ACCT 5110

Lecture Notes Ch. 6A FINAL

Reporting Cash

Skim Cash includes currency, demand deposits, and commercial paper, such as money orders, certified
checks, cashier checks, personal checks, and bank drafts, all of which are negotiable.

Currency, plus checking If current but restricted, be sure to

and savings accounts separate from unrestricted cash.

Cash equivalents broaden the

definition of cash to include
highly liquid investments with
maturities < 90 days.

If > 90 days, investments should

be accounted for as marketable
securities.

Classify as a prepaid expense if

travel advances are borne by the
employee’s company.

Bank overdrafts (NSF checks) are

offset against cash only if the
owner of the account has another
account in the same bank with
sufficient cash available.

If legally restricted, compensating

Minimum deposits required
in connection with a balances are not cash or cash
borrowing arrangement equivalents and must be included
as a current or noncurrent asset
e.g., “Cash on Deposit depending on whether the
maintained as a borrowing is short- or long-term.
compensating balance”

GAAP definition of Cash Equivalents:

- Short-term, highly liquid investments that are both (a) readily convertible to cash, and
(b) so near their maturity that they present insignificant risk of changes in value.
- Examples: Treasury bills, Commercial paper, and Money market funds.
Class Exercise BE 6.1
New Topic Bank Reconciliation

Goal is to calculate the “true” cash balance

 Differences between cash balance reported by the bank and the cash balance in the general ledger
- Deposits in transit – add to balance
- Outstanding checks – subtract from balance Bank balance
True Cash
- Service charges – subtract from balance Balance
- Nonsufficient funds – subtract from balance Book balance
- Interest income – add to balance
- Errors – add or subtract from either the bank balance or the book balance
- Debit memo (e.g., bank pays a bill for a business) – subtract from book balance
- Credit memo (e.g., bank collects a receivable for a customer – add to book balance
 Balance per books 12,650 Balance per bank 10,050
Less: Bank service charge - 10 Add: Deposits in transit + 3,000
*Bounced check Less: NSF check* - 90 Less: Outstanding checks - 500
Adjusted cash balance 12,550 12,550
True Balance – report on B/S

Review on
 Examples of adjusting entries from a bank reconciliation (not related to reconciliation, above)
your own

Recorded $87 in books

instead of $78 on check

Note: Only balance per book adjustments require a journal entry In-Class Exercises BE 6.16, 6.17, E6.24
CPA MC #150, #151
New Topic
Trade receivables involve sale of inventory
Nontrade receivables do NOT involve inventory

Examples of nontrade receivables:

 Advances to officers and employees.
 Advances to subsidiaries.
 Deposits paid to cover potential damages.
A/R reports amounts owed by
 Deposits paid as a guarantee of performance.
customers net of estimated bad
 Dividends and interest receivable.
debt; i.e., at Net Realizable Value
 Tax refunds due from IRS.
(NRV)
Accounts Receivable usually reflect oral commitments
from customers to pay for goods or services sold

Notes receivable always reflect written commitments

(or promissory notes) from customers

Revenue recognition criteria

All executed Delivery of good or service

pursuant to
a Bargained
Agreement

Collectibility

Dr, Accounts Receivable

Cr, Sales Revenue Entry in books of account after all

indicators have actually occurred
To record sale of goods

Accounts receivable reported on the balance sheet should be offset by an Allowance for
Doubtful Accounts resulting in Accounts Receivable at net realizable value (NRV)
New Topic Variable Consideration
In some cases the price of a good or service is dependent on future events. These future events often
include such items as sales discounts, returns and allowances, rebates, and performance bonuses.

SALES (CASH) DISCOUNTS TRADE DISCOUNTS* *Trade discounts are

used to (1) avoid
Offered to induce prompt payment Reductions from the list price frequent changes to
catalogue prices, (2)
Presented in terms such as: Not recognized in the accounting alter prices for different
records quantities purchased, or
2/10, n/30 OR (3) hide the true invoice
price from competitors
2/10, E.O.M. and Manufacturer bills a retailer
(their customers) net of discounts
net 30, E.O.M.
Skim Sales (Cash) Discounts (for retail customers)

2/10, net 30” are common payment terms

 “2/10” means the seller will take 2% off the sales price if payment is received within 10 days
 “Net 30” means the gross amount is due in 30 days 2/10, E.O.M., and net 30 E.O.M. means payment
 This practice encourages prompt payment is due by the tenth day of the following month
(for the discount) with full payment due by the
Gross Method
thirtieth day of the following month
 Records sale without regard to available discount
 If payment is received during the discount period, a contra-revenue account “sales discounts”
(taken) is debited to reflect the sales discount
Net Method
 Records sale net of the available discount
 If payment is received after the discount period, the contra-revenue account “sales discounts”
(not taken) is credited.

Example

DBA Company sells $100K worth of goods to CJA Company. The terms of the
sale are 2/10, n/30. How would DBA record the sale using the gross method and
net method?

Gross vs. Net

Dr, A/R $100K $ 98K

Cr, Sales $100K $ 98K

If payment is received during the discount period: w/in 10 days

Dr, Cash $ 98K $ 98K

Dr, Sales Discounts1 $ 2K
Cr, A/R $100K $ 98K

If payment is not received within discount period: after 10 days

Dr, Cash $100K $100K

Cr, A/R $100K $ 98K
Cr, Sales Discounts (forfeited) $ 2K

In-Class Exercises BE 6.2, 6.3, 6.4

Sales Returns/Allowances

Very conservative
 General rule: no sale until buyer’s “right of return” has expired

However, if sale has been recorded, goods returned represent deductions from Sales and A/R

Dr, Sales Returns and Allowance $500

Cr, A/R $500
To record return of defective goods

If, historically, a material percentage (>5%) of sales are returned, then GAAP requires a “Estimate and accrue” Sales
contra-revenue account “Sales Returns and Allowances” be established Returns and Allowances

Dr, Sales Returns and Allowance $500K

Cr, Allowance for Sales Returns and Allowances (A/R) $500K
To record estimated sales returns and allowances based on historical experience

New Topic Valuation of Accounts Receivable

Skim

A/R reported net of any estimated bad debt

Real-World:. MSFT. SBUX.

In-Class Exercises CPA MC #141

Accounts Receivable (usually oral or implied commitments)

 Amounts owed by customers
 A/R reported net of bad debt; i.e., at their net realizable value (NRV)

Bad Debt Expense

 Contra-Asset Account
 Dr. = a decrease
 Cr. = an increase

Dr/Cr are just the opposite

of a normal asset account

Contra-asset accounts
Balance Sheet approach
normally show a credit
balance

Income Stmt. approach

Allowance methods (% of Sales and A/R Aging) are GAAP. Allowance methods are
GAAP required to improve
Direct write-off method is required by IRS for tax purposes but is not the matching of bad debt
GAAP for financial reporting. expense with revenue

Emphasizes the net realizable

value (NRV) of A/R (called the
“Balance Sheet approach”)

Rather than a detailed aging

schedule some firms will simply
take a % of the A/R balance
(high-level aging) as
uncollectible based on historical
experience.

Estimated % uncollectible is based on historical analysis of prior collection. The amount of

bad debt expense for the period is the difference between the total estimated uncollectible
($3,070) and the existing balance in the allowance account.

Read
 Emphasizes matching of sales revenue
and uncollectible revenue from current
period sales (I/S approach)

Total Credit Sales x % of Credit

Sales Estimated to Default =
Estimated Bad Debt Expense

Estimated Bad Debt Expense = Total Credit Sales x % of Credit Sales Estimated to Default

While the applicable % is based on historical experience, this method is less accurate than an aging
analysis for the reason given in the chart above; however, it does more accurately match sales revenue
for the period against the related bad debt expense.

Analysis of Allowance Acct.

Beg. Balance $ XXX
- W/O’s ($_XX)
Pre-balance $ XXX
Bad Debt Ex. $ ?__
End Balance $ 3,070

The foregoing assumes no existing balance in the Allowance account (if

there were a balance, then the bad debt expense for the period would be
something less than $3,070).
 The write-off an uncollectible account will produce no impact on the financial
statements. The bad debt expense has already been recognized, and the NRV
will not change. See chart below.

In-Class Exercises: BE 6.5, 6.6

CPA MC # 143, 144

The write-off an uncollectible

account has no effect on the I/S
or B/S. The bad debt expense
has already been recognized,
and the NRV will not change.

Recovery of an account
previously written-off
(1) Restore the original entry:
Dr, A/R; Cr, Allowance account
(2) Record the collection
Dr, Cash; Cr, A/R
Alternatively (as tested on CPA
exam), simply:
Dr, Cash; Cr, Allowance account.

In-Class Exercises: CPA MC #145

Read Comparison of % of Sales and Aging Methods

The percentage of sales method estimates bad debt expense based on annual credit sales and,
therefore, better matches sales revenue to the related bad debt expense on the income
statement for a truer earnings figure on the Income Stmt.

The aging method analyzes the probability of accounts receivable collection and adjusts the
A/R balance accordingly to estimate net realizable value for a truer A/R figure on the B/S.

Summary
 Allowance method is
required by GAAP.

Direct Write-off Method

- Waits until an account is deemed uncollectible before reducing A/R and recording the
bad debt expense (could be years later); therefore, inconsistent with matching principle

- Only allowed by GAAP if bad debts are immaterial, but it is required by IRS

Question 2.

BRIEF EXERCISE 6.1

Cash in bank—savings account .................................................................. $68,000

Cash on hand ............................................................................................ 9,300

Checking account balance ......................................................................... 17,000

Cash to be reported .................................................................................. $94,300

*BRIEF EXERCISE 6.16

(a) Added to balance per bank statement (1)

(b) Deducted from balance per books (4)
(c) Added to balance per books (3)
(d) Deducted from balance per bank statement (2)
(e) Deducted from balance per books (4)

*BRIEF EXERCISE 6.17

(b) Office Expense .................................................................................... 25

Cash ........................................................................................ 25

(c) Cash ................................................................................................... 31

Interest Revenue .................................................................... 31

(e) Accounts Receivable ........................................................................... 377

Cash ........................................................................................ 377

Thus, all “Balance per books” adjustments in the reconciliation require a journal entry.

BRIEF EXERCISE 6.2

June 1 Accounts Receivable 50,000

Sales Revenue 50,000

June 12 Cash ($50,000 - $1,500) 48,500

Sales Discounts ($50,000 x .03) 1,500

Accounts Receivable 50,000

BRIEF EXERCISE 6.3

June 1 Accounts Receivable 48,500*

Sales Revenue 48,500

June 12 Cash 48,500

Accounts Receivable 48,500

*[$50,000 – ($50,000 X .03)] = $48,500

BRIEF EXERCISE 6.4

(a)

Accounts Receivable 9,000

Sales Revenue 9,000
(b)

Sales Returns and Allowances 700

Accounts Receivable 700
(c)
Sales Returns and Allowances 200
Allowance for Sales Returns and
Allowances.......................... 200
(Contra account to AR)

BRIEF EXERCISE 6.5

Bad Debt Expense 17,600
Allowance for Doubtful Accounts 17,600
Beginning Balance $ 2.4K
[($250,000 X 8%) – $2,400]
(-) Write-off ( 0 K)
Pre-Bal. 2.4K
+ Bad Debt Expense 17.6K “Squeeze”
Ending Balance $20.0K

BRIEF EXERCISE 6.6

(a) Bad Debt Expense 26,900
Allowance for Doubtful Accounts
[(10% X $250,000) + $1,900] 26,900
 (b) Bad Debt Expense 22,200
Allowance for Doubtful Accounts
($24,600 – $2,400) 22,200

(a) (b)
Beginning Balance ($ 1.9K) Beginning Balance $ 2.4K
(-) Write-off ( 0 K) (-) Write-off ( 0 K)
Pre-Bal. (1.9K) Pre-Bal. 2.4K
+ Bad Debt Expense 26.9K “Squeeze” + Bad Debt Expense 22.2K “Squeeze”
Ending Balance $25.0K Ending Balance $24.6K

Question 2.

(a) Cash (h) Investments, possibly other assets.

(b) Investments (i) Cash.
(c) Temporary investments. (j) Trading securities.
(d) Accounts receivable. (k) Cash.
(e) Accounts receivable, a loss if uncollectible. (l) Cash.
(f) Other assets if not expendable, cash if ex- (m) Postage expense, or prepaid ex-
pendable for goods and services in the for- pense, or supplies inventory.
eign country. (n) Receivable from employee if the
(g) Receivable if collection expected within one company is to be reimbursed;
year; otherwise, other asset. otherwise, prepaid expense.

*EXERCISE 6.24

(a) Angela Lansbury Company

Bank Reconciliation
July 31
Balance per bank statement, July 31 $8,650
Add: Deposits in transit 2,350a
Deduct: Outstanding checks (1,100)b
Correct cash balance, July 31 $9,900

Balance per books, July 31 $9,250

Add: Collection of note 1,000
Less: Bank service charge $ 15
NSF check 335 (350)
Correct cash balance, July 31 $9,900

Computation of deposits in transit

Deposits per books $5,810
Deposits per bank in July $5,000
Less deposits in transit (June) (1,540)
Deposits mailed and received in
July (3,460)
Deposits in transit, July 31 $2,350a

Computation of outstanding checks

Checks written per books $3,100
Checks cleared by bank in July $4,000
 Less outstanding checks
(June)* (2,000)
Checks written and cleared in
July (2,000)
Outstanding checks, July 31 $1,100b

*Assumed to clear bank in July

(b) Cash ($1,000 - $15 - $335) ............................................................... 650

Office Expenses—bank service charges ........................................... 15
Accounts Receivable ....................................................................... 335
Notes Receivable ................................................................ 1,000
 ACCT 5110
Lecture Notes Ch. 6B FINAL
New Topic Factoring of A/R
 To speed A/R collections, an increasingly common practice is to “factor” (or sell) receivables.
Skim
 “Factor” (an A/R buyer) acquires the right to collect A/R of seller but may bear risk of uncollectibility.
 When A/R are factored, the seller receives cash payment reduced by the fees of the factor.
Real-World: Nordstrom

Sale without recourse

- Factor assumes risk of collection
- Transfer is outright sale of receivables
- Seller records loss on sale

Sale with recourse

- Seller guarantees payment to purchaser
in case the debtor fails to pay
- Financial components approach used to
record transfer

advancing cash to businesses sooner than normal A/R collection period.

True sale of AR (sale is

final). Factor assumes risk
of any credit losses on
collection.

Protects the factor from

losses due to sales returns,
sales discounts, allowances
and customer disputes.

Factor’s JE upon purchase

of AR is virtually a mirror
$15K = Factor’s fee
image of the Seller’s JE.

Dr, Cash JE for Seller of AR

Dr, Due from factor Factor’s margin (mitigates collectability risk) (Crest Textiles)
Dr, Loss on sale of A/R Factor’s fee without recourse
Cr, Accounts Receivable
 Seller guarantees payment to factor
in event A/R customer fails to pay.

Net proceeds computation:

Cash received 460K
Due from factor +25K
Protects the factor from
Recourse liability - 6K
sales returns, discounts, etc.
Net proceeds 479K

Loss-on-sale computation:
Uncollectibles determined by Crest Book value 500K
Net proceeds - 479K
Loss on sale 21K

Commercial Factor’s fee If Commercial Factors incurs no

bad debts related to these A/R, then.
Crest’s recourse liability account
will be eliminated.

New Topic
In-Class Exercise BE6.10, BE6.11
Secured Borrowing (Assignments or “Pledges” of AR as collateral)

Skim Illustration: On April 1, 2020, Rasheed Company assigns $400,000 of its If a company pledges its AR as
collateral for a loan, it is called a
accounts receivable to the Third National Bank as collateral for a $200,000
secured borrowing. The company
loan due July 1, 2020. The assignment agreement calls for Rasheed to retains title to the AR, but pledges
protect
continue to collect the receivables. ThirdtheNational
factors Bank assesses a finance that it will use the proceeds to
textboz pay-off the loan. Secured
charge of 2% of the accounts receivable, and interest on the loan is 10% (a
borrowing requires only footnote
realistic rate of interest for a note of this type). disclosure. There are no
adjustments to the AR account.
a. Prepare the April 1, 2020, journal entry for Rasheed Company.

Dr, Cash 192,000

Dr, Finance Charge (2% x 400,000) 8,000
Cr, Notes Payable 200,000

b. Prepare the journal entry for Rasheed’s collection of $350,000 of the

accounts receivable during the period from April 1, 2020, through
June 30, 2020.

Dr, Cash 350,000

Cr, Accounts Receivable 350,000

c. On July 1, 2020, Rasheed paid Third National all that was due from
This collateral arrangement must
the loan it secured on April 1, 2020. Prepare the journal entry to be disclosed as follows:
record this payment.
Rasheed transferred receivable
Dr, Notes Payable 200,000
205,000 balances totaling $400,000 to
Third National Bank during the
Dr, Interest Expense* 5,000
fiscal year ending June 20,
Cr, Cash 205,000 2020. The transaction has been
accounted for as a secured
* (10% x $200,000 × 3/12)
borrowing.

Assignments and Factoring are methods to generate cash from AR In-Class Exercise BE6.9
CPA MC #149
 “Without recourse”
represents a true sale

“With recourse” could

be either a sale or a loan
(secured borrowing)

All three criteria must be

met for a sale with
recourse or else it’s a
loan backed by AR
collateral

The Fair Value Option is not covered in

New Topic Pertains to Notes Receivable Ch. 6 though it is relevant to it. Fair
Value is covered in detail in Ch. 16.
Skim

Firms may elect FV option at the time

the specific financial instrument is
- Originally recognized or
- When some event triggers a new basis
of accounting.

Firms must continue to use fair value

measurement for the specific
instrument until company no longer
Rather than as Other Comprehensive Income
owns the instrument.

If not elected at date of recognition,

firms may never use fair value option
on that specific instrument.

Illustration:
Escobar Company holds notes that have a fair value of $810,000 and a carrying amount of $620,000. Escobar
decides on December 31 of the current year to use the fair value option for these receivables. This is the first
valuation of these recently acquired receivables. At December 31, Escobar makes an adjusting entry to
record the increase in value of Notes Receivable and to record the unrealized holding gain, as follows.

Dr, Notes Receivable $190,000

Cr, Unrealized Holding Gain or Loss $190,000
BRIEF EXERCISE 6.10

Wood

Cash ($150,000 - $9,000 - $3,000) 138,000

Due from Factor 9,000*

Loss on Sale of Receivables 3,000**

Accounts Receivable 150,000***

*6% X $150,000*** = $9,000

**2% X $150,000*** = $3,000

Engram Factors

Accounts Receivable 150,000***

Due to Customer (Wood) 9,000*

Interest Revenue Factor’s Fee 3,000**

Cash ($150,000 - $9,000 - $3,000) 138,000

BRIEF EXERCISE 6.11

Wood

Cash ($150,000 - $9,000 - $3,000) 138,000

Due from Factor 9,000*

Loss on Sale of Receivables 10,500**

Accounts Receivable 150,000

Recourse Liability 7,500

Net proceeds computation:

*.06 X $150,000 = $9,000 Cash received 138K
Due from factor + 9K
**.02 X $150,000 = $3,000 + $7,500 = $10,500 Recourse liability - 7.5K
Net proceeds 139.5K

Loss-on-sale computation:
BRIEF EXERCISE 6.9 Book value 150.0K
Net proceeds - 139.5K
Chung, Inc. Loss on sale 10.5K

Cash ($750,000 - $20,000) 730,000

Interest Expense ($1,000,000 X .02) 20,000

Notes Payable 750,000

Seneca National Bank

Notes Receivable 750,000

Cash ($750,000 - $20,000) 730,000

Interest Revenue ($1,000,000 X .02) 20,000

 ACCT 5110
Lecture Notes Ch. 7A/B FINAL
Inventory Classifications and Inventory Systems
Inventory is valued based on all costs necessary to bring a good either to a “condition” or a
“location” for sale.
 Condition pertains to the manufacturing process and the following costs:
- Raw materials
- Direct labor Form of goods is altered
- Factory overhead
 Location pertains to the merchandising (e.g., retailing) process and the following costs:
- Invoice price
All may be
- Shipping-Transportation costs
components - Insurance-in-transit Form of goods is not altered
of RM $ - Storage if it “time” adds to "utility"
(e.g., aging wine for the proper consistency)

Skim

Merchandiser (e.g., retailer)

Manufacturer

Merchandiser uses only an Inventory

account to arrive at COGS.

Manufacturer uses all three inventory

accounts (RM, WIP, and FG) to
arrive at COGS.

GAAP requires that RM, WIP, and

FG be presented discretely either on
Manufacturing vs. Merchandising the face of the B/S or in a footnote
disclosure.
Skim
Boeing
#109

RM shows cost
of parts and
assemblies
purchased
from suppliers WIP shows cost of partially
completed goods on factory floor.

Finished Goods inventory shows

cost of completed units ready for
sale and delivery.

In-Class Exercise BE 7.1

 More expensive to run but
provides management with
more complete information
to control inventories

Cost of Goods Sold Model

Beginning inventory
+ Purchases_________________
Cost of goods available for sale
- Ending inventory (“count”)___
= Cost of goods sold (“derived”)

Review on
your own

Sales Purchases

2-line JE Dr, A/R $xx.xx Dr, Purchases $xx.xx Skim

Cr, Sales $xx.xx Cr, A/P $xx.xx
To record sale under the periodic system To record purchase under the periodic system
Dr, A/R $xx.xx Dr, Inventory $xx.xx
Cr, Sales $xx.xx Cr, A/P $xx.xx
4-line JE
Dr, COGS $xx.xx
Cr, Inventory $xx.xx To record purchase under the perpetual system

To record sale under the perpetual system

 Under the perpetual system, COGS is charged (debited) with each sale
 Under the periodic system, no COGS is charged (debited) until the end of the accounting period
 Under the periodic system, Purchases account is a temporary account and closed at end of period:

Dr, COGS
Based
Both areon COGS
based onModel above
year-end inventory count
Dr, Inventory
Cr, Purchases – entry wipes out temporary Purchases account In-Class Exercise BE 7.2
Skim

Versus Periodic System

1. Debit to Purchases account.

2. Freight-in debited to Purchases.

Purchase discounts credited to Purchases.

See BE 7.2

3. No COGS is debited and Purchases credited

until period end. Amounts are based on a
end-of-period inventory count. See COGS
model and JE below.

4. Same under both systems

Cost of Goods Sold Model

Beginning inventory
Dr, COGS + Purchases_________________
Dr, Inventory Both are based on year-end inventory count Cost of goods available for sale
Cr, Purchases – entry wipes out temporary purchases account - Ending inventory___________
= Cost of goods sold
Model can also be used to determine
inventory, COGS, and net income
New Topic Goods included in Inventory overstatement and understatement errors

FOB Shipping Point – Goods shipped are included in buyer’s inventory when they leave seller’s dock (buyer owns
the goods while in transit and bears the shipping costs)
FOB Destination – Goods shipped are included in buyer’s inventory when they arrive at buyer’s dock (seller owns
the good while in transit and bears the shipping costs)

Other Consigned Goods Value of Note: Sales with a high

inventory - Goods on consignment remain the property of the consignor who continues to hold title consigned goods rate of return cannot be
issues - Consignee makes no entry to the inventory account for goods received includes shipping recorded as sold until the
cost to consignee.
- Consignor reports consigned goods separately on balance sheet “return period” has
expired or unless the
Repurchase Agreements (product financing arrangement) amount of returns can be
- Goods transferred to a customer but expected to be repurchased as part of a financing agreement should not reasonably estimated.
be reported as sold but should continue to be reported in inventory

Sales with High Rates of Return (See note in textbox to the right) In-Class Exercise E7.1;
- Goods expected to be returned should not be reported as sold but should continue to be reported in inventory BE 7.3; CPA MC #134,
#137, 139; E7.3
E8.1, E8.3
New Topic Costs included in Inventory
Skim

For example, selling

costs are a period cost
and not an inventoriable
cost because they add no
intrinsic economic value
to the product itself

There are three discrete product costs included in a manufacturer’s

inventory: raw materials, direct labor, and manufacturing overhead
of a Merchandiser

When inventory is manufactured or

purchased, it is capitalized on the
balance sheet as an asset until sold.
Marketing costs, freight-out, etc., are considered period costs
When the inventory is sold, its cost is
because they add no intrinsic economic value to the product expensed on the income statement as
“cost of goods sold.”

Trade discounts: See Ch. 6A Lecture Notes *Trade discounts are used to (1)
avoid frequent changes to catalogue
*Trade discounts applicable to purchases are not prices, (2) alter prices for different
separately accounted for in the computation of COGS quantities purchased, or (3) hide the
true invoice price from competitors

Trade discounts are applied

sequentially; i.e., a trade discount of
40% then 10% is not a 50% discount

Either method valid under GAAP

If a firm shows a Purchase Discounts

account, then purchases are being
reported at their gross amount.

If a firm shows Purchase Discounts

Lost, then purchases are being
reported net of applicable discounts.

The net method is preferred because it

treats discounts lost as a financing
expense and is reported as such on the
income statement in the non-
operating section under “other
expenses and losses.”

Is the hypothetical firm above using a periodic or perpetual inventory system?

In-Class Exercise E7.7, E7.8
CPA MC #135, #140
End of Ch. 7A Lecture Notes
 Start of Ch. 7B Lecture Notes

Various Cost Selection Methods for determining COGS and Ending Inventory
Used when handling a
 Specific identification method determines the cost of ending inventory and the relatively small number of
COGS based on the identification of the actual units sold and in inventory. (Flow costly, distinguishable items
of goods matches the flow of costs, but method is impractical for most industries)
Assumes goods are sold in
44% of companies  First-in, First-out (FIFO) method assumes that the oldest costs recorded in inventory the same order in which
are the first costs transferred to COGS (Normally matches the physical flow of goods) they are purchased

24% of companies  Last-in, First-out (LIFO) method assumes that the most recent costs recorded in Assumes that the last goods
inventory are the first costs transferred to COGS. (Rarely matches the physical flow purchased are the first
of goods) goods sold

 Average Cost method assumes that COGS is the weighted average of all inventory
Used when measuring a
costs available in the period specific physical flow of
inventory is not possible.
GAAP does not require the physical flow of inventory to match the flow of costs Average cost approximates
FIFO when there is rapid
inventory turnover

Calculate COGS and the IN THE FIFO AND LIFO LECTURE

ending inventory balance NOTE EXAMPLES:
using FIFO Periodic END INVENTORY = 6,000 UNITS
INVENTORY SOLD = 4,000 UNITS

Start at end
Read FIFO approximates the
$4.75 $9,500
of period physical flow of goods
$4.40 $17,600
FIFO focuses on the “flow of
$27,100 goods,” mirroring what most
companies do in practice;
namely, sell or use their
Based on physical count oldest goods first to prevent
-27,100
holding old or obsolete items.
$16,800 “Derived”
As such it best approximates
the inventory pricing of the
specific identification method
in most manufacturing
situations.

FIFO fails to match current

costs against current
revenues. FIFO understates
COGS in periods of inflation,
creating a “holding gain” in
Calculate COGS and the reported earnings. Since
ending inventory balance earnings are higher than
using FIFO Perpetual under LIFO, taxes are
higher.

Start at FIFO ending inventory is

beginning 2,000 @ $4.00 = $ 8,000
close to current cost. FIFO
of period 6,000 @ $4.40 = 26,400 ending inventory is more
2,000 @ $4.00 $36,400 realistically stated on the
2,000 @ $4.40 CGS -16,800 balance sheet relative to
(16,800) $17,600
LIFO in periods of inflation.
2000 @ $4.75 = 9,500
EI $27,100

Why? Because FIFO

flow of costs matches
the flow of goods

If FIFO, always use the periodic method to calculate COGS and EI. It’s faster!
In-Class Exercises BE 7.4, BE 7.5
 IN THE FIFO AND LIFO LECTURE
NOTE EXAMPLES:
Calculate COGS and the
END INVENTORY = 6,000 UNITS
ending inventory balance
INVENTORY SOLD = 4,000 UNITS
using LIFO Periodic

Read
Start at LIFO focuses on the “flow of
$4.00 $8,000
beginning costs” not the physical “flow
$4.40 $17,600
of period of goods” that most companies
$25,600 use in practice.

$43,900 LIFO better matches COGS to

Based on physical count -25,600 current year revenues and
$18,300 mitigates inventory “holding
gains” that are exacerbated
under FIFO in periods of
inflation. Since LIFO
earnings are lower, taxes are
lower.

LIFO ending inventory may

be substantially understated
on the balance sheet.

“LIFO liquidation” occurs

Calculate COGS and the when more units are sold than
ending inventory balance
manufactured or purchased in
using LIFO Perpetual
a period.

Start at
beginning 2000 @ $4.00 = $ 8,000
6,000 @ $4.40 = 26,400
of period
4,000 @ $4.40 = $34,400
17,600 CGS -17,600
$16,800
2000 @ $4.75 9,500
EI $26,300

Why? Because LIFO

flow of costs does not
match the flow of goods

If LIFO, look for periodic or perpetual. If neither is stated, use the periodic method to calculate COGS and EI. It’s simpler!

In-Class Exercises BE 7.6

CPA MC #145

Reconciliation of LIFO to FIFO

GAAP requires companies that use LIFO

Mainly FIFO for external reporting to disclose the
amount by which inventory would have
changed if the company had used FIFO.
This amount is known as the LIFO Reserve
(tracked in the Allowance to Reduce
Inventory to LIFO account, a contra-
inventory asset – see box at left).

LIFO Reserve = FIFO EI $ (‒) LIFO EI $

The change in the LIFO Reserve from one

Adjusting JE to period to the next is known as the LIFO
convert FIFO
COGS increased to reflect newer LIFO costs Effect.
internal reporting
to LIFO external LIFO Effect = Dec. 31 LIFO Reserve (-)
financial reporting Inventory decreased to Jan. 01 LIFO Reserve
reflect older LIFO costs
The JE to record the LIFO Effect is shown
Account balance tracks
in the slide to the left.
the LIFO Reserve
Read

If FIFO inventories had been higher,

as the footnote describes, then COGS
would have been lower, and therefore
earnings higher.
GAAP requirement
Many companies use LIFO for IRS
tax and SEC reporting purposes
because it normally means lower
earnings and lower taxes. (IRS
requires firms that use LIFO for tax
purposes to also use LIFO for
reporting purposes.)

In-Class Exercise BE 7.7

Read side notes, below

LIFO Liquidation comes

about when older, low-cost
inventory is sold, resulting in
a lower cost of goods sold,
higher net income, and
higher taxes, contrary to the
purpose of LIFO.

Costs based on
LIFO specific-goods
(or unit) approach

The specific-goods unit approach

Base layer
to costing LIFO inventories is
often unrealistic because the cost
Add’l layers of tracking each item is
expensive ant the erosion of the
LIFO inventory can easily occur.

Additional LIFO layers are created when units manufactured or purchased exceed units sold.

Read side notes, below

To simply the accounting

and mitigate the effects of
LIFO liquidation on
earnings and taxes, it is
traditional for firms to create
LIFO specific-goods pools
with each pool consisting of
items that are “substantially
alike.” LIFO pools often
result in fewer LIFO
liquidations because as one
quantity of items in a pool
declines, other closely
identical items in the pool
may increase, mitigating, but
not eliminating, the erosion
of LIFO layers.
After creation of the initial base-year layer, additional LIFO layers may be created in any year in which
the ending inventory is greater than the beginning inventory. An additional LIFO layer is priced at the
earliest costs of the year in which it was created, consistent with the last-in, first-out model.
 Summary
Specific-goods unit LIFO quantities
- Costing goods on a unit basis is expensive and time consuming

Specific-goods pooled LIFO quantities

- Reduces record keeping and clerical costs
- More difficult to erode layers
- Using quantities can still lead to untimely LIFO liquidations* *Pooled approach should give fewer
liquidations because the reduction of one
Therefore, many firms opt for Dollar-Value LIFO unit type in the pool may be offset by an
(to mitigate LIFO erosion) increase in new unit type. Yet, the old and
new units may not be enough alike,
Normally firms use the unit or pooled approaches only when
causing a taxable holding gain
the product mix is stable and there are few goods to deal with.
(inflationary profit) when the unit is sold.

BRIEF EXERCISE 7.1

RIVERA COMPANY
Balance Sheet (Partial)

December 31

Current assets

Cash $ 190,000

Receivables (net) 400,000

Inventories

Finished goods $170,000

Balances in RM, WIP, and FG
Work in process must be disclosed on the Balance 200,000
Sheet or in a footnote disclosure
Raw materials 335,000 705,000

Prepaid insurance 41,000

Total current assets $1,336,000

BRIEF EXERCISE 7.2

Inventory (150 X $34) Dr, Purchases $5,100 5,100

Cr, A/P $5,100
Accounts Payable 5,100
To record purchase under the periodic system
Accounts Payable (6 X $34) 204

Inventory 204

Accounts Receivable (125 X $50) 6,250

Sales 6,250

Cost of Goods Sold (125 X $34) 4,250

Inventory Dr, A/R $6.250 4,250

Cr, Sales $6,250
To record sale under the periodic system
BRIEF EXERCISE 7.3

December 31 inventory per physical count $ 200,000

Goods-in-transit purchased FOB shipping point 25,000

Goods-in-transit sold FOB destination 22,000

December 31 inventory $ 247,000

BRIEF EXERCISE 7.4

$11,850
Weighted average cost per unit = $ 11.85
1,000

Ending inventory 400 X $11.85 = $ 4,740

Cost of goods available for sale $11,850

Deduct ending inventory 4,740

Cost of goods sold (600 X $11.85) $ 7,110

BRIEF EXERCISE 7.5

April 23 350 X $13 = $ 4,550

April 15 50 X $12 = 600

Ending inventory $ 5,150

Cost of goods available for sale $11,850

Deduct ending inventory 5,150

Cost of goods sold $ 6,700

BRIEF EXERCISE 7.6

April 1 250 X $10 = $ 2,500

April 15 150 X $12 = 1,800

Ending inventory $ 4,300

Cost of goods available for sale $11,850

Deduct ending inventory 4,300

Cost of goods sold $ 7,550

BRIEF EXERCISE 7.7

FIFO inventory balance at December 31, 2025 $2,900,000

LIFO inventory balance at December 31, 2025 (1,500,000)

LIFO reserve at December 31, 2025 1,400,000

LIFO reserve at December 31, 2025 $1,400,000

LIFO reserve at January 1, (1,300,000)

LIFO effect for 2025 100,000

At December 31, 2025, the entry to record the LIFO effect is:

Cost of Goods Sold 100,000

Allowance to Reduce Inventory to LIFO 100,000

EXERCISE 7.1

Items 1, 3, 5, 8, 11, 13, 14, 16, and 17 would be reported as inventory in the financial statements.

The following items would not be reported as inventory:

2. Cost of goods sold in the income statement.
4. Not reported in the financial statements.
6. Cost of goods sold in the income statement.
7. Cost of goods sold in the income statement.
9. Interest expense in the income statement.
10. Advertising expense in the income statement.
12. Office supplies in the current assets section of the balance sheet.
15. Not reported in the financial statements.
18. Short-term investments in the current asset section of the balance sheet.

EXERCISE 7.3

1. Include. Ownership of the merchandise passes to customer only when it is shipped.

2. Do not include. Title did not pass until January 3.
3. Include in inventory. Product belonged to Harlowe Inc. at December 31, 2025.
4. Include in inventory. Under invoice terms, title passed when goods were shipped.
5. Do not include. Goods received on consignment remain the property of the consignor.

EXERCISE 7.7

(a) May 10 Purchases 14,700

Accounts Payable 14,700

($15,000 X .98)

May 11 Purchases 13,068

Accounts Payable 13,068

($13,200 X .99)

May 19 Accounts Payable 14,700

Cash 14,700

May 24 Purchases 11,270

 Accounts Payable 11,270

($11,500 X .98)

(b) May 31 Purchase Discounts Lost 132

Accounts Payable

($13,200 X .01) 132

(Discount lost on purchase of $132 would be shown in the non-

operating section of the I/S under
Other Expenses and Losses and
May 11, $13,200, terms 1/15, n/30)
labelled “financing expense”

EXERCISE 7.8

(a) Feb. 1 Inventory [$10,800 – ($10,800 X .10)] 9,720

Accounts Payable 9,720

Feb. 4 Accounts Payable [$2,500 –

($2,500 X .10)] 2,250

Inventory 2,250

Feb. 13 Accounts Payable ($9,720 – $2,250) 7,470

Inventory (.03 X $7,470) 224.10

Cash 7,245.90

(b) Feb. 1 Purchases [$10,800 – ($10,800 X .10)] 9,720

Accounts Payable 9,720

Feb. 4 Accounts Payable [$2,500 – ($2,500 X

.10)] 2,250

Purchase Returns and Allowances 2,250

Feb. 13 Accounts Payable ($9,720 – $2,250) 7,470

Purchase Discounts (.03 X $7,470) 224.10

Cash 7,245.90

(c) Purchase price (list) $10,800.00

Less: Trade discount (.10 × $10,800) 1,080.00
Price on which cash discount based 9,720.00
Less: Cash discount (.03 × $9,720) 291.60
Net price $ 9,428.40
 ACCT 5110
Lecture Notes Ch. 7C FINAL
Read side notes
Special Issues Related to LIFO (cont’d) down to schedule

Increases and decreases in a LIFO

pool are measured in terms of total
Dollar-Value LIFO mitigates dollar value, not physical quantity of
the problems with the specific- goods.
goods and pooled approaches
and the erosion of LIFO layers. Advantages:
- Broader range of goods in pool
- Permits replacement of goods that
are “similar in nature and in use ”
- Helps protect LIFO layers from
erosion
Under regular
LIFO, inventory
is measured in
units and costed Many firms use the general price-
at unit prices. level index that the federal
government publishes each month.
Under $ Value
LIFO, inventory
Most popular is Consumer Price
is measured in Index for Urban Consumers (CPI-U).
dollars and is Specific indexes also may be used for
adjusted for certain commodities and industries.
changing prices. For this class, we will assume that the
index is given, similar to most firms
that use Dollar-Value LIFO.
Therefore, we will not cover the
To convert end-of-year prices to base year
prices, use simple algebra, setting x equal to
“Selecting a Price Index” on pp. 7-30
To convert 2017 base-year prices to 2018 current and 7-31 of the textbook.
base year prices and solving for x; e.g., for
prices, take the incremental layer added in 2018
2018 the algebraic equation would be: ($60K) and adjust for the CY (2018) price index.
1.15 x = $299,000 2017 @ base year cost: $200K
x = $299,000 / 1.15 2018 layer at CY prices: 69K ($60K x 1.15)
x = $260,000 2018 inventory @ CY cost: $269K

LIFO Reserve =
End-of-Year Prices
(-) $ Value LIFO

When EI at base-
year prices ($250K)
< BI ($260K), then
the firm must reduce
previous layers at
the prices then in
existence.

FIFO

$ Value LIFO Totals

LIFO Effect = the
change in the LIFO
Reserve from one
+ + = (67,500) period to the next

Specific-goods unit LIFO quantities

- Costing goods on a unit basis is expensive and time consuming
+0
Specific-goods pooled LIFO quantities
- Reduces record keeping and clerical costs
Question 16, 17, 18
- More difficult to erode layers In-Class Exercises BE 7.8, 7.9
- Using quantities can still lead to untimely LIFO liquidations CPA MC #147

Therefore, many firms opt for Dollar-Value LIFO

(to mitigate LIFO erosion)
 Summary of Financial Statement Effects of LIFO and FIFO

 In periods of rising prices (inflation), firms may choose LIFO, because it better matches current
revenue and current expense and produces the lowest current taxable income (and, as a
consequence, the lowest current income tax payment).

 IRS requires that if LIFO is used for tax purposes, it also must be used for GAAP F/S. This is
known as the LIFO conformity rule.

 LIFO is generally preferred if the firm has a fairly constant base stock, thereby avoiding LIFO
liquidation issues. Also, the low value of the base stock inventory makes the firm less vulnerable to
price declines and the write-down of inventory to a lower market value (covered in Ch. 8).

 However, LIFO understatement of ending inventory in periods of inflation makes the working
capital position of the firm appear worse than it really is. That is why the LIFO Reserve is so important.
See Ch. 7 White Board Notes
 When LIFO liquidations become imminent, it may encourage the purchase of more goods simply to
avoid charging the cost of old goods to expense, a manipulation of income frowned-on by the SEC.

Questions 15, 19
CPA MC #143

Skim on
your own from Kieso
Illustration 7.21

And vice versa: If ending inventory

is overstated in a given year, then
COGS will be understated, and both
NI and RE will be overstated.

Purchases and Ending Inventory Misstated from Kieso

Illustration 7.23
Balance Income

Inventory Understated Purchases Understated

Retained earnings No effect Cost of goods sold No effect Whether Inventory and Purchases
are overstated or understated, the
errors are offset in COGS. Same
Accounts payable Understated Net Income No effect “no effect” in either case.

Note: The effect of an error on net income in one year will be counterbalanced in the next year,
meaning there is no effect on RE at the end of the second year (see Gamestart example, Kieso Question 20
Illustration 7.22); however, the income statement will be misstated for both years. In-Class Exercise BE 7.10
Q15. The LIFO method results in a smaller net income because later costs, which are higher than earlier
costs, are matched against revenue. Conversely, in a period of falling prices, the LIFO method
would result in a higher net income because later costs in this case would be lower than earlier
costs, and these later costs would be matched against revenue.

Q16. The dollar-value method uses dollars instead of units to measure increments, or reductions in a LIFO
inventory. After converting the closing inventory to the same price level as the opening inventory, the
increases in inventories(“layers”), priced at base-year costs, is converted to the current price level and
added to the opening inventory. Any decrease (“erosion of a layer”) is subtracted at base-year costs to
determine the ending inventory.

The principal advantage is that it requires less record-keeping. It is not necessary to keep records or
make calculations of opening and closing quantities of individual items. Also, the use of a base inventory
amount gives greater flexibility in the makeup of the base and eliminates many detailed calculations.

The unit LIFO inventory costing method is applied to each type of item in an inventory. Any type of
item removed from the inventory base (e.g., magnets) and replaced by another type (e.g., coils) will
cause the old cost (magnets) to be removed from the base and to be replaced by the more current
cost of the other item (coils).

The dollar-value LIFO costing method treats the inventory base as being composed of a base of cost
in dollars rather than of units. Therefore, a change in the composition of the inventory (less
magnets and more coils) will not change the cost of inventory base so long as the amount of the
inventory stated in base-year dollars does not change.

Q17. (a) LIFO layer—a LIFO layer (increment) is formed when the ending inventory at base-year prices
exceeds the beginning inventory at base-year prices.

(b) LIFO reserve—the difference between the inventory method used for internal purposes
and LIFO.

(c) LIFO effect—the change in the LIFO reserve (Allowance to Reduce Inventory to LIFO) from
one period to the next.

Q18. December 31, 2025 inventory at December 31, 2024 prices, $1,053,000 ÷ 1.08 ...................... $975,000

Less: Inventory, December 31, 2024 ......................................................................................... 800,000

Increment added during 2025 at base prices (2024) .................................................................. $175,000

Increment added during 2025 at December 31, 2025 prices, $175,000 X 1.08 ......................... $189,000

Add: Inventory at December 31, 2024 ........................................................................................ 800,000

Inventory, December 31, 2025, under dollar-value LIFO method............................................... $989,000

Q19. The cost of goods sold therefore is understated and profit is considered overstated. Phantom profits
(“holding gains”) are said to occur when FIFO is used during periods of rising prices.

High inventory profits through involuntary liquidation occur if a company is forced to reduce its
LIFO base or layers. If the base or layers of old costs are eliminated, strange results can occur
because old, irrelevant costs can be matched against current revenues. A distortion in reported
income for a given period may result, as well as consequences that are detrimental from an
income tax point of view.

Q20. This omission would have no effect upon the net income for the year since the purchases and the
ending inventory are understated in the same amount. With respect to financial position, both the
inventory and the accounts payable would be understated. Materiality would be a factor in
determining whether an adjustment for this item should be made as omission of a large item would
distort the amount of current assets and the amount of current liabilities. It, therefore, might influence
the current ratio to a considerable extent.
BRIEF EXERCISE 7.8

2024 $100,000

2025 $119,900 ÷ 1.10 = $109,000

$100,000 X 1.00 $100,000

$9,000* X 1.10 9,900

$109,900

*$109,000 – $100,000

2026 $134,560 ÷ 1.16 = $116,000

$100,000 X 1.00 $100,000

$9,000 X 1.10 9,900

$7,000** X 1.16 8,120

$118,020

**$116,000 – $109,000

BRIEF EXERCISE 7.9

2025 inventory at base amount ($22,140 ÷ 1.08) $ 20,500

2024 inventory at base amount (19,750)

Increase in base inventory $ 750

2025 inventory under LIFO

Layer one $19,750 X 1.00 $ 19,750

Layer two $ 750 X 1.08 810

$ 20,560

2026 inventory at base amount ($25,935 ÷ 1.14) $ 22,750

2025 inventory at base amount 20,500

Increase in base inventory $ 2,250

2026 inventory under LIFO

Layer one $19,750 X 1.00 $ 19,750

Layer two $ 750 X 1.08 810

Layer three $ 2,250 X 1.14 2,565

$ 23,125
BRIEF EXERCISE 7.10

Cost of goods sold as reported $1,400,000

Overstatement of 12/31/24 inventory (110,000)

Overstatement of 12/31/25 inventory 35,000

Corrected cost of goods sold $1,325,000

12/31/20 retained earnings as reported $5,200,000

Overstatement of 12/31/25 inventory (35,000)

Corrected 12/31/25 retained earnings $5,165,000

ACCT 5110
Lecture Notes Ch. 8A FINAL
U.S. GAAP and IFRS
Lower of Cost or Net Realizable Value

Net Realizable Value (NRV) is defined

as estimated selling price in the
ordinary course of business, less
reasonably predictable costs of
completion, disposal, and
transportation.

Since 2017, FASB has required that

inventory, not costed using LIFO or
the “retail inventory method” (to be
covered later in this chapter), be
measured at the lower of cost or NRV.

Inventory costed using LIFO or the

retail inventory method should be
costed at the lower of cost or market
(to be covered later).
Lower of Cost ($950) vs. NRV ($750)

Three approaches are

acceptable in applying
LCNRV to inventory

The individual, item-by-item, method

produces the most conservative
inventory valuation. (IRS normally
requires item-by-item for tax purposes
in most circumstances.)

Whichever method is selected should

be applied consistently from one
period to the next.

The COGS method buries the loss in the

COGS account. The loss method identifies
the loss due to the write-down and shows
the loss separate from COGS.

Instead of crediting the Inventory account

for market adjustments, most firms
generally use an allowance account, often
titled “Allowance to Reduce Inventory to
NRV," a contra-asset account offsetting
the Inventory account value.

Or Allowance to Reduce Inventory to NRV B/S Presentation using an Allowance Account

Inventory at cost $82K
Allowance to reduce inventory to NRV ( 12K)
Or Allowance to Reduce Inventory to NRV Inventory at NRV $70K
Materiality
Inventory at NRV $70K
should drive the Question 4
method used. In-Class Exercises BE8-1, BE8-2, BE8-3
 U.S. GAAP only

Ceiling – prevents overstatement of

the value of obsolete, damaged, or
See text boxes
shopworn inventories
to the right.

NOTE: Market value is always the

middle value of these three amounts
and only replacement cost if it is the
middle value.

Floor – deters the understatement of

inventory and overstatement of loss
in current period

BE CAREFUL IT MAY NOT ALWAYS

BE REPLACEMENT COST!
NOTE: LC/M inventory value for LIFO and retail inventory method under GAAP
 Ceiling: net realizable value (sales price minus cost to complete and dispose)
 Floor: market ceiling less normal profit margin
 Array “floor,” “ceiling,” and replacement cost in descending order of value and use middle amount as FMV
 Compare FMV (middle amount) to cost and use lower of the two as the inventory value

NOTE: FASB introduced LCNRV in order to simplify the accounting and reduce the cost of inventory measurement, but
granted an exception for firms using LIFO and the retail inventory method when it learned that LCNRV for those firms was
leading to distortions in reported income and higher costs to track changes in the LIFO reserve.

The purpose of reducing inventory

to NRV or market value is to show
the probable loss (rule of
conservatism) in the period in
which the loss occurred, satisfying
the matching principle. Even so,
Disagree - some conceptual deficiencies
Conservative! remain. See accompanying slide on
Agree – violates the left.
Consistency.

Speculative

Question 7
Agree – not In-Class Exercises BE8.4, BE8.5. E8.3. E8.7.
objective. CPA MC #132, #133
Q4. (1) $12.80 ($14.80 - $1.50 - $0.50) NRV.
(2) $16.10 Cost.
(3) $13.00 ($15.20 - $1.65 - $0.55) NRV.
(4) $9.20 ($10.40 - $0.80 - $0.40) NRV.
(5) $15.90 Cost.

Q7. (1) $14.50 NRV.

(2) $16.10 Cost.
(3) $13.75 NRV – Normal profit margin.
(4) $9.70 Replacement cost.
(5) $15.90 Cost.

BRIEF EXERCISE 8.1

Item Cost NRV LCNRV

Skis $190.00 $161.00 $161.00

Boots 106.00 108.00 106.00

Parkas 53.00 50.00 50.00

BRIEF EXERCISE 8.2

(a) Item Cost NRV LCNRV

Item-by-item

Jokers $2,000 $2,100 $2,000

Penguins 5,000 4,950 4,950

Riddlers 4,400 4,625 4,400

Scarecrows 3,200 3,830 3,200

Total $14,600 $15,505 $14,550

(b) 1. Penguins only: $50

2. None on a whole group: $15,505 > $14,600.

BRIEF EXERCISE 8.3

(a) Cost-of-goods-sold-method

Cost of Goods Sold ............................................................................. 42,000

Inventory ($572,000 - $530,000) ............................................. 42,000

(b) Loss method

Inventory Loss .................................................................................... 42,000

Inventory ($572,000 - $530,000) ............................................. 42,000

BRIEF EXERCISE 8.4

(a) Ceiling $193.00 ($212 – $19)

Floor $161.00 ($212 – $19 – $32)
(b) $106.00
(c) $51.00

BRIEF EXERCISE 8.5

(a) Cost-of-goods-sold method

Cost of Goods Sold 21,000

Inventory 21,000*

*($286,000 – $265,000)

(b) Loss method

Inventory Loss 21,000

Inventory 21,000

EXERCISE 8.3

Final Inventory
Item No. Cost per Net Realizable Value
Unit Value LCNRV Quantity
1320 $3.20 $2.90* $2.90 1,200 $ 3,480
1333 2.70 2.40 2.40 900 2,160
1426 4.50 3.60 3.60 800 2,880
1437 3.60 1.85 1.85 1,000 1,850
1510 2.25 1.85 1.85 700 1,295
1522 3.00 3.10 3.00 500 1,500
1573 1.80 1.30 1.30 3,000 3,900
1626 4.70 4.50 4.50 1,000 4,500
$21,565
*$4.50 – $1.60 = $2.90.
Market
EXERCISE 8.7 Floor

Market
Ceiling
Net
Realizable
Cost Net Value Designated Final
Item per Replacement Realizable Less Market Inventory
No. Unit Cost Value Normal Value Quantity Value
Profit
1320 $3.20 $3.00 $4.15* $2.90** $3.00 1,200 $ 3,600
1333 2.70 2.30 3.00 2.50 2.50 900 2,250
1426 4.50 3.70 4.60 3.60 3.70 800 2,960
1437 3.60 3.10 2.95 2.05 2.95 1,000 2,950
1510 2.25 2.00 2.45 1.85 2.00 700 1,400
1522 3.00 2.70 3.40 2.90 2.90 500 1,450
1573 1.80 1.60 1.75 1.25 1.60 3,000 4,800
1626 4.70 5.20 5.50 4.50 5.20 1,000 4,700***
 $24,110
*$4.50 – $.35 = $4.15.

**$4.15 – $1.25 = $2.90.

***Cost is used because it is lower than designated market value.

 ACCT 5110
Lecture Notes Ch. 8B FINAL
Other Valuation Approaches Inventories reported at NRV (not cost) include:
(1) Valuation at NRV (even if higher than cost) - Gold and silver when there is an effective
 Existence of a controlled market with a government-controlled market at a fixed monetary
quoted market price for all quantities and value
- Agricultural and mineral products meeting the
 No significant cost of disposal and following criteria: (1) immediate marketability at
 Product available for immediate delivery or current prices; (2) homogenous units; and (3)
inability to determine appropriate costs.
 Cost is too difficult to determine

(2) Used when buying varying

units in a “basket purchase”

Read Side
Note, below

x = x = 40%
Illustration: Woodland Developers
24%
purchases land for $1 million that it
36%
will subdivide into 400 lots. These
%
lots vary in size, shape, and
attractiveness but can be roughly
sorted into three groups graded A, B,
and C. As Woodland sells the lots, it
apportions the purchase cost of $1
x =
million among the lots sold and the
lots remaining on hand. Calculate
the cost of lots sold, ending
COGS inventory, and gross profit.

Cost of lots remaining on hand (EI) = $1,000K (-) $680K, or $320K Question 9
In-Class Exercise BE 8.6
Skim

GAAP requires that if the

(3)
contract price is greater than
the market price, and the buyer
expects losses will occur when
purchase is effected, then the
buyer must recognize losses in
the period when the decline in
market prices take place, rather
than when the purchase occurs
(rule of conservatism).

All material firm purchase

commitments must be disclosed
in the financial statements for
each year 1-5 and in aggregate
for all years thereafter.

When St. Regis cuts the timber at a cost of $10 million, it would make the
following entry.

Purchases (Inventory) 7,000,000

Est. Liability on Purchase Commitments 3,000,000 Question 10
In-Class Exercises BE 8.7, BE 8.8
Cash 10,000,000
 Determining Ending Inventory by Applying the Gross Profit Method

Read Slide and Sidebars,

Firms use the gross profit

method to estimate COGS and
ending inventory for interim
financial statements when no
physical inventory has been
taken or when fire or some
other catastrophe destroys
inventory records or the
inventory itself, making a
Inventory is valued physical inventory impossible.
at retail, and an Plus freight-in, insurance in transit , etc. See Question 11.
average gross profit
percentage is used
$260K Goods available
to determine the
(-) 196K Est. cost of goods sold
approximate
$ 64K Est. inventory at cost
inventory cost.
COGS

Question 14

All proofs assume SP = $1.00/unit

Gross Profit on Sales

C + .33C = SP Given a 33% Markup

(1+.33)C = SP
1.33C = 1.00
C = 75%
GP% on SP = 25% (or 1.00 - .75)

C + .25C = SP Given a 25% Markup

(1+.25)C = SP
1.25C = 1.00
C = 80%
GP% on SP = 20% (or 1.00 - .80)

GP % % Markup C + .20C = SP Given a 20% Markup

(1+.20)C = SP
1.20C = 1.00
C = .8333%
For the gross profit method, firms normally GP% on SP = 16.67% (or 1.00 - .8333)
use “markup” in reference to cost and
“gross profit %” in reference to sales.

GP% on Selling Price = % Markup on Cost / (100% + % Markup on Cost) Markup on Cost
% Markup on Cost = GP% on Selling Price / (100% - GP on Selling Price) Given a 20% GP %
C + .20SP = SP
% Markup on Cost GP% on Selling Price C = (1.00 - .20) SP
C = .80 SP
C = .80 (1.00)
Given 33% .33 / (1.00 + .33) = 25%
C = .80
Given 25% .25 / (1.00 + .25) = 20% Markup on Cost = 25% (or .20 / .80))

Given 20% .20 / (1.00 + .20) = 16.67% Given a 25% GP %

C + .25C = SP
.20 / (1.00 - .20) = 25% Given 20% C = (1.00 - .25) SP
C = .75 SP
.25 / (1.00 - .25) = 33% Given 25% C = .75(1.00)
C = .75
Markup on Cost = 33% (or .25 / .75)
Note: Firms do not multiply sales by a cost-based %, but rather convert it to a % based on SP
Note: .33 has been rounded
Question 13 (HW)
E8.13 (HW)
 Read sidebar, below

Gross Profit Method: Assumptions

- Beginning inventory plus purchases
Inventoriable costs
equal total goods to be accounted for.
- Goods not sold must be on hand.
- Sales, reduced to cost, when deducted
Offset to Sales from the sum of the opening
Offset to Inventory inventory plus purchases, equal
ending inventory.
1
2

Read sidebars, below

1
GP% is given at 25% of sales.
No further computation needed.
GP %

Firms normally state GP% as a

% of sales because (1) goods are
normally stated at retail, not at
cost, for reasons of competition
and (2) profits at retail are lower
TGA on a % basis than profits at cost,
leaving a favorable impression
with the consumer.

Good available (at cost) $818,000

COGS (-) Sales (at cost) (697,500)
Approximate Inventory $120,500

% Markup Read sidebar, below

GP is given at 25% of cost.

Further computation is needed to
convert GP% to a % based on
sales price using the GP on
Selling Price formula.
TGA
Note: Firms normally do not
multiply sales by a cost-based %.
Hence the need to convert the
25% markup to a GP% of 20%.

COGS

In-Class Exercise BE 8.9

Skim

Firms must still take a physical inventory count once a year.

A current GP% is generally more appropriate than past GP%’s.

Okay for interim financial statements;

not okay for annual financial statements.

CPA MC #135
E8.14

Q9. Relative sales value is an appropriate basis for pricing inventory when a group of varying units is
purchased at a single lump-sum price (basket purchase). The purchase price must be allocated in
some manner or on some basis among the various units. When the units vary in size, character, and
attractiveness, the basis for allocation must reflect both quantitative and qualitative aspects. A
suitable basis then is the relative sales value of the units that comprise the inventory.

Q10. The drop in the market price of the commitment should be charged to operations in the current year
if it is material in amount. The following entry would be made [($6.20 – $5.90) X 150,000] = $45,000:

Unrealized Holding Gain or Loss—Income (Purchase Commitments) 45,000

Estimated Liability on Purchase Commitments 45,000

The entry is made because a loss in utility has occurred during the period in which the market
decline took place. The account credited in the above entry should be included among the current
liabilities on the balance sheet with an appropriate note indicating the nature and extent of the
commitment. This liability indicates the minimum obligation on the commitment contract at the
present time—the amount that would have to be forfeited in case of breach of contract.

Q11. The major uses of the gross profit method are: (1) it provides an approximation of the ending
inventory which the auditor might use for testing validity of physical inventory count; (2) it means
that a physical count need not be taken every month or quarter; and (3) it helps in determining
damages caused by casualty when inventory cannot be counted.

Q13. A markup of 25% on cost equals a 20% markup on selling price; therefore, gross profit equals
$1,000,000 ($5 million X 20%) and net income equals $250,000 [$1,000,000 – (15% X $5 million)].

The following formula was used to compute the 20% markup on selling price:

Percentage markup on cost .25

Gross profit on selling price = = = 20%
100% + Percentage markup on cost 1 + .25

Q14. Inventory, January 1, 2025 $ 400,000

Purchases to February 10, 2025 $1,140,000

Freight-in to February 10, 2025 60,000 1,200,000

Merchandise available (TGA) 1,600,000

 Sales revenue to February 10, 2025 1,950,000

Less gross profit at 40% 780,000

Sales at cost (CGS) 1,170,000

Inventory (approximately) at February 10, 2025 (EI) $ 430,000

BRIEF EXERCISE 8.6

1 100 $ 5 $ 500 5% 5/100* X $8,000 = $ 400 $ 4**

2 800 $10 8,000 80% 80/100 X $8,000 = 6,400 $ 8

%

3 100 $15 1,500 15% 15/100 X $8,000 = 1,200 $12

$10,000 $8,000

*$500/$10,000 = 5/100 **$400/100 = $4 Relative Sales Value Allocated Cost Cost/CD

100 CDs x $5 = $ 500 5% $8,000 x 5% = $ 400 $ 400/100 = 4.00/CD

800 CDs x $10 = $8,000 80% $8,000 x 80% = $6,400 $6,400/800 = 8.00/CD
100 CDs x $15 = $1,500 15% $8,000 x 15% = $1,200 $1,200/100 = 12.00/CD
$10,000

BRIEF EXERCISE 8.7

Unrealized Holding Loss (Purchase Commitments) 50,000

Estimated Liability on Purchase 50,000

Commitments ($1,000,000 – $950,000)

BRIEF EXERCISE 8.8

Periodic (Perpetual)

Purchases (Inventory) 950,000

Estimated Liability on Purchase Commitments 50,000

Cash 1,000,000

BRIEF EXERCISE 8.9

Beginning inventory $150,000

Purchases 500,000

Cost of goods available 650,000

Sales revenue $700,000

Less gross profit (35% X 700,000) 245,000

Estimated cost of goods sold 455,000

Estimated ending inventory destroyed in fire $195,000

EXERCISE 8.13

1. 20% = 16.67% OR 16 2/3%.

 100% + 20%

2. 25%
= 20%.
100% + 25%

3. 33 1/3%
= 25%.
100% + 33 1/3%

4. 50%
= 33.33% OR 33 1/3%.
100% + 50%

EXERCISE 8.14
(a) Inventory, May 1 (at cost) $160,000

Purchases (at cost) 640,000

Purchase discounts (12,000)

Freight-in 30,000

Goods available (at cost) 818,000

Sales revenue (at selling price) $1,000,000

Sales returns (at selling price) (70,000)

Net sales (at selling price) 930,000

Less: Gross profit (30% of $930,000) 279,000

Net sales (at cost) 651,000

Approximate inventory, May 31 (at cost) $167,000

(b) Gross profit as a percent of sales must be computed:

30%
= 23.08% of sales.
100% + 30%

Inventory, May 1 (at cost) $160,000

Purchases (at cost) 640,000
Purchase discounts (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales revenue (at selling price) $1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000
Less: Gross profit (23.08% of $930,000) 214,644
Net sales (at cost) 715,356
Approximate inventory, May 31 (at cost) $102,644
 ACCT 5110
Lecture Notes Ch. 8C FINAL
Determining Ending Inventory by Applying the Conventional Retail Inventory Methods (see 1 and 2 below)
Retailers must keep a record of:
Skim the four Businesses that sell a large volume of items with relatively low unit costs use the
- Total cost and retail value of goods
sidebars off conventional retail method. It requires aggregate records at both cost and retail.
to the right purchased;
Multiplying ending inventory at retail by the ratio of aggregate-cost-to-aggregate-retail - Total cost and retail value of goods
provides an estimate of ending inventory at cost and avoids a physical inventory count. available for sale; and
- Sales for the period.

1 Lower of cost or market Conventional Method approximates

an ending inventory at the lower-of-
cost-or-market.

Conventional retail method assumes

that the final inventory and the total
of goods available for sale contain
the same proportion of high-cost and
low-cost goods.

Under the Conventional Method,

markdowns are considered a current
Utility of units have declined loss. As such, they are omitted from
the cost-to-retail ratio, thereby
Goods sold @ lowering the ratio, but are deducted
retail prices
from goods available for sale to
arrive at ending inventory at retail
that approximates the lower-of-cost-
or- market method.
No physical count

Read on your own The cost-to-retail % (67%), above, is the complement of the GP% of 33%
Retailers do not need a record of:
($165K/$500K). Note: 67% is applied to ending inventory at retail after all
- Cost of products sold for the period
markdowns, in effect achieving a lower-of-cost-or-market valuation. The
- Inventory locations
ending inventory cost of $64,588 is $3,600 below original cost and is valued at
an amount which will produce the normal 33% GP% if sold at the present
retail prices, i.e., $64, 588 x 149.25% = $96,400. (Note: a GP% on selling price Question 17
In-Class Exercise BE 8.10
of 33% means a % markup on cost of .33/.67, or 49.25%).

There are different versions of the

2 retail inventory method including the
Cost Method (see chart to the left),
and the LIFO Retail Method, and
the Dollar-value LIFO Retail
Method (see Appendix 8A).

In this class, we will focus only on

the Conventional Method, above,
because it values ending inventory at
lower-of-cost or-market.

A higher cost-to-retail % than the

Conventional Method because
markdowns have been deducted in
calculating “goods available for
sale.” As such, markdowns are
averaged with markups under the
Cost Method, rather than treated as
a loss. To approximate lower-of-
cost-or-market, the Conventional
Retail Method treats markdowns as a
loss and are not included in
calculating the cost-to-retail ratio.
Skim Quick Review Special Items:

Freight-in is added to the cost (not

retail) of purchases

Purchase returns reduce both cost

and retail amounts.

Sales returns are deducted from

By subtracting net
sales at retail prices.
markdowns below the
cost-to-retail sale line, Employee discounts are deducted
the conventional from retail column. Such discounts
method automatically do not reflect a change in sales price.
writes ending inventory Normal shortage is deducted from
down to the lower-of- sales because these goods are no
cost-or market, a GAAP longer available for sale.
requirement.
Abnormal shortage reduce both the
cost and retail columns so as not to
overstate ending inventory and
distort the cost-to-retail ratio.

Skim

Distinct advantage of method for retailers

See Question 17

Good merchandising practice

To determine coverage in case of inventory loss

To prevent the averaging of

different GP% in different
departments In Class Exercises
CPA MC #136, #137
Glossary of Terms for Retail Inventory Method:
Markups – increases in SP above the original SP
Markdowns – decreases in the SP below the original SP
Markups, net – markups net of markup cancellations
Markdowns, net – markdowns net of markdown cancellations

Skim Accounting standards require disclosure of:

 Inventory costing methods used (e.g., LIFO, FIFO, average cost, etc.). “Methods”
 Consistent application of costing methods from one period to the next.
 Inventory financing arrangements (e.g., firm purchase commitments).
 Inventory composition (e.g., RM, WIP, FG) either on the balance sheet or in the footnotes. “Details and
 Inventories pledged as collateral for a loan Composition ”
 Basis on which it states inventory amounts (e.g., lower of-cost-or-market) and the method
used in determining cost (e.g., LIFO, FIFO, average cost, etc.).

Question 18
Q17. (a) Ending inventory:
Cost Retail

Beginning inventory $ 149,000 $ 283,500

Purchases 1,400,000 2,160,000

Freight-in 70,000

Totals 1,619,000 2,443,500

Add net markups Cost-to-Sales =

_________ 92,000
1,619,000/ 2,535.500
or 63.85%
$1,619,000 2,535,500

Deduct net markdowns 48,000

2,487,500

Deduct sales revenue 2,175,000

Ending inventory, at retail $ 312,500

$1,619,000
Ratio of cost to selling price = 63.85% (conservative)
$2,535,500

Ending inventory estimated at cost = 63.85% X $312,500 = $199,531.

(b) The retail method, above, showed an ending inventory at retail of $312,500; therefore,
mer­chandise not accounted for amounts to $17,500 ($312,500 – $295,000) at retail and
$11,174 ($17,500 X .6385) at cost.

Q18. Information relative to the composition of the inventory (i.e., raw material, work-in-process,
and finished goods); the inventory financing where significant or unusual (transactions
with related parties, product financing arrangements, firm purchase commitments,
involuntary liquidations of LIFO inventories, pledging inventories as collateral); and the
inventory costing methods employed (lower-of-cost-or-market, FIFO, LIFO, average cost)
should be disclosed. If Deere and Company uses LIFO, it should also report the LIFO
reserve.

BRIEF EXERCISE 8.10

Cost Retail

Beginning inventory $ 12,000 $ 20,000

Net purchases 120,000 170,000

Net markups 10,000

Totals $132,000 200,000

Cost-to-Sales
Deduct: = 132K / 200K
or 66%
Net markdowns 7,000

Sales revenue 147,000

Ending inventory at retail $ 46,000

 Cost-to-retail ratio: $132,000 ÷ $200,000 = 66%

Ending inventory at lower-of cost-or-market (66% X $46,000) = $30,360

EXERCISE 8.21
Cost Retail

Beginning inventory $ 200,000 $ 280,000

Purchases 1,375,000 2,140,000

Totals 1,575,000 2,420,000
Add: Net markups
Markups $95,000
Markup cancellations _________ (15,000) 80,000
Totals $1,575,000 2,500,000

Deduct: Net markdowns

Markdowns 35,000
Markdowns cancellations (5,000) 30,000
Sales price of goods available 2,470,000
Deduct: Sales revenue 2,200,000
Ending inventory at retail $ 270,000

$1,575,000
Cost-to-retail ratio = = 63%
$2,500,000

Ending inventory at cost = 63% × $270,000 = $170,100

 ACCT 5110
Lecture Notes Ch. 17A FINAL

Old economy produced tangible goods

and services under simple
arrangements. Today’s economy
Contract Asset-Liability Model includes the increasing sale of
intangible goods and services under
complex arrangements (just look at a
cell phone contract).

Companies required to analyze contracts

with customers.
New
Contracts indicate terms (length of time)
New and measurement of consideration ($’s).
New
Without contracts, companies cannot
know whether contract commitments
will be met; i.e., delivery of good or
service (performance obligations) and
collectability of the revenue.

New revenue recognition standard, encompassing these five

steps, is titled “Revenue from Contracts with Customers”
Skim Question 30 Boeing

Bargained Agreement (5)

1. Commercial substance*
2. Parties have approved
3. Their rights are established
4. Payment terms spelled-out
Little change from
5. Collectibility likely
prior standard

Performance obligations are

distinct if
- Customer can benefit from a
good or service on its own
- Transfer of goods or services
* Commercial substance means the are separately identified and
future cash flows will change as a not interdependent
result the transaction

Skim
In Class Exercise BE 17.1 (a)

Calculate total transaction

price, which may include:
- Variable considerations; e.g.,
bonus, discounts, rebates, etc.
- Implicit financing, such as
interest recognized over
implied loan period

Allocate price to performance

obligations based on (1)
standalone prices or (2) a
reasonable estimate if no
standalone price is available
Skim

Little change from

prior standard

Revenue is recognized each

time a good or service is
transferred to the customer and
the customer obtains control
over the transferred item.
-

Identifying Contract – Step 1 Note: Executing a contract does not impact the books of account July 31, 2020:
Dr, Acct. Receivable 5,000
Cr, Sales Revenue 5,000
Facts: On March 1, 2020, Margo Company enters into a contract to transfer a
product to Soon Yoon on July 31, 2020. The contract is structured such that Dr, Cost of Goods Sold 3,000
Cr, Inventory 3,000
Soon Yoon is required to pay the full contract price of $5,000 on August 31,
2020.The cost of the goods transferred is $3,000. Margo delivers the product August 31, 2020
to Soon Yoon on July 31, 2020. Note: No impact to books on March 1 Dr, Cash 5,000
Cr, Account Receivable 5,000

Question: What journal entries should Margo Company make in regard to

this contract in 2020? In Class Exercise BE 17.2

Separate Performance Obligations – Step 2

Assume that General Motors sells an automobile to Marquart Auto Dealers at

If we look at General Motors’
a price that includes six months of telematics services such as navigation and
objective, it appears that it is to
remote diagnostics. These telematics services are regularly sold on a sell two items, the automobile,
standalone basis by General Motors for a monthly fee. After the six-month and the telematics services. Both
period, the consumer can renew these services on a fee basis with General are distinct (they can be sold
separately) and are not
Motors. The question is whether General Motors sold one or two products. interdependent.

SoftTech Inc. licenses customer-relationship software to Lopez Company. In

addition to providing the software itself, SoftTech promises to provide
consulting services by extensively customizing the software to Lopez’s
The SoftTech license and the
information technology environment, for a total consideration of $600,000. consulting services are distinct
In this case, SoftTech is providing a significant service by integrating the but interdependent, and
goods and services (the license and the consulting service) into one combined therefore should be accounted
for as one performance
item for which Lopez has contracted. In addition, the software is significantly
obligation.
customized by SoftTech in accordance with specifications negotiated by
Lopez. Do these facts describe a single or separate performance obligation? Question 11.
In Class Exercises BE17.3, BE17.4,
BE17.5

Determining Transaction Price – Step 3 Variable Consideration (1) Expected Value:

- Probability-weighted amount in a
Facts: Peabody Construction Company enters into a contract with a customer range of possible consideration
amounts.
to build a warehouse for $100,000, with a performance bonus of $50,000
- May be appropriate if a company
that will be paid based on the timing of completion. The amount of the has a large number of contracts
with similar characteristics.
performance bonus decreases by 10% per week for every week beyond the
- Can be based on a limited number
agreed-upon completion date. The contract requirements are similar to of discrete outcomes &
contracts that Peabody has performed previously, and management believes probabilities.

that such experience is predictive for this contract. Management estimates (2) Most Likely Amount:
- Single most likely amount in a
that there is a 60% probability that the contract will be completed by the range of possible outcomes.
agreed-upon completion date, a 30% probability that it will be completed 1 - May be appropriate if the contract
has only two possible outcomes.
week late, and only a 10% probability that it will be completed 2 weeks late.
Question: How should Peabody account for this revenue arrangement?
 Determining Transaction Price – Step 3 Variable Consideration Note: The transaction price in a contract
is often easily obtained because the
Management has concluded that the probability-weighted method (known customer agrees to pay a fixed amount to
the company over a short period of time.
as “Expected Value”) is the most predictive approach:
(3) In the case of a variable
consideration, a firm will only allocate a
60% chance of $150,000 = $ 90,000 Expected Value is generally the variable amount if it is reasonably
30% chance of $145,000 = $ 43,500 best method for predicting a assured that it will be entitled to that
10% chance of $140,000 = $ 14,000 variable consideration. amount. If there is limited information
available, then no variable consideration
$147,500 is recognized until the contract is
completed.
Most likely outcome, if management believes they will meet the deadline (Variable consideration important when we
and receive the $50,000 bonus, the total transaction price would be: study % of completion contacts in Ch. 17B.)

$150,000 (the outcome with 60% probability) In Class Exercises BE 17.6, BE 17.7

Determining Transaction Price – Step 3 Extended Payment Terms Question - solution

Dr, Notes Receivable 1,416,163
Facts: On July 1, 2020, SEK Company sold goods to Grant Company for Cr, Sales Revenue 900,000
Cr, Discount on Notes 516,163
$900,000 in exchange for a 4-year, zero-interest-bearing note with a face
amount of $1,416,163. The goods have an inventory cost on SEK’s books of Dr, COGS 590,000
$590,000. Cr, Inventory 590,000
Similar to NR exercises covered in Ch. 6C Lecture Notes for self-study

Question: How much revenue should SEK Company record on July 1, 2020?
In Class Exercise BE 17.9

Determining Transaction Price – Step 3 Volume Discount Question- solution

Dr, Acct. Receivable 679,000
Facts: Samsung Company offers its customers a 3% volume discount if they Cr, Sales Revenue 679,000
Samsung should reduce its revenue by
purchase at least $2 million of its product during the calendar year. On $21,000 ($700,000 × 3%) because it is
March 31, 2020, Samsung has made sales of $700,000 to Artic Co. In the probable that it will provide this rebate.
If Samsung’s customer fails to meet the
previous 2 years, Samsung sold over $3,000,000 to Artic in the period April 1 discount threshold, Samsung makes the
to December 31. following entry upon payment.

Dr, Cash 700,000

Question: How much revenue should Samsung recognize for the first 3 Cr, Acct Receivable 679,000
Cr, Sales Discounts Forfeited 21,000
months of 2020?
Skim
In Class Exercise BE 17.12
Allocating Transaction Price to Separate Performance Obligations—Step 4

Facts: Handler Company is an established manufacturer of equipment used Boeing

in the construction industry. Handler’s products range from small to large
individual pieces of automated machinery to complex systems containing
numerous components. Unit selling prices range from $600,000 to
$4,000,000 and are quoted inclusive of installation and training. The
installation process does not involve changes to the features of the
equipment and does not require proprietary information about the
equipment in order for the installed equipment to perform to specifications.
Handler has the following arrangement with Chai Company:
Chai purchases equipment from Handler for a price of $2,000,000 and
chooses Handler to do the installation. Handler charges the same price for
the equipment irrespective of whether it does the installation or not. (Some
companies do the installation themselves because they either prefer their
own employees to do the work or because of relationships with other
customers.) The installation service included in the arrangement is estimated
to have a standalone selling price of $20,000. (Continued on next slide)
Handler has the following additional arrangements with Chai Company. If other firms can perform the
installation and training, as the facts
• The standalone selling price of the training sessions is estimated at in this question appear to indicate,
then the installation and training are
$50,000. Other companies can also perform these training services.
separate performance obligations for
• Chai is obligated to pay Handler the $2,000,000 upon the delivery Handler.
and installation of the equipment.
• Handler delivers the equipment on September 1, 2020 and Question: (a)
completes the installation of the equipment on November 1, 2020 Handler’s primary objective is to sell
equipment. The other services
(transfer of control is complete). Training related to the equipment
(installation and training) can be
starts once the installation is completed and lasts for 1 year. The performed by other parties if
equipment has a useful life of 10 years. necessary. As a result, the
equipment, installation, and training
Question: (a) are three separate products or
services. Each of these items has a
What are the performance obligations for purposes of accounting for the
standalone selling price and is not
sale of the equipment? interdependent.
Question: (b)
If there is more than one performance obligation, how should the payment For the homework, be sure to
of $2,000,000 be allocated to various components? determine the objective of the
transaction. If the objective is to
Question: (b) Sales Revenue transfer distinct goods or services,
Handler makes the following entry on November 1, 2020, to record both then account for these performance
obligations separately. Indicators of
sales revenue and service revenue on the installation, as well as unearned
distinct performance obligations are
service revenue. (1) a standalone selling price and (2)
Dr, Cash (A) 2,000,000 Relative Sales Value the goods or services are not highly
Cr, Service Revenue (installation) (OE) 19,324 $.02M / $2.070M = 0.97% x $2M interdependent or interrelated (i.e.,
Cr, Unearned Service Revenue (training) (L) 48,309 $.05M / $2.070M = 2.42% x $2M sells separately).
Cr, Sales Revenue (OE) 1,932,367 $2.0M / $2.070M = 96.62% x $2M

Question: (b)
Question (b) Cost of Goods Sold
The total revenue of $2,000,000
Assuming the cost of the equipment is $1,500,000, the entry to record cost should be allocated to the three
of goods sold is as follows. components based on their relative
standalone selling prices. In this
Dr, Cost of Goods Sold 1,500,000
case, the standalone selling price of
Cr, Inventory 1,500,000
the equipment is $2,000,000, the
As indicated by these entries, Handler recognizes revenue from the sale of installation fee is $20,000, and the
training is $50,000. The total
the equipment once the installation is completed on November 1, 2020. In
standalone selling price therefore is
addition, it recognizes revenue for the installation fee because these services $2,070,000 ($2,000,000 + $20,000 +
have been performed. $50,000). The allocation is as
follows.
Handler recognizes the training revenue on a straight-line basis starting on
November 1, 2020, or $4,026 ($48,309 ÷ 12) per month for 1 year (unless a Equipment $1,932,367 [($2,000,000
more appropriate method such as the percentage-of-completion method— ÷ $2,070,000) × $2,000,000]

discussed in Ch. 17B—is warranted). The journal entry to recognize the Installation $19,324 [($20,000 ÷
training revenue for 2 months in 2020 is as follows. $2,070,000) × $2,000,000]
Dr, Unearned Service Revenue (L) 8,502 Training $48,309 [($50,000 ÷
Cr, Service Revenue (training) ($4,026 × 2) (OE) 8,502
$2,070,000) × $2,000,000]

Recognizing Revenue as each Performance Obligation is Satisfied—Step 5

Company satisfies its performance obligation when the customer obtains
control of the good or service. “Change in Control” Indicators:
1. Company has a right to payment for asset. Little change from
2. Company has transferred legal title to asset. prior standard

3. Company has transferred physical possession of asset.

4. Customer has significant risks and rewards of ownership. Question 11, 19
5. Customer has accepted the asset. In Class Exercise BE 17.8
 Accounting for Revenue Recognition Issues – Sales Returns and Allowances
Basics covered in Ch. 6;
Supplemental Content: Review for Homework JE detail provided here.

January 12, 2020:

Little change from Dr, Acct. Receivable 10,000
prior standard Cr, Sales Revenue 10,000

Dr, Cost of Goods Sold 6,000

Cr, Inventory 6,000

January 24, 2020

Dr, Sales Returns 200
Cr, Account Receivable 200

Dr, Returned Inventory 120

Cr, Cost of Goods Sold 120

January 31, 2020

Dr, Sales Returns 100
Cr, Allowance for Sales Returns 100

Dr, Est. Inventory Returns 60

Cr, Cost of Goods Sold 60

In Class Exercise BE 17.13

Skim Accounting for Revenue Recognition Issues – Repurchase Agreement New to standard, but already covered in Ch. 7A, p.3

Facts: Morgan Inc., an equipment dealer, sells equipment on January 1, 2020, to Lane
Repurchase agreement allows a
Company for $100,000. It agrees to repurchase this equipment on December 31, company to transfer an asset to a
2021, for a price of $121,000. customer but to retain the right (or
Question: How should Morgan Inc. record this transaction? obligation) to repurchase the asset
at a later date.
Assuming an interest rate of 10 percent is imputed from the agreement, Morgan
makes the following entry to record the financing on January 1, 2020. If the right to repurchase the asset
is for an amount greater than or
Dr, Cash 100,000 equal to the selling price, then the
Cr, Liability to Lane Company 100,000 transaction is a financing
transaction.
Morgan Inc. records interest on December 31, 2020, as follows.
In this example, Morgan continues
Dr, Interest Expense 10,000 to control the asset because it has
Cr, Liability to Lane Company ($100,000 × 10%) 10,000 agreed to repurchase the asset at an
amount greater than the selling
Morgan Inc. records interest and retirement of its liability to Lane Company on price. Therefore the transaction is
December 31, 2021, as follows. a financing transaction and not an
outright sale. For this reason, the
Dr, Interest Expense 11,000 asset is not removed from the books
Cr, Liability to Lane Company ($110,000 × 10%) 11,000 of Morgan.

Dr, Liability to Lane Company 121,000 Note: There is no earnings impact

Cr, Cash ($100,000 + $10,000 + $11,000) 121,000 based on the terms of the
repurchase agreement.

Accounting for Revenue Recognition Issues – Bill and Hold New

Facts: Butler Company sells $450,000 (cost $280,000) of fireplaces on March 1, 2020, Bill and Hold: A contract under which
an entity bills a customer for a product,
to a local coffee shop, Baristo, which is planning to expand its locations around the but the entity retains physical
city. Under the agreement, Baristo asks Butler to retain these fireplaces in its possession until a future point in time.
warehouses until the new coffee shops that will house the fireplaces are ready. Title Bill-and-hold sales result when buyer is
passes to Baristo at the time the agreement is signed. not yet ready to take delivery (because it
has no space for the product or because
of delays in its production schedule) but
Question: When should Butler recognize the revenue from this bill-and-hold
does take title and accepts billing.
arrangement?
 For Baristo to have obtained control of a product in a bill-and-hold arrangement, all of In this case, it appears that the required
criteria were met, and therefore revenue
the following criteria should be met:
recognition should be permitted at the
(a) The reason for the bill-and-hold arrangement must be substantive. time the contract is signed.
(b) The product must be identified separately as belonging to Baristo.
Butler makes the following entry to
(c) The product currently must be ready for physical transfer to Baristo. record the sale on March 1, 2020.
(d) Butler cannot have the ability to use the product or to direct it to another
Dr, Acct. Receivable 450,000
customer.
Cr, Sales Revenue 450,000

Butler has transferred control (Step 5 of new Revenue Recognition Standard) to Dr, Cost of Goods Sold 280,000
Baristo; i.e., Butler has a right to payment and legal title has transferred. Cr, Inventory 280,000

Little change from In Class Exercise BE 17.15

Accounting for Revenue Recognition Issues – Principle-Agent
prior standard
Agent’s performance obligation is to arrange for principal to provide goods or
services to a customer. Examples:
• Travel Company (agent) facilitates booking of cruise for Cruise
Company (principal).
• Priceline (agent) facilitates sale of various services such as car rentals
at Hertz (principal).
Amounts collected on behalf of the principal are not revenue of the agent.
• Revenue for agent is amount of commission received, nothing more. In Class Exercise BE 17.11, BE 17.16

Question 30. Under the asset-liability model for recognizing revenue, companies
recognize assets and liabilities according to the definitions of assets and liabilities in
a revenue arrangement. For example, when a company has a right to consideration
for meeting a performance obligation, it has a right to consideration from the
customer and therefore has a contract asset. A contract liability is a company’s
obligation to transfer goods or services to a customer for which the company has
received consideration from the customer. Thus, if the customer performs first, by
Contract Liability – No Change
prepaying for the product, then the seller has a contract liability. Companies must
present these contract assets and contract liabilities on their balance sheet. Contract
assets are of two types: (a) Unconditional rights to receive consideration because
the company has satisfied its performance obligation with the customer, and (b)
Conditional rights to receive consideration because the company has satisfied one
performance obligation but must satisfy another performance obligation in the
contract before it can bill the customer. Companies should report unconditional
rights to receive consideration as a receivable on the balance sheet. Conditional Dr, Contract Asset (New)
rights on the balance sheet (e.g., unbilled receivables) should be reported separately Cr, Sales Revenue

as contract assets.

BRIEF EXERCISE 17.1

(a) In applying the 5-step process, it appears that a valid contract exists between Leno
Computers and Fallon Electronics for the following reasons:
1. The contract has commercial substance—Fallon Electronics has agreed to pay cash
for the computers.
2. The parties have approved the contract and are committed to perform—Fallon
Electronics has made a commitment to purchase the computers and Leno has
approved the selling of the computers. In fact, Leno has delivered the computers to
Fallon.
3. The identification of the rights of the parties—Fallon has the right to the computers and
Leno has the right to payment.
4. The identification of the payment terms—Fallon has agreed to pay $20,000 within 30
days for the computers.
5. It is probable that the consideration will be collected—although no cash has yet been
paid by Fallon. Fallon has a good credit rating which indicates that the consideration
will be collected.
Questions

11. In this situation, it appears that Engelhart has two performance obligations: (1) one related to
providing the tractor and (2) the other related to the GPS services. Both are distinct (they can be
sold separately) and are not interdependent.

19. Since each element sells separately and has a separate standalone selling price, the
equipment, installation, and training are three separate performance obligations.
The total revenue of $80,000 should be allocated to the three performance obligations based on
their relative standalone selling price.
Thus, the total estimated selling price is $100,000* ($90,000 + $7,000 + $3,000). The allocation is as
follows:
Equipment ($90,000 ÷ $100,000) X $80,000 = $72,000. Contact asset 72K
Installation ($7,000 ÷ $100,000) X $80,000 = $5,600. Revenue 72K
Training ($3,000 ÷ $100,000) X $80,000 = $2,400.

BRIEF EXERCISE 17.2

No entry is required on May 10, 2025, because neither party has performed under the contract and
either party may terminate the contract without compensatory damages. On June 15, 2025, Cosmo
delivers the product and therefore, should recognize revenue as Cosmo satisfies its performance
obligation by delivering the product to Greig.

The journal entry to record the sale and related cost of goods sold is as follows.

June 15, 2025

Accounts Receivable ............................................................................................... 2,000

Sales Revenue ............................................................................................... 2,000

Cost of Goods Sold .................................................................................................. 1,300

Inventory ........................................................................................................ 1,300

After receiving the cash payment on July 15, 2020, Cosmo makes the following entry.

July 15, 2025

Cash ................................................................................................................2,000
Accounts Receivable .................................................................................... 2,000

BRIEF EXERCISE 17.3

There is one performance obligation in this situation, which is the providing of the licensed software
and custom support together. Both the software license and the custom customer support services
are distinct, but they are not distinct within the contract. It appears that Hillside’s objective is to
transfer a combined product. That is, the customer support services are highly interrelated and
interdependent with the licensed software and therefore, these customer support services should
be combined with the licensed software in determining the performance obligation.

BRIEF EXERCISE 17.4

Three performance obligations exist in this contract—manufacture of the 3-D printer, installation
services and the maintenance services. Destin does clearly have a performance obligation for the
manufacture of the 3-D printer. Destin may or may not have a performance obligation for the
installation of the 3-D printer as installation can be done by another company. In other words, there
is no indication that customization is required by Destin. Also, Destin may or may not have a
separate performance obligation for the maintenance agreement, as it can be provided by other
companies. In summary, there are three performance obligations related to this contract, some of
which may end up being performed by companies other than Destin.
BRIEF EXERCISE 17.5

Ismail accounts for the bundle of goods and services as a single performance obligation because
the goods or services in the bundle are highly interrelated. Ismail also provides a significant service
by integrating the goods or services into the combined item (that is, the hospital) for which the
customer has contracted. In addition, the goods or services are significantly modified and
customized to fulfill the contract. In other words, the company’s objective is to transfer a combined
item. Revenue for the performance obligation would be recognized over time by selecting an
appropriate measure of progress toward satisfaction of the performance obligation.

BRIEF EXERCISE 17.6

The transaction price should include management’s estimate of the amount of consideration to
which the entity will be entitled. Given the multiple outcomes and probabilities available based on
prior experience, the probability-weighted method is the most predictive approach for estimating
the variable consideration in this situation:

Completion Date Probability Expected Value

August 1 70% chance of $1,150,000 = $ 805,000
August 8 20% chance of $1,100,000 = 220,000
August 15 5% chance of $1,050,000 = 52,500
After August 15 5% chance of $1,000,000 = 50,000
$1,127,500

Thus, the total transaction price is $ 1,127,500 based on the probability-weighted estimate.

BRIEF EXERCISE 17.7

(a) In this situation, Nair uses the most likely amount as the estimate - $1,150,000.

(b) When there is limited information with which to develop a reliable estimate of completion,
then no revenue related to the incentive should be recognized until the uncertainty is
resolved. Therefore, no revenue is recognized until the completion of the contract, with a
transaction price of $1,000,000.

BRIEF EXERCISE 17.8

(a) Groupo would recognize revenue of $1,000,000 at delivery.

(b) Groupo would recognize revenue of $800,000 at the point of sale.

(c) Groupo would recognize revenue of $464,000 at the point of sale and recognize interest
revenue of $36,000 ($500,000 - $464,000) over the payment period.

BRIEF EXERCISE 17.9

January 2, 2025

Notes Receivable ......................................................................................... 11,000

Discount on Notes Receivable ........................................................ 1,000
Sales Revenue .................................................................................. 10,000

Cost of Goods Sold .................................................................................... 6,000

Inventory .......................................................................................... 6,000

Revenue Recognized in 2025

Sales revenue.............................................................................................. $ 10,000

Interest revenue ($11,000 – $10,000) ......................................................... 1,000
Total revenue.................................................................................... $ 11,000
BRIEF EXERCISE 17.11

January income ............................................................................................ $ 0

February income ($4,000 – $3,000) X .50 ................................................... $500
March income ($4,000 – $3,000) X .30) ....................................................... $300
April income ($4,000 – $3,000) X .20) ......................................................... $200

BRIEF EXERCISE 17.12

Manual reduces revenue by $6,600 ($110,000 X .06) because it is probable that it will provide rebates
amounting to 6%. As a result, Manual recognizes revenue of $103,400 ($110,000 - $6,600) in the first
quarter of the year.

BRIEF EXERCISE 17.13

July 10, 2025

Accounts Receivable .................................................................................. 700,000

Sales Revenue .................................................................................. 700,000

Cost of Goods Sold ..................................................................................... 560,000

Inventory ........................................................................................... 560,000

October 11, 2025

Sales Returns and Allowances .................................................................. 78,000

Accounts Receivable ....................................................................... 78,000
Returned Inventory ..................................................................................... 62,400
Cost of Goods Sold
[($560,000 ÷ $700,000) x $78,000] ................................................ 62,400

October 31, 2025

No entries are needed as the return period has expired.

BRIEF EXERCISE 17.15

When to recognize revenue in a bill-and-hold arrangement depends on the circumstances. Mills

determines when it has satisfied its performance obligation to transfer a product by evaluating when
ShopBarb obtains control of that product. For ShopBarb to have obtained control of a product in a
bill-and-hold arrangement, all of the following criteria should be met:

(a) The reason for the bill-and-hold arrangement must be substantive.

(b) The product must be identified separately as belonging to ShopBarb.
(c) The product currently must be ready for physical transfer to ShopBarb.
(d) Mills cannot have the ability to use the product or to direct it to another customer.

In this case, the criteria are assumed to be met. As a result, revenue recognition should be permitted
at the time the contract is signed. Mills makes the following entry to record the bill and hold sale.

June 1, 2025

Accounts Receivable .................................................................................. 200,000

Sales Revenue .................................................................................. 200,000

Cost of Goods Sold ..................................................................................... 110,000

Inventory ........................................................................................... 110,000
Mills makes the following entry to record the cash received.

September 1, 2025

Cash ............................................................................................................ 200,000

Accounts Receivable ....................................................................... 200,000

If a significant period of time elapses before payment, the accounts receivable is discounted. In
addition, if one of the four conditions is violated, revenue recognition should be deferred until the
goods are delivered to ShopBarb.

BRIEF EXERCISE 17.16

(1)
Cash ............................................................................................................... 70,000
Accounts Payable (ShipAway Cruise Lines) ....................................... 70,000

(2)
Accounts Payable (ShipAway Cruise Lines) .............................................. 70,000
Sales Revenue ($70,000 X .06) .............................................................. 4,200
Cash......................................................................................................... 65,800
ACCT 5110
Lecture Notes Ch. 17B FINAL
Supplemental Content:
Accounting for Revenue Recognition Issues – Consignments Review for Homework

Little change from Basics covered in Ch. 7;

prior standard JE detail provided here.

Manufacturers (or wholesalers)

deliver goods but retain title to the
goods until they are sold.

Consignor (manufacturer or
wholesaler) ships merchandise to
the consignee (dealer), who is to act
as an agent for the consignor in
selling the merchandise.

Consignor makes a profit on the

sale. Carries merchandise as
inventory.

Consignee makes a commission on

the sale.

Note: Inventory cost includes

shipping cost to consignee.

Revenue is recognized when the

goods are sold to a third party.
Until the sale, the goods remain in
the consignor’s inventory because
title and risk of loss stays with the
consignor even though the
consignee holds the goods. Title
passes directly to the third-party
buyer at the time of sale, not
through the consignee.

In Class Exercise BE 17.17

Accounting for Revenue Recognition Issues – Warranties

Facts: Maverick Company sold 1,000 Rollomatics on October 1, 2020, at total price of Two types of customer warranties:
$6,000,000, with a warranty guarantee that the product was free of defects. The cost 1. Product meets agreed-upon
of the Rollomatics is $4,000,000. The term of this assurance warranty is 2 years, with specifications in contract at time
product is sold. Warranty is
an estimated cost of $80,000. In addition, Maverick sold extended warranties related
included in sales price (assurance-
to 400 Rollomatics for 3 years beyond the 2-year period for $18,000. On November type warranty).
22, 2020, Maverick incurred labor costs of $3,000 and part costs of $25,000 related to 2. Not included in sales price of
the assurance warranties. Maverick prepares financial statements on December 31, product (service-type warranty) but
2020. It estimates that its future assurance warranty costs will total $44,000 at is a separate service recorded as a
December 31, 2020. distinct performance obligation.
 Little change from
prior standard Additional Journal Entries

To record assurance warranty costs

incurred on November 22, 2020:
Dr, Warranty Expense 28,000
Cr, Salaries Payable 3,000
Cr, Parts Inventory 25,000

To record the adjusting entry related to its

assurance warranty at the end of the year,
December 31, 2020:
Dr, Warranty Expense 44,000
Cr, Warranty Liability 44,000
Service-type Warranty
Note: Unearned service-type warranty
will be amortized over the two-year service
period and the associated warranty costs
are expensed as incurred.

In Class Exercise BE 17.18

Accounting for Revenue Recognition Issues – Nonrefundable Upfront Fees

Payments from customers before The upfront payment should be

New allocated over the periods benefited.
• Delivery of a product
For example:
• Performance of a service If a health club required a
nonrefundable membership fee of
Generally relate to initiation, activation, or setup of a good or service to be provided
$360 as part of a renewable one-year
or performed in the future. membership in the club, and
members normally renewed twice,
Most cases, upfront payments are nonrefundable. Examples include:
then the upfront fee would be
• Membership fee in a health club allocated and recognized monthly
• Activation fees for phone, Internet, or cable over three years ($360 / 36 months =
$10/month).

Presentation and Disclosure of Revenue In Class Exercise BE 17.20

New Contract assets are of two types:

1. Unconditional rights to receive

consideration because
company has satisfied its
performance obligation.

2. Conditional rights to receive

consideration because
company has satisfied one
performance obligation but
must satisfy another
performance obligation before
it can bill the customer.
 Conditional rights on the balance
sheet should be reported
separately as contract assets.

The term “accounts receivable”

reflects unconditional rights to
receive consideration, while the
term “contract assets” reflects
conditional rights to receive
consideration.

Presentation – Contract Liability

Facts: On March 1, 2020, Henly Company enters into a contract to transfer a product
to Propel Inc. on July 31, 2020. It is agreed that Propel will pay the full price of
$10,000 in advance on April 15, 2020. Henly delivers the product on July 31, 2020.
The cost of the product is $7,500.
No entry is required on March 1,
2020 because neither party has
Question: What journal entries are required in 2020?
performed on the contract.

Companies are not required to use

the terms “contract assets” or
“contract liabilities” on the
balance sheet if more descriptive
titles are available.

In Class Exercise E17-28; BE 17.19

 Supplemental Content:
Contract Modifications Review for Homework

Separate Performance Obligation Contract Modifications represent

Accounted for as a new contract if both of the following conditions are satisfied: a change in contract terms while
the contract is ongoing.
1. Promised goods or services are distinct (i.e., company sells them separately and
they are not interdependent with other goods and services), and Companies must determine (1)
whether a new contract (and new
2. The company has the right to receive an amount of consideration that reflects performance obligations) results
the standalone selling price of the promised goods or services. or (2) whether it is a modification
of an existing contract.
Otherwise, the modification reflects a change to an existing contract.

Prospective Modifications:

Prospective Modification Company should account for the

effect of a contract modification in
For Crandall, the amount recognized as revenue for each of the remaining the period of change, as well as
products would be a blended price of $98.33, computed as shown in below. future periods, if change affects
both.
Products not delivered under original contract ($100 × 40) = $4,000 All previously reported results
Products to be delivered under contract modification ($95 × 20) 1,900 remain the same.
=
Total remaining revenue $5,900

Revenue per remaining unit ($5,900 ÷ 60) = $98.33 Blended price

Blank Revenue Separate Performance Obligation

vs. Prospective Modifications
Revenue Recognized Recognized After Total Revenue
Prior to Modification Modification Recognized - New contract, same revenue

Separate $6,000 $5,900 $11,900 - Old contact, same revenue

performance However a blended price is used
obligation for sales in the periods after the
modification under the prospective
No separate $6,000 $5,900 $11,900 approach.
performance
obligation —
prospectively
In Class Exercise BE 17.21

For Crandall, the amount recognized as revenue for each of the remaining
products would be a blended price of $98.33, computed as shown in below.
 Two methods of accounting for
revenue over time:
New Topic
1. Percentage-of-Completion Method
- Recognize revenues and gross
1.
profits each period based on the
progress of the construction
- Buyer and seller have enforceable
rights

2. Completed-Contract Method
- Recognize revenues and gross
Total contract price
profit only at the point of sale
= Est. total revenue
when the contract is completed
- No interim charges or credits to
income statement accounts for
revenues, costs, or gross profit.

Hardhat Construction Company has a contract to construct a

$4,500,000 bridge at an estimated cost of $4,000,000. The Note that the estimated cost has been
contract is to start in July 2020,
2025 and the bridge is to be revised from 4,000,000 to 4,050,000

completed in October 2022. 2027 The following data pertain to the

construction period.
Blank 2020
2025 2021
2026 2022
2027

Costs to date $1,000,000 $2,916,000 $4,050,000 Revenues, costs, and profit by year:
2025
Estimated costs to complete 3,000,000 1,134,000 -
Revenues (25% x 4.5M) 1,125,000
Progress billings during the year 900,000 2,400,000 1,200,000 Costs 1,000,000
Gross profit 125,000
Cash collected during the year 750,000 1,750,000 2,000,000
2026
Revenues (72% x 4.5M) 3,240,000
Costs 2,916,000
Gross profit 324,000
Less: already recognized profit (125,000)
2026 Gross profit 199,000
2027
Revenues (100% x 4.5M) 4,500,000
Costs 4,050,000
Gross profit 450,000
Less: already recognized profit (324,000)
2027 Gross profit 126,000

In-Class Exercises: CPA MC 124, 125, 126

2025 2026 2027 Based on the above data, Hardhat would

make the accompanying journal entries as
well as the following entries for costs/profit.
2025
Construction in Process (GP) 125,000 (A)
Construction in Process 1,000,000
Revenue 1,125,000
2026
Construction in Process (GP) 199,000 (A)
Construction in Process 1,916,000
Contra-Asset Revenue 2,115,000
2027
Construction in Process (GP) 126,000 (A)
Construction in Process 1,134,000
Revenue 1,260,000
 To close project:
Billings on Construction in Process 4.5M
2025
12/31/27 Construction in Process 4.5M
2025
Note that the account Construction in
2026
Process includes both Construction Costs
2026 and Gross Profit, nominal accounts that are
2027 closed at the completion of the contract.
2027
Also note that only income statement
accounts will show at 12/31/2027, because
the project is done, eliminating the balance
sheet accounts.

In Class Exercise BE 17.22

2025
See Kieso, p. 17-45, for F/S presentations
for Year 2 (2026) and Year 3 (2027).
2025

Subtracting the balance in the Progress

2025 Billings account from Construction in
Process avoids double-counting inventory.
Over the life of the contract, the difference
between Construction in Process and
Billings on Construction in Process, if a
debit, is reported as a current asset (as is the
case in 2025) or as a current liability if the
difference is a credit.

2. Cost Recovery Method (formerly known as Completed Contract Method)

Under the Cost-Recovery Method,
Hardhat would recognize gross profit
only in the year of project completion
(See Year 2027 row in slide to the left).
2025

See Journal Until then, revenue is recognized

Entries: Cost- annually only to the extent that
Recovery Method,
construction costs have been incurred.
below
2026

For progress billings, and collections

from customers, Hardhat would make
similar annual journal entries to those
2027
illustrated under the percentage-of-
completion method, above.

Hardhat Construction Company

Comparison of Gross Profit Recognized under Different Methods Income Statement
as of 12-31-2027

Cost-Recovery Revenue from Long-term Contracts:

2025 $1,584,000
2026 Costs of Construction 1,134,000
2027 Gross Profit $ 450,000
 Journal Entries: Cost-Recovery Method
2025 2026 2027

In Class Exercises BE 17.23, BE 17.24

BRIEF EXERCISE 17.17

Cash ......................................................................................................................... 18,850*

Advertising Expense ................................................................................................ 500
Commission Expense ($21,500 X .10) .................................................................... 2,150
Revenue from Consignment Sales .............................................................. 21,500

*[$21,500 – $500 – ($21,500 X .10)]

Cost of Goods Sold .................................................................................................. 13,200

Inventory on Consignment
[.60 X ($20,000 + $2,000)] ........................................................................... 13,200

BRIEF EXERCISE 17.18

Amounts Reported in Income

Sales revenue .............................................................................................. $1,000,000
Warranty Expense ....................................................................................... 40,000

Amounts Reported on the Balance Sheet

Unearned Service Revenue ........................................................................ $ 12,000

Cash ($1,000,000 + $12,000) ....................................................................... 1,012,000
Warranty Liability ........................................................................................ 40,000

Because the transaction takes place at the end of the year, which is a reporting date, (assurance-
type) warranty expense and warranty liability are reported at their estimated amounts.

The company recognizes revenue related to the service type warranty over the two-year period that
extends beyond the assurance warranty period (two years). In most cases, the unearned warranty
revenue is recognized on a straight-line basis and the costs associated with the service type
warranty are expensed as incurred.

BRIEF EXERCISE 17.19

No entry is required on May 1, 2025 because neither party has performed on the contract. On June
15, 2025, Eric agreed to pay the full price and therefore, Mount has an unconditional right to those
funds on that date.

On receiving the cash on June 15, 2020, Mount records the following entry.

June 15, 2025

Cash ............................................................................................................ 25,000

Unearned Sales Revenue................................................................. 25,000

On satisfying the performance obligation on September 30, 2017, Mount records the following entry
 September 30, 2025

Unearned Sales Revenue ........................................................................... 25,000

Sales Revenue .................................................................................. 25,000

BRIEF EXERCISE 17.20

The initiation fee may be viewed as separate performance obligation because it provides a renewal
option at a lower price than normally charged. As a result, BlueBox is providing a discounted price
in the subsequent years. This should be reflected in the revenue recognized in all four periods. In
this situation, in the total transaction price is $280 ([($5 X 12) X 3] + $100). In the first year (2020),
BlueBox would report revenue of $70 ($280 ÷ 4). The initiation fee is allocated over the entire four-
year period.

BRIEF EXERCISE 17.21

In evaluating how to account for the modification, Stengel Co. concludes that the remaining
services to be provided are distinct from the services transferred on or before the date of the
contract modification. In addition, Stengel has the right to receive an amount of consideration that
reflects the standalone selling price of the reduced menu of maintenance services. Therefore,
Stengel allocates the new transaction price of $80,000 to the third year of service. In effect, Stengel
should account for this modification as a termination of the original contract and the creation of a
new contract.

*BRIEF EXERCISE 17.22

Construction in Process (Asset) ................................................................ 1,700,000

Materials, Cash, Payables................................................................ 1,700,000

Accounts Receivable .................................................................................. 1,200,000

Billings on Construction in Process (contra-asset) ...................... 1,200,000

Cash ............................................................................................................ 960,000

Accounts Receivable ....................................................................... 960,000

Construction in Process (A) (Gross Profit)

($2,000,000 X .34) ........................................................................... 680,000
Construction in Process) (Costs) (I/S ........................................................ 1,700,000
Revenue from Long-Term Contracts (I/S)
($7,000,000 X .34*) ......................................................................... 2,380,000
*[$1,700,000 ÷ ($1,700,000 + $3,300,000)] = 34%

*BRIEF EXERCISE 17.23

Current Assets
Accounts receivable......................................................................... $240,000
Inventories
Construction in process ....................................................... $1,715,000
Less: Billings ........................................................................ 1,000,000
Costs in excess of billings ........................................................ 715,000
*BRIEF EXERCISE 17.24

(a) Construction Expenses ................................................................... 285,364

Construction in Process ($265,364 - $285,364)................... 20,000*
Revenue from Long-Term Contracts ................................... 265,364**

(b) Loss from Long-Term Contracts..................................................... 20,000*

Construction in Process ....................................................... 20,000
*[$420,000 – ($278,000 + $162,000)]

**$420,000 X [$278,000/($278,000 + $162,000)]

Exercise 17.28

(a) No entry – neither party has performed on the contract on January 1, 2025.

(b) The entries to record the sale and related cost of goods sold of the wiring base are as follows:

February 5, 2025

Contract Asset 1,200

Sales Revenue 1,200

Cost of Goods Sold 700

Inventory 700

(c) The entries to record the sale and related cost of goods sold of the shelving unit are as follows:

February 25, 2025

Cash 3,000
Contract Asset 1,200
Sales Revenue 1,800

Cost of Goods Sold 320

Inventory 320
 ACCT 3110
WHITE BOARD NOTES
CHAPTER 7

Dollar-Value LIFO and the Liquidation of LIFO Layers

Dollar-value LIFO largely reduces or eliminates the LIFO liquidation issue because it allows
Factoring
inventory items that are “similar without
in nature Recourse
and similar in use” to be accounted for in a single
pool, a much wider range of goods than allowed under the specific-goods pooled approach (in
which goods must be “substantially alike” to be pooled). Often one pool alone may contain a
firm’s entire inventory, thus eliminating LIFO layers almost entirely and any LIFO liquidation
problem, namely, selling inventory items from older layers and at a cost less than today’s
prices. When the erosion of LIFO layers happens, it defeats the whole purpose of LIFO; i.e., to
reduce income taxes by reporting COGS at near current prices.

Research shows that most companies over the past thirty-plus years have avoided the specific-
goods pooling approach, in which inventory items must be nearly identical to be included in a
pool, and have opted instead for dollar-value LIFO to avoid the liquidation of LIFO layers and
the higher income taxes that result.

“similar in nature and similar in use”

e.g., aluminum, magnesium, and titanium

“substantially alike”

e.g., Honeycrisp, Golden Delicious, and Granny Smith apples

 ACCT 5110
WHITE BOARD NOTES
CHAPTER 8

1. Inventory valuation to determine if market value is less than cost

LC/NRV: FIFO, Average Cost, Specific Identification (Market = NRV)

LC/M: LIFO only. Market = NRV (market ceiling), or NRV (-) GP (market floor), or replacement cost
Array three amounts in descending order of value and select middle amount as FMV

2. Gross Profit Method – Board Template (based on Ch. 8, Question #14)

400K Beg. Balance

1.2M + Purchases
K
1.6M = TGA
K //////////////////////
1.95M Sales TGA (-) Sales @ cost = Ending Inventory @ cost
K1.95 (-) GP*
1.6M (-) 1.17M = 430K
1.17M = Sales @ cost
*(GP% x Sales)

3. Conventional Retail Inventory Method – Board Template

Cost Retail
Beginning Inventory Balance
+ Purchases
+ Freight-in
+ Mark-ups, Net _____ ______
= TGA Cost-to-Retail %
(-) Sales
Blank
(-) Markdowns, Net Blank ______
= Ending Inventory @ retail Blank (times Cost-to-Retail %)

4. Review

Standard costing methods (to determine COGS and EI)

LIFO; FIFO; Average Cost; Specific Identification

Special LIFO issues

LIFO Reserve: Useful when one firm uses FIFO and another LIFO.
LIFO Liquidation: Increases taxes in periods of rising prices, defeating purpose of LIFO.
Dollar Value LIFO: GAAP allows a broader range of goods in a dollar-value pool, mitigating LIFO liquidation

Special Costing Methods

NRV (controlled market, costs difficult to determine)

Relative Sales Value (“basket purchases”)
Gross Profit Method (for interim financial statements, lost inventory)
Conventional Retail Inventory Method (used to arrive at LCM)

Special Inventory Problems

Purchase Commitments (All must be disclosed)

 ACCT 5110
WHITE BOARD NOTES
CHAPTER 17

A. New Revenue Recognition Standard: Introduction to 5-Step Process

1) Valid Contract: Are all five required contract elements present?
2) Performance Obligations: Are they distinct or interdependent ?
- Criteria: If there is a standalone sales price or if another vendor can provide the
good/service, then a distinct obligation is indicated.
3) Contract Price: Is it a fixed price or are variable considerations involved?
- If variable considerations are indicated, then use Expected Value or Most Likely Amount
to determine Contract Price
4) Allocation of Contract Price: How should price be allocated to each performance obligation?
- Compute allocation based on relative sales price of each performance obligation
5) Revenue Recognition: Has the customer obtained control of the good or service?

B. Allocating Transaction Price to Separate Performance Obligations—Step 4

If Chai did not pay cash on the sale of the equipment but instead requested credit from
Handler, then until the installation was complete, Handler would record a Contract Asset (see Q. 30),
not an AR, because the equipment and installation performance obligations are interrelated.
Dr, Contract Asset* $1,932,367 New, additional JE
Cr, Revenue $1,932,367

Once the installation has been completed, the Contract Asset would be converted to an AR.

Dr, Accounts Receivable $1,932,367

Cr, Contract Asset* $1,932,367 *In this case, an unbilled receivable

Dr, Account Receivable $19,324

Cr, Revenue $19,324

C. Seven Revenue Recognition Issues

1) Credit Sales with returns/allowances: No real change (covered in Ch. 7)

2) Repurchase Agreements: Financing transaction, not a sale. Asset remains on seller’s books

3) Bill & Hold: Control must transfer to buyer for revenue to be earned by seller

4) Principal/Agent: Agent earns commission by selling services of Principal

- All cash from customers remitted by the Agent to the Principal but for Agent’s commission

5) Consignments: No change (covered in Ch. 7 with additional details in Ch. 17)

6) Warranties: No change (to be covered in further detail in ACCT 5120)

- Estimate and record warranty expense at period-end for assurance-type warranties
- Amortize revenue as earned (based on passage of time) on service-type warranties and
recognize warranty expenses as they are incurred

7) Nonrefundable Fees: Allocate upfront fees over periods projected to benefit

D. Long-term Contractor’s Accounting: % of Completion

1) Computation of CY Contract Costs (MC #124)

- % of Completion = Contract Costs incurred to date / Total Est. Contract Costs at Completion
- Total Contract Costs incurred to date = % of Completion x Total Est. Contact Costs at Completion
- CY Contract Cost = Total Contract Costs incurred to date (-) Contract Costs recognized in prior years

2) Computation of Gross Profit for a given year (MC #125)

- Total Est. Contract Costs at Completion = Contract Costs incurred to date + Est. Costs to complete
- % of Gross Profit = Contract Costs incurred to date / Total Est. Costs to complete
- Estimated Gross Profit = Contract Price (-) Total Est. Contract Costs at Completion
- CY Gross Profit = % of Gross Profit x Estimated Gross Profit
 ACCT 5110
WHITE BOARD NOTES
CHAPTER 7 REVIEW: KEY TOPICS

Cost of Goods Sold Model Analytical format used extensively in Ch. 7 but
Beginning inventory only for the Periodic Method – it is not needed for
+ Purchases_________________ the Perpetual Method other than to validate the
Cost of goods available for sale inventory count for audit purposes – to accomplish
our two inventory costing objectives (to determine
- Ending inventory___________
COGS and the EI balance). The format is applicable
= Cost of goods sold
to all three major inventory costing techniques:
FIFO, LIFO, and average cost.

Purpose of the LIFO Reserve:

To provide the capability to compare companies when one company uses LIFO
and the other FIFO. See discussion in Kieso, p. 7-24.

LIFO Reserve: Steps to Compute and Report

1. LIFO Reserve = FIFO EI $ (-) LIFO EI $

2. LIFO Reserve is tracked in the Allowance to Reduce Inventory to LIFO

account, a contra asset account.

3. The change in the LIFO Reserve from one period to the next is known
as the LIFO Effect.

4. LIFO Effect = Dec. 31 LIFO Reserve (-) Jan. 01 LIFO Reserve

5. JE to reduce Inventory to LIFO based on LIFO Effect:

Dr, Cost of Goods Sold (Income Stmt.)

Cr, Allowance to Reduce Inventory to LIFO (Balance Sheet)

(EI = Ending Inventory)

Purpose of $ Value LIFO:

To reduce the potential for liquidating LIFO layers. If liquidation occurs, it may
defeat LIFO’s main purpose (tax reduction) in periods of rising pricing. (See the
first three paragraphs of the Dollar-Value LIFO section in Kieso, pp. 7-27 and 7-
28.) Also see: Ch. 7C White Board Notes Go Back Dollar Value LIFO.

$ Value LIFO: Steps to Compute

1. Convert EI (of a subsequent year) to base-year prices

2. Subtract EI @ base-year prices from base-year EI, yielding the inventory

layer added during that year

3. Multiply this additional inventory layer times the CY price index

4. Add the incremental price-level adjusted inventory layers for all prior
years to the base-year inventory, yielding $ Value LIFO Total EI

(EI = Ending Inventory)