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8.18 Measuring Income For A Long-Haul Transport Firm.: Required

CN recognizes freight revenue using the percentage-of-completion method, based on the percentage of the service performed. CN transports freight for customers on a scheduled basis from origin to destination for a fixed fee. Revenue is recognized as the freight is transported along the route based on the progress of the shipment. The document asks the reader to discuss the appropriateness of CN's revenue recognition technique.

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125 views2 pages

8.18 Measuring Income For A Long-Haul Transport Firm.: Required

CN recognizes freight revenue using the percentage-of-completion method, based on the percentage of the service performed. CN transports freight for customers on a scheduled basis from origin to destination for a fixed fee. Revenue is recognized as the freight is transported along the route based on the progress of the shipment. The document asks the reader to discuss the appropriateness of CN's revenue recognition technique.

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© © All Rights Reserved
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E-WAHLEN-09-1211-008.qxd:.

6/30/10 3:08 PM Page 705

Questions, Exercises, Problems, and Cases 705

contracts. Discuss the criteria used to recognize revenue for each type of contract and
the difficulties in applying the criteria.
b. Discuss the appropriateness of the revenue recognition techniques employed by
Sapient in relation to the general revenue recognition criterion of “substantial portion
of services has been provided” as discussed in the text of this chapter.
c. As detailed earlier, some contracts have multiple-element arrangements with separate
deliverable components. Discuss the criteria used to distinguish among multiple
components of the contract. Also speculate on how the firm recognizes revenue when
the contract cannot be separated into distinct deliverable components.

8.18 MEASURING INCOME FOR A LONG-HAUL TRANSPORT FIRM.


Canadian National Railway Company (CN) spans Canada and mid-America and provides
freight transport services from the Atlantic Ocean to the Pacific Ocean and to the Gulf of
Mexico. It is currently the largest private rail system in Canada and was privatized by the
Canadian government when it was considered one of the worst rail transport companies in
North America. CN has been a success story since its privatization and is now considered one
of the strongest and most efficient rail freight transport companies. Its success is partly due
to a fundamental change in the way it offers freight services to customers. CN runs what the
firm refers to as a scheduled railroad. Similar to rail passenger service, as much as possible CN
maintains a fixed operating schedule and a fixed freight-car fleet movement across the conti-
nent. Thus, customers know what shipment options are available to them and know with a
high degree of accuracy when shipments will arrive at designated locations.
Typically, a customer contracts a fixed fee with CN to ship its freight from the point of
origination (for example, the Port of Halifax) to the point of destination (for example, the
Port of Vancouver). CN provides the entire transport (that is, CN does not contract out a
portion of the shipment to other rail transport companies), and the length of time taken to
deliver the freight depends on the distance and the type of service (fast delivery versus nor-
mal delivery, for example) purchased by the customer. In a recent annual report, CN suc-
cinctly states its policy on recognizing revenue: “Freight revenues are recognized on services
performed by the Company, based on the percentage of complete service method. Costs
associated with movements are recognized as the service is performed.”

Required
Discuss the appropriateness of the revenue recognition techniques employed by CN for
recognizing freight revenues.

8.19 MEASURING INCOME FROM LONG-TERM CONTRACTS. On


January 1, 2010, Turner Construction Company agreed to construct an observatory for
Dartmouth College for $120 million. Dartmouth College must pay $30 million upon signing
and $30 million at the end of 2010, 2011, and 2012. Expected construction costs are $10 mil-
lion for 2010, $60 million for 2011, and $30 million for 2012. Assume that these cash flows
occur at the end of each year. Also assume that an appropriate interest rate for this contract
is 10 percent. Amortization schedules for the deferred cash flows follow.

Amortization Schedule for Cash Received (amounts in thousands)


Balance Interest Reduction Balance
Year Jan. 1 Revenue Payment in Principal Dec. 31
2010 $74,606 $7,460 $30,000 $22,540 $52,066
2011 52,066 5,207 30,000 24,793 27,273
2012 27,273 2,727 30,000 27,273 0
E-WAHLEN-09-1211-008.qxd:. 6/30/10 3:08 PM Page 706

706 Chapter 8 Operating Activities

Amortization Schedule for Cash Disbursed (amounts in thousands)


Balance Interest Reduction Balance
Year Jan. 1 Expense Payment in Principal Dec. 31
2010 $81,217 $8,122 $10,000 $ 1,878 $79,339
2011 79,339 7,934 60,000 52,066 27,273
2012 27,273 2,727 30,000 27,273 0

Required
a. Indicate the amount and nature of income (revenue and expense) that Turner would
recognize during 2010, 2011, and 2012 if it uses the completed-contract method. Ignore
income taxes.
b. Repeat Part a using the percentage-of-completion method.
c. Repeat Part a using the installment method.
d. Indicate the balance in the construction in process account on December 31, 2010,
2011, and 2012 (just prior to completion of the contract) under the completed-con-
tract and the percentage-of-completion methods.
8.20 INTERPRETING FINANCIAL STATEMENT DISCLOSURES RELAT-
ING TO INCOME RECOGNITION. Deere & Company manufactures agricultural
and industrial equipment and provides financing services for its independent dealers and their
retail customers. In recent notes to the financial statements, Deere discloses the following:
Note 1: Deere recognizes income from equipment sales for financial reporting at the time
of shipment to dealers. Provisions for sales incentives to dealers, returns and allowances,
and uncollectible accounts are made at the time of sale. There is a time lag, which varies
based on the timing and level of retail demand, between when Deere records sales to deal-
ers and when dealers sell equipment to retail customers. Deere recognizes income from
equipment sales using the installment method for tax reporting.
Note 2: Deere provides financing to independent dealers and retail customers for
Deere products. Accounts and notes receivable appear net of unearned finance
income. Deere recognizes the unearned finance income as finance revenue over the
period that dealer and customer notes are outstanding.

Required
a. Using the criteria for revenue recognition, justify Deere’s timing of revenue recogni-
tion for its equipment sales. Consider why recognition of revenue earlier or later than
the time of shipment to dealers would not be more appropriate.
b. Describe briefly how the balance sheet accounts of Deere & Company listed here
would change if it recognized revenues during the period of production using the per-
centage-of-completion method. You do not need to give amounts, but indicate the
likely direction of the change and describe the computation of its amount.
• Accounts and Notes Receivable
• Inventories
• Retained Earnings
c. Respond to Part b assuming that Deere & Company recognized revenue using the
installment method.
• Accounts and Notes Receivable
• Inventories
• Retained Earnings

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