Joan Holtz (A)*

“Your course unfortunately doesn’t give me the answer to a great many real-life problems,”
said Joan Holtz to an accounting professor. “I’ve read the text and listened to you attentively,
but every once in a while I run across something that doesn’t seem to fit the rules.”

“Not all of life’s complications can be covered in a first course,” the professor replied. “As is
the case with law, medicine, or indeed any of the professions, many matters are dealt with in
advanced courses, and others are not settled in any classroom. Nevertheless, some problems
that are not specifically discussed can be solved satisfactorily by relating them-to principles
that you already have learned. Let’s take revenue recognition as a particularly difficult case in
point. If you will write down some of the matters about which you are uncomfortable, I’d be
glad to discuss them with you—that is, after you have given some thought as to the most
reasonable solution.”

A week later, Holtz returned with - list given below:

1. Electric Utility Bill. When an electric utility customer uses electricity, the electric
company has earned revenues. It is obviously impossible, however, for the company
to read all of its customers’ meters at the end of accounting year. How does the
electric company know its revenue for a given accounting year? Explain.
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2. Retainer Fee. A law firm received “retainer ” of $l0,000 on July 31, 2001, from a
client. In return, it agreed to furnish general legal advice upon request for one year. In
addition, the client would be billed for regular legal services such as representation in
litigation. There was no way of knowing how often, or when, the client would request
advice, and it was quite possible that no such advice would be requested. How much
of the $10,000 should be counted as revenue in 2001? Why?

3. Cruise. Raymond’s, a travel agency, chartered a cruise ship for two weeks beginning
April 23, 2002, for $200,000. In return, the ship’s owner agreed to pay all costs of the
cruise. In financial year 2001, Raymond’s sold all available space on the ship for
$260,000. It incurred $40,000 in selling and other costs in doing so. All the $260,000
was received in cash from passenger in 2001. Raymond’s paid $50,000 as an advance
payment to the ship owner in 2001. How much, if any, of the $260,000 was revenue
to Raymond’s in 2001? Why? Does the question of whether passengers were entitled
to a refund in 2002 if they canceled their reservations make any difference in the
answer? Why?

4. Accretion. A nursery owner had one plot of land containing Christmas trees that were
four years old November1, 2001. The owner had: incurred costs of $3 per tree up to
that time. A wholesaler offered to buy the trees for $4 each and to pay in addition all
costs of cutting and bundling and transporting them to market.
The nursery owner declined this offer, deciding that it would be more profitable to let
the trees grow for one more year. Only a trivial amount of additional cost would be
involved. The price of Christmas trees varies with their height. Should the nursery
owner recognize any revenue from these trees in 2001? Why?

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The act of a client by which the services of a lawyer, counselor, or adviser are engaged
 5. “Unbilled” Receivables. The balance sheet of an architectural firm shows a significant
asset labeled as Unbilled Receivables. The firm says this represents in-process
projects, valued at the rates at which the customers will be charged for the architects’
time. Why would a firm do this instead of valuing projects in process at their cost, the
same as a manufacturing firm would value its in-process Inventory? Does it make any
difference in the reported owners’ equity for the architectural firm to report such in-
process work as receivable rather than as inventory? Why?

6. Premium Coupons. A manufacturer of coffee enclosed a premium coupon with each

$2.50(at wholesale) jar of coffee that it sold to retailers. Customers could use coupon to
apply to $0.50 of the price of a new type of instant . tea that the manufacturer was
introducing and that sold for $2.00 wholesale2. The manufacturer reimbursed retail
stores $0.60 for each such coupon they submitted Past experience with similar prem-
ium offers indicated that approximately 20 percent of such coupons are event-
ually redeemed. At the end of 2001, however, only about 10 percent of the coupons
issued in 2001 had been redeemed. In recording the revenues for the company for
2001, what allowance if any, should be made for these coupons? Why? If an allo-
wance should be made, should it apply to the salesrevenue of coffee or to the sales re-

venue of tea? Why?

7. Traveler’s Checks. A bank sells a customer $500 of American Express traveler’s

checks, for which the bank collects from the customer $505. (The bank charges a 1
percent fee for this service.) How does the bank record this transaction? How does the
transaction affect American Express’s balance sheet?

8. Product Repurchase Agreement. In December 2001 Manufacturer A sold merchandise

to Wholesaler B. B used this inventory as collateral for a bank loan of $lOO,000 and
sent the $l00,000 to A. Manufacturer A agreed to repurchase the goods on or before
July 1, 2002, for $112,000, the difference representing interest on the loan and
compensation for B’s services. Does Manufacturer A have revenue in 2001? Why?

9. Franchises. A national real estate brokerage firm has become highly successful by
selling franchises to local real estate brokers. It charges $10,000 for the initial
franchise fee and a service fee of 6 percent of the broker’s revenue thereafter. For this
it permits use of its well-known name, and provides a one-week initial training
course, a nationwide referral system, and various marketing and management aids.
Currently, the franchise fee accounts for 25 percent of the national firm’s receipts, but
it expects that the United States market will be saturated within the next three years,
and thereafter the firm will have to depend on the service fee and new sources of
revenue that it may develop. Should it recognize the $10,000 as revenue in the year in
which the franchise agreement is signed? Why? If it does, what will happen to its
profits after the market become saturated? Why?

10. Computer Systems. In early 2001 the sales vice president of Tech-Logic reached
agreement to deliver several computer systems with a total price of $570,000 to an
organization in one of the newly independent countries established following the
dissolution of the former Soviet Union. Tech-Logic management was very excited

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The extra $0.10 was to pay the grocer for coupon handling costs.
 about this contract. The countries that were part of the former Soviet Union
represented a major market that was just opening up for trade, and these countries
especially needed the kinds of high-technology products that Tech-Logic sold. Tech-
Logic manufactured and shipped the entire $570,000 order during 2001. Tech-Logic
normally recognized revenue on the sale of its products when they were shipped.
However, Tech-Logic’s controller wondered whether the same revenue recognition
policy should apply to this contract. First, contract law in these countries was
evolving and it was hard to know if certain laws existed or what they were. In
addition, the controller was uncertain when Tech-Logic would receive the $570,000
in cash. He had heard that in many of these countries it was difficult to obtain
currencies needed for foreign exchange, although the customer kept assuring Tech-
Logic that they would receive cash shortly. The controller pondered whether to
recognize the entire $570,000 as revenue in 2001. If not, then when this revenue
should be recognized? Why?

Question

1. Answer the questions raised by Holtz in each of the 10 issues on her list.