3.0 Select Transactions FAR Practice Quiz

• A. Retrospective approach, all prior periods presented are restated to reflect the new principle, and the cumulative effect on periods not presented is recorded as an adjustment to the opening balance of retained earnings
• B. Prospective approach, the new principle is applied only to current and future periods
• C. Modified retrospective approach, the cumulative effect is recorded in current-period net income as a special item
• D. No restatement is permitted, companies must continue with their original accounting principle once adopted

ASC 250-10-45-5 requires retrospective application when an entity changes an accounting principle. All prior periods presented in the financial statements are revised to reflect the new principle. The cumulative effect on all periods prior to those presented is reported as an adjustment to the opening balance of retained earnings (or net assets, or other applicable equity account) of the earliest period presented. This restated presentation allows users to compare periods on a consistent basis.

• A. A change in accounting estimate effected by a change in accounting principle, accounted for prospectively in current and future periods
• B. A change in accounting principle requiring retrospective restatement of all prior periods
• C. An error correction requiring a prior period adjustment to retained earnings
• D. A change in reporting entity requiring restatement of all historical periods

ASC 250-10-45-17 classifies depreciation method changes (e.g., declining balance to straight-line) as changes in accounting estimate effected by a change in accounting principle. Because depreciation methods inherently involve estimating how an asset's economic benefits are consumed, a method change reflects revised assumptions about the pattern of consumption. These are accounted for prospectively, applied to the current period and future periods, without restating prior periods. The change is disclosed in the notes including the justification that the new method is preferable.

• A. No recognition, purchase commitments are always off-balance-sheet
• B. Disclose the commitment in footnotes only, the penalty is not yet due
• C. Accrue the full contract value of $1,000,000, the entire purchase commitment must be expensed when the decision to exit is made
• D. Accrue the $500,000 loss if the decision to pay the penalty is firm and the obligation is probable and estimable, the minimum loss under the contract should be recognized

When it is probable that a purchase commitment will result in a loss (either by taking delivery of goods worth less than the contract price, or by paying a penalty to exit), the minimum probable loss is accrued. Here, the company will pay $500,000 rather than honor the $1,000,000 contract, the $500,000 penalty is the minimum loss under the contract and should be accrued when the decision is firm and payment is probable: Debit Loss on Purchase Commitment $500,000; Credit Accrued Liability $500,000.

• A. Software license: $900; support: $0, the entire price is allocated to the most significant deliverable
• B. Software license: $450; support: $450, split equally between the two elements
• C. Software license: $500; support: $400, the support receives its full standalone price and the residual goes to the license
• D. Software license: $540; support: $360, allocated based on relative standalone selling prices: license = $900 × ($600/$1,000); support = $900 × ($400/$1,000)

ASC 606-10-32-31 requires allocating the transaction price based on relative standalone selling prices. License SSP = $600; Support SSP = $400; Total SSP = $1,000. License allocation = $900 × ($600/$1,000) = $540. Support allocation = $900 × ($400/$1,000) = $360. Total = $900 ✓. Revenue is recognized: $540 at license delivery (point in time) and $360 over the 2-year support period (over time).

• A. $10,000,000, all revenue is recognized when the contract is signed
• B. $3,000,000, revenue equals costs incurred
• C. $3,750,000, percentage complete = $3,000,000/$8,000,000 = 37.5%; revenue = 37.5% × $10,000,000
• D. $5,000,000, revenue is split evenly over two years

Cost-to-cost percentage of completion: Percentage complete = Costs incurred to date / Total estimated costs = $3,000,000 / $8,000,000 = 37.5%. Revenue recognized = 37.5% × $10,000,000 = $3,750,000. Gross profit recognized = $3,750,000 − $3,000,000 = $750,000. This method satisfies ASC 606's 'over time' recognition when the customer controls the asset as it is created or enhanced, and the contractor's performance does not create an asset with alternative use.

• A. $1,200,000 and $300,000 are both recognized in current-year net income as a combined $1,500,000 gain
• B. The $1,200,000 cumulative effect is an extraordinary item; the $300,000 is in continuing operations
• C. The $1,200,000 is reported in OCI; the $300,000 higher income appears in net income
• D. The $1,200,000 cumulative effect adjusts the opening balance of retained earnings for the earliest period presented; the $300,000 higher income is reflected in the current-period income statement through normal operations under the new FIFO method, prior periods are also restated to FIFO basis

Under retrospective application: (1) All prior periods presented are restated from LIFO to FIFO basis, cost of goods sold, income taxes, and net income are revised for each prior period; (2) The cumulative effect on all periods prior to those presented ($1,200,000 net of tax) is an adjustment to the opening retained earnings of the earliest period presented, it does not go through current-year income; (3) The current year's income under FIFO ($300,000 higher) simply reflects normal FIFO results, no special presentation is needed beyond using FIFO throughout the income statement. This approach ensures all periods shown are on a consistent FIFO basis.

• A. Recognized in current-year net income, cumulative effects of principle changes are always in the current period
• B. Allocated proportionally to each prior year presented based on relative revenues
• C. Deferred and amortized over future periods as a deferred credit
• D. As a prior period adjustment: the $180,000 (net of tax) increases opening retained earnings of the earliest period presented; each prior year presented is restated on the accrual basis; the $25,000 current-year difference is included in current-year income on the accrual basis

The retrospective approach requires: (1) Restate each prior year presented to accrual-basis income, adjusting revenues, expenses, receivables, and payables for each presented year; (2) The $180,000 cumulative pre-presentation effect (net of tax) is added to opening retained earnings of the earliest period presented, a direct equity adjustment bypassing the income statement; (3) Current-year income ($25,000 higher on accrual basis) is included in the income statement as part of normal operations. Full disclosures explain the nature of the change, the reason it is preferable, and the effect on each period.

• A. Recognized immediately as revenue, nonrefundable fees are always recognized at receipt
• B. Expensed by the customer and recognized by the service provider at contract termination
• C. Recognized as OCI and reclassified to revenue when the service contract ends
• D. Recognized as a contract liability and allocated to the performance obligation(s) in the contract, the fee is part of the transaction price but relates to future service delivery, not a distinct deliverable

Under ASC 606-10-55-51, nonrefundable upfront fees must be evaluated to determine whether they are payment for a distinct good or service. Setup activities that are administrative necessities do not transfer a distinct good or service to the customer, they represent fulfillment activities. Therefore: the $50,000 is a contract liability at receipt; it is allocated to the service performance obligation and recognized over the service period as services are delivered. The customer is effectively prepaying for the ongoing service, not for a separate distinct deliverable.