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Chapter 18: Q.18-8CA_1 (page 1048)

Question: CA18-8 ETHICS (Revenue Recognition鈥擬embership Fees) Midwest Health Club (MHC) offers 1-year memberships. Membership fees are due in full at the beginning of the individual membership period. As an incentive to new customers, MHC advertised that any customers not satisfied for any reason could receive a refund of the remaining portion of unused membership fees. As a result of this policy, Richard Nies, corporate controller, recognized revenue ratably over the life of the membership. MHC is in the process of preparing its year-end financial statements. Rachel Avery, MHC鈥檚 treasurer, is concerned about the company鈥檚 lacklustre performance this year. She reviews the financial statements Nies prepared and tells Nies to recognize membership revenue when the fees are received.

Instructions

Answer the following questions.

(a) What are the ethical issues involved?

Short Answer

Expert verified

Answer

There will beethical issues between the fair reporting of financial information and higher corporate profits.

Step by step solution

01

Definition of Corporate Profit

The money that remains in the hand of the corporation after paying all of its expenses is known as corporate profit.

02

 Step 2: Ethical issued involved

In the above case, the business entity must recognize revenue over the period rather than the point of time because the membership fee might be refunded if the customer is not satisfied. But to report higher gross, the business entity is recognizing revenue at a point in time that will misrepresent the financial statement and consequently mislead the users of the financial statement. This would create an ethical issue.

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Most popular questions from this chapter

P18-7 (LO3) (Customer Loyalty Program) Martz Inc. has a customer loyalty program that rewards a customer with 1 customer loyalty point for every \(10 of purchases. Each point is redeemable for a \)3 discount on any future purchases. On July 2, 2017, customers purchase products for \(300,000 (with a cost of \)171,000) and earn 30,000 points redeemable for future purchases. Martz expects 25,000 points to be redeemed. Martz estimates a standalone selling price of \(2.50 per point (or \)75,000 total) on the basis of the likelihood of redemption. The points provide a material right to customers that they would not receive without entering into a contract. As a result, Martz concludes that the points are a separate performance obligation.

Instructions

Prepare the journal entries to record the sale of the product and related points on July 2, 2017.

Describe the critical factor in evaluating whether a performance obligation is satisfied.

(Allocate Transaction Price) Appliance Center is an experienced home appliance dealer. Appliance Center also offers a number of services for the home appliances that it sells. Assume that Appliance Center sells ovens on a standalone basis. Appliance Center also sells installation services and maintenance services for ovens. However, Appliance Center does not offer installation or maintenance services to customers who buy ovens from other vendors. Pricing for ovens is as follows.

Oven only \( 800

Oven with installation service 850

Oven with maintenance services 975

Oven with installation and maintenance services 1,000

In each instance in which maintenance services are provided, the maintenance service is separately priced within the arrangement at \)175. Additionally, the incremental amount charged by Appliance Center for installation approximates the amount charged by independent third parties. Ovens are sold subject to a general right of return. If a customer purchases an oven with installation and/or maintenance services, in the event Appliance Center does not complete the service satisfactorily, the customer is only entitled to a refund of the portion of the fee that exceeds \(800.

Instructions

(a) Assume that a customer purchases an oven with both installation and maintenance services for \)1,000. Based on its experience, Appliance Center believes that it is probable that the installation of the equipment will be performed satisfactorily to the customer. Assume that the maintenance services are priced separately (i.e., the three components are distinct). Identify the separate performance obligations related to the Appliance Center revenue arrangement.

(b) Indicate the amount of revenue that should be allocated to the oven, the installation, and to the maintenance contract.

(Recognition of Profit on Long-Term Contracts) During 2017, Nilsen Company started a construction job with a contract price of \(1,600,000. The job was completed in 2019. The following information is available.

2017 2018 2019

Costs incurred to date \)400,000 \(825,000 \)1,070,000

Estimated costs to complete 600,000 275,000 鈥�0鈥�

Billings to date 300,000 900,000 1,600,000

Collections to date 270,000 810,000 1,425,000

Instructions

(a) Compute the amount of gross profit to be recognized each year, assuming the percentage-of-completion method is used.

(b) Prepare all necessary journal entries for 2018.

(c) Compute the amount of gross profit to be recognized each year, assuming the completed-contract method is used.

Hillside Company enters into a contract with Sanchez Inc. to provide a software license and 3 years of customer support. The customer-support services require specialized knowledge that only Hillside Company鈥檚 employees can perform. How many performance obligations are in the contract?
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