COMMERCE 1AA3 Study Guide - Quiz Guide: Cash Flow Statement, Cash Flow, Sales PromotionExam
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Question 1: Four of your friends, already finished college, recently started a construction
company in Brantford, Ontario. They are building low cost residential houses in the city’s north
end, a 20 minute commute from McMaster’s main campus. Sales were initially quite slow.
However, with a recent sales promotion, all 30 remaining homes sold in 7 days. The sales
promotion stated the following: “Special introductory price of $250,000 for 2 story, 3 bedroom
home. Only 5% deposit required. All credit applications approved; financing provided by
HomeLine Credit Union. If you don’t like your new home, we will buy it back within the next 3
years for 90% of your purchase price.” Should your friends recognize revenue now for these 30
homes recently sold? Provide a well-reasoned explanation, referencing the 5 revenue
recognition criteria in your response.
Five criteria for revenue recognition as follows:
1) Risks and rewards have been transferred from the seller to the buyer – this criterion has not been
met; the buyer has the option to sell the house back to the seller for 90% of purchase price within
the next 3 years.
2) The seller has no control over the goods sold – this criterion is met – the seller cannot force the
buyer to sell the house back to the seller in the future
3) Collection of payment is reasonably assured – this criterion is met – while the customer may not
be paying cash for the house, the customer will receive financing from HomeLine Credit Union to
purchase the house; this money will be transferred from HomeLine Credit Union to the seller
4) The amount of revenue can be reasonably measured – this criterion is met – the amount of
revenue is $250,000.
5) Cost of earning the revenue can be reasonably measured – this criterion is met – the 30 homes
recently sold have already been built. As such, the costs are known.
Overall, then, since not all revenue recognition criteria have been met, revenue cannot be recognized.
The journal entry should be: DR Cash CR Unearned revenue.
Question 2: Explain the concept of unearned revenue using your student tuition fees. How
does your academic institution account for the payment of tuition in its financial statements?
Your university or college collects cash from you in August or September before providing any course
lectures, tutorials, etc. In other words they have collected cash before providing any services. Until this
takes place your tuition is considered unearned revenue. When the course is delivered the administration
can begin to recognized revenue. Journal entry upon receipt of cash: DR Cash CR Unearned revenue.
Journal entry upon teaching the courses: DR Unearned revenue CR Revenue.
Question 3: Your friend recently started a Starbuck’s franchise in downtown Hamilton. While
sales have been strong for the first six months, your friend is very confused as overall cash flow
is still negative. How can this be? Briefly explain, with reference to the three types of cash
flows noted in a cash flow statement. More specifically, outline which type(s) of cash flows are
likely positive and which type(s) of cash flows are likely negative.
Three types of cash flows as follows:
1) Operating – these cash flows are likely positive as sales have been strong and selling price of
items is likely higher than cost of items.
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