Principles of Accounting – Homework #3

Principles of Accounting – Homework #3

Question 1 – Accounting Standards

In this question, we will practice navigating the official source of accounting standards.

(1) You can access the U.S. GAAP through the U.S. Accounting Standards Codification
(ASC; [Link] In the U.S. ASC, find paragraph 606-10-05-4, which
summarizes the five-step process for revenue recognition and copy the paragraph below.
To find this paragraph, go through ‘Revenue,’ ‘606 Revenue from Contracts with
Customers,’ ‘10 Overall,’ and ‘05 Overview and Background.’

An entity recognizes revenue in accordance with that core principle by applying the following
steps:
a. Step 1: Identify the contract(s) with a customer—A contract is an agreement between two or
more parties that creates enforceable rights and obligations. The guidance in this Topic
applies to each contract that has been agreed upon with a customer and meets specified
criteria. In some cases, this Topic requires an entity to combine contracts and account for
them as one contract. This Topic also provides requirements for the accounting for contract
modifications. (See paragraphs 606-10-25-1 through 25-13.)
b. Step 2: Identify the performance obligations in the contract—A contract includes promises to
transfer goods or services to a customer. If those goods or services are distinct, the promises
are performance obligations and are accounted for separately. A good or service is distinct if
the customer can benefit from the good or service on its own or together with other resources
that are readily available to the customer and the entity's promise to transfer the good or
service to the customer is separately identifiable from other promises in the contract. (See
paragraphs 606-10-25-14 through 25-22.)
c. Step 3: Determine the transaction price—The transaction price is the amount of consideration
in a contract to which an entity expects to be entitled in exchange for transferring promised
goods or services to a customer. The transaction price can be a fixed amount of customer
consideration, but it may sometimes include variable consideration or consideration in a form
other than cash. The transaction price also is adjusted for the effects of the time value of
money if the contract includes a significant financing component and for any consideration
payable to the customer. If the consideration is variable, an entity estimates the amount of
consideration to which it will be entitled in exchange for the promised goods or services. The
estimated amount of variable consideration will be included in the transaction price only to
the extent that it is probable that a significant reversal in the amount of cumulative revenue
recognized will not occur when the uncertainty associated with the variable consideration is
subsequently resolved. (See paragraphs 606-10-32-2 through 32-27.)
d. Step 4: Allocate the transaction price to the performance obligations in the contract—An
entity typically allocates the transaction price to each performance obligation on the basis of
the relative standalone selling prices of each distinct good or service promised in the contract.
If a standalone selling price is not observable, an entity estimates it. Sometimes, the
transaction price includes a discount or a variable amount of consideration that relates
entirely to a part of the contract. The requirements specify when an entity allocates the

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discount or variable consideration to one or more, but not all, performance obligations (or
distinct goods or services) in the contract. (See paragraphs 606-10-32-28 through 32-41.)
e. Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation—An
entity recognizes revenue when (or as) it satisfies a performance obligation by transferring a
promised good or service to a customer (which is when the customer obtains control of that
good or service). The amount of revenue recognized is the amount allocated to the satisfied
performance obligation. A performance obligation may be satisfied at a point in time
(typically for promises to transfer goods to a customer) or over time (typically for promises to
transfer services to a customer). For performance obligations satisfied over time, an entity
recognizes revenue over time by selecting an appropriate method for measuring the entity's
progress toward complete satisfaction of that performance obligation. (See paragraphs 606-
10-25-23 through 25-30.)

(2) You can access the IFRS through its official website [Link] However, you
have to register for the website to access the IFRS (Accessing the official standards in the
IFRS does not require any payment). After you log in to the website, you can go to
‘Issued Standards’ and ‘IFRS Accounting Standards Navigator’ to find the standards.

In this ‘IFRS Accounting Standards Navigator,’ you can see the list of all individual
IFRS standards. Unlike the U.S. ASC, the standards are not realigned by topic but are
listed with regard to their issuance dates. Among the standards, go into ‘IFRS 15
Revenue from Contracts with Customers.’

IFRS 15 does not have a succinct summary paragraph like U.S. ASC 606-10-05-4.
Therefore, the five-step process for revenue recognition should be extracted from the
detailed description of IFRS 15. Find paragraphs 9, 22, 31, 47, and 73 in IFRS 15 and
then copy those paragraphs below in the order of the five steps in U.S. ASC 606-10-05-4.

- Paragraph 9 - Identifying the contract

: An entity shall account for a contract with a customer that is within the scope of this
Standard only when all of the following criteria are met:
(a) the parties to the contract have approved the contract (in writing, orally or in accordance
with other customary business practices) and are committed to perform their respective
obligations;
(b) the entity can identify each party’s rights regarding the goods or services to be transferred;
(c) the entity can identify the payment terms for the goods or services to be transferred;
(d) the contract has commercial substance (ie the risk, timing or amount of the entity’s future
cash flows is expected to change as a result of the contract); and
(e) it is probable that the entity will collect the consideration to which it will be entitled in
exchange for the goods or services that will be transferred to the customer. In evaluating
whether collectability of an amount of consideration is probable, an entity shall consider only
the customer’s ability and intention to pay that amount of consideration when it is due. The
amount of consideration to which the entity will be entitled may be less than the price stated

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in the contract if the consideration is variable because the entity may offer the customer a
price concession (see paragraph 52).
- Paragraph 22 - Identifying performance obligations
: At contract inception, an entity shall assess the goods or services promised in a contract
with a customer and shall identify as a performance obligation each promise to transfer to the
customer either:
(a) a good or service (or a bundle of goods or services) that is distinct; or
(b) a series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customer (see paragraph 23).
- Paragraph 31 - Satisfaction of performance obligations
: An entity shall recognise revenue when (or as) the entity satisfies a performance obligation
by transferring a promised good or service (ie an asset) to a customer. An asset is transferred
when (or as) the customer obtains control of that asset.
- Paragraph 47 - Determining the transaction price
: An entity shall consider the terms of the contract and its customary business practices to
determine the transaction price. The transaction price is the amount of consideration to which
an entity expects to be entitled in exchange for transferring promised goods or services to a
customer, excluding amounts collected on behalf of third parties (for example, some sales
taxes). The consideration promised in a contract with a customer may include fixed amounts,
variable amounts, or both.
- Paragraph 73 - Allocating the transaction price to performance obligations
: The objective when allocating the transaction price is for an entity to allocate the transaction
price to each performance obligation (or distinct good or service) in an amount that depicts
the amount of consideration to which the entity expects to be entitled in exchange for
transferring the promised goods or services to the customer.

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Question 2 – Five-Step Revenue Recognition

In this question, we will examine financial information from HP Inc. (as of October 31, 2024)
and Dell Technologies Inc. (as of January 31, 2025). Find their most recent financial statements.

(1) The two companies describe their revenue recognition policies according to the five steps
of revenue recognition we learned in class. Find those descriptions and read them. For the
question, write down which note includes that description from which page.
Dell Technologies Inc.: Note 2 — Summary of Significant Accounting Policies (from
page 86)
HP Inc.: Note 1— Summary of Significant Accounting Policies (from page 58)

(2) The two companies largely have two categories of performance obligations: hardware
(products) vs. services. Why do they treat them as distinct performance obligations?
HP and Dell treat hardware and services as distinct performance obligations because they
provide benefits in different ways. Hardware transfers control to the customer at a single
point in time, while services provide benefits gradually over time. Therefore, they are
recognized separately; hardware revenue at a point in time and service revenue over time.

The questions below consider a hypothetical sales transaction HP made on February 1, 2024. In
that transaction, HP sold a computer for $1,200. The hardware is delivered that day, but services
(e.g., maintenance) are delivered over the next 24 months. The standalone selling prices of the
two components are $1,120 (hardware) and $480 (services). HP uses straight-line recognition for
services revenue. Beware that HP’s fiscal year ends on October 31, not December 31.

(3) How much revenue should HP recognize for the fiscal year ended on October 31, 2024?
How much deferred revenue should HP have as of October 31, 2024? How much of that
deferred revenue is current?
total transaction price = $1,200
allocation based on SSP:
- hardware = $1,200 * (1,120 / 1,600) = $840
- services = $1,200 * (480 / 1,600) = $360

revenue: $975 (= $840 from hardware + $135(15*9) from services.)

remaining deferred revenue: $225 (12 months current, 3 months non-current)
current deferred revenue: $180 (= 12 months * $15)

(4) Additional to the given information, suppose that HP also sold a 3-year extended
warranty for $400 to the customer. The extended warranty is another performance

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obligation of the expanded contract. How does this information change your answer to
(3)?
total transaction price = $1,600 (= $1,200 + $400)
allocation based on SSP:
- hardware = $1,600 × (1,120 / 2,000) = $896
- services = $1,600 × (480 / 2,000) = $384
- extended warranty = $1,600 × (400 / 2,000) = $320
-
Revenue:
= $896 (hardware) + $144 (services: $384 ÷ 24 × 9) + $80 (warranty: $320 ÷ 36 × 9)
= $1,120 total revenue recognized

Remaining deferred revenue:

= $240 (services: $384 − $144) + $240 (warranty: $320 − $80)
= $480 total deferred revenue

Current deferred revenue:

= 12 months × ($384 ÷ 24 = $16) + 12 months × ($320 ÷ 36 = $8.89)
= 12 × (16 + 8.89) = $298.7 current deferred revenue

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Question 3 – Proportion of Revenue Deferral

In this question, we will examine financial information from Tesla, Inc. Find Tesla’s most recent
financial statements as of December 31, 2024.

(1) Read Tesla’s description of its revenue recognition policy with regard to automotive sales
(with and without resale value guarantee) in Note 2. According to the description, does
Tesla recognize the full price of the automotive at the time of initial sale?

For the following questions, you will infer the percentage of transaction price Tesla defers in its
automotive sales transactions, using information in pages 54-55. The flow will be similar to what
you have seen in class (the Apple example).

(2) How much is Tesla’s revenues from automotive sales for fiscal 2024?

(3) How much of your answer to (2) is recognition of deferred revenue? Given that answer,
how much is Tesla’s revenues from fiscal 2024 automotive sales recognized immediately
at the time of initial sale?

(4) How much deferred revenue did Tesla newly recognize from its fiscal 2024 automotive
sales?

(5) Given your answers to (3) and (4), what percentage of transaction price does Tesla defer
in its automotive sales transactions?

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Question 4 – Estimation of Service Period

In this question, we will examine financial information from Tesla, Inc (December 31, 2024) and
Alphabet Inc. (December 31, 2024). Find their most recent financial statements.

Tesla’s sales model is similar to Apple’s, so we can use its deferred revenue balances to estimate
its average service period using the assumptions we used in class.

(1) How much deferred revenue does Tesla have on its balance sheet as of December 31,
2024? What is the proportion of current deferred revenue out of that total amount?

(2) Extending the exercises we did for Apple and Microsoft in class, what is Tesla’s
estimated average service period based on your answer to (1)? To remind you, in class,
we found that 2 years of average service period leads to 67% of deferred revenue being
current and that 4 years of average service period leads to 40% of deferred revenue being
current.

Alphabet (Google) has a sales model similar to Microsoft’s, so we cannot use its deferred
revenue balances to estimate its average service period. Therefore, similar to Microsoft’s case,
we will use Alphabet’s disclosure of its remaining performance obligations, including those
unbilled.

(3) In page 64 of Alphabet’s most recent Form 10-K, find a disclosure about Alphabet’s
remaining performance obligations (revenue backlog). How much of its remaining
performance obligations does Alphabet expect to recognize within the next 24 months?

(4) Based on your answer to (3), what is Alphabet’s estimated average service period?

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Question 5 – Principal vs Agent

In this question, we will examine financial information from Apple Inc. (September 28, 2024)
and [Link], Inc. (December 31, 2024). Find their most recent financial statements.

The first part is about Apple’s App Store sales.

(1) Apple discloses revenue disaggregated by product lines in Note 2. Which of the five
product lines seems most likely to include App Store sales? See page 2 of the Form 10-K
for more insight. How much is Apple’s net sales from that product line for fiscal 2024?

(2) Industry analysts examine Apple’s other disclosure to infer App Store revenues. Recent
estimates (link) for Apple’s App Store sales are around $90 billion for the calendar year
2023. Is your answer to (1) large enough to comfortably include that amount given that
Apple provides many other services to its customers? If not, how can you reconcile the
two figures? In your answer, consider Apple’s revenue recognition policy described in
Note 2.

The second part is about Amazon’s sales through third-party sellers.

(3) How much is Amazon’s net sales for fiscal 2024?

(4) From Note 10, find how much of Amazon’s net sales are from its own online stores
versus from third-party seller services in fiscal 2024. Which one is larger?

(5) When you purchase a good from Amazon’s website, Amazon makes it clear whether it is
“sold by” [Link] or “sold by” some other merchant. Given your answer to (4), can
you definitively say that the majority of goods are “sold by” [Link]? In your
answer, consider Amazon’s revenue recognition policy described in Note 1 (page 43).

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Question 6 – Comparing Loyalty Programs

In this question, we will examine financial information from United Airlines Holdings, Inc.
(December 31, 2024) and Delta Air Lines, Inc. (December 31, 2024). Find their most recent
financial statements.

In the following questions, you will make a rough comparison of the loyalty programs of these
two airline companies (along with Southwest’s we saw in class). Although all airline companies
have similar loyalty programs, it is difficult to directly compare their terms and objectively
conclude which one is more generous than others. As an alternative, you can use financial
statement information to assess how the airline companies view their loyalty programs
themselves. If an airline company defers a larger portion of the ticket price due to loyalty
programs, that can be indirect evidence that the company’s loyalty program is more generous. Of
course, a lower portion of deferral may be due to fewer customers having joined the loyalty
program. However, that is also another indirect evidence of the attractiveness of the company’s
loyalty program.

Use Note 2 for United and Note 2 for Delta along with their income statements.

(1) How much passenger revenue did United and Delta recognize in fiscal 2024?

(2) Based on their notes, how much of the passenger revenue you found in (1) is redemption
of loyalty mileage (realization of deferred revenue)?

(3) From your answers in (1) and (2), how much is passenger revenue immediately
recognized at the time of flight (corresponding to $20,467 million for Southwest in
2024)?

(4) Based on their notes, how much revenue is deferred at the time of flight due to the loyalty
programs (corresponding to $3,532 million for Southwest in 2024)?

(5) From your answers in (3) and (4), what are the proportions of revenue United and Delta
are deferring at the time of flight due to their loyalty programs (corresponding to 14.7%
for Southwest in 2024)?

(6) From your answer in (5), which airline company (among Southwest, United, and Delta)
seems to be most generous in its loyalty program?

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Question 7 – Allowances

In this question, we will examine financial information from Nvidia Corporation. Find Nvidia’s
most recent financial statements as of January 26, 2025.

(1) How much is Nvidia’s revenue for fiscal 2025 on its statement of income?

(2) Your answer to (1) is net of contra revenue accounts. From Schedule II in page 82, find
out how much reduction to gross revenue occurred to due sales returns in fiscal 2025.

(3) Assuming that sales returns are the only contra revenue account for Nvidia, how much
gross revenue for fiscal 2025 is Nvidia estimating to be returned back to customers?

(4) How much sales return did Nvidia actually issue during fiscal 2025?

(5) How much is Nvidia’s accounts receivable as of January 26, 2025 on its balance sheet?

(6) According to Schedule II in page 82, what proportion of gross accounts receivable does
Nvidia expect to be uncollectible?

(7) From Schedule II, is there any evidence that Nvidia actually determined that a specific
account receivable is definitively uncollectible during fiscal 2025?

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