the amount that the customer has agreed to
pay must be known.
4. The costs required to earn the It’s necessary to know the costs that will be incurred to earn
revenue can be reasonably measured. the revenue. This criterion is necessary if expenses are
going to be matched to revenue. Costs include not only
those incurred to the time the revenue is recognized, but
also costs related to the revenue that will be incurred in the
future.

5. Collection of payment is probable. For revenue to be recognized there must be a reasonable


expectation that payment will be received. If the revenue
isn’t collected, there is no economic benefit.

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Q4-19.
The effect of recognizing revenue at one point in time rather than another can have significant
implications for the numbers that appear in the financial statements and economic consequences
for those who prepare financial statements and for stakeholders who use the financial statements.
When revenue is recognized can affect wealth distribution by affecting the amount of tax an
entity pays, the bonus managers receive, the amount buyers pay for an entity, and so on. In
addition, the users’ perspective regarding the profitability and performance of the entity may be
affected. Note that how or when revenue is recognized doesn’t affect the actual underlying
economic activity of the entity. Only the representation of that activity is affected.

Q4-20.
To use the percentage-of-completion method it’s necessary to estimate the total costs that will be
incurred over the contract, the amount of revenue that will be earned, and the percentage of the
project that has been completed on the financial statement date. There also has to be a reasonable
expectation of payment. If any of these requirements isn’t met, IFRS requires entities to use the
zero-profit method.

Q4-21.
A gain arises when a firm sells an asset that it doesn’t usually sell in the ordinary course of
business (i.e. not inventory) for an amount greater than the carrying amount at the time of the
sale (carrying amount = cost – accumulated depreciation). If the sale is for less than the carrying
amount, there is a loss. Gains and losses are reported separately from revenues and expenses on
the income statement because they don’t reflect the normal continuing operations of the business.
Reporting gains and losses separately is important so that stakeholders can understand the
amount of revenue the entity is generating from its ordinary activities. The amounts are typically
shown “net” on the financial statements (the gain or loss is reported on the income statement, not
the selling price less the carrying amount).

Q4-22.
The gains and losses are shown separately because they aren’t part of the usual operating
activities of the business. To include these transactions with revenue earned from the entity’s
ordinary business activities would be misleading to the users of financial statements. For
example, investors often look to the gross margin percentage on the income statement as an
important indicator of the company’s ability to offer a product that is valued by customers and
compare that percentage to that of other firms in the same industry. Including gains and losses in
revenue would distort the gross margin percentage. Similarly, year-to-year trends in revenues are
distorted if non-operating transactions are included. Also, including sales of incidental assets in
revenue distorts the size of the business by overstating the amount of sales the entity has in its
primary business activity. In each case, users’ ability to assess the performance of the entity and
to predict future performance is distorted.

Q4-23.
The two factors are the information needs of stakeholders and the self-interest of managers. The
information needs of stakeholders are a major reason for financial reporting. Stakeholders
require information for decision making and accounting information should help stakeholders

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make the best possible decisions. Self-interest means that managers may take their own needs
into consideration when making accounting choices, including such needs as maximizing their
compensation, keeping their jobs, increasing the price of shares or the apparent value of the
business, and so on.

Q4-24.
The people who prepare financial statements are human beings and as such have their own
preferences. Like other people, preparers of financial statements will pursue their preferences
(self-interests). Since financial statements can affect the compensation, wealth, and careers of
managers, they will likely take steps to achieve the outcomes that are best for them (within
reason, of course). As an analogy, when you prepare a resume, you aren’t neutral regarding the
reaction of those who review the resume as a basis for a decision as to whether to invite you for
an interview. Your preference would be to obtain interviews from entities you are applying to so
you will likely try to craft your resume to make yourself attractive to the prospective employers.
This doesn’t mean you lie or misrepresent in your resume but that you try to put your best foot
forward.

Ideally, self-interest wouldn’t play a role in financial reporting. Ideally, financial information
should provide the best possible information to stakeholders for decision making. Self-interest
can divert financial reporting from its purpose of providing the best possible information to
stakeholders. However, it’s unlikely that it will ever be possible to prevent preparers from
pursuing their self-interests. Controls such as audits and accounting standards can be put in place
to try to mitigate the effects of self-interest.

Q4-25.
a. Tax minimization means that the entity will take steps to reduce or defer the amount of
income taxes it must pay by, for example, choosing to recognize less revenue or more
expenses in the current period. To minimize taxes, any accounting choices made must be
allowable under the Income Tax Act.
b. Management evaluation: this objective means that information provided will help
stakeholders assess the decisions made by managers on the performance of the entity and
evaluate how well they have done their jobs.
c. Minimum compliance: the entity provides only information that is necessary to meet
reporting requirements (such as IFRS, ASPE, stock exchange listing requirements, securities
regulator requirements).
d. Cash flow prediction: this objective means that the financial statements can be used to assist
in the predictions of the amount and timing of future cash flows to and from the entity. An
important use of this information is to assess the ability of the firm to meet future obligations
as they become due. This is an important objective because financial statements prepared
under IFRS or ASPE aren’t predictions; they can be used to make predictions
e. Stewardship: is the use of financial statements to report to the stakeholders on use of
resources by the management of the enterprise.
f. Earnings management: Managing earnings means that managers make accounting choices
that report financial statement numbers that satisfy the objectives or self-interests of the
managers. Earnings management can serve the purpose of providing more useful information

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to stakeholders, as well as allowing the managers to satisfy their personal objectives.
Earnings management can also be used to benefit some stakeholders at the expense of others.

Q4-26.
It means that there is a specific point in time, such as the delivery of a product to a customer,
when 100% of the revenue is recognized. The alternative is a gradual approach, whereby a
portion of the revenue is recognized in each of several periods.

Q4-27.
Some products that are sold in a bundle include, automobiles with maintenance/warranty
included in the purchase, computer software with updates and aftermarket support, packaged
vacations, free products with a contract of some kind, etc. Sometimes it’s difficult to determine
the revenue associated with each part of the bundle. For example, how should the price of
vacation package be allocated among air fare, hotel, meals, and so on. If the amount paid is less
than the fair values of the component parts the allocation could be difficult.

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EXERCISES

E4-1.
a. These are all product costs because they can easily be specifically traced to individual toys
that are sold to generate revenue.
b. Sales commissions are product costs because they can be matched to specific revenues, the
revenues that were earned as a result of the efforts by the sales person. Sales commissions
would be expensed when the revenue they pertained to was recognized.
c. These salaries would be period costs since the work of head office employees and senior
executives can’t reasonably be associated with specific products.
d. Conceptually these would be product costs since they can be allocated to products. Utilities
in a plant can be associated with the production of products. In practice, utilities might be
treated as period costs if the allocation of the costs is too arbitrary.
e. These costs would be product costs since they can be allocated to specific products.
f. These could be product costs because they can be associated with particular sales (i.e. the
revenue associated with the merchandise in the truck).
g. Conceptually design costs are part of the costs of the new toys brought to market, but in
practice they could be expensed as period cost or capitalized as an asset and amortized over
the life of the life of the toy. Capitalizing could be somewhat arbitrary since a basis for
amortizing the costs would have to be determined.
h. These costs are traceable back to the individual toys so they would be classified as product
costs.
i. These are period costs, since they don’t relate to a specific product. It’s not possible to tell
how, if, or when particular advertising contributed to sales.

E4-2. – It’s possible to have different acceptable bases for estimating the percentage of the job
that is competed; here are some examples.
a) Number of kilometres completed, pounds of asphalt poured, number of hours worked. As is
done with using cost, the proportion or revenue recognized would be based on comparing the
amount completed with the actual or estimated total. For example, for the number of
kilometres of highway completed, if 20 kilometres were completed in a period then 40% of
the revenue would be recognized (20 km completed in period)/ (50 km).
b) Tonnes of earth excavated, number of equipment hours used, number of labour hours used.
((Amount of contaminated earth removed in period)/(Total estimated contaminated earth that
needs to be removed)) These measures would require estimates of the total amounts (such as
the total tonnes of earth, labour hours, etc.).
c) Identify specific milestones in the overhaul (this is a vague alternative but an overhaul will
involve a number of different activities), number of labour hours used. (Square footage of
overhaul that was completed in a period)/(Total square footage of vessel).

E4-3.
a. Recognize revenue when the contract is signed.

December 13, 2016


Dr. Accounts Receivable 750,000

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Cr. Revenue 750,000

Dr. Cost of goods sold 450,000


Cr. Liability for design/installation/warranty costs 450,000
[It’s assumed that the provision for warranty costs is included in this entry. A student
could also prepare a separate entry to record the warranty provision (Dr. Warranty
expense, Cr. Warranty liability). The important point is that the warranty cost should be
accrued at the time the revenue is recognized.]

Over the term of the contract


Dr. Liability for design/installation/warranty costs xxx
Cr. Accounts Payable/Cash xxx
[Over the term of the contract expenses accrued at the date the revenue was recognized
would have to be paid. This entry is required each time.]

October 15, 2017


No entry required

December 12, 2017


Dr. Liability for design/installation/warranty costs 22,500
Cr. Accounts Payable/Cash 22,500
[This entry follows from the assumption above that the warranty provision is included in
the liability for installation costs.]

January 8, 2018
Dr. Cash 750,000
Cr. Accounts Receivable 750,000

April 15, 2018


No entry required.

b. Recognize revenue when installation of the system is complete.

December 13, 2016


No entry required.

December 13, 2016—October 15, 2017


Dr. Inventory (system development costs) 427,500
Cr. Accounts Payable/Cash/Accrued liabilities 427,500
[Costs are accumulated in an inventory type account over the contract period. The
amount excludes the estimated warranty cost which would be accrued when the revenue
is recognized. It’s assumed here that the estimated warranty costs will be $22,500.]

October 15, 2017


Dr. Accounts Receivable 750,000
Cr. Revenue 750,000

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Copyright © 2013 McGraw-Hill Ryerson Ltd.
Dr. Cost of Goods Sold 450,000
Cr. Inventory (system development costs) 427,500
Cr. Accrued warranty liability 22,500
[All costs are expensed when revenue is recognized, including the future warranty costs.]

December 12, 2017


Dr. Accrued warranty liability 22,500
Cr. Accounts Payable/Cash 22,500

January 8, 2018
Dr. Cash 750,000
Cr. Accounts Receivable 750,000

April 15, 2018


No entry required.

c. Recognize revenue when cash is collected.

December 13, 2016


No entry

December 13, 2016—October 15, 2017


Dr. Inventory 427,500
Cr. Accounts Payable/Cash 427,500
[Costs are accumulated in an inventory type account over the contract period. The
amount excludes the estimated warranty cost which would be accrued when the revenue
is recognized. It’s assumed here that the estimated warranty costs will be $22,500.]

December 12, 2017


Dr. Deferred Warranty Costs (asset +) 22,500
Cr. Accounts Payable/Cash 22,500
[Since the warranty service was provided, it must be accounted for. Feeder incurred costs
but those costs shouldn’t be expensed until the revenue from the sale is recognized when
cash is received. As a result, the warranty costs incurred are recorded as a deferred cost
that is reported on the asset side of the balance sheet.]

January 8, 2018
Dr. Cash 750,000
Cr. Revenue 750,000

Dr. Cost of Goods Sold 450,000


Cr. Inventory 427,500
Cr. Deferred Warranty costs 22,500

April 15, 2018

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No entry required.

d. Recognize revenue when the warranty period expires.

December 13, 2016


No entry required.

December 13, 2016—October 15, 2017


Dr. Inventory 427,500
Cr. Accounts Payable/Cash 427,500
[Costs are accumulated in an inventory type account over the contract period. The
amount excludes the estimated warranty cost which would be accrued when the revenue
is recognized. It’s assumed here that the estimated warranty costs will be $22,500.]

December 12, 2017


Dr. Deferred Warranty Costs (asset +) 22,500
Cr. Accounts Payable/Cash 22,500
[Since the warranty service was provided, it must be accounted for. Feeder incurred costs
but those costs shouldn’t be expensed until the revenue from the sale is recognized when
cash is received. As a result, the warranty costs incurred are recorded as a deferred cost
that is reported on the asset side of the balance sheet.]

January 8, 2018
Dr. Cash 750,000
Cr. Unearned Revenue 750,000
[The payment is recorded as unearned revenue because the revenue isn’t recorded until
the end of the warranty period.]

April 15, 2018


Dr. Unearned Revenue 750,000
Cr. Revenue 750,000

Dr. Cost of Goods Sold 450,000


Cr. Inventory 427,500
Cr. Deferred Warranty costs 22,500

E4-4.
a. In this case, the motivation would be to report lower profits to the union. This would be
consistent with a tax minimization objective, which would be in line with the focus of some
private companies. The union would look at the income statement (if it was available to it) to
assess the ability of the company to afford wage increases and the company would probably
want to show low profits to suggest an inability to meet significant wage demands. An
assumption is needed here regarding whether the union of a private company could see the
company’s financial statements. Other users might include lenders (an assumption), which
would be interested in making cash flow predictions and assessing liquidity, and the private

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Copyright © 2013 McGraw-Hill Ryerson Ltd.
shareholders (if not actively involved in management) who would be interested in evaluating
performance and stewardship. Management would likely want to keep these latter two parties
satisfied, which might conflict with the tax minimization/income reduction objective.

b. Since the income of the partnership would be taxable in the hands of the partners when
reported by the partnership, there would be an incentive to minimize taxes. However, since
partners are compensated based on reported performance reporting higher income would be
desirable as well. In this case, there is a trade-off that could go either way. It might be
necessary to prepare special purpose reports for determining the compensation.

c. The users of the financial statements will be the president, CRA and prospective lenders or
equity investors. The need to provide information to prospective lenders would probably be
more pressing than the postponement of income taxes because of the urgent need for cash.
The president would want to make the company look attractive to the potential lenders, to
show that it’s a good credit risk, likely to repay the principal and interest that would be owed
to the bank.

d. The users of the financial statements are shareholders and potential shareholders, CRA, and
lenders and prospective lenders. Getting loans to fund expansion is the most important
priority for management. The objective will depend on the terms of getting the loan. If the
loan is based on the success of the company, management will manage earnings to increase
income and provide favourable ratios. Prospective lenders will be interested in assessing the
ability of the entity to repay the loan and interest on time. They will use the financial
statements to predict future performance and cash flow. Financial statements that show
strong performance and financial position may give lenders the confidence to lend.

e. The users of the financial statements will be the club members, members on the board of
directors, and managers. The managers would be focused on satisfying the board of directors
because they would be the ones that will remove management if things don’t go right and in
turn, the board of directors are going to want to satisfy the other members of the golf
organization because they are the ones that elect them. The main objective of the managers
will be stewardship. Members will want to know that the resources invested in the golf club
have been used efficiently since the various fees and charges will be affected by how well the
club is managed. The managers will want to provide financial statements that have a good
description of the entity’s activities and in a way that members can understand. Presentation
of a good financial position may help attract new members and keep existing ones.

E4-5.

a. The current users of the financial statements would include the owners, the bank, and the
taxation authorities. At this stage, the prospective public investors would be most important.
Those investors would desire information to help them predict future cash flows, profitability
and riskiness of the business so that they can determine what they are willing to pay for
shares. The owners of the company would therefore be motivated to present the company as
favourably as possible, meaning higher income and revenue, lower expenses, and lower
liabilities as these might help increase the price at which the shares can be offered and sold.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-13
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
Financial intermediaries such as investment bankers, stock dealers, financial analysts, etc.
would play an important role in interpreting information and distributing it to the public.
Other objectives will be minor compared with the one described but could include tax
minimization and stewardship and management evaluation for the existing family
shareholders.

b. The primary users of the financial statements would be the citizens of the municipality,
municipal council members (politicians), provincial government, and lenders; Citizens are
interested in stewardship—they want to see that the government is managing their tax dollars
well. The provincial government is a major source of financing for municipalities so they will
want to see that resources are being used properly. Lenders (if any) will want to assess the
financial stability and viability to determine whether they will lend to the municipality and
under what terms. The emphasis on the financial statements would be identifying how much
money was spent on administration, garbage collection, parks and recreation, transportation,
libraries, and other community functions. The government may use the statements politically
to obtain more money from the province by showing financial difficulties.

c. There are contradictory incentives here. The firm may want to exaggerate the impact of the
competition on profits and make accounting choices that show that the company has been
adversely affected by competition to encourage higher subsidies. However, since the
company is publicly traded, such a strategy could adversely affect share prices if investors
believe that the company isn’t performing to expectations (unless you assume that investors
wouldn’t be misled).

d. The primary users of the financial statements would be the donors of money to the
organization, since their ongoing support to the organization is vital for its continuing
operations. The objective would be stewardship or accountability for the use of the money.
The emphasis on the financial statements would be identifying how much money was spent
on administration and fundraising and how much was spent on food and distribution costs.

e. The users would include the owner, the bank, and CRA. Since the bank loan is small, the
bank’s information needs wouldn’t be a concern, so tax minimization would likely be most
important to the owner. Accounting choices would postpone revenues and expense earlier.

E4-6.
a. The revenue should be recognized when the donut and coffee are sold. Performance has
occurred because the consumer has acquired the risk and rewards of ownership of the items
and Tim Horton’s no longer has management or control over the donut and coffee. The
amount of revenues and cost are known. Collection has occurred since the customer has paid.

b. A concert is a service performed at a point in time. Goods aren’t involved so the transfer of
the risks and rewards of ownership doesn’t occur but the concept of performance is relevant.
Possible times to recognize revenue are when the tickets are purchased, when the concerts
are performed, or at the end of the 10 performances. At the time the tickets are sold the
amount of revenue is known and collection has occurred. However, performance hasn’t
occurred (the show hasn’t taken place) and costs may not be predictable. Performance is

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-14
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
achieved when concert occurs because at that time the service being purchased is provided.
When a show is performed collection has already occurred, the amount of revenue is known,
and costs of putting on the production should be known. (Rent, salaries, and most costs
should be known, though there could be some uncertainties). A student may try to take a
conservative approach and recognize all the revenue at the end of the season but to be
successful with this approach the student must prove that costs aren’t known and are difficult
to measure, which is probably not reasonable in most cases.

c. The customer is buying warranty protection for years two and three of ownership of the TV.
This is a service contract that provides warranty coverage continuously over the life of the
warranty. (Note: The warranty provides the right to service over the warranty period, not just
any service provided.) Possible times to recognize revenue are when warranty is sold,
warranty starts (one year after sale – manufacture warranty is over), over the warranty period,
or at the end of the warranty period. The relevant considerations are the ability to estimate
revenues and costs, collection, and performance. Performance is occurring continuously as
time passes, starting when the manufacturer warranty runs out, since what is being purchased
is the right to service and that service is provided continuously over the life of the contract.
However, the total cost of providing the warranty won’t be known until it expires. If a
reasonable estimate can be made for the total cost then revenue can be recognized with the
passage of time. If more costs are expected to be incurred later (or earlier) in the warranty
period more revenue can be allocated to when more service is expected to be required. If the
claims can’t be estimated based on experience, the revenue could be delayed until the expiry
of the warranty or on a zero-profit basis.
d. There are two items being sold in this arrangement: the graphics program and the support
(this is a multiple delivery). Revenue should be recognized for the program itself upon sale
(delivery). Since at that time risk and rewards has been transferred to the buyer, control over
how and when the program is used or stored is the responsibility of the buyer, revenue and
cost are known at the time of the sale and assuming it was a cash sale, collection has
occurred.

For the support services the options are to recognize revenue when the program is sold, over
the 18 month support period, or when support period has expired. Support is available 24/7
over the contract period and performance is occurring as time passes starting when the
program is sold. If a reasonable estimate can be made of the total cost of the service then
revenue can be recognized over the contract period, probably based on the passage of time. If
the service costs can’t be estimated based on experience, revenue recognition should be
delayed until the end of the 18 months. With experience, it would be acceptable to estimate
the costs and recognize revenue proportionately over the term of the service contract. If costs
are expected to occur evenly over the 18 months then the costs could be expensed as incurred
(the service costs are probably fixed over time). Revenue and collectability are known at the
time the program is sold. However, performance doesn’t occur until the service is actually
provided.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-15
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
E4-7.
a) Interest revenue is earned with the passage of time. Since the borrower has an excellent
credit rating the lender can recognize the interest revenue as it’s earned.
b) Interest is earned with the passage of time but collection is a problem. Revenue shouldn’t
be recognized until cash is collected. However, if the lender has a large portfolio of loans
it may be possible to make an allowance for uncollectables for the entire portfolio, in
which case interest revenue can be accrued as it’s earned.
c) This situation is similar to part b) but is more ambiguous because the company is making
its payments and has indicated that it will continue to do so. The expansion suggests the
borrower has short-term challenges but the outlook is positive for the longer term (which
is good for getting a loan repaid). Therefore revenue should still be recognized with the
passage of time, even if payments are late. A more conservative approach would be to not
recognize the revenue until collection of interest but this seems drastic given that the
borrower has made all its payments. If the lender has a large portfolio of loans the
allowance for uncollectables for the entire portfolio would capture issues with this loan.

E4-8.
In this situation the critical event can be when goods are delivered to the retail store, when
the customer purchase snacks from the store, or when the retail store pays for snacks sold.
HSL’s agreement with the retail stores is that of a consignment relationship with a contract
that transfers all management and control to the retailer but not the risk and rewards. The key
question for this transaction is when do the risks and rewards of ownership transfer from
HSL? Retailers have minimal risk and involvement with the product. HSL is responsible for
stocking and maintaining the racks. The retail merchant doesn’t pay for the snacks and earns
a commission for any snacks sold. The merchant pays HSL monthly for any snacks sold
during the month, less commission. The merchant’s only responsibility is for snacks that are
lost, stolen, or damaged. Only when the goods are sold to the customer is HSL free of
responsibilities. Therefore, HSL should recognize revenue when the retailer sells snacks to its
customers.

E4-9.
For annual memberships revenue should be recognized with the passage of time. Payments
made upfront should be credited to unearned revenue and revenue recognized each period
(month, quarter, year). Victory earns its revenue by providing access to its fitness facility.
Since a member can use the facility any time the club is open it makes sense to recognize
revenue evenly over the year.

For the life time membership is a more difficult because the membership applies to an
indefinite period (could be a year, five years, etc.). Victory still earns its revenue by
providing access to the facility. The challenge is determining an appropriate period to
recognize revenue. It would make sense to spread the membership over the average period a
person belongs to a club for. If Victory doesn’t have enough data to determine a period there
are probably industry statistics available to help.

E4-10.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-16
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
Usually revenue on the sale of goods is recognized on delivery. The facts of a transaction
sometimes make consideration of another critical event appropriate. In this case there are
uncertainties that suggest a later revenue recognition point. Most significant is the policy that
allows the customer to return any and all goods delivered in December at any time up until
March 1, 2018. Because this is a new customer in a new market it may be very difficult to
estimate returns. It’s also an uncommon policy for Kakisa. As a result it’s appropriate to wait
until after March 1 to determine how much the new customer actually purchases (how much
revenue). Because any and all of the goods can be returned until March 1 the significant risks
and rewards of ownership remain with Kakisa. After March 1 the risks and rewards are fully
transferred to the buyer since it can’t return the product. Some could argue that because the
customer is new collectability is in question. This is reasonable although a proper credit
check would mitigate this uncertainty.

E4-11.
a. Possible points in time to recognize revenue include: when the contract was signed, on
cash collection, May 1st, when the number of guests attending is known, August 15 (when
the dinner was held), and upon final payment.
b. Unless collection is an issue the only method consistent with IFRS is on August 15, when
the dinner was held. It’s on August 15 DCL has performed what it promised under the
contract. Before August 15 DCL has done very little (the percentage of the arrangement
complete is close to zero). Also, until the dinner is held the costs won’t be known (food
prices may vary), nor with the revenue since the number of guests is uncertain until close
to August 15. Some might argue that revenue could be recognized for the minimum
number of guests when the contract is signed, but DCL hasn’t performed as of that date.
Students are often drawn to cash collection but payments received before August 15 are
unearned revenue, again because DCL hasn’t performed so the revenue hasn’t been
earned. Delaying to when payment is received is only appropriate if there is uncertainty
about collection and the issue isn’t addressed through an allowance for uncollectibles.

E4-12.
Possible times to recognize revenue are when the contract is signed, when each payment is
received in September and January, or as the flights are provided to the teams. Revenue is
best recognized when each flight is provided. This is a service contract where Charter
Airways in providing a series of flights. The percentage of completion approach can be
applied based on each flight. This is similar to purchasing season tickets for a sports team—
revenue is recognized on performance; when the flight occurs. Each flight isn’t identical to
the others because they go to different destinations, so revenue might not be the same each
time (allocation could be based on kilometers traveled or the fair value of each flight).
Although the revenue is guaranteed in the contract it isn’t appropriate under IFRS to
recognize revenue when the contract is signed because the services haven’t been provided.
Also, there may be uncertainty about costs (for example, fuel prices vary). Students are often
attracted to cash collection as a basis for recognizing revenue but it’s not appropriate since
the cash is being paid before the service is provided. Cash collected should be classified as
unearned revenue when it’s received.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-17
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
One other aspect of this arrangement is that Charter Airways must put the team’s logo on its
aircraft. This is a separate stream of revenue that could be recognized separately. To do so it’s
necessary to separate the fair value of the flights and the advertising. The advertising revenue
should be recognized evenly over the term of the contract.

E4-13.
Revenue from the licence fee could be recognized at the inception of the contract when cash
is received or over the lifetime of the licensing agreement. The key question is what is the
foreign producer buying with the $1 million fee? If it’s simply to purchase the right to
produce the drug, regardless of whether it makes or sells any, then it’s appropriate to
recognize the revenue at the inception of the contract. At that time Quesnel has fulfilled its
responsibility by providing the customer with the right to produce. If the $1 million is
somehow tied to the production of the drug (perhaps a minimum royalty payment) then the
fee should be tied to production. From the information provided it appears that the upfront
fee is independent of production so recognition at the inception of the contract is appropriate.

Royalties are earned when the foreign producer sells the licensed drugs so it makes sense to
recognize the revenue on royalties when the producer makes a sale. Unless there is concern
about collection the amount earned should be accrued in the period the sale is made. There is
little basis for other points. Recognizing revenue at the time the initial agreement is signed
would be difficult to support because it’s unknown how much of the drug the company will
produce and so revenues aren’t determinable. Quesnel hasn’t earned the royalty because
drugs haven’t been sold to customers. Points after sale by the foreign producer are too
conservative and can’t be justified.

E4-14
According to IFRS (and ASPE) the transfer to the third party warehouse isn’t a sale. Badger
still has the risks and rewards of ownership and still controls many aspects of the
merchandise. The amount of revenue also isn’t known. The goods in the warehouse haven’t
been sold to anyone and there is no assurance they ever will be. The goods in the warehouse
should be classified as inventory until it’s sold to a customer. Since typical terms are to
recognize revenue on shipment, the appropriate time would be when goods are shipped from
the third party warehouse. The fact that the warehouse assumes responsibility for loss and
damage mitigates certain risks but doesn’t make the warehouse a customer. When the goods
are shipped to the warehouse there is no customer, no payment forthcoming, and no price for
the goods shipped.

E4-15.
a. Revenue should be recognized upon sale. At this time risks and rewards have been
transferred (the customer has the books in their possession) and Alma no longer has
management responsibilities for the books, performance has occurred (the sale is
complete), collection is assured (the customer has paid), and revenues and expenses are
measurable (the sale is complete). The only item that could be difficult to measure would
be the expenses related to potential returns. However, since Alma is a national chain it’s
likely they could reasonably estimate a sales return allowance.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-18
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
b. Revenue could be recognized upon order, shipment, or delivery. At the time the order is
placed revenues and expenses are measurable (the company would likely know the cost
to obtain and ship the item(s) ordered). Payment is also assured as the customer has
provided a reliable source of funds (paying by credit card or Pay Pal would be equivalent
to paying with cash). However, risks and rewards have not been transferred (the item
isn’t in the customers possession) and the company still retains the control over the
merchandise (the company hasn’t shipped the item). Upon shipment performance has
occurred, but risks and rewards have not been transferred as the customer doesn’t yet
have the book (risks and rewards could be considered transferred if the customer is
responsible for any losses during shipment but this isn’t likely the case). Therefore
delivery is likely the best time to recognize revenue as all the criteria have been satisfied,
although shipment may be more practical since it may be difficult to determine when an
item is delivered if sent by mail.
c. By purchasing a loyalty card the customer is purchasing the right to discounts over the
next year. Alma performs by providing those discounts throughout the year. (Students
should recognize that it’s not the discounts being purchased but the right to the
discounts), which is available continuously over the membership year. Upon signing up
for membership collection is assured (payment has been provided) and revenue is
measurable. Performance occurs on a day-to-day basis. It’s not possible to match the
costs with an individual member day-to-day but Alma could estimate the average
discount that’s obtained, or simply recognize the discounted amount as revenue when a
sale of a book is made. If sales are seasonal more revenue could be allocated to the busier
times of year. Revenue could also be recognized at the end of the membership but this
would be too conservative.
d. A gift card represents prepaid merchandise. Until a customer uses the gift card the
amount Alma received is unearned revenue. When the gift card is purchased the cost of
what will be purchased isn’t known. Cash is received when the card is purchased and the
risk and rewards associated with the card are transferred, but not for the goods the card
holder will purchase. Revenue should be recognized when the customer uses the gift
card. A challenge with a gift card is estimating the proportion of cards that won’t be used
(because they lost, misplaced, or aren’t useful to the owner).

E4-16.
Percentage of Completion 2017 2018 2019 Total
Percentage completed 20.71% 53.25% 26.04% 100.00%
(Cost in year/Total cost)
Revenue Recognition $5,177,515 $13,313,609 $6,508,876 $25,000,000
(percentage completed x $25,000,000)
Expense Recognition (given) $3,500,000 $9,000,000 $4,400,000 $16,900,000

Zero-Profit 2017 2018 2019 Total


Revenue Recognition $3,500,000 $9,000,000 $12,500,000 $25,000,000
= expenses in 2017 and 2018
Expense Recognition $3,500,000 $9,000,000 $4,400,000 $16,900,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-19
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
E4-17.
NOTE: Amounts may not be exact due to rounding.
Percentage-of-completion based on percentage of costs
incurred

2016 2017 2018 2019 Total

Estimated Costs $4,000,000 $6,500,000 $8,000,000 $2,500,000 $21,000,000


Percentage of costs
incurred 19.05% 30.95% 38.10% 11.90% 100.00%

Revenue Recognized $5,904,762 $9,595,238 $11,809,524 $3,690,476 $31,000,000

Percentage-of-completion based on engineering


estimates
2016 2017 2018 2019 Total

Percentage completed 12% 38% 40% 10% 100%

Revenue Recognized $3,720,000 $11,780,000 $12,400,000 $3,100,000 $31,000,000

Percentage-of-completion based on hours


worked
2016 2017 2018 2019 Total
Hours worked 10,000 25,000 50,000 18,000 103,000
Percentage of hours
worked 9.71% 24.27% 48.54% 17.48% 100.00%

Revenue Recognized $3,009,709 $7,524,272 $15,048,543 $5,417,476 $31,000,000

The amount of revenue varies significantly with the choice of the method and the company may
have preferences about timing of the income, which would be tied to the objectives of financial
reporting. If Wekusko has used a particular method for similar contracts in the past consistency
would suggest using the same method. If this is the first time a contract of this type has been
undertaken, each of these methods is, in principle, legitimate. It’s difficult to say definitively
which method provides the best indication. Each method provides a different view of the
proportion of the job completed. Disclosure of the method used so stakeholders can
understanding the accounting may be the best that can be asked for.

E4-18.
This question is intended to get students thinking about how the interests of different
stakeholders conflict. The responses below aren’t intended to be comprehensive. Students may
raise other valid points and conflicts not mentioned below. This a good exercise for class
discussion because it helps students understand the existence and conflicts among stakeholders.
It may be too difficult for students to attempt on their own since there is a fair bit of institutional
detail that introductory students may not be aware of. Instructors will be able to identify other
conflicts (for example, politicians, governments, communities, employees) for discussion.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-20
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
a) Leaders of a union want to get a good deal for its members. The deal has to be satisfactory to
the members because if it’s not the members may be less supportive of the union leaders and
they may ultimately lose their jobs. The union leaders will be concerned about the viability
of the company because if the company isn’t viable as a result of the contract the employees
(and union leaders) will lose their jobs. The union leaders aren’t going to be very concerned
about the return the shareholders earn on their investment. Whereas the shareholders will
want a high return the union would be satisfied to take some of the return that would go to
the shareholders to give to the employees. Thus the union and shareholders will fight about
how the “pie” is divided between them.
b) The supplier is concerned about Strathroy’s ability to continue operations therefore it
would use the financial statements to determine how much credit (if any) to extend and to
assess whether the company will continue long enough to make the contract worthwhile. If
Strathroy were to go bankrupt, they would no longer require newsprint supplies and thus the
contract would be worthless. To protect itself, the supplier may require Strathroy to pay on
delivery and may charge a higher price for its supplies to ensure that it receives an adequate
amount of revenue in the event that the contract was terminated due to bankruptcy (thereby
reducing any volume discounts that are available).
c) By paying a bonus based on company performance, the CEO would be motivated to
maximize income to maximize her bonus. The idea of this pay structure is to ensure that
those in charge of the company are motivated to see it succeed. However, many people argue
that this isn’t completely effective as managers may take a short-term view (to try to increase
bonuses in initial periods). This approach will enhance the wealth of the CEO in the short-
term but may not serve the objectives of shareholders, which may be longer term. Therefore
the objectives of the may conflict with shareholder objectives.
d) This situation represents an ethical problem. Investment bankers have been accused
of making positive or overly optimistic reports on companies that they do corporate work for.
The financial analysts’ reports on these companies could be more positive than they might be
if they were more independent and objective. The incentive for the investment banker isn’t to
alienate existing or potential corporate clients (from whom they generate a lot of revenue).
For the analysts the incentive would be to follow the instructions of the employer and
maintain their status in the company (keep their jobs, improve the compensation, etc.). For
prospective shareholders, particularly small retail investors, this relationship between the
reporting companies and the investment bankers could induce them to buy shares they might
otherwise not.
e) The objectives of the family shareholders may be in conflict with the objectives of
other shareholders. The family shareholders may wish to make choices that maximize
income to ensure the value of their shares are maintained and that the family business is able
to carry on. The other investors would want the financial statements to accurately reflect the
underlying economic activity in order to make decisions regarding whether or not they
should continue to invest in the company. The other investors would also use the statements
for stewardship purposes to assess the effectiveness of management.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-21
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
E4-19.
a.
Dr. Cash 410,000
Dr. Loss on sale of land 90,000
Cr. Land 500,000

b.
Dr. Cash 4,000,000
Cr. Land 1,300,000
Cr. Gain on sale of land 2,700,000

c.
Dr. Cash 1,800,000
Cr. Land 1,800,000

E4-20.
Carrying amount of Gain (loss) on sale Selling price of land
land of land
$115,000 $27,000 $142,000
a.
b. 695,000 (85,000) 610,000
c. 250,000 0 250,000
d. 47,000 (15,000) 32,000
e. 258,000 122,000 380,000

E4-21.
a. An arbitrator won’t be biased in favour of any of the parties to the dispute. The arbitrator will
attempt to provide a fair resolution of the issues based on his or her interpretation of the
economic circumstances (facts), applying whatever constraints apply (IFRS/ASPE or the
terms of a contract for example). In some cases, it may be necessary to establish the
parameters for resolving the dispute (no constraints might be specified).

b. In a selling arrangement based on net income the seller has an incentive to overstate net
income to increase the amount the seller will receive. An advisor to the buyer would evaluate
the accounting choices the seller made (the seller prepared the financial statements) to ensure
they are fair to the buyer. When valid alternatives exist the advisor would argue for choices
that result in lower net income. The advisor would check that the statements comply with any
constraints.

c. Advisor to the board of directors of the company: since the board is expected to serve the
interests of the shareholders as well as other stakeholders, the advisor would be expected to
aid them in carrying out oversight of management, and be alert to management manipulation
of accounting numbers to hide the effect of bad decisions. For example, if a strike extends
longer than expected, management may try to hide the real cost. The board’s interests might
John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-22
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
be to evaluate management and/or the performance of the entity so accounting choices that
aid these purposes would be appropriate.

d. The external auditor is approved by the shareholders but usually chosen by management.
Their purpose is to provide reasonable assurance that the financial statements aren’t
materially misleading and to ensure that the financial statements are in accordance with
IFRS/ASPE (usually, although auditors can audit to other standards). This is part of an
auditor’s professional responsibility to protect the interests of the users of the financial
statements. It’s also in an auditor’s interest to do a good job to protect his or her reputation.
For example, one of the concerns of the auditor is to avoid the possibility that the amount of
inventory on the balance sheet is materially overstated either in terms of the value of
individual items or of quantity. Auditors have a professional responsibility to the users of the
financial statements to ensure that the financial statements present the financial position of an
entity fairly. (Note: the description provided here gives the ideal case. However, there is
currently considerable controversy about the relationship between auditors and management
that questions the actual independence of the auditors and whose interests they might be
looking out for. While this point is advanced at this stage in the course some classroom
mention might be appropriate.)

e. The lender wants to make sure that the borrower has the ability to repay the loan and has
collateral that can be sold if the borrower doesn’t pay. This role takes the perspective of a
user of the financial statements, not a preparer, which means that the advisor will be
examining the financial statements prepared by the prospective borrower (the advisor won’t
be dealing with the people preparing the statements). The advisor’s purpose will be to assess
the appropriateness of the financial statements for a specified purpose—determine the credit
worthiness of the prospective borrower and the availability and value of collateral.
Management of the prospective borrower might choose accounting policies that improve the
likelihood of receiving a loan so the statements might have some bias. The advisor to the
lender would have to be alert to this situation.

f. Again this is a user role, although a major shareholder may have some influence on how the
entity does its accounting. The advisor will use the financial statements prepared by
management. The advisor would want to help the shareholder evaluate management and the
performance of the entity. Management might be inclined to choose accounting policies that
“dress up” performance and the advisor would have to be aware of this. A user role requires a
critical look at the financial reporting from the point of view of the user. That means that the
analysts or accountant would critically evaluate choices and present alternatives, when
appropriate, to ensure the meet the interests of the user.

E4-22.
a. Possible critical events would be:
 signing of the contract
 production of the furniture
 delivery of the merchandise
 cash collection
 completion of the contract
John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-23
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
b. Objectives: [For this part of the question the focus is for students to recognize that different
revenue recognition points can serve different purposes of financial reporting. This part of the
question should be analyzed without consideration of accounting rules or “right” answers.
 Tax minimization: the latest possible time, which would be completion of the contract.
Cash collection would be the next best.
 Evaluation of management: To evaluate management, the financial statements should
reflect the accomplishments of management. Revenue should be recognized when
management has achieved its main purposes. If you believe that obtaining the order is the
important management activity, then revenue should be recognized when the contract is
signed. If obtaining the order and producing the product is key, then recognizing revenue
on production would make sense (this could be a good idea here since there is a
guaranteed contract with the store and at this point profitability could be reasonably
measured). If delivery is the key event (not only does the furniture have to be produced,
the customer has to be satisfied—i.e. are returns possible, likely, potentially a problem?),
then recognizing revenue at shipment could make sense.
 For income smoothing, since the deliveries are equal each month, you likely would
recognize revenue at shipment.
 Managed earnings to increase income you would recognize revenue in the period when
the contract is signed (perhaps so management can maximize its bonus or attract
investors. However, there is no way to increase income in every period from this contract.
An increase in one period will decrease income in another (since total revenue from the
contract is the same regardless of when it’s recognized).
 Cash flow prediction could be achieved in different ways. By disclosing the existence and
terms of the contract, users would know the cash that would be coming in over the next
couple of years. To predict future cash flows from the financial statements themselves,
reporting recurring revenue (levels of revenue that are expected to repeat in future) would
make sense.

c. The discussion above is intended to get students thinking about different points in time of
recognizing revenue and when those different points might make sense. This discussion is
provided in the absence of constraints. The revenue recognition criteria represent an IFRS
constraint and severely limit the alternatives. Recognizing revenue on manufactured goods
usually occurs when goods are delivered to a customer (although circumstances can cause
some variation, usually to points later than shipment/delivery, though occasionally earlier).
Application of the criteria:
 Performance has occurred: 1) the rights and risks of ownership transfer on
delivery. Before that time the customer could cancel the order (this would likely result in
legal action), the customer could file for bankruptcy, the furniture could be stolen or
destroyed in Pisquid’s warehouse (for which Pisquid would be responsible), and so on.
The earnings process could be delayed if returns are possible/likely and unpredictable
(for example the buyer may have to be satisfied with the quality and that the
specifications have been met). 2) Control and management of the goods being sold is still
in the hands of the seller until the furniture is delivered therefore delivery would be when
this criteria is met.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-24
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
 Revenue is known at the time the contract is signed since the terms are specified
in the contract.
 Most costs will be known once production is complete. Delivery is likely a small
cost and can be estimated with accuracy.
 Cash collection isn’t likely a problem since the buyer is a chain of retail stores.
However, retail stores do suffer financial distress and if this were the case, collection
might not be assured.

This analysis suggests that delivery is the most likely appropriate time for recognizing
revenue, in the absence of other circumstances.

E4-23.
a. Bedeque is selling two different products when a customer signs up for the three-year
plan – the free phone and the monthly service (usage).

b. There are two ways of recognizing revenue in this scenario option 1) Treat it as a bundled
item and recognize the revenue at the end of every month over the life of the contract. 2)
Separate the phone from the service using the fair value of the service contract and the
fair value of the phone. Recognize the revenue from the phone immediately and the
service portion at the end of every month. Expense the cost of the phone when the related
revenue is recognized.

c.
Totals

Fair Value of Phone Plan


(3 years x 12 months x
$25/month) $ 900

Fair Value of Phone 450

Total Fair value $ 1,350

Total Value of the Contract


(3 years x 12 months x
$35/month) $ 1,260

Totals Per Year Inception Per Month


Option 1 Revenue $ 1,260 $ 420 $ - $ 35

Option 2
Revenue from Phone Plan
($1,260 x $900 / $1,350) $ 840 $ 280 $ - $ 23.33

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-25
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Revenue from Phone
($1,260 x $450 / $1,350) $ 420 - $ 420 -

Total $ 1,260 $ 280 $ 420 $ 23.33

Under option #1 no revenue is recognize when the contract is signed and all revenue is
recognized monthly. Under Option #2 the revenue is proportioned based on the fair values of the
two products, with the revenue from the phone can be recognized at the inception of the contract
and service revenues recognized monthly.

E4-24.
a. Revenue could be recognized:
 at delivery
 when all the payments are complete
 proportionally as each payment is made (instalment method)

b. Objectives satisfied are:

 at delivery
 For increasing income (income maximization) in a period, recognizing revenue on
delivery would be best.
 Cash flow prediction would also probably be served by recognizing revenue at
delivery, although an appropriate allowance for amounts expected not to be
collected would make sense.
 when all the payments are complete
 tax minimization—this is the latest possible time;
 Evaluation of management: If the profit is earned by delivering product, revenue
would be recognized at delivery. However, in this business when is profit earned?
When has management completed its task? For many transactions, a profit would
be recognized initially with the ultimate outcome being a loss if the product
couldn’t be sold after repossession so waiting until all cash is in hand or the
instalment method could make more sense.
 proportionally as each payment is made (instalment method)
 For income smoothing, you would recognize revenue as the payments are
received.

c. The amount of revenue the customer agrees to pay is known when the customer makes his or
her down payment or takes delivery. The amount of revenue that will be realized is another
matter. Default is high and how much each customer pays will be highly variable. The
amount of repossessions is large and quite variable. However, it may be possible to make an
estimate of the likely defaults and losses based on experience, but these estimates could have
significant errors (which undermines the reliability of the financial statements). The cost of
the product will be known before delivery but repairs and losses on repossession won’t.
Again, an allowance could be estimated. Collection of the purchase price is especially
John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-26
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
uncertain in this case. Presumably customers who complete 24 payments are much more
likely to submit the remaining 12, so there could be a decision rule to recognize revenue after
sufficient payments have been collected to cover the cost of the product. The risks and
rewards of ownership of the furniture would transfer on delivery and management would
have little involvement with the furniture once it’s delivered. Management will still have a lot
to do after delivery to make sure the cash keeps coming in.

The most conservative response to the collection uncertainty would be to recognize revenue
when all payments have been received. That would also be the most appropriate timing if
there was inadequate experience to estimate defaults. The earliest point that would be
credible for an established company would be delivery, but that would be fairly difficult to
defend. An approach that recognizes revenue equal expenses in each period until the cost is
covered might make sense so no profit is recognized until it’s realized. This may not be as
simple as it seems since the cost associated with repossessed furniture will be uncertain in
some cases when the cost of the furniture itself is covered.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-27
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
PROBLEMS

P4-1.
a. The possible revenue recognition points are the signing of the contract, the beginning of
construction, the progress stages of the construction (gradually over the life of the contract),
the completion of the project to the satisfaction of the customer, and collection of the cash.
To postpone taxes, you would want to delay recognition of revenue until the next year, even
though you have completed more than half of the project. Of the five criteria, the strongest
argument might be that the costs won’t be fully known until the customer has indicated that
the work is satisfactory. Collectability of the payment may also be somewhat uncertain. The
Income Tax Act allows completed contract accounting on contracts of less than 24 months, so
at a minimum this revenue could be recognized when the contract is complete.

b. The gain on the portfolio could be recognized in the year in which it occurs or when the
shares are sold. To postpone taxes, revenue should be recognized when the shares are sold
and the gain realized. That can be supported based on the fact that the selling prices of the
shares are quite volatile and may very well fall back to, or even below, the original cost. In
other words, the amount earned isn’t known until the sale actually takes place. This treatment
is consistent with the requirements of the Income Tax Act, which only requires that income
from investments be recognized on disposition.

c. Revenue could be recognized when the passes are sold, over the 90 days from when the
passes are sold until they expire, over the 60 days from the initial usage, when the travelers
actually use the passes to ride on the bus, or when they expire. To postpone taxes, revenue
would be recognized as late as possible. The preferred time would be when the pass expires
because this is the latest possible point. While preferable, recognition on expiry has little
merit. In addition, since most of the costs associated with the pass will be expensed as they
are incurred (it will be difficult to match fuel and the cost of the driver, for example, to the
specific pass), deferring recognition until expiry would result in mismatching of expenses
and revenue (which would be good for tax purposes). Probably, the most realistic time would
be evenly over the life of the pass.

d. Revenue could be recognized when the fee is paid, which presumably is in advance, it could
be recognized over the year the payment applies to, or at the completion of the period of
coverage. For minimizing taxes recognizing revenue at the end of the year is best; at the
initiation of the contract is the least attractive. At the end of the term has little merit since
there aren’t any significant uncertainties to justify waiting. Spreading the payment over the
entire year makes sense if it can be tied to the cost of the service provided (as a result of the
fee a lawyer is available at any time and there may be a cost associated with this). Spreading
the payment is more attractive than recognizing the amount at the initiation of the
arrangement.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-28
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
P4-2. The objective in this situation is the recognition of revenue that is most reflective of the
earning cycle and performance of the entity. Some of the situations have revenue recognition
points that are accepted without controversy in practice. The purpose of the question is to get
students thinking about different ways of interpreting the revenue recognition criteria and to
think beyond the world of IFRS to what else might make sense and why. Students should be
encouraged to think broadly in questions like this and they shouldn’t be forced into an IFRS
answer right away.

a. Possible revenue recognition points are the signing of the contract, the beginning of
construction, the progress stages of the construction (gradually over the life of the contract),
the completion of the project to the satisfaction of the customer, and collection of the cash.
To reflect performance it would be most desirable to recognize revenue over the term of the
contract. The company's business is construction and recognizing revenue as work is done
best reflects this. Waiting until the end of the contract would reduce uncertainties (how much
revenue belongs in each period, total costs, etc.), but wouldn’t be more informative for
assessing performance. Students may argue that the signing of the contract is a significant
step in the earnings process but doesn’t indicate their performance in fulfilling the contract.
The option that best satisfies the earning process and performance would be to recognize
revenue using the gradual approach, in this case the percentage-completion method provides
the most relevant information in terms of performance.

b. The gain on the portfolio could be recognized in the year in which it occurs or when the
shares are sold. For assessing performance recognizing the gain when it occurs makes sense.
The purpose of investing in securities is to generate dividends and gains so recognizing the
gains when they occur provides information about the investment decisions of management.
The main drawback to recognizing unrealized gains is that they aren’t realized. There is
some validity to this position (it was GAAP for a long time). If the gain isn’t realized when
it’s recognized it may prove to be fictitious. On the other hand, if the shares were sold then
repurchased is that an economically different situation? Valuing at fair value is appropriate
under IFRS and under ASPE for publicly traded shares.

c. Revenue could be recognized when the passes are sold, over the 60 days from the initial
usage, over the 90 days from when the passes are sold until they expire, when the travelers
actually use the passes to ride on the bus, or when they expire. A case can be made that for
performance evaluation, recognizing revenue when the pass is sold makes sense because it’s
the key step in the earnings process. Once sold money won’t be refunded and the costs of
operating the busses are mainly fixed. Matching would be difficult since the costs would be
incurred after a pass was purchased. This approach isn’t supportable by IFRS or ASPE
because the service hasn’t been provided. Recognizing revenue over the life of the pass with
the passage of time would reflect the service as it’s provided and would match expenses to
revenues (the cost of operating the busses would be recognized when the revenue was
recognized).

d. Revenue could be recognized when the fee is paid, which presumably is in advance; over the
period the client has access to a lawyer; or at the completion of the coverage period. IFRS

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-29
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
could support recognizing the revenue when the fee is paid or over the course they year.
What constitutes success for this type of contract? If it’s simply signing people up and getting
them to pay the fee, recognition at the initiation of the contract makes sense. If there is
uncertainty about whether the law firm can fulfil its obligations to clients (and so the fee
would have to be refunded) then perhaps spreading it over the term of the arrangement would
make sense. A valuable part of this discussion is what constitutes performance (not in an
accounting sense) in this case and then choosing the accounting treatment that best ties into
this.

P4-3.
There are two objectives to consider that of the buyer and the seller of the business. The seller
wants to maximize the income of Canadian Equipment in the fiscal year 2017 to get the highest
possible selling price. The buyers want to minimize income in 2017 to pay the lowest selling
price. The role is an objective third party who is to resolve the disagreement between the buyer
and the seller and should not be influenced by the objectives of either party. Revenue from the
transaction has been recognized on delivery, which was in the fiscal year ended 2017. The
revenue recognition criteria are clearly met in 2017. At this point: 1) The significant risks and
rewards has been transferred from seller to buyer (the customer has the equipment and can use it
as it sees fit). There is some risk remaining with Canadian Equipment because of the standard
warranty, but there doesn’t appear to be anything out of the ordinary with this and therefore the
amount can be estimated. 2) Canadian Equipment no longer has control or management
responsibilities of the good once the customer has accepted delivery. 3) The amount of revenue
can be reasonably measured per the selling price stated. 4) The cost of production and shipping
are also known at the point of delivery, although the cost of the standard warranty may not be
known (although it appears this is a standard warranty for a standard item), and 5) There is no
evidence of collectability problems so it can be assumed that collection is probable. Therefore
Canadian Equipment’s recognition of the revenue on delivery on December 31, 2017 is
consistent with IFRS and ASPE.

Another question is whether this is a fair outcome. The original plan was to deliver the goods in
2018, which would have put the revenue in 2018. The sellers may have accelerated completion
of the sale to increase income in 2017 and increase the amount they would receive from the sale
of the company. While it might have been opportunistic for the sellers to accelerate the
transaction the accounting treatment is appropriate. Also, the circumstances that caused the
transaction to be completed early may have made good business sense. Additional information is
required to assess that aspect.

P4-4.
a.
Two alternative ways of recognizing revenue are as follows:
1) Unbundle the products and recognize the network installation once it’s complete
(delivered installed), training as its provided over the six months on a percentage of
completion basis and service over the five year term on an appropriate percentage of
completion basis.
2) Recognize revenue when the system is sold (at delivery). It would be necessary to accrue
the expenses associated with the training and service.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-30
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Total Value of the Contract $ 2,000,000

Fair Value of Network System $ 1,500,000


Fair Value of training 125,000
Fair value of Services 750,000
Total Fair value $ 2,375,000

Totals Year 1 Year 2 Year 3 Year 4 Year 5


Option 1
Revenue from Network System
($2,000,000 x $1,500,000 / $2,375,000) $ 1,263,158 $ 1,263,158
Revenue from Training
($2,000,000 x $125,000 / $2,375,000) $ 105,263 $ 105,263
Revenue from Services
($2,000,000 x $750,000 / $2,375,000) $ 631,579 $ 126,316 $ 126,316 $ 126,316 $ 126,316 $ 126,316
Total $ 2,000,000 $ 1,494,737 $ 126,316 $ 126,316 $ 126,316 $ 126,316

Option 2 $ 2,000,000 $ 2,000,000 $0 $0 $0 $0

b.
Option 1 – provides for some smoothing since income is deferred from year one. Also provides
for tax deferral of more than $500,000 of income

Option 2 – would serve income maximization.

c.
c.
Support could be found for both methods but unbundling seems best. This is a group of separate
(albeit related products) each of which can be sold separately. There are market values for each
component and the pieces can be purchased separately, which suggests that they represent
independent products to which the revenue recognition criteria could be separately applied. On
the other hand, the sale is being sold as a bundle of closely related, dependent items, so it makes
sense to view the entire package as a single economic event. In this view one could look at
physical delivery at the revenue recognition point with estimates required for the cost of the
training and service. The risks and rewards of ownership transfer on delivery, after which the
seller has little involvement.

d.
The choice depends on the objective. Option 2 is consistent with income maximization. Option 1
provides some smoothing and tax deferral. Given that the fair values of the components are
known Option 1 would be the most relevant since each product is recognized separately and best
reflects the economic reality of the contract. It’s also the only option that is IFRS compliant
given it’s a public company and IFRS would be a constraint that comes before management’s
objective.
John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-31
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
P4-5.
a.
Given that this is a long term contracts two possible options to recognizing the revenue using the
gradual approach are as follows:
1) Recognizing the revenue evenly as time passes or
2) Recognizing the revenue based on the ratio of estimated cost using the percentage-of-
completion method.
Year 1 Year 2 Year 3 Year 4 Total
Option 1 $ 5,000 $ 5,000 $ 5,000 $ 5,000 $ 20,000

Option 2
Year 1 @ 15% $ 3,000.0
Year 2 @ 20% $ 4,000.0
Year 3 @ 30% $ 6,000.0
Year 4 @ 35% $ 7,000.0
$ 3,000 $ 4,000 $ 6,000 $ 7,000 $ 20,000

b.
Option 1 would serve the reporting objective of income smoothing (same amount of revenue
each year) and would support income maximization in the first years of a contract (more revenue
than option two in the first years of the contract).
Option 2 would better reflect performance evaluation as this option better reflects the economic
activity of the contract. It would also defer taxes because less revenue is recognized in the first
years.

c.
If management’s assumption about the incurrence of costs for the contract is valid, option 2
would meet the criteria. Strictly speaking the revenue recognition criteria should reflect the
service required. However, it the assumption is less definitive the straight-line approach would
be acceptable. The criteria and related accounting standards provide considerable latitude for
judgement. The issue for service agreements is being able to estimate the percentage completed
at a point in time. The criteria of collectability and estimation of revenue and expenses are met
for both options.

d.
If both options are justifiable under IFRS, Noggle’s objectives would determine which one to
choose. If the facts clearly dictate that the percentage of completion should be determined
according to the costs incurred each year then Option 2 should be chosen.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-32
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
P4-6.
There are two revenue streams: newsstand sales and subscriptions. For subscriptions revenue
could be recognized upon payment, with the delivery of each issue, or at the end of the
subscription. With each issue the company performs and transfers the risks and rewards of
ownership by providing the magazine. Once delivered management has no control over the
goods. At delivery collection has occurred and the amount of revenue is known as the customer
pays upfront. Expenses are known when each issue is published (although it’s likely that
expenses could be estimated well in advance). Therefore subscription revenue should be
recognized monthly over the life of the subscription as this method best satisfies the revenue
recognition criteria. On payment or initiation of the subscription the company hasn’t performed
—it hasn’t delivered the magazine. At inception of the subscription (and receipt of payment)
revenue and collection are satisfied. Performance hasn’t occurred and costs would be difficult to
estimate. Cancelled subscriptions could be estimated. Recognizing revenue at the end of the
subscription period would be too conservative, although the cost of the entire subscription would
be known.
Newsstand revenue could be recognized on delivery to the newsstand or at the end of the
month when returns are gathered. Since the company is able to estimate returns reasonably well
it could be argued that revenue and costs can be measured. Additionally, since the magazines are
in the possession of the newsstands, risks and rewards have been arguably transferred and
performance has occurred. If the newsstand owners historically pay in a reliable manner then
collection could be considered reasonably assured. If collection is a problem and bad debts not
reasonably estimable, and returns can’t reasonably be estimated, recognizing revenue at the end
of each month would be appropriate.

P4-7.
a. and b.
Revenue Recognition Based on Percentage-of-
Completion
2016 2017 2018 2019 Total
Costs incurred $0 $8,000,000 $4,800,000 $0 $12,800,000
Percentage of
costs incurred 0% 63% 37% 0% 100%
Revenue
Recognized $0 $12,500,000 $7,500,000 $0 $20,000,000
Construction
Costs Expensed $0 $8,000,000 $4,800,000 $0 $12,800,000
Gross Margin $0 $4,500,000 $2,700,000 $0 $7,200,000
Other expenses $1,600,000 $1,600,000 $3,200,000
Net income $0 $2,900,000 $1,100,000 $0 $4,000,000
Gross Margin % 36.00% 36.00% 36.00%
Profit margin % 23.2% 14.67% 20.00%

Revenue Recognition Based on Zero-Profit

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-33
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
2016 2017 2018 2019 Total
Costs incurred $0 $8,000,000 $4,800,000 $0 $12,800,000

Revenue
Recognized $0 $8,000,000 $12,000,000 $0 $20,000,000
Construction
Costs Expensed $0 $8,000,000 $4,800,000 $0 $12,800,000
Gross Margin $0 $0 $7,200,000 $0 $7,200,000
Other expenses $1,600,000 $1,600,000 $3,200,000
Net income $0 ($1,600,000) $5,600,000 $0 $4,000,000
Gross Margin % 0.00% 60.00% 36.00%
Profit margin % -20.00% 46.67% 20.00%

Revenue Recognition Based on Cash Collection


2016 2017 2018 2019 Total
Cash collected $4,000,000 $4,800,000 $8,000,000 $3,200,000 $20,000,000
Percentage
collected 20% 24% 40% 16% 100%
Revenue
Recognized $4,000,000 $4,800,000 $8,000,000 $3,200,000 $20,000,000
Construction
Costs Expensed $2,560,000 $3,072,000 $5,120,000 $2,048,000 $12,800,000
Gross Margin $1,440,000 $1,728,000 $2,880,000 $1,152,000 $7,200,000
Other expenses $1,600,000 $1,600,000 $3,200,000
Net income $1,440,000 $128,000 $1,280,000 $1,152,000 $4,000,000
Gross Margin % 36.00% 36.00% 36.00% 36.00% 36.00%
Profit margin % 36.00% 2.67% 16.00% 36.00% 20.00%

c. It may matter a great deal how Tidnish accounts for its revenue, depending on who will use
the financial statements and for what purpose. Obviously the earlier the income is
recognized, the earlier the income taxes will need to be paid. Assessment of the profitability
of the company or evaluation of management performance will be distorted with method
other than percentage-of-completion. In other words, financial statements have economic
consequences for stakeholders and how an entity accounts for its revenues can change the
consequences. Bonuses, taxes, other contracts, etc. may be affected by accounting choices.

d. No, the choice of revenue recognition method doesn’t affect the actual economic
performance of the firm. As explained in c. accounting has economic consequences.
Accounting is a representation or mapping of an entity’s economic activity. Changing the
accounting doesn’t affect the activity or performance of the entity, just how that activity or
performance is reported. There are secondary effects on performance in that how accounting
is done may affect the amount of tax the entity pays, the bonus managers receive, etc. and
payments for income taxes will also affect cash flows. Individual stakeholders may interpret

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-34
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
the information in the financial statements differently depending on how it’s presented, but
the underlying economic reality isn’t affected.
P4-8.
a. and b.

Revenue Recognition Based on Percentage-of-Completion


2017 2018 2019 2020 Total

Costs incurred $0 $21,000,000 $12,600,000 $0 $33,600,000

Percentage of costs incurred 0% 63% 38% 0% 100%

Revenue Recognized $0 $32,812,500 $19,687,500 $0 $52,500,000

Construction Costs Expensed $0 $21,000,000 $12,600,000 $0 $33,600,000

Gross Margin $0 $11,812,500 $7,087,500 $0 $18,900,000

Other expenses $4,200,000 $4,200,000 $8,400,000


Net income $0 $7,612,500 $2,887,500 $0 $10,500,000

Gross Margin % 36.00% 36.00% 36.00%

Profit margin % 23.20% 14.67% 20.00%

Revenue Recognition Based on Zero-Profit


2017 2018 2019 2020 Total

Costs incurred $0 $21,000,000 $12,600,000 $0 $33,600,000

Revenue Recognized $0 $21,000,000 $31,500,000 $0 $52,500,000

Construction Costs Expensed $0 $21,000,000 $12,600,000 $0 $33,600,000

Gross Margin $0 $0 $18,900,000 $0 $18,900,000

Other expenses $4,200,000 $4,200,000 $8,400,000


Net income $0 ($4,200,000) $14,700,000 $0 $10,500,000

Gross Margin % 0.00% 60.00% 36.00%

Profit margin % -20.00% 46.67% 20.00%

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-35
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Revenue Recognition Based on Cash Collection
2017 2018 2019 2020 Total

Cash collected $10,500,000 $13,300,000 $21,000,000 $7,700,000 $52,500,000

Percentage collected 20% 25% 40% 15% 100%

Revenue Recognized $10,500,000 $13,300,000 $21,000,000 $7,700,000 $52,500,000

Construction Costs Expensed $6,720,000 $8,512,000 $13,440,000 $4,928,000 $33,600,000


Gross Margin $3,780,000 $4,788,000 $7,560,000 $2,772,000 $18,900,000

Other expenses $4,200,000 $4,200,000 $2,800,000

Net income $3,780,000 $588,000 $3,360,000 $2,772,000 $10,500,000


Gross Margin % 36.00% 36.00% 36.00% 36.00% 36.00%

Profit margin % 36.00% 4.42% 16.00% 36.00% 20.00%

c. It may matter a great deal how Thorsby accounts for its revenue, depending on who will use
the financial statements and for what purpose. Obviously the earlier the income is
recognized, the earlier the income taxes will need to be paid. Assessment of the profitability
of the company or evaluation of management performance will be distorted with method
other than percentage-of-completion. In other words, financial statements have economic
consequences for stakeholders and how an entity accounts for its revenues can change the
consequences. Bonuses, taxes, other contracts, etc. may be affected by accounting choices.

d. No, the choice of revenue recognition method doesn’t affect the actual economic
performance of the firm. As explained in c. accounting has economic consequences.
Accounting is a representation or mapping of an entity’s economic activity. Changing the
accounting doesn’t affect the activity or performance of the entity, just how that activity or
performance is reported. There are secondary effects on performance in that how accounting
is done may affect the amount of tax the entity pays, the bonus managers receive, etc. and
payments for income taxes will also affect cash flows. Individual stakeholders may interpret
the information in the financial statements differently depending on how it’s presented, but
the underlying economic reality isn’t affected.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-36
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
P4-9.
a.
i) Revenue recognized on Production
Assets (=) Liabilities (+) Shareholder Equity
Expenses
Accounts Prepaid Accounts Interest Long-term
Trans Cash Receivable Inventory Rent Payable Payable Note C/S R/E Revenue Cost of Sales Rent Other Interest
Beg
i) 1,000,000 i) i) 1,000,000
ii) 500,000 ii) 500,000 ii)
ii) ii) 50,000 ii) (50,000)
iii) (400,000) 400,000 iii) iii)
iii) (200,000) iii) iii) (200,000)
v) 2,800,000 v) v) 2,800,000
v) (1,680,000) v) v) (1,680,000)
v) 1,050,000 (1,050,000) v) v)
vi) 1,680,000 vi) 1,680,000 vi)
vi) (1,520,000) vi) (1,520,000) vi)
vii) vii) 420,000 vii) (420,000)
vii) (350,000) vii) (350,000) vii)
End 280,000 1,750,000 0 200,000 230,000 50,000 500,000 1,000,000 0 2,800,000 (1,680,000) (200,000) (420,000) (50,000)

Closing Entries 450,000 (2,800,000) 1,680,000 200,000 420,000 50,000


2,230,000 2,230,000 Ending Balance 1,000,000 450,000 0 0 0 0 0
*Note: Cost of sales equals 60% of sales.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-37
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
ii) Revenue recognized on delivery
Assets (=) Liabilities (+) Shareholder Equity
Expenses
Accounts Prepaid Accounts Interest Long-term
Trans Cash Receivable Inventory Rent Payable Payable Note C/S R/E Revenue Cost of Sales Rent Other Interest
Beg
i) 1,000,000 i) i) 1,000,000
ii) 500,000 ii) 500,000 ii)
ii) ii) 50,000 ii) (50,000)
iii) (400,000) 400,000 iii) iii)
iii) (200,000) iii) iii) (200,000)
v) 1,800,000 v) v) 1,800,000
v) (1,080,000) v) v) (1,080,000)
v) 1,050,000 (1,050,000) v) v)
vi) 1,680,000 vi) 1,680,000 vi)
vi) (1,520,000) vi) (1,520,000) vi)
vii) vii) 420,000 vii) (420,000)
vii) (350,000) vii) (350,000) vii)
End 280,000 750,000 600,000 200,000 230,000 50,000 500,000 1,000,000 0 1,800,000 (1,080,000) (200,000) (420,000) (50,000)

Closing Entries 50,000 (1,800,000) 1,080,000 200,000 420,000 50,000


1,830,000 1,830,000 Ending Balance 1,000,000 50,000 0 0 0 0 0

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-38
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
iii) Revenue recognized on cash collection
Assets (=) Liabilities (+) Shareholder Equity
Expenses
Accounts Prepaid Accounts Interest Long-term
Trans Cash Receivable Inventory Rent Payable Payable Note C/S R/E Revenue Cost of Sales Rent Other Interest
Beg
i) 1,000,000 i) i) 1,000,000
ii) 500,000 ii) 500,000 ii)
ii) ii) 50,000 ii) (50,000)
iii) (400,000) 400,000 iii) iii)
iii) (200,000) iii) iii) (200,000)
v) 1,050,000 v) v) 1,050,000
v) (630,000) v) v) (630,000)
v) 1,050,000 (1,050,000) v) v)
vi) 1,680,000 vi) 1,680,000 vi)
vi) (1,520,000) vi) (1,520,000) vi)
vii) vii) 420,000 vii) (420,000)
vii) (350,000) vii) (350,000) vii)
End 280,000 0 1,050,000 200,000 230,000 50,000 500,000 1,000,000 0 1,050,000 (630,000) (200,000) (420,000) (50,000)

Closing Entries (250,000) (1,050,000) 630,000 200,000 420,000 50,000


1,530,000 1,530,000 Ending Balance 1,000,000 250,000 0 0 0 0 0

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-39
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
b. Financial Statements based on revenue recognized at production:

Antler Manufacturing Ltd.


Balance Sheet
As of December 31, 2017

Assets Liabilities and Shareholders’ Equity


Current Assets: Current Liabilities
Cash $280,000 Accounts payable $230,000
Accounts receivable 1,750,000 Interest payable 50,000
Inventory - Total Current Liabilities 280,000
Prepaid assets 200,000 Long-term debt 500,000
Total Liabilities 780,000
Total current assets 2,230,000 Shareholders’ Equity
Capital stock 1,000,000
Retained earnings 450,000
Total Assets $2,230,000 Total Liabilities and Shareholders’ Equity $2,230,000

Antler Manufacturing Ltd.

Income Statement
For the year Ended December 31, 2017

Sales $2,800,000
Cost of Sales 1,680,000
Gross margin 1,120,000
Expenses:
Rent $200,000
Other 420,000
Interest 50,000
Total Expenses 670,000
Net Income $450,000

Antler Manufacturing Ltd.


Statement of Retained Earnings
For the year Ended December 31, 2017
R/E at beginning $-
Net Income 450,000
Less Dividends -
R/E at end $450,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-40
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Financial Statements based on revenue recognized at delivery:

Antler Manufacturing Ltd.


Balance Sheet
As of December 31, 2017

Assets Liabilities and Shareholders’ Equity


Current Assets: Current Liabilities
Cash $280,000 Accounts payable $230,000
Accounts receivable 750,000 Interest payable 50,000
Inventory 600,000 Total Current Liabilities 280,000
Prepaid assets 200,000 Long-term debt 500,000
Total Liabilities 780,000
Total current assets 1,830,000 Shareholders’ Equity
Capital stock 1,000,000
Retained earnings 50,000
Total Assets $1,830,000 Total Liabilities and Shareholders’ Equity $1,830,000

Antler Manufacturing Ltd.

Income Statement
For the year Ended December 31, 2017

Sales $1,800,000
Cost of Sales 1,080,000
Gross margin 720,000
Expenses:
Rent 200,000
Other 420,000
Interest 50,000
Total Expenses 670,000
Net Income $50,000

Antler Manufacturing Ltd.


Statement of Retained Earnings
For the year Ended December 31, 2017
R/E at beginning $-
Net Income 50,000
Less Dividends -

R/E at end $50,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-41
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Financial Statements based on revenue recognized at time of collection:

Antler Manufacturing Ltd.

Balance Sheet
As of December 31, 2017

Assets Liabilities and Shareholders’ Equity


Current Assets: Current Liabilities
Cash $280,000 Accounts payable $230,000
Accounts receivable - Interest payable 50,000
Inventory 1,050,000 Total Current Liabilities 280,000
Prepaid assets 200,000 Long-term debt 500,000
Total Liabilities 780,000
Total current assets 1,530,000 Shareholders’ Equity
Capital stock 1,000,000
Retained earnings (250,000)
Total Assets $1,530,000 Total Liabilities and Shareholders’ Equity $1,530,000

Antler Manufacturing Ltd.

Income Statement
For the year Ended December 31, 2017

Sales $1,050,000
Cost of Sales 630,000
Gross margin 420,000
Expenses:
Rent $200,000
Other 420,000
Interest 50,000
Total Expenses 670,000
Net Income $(250,000)

Antler Manufacturing Ltd.


Statement of Retained Earnings
For the year Ended December 31, 2017
R/E at beginning $-
Net Income (250,000)
Less Dividends -
R/E at end $(250,000)

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-42
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
c.

Production Delivery Collection


Revenue $2,800,000 $1,800,000 $1,050,000
Cost of Sales 1,680,000 1,080,000 630,000
Gross Margin 1,120,000 720,000 420,000
Other Expenses 670,000 670,000 670,000
Net Income 450,000 50,000 (250,000)
Gross Margin % 40.00% 40.00% 40.00%
Profit Margin % 16.07% 2.78% -23.81%

Current Assets 2,230,000 1,830,000 1,530,000


Current Liabilities280,000 280,000 280,000
Current Ratio 7.96 6.53 5.46

Total Liabilities 780,000 780,000 780,000


Total Equity 1,450,000 1,050,000 750,000
Debt to Equity 0.54 0.74 1.04

d. It’s difficult to conclusively say which measure of performance is best without first defining
what constitutes success in this business. The guaranteed contracts may indicate that once the
product is produced the company has done pretty much all of what it has to do so
performance is best measured at production. Other interpretations are possible. The
production and delivery methods provide more information about future cash flows than does
the collection basis, and are therefore better indicators of liquidity. However, recognize that
the actual liquidity of the company isn’t affected by how liquidity is measured. It’s also
necessary to consider the decisions stakeholders are making when considering how to
measure economic events.

e. It may matter a great deal how Antler accounts for its revenue, depending on who will use the
financial statements and for what purpose. Obviously the earlier the income is recognized,
the earlier the income taxes will need to be paid. Assessment of the profitability of the
company or evaluation of management performance will be distorted with method other than
percentage-of-completion. In other words, financial statements have economic consequences
for stakeholders and how an entity accounts for its revenues can change the consequences.
Bonuses, taxes, other contracts, etc. may be affected by accounting choices.

f. No, the choice of revenue recognition method doesn’t affect the actual economic
performance of the firm. As explained in c. accounting has economic consequences.
Accounting is a representation or mapping of an entity’s economic activity. Changing the
accounting doesn’t affect the activity or performance of the entity, just how that activity or
performance is reported. There are secondary effects on performance in that how accounting
is done may affect the amount of tax the entity pays, the bonus managers receive, etc. and
payments for income taxes will also affect cash flows. Individual stakeholders may interpret
the information in the financial statements differently depending on how it’s presented, but
the underlying economic reality isn’t affected.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-43
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
P4-10.

(i) Recognize revenue when goods are produced


Assets (=) Liabilities (+) Shareholder Equity
Accounts Prepaid Accounts Interest Long-term Expenses
Trans Cash Receivable Inventory Rent Payable Payable Note C/S R/E Sales Cost of Sales Rent Other Interest
Beg
i) 200,000 i) i) 200,000
ii) 400,000 ii) 400,000 ii)
ii) ii) 40,000 ii) (40,000)
iii) (150,000) 150,000 iii) iii)
iii) (75,000) iii) iii) (75,000)
v) 1,300,000 v) v) 1,300,000
v) (650,000) v) v) (650,000)
v) 460,000 (460,000) v) v)
vi) 650,000 vi) 650,000 vi)
vi) (580,000) vi) (580,000) vi)
vii) vii) 190,000 vii) (190,000)
vii) (160,000) vii) (160,000) vii)
End 170,000 840,000 0 75,000 100,000 40,000 400,000 200,000 0 1,300,000 (650,000) (75,000) (190,000) (40,000)

Closing Entries 345,000 (1,300,000) 650,000 75,000 190,000 40,000


1,085,000 1,085,000 End Balance 200,000 345,000 0 0 0 0 0

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-44
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
(ii) Recognize revenue when merchandise is delivered to customers
Assets (=) Liabilities (+) Shareholder Equity
Accounts Prepaid Accounts Interest Long-term Expenses
Trans Cash Receivable Inventory Rent Payable Payable Note C/S R/E Sales Cost of Sales Rent Other Interest
Beg
i) 200,000 i) i) 200,000
ii) 400,000 ii) 400,000 ii)
ii) ii) 40,000 ii) (40,000)
iii) (150,000) 150,000 iii) iii)
iii) (75,000) iii) iii) (75,000)
v) 800,000 v) v) 800,000
v) (400,000) v) v) (400,000)
v) 460,000 (460,000) v) v)
vi) 650,000 vi) 650,000 vi)
vi) (580,000) vi) (580,000) vi)
vii) vii) 190,000 vii) (190,000)
vii) (160,000) vii) (160,000) vii)
End 170,000 340,000 250,000 75,000 100,000 40,000 400,000 200,000 0 800,000 (400,000) (75,000) (190,000) (40,000)

Closing Entries 95,000 (800,000) 400,000 75,000 190,000 40,000


835,000 835,000 End Balance 200,000 95,000 0 0 0 0 0

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-45
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
(iii) Recognize revenue when cash is collected
Assets (=) Liabilities (+) Shareholder Equity
Accounts Prepaid Accounts Interest Long-term Expenses
Trans Cash Receivable Inventory Rent Payable Payable Note C/S R/E Sales Cost of Sales Rent Other Interest
Beg
i) 200,000 i) i) 200,000
ii) 400,000 ii) 400,000 ii)
ii) ii) 40,000 ii) (40,000)
iii) (150,000) 150,000 iii) iii)
iii) (75,000) iii) iii) (75,000)
v) 460,000 v) v) 460,000
v) (230,000) v) v) (230,000)
v) v) v)
vi) 650,000 vi) 650,000 vi)
vi) (580,000) vi) (580,000) vi)
vii) vii) 190,000 vii) (190,000)
vii) (160,000) vii) (160,000) vii)
End 170,000 0 420,000 75,000 100,000 40,000 400,000 200,000 0 460,000 (230,000) (75,000) (190,000) (40,000)

Closing Entries (75,000) (460,000) 230,000 75,000 190,000 40,000


665,000 665,000 End Balance 200,000 (75,000) 0 0 0 0 0

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-46
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Financial Statements based on revenue recognized at production:
Kinkora Manufacturing Ltd.
Balance Sheet
As of December 31, 2018

Assets Liabilities and Shareholders’ Equity


Current Assets: Current Liabilities
Cash 170,000 Accounts payable 100,000
Accounts receivable 840,000 Interest payable 40,000
Inventory - Total Current Liabilities 140,000
Prepaid assets 75,000 Long-term debt 400,000
Total Liabilities 540,000
Total current assets 1,085,000 Shareholders’ Equity
Capital stock 200,000
Retained earnings 345,000
Total Assets 1,085,000 Total Liabilities and Shareholders’ Equity 1,085,000

Kinkora Manufacturing Ltd.

Income Statement
For the year Ended December 31, 2018

Sales 1,300,000
Cost of Sales 650,000
Gross margin 650,000
Expenses:
Rent 75,000
Other 190,000
Interest 40,000
Total Expenses 305,000
Net Income 345,000

R/E at beginning -
Net Income 345,000
Less Dividends -
R/E at end 345,000

Financial Statements based on revenue recognized at delivery:


John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-47
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Kinkora Manufacturing Ltd.
Balance Sheet
As of December 31, 2018

Assets Liabilities and Shareholders’ Equity


Current Assets: Current Liabilities
Cash 170,000 Accounts payable 100,000
Accounts receivable 340,000 Interest payable 40,000
Inventory 250,000 Total Current Liabilities 140,000
Prepaid assets 75,000 Long-term debt 400,000
Total Liabilities 540,000
Total current assets 835,000 Shareholders’ Equity
Capital stock 200,000
Retained earnings 95,000
Total Assets 835,000 Total Liabilities and Shareholders’ Equity 835,000

Kinkora Manufacturing Ltd.

Income Statement
For the year Ended December 31, 2018

Sales 800,000
Cost of Sales 400,000
Gross margin 400,000
Expenses:
Rent 75,000
Other 190,000
Interest 40,000
Total Expenses 305,000
Net Income 95,000

R/E at beginning -
Net Income 95,000
Less Dividends -
R/E at end 95,000

Financial statements based on revenue recognized at cash collection:


Kinkora Manufacturing Ltd.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-48
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Balance Sheet
As of December 31, 2018

Assets Liabilities and Shareholders’ Equity


Current Assets: Current Liabilities
Cash 170,000 Accounts payable 100,000
Accounts receivable 0 Interest payable 40,000
Inventory 420,000 Total Current Liabilities 140,000
Prepaid assets 75,000 Long-term debt 400,000
Total Liabilities 540,000
Total current assets 665,000 Shareholders’ Equity
Capital stock 200,000
Retained earnings (75,000)
Total Assets 665,000 Total Liabilities and Shareholders’ Equity 665,000

Kinkora Manufacturing Ltd.

Income Statement
For the year Ended December 31, 2018

Sales 460,000
Cost of Sales 230,000
Gross margin 230,000
Expenses:
Rent 75,000
Other 190,000
Interest 40,000
Total Expenses 305,000
Net Income (75,000)

R/E at beginning -
Net Income (75,000)
Less Dividends -
R/E at end (75,000)

c.
Production Delivery Collection
Revenue 1,300,000 800,000 460,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-49
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Cost of Sales 650,000 400,000 230,000
Gross Margin 650,000 400,000 230,000
Other Expenses 305,000 305,000 305,000
Net Income 345,000 95,000 (75,000)
Gross Margin % 50.00% 50.00% 50.00%
Profit Margin % 26.54% 11.88% -16.30%

Current Assets 1,085,000 835,000 665,000


Current Liabilities 140,000 140,000 140,000
Current Ratio 7.75 5.96 4.75

Total Liabilities 540,000 540,000 540,000


Total Equity 545,000 295,000 125,000
Debt to Equity 0.99 1.83 4.32

d. It’s difficult to conclusively say which measure of performance is best without first defining
what constitutes success in this business. The guaranteed contract may indicate that once
ovens are produced the company has done pretty much all of what it has to do so
performance is best measured at production. Other interpretations are possible. The
production and delivery methods provide more information about future cash flows than does
the collection basis, and are therefore better indicators of liquidity. However, recognize that
the actual liquidity of the company isn’t affected by how liquidity is measured. It’s also
necessary to consider the decisions stakeholders are making when considering how to
measure economic events.

e. It may matter a great deal how Kinkora accounts for its revenue, depending on who will use
the financial statements and for what purpose. Obviously the earlier the income is
recognized, the earlier the income taxes will need to be paid. Assessment of the profitability
of the company or evaluation of management performance will be distorted with method
other than percentage-of-completion. In other words, financial statements have economic
consequences for stakeholders and how an entity accounts for its revenues can change the
consequences. Bonuses, taxes, other contracts, etc. may be affected by accounting choices.

f No, the choice of revenue recognition method doesn’t affect the actual economic
performance of the firm. As explained in c. accounting has economic consequences.
Accounting is a representation or mapping of an entity’s economic activity. Changing the
accounting doesn’t affect the activity or performance of the entity, just how that activity or
performance is reported. There are secondary effects on performance in that how accounting
is done may affect the amount of tax the entity pays, the bonus managers receive, etc. and
payments for income taxes will also affect cash flows. Individual stakeholders may interpret
the information in the financial statements differently depending on how it’s presented, but
the underlying economic reality isn’t affected.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-50
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
P4-11.
Revenue can be recognized in a bill and hold arrangement if all conditions of the sale have been
met except for delivery, and the terms of delivery have been specified. In evaluating or taking up
this question emphasis should be placed on students’ ability to interpret the terms of the
transaction and to apply the revenue recognition criteria. It’s not intended that students become
intimately familiar the specifics of bill and hold accounting but that they understand that
different business arrangements can result in different accounting treatments.
a) The terms of this arrangement suggest that Wandby can recognize the revenue in fiscal
2017. The rights and risks of ownership have for the most part been transferred because
the customer is fully committed to purchase the furniture based on the contractual terms
and confirmation of acceptance of the goods by the customer. The customer clearly plans
on accepting the goods and the delay in shipping is simply a logistical matter that is
resolved by Wandby keeping the merchandise for a short period of time. Other facts that
support the early recognition under the bill and hold agreement include the segregation of
the inventory that is labelled and assigned to the specific customer.
b) Situation b) is quite different from Situation a). In b) the customer isn’t committed to buy
the merchandise and the price is determined by the market price when the goods are
actually purchased. As a result the risks and rewards of ownership haven’t transferred
since changes in demand for the customer’s products, changes in price, or for any other
reason the customer could decide not to order. It isn’t, therefore, appropriate to recognize
the revenue in fiscal 2017. It would be more appropriate to recognize the revenue when
(if?) the furniture is delivered to the customer.
c) This isn’t a bill and hold arrangement. The customer has placed an order but the
merchandise hasn’t been produced. A bill and hold arrangement requires that everything
regarding the sale is complete, except for delivery. In this case only an order has been
made. Revenue should be recognized when the order is delivered, provided all the
revenue recognition criteria are met at that point.

P4-12.
(NOTE: For this question students aren’t expected to know what IFRS or ASPE require. They
should apply the revenue recognition criteria to the facts to develop a reasonable solution to the
situation.) This is consignment sale. The owners of the clothing have an arrangement with Wear
It Again Sam to act as a sales agent. Although Wear It Again has to care, store and sell the goods
it has no responsibility for items that don’t sell and can return the articles back to the owner.
Therefore the risk and rewards of ownership haven’t changed hands even though control and
management has. The clothing remains property of the owners until they are sold, thus
performance hasn’t occurred until the items are sold to a third party. Therefore Wear It Again
Sam shouldn’t recognize the revenue until an article is sold. At this time risk and rewards are
transferred, Wear It Again Sam no longer retains management of the goods, revenue and cost are
known and collection has been made. Wear It Again Sam should recognize its 50 percent share of
the amount received, not the full amount.

Wear It Again Sam should include in revenue cash received for clothing items sold but not
collected. If the arrangement with customers requires collection by a certain date then amounts
not collected after the date should be taken into revenue. If no time period is specified then a

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-51
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
basis for estimating the amount that won’t be collected is required. Amounts owing should be
recorded as a payable on the balance sheet.

P4-13.
(NOTE: For this question students aren`t expected to know what IFRS or ASPE require. They
should apply the revenue recognition criteria to the facts to develop a reasonable solution to the
situation.) Possible times to recognize revenue are when customers make the down payment or
when the full amount is paid and delivery occurs. There is no contract so the jeweller has no
recourse for obtaining amounts owing. When the jeweler accepts cash it isn’t providing
merchandise so risks and rewards haven’t shifted to the buyer. On the other hand the jeweler has
set aside the merchandise for the customer. There are uncertainties about collection but the extent
to which people don’t fulfill their obligations can be estimated. Key is actual delivery, which
occurs when payment is received in full. If 180 days pass and the customer doesn’t pay then the
dealer can recognize the down payment as revenue. Before this time performance hasn’t
occurred and the down payment is unearned revenue. If IFRS/ASPE isn’t a constraint an
argument could be made to recognize the down payment as revenue because Fair can keep the
money if the customer doesn’t complete the purchase. It would be difficult to match costs to this
revenue (because the inventory may never actually be transferred to the customer) but that might
not matter if IFRS/ASPE isn’t a constraint.

P4-14.
(NOTE: For this question students aren`t expected to know what IFRS or ASPE require. They
should apply the revenue recognition criteria to the facts to develop a reasonable solution to the
situation.) Normally Molanosa would recognize the revenue when the goods are delivered. This
deal is different than the normal type of arrangements Molanosa makes with its customers
because the customer has the right to return any and all goods up until March 1. When the
revenue on this sale is recognized is important because it appears to increase net income above
the threshold for the $100,000 bonus. The key question is whether the risks and rewards of
ownership transfer on delivery or at a later date (after March 1, 2018). Molanosa bears
considerable risk because it’s responsible for any and all items the customer chooses to return.
This problem can be addressed if the amount that will be returned could be estimated, but this
may be problematic with a new customer in a new market. Also important is that this is an
unusual arrangement. The transaction is on terms not given to other customers so using the same
basis of revenue recognition may not be appropriate. The fact that the buyer has negotiated this
agreement shows that it isn’t sure if they can sell the goods. After March 1 all the uncertainty
about the amount that will actual be sold is resolved and recognition can take place. As a result
of the uncertainty about the quantity that will be returned, the amount of revenue, the cost of the
goods sold, and the amount of cash that will be collected in uncertain. If IFRS/ASPE isn’t a
constraint then recognition could occur earlier, perhaps when the goods are shipped, since that
has been the customary time for recognizing revenue and is the point where control of the goods
has been transferred from the seller to the buyer.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-52
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
P4-15.
(NOTE: For this question students aren`t expected to know what IFRS or ASPE require. They
should apply the revenue recognition criteria to the facts to develop a reasonable solution to the
situation.)
a) The most obvious user of Duthil’s financial statements is the public shareholders, who will
use the statements for stewardship, performance evaluation, and prediction purposes. The
35% shareholder could be a user (particularly if he has some kind of bonus plan) although
he wouldn’t need the statements to find out what was going on, since he manages the
company. No information is given that there is a bonus plan though. CRA would be a user
to check for compliance with the Income Tax Act. Lenders could be users if there are loans
outstanding of if borrowing will be needed in the future.
b) Objectives could include income smoothing or income maximization for the benefit of
public shareholders or tax (income) minimization. With a smoothing or income increasing
objectives management might try to show that management is doing a good job or to
provide satisfactory accounting measures of return. Tax minimization conserves cash in the
entity and is in conflict with income maximization efforts.
c) Different rankings are possible depending on students’ interpretation of the facts. Students
should be rewarded based on the quality of the support for their rankings, not the ranking
itself. For example, the CEO and major shareholder might want to emphasize income
maximization or income smoothing to maintain the value of his shares in the company.
d) There are two possible treatments for the campaign costs: expense or capitalize. To justify
capitalizing the costs it’s necessary to argue that the amount meet the definition of an asset,
in particular in this case that there is future benefit. The future benefit would be that the
costs will contribute to revenue generation in future periods. This is a reasonable argument
because of the subscription revenue that will be earned in 2018 (and possibly beyond). If
the costs are capitalized there is the question of how to amortize them.

Expensing the cost would satisfy the tax minimization objective. Capitalizing and
amortizing the cost on some basis would increase income in 2017 (or 2018 if they were not
fully expensed in that year), which would help the income smoothing/income
maximization objective. For tax purposes the ideal treatment would be to expense the full
amount in 2017 (and this may be allowable for tax purposes). From a financial reporting
standpoint there isn’t strong support for expensing in 2017. The subscriptions come into
effect in 2018 and the amount of revenue in that year alone exceeds the cost of finding the
new subscribers. Thus matching would argue for expensing commencing in 2018. Then the
question is whether the $66,000 should be expensed in full in 2018 or whether some of the
expense should be deferred. Management believes that 50% of the subscribers will renew
their subscriptions for 2019 and then 75% of those will renew each year from 2020 on. A
question is whether there is some support for this expectation. If the expectation can be
relied on it would be reasonable to expense only part of the amount in 2018 and the rest
beyond. If there is little support for management’s expectation then expensing in full in
2018 might be more appropriate. Thus a possible treatment would be to expense two-thirds
of the amount in 2018 ($44,000) and the remainder in 2019 ($22,000). This treatment
recognizes that the development of the subscription likely has a life of more than one year
but recognizes the difficulty in determining the amount and existence of revenues in years

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Copyright © 2013 McGraw-Hill Ryerson Ltd.
beyond 2019. Students can propose different ways of spreading the cost over time. The key
is that students provide a reasonable rationale for their proposed treatment.

P4-16.
a. There are a number of possible objectives some of which are as follows:
 Performance evaluation—The owners would probably be interested in assessing the
performance of their investment, especially since they aren’t involved in day-to-day
management of the company. Bankers may also be interested in performance evaluation.
 Stewardship—The non-managing owners have entrusted senior management with their
investment. They would want information about how the company is being managed.
 Income maximization: As the mine wouldn’t have shown a profit yet, management may
wish to show a large net income to reassure investors. Income maximization would also
benefit the company if they were seeking financing or additional investment.
 Income smoothing: Rather than maximizing income this year (and potentially reducing it
in subsequent years), management may wish to show investors that the mine is steadily
performing and is stable.

b. There are a number of possible rankings. The key is providing some support for the choice.
The support for the ranking should be based on the information provided in the question and
assumptions about the relative importance of the objectives. For example, an argument for
ranking performance evaluation first could be made by explaining that because owners aren’t
involved in the daily operations they would want information presented in a way that would
allow them to assess how the business was doing. For the same reason, stewardship would be
important. Income maximization would be important for senior management if they had
bonuses tied to performance or were concerned that investors may react poorly if income
were low or if the company was hoping to find additional investors or obtain financing (or
maintain certain income levels as required by existing financing covenants). Income
smoothing could be important as the company may wish to present the mine as a stable and
profitable investment (if additional investment is required from existing shareholders, new
shareholders, or lenders. Since the company spent the initial investment finding new
investment may be important).

c. Revenue could be recognized at the time of extracting the ore, once the metal is refined, once
the metal is delivered to the final customer, or once payment is received. Upon extraction
costs and revenues can be estimated (expenses associated with extraction would be known,
expenses for refining could likely be estimated easily; revenues would be known from the
contracts and widely available commodity prices and since the metal is a commodity is can
be assumed that finding a buyer wouldn’t be difficult). The exact amount of refined metal
from the ore may be somewhat difficult to estimate. The most realistic alternatives once
Notigi has the refined metal available to it to sell and delivery to customers. Cash collection
should be considered if collection is an issue.

Risk and rewards of ownership and management control don’t transfer until product is
delivered to customers. However it could be argued that because of the nature of the product
(a commodity) the revenue is earned once the refined metal is in hand, especially for metal
that is sold in advance under contract. (For metal not sold under contract waiting until

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-54
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
delivery might be appropriate since the exact amount of revenue won’t be known.
Furthermore, collection is a grey area – it’s unlikely that company’s purchasing large
quantities of metal will default on their payments, but as Notigi is a new company there is a
risk that they could extend credit to customers inappropriately.

IFRS isn’t listed as a constraint in this case, but due to the high costs involved with mining
and the professional nature of the owners following IFRS may be required. If IFRS isn’t a
constraint then recognizing revenue at extraction could provide useful information for
stakeholders provided the amount of refined metal could be reasonably estimated. These
options would help to maximize income as revenue could be recognized sooner.

Performance evaluation is likely served by recognizing revenue once the metal is refined
because delivery/sale is a minor step for a commodity. Stewardship is also served by
recognition on refining the metal. Tax minimization requires delay so recognition of delivery
would be preferred.

P4-17.
a. Possible objectives include:
 Tax minimization—As a closely held private company, minimizing taxes is an important
consideration. The absentee owners may be able to get additional information from Alex
and Evan and so the statements can be used for tax purposes.
 Performance evaluation—The cousins would probably be interested in assessing the
performance of their investment, especially those who aren’t involved in day-to-day
management of the company. Bankers may also be interested in performance evaluation.
 Cash flow prediction—for the bank to monitor Chetwynd’s ability to pay its loan.
 Stewardship—The non-managing owners have entrusted Alex and Evan with their assets.
They would want information about how those assets are being managed.

b. There are a number of possible rankings. The key is providing some support for the choice.
The support for the ranking should be based on the information provided in the question and
assumptions about the relative importance of the objectives. For example, an argument for
ranking tax minimization first could be made by arguing that as a private company the main
interest of the owners is to keep as much cash in the business as possible, which tax
minimization would help accomplish. One could go on to argue that with the small number
of owners and the fact that they are likely close, information about the performance of the
company could be obtained in ways other than the general purpose financial statements. Cash
flow prediction and other information important to the bank could be argued for as most
important since the company has loans outstanding and may be in need of additional
financing because the cash borrowed has been used. Other reasonably supported rankings are
possible.

c. Possible revenue recognition points (these would not all be acceptable under IFRS or ASPE)
1. Signing of contract—Revenues are known and there is no information to suggest
collection is a problem. Costs are highly uncertain given the nature of the business and
that this is the company’s first large job. It’s hard to argue that revenue is earned since a
shovel hasn’t yet been placed in the ground. Little effort has been made yet.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-55
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
2. Percentage-of-completion method—Percentage-of-completion is certainly a fit here
because this is a long-term project. As long as costs can be reasonably estimated this
method is acceptable (it’s assumed that revenue is known (the amount is in the contract))
and cash is collectable. With the percentage-of-completion method revenue is recognized
over the term of the contract. Again, costs are key here. Estimation of costs could be a
problem because this is Chetwynd’s first large job so it may be appropriate to argue
against this alternative on the grounds that costs are difficult to estimate.
3. Cash collection—A possible choice if collection is seen as a problem. However, because
cash is received over the entire contract, costs need to be reasonably measured. This may
not be straightforward, especially given that this is Chetwynd’s first big job. Because
payments are made over the life of the contract, this becomes similar to a gradual
approach where the determinant of revenue recognition is cash collection. Also, cash is
received at the inception of the contract and there is little basis for recognizing revenue at
this point.
4. Zero-profit method—if there are uncertainties that make recognizing revenue a problem
over the course of the contract IFRS requires the use of the zero-profit method. If the is
significant uncertainty about the total cost of the project this method would recognize
revenue equal to the costs incurred in the period. Revenue would be recognized but
income would be zero.
5. Completion of the construction—At this point it can be assumed that revenue is earned
since construction is done. Revenue is known since there is a contract. It’s assumed that
cash collection isn’t a problem. If it’s, the last $600,000 should not be recognized at this
point. Costs will likely be known but there can be some doubt about additional costs to be
incurred until the final payment is received (this period is called the holdback period).
6. Completion of the contract—Attractive for tax purposes and allowable under the tax act
because the contract is for less than 24 months. Very late in terms of the criteria unless
there is uncertainty about collection, which there is no indication of in the question, or
estimation of the costs over the term of the contract. This method isn’t allowable under
IFRS but it is under ASPE and for tax purposes.

Revenue
Recognized Total
2017 2018 2019 Total
1. Signing the contract $5,880,000 $- $- $5,880,000

2. Percentage-of-completion
method
Costs incurred 3,000,000 1,500,000 4,500,000
Percentage of costs incurred 67% 33% 100%
Revenue Recognized 3,920,000 1,960,000 5,880,000
3. Cash collection - 2,820,000 3,060,000 5,880,000

4. Zero-profit method

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-56
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
Costs incurred 3,000,000 1,500,000 4,500,000
Revenue Recognized 3,000,000 2,880,000 5,880,000
5. Completion of the construction - - 5,880,000 5,880,000
6. Completion of the contract - - 5,880,000 5,880,000

d. The preferred alternative depends on the ranking of the objectives. Given there is a choice for
constraints between ASPE and IFRS for ease of selection ASPE is used in the discussion. The
purpose is to choose the revenue recognition method that satisfies the objective or objectives
that was/were ranked as most important while being justified. Remember, once the criteria
are met, revenue has to be recognized (if ASPE is being followed—if ASPE isn’t being
followed there should be some set of criteria being applied). In other words, revenue must be
recognized at the earliest time that one can argue that the criteria are met. If you want to
argue for a time beyond that earliest time, you have to make a case that the criteria aren’t met
prior to that time. The ASPE criteria won’t support recognizing revenue on signing. It’s
clearly too early. However, for cash flow prediction information about this contract, whether
it’s disclosed or recognized in the statements is important. Chetwynd would certainly want to
convey knowledge of this contract to the bank so they would understand the cash flows that
were forthcoming. Both the percentage-of-completion and completed contract methods could
be supported under the ASPE criteria (as could completion of construction). A key is
assumptions regarding the ability to estimate costs. Note that this assumption isn’t academic.
One could anticipate management claiming the ability to estimate costs with reasonable
accuracy to justify the percentage-of-completion method even though making such estimates
the first time could be problematic. Percentage-of-completion is probably most appropriate
for conveying information about how the company is doing to the non-involved shareholders
and to the bank. Disclosure of the terms of the contract would be important to these users as
well. For tax purposes, the completed contract method is acceptable and should be selected to
minimize taxes.

P4-18.
a. The financial statements will be used by:
 Rima Ishtiaque to assess the performance of Mr. Krajden, the performance of the
business and to determine the amount of the bonus.
 CRA will use the statements to determine compliance with the Income Tax Act and for
determining the amount of tax that must be paid.
 Mr. Krajden for determining his bonus.
 The bank for ongoing assessment of Teslin’s ability to repay its loan—examine cash
flows, liquidity, and collateral—and ensure compliance with any covenants.
 Possibly the government to assess the ability of Teslin to deliver the product as
contracted, although it’s not likely that they will receive them on an ongoing basis. It’s
possible the government may have wanted to see the statements before the contract was
signed.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-57
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
Many students will continue with a list of very marginal users such as employees and suppliers.
While these parties may have access to the financial statements, it’s not likely and these users
are minor. Students should be encouraged to focus on the important users.

b. Mr. Krajden might consider the following objectives:


 tax postponement
 stewardship reporting to Ms. Ishtiaque
 management evaluation and performance evaluation of the company
 cash flow information for the bank
 income maximization (to meet Mr. Krajden’s personal objectives of maximizing his
bonus and conveying positive information about the company to Ms. Ishtiaque and the
bank).

c. For Mr. Krajden’s own interests, the determination of the bonus will be a high priority. As the
manager of the business, he will also be concerned with the ability of the company to obtain
adequate bank financing and conserve cash by postponing taxes. The needs of the bank may
be satisfied by providing supplementary information on expected cash receipts and
disbursements and summary information on accounts receivable. He may also want to ensure
that the general-purpose financial statements show Teslin to be performing well and to be in
good financial position to satisfy Ms. Ishtiaque that he’s doing a good job. This might be
achieved by recognizing revenue early to increase income and assets. This approach would
also be consistent with Mr. Krajden’s wish to maximize his bonus. The information needs of
Ms. Ishtiaque could be served by less formal reporting and the bonus could conceivably be
determined outside the financial statements, although this approach may be inconsistent with
the contract between Teslin and Mr. Krajden. (In other words, if the general purpose financial
statements aren’t the basis for determining the bonus, could Mr. Krajden and Ms. Ishtiaque
agree to an alternative?) Also, because Ms. Ishtiaque is an absentee owner, she may in fact
rely on the general-purpose financial statements to assess performance although as the sole
owner she could demand whatever specific reporting she wanted. In theory, the most
valuable objective would be to minimize tax because it would free up cash for the company
and thus be beneficial to Ms. Ishtiaque. Without knowing the financial strength of the
company, it’s difficult to assess the importance of the bank to the company. However,
emphasizing the bank’s information needs will also serve to increase his bonus. From this
analysis, a number of reasonable rankings can emerge. Increasing (maximizing) income, tax
minimization, or performance/management evaluation could be supported. (Students have to
provide a ranking to lead their analysis of the revenue recognition alternatives.)

d. The critical events that might be considered are:


 signing of the contract
 as containers are produced
 delivery of the containers
 collection of the cash
 end of the contact (once all containers are delivered).

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-58
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e. Unless the bank insists on audited financial statements, IFRS/ASPE isn’t likely to be a
constraint on the accounting choices (although banks would probably want IFRS/ASPE even
if the statements weren’t audited). The most significant fact is the uncertainty around the
amount of the penalty that may be assessed. Clearly, costs can’t be known with certainty until
the contract is completed in full. Assuming that this particular contract is well within the
competence of the company and there are no supplier or labour uncertainties, the probability
of penalties may be considered to be low. In that case, there may be no objection to
recognizing revenue as the containers are delivered. Delaying revenue recognition until the
contract is fully completed doesn’t seem necessary unless the penalties are totally
unpredictable, although it would be attractive to reduce income. Although it wouldn’t likely
be allowable under IFRS or ASPE, recognizing revenue when the containers are produced
should be considered. At that point there is little uncertainty about costs (save the potential
penalty, and if production gets way ahead of delivery, the likelihood of a penalty is
diminished), revenue is known and collection is virtually certain as long as there is no
problem with the containers such that the government rejects them. Production would likely
not be acceptable according to ASPE/IFRS because the company still has custody of the
containers and therefore hasn’t transferred the risks and rewards of ownership (and this isn’t
a bill and hold arrangement). Cash collection has merit if collection is an issue, which it’s not
in this case since the government is a reliable debtor. Note that cash collection isn’t a
conservative approach because some cash is received in advance of delivery. Disclosure of
the contract would be valuable to the bank because it provides important information about
future cash flows. Recognizing revenue when the contract is signed wouldn’t be allowable
under IFRS/ASPE because performance hasn’t occurred.

Note that students are expected to weigh the issues raised in e. to provide a recommendation
that is tied to the primary objective(s) they rank in d.

P4-19.
a. Possible objectives of accounting are:
Tax minimization, particularly since the income taxes paid by each partner are directly
determined from the amount of income that is reported by the partnership. The preference
here would be to pay less tax by reporting lower income.
Income maximization—partners might want to increase the amount they each draw from the
firm. The higher the net income, the higher the draw. Some partners might prefer lower
income to defer taxes. The preference of individual partners will depend on their cash
situation and needs. From the firm’s perspective, income that was close to cash (not a lot of
accruals that make cash and income very different) would be helpful because if revenue was
accelerated, the firm would have to borrow money to make payments to the partners, which
would be costly to the firm.
Management evaluation, since the managing partner is more directly involved in managing
the company than others, there will be a need for accountability to the other partners. For this
objective, the emphasis would be the accurate measurement of the results of the year. The
managing partner might want to enhance the apparent performance of the firm so that the
other partners would be satisfied with his/her stewardship.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-59
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
Performance evaluation/fair valuation of firm—In this case, the focus is on determining
neutrally the income that was earned during the year. The implications may be significant if
partners join or leave the firm. To illustrate, suppose the firm adopts accounting policies to
reduce income early in the company’s history. The effect will be that the income will be
overstated later, benefiting the partners who join the firm later. Similarly, partners joining the
firm will pay too little for their share and partners leaving will receive too little. Fairness
therefore requires an unbiased measurement of income.

Providing information to the bank can probably be accomplished by providing the same
financial statements along with cash flow forecasts.

There are a number of conflicts. Tax minimization conflicts with income maximization. The
partners face a trade-off because higher income results in a larger draw but also higher taxes.
By minimizing taxes, the wealth of the firm and therefore the partners is higher but the
amount of cash they have in the year is lower. Different partners may have different
preferences in this regard. Partners who are cash poor might be willing to pay higher taxes to
get access to after tax dollars. Others would prefer to save the tax. Income maximization and
tax minimization also conflict with management evaluation and determining the amount
incoming and outgoing partners pay/receive to enter/leave the partnership. Other conflicts
can arise depending on who has control over the accounting (managing partner versus a
committee representing all partners). For example, the managing partner may prefer income
increasing or smoothing accounting choices whereas the partners might prefer fair
representation of activity for management evaluation purposes.

b. Since the income that is distributed to the partners is presumably the primary source of
income for each partner, the measurement of income for the period will be of primary
importance. The firm would want the amount of income to reflect the economic gains during
the period. Some consideration might be given to actual cash flows since payments based on
accrual earnings may be distant from the actual cash collected and it might be necessary for
the partnership to borrow to make the required payments. Tax postponement will be
secondary for reasons explained in part a. Assuming the law firm is reasonably successful,
there should be no significant pressure to bias the financial statements to influence the
decisions of the bank. Financial statements prepared as neutrally as possible to measure the
income for distribution to partners should also reflect fairly well the performance of the
managing partner. (This isn’t the only possible ranking. Different analyses could yield a
different ranking.)

Constraints: In general, partnerships aren’t constrained by IFRS/ASPE. The only


external users of the financial statements that could insist that the financial statements
comply with IFRS/ASPE would be the bank and prospective partners. Since it’s unlikely that
the law firm would be highly leveraged, the bank would probably not require audited
financial statements. On the assumption that the bank won’t have the power to insist on
audited statements, we can conclude that IFRS/ASPE won’t be a constraint on the accounting
policies. The partners may want audited statements if they don’t have adequate access to
information from other sources.

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c. (Note the ASPE criteria are applied here even though ASPE isn’t a constraint. Given if there
is a choice ASPE is more likely the standard of choice. These criteria provide a useful
framework for evaluating revenue recognition problems. Deviation from the ASPE
constraints would be allowable but it would be necessary to apply some rationale to the
analysis).

Case (i): For ongoing legal work that is billed at the end of a case, a number of alternatives
exist for when to recognize revenue. The alternatives include: as the work is done by the
lawyers, when a case is completed, when the billing is rendered to the client, and when cash
is collected.

The earliest possible time to recognize revenue would be as the work is done. The amount
earned is based on the number of hours worked by the lawyers. The relationship between
hours worked and amount billed isn’t one-to-one since billing adjustments are made based on
the judgement of the partner in charge of the case. Performance occurs in this way because
revenue is related to work done by lawyers. The client is purchasing legal services, so an
hour worked by a lawyer is revenue earned by the firm (based on the lawyer’s charge-out
rate). Costs will be known since the lawyers (if not partners) will receive either a flat wage or
a wage based on work done. Cash collection may be an issue if accounts are often
uncollected. However, if the practice is fairly large, there is a basis for making an estimate.
The uncertainty here is the actual amount of revenue that will be billed and collected,
because of these adjustments to the amount billed. The partners may be willing to accept this
uncertainty if the alternative is to wait a long time for receiving money from the practice. The
time between recognition of revenue and cash collection might be large, necessitating
borrowing to make payments to the partners. Also, partners might have to tolerate retroactive
adjustments to their payments if there were significant adjustments to the amounts billed to
and paid by clients. For purposes of determining the payments to the partners, this point
makes some sense because it’s representative of the work done by the firm. The major
problem is that cash collection may be distant in time from payment to partners, which
creates the need for borrowing to pay (since cash hasn’t yet been received). The point is also
useful for purposes of valuing the practice because it reflects the work done by the firm and
the revenue earned, which is the basis for paying partners and valuing the practice. It’s
necessary to make assumptions regarding the ability of the firm to make reasonable estimates
of uncertain amounts (billings versus hours, collections). If these estimates are too uncertain
then the appropriateness of this point could be questioned. (Note that this approach would
trigger earlier tax payments, which would be an issue if a student chose tax minimization as
the main objective.)

At the time the bill is rendered the amount of revenue is known since the partner has decided
the exact amount to bill. As stated before, performance has occurred and the costs known.
There remains uncertainty about collectability. Assuming the uncollectible amounts can be
reasonably estimated (this would require a significant number of cases so that an estimate
could be made. If there are few cases it’s difficult to apply an historical average since the
small number of cases would result in significant variability in the actual amount that isn’t
collected.) This would be an attractive time for tax minimization and would be allowable for

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-61
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
tax purposes. Recognizing revenue after the bill is rendered would be more attractive for tax
purposes but probably not acceptable by CRA and under the Income Tax Act.

When cash is collected there is no uncertainty remaining. Performance has occurred, revenue
and costs are known, and cash has been collected. This is a very late point in the process but
it would ensure that cash is on hand for purposes of making payments to the partners.

Recognizing revenue at the inception of the relationship between the firm and the client
would be attractive for maximizing revenue but there is little support in favour of this point.
At the onset of the relationship, the law firm hasn’t provided any service, revenues and costs
aren’t known, and collection is far off and unpredictable. Revenue recognition at this point
tells users little about the performance of the firm and wouldn’t be useful for valuing the
partnership for incoming and outgoing partners since the future cash flows are highly
uncertain. As a result, revenue recognized at the onset would involve too much speculation
and uncertainty and the measurements in the statements would be too unreliable to base
payments to partners or for determination of the price for purchase and sale of partnership
units.

Case (ii) The revenue from contingent fees is too uncertain to recognize any time before
the amount of the settlement is determined, which would be at the time a settlement is
reached or the judge renders a decision. While performance occurs gradually over the case,
the amount of revenue that will be earned won’t be known until the end of the case. Costs are
incurred gradually over the case (for time put in by the lawyers). These could be deferred
until the case is resolved so matching of costs to revenues can occur. On the other hand since
winning (and receiving anything) is uncertain so it might make better sense to expense all
costs as incurred. Objectives won’t play much of a role in determining when the revenue
should be recognized here because of the uncertainty. Recognition of contingent fees earlier
would be pure guesswork and wouldn’t be appropriate for recognizing revenue for
determining payouts to partners and for determining prices for purchase and sale of
partnership interests.

Case (iii) Retainers are unearned revenue when received. The revenue is earned as services
are provided by the law firm. However, cash is available for distribution to partners. If
performance is measured on a cash basis then recognizing the retainer as revenue would
make sense. Some uncertainty exists if retainers are refundable (if a client asks for his/her
money back). Determining expenses at the time the retainer is paid presents some problem
because the cost of the services provided may not be known so matching may be impaired.
This point wouldn’t be attractive for tax purposes. If the retainers are applied to cases
described in (i), then the treatment described there could be applied, although cash collection
wouldn’t be an issue.

Case (iv) There are three possible points to recognize the fee for 24/7 access to a lawyer as
revenue: when the client and firm agree to the relationship (or when cash is collected, which
is assumed to be at the same time), over the one-year term, and at the end of the one-year
term. A case can be made for recognizing revenue at the inception of the contract/when cash
is paid.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-62
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The key question is when has performance occurred—what does the law firm have to do to
earn the $10,000? Presumably, at the time the agreement is reached the amount of revenue is
known ($10,000), costs are known (it’s assumed that the costs are associated with obtaining
the client, not with providing services to the client), cash is collectable (it’s assumed the
client pays at the time of signing). If what is being purchased is simply the right to access
legal services then it can be argued that the law firm has fulfilled its obligation simply by
accepting the money; any work done by the lawyer has to be paid for by the client. If the
purchase of access to legal service is tied to the provision of services themselves, then
earning of revenue takes place as the services are provided. Since the actual acquisition of
services can be irregular during the year, a straight-line approach would make sense. In this
way, the $10,000 of revenue would be spread over the year. (This spreading would have an
effect if the client signed up at a time other than the start of the law firm’s fiscal year.)
Recognizing revenue at the end of the year term is too conservative and would be difficult to
support unless there was some provision allowing for a refund. ASPE would probably prefer
recognizing revenue on a pro-rata basis, but for purposes of determining payments to
partners’ early recognition is appropriate. Pro rata recognition is probably more appropriate
for valuing the practice for incoming and outgoing partners. (If a student pursues different
objectives then a different recommendation could be appropriate.)

P4-20.
(Students make take different perspectives when addressing this guided case. Below is a sample
solution and therefore answers may vary. Students should be marked based on how well they
support each required element)

Board of Directors,

General purpose financial statements created for Graphite for the upcoming and future years will
have different uses depending on the particular stakeholders. As owners you are the most
important stakeholder who will use the financial statements to help measure performance of
Graphite, but must also consider the other important users which include:
1) The previous owners will be using the audited financial statements to determine how
much is owed to them at the end of each year since part of the acquisition cost was based
on 10% of the net income for three years commencing 2017.
2) New management at graphite will use the financial statements to determine how much
their bonus will be paid since their performance based bonus is tied to net income.
3) The CRA since they will be using financial statements to assess taxes that the company
will owe based on the Income Tax Act.
As the board of directors you aren’t directly involved in the day to day management of the
business and as a result will rely on the financial statements to measure performance and know
how much you will continue to have to pay for the recent acquisition of Graphite.

There are several reporting objectives that may be considered when making the selecting the
appropriate accounting treatment. As a result I will look at the board’s objective as being the
most important when ranking the objectives. (Note: Different rankings are possible and
reasonable. Support for a particular ranking is key.)

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-63
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
1) Contract Compliance – With the recent purchase of Graphite the final amount to be paid
for the business is still tied to the terms of purchase. As a result there is a requirement of
having audited financial statements according to a standard. In this case given the cost
benefit of standards ASPE will be the standard used for audited financial statements.
2) Tax minimization – This objective serves two purposes i) it allow Graphite to retain as
much cash within the operations allowed while complying with the Income Tax Act ii) by
minimizing taxes it also translates to minimizing income which will reduce the purchase
price of Graphite for the next three years.
3) Management evaluation and stewardship – As mentioned earlier the owners aren’t
involved in the day to day management of the operation. As owners you rely on the
information to evaluate how the new management team is performing and using the
resources entrusted to them. Also since compensation is tied to financial performance this
objective is very import in ensuring that information is reliable for bases of evaluation.
4) Performance evaluation – This is to ensure that the information reported is separated from
unusual items that are less likely to occur along with matching costs and economic
benefits. The key is to determine which performance measure is the result of management
decisions and which are a result of externalities.

Given that the purchase of the company was on a cash basis there are no facts as it pertains to
bank covenants as a result the only constraints that exist for Graphite are 1) ASPE the accounting
standard recommended for audited financial reports and 2) the Income Tax Act. Therefore with
each of the given scenarios the appropriate time to recognize revenue would be as follows:

a) Annual Membership Fees- Revenue for annual fees may be recognized when a new
member signs up and pays the fee, throughout the period for which the fee applies, or
upon expiration of the membership. Given that this is a relatively new program and there
is no historical information to support the 40% refund request it’s difficult to recognize
revenue with provisions to recognize the revenue upon signing up. Since the customer
may still cancel the risk and rewards have not transferred from buyer to seller despite
performance. Therefore recognizing the membership revenue throughout the membership
period is also questionable given the loose refund policy. As a result the most appropriate
time to recognize revenue, while being very conservative is at the end of the membership
period. At this point revenue is known along with costs and performance is complete.
While management may argue that their estimates are sound, since their desire would be
to income maximize to receive their bonuses, taking a more conservative approach will
meet the objective of income minimization while meeting the revenue recognition criteria
under ASPE. Once a reasonable estimate of refunds is possible recognizing revenue over
the course of the membership period will be acceptable.
b) Builders and Contractors – There isn’t a lot of options for recognizing revenue for
builders and contractors that pay with cash or credit card. In these transactions revenue
should be recognized at the point of sale since at that point collections have been made,
risk and rewards have been transferred and both revenue and costs are known. For those
contractors where credit’s extended there are two options for recognizing revenue: 1)
When the goods are sold or 2) when collection is made. Normally waiting for collection
is too conservative. However given the facts surrounding the ability of builders the sell

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-64
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
their homes, Graphite’s ability to collect is also unknown. One would imagine this isn’t
the normal course of business to extent such loose repayment terms. By waiting to
recognize revenue upon collection this will be in line with the objective to tax
minimization and hence reducing the amount to be paid out in the first year but will net
with future years. However recognizing revenue on collections isn’t a good measure of
performance since economic outflow doesn’t match when benefits are realized. Once
again management may want to recognize revenue earlier rather than later, for bonus
purposes. If a reasonable estimate the amount that will not be collected from these
builders can be made it would be appropriate to recognize the sale on delivery and record
an allowance for uncollectibles.
c) Advertising Campaign – The option here is to recognize the amount spent as an expense
or to capitalize it as an asset. Matching states that expenses should be matched to the
revenue they helped to earn. If the advertising campaign contributes to the company’s
future earnings one could argue to capitalize it. More important under ASPE is that to
capitalize an expenditure it is necessary that the amount capitalized meet the definition of
an asset. It is not clear whether the advertising expenditures will give rise to any future
benefits; they may or they may not. Clearly, the advertising expenses are incurred to earn
revenue in the future but it can be difficult to attach them to any particular future revenue.
As a result it’s appropriate to be conservative and treat these costs as period costs and
expense them as incurred. Therefore meeting the objective of tax minimization and the
overall reduction in the first year’s payment.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-65
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
USING FINANCIAL STATEMENTS

FS4-1.
The phones aren’t really free as this is part of a “multiple deliverable arrangement” whereby the
cost of the phone is bundled with the phone service. The revenue earned over the life of the
contract will likely cover the cost of the phone along with the cost of providing phone services to
the customer. When customers pay their monthly bills they are essentially paying for the phone
and service. The possible ways Roger’s may recognize revenue on packages that include a free
phone and a three-year service contract are as follows:

1) Recognize revenue monthly over the life of the plan. Revenue for the phone and service
is recognized over the contract term.
2) Recognize the revenue for the phone and service separately. Revenue from the phone is
recognized when the customer receives (value the sale at fair value) and recognize the
service revenue as it is earned (as the customer uses the service). The cost of the phone
would be expensed when the revenue is recognized.

Impact on the financial statements: With option 1 there is an income smoothing effect because
the revenue from the phone is spread over the life of the contract. Option 2 has more revenue
recognized at the inception of the contract. would recognize more revenue upfront and therefore
net income would be higher. Recognizing revenue using option 2 will result in more revenue
being recognized since the phone revenue would be recognized when the contract is signed.

There is no right answer to a student’s recommendation. Students should make their


recommendations based on application of the revenue recognition criteria and consideration of
possible objectives of financial reporting.

FS4-2.
The note on estimations is included in the financial statement so that stakeholders are aware that
numbers aren’t exact and there is uncertainty in the measurements in the financial statements. It
helps stakeholders by ensuring their examination of the statements takes into account the fact
that values for certain items are uncertain. Information in the statements would be more relevant
and reliable if no estimates had to be made. If it was possible to know each number for certain
then the information would be much more reliable. However, with accrual accounting
uncertainty in reported numbers almost always exists on the financial statements date. The only
way to avoid estimates would be to delay accounting recognition until no uncertainty remained.
This would impair the usefulness of financial statement information because information would
be provided to stakeholders much later.

Some estimates that management would make with respect to revenue and revenue recognition
include: collection of amounts; when revenue should be recognized; fair values of service and
phones; loyalty program redemptions; returns and contract cancellations etc.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-66
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
FS4-3.
New customer activation and installation fees for cable are deferred and amortized over the
service period. This treatment makes sense because the installation and activation has no rewards
and benefits on its own. Customer “buy” activation and installation to receive cable TV so the
payment is attached to the service for the customer receives. As a result the revenue is combined
with the cable service over the service period. On the other hand his treatment of the revenue
doesn’t make sense because the revenue recognition criteria have been met once the activation
and installation is complete. 1) Costs are known when the installation is complete; 2) The
revenue associated with the installation is known; 3) Collection is reasonable assured since a
credit check is typically done for new customers; 4) In terms of performance Rogers has fulfilled
that part of the installation and the customer is enjoying the benefits of having cable. Therefore it
would be more relevant to recognize the revenue one the installation is complete.

FS4-4.
Rogers has multiple revenue streams. These are all described in Note 2(d) to the financial
statements and are reproduced below:

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-67
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
FS4-5.
Rogers recognized $326,000,000 in prepaid revenue in 2011. Rogers recognizes revenue as the
customer uses the prepaid service, i.e. airtime or data. The journal entry for when the customer
prepays would be as follows:

Dr. Cash XXX


Cr. Unearned Revenue-Prepaid cards XXX

If the service is not used then Roger’s still has an obligation to deliver the service so revenue
should not be recognized if the service isn’t. As a practical matter, some amount of prepaid
service will go unused (the same way that gift cards go unused). Rogers can likely estimate that
amount from experience. The estimated amount of prepayments that will never be used should be
recognized as revenue in the period it’s paid. If the prepaid period has an expiry date that date
could be used to recognize the revenue from unused service payments.

FS4-6.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-68
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
Loyalty programs are designed to promote customer retention for repeat business. Customers pay
for the “free” goods and services when they make purchases that they do pay for. In other words,
part of the revenue from a sale is actually for the loyalty rewards the customer will receive in the
future. Rogers attributes a portion of the price of a good or service to the future loyalty reward
the customer will receive. The journal entry Rogers would record is:

Dr. Cash/accounts receivable XXX


Cr. Deferred revenue XXX

Accounting for loyalty rewards in challenging. Roger’s would have to estimate the amount of
revenue to defer, which is related to the value of the rewards the customer will receive (Rogers
has to estimate what customers will receive in rewards in the future). Rogers also has to estimate
the amount of loyalty points that will be redeemed. Not all loyalty points are redeemed so an
estimate of the redemption rate is necessary.

FS4-7
a. Segmented financial information provides additional details the different lines of business
and geographical regions a company operates in. It separates balances into source of
income, and other sub-categories. This information is helpful to users because it helps
them to better understand the company’s operations and how they generate (or lose)
money. For example, users may examine segmented information and find that one
business unit is very profitable whereas another isn’t or that one line of business is
keeping several other struggling lines afloat. This information can help users make better
decisions about the company (whether or not to further invest, lend money, take the
company in a new direction, etc.). This is important for a company like Rogers that is in
many lines of business. Segmented information provides insight into the different
components of the business.
b. Rogers provides information for the following segments: Wireless, Cable and Media.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-69
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Copyright © 2013 McGraw-Hill Ryerson Ltd.
c.
Amounts in millions of dollars 2010 2011
Revenues - Wireless $6,973 $7,138
Revenues– Cable 3,785 3,796
Revenues– Media 1,461 1,611

Operating income – Wireless 2,503 2,334


Operating profit margin – Wireless 35.90% 32.70%

Operating income – Cable 584 716


Operating profit margin – Cable 15.43% 18.86%

Operating income – Media 34 91


Operating profit margin – Media 2.33% 5.65%

The wireless division has seen an increase in revenue but decreases in operating income and
profit margin between the two years. This could be attributable to the increase competition in the
market place with new wireless providers entering the market. Therefore to compete, Roger’s
maybe reducing their price to their customers. However the wireless division is still the most
profitable of the three divisions.

The cable division has not grown in revenue but operating profit and operating profit margin
have improved due to a reduction of operating costs.

The media division is the least profitable of the three divisions but operating income has nearly
tripled from 2010 to 2011 even though revenue only increased by 10%. Operating profit margins
has also more than double indicating that the business unit is showing signs of improvement
even though it is the weakest performer of the three divisions.

d. Depending on how the different business units complement each other, it may not be wise to
dispose of the segment that generates the lowest amount of operating income or profit
margin. Removing one segment may hurt other segments, for example the media division
maybe used by the other division to leverage their marketing and advertising campaigns that
helps builds brand equity. Also given that the media division is improving there may still be
opportunities for growth in the future.

FS4-8.
The revenue for the Toronto Blue Jays is recognized as the games are played throughout the
season. This treatment makes sense because at the critical event of the games being played
Roger’s has performed it obligation and it is also at a point when both cost and revenue along
with collections are estimable and reasonably assured. If a fan purchased seasons tickets in 2016
for the 2017 baseball season the journal entry would be as follows:
John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-70
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.
Dr. Cash XXX
Cr. Unearned Revenue-2017 Season tickets XXX

FS4-9.
a. Advertising revenue is recorded in the period which the advertising airs. At this point
Rogers has provided the promised service with cost and revenue estimable and, it’s
assumed, that collection is reasonably assured.
b. Amounts received from non-Rogers cable and satellite providers are recognized in the
month in which they are earned. This is a percentage completion situation where a service
is provided evenly over time. Customers receive access to channels over the month so it’s
reasonable to recognize the revenue evenly over the period.
c. Revenue from the sale of hardware to retailers and subscribers are recognized when the
equipment is delivered and accepted by the customer. At the critical event of delivery
Rogers no longer has management responsibilities over the equipment; the customer has
the risks and rewards of ownership; cost and revenue are known for the equipment, and
either payment has been received (cash or credit card) or the customer’s credit has been
checked so collection is reasonably assured.

FS4-10.
Rogers reported $335,000,000 in unearned revenue on its 2011 balance sheet. This amount
includes advance ticket sales, prepaid airtimes, and other prepaid advertising slots that Rogers
has not delivered yet delivered. It’s considered a liability because it represents an obligation from
Rogers to the customer to deliver on a good or service that the customer has already paid for. The
increase in unearned revenue represents a positive cash flow for Rogers because it means the
company has received cash.

FS4-11.
Rogers added 1,449,000 postpaid customers in 2011 but lost 1,180,000 postpaid customers in the
same period; a net gain of 269,000 new customers. The monthly churn rate is 1.32% which is the
total number of subscriber deactivating divided by the aggregate number of subscribers. This is
important for wireless companies because it represents the ability of the company to retain its
customers and build its base to maintain a stable income stream. The lower the churn rate the
more loyal the customer base and the more reliable the revenue and cash flow stream is. Rogers
can offer loyalty programs, special retention promotions, or impose stiffer contracts to reduce
churn rate. The ARUP is the average revenue earned by each subscriber for the month. This is an
important statistics because it tells investors and the company how much a customer spends with
a provider each month, which is useful for predicting future revenues, net incomes, and cash
flows. From 2010 to 2011 the ARUP has dropped from $72.62 to $70.26 per post-paid customer.
This has caused the revenue to increase at a lower rate than expected despite the increase in
subscribership. To increase ARUP Rogers should find new services that customers will be
willing to pay for. These could be unique service not offered by competitors or services offered
by others. It could also identify ways to encourage customers to use more services. For example
Rogers could provide more programming on its wireless devices.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 4-71
Solutions Manual
Copyright © 2013 McGraw-Hill Ryerson Ltd.