Question

On April 1 of year 0 Stephanie received a $9,000 payment for full payment on a three-year service contract (under the contract Stephanie is obligated to provide advisory services for the next three years). (Leave no answers blank. Enter zero if applicable.)

a.) What amount of income should Stephanie recognize in year 0 if she uses the accrual method of accounting? (She recognized $2,250 for financial accounting purposes.)

b.) What amount of income will Stephanie recognize in year 1 if she uses the accrual method of accounting?

c.) What amount of income will Stephanie recognize in year 2 if she uses the accrual method of accounting?

d.) What amount of income will Stephanie recognize in year 0 if she recognizes $5,000 of income from the contract for financial statement purposes?

Answer 1

Revenue recognition as per accrual basis of accounting is a concept where revenue is recognized when sale or provision of service is complete. Revenue must be recognized as and when realized or earned and not when cash is received. Here in this case, Stephanie has received full payment in year 0 and the contract obligations continue for three years. So, Stephanie will have to provide the service for three years and would not receive any further payment. Thus, revenue would be recognized as per performance or completion of contract over the period of three years.

Assumptions:

As it begins on April 1 of year 0, we take year 0 as first year, year 1 as second year and year 2 as third year.

The answer to the question is as follows:

a) The fact that Stephanie recognized $ 2250 for financial accounting purposes means that she must have completed her services which amounts to $ 2250 in year 0. Thus, we recognize $ 2250 revenue in year 0.

Entry to be passed:

On april 1 of year 0

Cash/Bank $ 9000

Customer/Accounts receivable $ 9000

(Being payment received from customer in full)

At the end of year 0

Customer/Accounts receivable $ 2250

Income from advisory services $ 2250

(Being revenue recognized for 1st year)

b) Now, $ 2250 revenue has already been recognized. We will recognize the balance in the remaining two years in equal halves as the question is silent about how much recognition to be made in each year.

Remaining revenue= $ 9000 - $2250 =$ 6750

Share of revenue for each year = $ 6750/2 = $ 3375

Revenue recognition of $ 3375 in year 1.

Entry to be passed:

Customer/Accounts receivable $ 3375

Income from advisory services $ 3375

(Being revenue recognized for 2nd year)

c) Following the same principle as in part b) revenue recognition of $ 3375 in year 2.

Entry to be passed:

Customer/Accounts receivable $ 3375

Income from advisory services $ 3375

(Being revenue recognized for 3rd year)

d) Stephanie recognized $ 5000 as income for financial statement purposes in year 0, which may signify that her financial statements were drawn as per IFRS and may be because of the standards in place she may had to recognize $ 5000 as income in year 0. That means as per her completion percentage towards the contract she has earned or realized $ 5000 as revenue.

Entry to be passed:

On April 1 of year 0:

Cash/Bank $ 9000

Customer/Accounts receivable $ 9000

(Being payment received from customer in full)

At the end of year 0:

Customer/Accounts receivable $ 5000

Income from advisory services $ 5000

(Being revenue recognized in 1st year)

Rest $ 4000 will be recognized in equal share in year 1 and year 2.