ch03 - CHAPTER 3 THE MEASUREMENT FUNDAMENTALS OF FINANCIAL...

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CHAPTER 3 THE MEASUREMENT FUNDAMENTALS OF FINANCIAL ACCOUNTING BRIEF EXERCISE BE3–1 1. Fiscal period 6. Materiality 2. Economic entity 7. Matching 3. Conservatism 8. Objectivity 4. Consistency 9. Objectivity 5. Revenue recognition 10. Stable dollar EXERCISES E3–4 a. The most common point at which a company would recognize revenue is at the time of delivery. So in this case McKey and Company would recognize revenue in February. b. The four criteria for recognizing revenue are (1) the company has completed a significant portion of the production and sales effort, (2) the amount of revenue can be objectively measured, (3) the company has incurred the majority of costs, and remaining costs can be reasonably estimated, and (4) cash collection is reasonably assured. Presumably McKey and Company is reasonably assured that Cascades Enterprises will eventually be able to pay the $40,000, or McKey would not have entered into the agreement with Cascades Enterprises. Since the production and sales effort was not really complete until McKey shipped the brackets on February 9, February 9 appears to be the appropriate date to recognize the revenue. c. Under the appropriate conditions, revenue can be recognized at several points in time. Revenue could be recognized (1) during production, (2) at the completion of production, (3) at the point of delivery, or (4) when the cash is collected. Case 1 normally arises in long-term construction projects such as office buildings, bridges, and so forth. Case 2 arises where goods are manufactured to the exact specifications of a customer, and the goods cannot be sold to another party. Case 3 is the most common point of revenue recognition. Case 4 arises when cash collection is not reasonably assured. d. McKey's managers could be interested in the timing of revenue recognition due to incentives provided by contracts. For example, the managers may be paid a bonus based upon accounting income. A manager who is trying to maximize his or her bonus might prefer recognizing revenue in a particular period rather than in a different period. Another contract that might influence the actions of managers would be a debt covenant. If a debt covenant stipulates a maximum debt-to- equity ratio, and the company is nearing the ratio, the managers could improve the ratio by increasing stockholders' equity. One way to increase stockholders' equity is to increase net income. Consequently, speeding up the recognition of revenue (called front loading) might prevent the company from violating a debt covenant. 1
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PROBLEMS P3–9 a. ABC XYZ Inventory Depreciation Working Working Method Method Income Capital Income Capital B Y $28,000 $26,000 $24,000 $30,000 B X 20,000 26,000 16,000 30,000 A Y 18,000 16,000 14,000 20,000 A X 10,000 16,000 6,000 20,000 Note: Changes in the companies' inventory balances affect net income through Cost of Goods Sold. b.
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This note was uploaded on 09/06/2010 for the course BUSINESS ACG 6025 taught by Professor Karenlivingstone during the Fall '10 term at University of South Florida.

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ch03 - CHAPTER 3 THE MEASUREMENT FUNDAMENTALS OF FINANCIAL...

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