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Chapter 18: 23Q (page 1031)

Explain the accounting for sales with the right of return.

Short Answer

Expert verified

Revenue is recognized by companies with the right of return when the company’s assets have the right to reclaim inventory from clients.

Step by step solution

01

Meaning of Right of Return

Customers who use their right of return are frequently entitled to a full or partial refund of their purchase price, as well as a credit for future purchases. Under the new standard, a right of return is no longer a discrete performance criterion, albeit it does have an impact on the transaction price assessed for transferred products.

02

Accounting for sale with right of return

Companies mainly recognize all of the following when accounting for sales with return rights (and some services that are supplied subject to a refund).

a. Revenue for transferred things in the amount of consideration to which the seller is reasonably assured to be entitled, taking into account products that are expected to be returned or for which allowances are made.

b. An asset that represents the company's right to recover inventory from consumers (along with a cost of goods sold adjustment).

If the firm can't forecast the number of returns, it shouldn't record revenue until it can.

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Most popular questions from this chapter

(Determine Transaction Price) Aaron’s Agency sells an insurance policy offered by Capital Insurance Company for a commission of \(100 on January 2, 2017. In addition, Aaron will receive an additional commission of \)10 each year for as long as the policyholder does not cancel the policy. After selling the policy, Aaron does not have any remaining performance obligations. Based on Aaron’s significant experience with these types of policies, it estimates that policyholders on average renew the policy for 4.5 years. It has no evidence to suggest that previous policyholder behavior will change.

Instructions

(a) Determine the transaction price of the arrangement for Aaron, assuming 100 policies are sold.

(b) Determine the revenue that Aaron will recognize in 2017.

Explain the importance of a contract in the revenue recognition process.

Frozen Delight, Inc. charges an initial franchise fee of \(75,000 for the right to operate as a franchisee of Frozen Delight. Of this amount, \)25,000 is collected immediately. The remainder is collected in four equal annual installments of \(12,500 each. These installments have a present value of \)41,402. As part of the total franchise fee, Frozen Delight also provides training (with a fair value of $2,000) to help franchisees get the store ready to open. The franchise agreement is signed on April 1, 2017, training is completed, and the store opens on July 1, 2017. Prepare the journal entries required by Frozen Delight in 2017.

Tyler Financial Services performs bookkeeping and tax-reporting services to startup companies in the Oconomowoc area. On January 1, 2017, Tyler entered into a 3-year service contract with Walleye Tech. Walleye promises to pay \(10,000 at the beginning of each year, which at contract inception is the standalone selling price for these services. At the end of the second year, the contract is modified and the fee for the third year of services is reduced to \)8,000. In addition, Walleye agrees to pay an additional $20,000 at the beginning of the third year to cover the contract for 3 additional years (i.e., 4 years remain after the modification). The extended contract services are similar to those provided in the first 2 years of the contract.

Instructions

(a) Prepare the journal entries for Tyler in 2017 and 2018 related to this service contract.

(b) Prepare the journal entries for Tyler in 2019 related to the modified service contract, assuming a prospective approach.

(c) Repeat the requirements for part (b), assuming Tyler and Walleye agree on a revised set of services (fewer bookkeeping services but more tax services) in the extended contract period and the modification results in a separate performance obligation.

(Allocate Transaction Price) Geraths Windows manufactures and sells custom storm windows for three-season porches. Geraths also provides installation service for the windows. The installation process does not involve changes in the windows, so this service can be performed by other vendors. Geraths enters into the following contract on July 1, 2017, with a local homeowner. The customer purchases windows for a price of \(2,400 and chooses Geraths to do the installation. Geraths charges the same price for the windows irrespective of whether it does the installation or not. The installation service is estimated to have a standalone selling price of \)600. The customer pays Geraths \(2,000 (which equals the standalone selling price of the windows, which have a cost of \)1,100) upon delivery and the remaining balance upon installation of the windows. The windows are delivered on September 1, 2017, Geraths completes installation on October 15, 2017, and the customer pays the balance due. Prepare the journal entries for Geraths in 2017. (Round amounts to nearest dollar.)
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