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Unformatted text preview: Chapter 05 - Income Measurement and Profitability Analysis Question 5-1 The realization principle requires that two criteria be satisfied before revenue can be recognized: 1. The earnings process is judged to be complete or virtually complete. 2. There is reasonable certainty as to the collectibility of the asset to be received (usually cash). Question 5-2 At the time production is completed, there usually exists significant uncertainty as to the collectibility of the asset to be received . We dont know if the product will be sold, nor the selling price, nor the buyer if eventually the product is sold. Because of these uncertainties, revenue recognition usually is delayed until the point of product delivery. Question 5-3 If the installment sale creates a situation where there is significant uncertainty concerning cash collection and it is not possible to make an accurate assessment of future bad debts, revenue and cost recognition should be delayed beyond the point of delivery. Question 5-4 The installment sales method recognizes gross profit by applying the gross profit percentage on the sale to the amount of cash actually received each period. The cost recovery method defers all gross profit recognition until cash has been received equal to the cost of the item sold. Question 5-5 Deferred gross profit is a contra installment receivable account. The balance in this account is subtracted from gross installment receivables to arrive at installment receivables, net. The net amount of the receivables represents the portion of remaining payments that represent cost recovery. 5-1 Chapter 5 Income Measurement and Profitability Analysis QUESTIONS FOR REVIEW OF KEY TOPICS Chapter 05 - Income Measurement and Profitability Analysis Question 5-6 Because the return of merchandise can retroactively negate the benefits of having made a sale, the seller must meet certain criteria before revenue is recognized in situations when the right of return exists. The most critical of these criteria is that the seller must be able to make reliable estimates of future returns. In certain situations, these criteria are not satisfied at the point of delivery of the product. Question 5-7 Sometimes a company arranges for another company to sell its product under consignment. The consignor physically transfers the goods to the other company (the consignee), but the consignor retains legal title. If the consignee cant find a buyer within an agreed-upon time, the consignee returns the goods to the consignor. However, if a buyer is found, the consignee remits the selling price (less commission and approved expenses) to the consignor. Because the consignor retains the risks and rewards of ownership of the product and title does not pass to the consignee, the consignor does not record revenue (and related costs) until the consignee sells the goods and title passes to the eventual customer....
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