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CHAPTER 5 Revenue Recognition and Profitability Analysis 297 Broaden Your Perspective Apply your critical-thinking ability to the knowledge you’ve gained. These cases will provide you an opportunity to develop your research, analysis, judgment, and communication skills. You also will work with other students, integrate what you’ve learned, apply it in real-world situations, and consider its global and ethical ramifications. This practice will broaden your knowledge and further develop your decision-making abilities. An article published in Accounting Horizons describes various techniques that companies use to manage their earnings. Required: In your library, on the Internet, or from some other source, locate the article “How Are Earnings Managed? Evidence from Auditors” in Accounting Horizons, 2003 (Supplement), and answer the following questions: 1. What are the four most common revenue-recognition abuses identified by auditors in that article? From the examples provided in the article, briefly explain each abuse. 2. What is the revenue-recognition abuse identified in the article related to the percentage-of-completion method? 3. Did revenue-recognition abuses tend to increase or decrease net income in the year they occurred? 4. Did auditors tend to require their clients to make adjustments that reduced the revenue-recognition abuses they detected? Assume McDonald’s enters into a contract to sell Billy Bear dolls for Toys4U Stores. Based on the contract, McDonald’s displays the dolls in selected stores. Toys4U is not paid until the dolls have been sold by McDonald’s, and unsold dolls are returned to Toys4U. Required: Determine whether Toys4U has satisfied its performance obligation when it delivers the dolls to McDonald’s. Explain your answer. Cutler Education Corporation developed a software product to help children under age 12 learn mathematics. The software contains two separate parts: Basic Level (Level I) and Intermediate Level (Level II). Parents purchase each level separately and are eligible to purchase the access code for Level II only if their children pass the Level I exam. Kerry purchases the Level I software at a price of $50 for his son, Tom, on December 1. Suppose Tom passed the Level I test on December 10, and Kerry immediately purchased the access code for Level II for an additional $30. Cutler provided Kerry with the access code to Level II on December 20. Required: When would Cutler recognize revenue for the sale of Level I and Level II software? Horizon Corporation manufactures personal computers. The company began operations in 2011 and reported profits for the years 2011 through 2014. Due primarily to increased competition and price slashing in the industry, 2015’s income statement reported a loss of $20 million. Just before the end of the 2016 fiscal year, a memo from the company’s chief financial officer to Jim Fielding, the company controller, included the following comments: If we don’t do something about the large amount of unsold computers already manufactured, our auditors will require us to write them off. The resulting loss for 2016 will cause a violation of our debt covenants and force the company into bankruptcy. I suggest that you ship half of our inventory to J.B. Sales, Inc., in Oklahoma City. I know the company’s president and he will accept the merchandise and acknowledge the shipment as a purchase. We can record the sale in 2016 which will boost profits to an acceptable level. Then J.B. Sales will simply return the merchandise in 2017 after the financial statements have been issued. Required: Discuss the ethical dilemma faced by Jim Fielding. Consider each of the following scenarios separately: Scenario 1: Crown Construction Company entered into a contract with Star Hotel for building a highly sophisticated, customized conference room to be completed for a fixed price of $400,000. Nonrefundable progress payments are made on a monthly basis for work completed during the month. Legal title to the conference room equipment is held by Crown until the end of the construction project, but if the contract is terminated before the conference room is finished, Star retains the partially completed job and must pay for any work completed to date. Scenario 2: Regent Company entered into a contract with Star Hotel for constructing and installing a standard designed gym for a fixed price of $400,000. Nonrefundable progress payments are made on a monthly basis Research Case 5–1 Earnings management with respect to revenues ● LO5–1 Judgment Case 5–2 Satisfaction of performance obligations ● LO5–2 Judgment Case 5–3 Satisfaction of performance obligations ● LO5–2 Ethics Case 5–4 Revenue recognition ● LO5–2 Judgment Case 5–5 Satisfying performance obligations ● LO5–2, LO5–3


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