Module 5
Revenue Recognition and
Operating Income
Learning Objectives – coverage by question
True / Multiple Exercise Problem Essays
False Choice s s
LO1 – Explain revenue
recognition criteria and
1-4 1-6 1-6 1-2 1-3
identify transactions of
special concern.
LO2 – Describe
accounting for operating
expenses, including 5-9 7-14 7-12 3-5 4-6
research and
development, and
restructuring.
LO3 – Explain and
10-12 15-20 13-19 6-7 7
analyze accounting for
income taxes.
LO4 – Explain how foreign
currency fluctuations 13 21 20-21 8 8
affect the income
statement.
LO5 – Compute earnings
per share and explain the 14-15 22-25 22-25 9-10 9-10
effect of dilutive
securities.
LO6 – Explain
accounting quality and
identify areas for
analysis.
©Cambridge Business Publishers,
Test Bank, 2013
Module 5 5-1
, Module 5: Revenue Recognition and Operating Income
True/False
Topic: Revenue
Recognition LO: 1
1. According to GAAP revenue recognition criteria, in order for revenue to be recognized
on the income statement, it must be earned and realized (realizable).
Answer: True
Rationale: According to GAAP revenue recognition criteria, revenue must be both
realized (realizable) and earned, to be recognized on the income statement. The issue
of when the revenue is earned is subject to professional judgment.
Topic: Percentage of
Completion LO: 1
2. Companies that engage in long-term sales contracts such as construction projects
often use the percentage of completion method to recognize revenue. This means
that revenue is recognized in proportion to the project’s completion.
Answer: True
Rationale: Percentage of completion method recognizes revenue by determining the
costs incurred under the contract relative to its total expected costs and not evenly
over time.
Topic: Sales on
Consignment LO: 1
3. Revenue from a consignment sale is recognized when the item is placed on
consignment with the middleman, if sales are probable, based on past experience.
Answer: False
Rationale: When the item is delivered to the middleman (the consignee) no title has
passed therefore no revenue has been earned. Revenue is only earned when the third
party buys the item.
Topic: Revenue
Recognition LO: 1
4. Bed Bath and Beyond has a 60-day return policy. The company can report revenue on
the full amount as soon as the merchandise is sold.
Answer: False
Rationale: Revenue will be recognized as soon as the merchandise is sold but only for the
portion that the company estimates will not be returned within the 60-day return period.
The estimated returns are netted against sales and set up as a liability (reserve).
Topic: R&D
Costs LO: 2
5. R&D expense is treated as an operating expense, not a capital expenditure, unless the
R&D assets acquired have an alternative future use.
Answer: True
Rationale: Although the R&D assets are similar to regular plant assets, under GAAP, R&D
©Cambridge Business
Publishers, 2013 5-2 Financial Statement Analysis & Valuation,
, costs are expensed unless the R&D assets have alternative future uses.
©Cambridge Business Publishers,
Test Bank, 2013
Module 5 5-3
, Topic: R&D
Costs LO: 2
6. Next year, Dow Chemical Corporation plans to build a laboratory dedicated to a special
project. The company will not use the laboratory after the project is finished. Under
GAAP, this laboratory should be expensed.
Answer: True
Rationale: R&D costs must be expensed under GAAP unless they have alternative future
uses. If these assets do, indeed, have alternative future uses, they will be capitalized
and depreciated.
Topic: Discontinued Operations
LO: 2
7. Revenues from discontinued operations of a company are reported separately from
revenues from continuing operations in the income statement.
Answer: True
Rationale: Discontinued operations refer to any identifiable business unit that the
company intends to sell. The income (loss) of the discounted operation (net of tax), and
the after-tax gain (loss) on sale of the unit, are reported in a separate section of the
income statement below income from continuing operations.
Topic: Restructuring
Costs LO: 2
8. Employee severance costs, as part of board-approved restructuring plans, are reported
in the income statement even if the actual payment for these costs occurs in
subsequent periods.
Answer: True
Rationale: Employee severance costs are reported in the income statement as accrued
costs. Total estimated costs of terminating or relocating a targeted employee group
are recorded as an expense in the period in which these costs are estimated.
Topic: Extraordinary
Items LO: 2
9. For an item to be classified as extraordinary, it needs to be both unusual and
infrequent. However, there is an exception for material items – for one-time items that
are extremely large, firms have the option of classify these items as extraordinary to
provide better information to investors.
Answer: False
Rationale: Both of the above conditions need to be fulfilled for an item to be
categorized extraordinary. There is no materiality exception.
Topic: Income
Taxes LO: 3
10. Income tax expense is not recorded at the amount owing to the tax authorities even if
this is the most objectively measured amount.
Answer: True
Rationale: Income tax expense is based on GAAP numbers. The amount paid is based on
tax rules. The difference between the two is recorded as deferred tax expense
(benefit).
©Cambridge Business
Publishers, 2013 5-4 Financial Statement Analysis & Valuation,
Revenue Recognition and
Operating Income
Learning Objectives – coverage by question
True / Multiple Exercise Problem Essays
False Choice s s
LO1 – Explain revenue
recognition criteria and
1-4 1-6 1-6 1-2 1-3
identify transactions of
special concern.
LO2 – Describe
accounting for operating
expenses, including 5-9 7-14 7-12 3-5 4-6
research and
development, and
restructuring.
LO3 – Explain and
10-12 15-20 13-19 6-7 7
analyze accounting for
income taxes.
LO4 – Explain how foreign
currency fluctuations 13 21 20-21 8 8
affect the income
statement.
LO5 – Compute earnings
per share and explain the 14-15 22-25 22-25 9-10 9-10
effect of dilutive
securities.
LO6 – Explain
accounting quality and
identify areas for
analysis.
©Cambridge Business Publishers,
Test Bank, 2013
Module 5 5-1
, Module 5: Revenue Recognition and Operating Income
True/False
Topic: Revenue
Recognition LO: 1
1. According to GAAP revenue recognition criteria, in order for revenue to be recognized
on the income statement, it must be earned and realized (realizable).
Answer: True
Rationale: According to GAAP revenue recognition criteria, revenue must be both
realized (realizable) and earned, to be recognized on the income statement. The issue
of when the revenue is earned is subject to professional judgment.
Topic: Percentage of
Completion LO: 1
2. Companies that engage in long-term sales contracts such as construction projects
often use the percentage of completion method to recognize revenue. This means
that revenue is recognized in proportion to the project’s completion.
Answer: True
Rationale: Percentage of completion method recognizes revenue by determining the
costs incurred under the contract relative to its total expected costs and not evenly
over time.
Topic: Sales on
Consignment LO: 1
3. Revenue from a consignment sale is recognized when the item is placed on
consignment with the middleman, if sales are probable, based on past experience.
Answer: False
Rationale: When the item is delivered to the middleman (the consignee) no title has
passed therefore no revenue has been earned. Revenue is only earned when the third
party buys the item.
Topic: Revenue
Recognition LO: 1
4. Bed Bath and Beyond has a 60-day return policy. The company can report revenue on
the full amount as soon as the merchandise is sold.
Answer: False
Rationale: Revenue will be recognized as soon as the merchandise is sold but only for the
portion that the company estimates will not be returned within the 60-day return period.
The estimated returns are netted against sales and set up as a liability (reserve).
Topic: R&D
Costs LO: 2
5. R&D expense is treated as an operating expense, not a capital expenditure, unless the
R&D assets acquired have an alternative future use.
Answer: True
Rationale: Although the R&D assets are similar to regular plant assets, under GAAP, R&D
©Cambridge Business
Publishers, 2013 5-2 Financial Statement Analysis & Valuation,
, costs are expensed unless the R&D assets have alternative future uses.
©Cambridge Business Publishers,
Test Bank, 2013
Module 5 5-3
, Topic: R&D
Costs LO: 2
6. Next year, Dow Chemical Corporation plans to build a laboratory dedicated to a special
project. The company will not use the laboratory after the project is finished. Under
GAAP, this laboratory should be expensed.
Answer: True
Rationale: R&D costs must be expensed under GAAP unless they have alternative future
uses. If these assets do, indeed, have alternative future uses, they will be capitalized
and depreciated.
Topic: Discontinued Operations
LO: 2
7. Revenues from discontinued operations of a company are reported separately from
revenues from continuing operations in the income statement.
Answer: True
Rationale: Discontinued operations refer to any identifiable business unit that the
company intends to sell. The income (loss) of the discounted operation (net of tax), and
the after-tax gain (loss) on sale of the unit, are reported in a separate section of the
income statement below income from continuing operations.
Topic: Restructuring
Costs LO: 2
8. Employee severance costs, as part of board-approved restructuring plans, are reported
in the income statement even if the actual payment for these costs occurs in
subsequent periods.
Answer: True
Rationale: Employee severance costs are reported in the income statement as accrued
costs. Total estimated costs of terminating or relocating a targeted employee group
are recorded as an expense in the period in which these costs are estimated.
Topic: Extraordinary
Items LO: 2
9. For an item to be classified as extraordinary, it needs to be both unusual and
infrequent. However, there is an exception for material items – for one-time items that
are extremely large, firms have the option of classify these items as extraordinary to
provide better information to investors.
Answer: False
Rationale: Both of the above conditions need to be fulfilled for an item to be
categorized extraordinary. There is no materiality exception.
Topic: Income
Taxes LO: 3
10. Income tax expense is not recorded at the amount owing to the tax authorities even if
this is the most objectively measured amount.
Answer: True
Rationale: Income tax expense is based on GAAP numbers. The amount paid is based on
tax rules. The difference between the two is recorded as deferred tax expense
(benefit).
©Cambridge Business
Publishers, 2013 5-4 Financial Statement Analysis & Valuation,
