MODAUD2 Unit 10 Audit of Revenues T31516
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UNIT 10 AUDIT OF REVENUES Estimated Time: 2.0 HOURS Discussion Questions 10-1: Choose the best answer (Refer to PAS 18). (1) Which of the following statement is not correct? a. Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants. b. Revenue shall be measured at the fair value of the consideration received or receivable. c. When goods or services are exchanged or swapped for goods or services which are of a similar nature and value, the exchange can still be regarded as a transaction which generates revenue. d. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. e. For retail sale when a refund is offered if the customer is not satisfied, revenue is recognized at the time of sale provided the seller can reliably estimate future returns and recognizes a liability for returns based on previous experience and other relevant factors. (2) Revenue from the sale of goods shall be recognized when all the following conditions have been satisfied, except: a. the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; b. the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; c. the amount of revenue can be measured reliably; d. it is possible that the economic benefits associated with the transaction will flow to the entity; e. the costs incurred or to be incurred in respect of the transaction can be measured reliably. (3) Revenue shall be recognized on the following bases, except: a. interest shall be recognised using the effective interest method; b. royalties shall be recognized on an accrual basis in accordance with the substance of the relevant agreement; c. dividends shall be recognized when the shareholder’s right to receive payment is established. d. all of the above statements are correct. (4) All of the above statements are correct, except: a. If an entity retains only an insignificant risk of ownership, the transaction is a sale and revenue is recognised. b. When an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible amount, or the amount in respect of which recovery has ceased to be probable, is treated as an adjustment of the amount of revenue originally recognized. c. If the entity retains significant risks of ownership, the transaction is not a sale and revenue is not recognised. d. SAB 104 provides four criteria (also known as “CDEF”) in order for revenue to be considered realized. These are as follows: Collectibility is reasonably assured, Delivery has occurred (services have been rendered), persuasive Auditing Practice II Workbook
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evidence of an arrangement exists, and there is a Fixed or determinable price. (5) Provided below are examples of significant risk of ownership except: a. when the entity retains an obligation for unsatisfactory performance not covered by normal warranty provisions; b. when the receipt of the revenue from a particular sale is contingent on the derivation of revenue by the buyer from its sale of the goods; c. when the goods are shipped subject to installation and the installation is a significant part of the contract which has not yet been completed by the entity; and d. when the buyer has the right to rescind the purchase for a reason specified in the sales contract and the entity is uncertain about the probability of return. e. When a seller retains legal title to the goods solely to protect the collectibility of the amount due. (6) When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage of completion of the transaction at the end of the reporting period. The outcome of a transaction can be estimated reliably when all the following conditions are satisfied, except: a. the amount of revenue can be measured reliably; b. it is probable that the economic benefits associated with the transaction will flow to the entity; c. the stage of completion of the transaction at the end of the reporting period can be measured reliably; d. the costs incurred for the transaction and the costs to complete the transaction can be measured reliably. e. All of the above statements are correct. Problem 10-1: Various Issues on Revenue Recognition 1. Transfer of Risk and Rewards (PAS 18, par 15): A seller pays for the insurance on goods in transit from its factory to the buyer’s premises. The insurance policy reimburses the seller for the full market value of the goods in the event of loss or damage from the point when the goods depart from the factory to the point when the goods arrive at the buyer’s premises. The legal title passes when the goods arrive at the buyer’s premises one month later. With the insurance cover, can the seller recognize sales at the point when the goods depart from the factory? 2. Bill and Hold (PAS 18, Appendix 1): AB Company entered into a contract on December 31, 20x0 to supply video game consoles to customer A. The Contract is for 100,000 game consoles at $500 each. The wholesaler has a stock of 120,000 consoles at December 31, 2005. The contract contains specific instructions with regard to the timing and location of the delivery. AB Company must deliver the consoles to the customer in the following period at a date to be specified by the customer. AB Company cannot use the 100,000 consoles to satisfy other sales orders. Customer A has made a deposit of $15,000 at the time the contract was signed. Usual payment terms apply. Can AB Company recognize revenue for the 100,000 game consoles? 3. Right to exchange for goods (PAS 18, Appendix 2): BC Company sells ties. Customers can return any product within 28 days of the date of the purchase. Returns will only be accepted with proof of purchase and if the ties are unused and saleable as new. The retailer will accept returned ties, subject to the above conditions only in exchange for other ties of the same value. 12% of the retailer’s Auditing Practice II Workbook
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sales are exchanged for other goods within 28 days of purchase. How should BC Company recognize revenue in this case? A. Recognize 100% of the value of the ties as revenues are sold or; B. Recognize 88% of the value of ties as revenue when sold and then the remaining 12% revenue when finally exchanged or the expiration of the 28 days. 4. Goods shipped subject to conditions (PAS 18, Appendix 2): CD Company offered Customer A kitchen fittings at either a fixed price of P 10,000 including installation or P 8,000 ex-works. Customer A signed for the P 10,000 where CD agreed to deduct actual installation costs from P 10,000 should it fail to install the kitchen fittings. A fair value of the installation cost is P 2,500 which is known to both parties. At the balance sheet date, the kitchen fittings are delivered to Customer A’s home but waiting to be installed. How much revenue from Customer A should be recognized by CD company as of balance sheet date? A. P 10,000 B. P 8,000 C. P 7,500 i.e., (P 10,000 – 2,500) D. P 7,619 i.e., [P 10,000 x P 8000/(8000+2500)] 5. Goods shipped subject to conditions (PAS 18, Appendix 6): DE Company, a pharmaceuticals Company, manufactures Vitamin V. It entered into an exclusive distribution agreement with EF Pharma. Under the terms of the agreement, EF Pharma is allowed to maintain a maximum of 60 days inventory of Vitamin V in its warehouse. This is to ensure that delivery for orders from various retailers around the country is assured. EF Pharma is entitled to a 5% distribution margin. The agreement further provides a collection term of 45 days from the date EF Pharma invoices its customers (the retailers of Vitamin V). As of balance sheet date, EF Pharma has in its warehouse 60 days inventory. Given that these 60 days inventories were purchased this year, should DE Company recognize these as revenue during the year? 6. Special cases – Buy one get one free: EF Company is a manufacturer of chocolate and has a sales promotion campaign to attract new customers. During the campaign, customers are entitled to an offer of “Buy One Get One Free”. The sales price of one bar is P 5 and the production costs are P 2. How should the sale of one transaction appear in the Income Statement: A. Revenue of P 5 and Cost of Sales of P 4 (P2 x 2) B. Revenue of P 3 (P 5 less P 2) and Cost of Sales of P 2? 7. Special cases – Fee-based Arrangement: FG & Associates is a CPA firm that provides external audit to companies. GH Company is one of its retainers with a fixed professional fee of Php 12 million. The fee is billed evenly over the course of the year at Php 1 million. FG & Associates is not required to submit the actual number of hours worked, nor is it entitled to recover cost overruns if its costs exceeds Php 12 million. As of today, the firm has billed Php 6 million for the year, and out of the Php 6 million receivable, it has collected Php 4 million cash. What amount of revenue should be recognized as of today? 8. Your client, GH Company, is an IT Company developing a specialized IT platform for a certain customer JK. Work on the IT platform commenced on January 1, 20x0. At December 31, 20x0, the hardware which is sold separately has been installed at the customer’s site and the software is 50% complete. GH Company does not anticipate any problem with the software development which should take
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another six (6) months to complete. The customer has the right to return the hardware if the software does not work according to the customer specifications. The Contract as a whole, is approximately 70% completed based on costs incurred, which is a reliable measure of the services performed. Costs incurred to date and costs to complete can be reliably measured for the hardware and software separately and in total. The hardware and software account for 30% and 70% of the total consideration respectively. Issues: The Revenue Recognition Policy of your client is as follows: For Hardware, Sale of Goods under PAS 18. For Software, Rendering of Services under PAS 18. Is this appropriate? 9. Your client, HI Company, is a real estate company that is currently developing condominium projects. During your audit for the year, the Company is selling the KL Condominiums project, which has 100 property units for sale to third parties. After completing 60% of the construction, the property developer did a soft launch and sold 50 unfinished property units. The buyers of 50 pre-completed units paid 20% as initial down payment. The buyer can choose from a limited number of options in the final looks of the condominium (e.g. kitchen, with or without balcony or an extra room, color of the tiles). The property developer does not anticipate any problems with the remaining 40% development, which should take another 9 months to complete as of BS date. Issues: The Company did not recognize any revenue for the 50 units sold. Is this appropriate? Refer to PAS 18 par. 19 and PIC Q&A 2006-01. 10. Your client, Precious Company, is developing residential real estate and starts marketing individual units (apartments) while construction is still in progress. Buyers enter into a binding sale agreement that gives them the right to acquire a specified unit when it is ready for occupation. They pay a deposit that is refundable only if Precious Company fails to deliver the completed unit in accordance with the contracted terms. Buyers are also required to make progress payments between the time of the initial agreement and contractual completion. The balance of the purchase price is paid only on contractual completion, when buyers obtain possession of their unit. Buyers are able to specify only minor variations to the basic design but they cannot specify or alter major structural elements of the design of their unit. In the jurisdiction, no rights to the underlying real estate asset transfer to the buyer other than through the agreement. Consequently, the construction takes place regardless of whether sale agreements exist. Issue: When should the Company recognize the revenue? Please explain. 11. Same scenario as no. 10 but assume that in the jurisdiction, the law requires the Company to transfer immediately to the buyer ownership of the real estate in its current state of completion and that any additional construction becomes the property of the buyer as construction progresses. Issue: When should the Company recognize the revenue? Please explain. 12. Your client, LM Company, is engaged in indent sales of techno-gadgets. Under this revenue category, there are three types of suppliers. The first supplier, AB Supplier, prefers to deliver and bill the customer directly, while giving LM Company a commission in the process. The second supplier, CD Supplier, Auditing Practice II Workbook
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prefers to deliver the goods to the customer directly, but the billing to the customer will be made by LM Company. The third supplier, EF supplier, prefers to deliver the goods to LM Company, but directly bills the customer. The delivery will be made by LM Company. Issues: The Company recognizes revenues from these indent sales to the extent of the commission earned. Is this appropriate? 13.
Your client, Level Down! Corp, is engaged in online internet gaming transactions. Assume that you are being consulted for the proper revenue recognition policy on the sale of prepaid cards: A. Discuss the background of Online RPG Games B. Discuss how the company will apply the appropriate provisions of PAS 18 and other related standards for prepaid cards.
Problem 10-2: Provided below is Gold Label’s pre-audit income statement for the year ended December 31, 2015: Sales Cost of goods sold Gross income Operating expenses: Rent expense Salaries expense Utilities expense Advertising expense Warranty expense Other expenses Net income
4,464,000 2,726,000 1,738,000 250,000 345,000 219,000 105,000 14,000 35,500
You obtained the following information from the company’s accounting records: a. Some of Gold Label’s customers pay for their orders in advance. At December 31, 2015, orders paid for in advance of shipment totaled P30,000. These have been included in the sales figure. b. Gold Label’s products are sold with a 30-day money-back guarantee. Customers seldom returned the products during the year. Gold Label has not included in the sales figure and in the cost of goods sold those products sold within the last 30 days of the current year. The revenue is P146,000 and the cost of the products is P94,900. c. On July 1, 2015, Gold Label prepaid its office space rent for 18 months. The amount paid, P216,000, was recorded as rent expense. d. Gold Label paid P120,000 on July 1, 2015, for general advertising to be completed prior to December 31, 2015. Gold Label’s management believes that the said advertising paid will benefit a 2-year period and, therefore, has decided to charge the costs to the income statement at the rate of P5,000 per month. e. In prior years, Gold Label has estimated warranty expense using a percentage of sales. Future warranty costs relating to 2015 sales are estimated to amount to 2% of sales. However, during 2015, Gold Label elected to charge costs to warranty expense as costs were incurred. Gold Label spent P14,000 during 2015 to repair and replace defective products sold in current and prior years. Auditing Practice II Workbook
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Also included in the above amount for advertising is the P75,000 cost of product posters for a sales promotional campaign in January 2016. g. Radio advertisements broadcast during December 2010 were billed to Gold Label on January 3, 2016. Gold Label paid the P30,000 invoice on January 15, 2016. You also noted that the following transactions were not yet recorded in the books by Gold Label for 2015: h. Gold label also received dividends from its ordinary share investments during the year ended December 31, 2015 as follows: i. A cash dividend of P10,000 from Hermione Corporation, in which Gold Label owns a 2% interest. ii. A cash dividend of P65,000 from Cho-Chang Corporation, in which Gold Label owns a 30% interest. A majority of Gold Label’s directors are also directors of Cho-Chang. iii. A share dividend of 300 shares from Potter Corporation was received on December 10, 2015, on which date the quoted market value of Potter’s shares was P10 per share. Gold Label owns less than 1% of Potter’s ordinary shares. i.
Gold Label does not carry insurance on its office machines. On December 31, 2015, Machine A was totally destroyed by fire. The book value of Machine A, depreciated to the date of the fire was P62,000. Disposal costs were P3,000. On January 17, 2016, prior to the issuance of the 2015 financial statements, Machine B was totally destroyed in an explosion. The book value of Machine B, depreciated to the date of the explosion was P74,000. Disposal costs were P4,000.
Required: Compute for the following as of & for the year ended December 31, 2015: 1. Correct amount of sales revenue 2. Gross income 3. Total advertising expense 4. Total amount of losses related to explosion that should be charged to income 5. Total operating expenses (exclusive of other income, if any) 6. Dividend income to be recorded by Gold Label 7. Net income
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