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Unformatted text preview: Suggested solutions to homework questions – Week 6 Problem 12.5 1 Outback Gold • The company can sell its entire inventory of gold at any time at the prevailing market price. This means that the amount of revenue can be measured in dollar terms. Although the gold has not been provided to customers, sales are basically guaranteed. • Since mining and refining are the major costs of producing and selling gold, these costs have been incurred or are estimable at the end of the production process. • No collectibility problems. Therefore, recognise revenue when the production process is complete. 2 Crazy Freddie Co. • Goods have been provided to customers when they take delivery. • Cost of the goods has been established by purchase by Freddie from the wholesaler. • Amount of revenue is estimable by the selling price of the goods. • Severe collectibility problems because of customer defaults. Therefore, recognise revenue when cash is received. 3 Tom and Mark’s Construction • Revenue can be reasonably measured because contracts are for a fixed fee. • Not likely to be a collection problem because there has never been a problem in the past. • Costs can be measured with reasonable accuracy. • Although all of the services have not been performed until construction is complete, the customer has already been identified and it is usually the case that as construction proceeds, the purchaser obtains an interest in the partially completed asset. Therefore, recognise revenue as construction proceeds using the percentage of completion method for accounting for long‐term construction. 4 Cecily Cedric • Costs to generate revenue have been incurred by the time the toys are shipped. • Once the toys are shipped, the goods have been provided to the customers. • Revenue is established by the selling price of the toys. • Collection problems are minimal and can be estimated, thus the amount of cash or receivables can be measured with reasonable accuracy. Therefore, recognise revenue at the time the toys are shipped. Problem 12.10 1. Franchise revenue recognised by each company (assuming no discounting of future cash flows): Pickin Chicken Country Delight $ $ 2006: PC $50,000x8 400,000 0 CD $20,000x8 160,000 2007: PC $50,000x8 250,000 CD $(20,000x5)+(6,000x8) 148,000 2008: PC no sales nil CD $6,000x13 78,000 2009: PC no sales nil CD $6,000x13 78,000 2. Any of the three possibilities could be chosen with a careful analysis based on the four main revenue recognition criteria: i. All or most of products/services provided? ii. Most costs incurred, the rest estimable? iii. Revenue reasonably measurable? iv. Cash received or reasonably assured? However, it is unlikely that such an analysis would support PC’s method (all revenue recognised upon signing). It is not generally acceptable in franchising because of the great initial uncertainty that a new franchisee can make a go of it (criterion iv) and about how much help the franchisee will need (criterion ii). Recognition over the life of the franchise agreement would be the usual method, and recognition as cash is received would be indicated if there is substantial uncertainty about the viability of the franchises and/or the franchisees’ ability to make the promised payments to the franchiser. Problem 12.17 No.1 • Effect on net profit = $8 649 000 (.05 – .02) x (1 – .30) = $181 629 reduction • Revised net profit = $223 650 – $181 629 = $42 021 • So the change would reduce net profit by over 80% but would not reduce it to zero. • There would be no effect on cash flow (this is an accrual accounting change: cash flow effects come from the company’s actual success in collections). • Appropriate accounting should be chosen even if the managers are not pleased with the result. No. 2 The journal entry is: DR Bad debts expense CR Allowance for doubtful debts Therefore this increase of 3% will reduce profits because it increases expenses. However, increasing the allowance has no impact on cash flow. Case 12F The issue here is whether certain marketing expenses to be expensed as incurred or whether they should be capitalised (i.e. made an asset and written off as an expense over the period which the company will get future benefits from these marketing expenses). 1. The main arguments advanced in favour of One.Tel capitalising the expenditure was that this practice was in line with other industry players, i.e. the argument is that the marketing expenses will provide future benefits and therefore more than one accounting period will benefit from these expenses. However One.Tel did acknowledge that the practice was more aggressive than its counterparts because it was acquiring new customers very quickly. 2. The difference in the financial statements can be quite large. By placing all these marketing expenses as an asset they will gradually be written off over a number of years and so each year gets a share of the expenses. On the other hand if they are written off all in the initial year the whole expense goes to that period rather than any of it going to later years. In this case it meant that the company would end up making a loss as a result of the write‐off. 3. The arguments put forward by ASIC that it did not comply with accounting standards and the Corporations Law, while not stated in the article it is likely the arguments would have revolved around how probable the future benefits from these marketing expenses would be. There also is the issue of whether the future benefits could be reliably measured. ...
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- Spring '11