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Chapter 5

Income Measurement and Profitability Analysis

AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise, and problem in Intermediate Accounting, 7e, with the following AACSB learning skills:

Questions
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AACSB Tags
Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Diversity, Reflective thinking Reflective thinking Reflective thinking Reflective thinking Diversity, Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Diversity, Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking

Brief Exercises
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AACSB Tags
Analytic Reflective thinking Analytic Analytic Analytic Reflective thinking, Communications Analytic Analytic Analytic Diversity, Analytic Analytic Reflective thinking, Analytic Diversity, Reflective thinking, Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking Reflective thinking Reflective thinking Analytic Analytic Reflective thinking Analytic

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Exercises
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AACSB Tags
Reflective thinking, Analytic Reflective thinking, Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking, Communications Analytic Diversity, Analytic Analytic Analytic Analytic Analytic Reflective thinking, Communications Analytic Analytic Diversity, Analytic Analytic Reflective thinking Analytic, Communications Analytic, Communications Analytic Analytic Analytic Analytic Analytic Diversity, Analytic Reflective thinking, Analytic Reflective thinking, Analytic Reflective thinking Reflective thinking, Analytic Analytic Reflective thinking Reflective thinking Analytic

CPA/CMA
1 2 3 4 5 6 7 8 9 10 1 2 3

AACSB Tags
Analytic Analytic Analytic Reflective thinking Analytic Analytic Diversity, Reflective thinking Diversity, Analytic Diversity, Reflective thinking Diversity, Reflective thinking Analytic Reflective thinking Analytic Analytic Analytic Analytic Analytic, Communications Analytic Analytic Diversity, Analytic Analytic Analytic, Communications Analytic, Communications Analytic Analytic, Communications Analytic Analytic, Communications Analytic Reflective thinking, Analytic Reflective thinking, Communications Analytic Analytic

Problems
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QUESTIONS FOR REVIEW OF KEY TOPICS


Question 51
The realization principle requires that two criteria be satisfied before revenue can be recognized: 1. The earnings process is judged to be complete or virtually complete. 2. There is reasonable certainty as to the collectibility of the asset to be received (usually cash).

Question 52
At the time production is completed, there usually exists significant uncertainty as to the collectibility of the asset to be received. We dont know if the product will be sold, nor the selling price, nor the buyer if eventually the product is sold. Because of these uncertainties, revenue recognition usually is delayed until the point of product delivery.

Question 53
A principal has primary responsibility for delivering a product or service, and recognizes as revenue the gross amount received from a customer. An agent doesnt primarily deliver goods or services, but acts as a facilitator that earns a commission for helping sellers to transact with buyers, and recognizes as revenue only the commission it receives for facilitating the sale.

Question 54
If the installment sale creates a situation where there is significant uncertainty concerning cash collection and it is not possible to make an accurate assessment of future bad debts, revenue and cost recognition should be delayed beyond the point of delivery.

Question 55
The installment sales method recognizes gross profit by applying the gross profit percentage on the sale to the amount of cash actually received each period. The cost recovery method defers all gross profit recognition until cash has been received equal to the cost of the item sold.

Question 56
Deferred gross profit is a contra installment receivable account. The balance in this account is subtracted from gross installment receivables to arrive at installment receivables, net. The net amount of the receivables represents the portion of remaining payments that represent cost recovery.

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Question 57
Because the return of merchandise can retroactively negate the benefits of having made a sale, the seller must meet certain criteria before revenue is recognized in situations when the right of return exists. The most critical of these criteria is that the seller must be able to make reliable estimates of future returns. In certain situations, these criteria are not satisfied at the point of delivery of the product.

Question 58
Sometimes a company arranges for another company to sell its product under consignment. The consignor physically transfers the goods to the other company (the consignee), but the consignor retains legal title. If the consignee cant find a buyer within an agreed-upon time, the consignee returns the goods to the consignor. However, if a buyer is found, the consignee remits the selling price (less commission and approved expenses) to the consignor. Because the consignor retains the risks and rewards of ownership of the product and title does not pass to the consignee, the consignor does not record revenue (and related costs) until the consignee sells the goods and title passes to the eventual customer.

Question 59
For service revenue, if there is one final service that is critical to the earnings process, revenues and costs are deferred and recognized after this service has been performed. On the other hand, in many instances, service revenue activities occur over extended periods and recognizing revenue at any single date within that period would be inappropriate. Instead, its more meaningful to recognize revenue over time in proportion to the performance of the activity.

Question 510
The completed contract method of recognizing revenues and costs on long-term construction contracts is equivalent to recognizing revenue at point of delivery, i.e., when the construction project is complete. The percentage-of-completion method assigns a fair share of the projects expected revenues and costs to each period in which the earnings process takes place, i.e., the construction period. The fair share typically is estimated as the project's costs incurred each period as a percentage of the project's total estimated costs. The completed contract method should only be used when the lack of dependable estimates or inherent hazards cause forecasts of future costs to be doubtful.

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Question 511
The completed contract method recognizes revenue, cost of construction, and gross profit at the end of the contract, after the contract has been completed. The cost recovery method will recognize an amount of revenue equal to the amount of cost that can be recovered, which typically is an amount that exactly offsets costs until all costs have been recovered, and then will recognize the remaining revenue and gross profit. Therefore, revenue and cost are recognized earlier under the cost recovery method than under the completed contract method, but gross profit recognition is delayed until late in the contract for both approaches. Assuming that the final costs are incurred just prior to completion of the contract, both approaches should recognize gross profit at the same time.

Question 512
The billings on construction contract account is a contra account to the construction in progress asset. At the end of each reporting period, the balances in these two accounts are compared. If the net amount is a debit, it is reported in the balance sheet as an asset. Conversely, if the net amount is a credit, it is reported as a liability.

Question 513
An estimated loss on a long-term contract must be fully recognized in the first period the loss is anticipated, regardless of the revenue recognition method used.

Question 514
This guidance requires that if an arrangement includes multiple elements, the revenue from the arrangement should be allocated to the various elements based on the relative fair values of the individual elements. If part of an arrangement does not qualify for separate accounting, revenue recognition is delayed until revenue is recognized for the other parts.

Question 515
IFRS has less specific guidance for recognizing revenue for multiple-deliverable arrangements. IAS No. 18 simply states that: in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction and gives a couple of examples, whereas U.S. GAAP provides more restrictive guidance concerning how to allocate revenue to various components and when revenue from components can be recognized.

Question 516
Specific guidelines for revenue recognition of the initial franchise fee are provided by FASB ASC 952605251. A key to these guidelines is the concept of substantial performance. It requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue. The term substantial requires professional judgment on the part of the accountant. In situations when the initial franchise fee is collectible in installments, even after substantial performance has occurred, the installment sales or cost recovery method should be used for profit recognition, if a reasonable estimate of uncollectibility cannot be made.

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Question 517
Receivables turnover ratio = Net sales Average accounts receivable (net) Cost of goods sold Average inventory Net sales Average total assets

Inventory turnover ratio

Asset turnover ratio

Activity ratios are designed to provide information about a companys effectiveness in managing assets. Activity or turnover of certain assets measures the frequency with which those assets are replaced. The greater the number of times an asset turns over, the less cash a company must devote to that asset, and the more cash it can commit to other purposes.

Question 518
Profit margin on sales = Net income Net sales Net income Average total assets Net income Average shareholders' equity

Return on assets

Return on shareholders' equity

A fundamental element of an analysts task is to develop an understanding of a firms profitability. Profitability ratios provide information about a companys ability to earn an adequate return relative to sales or resources devoted to operations. Resources devoted to operations can be defined as total assets or only those assets provided by owners, depending on the evaluation objective.

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Question 519
Return on equity Net income Avg. total equity = = Profit margin Net income Total sales X X Asset turnover Total sales Avg. total assets X Equity multiplier X Avg. total assets Avg. total equity

The DuPont framework shows return on equity as being driven by profit margin (reflecting a companys ability to earn income from sales), asset turnover (reflecting a companys effectiveness in using assets to generate sales), and the equity multiplier (reflecting the extent to which a company has used debt to finance its assets).

Question 520
These perspectives are referred to as the discrete and integral part approaches. Current interim reporting requirements and existing practice generally view interim reports as integral parts of annual statements. However, the discrete approach is applied to some items. Most revenues and expenses are recognized in interim periods as incurred. However, if an expenditure clearly benefits more than just the period in which it is incurred, the expense should be spread among the periods benefited. Examples include annual repair expenses, property tax expense, and advertising expenses incurred in one quarter that clearly benefit later quarters. These are assigned to each quarter through the use of accruals and deferrals. On the other hand, major events such as discontinued operations, extraordinary items, and unusual or infrequent items should be reported separately in the interim period in which they occur.

Question 521
U.S. GAAP views interim reports as an integral part of the annual report, so amounts that affect multiple interim periods are accrued or deferred and then charged to each of the periods they affect. IFRS takes much more of a discrete-period approach than does U.S. GAAP, such that costs for repairs, property taxes, advertising, etc., that do not meet the definition of an asset at the end of an interim period are expensed entirely in the period in which they occur.

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SUPPLEMENT QUESTIONS FOR REVIEW OF KEY TOPICS


Question 522
The five key steps in recognizing revenue under the new standard are: 1. Identify a contract(s) with a customer. 2. Identify the separate performance obligation(s) in the contract. 3. Determine the transaction price. 4. Allocate the transaction price to the separate performance obligations. 5. Recognize revenue when (or as) the entity satisfies each performance obligation.

Question 523
Under the proposed ASU, a good or service is a separate performance obligation if it is distinct, which is the case if either: 1. The seller regularly sells the good or service separately, or 2. A buyer could use the good or service on its own or in combination with goods or services the buyer could obtain elsewhere.

Question 524
Under the proposed ASU, if an entity grants a customer the option to acquire additional goods or services, that promise gives rise to a separate performance obligation in the contract only if the option provides a material right to the customer that the customer would not receive without entering into the contract. If the option provides a material right, the customer in effect pays the entity in advance for future goods or services and the entity recognizes revenue when those future goods or services are transferred or when the option expires.

Question 525
Under the proposed ASU, if an arrangement has multiple separate performance obligations, the seller allocates the transaction price to the separate performance obligations in proportion to the stand-alone selling prices of the goods or services underlying those performance obligations. If the seller cant observe actual stand-alone selling prices, the seller should estimate them.

Question 526
Under the proposed ASU, a performance obligation for a good is satisfied when control of the good is transferred to the buyer. Four key indicators that control of a good has passed from the seller to the buyer are: 1. Buyer has an unconditional obligation to pay. 2. Buyer has legal title. 3. Buyer has physical possession. 4. Buyer has the risks and rewards of ownership.

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Question 527
Under the proposed ASU, if a seller provides the service of integrating products and services into one asset (for example, as is done in the construction industry), the risks of providing the goods and services are not separable, so that arrangement is treated as a single service-related performance obligation. The performance obligation is viewed as satisfied over time if at least one of two criteria is met: 1. The seller is creating or enhancing an asset that the buyer controls as the service is performed. 2. The seller is not creating an asset that the buyer controls or that has alternative use to the seller, and at least one of the following conditions hold: a. The customer receives and consumes a benefit as the seller performs. b. Another seller would not need to reperform the tasks performed to date if that other seller were to fulfill the remaining obligation. c. The seller has the right to payment for performance even if the customer could cancel the contract at the customers discretion.

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BRIEF EXERCISES
Brief Exercise 51
2013 gross profit = $3,000,000 1,200,000 = $1,800,000 2014 gross profit = 0

Brief Exercise 52
Indicators that the seller is a principal (recognizing gross revenue) as opposed to an agent (recognizing net revenue) include the following: The company is primarily responsible for providing the product or service to the customer. The company has general inventory risk, meaning that the company owns inventory prior to a customer ordering it and after a customer returns it. The company has discretion in setting prices and identifying suppliers. In this transaction, Amazon never bears inventory risk, and is paid a fixed commission such that it has no discretion in setting prices. Therefore, Amazon appears to be an agent, and would only recognize revenue on the transaction equal to the amount of the commission it receives.

Brief Exercise 53
2013 Cost recovery % = Cost Sales: $1,200,000 = 40% (implying a gross profit % = 60%) $3,000,000 2013 gross profit = 2013 cash collection of $150,000 x 60% = $90,000 2014 gross profit = 2014 cash collection of $150,000 x 60% = $90,000

Brief Exercise 54
No gross profit will be recognized in either 2013 or 2014. Gross profit will not be recognized until the entire $1,200,000 cost of the land is recovered. In this case, it will take eight payments to recover the cost of the land ($1,200,000 $150,000 = 8), so
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gross profit recognition will equal 100% of the cash collected beginning with the ninth installment payment.

Brief Exercise 55
Initial deferred gross profit ($3,000,000 1,200,000) Less gross profit recognized in 2013 ($150,000 x 60%) Less gross profit recognized in 2014 ($150,000 x 60%) Deferred gross profit at the end of 2014 $1,800,000 (90,000) (90,000) $1,620,000

Brief Exercise 56
The seller must meet certain criteria before revenue can be recognized in situations when the right of return exists. The most critical of these criteria is that the seller must be able to make reliable estimates of future returns. If Meyers management can make reliable estimates of the furniture that will be returned, revenue can be recognized when the product is delivered, assuming the company has no additional obligations to the buyer. If reliable estimates cannot be made because of significant uncertainty, revenue and related cost recognition is delayed until the uncertainty is resolved.

Brief Exercise 57
Total estimated cost to complete = $6 million + 9 million = $15 million % of completion = $6 million $15 million = 40% Total estimated gross profit ($20 million 15 million) = multiplied by the % of completion Gross profit recognized the first year First year revenue = $20,000,000 x 40% = $8,000,000 $5,000,000 40% $2,000,000

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Brief Exercise 58
Assets: Accounts receivable ($7 million 5 million) Cost plus profit ($6 million + 2 million*) in excess of billings ($7 million) * Total estimated gross profit ($20 million 15 million) = multiplied by the % of completion Gross profit recognized in the first year $2,000,000 1,000,000 $5,000,000 40% $2,000,000

Brief Exercise 59
Year 1 = 0 Year 2 = $4 million Revenue Less: Costs in year 1 Costs in year 2 Actual profit $20,000,000 (6,000,000) (10,000,000) $ 4,000,000

Brief Exercise 510


Year 1: Revenue: Cost: Gross profit: $6 million $6 million $0

Year 2: Revenue: $14 million ($20 million total 6 million in year 1) Cost: $10 million Gross profit: $ 4 million

Brief Exercise 511


The anticipated loss of $3 million ($30 million contract price less total estimated costs of $33 million) must be recognized in the first year applying either method.

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Brief Exercise 512


Orange has separate sales prices for the two parts of LearnIt-Plus, so that vendorspecific objective evidence (VSOE) allows them to allocate revenue to those parts according to their relative selling prices. LearnIt will be allocated $200 x [$150 ($150 + 100)] = $120, and that revenue will be recognized upon delivery of the LearnIt software. LearnIt Office Hours will be allocated $200 x [$100 ($150 + 100)] = $80, and that revenue will be deferred and recognized over the life of the one-year period in which the Office Hours are delivered. If LearnIt were not sold separately, Orange would not have VSOE for all of the parts of the contract. In that case, revenue would be delayed until the later part was delivered. In this case, the $200 would be deferred and recognized over the life of the one-year period in which the Office Hours are delivered.

Brief Exercise 513


Orange has separate sales prices for the two parts of LearnIt-Plus, so the company can base its estimates of the fair value of those parts according to their relative selling prices. LearnIt will be allocated $200 x [$150 ($150 + 100)] = $120, and that revenue will be recognized upon delivery of the LearnIt software. LearnIt Office Hours will be allocated $200 x [$100 ($150 + 100)] = $80, and that revenue will be deferred and recognized over the life of the one-year period in which the Office Hours are delivered. If LearnIt were not sold separately, the accounting would be the same. Orange would estimate the fair value of LearnIt Office Hours to be $100 and allocate revenue in the same fashion as it did when that product was sold separately. (VSOE is not required under IFRS).

Brief Exercise 514


Specific conditions for revenue recognition of the initial franchise fee are provided by FASB ASC 952605251. A key to these conditions is the concept of substantial performance. It requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue. The term substantial requires professional judgment on the part of the accountant. Often, substantial performance is considered to have occurred when the franchise opens for business. Continuing franchise fees are recognized over time as the services are performed.

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Brief Exercise 515


Receivables turnover ratio = Net sales Average accounts receivable (net) $600,000 [$100,000 + 120,000] 2 5.45 times Cost of goods sold Average inventory $400,000* [$80,000 + 60,000] 2 5.71 times

Receivables turnover ratio

= =

Inventory turnover ratio

Inventory turnover ratio

= =

*$600,000 200,000

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Brief Exercise 516


Profit margin = = = Return on assets = = = Return on shareholders equity Net income Sales $65,000 $420,000 15.5% Net income Average total assets $65,000 $800,000 8.1%

Net income Average shareholders equity $65,000 $522,500* 12.4%

= =

Shareholders equity, beginning of period Add: Net income Deduct: Dividends Shareholders equity, end of period

$500,000 65,000 (20,000) $545,000

*Average shareholders equity = ($500,000 + 545,000) 2 = $522,500

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Brief Exercise 517


Return on equity Net income Avg. total equity = Profit margin X Asset turnover X Equity multiplier

= Net income Total sales

Total sales X Avg. total assets Avg. total assets Avg. total equity

Return on shareholders equity

= = =

Net income Average shareholders equity $65,000 $522,500 12.4% Net income Sales $65,000 $420,000 15.5%

Profit margin

= = =

Asset turnover

= = =

Sales Average total assets $420,000 $800,000 .525 times

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Brief Exercise 517 (concluded) Equity multiplier = Average total assets Average shareholders equity $800,000 $522,500 1.53

= =

Check: 12.4% ROE = 15.5% profit margin x .525 times asset turnover x 1.53 equity multiplier.

Brief Exercise 518


Inventory turnover ratio = Cost of goods sold Average inventory 6.0 = x $75,000 Cost of goods sold = $75,000 x 6.0 = $450,000
Cost of goods sold = Gross profit Sales $600,000 450,000 = $150,000

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SUPPLEMENT BRIEF EXERCISES


Brief Exercise 519
An agreement needs to have the following five characteristics to qualify as a contract for revenue recognition purposes under the proposed ASU: 1. Commercial substance. The contract is expected to affect the sellers future cash flows. 2. Approval. Each party to the contract has approved the contract and is committed to satisfying their respective obligations. 3. Rights. Each partys rights are specified with respect to the goods and services to be transferred. 4. Payment terms. The terms and manner of payment are specified. 5. Performance. A contract does not exist if either party can terminate a wholly unperformed contract without penalty. The Richter agreement does not satisfy characteristic number 4, and may not satisfy characteristics 3 and 5 as well. Therefore, it does not qualify as a contract for purposes of recognizing revenue.

Brief Exercise 520


Yes, these are separate performance obligations, because each good is sold separately to individual customers.

Brief Exercise 521


Yes, they are separate. The renewal option is a material right because it allows the customer to renew at a better price than could be obtained without the right.

Brief Exercise 522


Total estimated contract price = $25,000 + (50% x $10,000) = $30,000

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Brief Exercise 523


Based on relative stand-alone selling prices, the software comprises 80% of the total fair values ($80,000 ($20,000 + 80,000)), and the technical support comprises 20% ($20,000 ($20,000 + 80,000)). Therefore, the seller would recognize $72,000 ($90,000 80%) in revenue up front when the software is delivered, and defer the remaining $18,000 ($90,000 20%) and recognize it ratably over the next six months as the technical support service is provided, making the following journal entry: Cash 90,000 Revenue 72,000 Unearned revenue 18,000

Brief Exercise 524


A performance obligation is satisfied over time if at least one of two criteria is met: 1. The seller is creating or enhancing an asset that the buyer controls as the service is performed. 2. The seller is not creating an asset that the buyer controls or that has alternative use to the seller, and at least one of the following conditions hold: a. The customer receives and consumes a benefit as the seller performs the service. b. Another seller would not need to reperform the tasks performed to date if that other seller were to fulfill the remaining obligation. c. The seller has the right to payment for performance even if the customer could cancel the contract at the customers discretion. Under Estates construction agreement with CyberB, if for some reason Estate could not complete construction, CyberB would own the partially completed building and could retain another construction company to complete the job. A new construction contractor would not need to reperform Estates work if the new contractor completed the job. Therefore, criterion 2b is satisfied.

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Brief Exercise 525


Patterson initially would record the payment as unearned revenue. Then Patterson would accrue interest expense of $10,000 x 5% = $500 in year one of the contract, and interest expense of ($10,000 + 500) x 5% = $525 in year two of the contract, in each case debiting interest expense and crediting unearned revenue. Therefore, at the point in time Patterson delivers the novel, it would have unearned revenue totaling $10,000 + 500 + 525 = $11,025, and would recognize that amount as revenue.

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EXERCISES
Exercise 51
Requirement 1 Alpine West should recognize revenue over the ski season on an anticipated usage basis, in this case equally throughout the season. The fact that the $450 price is nonrefundable is not relevant to the revenue recognition decision. Revenue should be recognized as it is earned, in this case as the services are provided during the ski season. Requirement 2 November 6, 2013 Cash ................................................................................ Unearned revenue ....................................................... To record the cash collection

450 450

December 31, 2013 Unearned revenue ($450 x 1/5) ....................................... 90 Revenue ...................................................................... To recognize revenue earned in December (no revenue earned in November, as season starts on December 1).

90

Requirement 3 $90 is included in revenue in the 2013 income statement. The $360 remaining balance in unearned revenue is included in the current liability section of the 2013 balance sheet.

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Exercise 52
When other parties are involved in providing goods or services to a sellers customer, the seller has to determine whether its performance obligation is to provide the goods or services itself, making the seller a principal, or the seller arranges for another party to provide those goods or services, making the seller an agent. That determination affects whether the seller recognizes revenue in the amount of consideration received in exchange for those goods or services (if principal) or in the amount of any fee or commission received in exchange for arranging for the other party to provide the goods or services (if agent). Requirement 1 AuctionCo is a principal because it obtained control of the used bicycle before the bicycle was sold. Therefore, AuctionCo should recognize revenue of $30. Requirement 2 AuctionCo is an agent because it never controlled the product before it was sold. Therefore, AuctionCo should recognize revenue for the commission fees of $10 retained upon sending $20 to the original owner. Requirement 3 In this case it appears that AuctionCo is acting as an agent, given that the bicycles are shipped directly from the owner to the customer. However, additional aspects of the arrangement could make it more appropriate to treat AuctionCo as a principal. For example, if AuctionCo must pay the bicycle owner the $20 wholesale price regardless of whether the bicycle is sold, then AuctionCo would appear to have purchased the bicycle and should be treated as a principal.

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Exercise 53
Requirement 1 2013 cost recovery %: $234,000 = 65% (gross profit % = 35%) $360,000 2014 cost recovery %: $245,000 = 70% (gross profit % = 30%) $350,000 2013 gross profit: Cash collection from 2013 sales of $150,000 x 35% = 2014 gross profit: Cash collection from 2013 sales of $100,000 x 35% = + Cash collection from 2014 sales of $120,000 x 30% = Total 2014 gross profit Requirement 2 2013 deferred gross profit balance: 2013 initial gross profit ($360,000 234,000) Less: Gross profit recognized in 2013 Balance in deferred gross profit account 2014 deferred gross profit balance: 2013 initial gross profit ($360,000 234,000) Less: Gross profit recognized in 2013 Gross profit recognized in 2014 2014 initial gross profit ($350,000 245,000) Less: Gross profit recognized in 2014 Balance in deferred gross profit account

$52,500

$ 35,000 36,000 $71,000

$126,000 (52,500) $73,500

$ 126,000 (52,500) (35,000) 105,000 (36,000) $107,500

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Exercise 54
2013 Installment receivables .................................................... 360,000 Inventory ..................................................................... 234,000 Deferred gross profit ................................................... 126,000 To record installment sales 2013 Cash ................................................................................. 150,000 Installment receivables ................................................ 150,000 To record cash collections from installment sales 2013 Deferred gross profit ....................................................... Realized gross profit ................................................... To recognize gross profit from installment sales

52,500 52,500

2014 Installment receivables .................................................... 350,000 Inventory ..................................................................... 245,000 Deferred gross profit ................................................... 105,000 To record installment sales 2014 Cash ................................................................................. 220,000 Installment receivables ................................................ 220,000 To record cash collections from installment sales 2014 Deferred gross profit ....................................................... Realized gross profit ................................................... To recognize gross profit from installment sales

71,000 71,000

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Exercise 55
Requirement 1 Year 2013 2014 2015 2016 Total Income recognized $180,000 ($300,000 120,000) -0-0-0$180,000

Requirement 2 Cost recovery %: $120,000 ------------- = 40% (gross profit % = 60%) $300,000 Year 2013 2014 2015 2016 Totals Cash Collected $ 75,000 75,000 75,000 75,000 $300,000 Cost Recovery(40%) $ 30,000 30,000 30,000 30,000 $120,000 Gross Profit(60%) $ 45,000 45,000 45,000 45,000 $180,000

Requirement 3 Year 2013 2014 2015 2016 Totals Cash Collected $ 75,000 75,000 75,000 75,000 $300,000 Cost Recovery $ 75,000 45,000 -0-0$120,000 Gross Profit -0$ 30,000 75,000 75,000 $180,000

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Exercise 56
Requirement 1 July 1, 2013 Installment receivables .................................................... 300,000 Sales revenue............................................................... 300,000 To record installment sale Cost of goods sold ........................................................... 120,000 Inventory ..................................................................... 120,000 To record cost of installment sale Cash ................................................................................. Installment receivables ................................................ To record cash collection from installment sale July 1, 2014 Cash ................................................................................. Installment receivables ................................................ To record cash collection from installment sale 75,000 75,000

75,000 75,000

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Exercise 56 (continued) Requirement 2 July 1, 2013 Installment receivables ................................................... 300,000 Inventory ..................................................................... 120,000 Deferred gross profit................................................... 180,000 To record installment sale Cash ................................................................................ Installment receivables ............................................... To record cash collection from installment sale Deferred gross profit....................................................... Realized gross profit ................................................... To recognize gross profit from installment sale July 1, 2014 Cash ................................................................................ Installment receivables ............................................... To record cash collection from installment sale Deferred gross profit....................................................... Realized gross profit ................................................... To recognize gross profit from installment sale 75,000 75,000

45,000 45,000

75,000 75,000

45,000 45,000

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Exercise 56 (concluded) Requirement 3 July 1, 2013 Installment receivables .................................................... 300,000 Inventory ..................................................................... 120,000 Deferred gross profit ................................................... 180,000 To record installment sale Cash ................................................................................. Installment receivables ................................................ To record cash collection from installment sale July 1, 2014 Cash ................................................................................. Installment receivables ................................................ To record cash collection from installment sale Deferred gross profit ....................................................... Realized gross profit ................................................... To recognize gross profit from installment sale 75,000 75,000

75,000 75,000

30,000 30,000

Exercise 57
Requirement 1 Cost of goods sold ($1,000,000 600,000) Add: Gross profit if using cost recovery method Cash collected Requirement 2 $ 600,000 Gross profit percentage = $1,000,000 Cash collected x Gross profit percentage = Gross profit recognized $500,000 x 60% = $300,000 gross profit
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$400,000 100,000 $500,000

= 60%

Exercise 58
October 1, 2013 Installment receivable ...................................................... 4,000,000 Inventory ..................................................................... 1,800,000 Deferred gross profit................................................... 2,200,000 To record the installment sale Cash ................................................................................ 800,000 Installment receivable ................................................. 800,000 To record the cash down payment from installment sale Deferred gross profit ($800,000 x 55%*) ...................... 440,000 Realized gross profit ................................................... 440,000 To recognize gross profit from installment sale October 1, 2014 Repossessed inventory (fair value) ................................ 1,300,000 Deferred gross profit (balance)....................................... 1,760,000 Loss on repossession (difference) ................................. 140,000 Installment receivable (balance) ................................. 3,200,000 To record the default and repossession ...................... *$2,200,000 $4,000,000 = 55% gross profit percentage

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Exercise 59
Requirement 1 April 1, 2013 Installment receivables .................................................... 2,400,000 Land............................................................................. 480,000 Gain on sale of land .................................................... 1,920,000 To record installment sale April 1, 2013 Cash ................................................................................. Installment receivables ................................................ To record cash collection from installment sale April 1, 2014 Cash ................................................................................. Installment receivables ................................................ To record cash collection from installment sale

120,000 120,000

120,000 120,000

Requirement 2 April 1, 2013 Installment receivables .................................................... 2,400,000 Land............................................................................. 480,000 Deferred gain............................................................... 1,920,000 To record installment sale

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Exercise 59 (concluded) When payments are received, gain on sale of land is recognized, calculated by applying the gross profit percentage ($1,920,000 $2,400,000 = 80%) to the cash collected (80% x $120,000).

April 1, 2013 Cash ................................................................................ Installment receivables ............................................... To record cash collection from installment sale Deferred gain .................................................................. Gain on sale of land (80% x $120,000) .......................... To recognize profit from installment sale April 1, 2014 Cash ................................................................................ Installment receivables ............................................... To record cash collection from installment sale Deferred gain .................................................................. Gain on sale of land (80% x $120,000) .......................... To recognize profit from installment sale

120,000 120,000

96,000 96,000

120,000 120,000

96,000 96,000

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Exercise 510
The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. When a provision for loss is recognized for a percentage-of-completion contract: FASB ASC 605352546: Revenue RecognitionConstructionType and ProductionType ContractsRecognitionProvisions for Losses on Contracts. 2. Circumstances indicating when the installment method or cost recovery method is appropriate for revenue recognition: FASB ASC 60510254: Revenue RecognitionOverallRecognition Installment and Cost Recovery Methods of Revenue Recognition. (Note: ASC 60510253 also provides some guidance, as it indicates when installment method is not acceptable). Criteria determining when a seller can recognize revenue at the time of sale from a sales transaction in which the buyer has the right to return the product: FASB ASC 60515251: Revenue RecognitionProductsRecognition GeneralSales of Product when Right of Return Exists.

3.

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Exercise 511
Requirement 1 Contract price Actual costs to date Estimated costs to complete Total estimated costs Gross profit (estimated in 2013) 2013 $2,000,000 300,000 1,200,000 1,500,000 $ 500,000 2014 $2,000,000 1,875,000 -01,875,000 $ 125,000

Gross profit recognition: 2013: $ 300,000 = 20% x $500,000 = $100,000 $1,500,000 2014: $125,000 100,000 = $25,000

Requirement 2 2013 2014 Requirement 3

$ -0$125,000

Balance Sheet At December 31, 2013 Current assets: Accounts receivable Costs and profit ($400,000*) in excess of billings ($380,000) * Costs ($300,000) + profit ($100,000) $ 130,000 20,000

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Exercise 511 (concluded) Requirement 4 Balance Sheet At December 31, 2013 Current assets: Accounts receivable Current liabilities: Billings ($380,000) in excess of costs ($300,000) $ 130,000

$ 80,000

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Exercise 512
Requirement 1
($ in millions)

Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015) Gross profit (loss) recognition: 2013: $40

2013 $220 40 120 160 $ 60

2014 $220 120 60 180 $ 40

2015 $220 170 -0170 $ 50

= 25% x $60 = $15 $160 2014: $120 = 66.67% x $40 = $26.67 15 = $11.67 $180 2015: $220 170 = $50 (15 + 11.67) = $23.33

Requirement 2 2013: $220 x 25% = $55 2014: $220 x 66.67% = $146.67 55 = $91.67 2015: $220 146.67 = $73.33 Requirement 3 Year 2013 2014 2015 Total project income Gross profit (loss) recognized -0-050 $50

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Exercise 512 (concluded) Requirement 4 2013: Revenue: Cost: Gross profit: 2014: Revenue: Cost: Gross profit: 2015: Revenue: Cost: Gross profit: Requirement 5 2014: $120 = 60% x $20* = $12 15 = $(3) loss $200 *$220 (40 + 80 + 80) = $20 $100 ($220 contract price 40 80) 50 $ 50 $80 80 $ 0 $40 40 $ 0

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Exercise 513
Requirement 1 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) 2013 $8,000,000 2,000,000 4,000,000 6,000,000 $2,000,000 2014 $8,000,000 4,500,000 3,600,000 8,100,000 $ (100,000) 2015 $8,000,000 8,300,000 -08,300,000 $ (300,000)

Gross profit (loss) recognition: 2013: $2,000,000 = 33.3333% x $2,000,000 = $666,667 $6,000,000 2014: $(100,000) 666,667 = $(766,667) 2015: $(300,000) (100,000) = $(200,000)

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Exercise 513 (continued) Requirement 2 Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress
(gross profit)

2013 2014 2,000,000 2,500,000 2,000,000 2,500,000

2,500,000 2,750,000 2,500,000 2,750,000

2,250,000 2,475,000 2,250,000 2,475,000

Cost of construction Revenue from long-term contracts


(33.3333% x $8,000,000)

666,667 2,000,000 2,666,667

To record gross profit Cost of construction (2) Revenue from long-term contracts Construction in progress (loss) To record expected loss 2,544,000 1,777,333 766,667

(1)

(1) and (2): Percent complete = $4,500,000 $8,100,000 = 55.55% Revenue recognized to date: 55.55% x $8,000,000 = $4,444,000 Less: Revenue recognized in 2013 (above) (2,666,667) Revenue recognized in 2014 1,777,333 (1) Plus: Loss recognized in 2014 (prior page) 766,667 Cost of construction, 2014 $2,544,000 (2)

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Exercise 513 (concluded) Requirement 3 Balance Sheet Current assets: Accounts receivable Costs and profit ($2,666,667*) in excess of billings ($2,500,000) Current liabilities: Billings ($5,250,000) in excess of costs less loss ($4,400,000**) 2013 2014

$250,000 $525,000 166,667

$850,000

* Costs ($2,000,000) + profit ($666,667) ** Costs ($2,000,000 + 2,500,000) loss ($100,000 = $766,667 666,667)

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Exercise 514
Requirement 1 Year 2013 2014 2015 Total project loss Requirement 2 2013 2014 2,000,000 2,500,000 2,000,000 2,500,000 Gross profit (loss) recognized -0$(100,000) (200,000) $(300,000)

Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Loss on long-term contract Construction in progress To record expected loss

2,500,000 2,750,000 2,500,000 2,750,000

2,250,000 2,475,000 2,250,000 2,475,000

100,000 100,000

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Exercise 514 (concluded) Requirement 3 Balance Sheet Current assets: Accounts receivable Current liabilities: Billings ($2,500,000) in excess of costs
($2,000,000)

2013 $250,000

2014 $525,000

$500,000

Billings ($5,250,000) in excess of costs less loss ($4,400,000*)

$850,000

* Costs ($2,000,000 + 2,500,000) loss ($100,000)

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Exercise 515
SUMMARY

Percentage-of-Completion Completed Contract Situation 2013 2014 2015 2013 2014 2015 1 $166,667 $233,333 $100,000 $0 $0 $500,000 2 $166,667 $(66,667) $100,000 $0 $0 $200,000 3 $166,667 $(266,667) $(100,000) $0 $(100,000) $(100,000) 4 $125,000 $375,000 $0 $0 $0 $500,000 5 $125,000 $(125,000) $200,000 $0 $0 $200,000 6 $(100,000) $(100,000) $(100,000) $(100,000) $(100,000) $(100,000)

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Exercise 515 (continued) Situation 1 - Percentage-of-Completion Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015) 2013 $5,000,000 1,500,000 3,000,000 4,500,000 $ 500,000 2014 $5,000,000 3,600,000 900,000 4,500,000 $ 500,000 2015 $5,000,000 4,500,000 -04,500,000 $ 500,000

Gross profit (loss) recognized: 2013: $1,500,000 = 33.3333% x $500,000 = $166,667 $4,500,000 2014: $3,600,000 = 80.0% x $500,000 = $400,000 166,667 = $233,333 $4,500,000 2015: $500,000 400,000 = $100,000

Situation 1 - Completed Contract Year 2013 2014 2015 Total gross profit Gross profit recognized -0-0$500,000 $500,000

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Exercise 515 (continued) Situation 2 - Percentage-of-Completion 2013 $5,000,000 1,500,000 3,000,000 4,500,000 $ 500,000 2014 $5,000,000 2,400,000 2,400,000 4,800,000 $ 200,000 2015 $5,000,000 4,800,000 -04,800,000 $ 200,000

Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015)

Gross profit (loss) recognized: 2013: $1,500,000 = 33.3333% x $500,000 = $166,667 $4,500,000 2014: $2,400,000 = 50.0% x $200,000 = $100,000 166,667 = $(66,667) $4,800,000 2015: $200,000 100,000 = $100,000

Situation 2 - Completed Contract Year 2013 2014 2015 Total gross profit Gross profit recognized -0-0$200,000 $200,000

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Exercise 515 (continued) Situation 3 - Percentage-of-Completion 2013 $5,000,000 1,500,000 3,000,000 4,500,000 $ 500,000 2014 $5,000,000 3,600,000 1,500,000 5,100,000 $ (100,000) 2015 $5,000,000 5,200,000 -05,200,000 $ (200,000)

Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015)

Gross profit (loss) recognized: 2013: $1,500,000 = 33.3333% x $500,000 = $166,667 $4,500,000 2014: 2015: $(100,000) 166,667 = $(266,667) $(200,000) (100,000) = $(100,000)

Situation 3 - Completed Contract Year 2013 2014 2015 Total project loss Gross profit (loss) recognized -0$(100,000) (100,000) $(200,000)

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Exercise 515 (continued) Situation 4 - Percentage-of-Completion 2013 $5,000,000 500,000 3,500,000 4,000,000 $1,000,000 2014 $5,000,000 3,500,000 875,000 4,375,000 $ 625,000 2015 $5,000,000 4,500,000 -04,500,000 $ 500,000

Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015)

Gross profit (loss) recognized: 2013: $ 500,000 = 12.5% x $1,000,000 = $125,000 $4,000,000 2014: $3,500,000 = 80.0% x $625,000 = $500,000 125,000 = $375,000 $4,375,000 2015: $500,000 500,000 = $ - 0 -

Situation 4 - Completed Contract Year 2013 2014 2015 Total gross profit Gross profit recognized -0-0$500,000 $500,000

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Exercise 515 (continued) Situation 5 - Percentage-of-Completion 2013 $5,000,000 500,000 3,500,000 4,000,000 $1,000,000 2014 $5,000,000 3,500,000 1,500,000 5,000,000 $ -02015 $5,000,000 4,800,000 -04,800,000 $ 200,000

Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015)

Gross profit (loss) recognized: 2013: $ 500,000 = 12.5% x $1,000,000 = $125,000 $4,000,000 2014: 2015: $0 125,000 = $(125,000) $200,000 0 = $200,000

Situation 5 - Completed Contract Year 2013 2014 2015 Total gross profit Gross profit recognized -0-0$200,000 $200,000

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Exercise 515 (concluded) Situation 6 - Percentage-of-Completion 2013 $5,000,000 500,000 4,600,000 5,100,000 $ (100,000) 2014 $5,000,000 3,500,000 1,700,000 5,200,000 $ (200,000) 2015 $5,000,000 5,300,000 -05,300,000 $ (300,000)

Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015)

Gross profit (loss) recognized: 2013: $(100,000) 2014: $(200,000) (100,000) = $(100,000) 2015: $(300,000) (200,000) = $(100,000) Situation 6 - Completed Contract Year 2013 2014 2015 Total project loss Gross profit (loss) recognized $(100,000) (100,000) (100,000) $(300,000)

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Exercise 516
Requirement 1 Construction in progress = Costs incurred + Profit recognized $100,000 = ? + $20,000

Actual costs incurred in 2013 = $80,000 Requirement 2 Billings = Cash collections + Accounts receivable $94,000 = ? + $30,000

Cash collections in 2013 = $64,000 Requirement 3 Let A = Actual cost incurred + Estimated cost to complete Actual cost incurred x (Contract price A) = Profit recognized A $80,000 ($1,600,000 A) = $20,000 A $128,000,000,000 80,000A = $20,000A $100,000A = $128,000,000,000 A = $1,280,000 Estimated cost to complete = $1,280,000 80,000 = $1,200,000 Requirement 4 $80,000 = 6.25% $1,280,000

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Exercise 517
Requirement 1 The specific citation that specifies the the circumstances and conditions under which it is appropriate to use the percentage-of-completion method is: FASB ASC 60535 2557: Revenue RecognitionConstructionType and ProductionType Contracts RecognitionCircumstances Appropriate for Using the Percentage-of-Completion Method. Requirement 2 FASB ASC 605352557 reads as follows: The percentage-of-completion method is considered preferable as an accounting policy in circumstances in which reasonably dependable estimates can be made and in which all the following conditions exist: a. Contracts executed by the parties normally include provisions that clearly specify the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement. b. The buyer can be expected to satisfy all obligations under the contract. c. The contractor can be expected to perform all contractual obligations.

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Exercise 518
Requirement 1 Revenue should be recognized as follows: Software date of shipment, July 1, 2013 Technical support evenly over the 12 months of the agreement Upgrade date of shipment, January 1, 2014 The amounts are determined by an allocation of total contract price in proportion to the individual fair values of the components if sold separately: Software Technical support Upgrade Total Requirement 2 $210,000 $270,000 x $243,000 = $189,000 $30,000 $270,000 x $243,000 = 27,000 $30,000 $270,000 x $243,000 = 27,000 $243,000

July 1, 2013

Cash ................................................................................ 243,000 Revenue ...................................................................... 189,000 Unearned revenue ($27,000 + 27,000) ........................... 54,000 To record sale of software

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Exercise 519
Requirement 1 Conveyer Labeler Filler Capper Total Requirement 2 ($20,000 $50,000) x $45,000 = $18,000 ($10,000 $50,000) x $45,000 = 9,000 ($15,000 $50,000) x $45,000 = 13,500 ($5,000 $50,000) x $45,000 = 4,500 $45,000

All $45,000 of revenue is delayed until installation of the conveyer, because the usefulness of the other elements of the multi-part arrangement is contingent on its delivery.

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Exercise 520
Requirement 1 Conveyer Labeler Filler Capper Total Requirement 2 ($20,000 $50,000) x $45,000 = $18,000 ($10,000 $50,000) x $45,000 = 9,000 ($15,000 $50,000) x $45,000 = 13,500 ($5,000 $50,000) x $45,000 = 4,500 $45,000

Under IFRS, it is likely that Richardson would recognize revenue the same as in Requirement 1, because (a) revenue for each part can be estimated reliably and (b) the receipt of economic benefits is probable.

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Exercise 521
October 1, 2013 Cash (10% x $300,000) ....................................................... 30,000 Note receivable................................................................ 270,000 Unearned franchise fee revenue .................................. 300,000 To record franchise agreement and down payment

January 15, 2014 Unearned franchise fee revenue ...................................... 300,000 Franchise fee revenue.................................................. 300,000 To recognize franchise fee revenue

Exercise 522
List A
h d g a b i c k l m f j e 1. Inventory turnover 2. Return on assets 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

List B

a. Net income divided by net sales. b. Defers recognition until cash collected equals cost. Return on shareholders' equity c. Defers recognition until project is complete. Profit margin on sales d. Net income divided by assets. Cost recovery method e. Risks and rewards of ownership retained by seller. Percentage-of-completion method f. Contra account to construction in progress. Completed contract method g. Net income divided by shareholders' equity. Asset turnover h. Cost of goods sold divided by inventory. Receivables turnover i. Recognition is in proportion to work completed. Right of return j. Recognition is in proportion to cash received. Billings on construction contract k. Net sales divided by assets. Installment sales method l. Net sales divided by accounts receivable. Consignment sales m. Could cause the deferral of revenue recognition beyond delivery point.

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Exercise 523
Requirement 1 Inventory turnover ratio = Cost of goods sold Average inventory $1,840,000 [$690,000 + 630,000] 2 2.79 times

= =

Requirement 2 By itself, this one ratio provides very little information. In general, the higher the inventory turnover, the lower the investment must be for a given level of sales. It indicates how well inventory levels are managed and the quality of inventory, including the existence of obsolete or overpriced inventory. However, to evaluate the adequacy of this ratio it should be compared with some norm such as the industry average. That indicates whether inventory management practices are in line with the competition. Its just one piece in the puzzle, though. Other points of reference should be considered. For instance, a high turnover can be achieved by maintaining too low inventory levels and restocking only when absolutely necessary. This can be costly in terms of stockout costs. The ratio also can be useful when assessing the current ratio. The more liquid inventory is, the lower the norm should be against which the current ratio should be compared.

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Exercise 524
Turnover ratios for Anderson Medical Supply Company for 2013: Inventory turnover ratio = = Receivables turnover ratio = = Average collection period = = Asset turnover ratio = = $4,800,000 [$900,000 + 700,000] 2 6 times $8,000,000 [$700,000 + 500,000] 2 13.33 times 365 13.33 27.4 days $8,000,000 [$4,300,000 + 3,700,000] 2 2 times

The company turns its inventory over 6 times per year compared to the industry average of 5 times per year. The asset turnover ratio also is slightly better than the industry average (2 times per year versus 1.8 times). These ratios indicate that Anderson is able to generate more sales per dollar invested in inventory and in total assets than the industry averages. However, Anderson takes slightly longer to collect its accounts receivable (27.4 days compared to the industry average of 25 days).

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Exercise 525
Requirement 1 a. Profit margin on sales b. Return on assets c. Return on shareholders equity Requirement 2 Retained earnings beginning of period Add: Net income Less: Retained earnings end of period Dividends paid $180 $5,200 = 3.5% $180 [($1,900 + 1,700) 2] = 10% $180 [($550 + 500) 2] = 34.3% $100,000 180,000 280,000 150,000 $130,000

Exercise 526
Requirement 1 a. Profit margin on sales $180 $5,200 = 3.46% b. Asset turnover $5,200 [($1,900 + 1,700) 2] = 2.89 c. Equity multiplier [($1,900 + 1,700) 2] [($550 + 500) 2] = 3.43 d. Return on shareholders equity $180 [($550 + 500) 2] = 34.3% Requirement 2 Profit margin x Asset turnover x Equity multiplier = ROE 3.46% x 2.89 x 3.43 = 34.3%

Exercise 527
First Cumulative income before taxes $50,000 Estimated annual effective tax rate 34% 17,000 Less: Income tax reported earlier -0Tax expense to be reported $17,000 Quarter Second Third $90,000 $190,000 30% 36% 27,000 68,400 17,000 27,000 $10,000 $ 41,400

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Exercise 528
Incentive compensation Depreciation expense Gain on sale $300 million 4 = $75 million $60 million 4 = $15 million $23 million

Exercise 529
Quarters Ending March 31 June 30 Sept. 30 Dec. 31 Advertising $200,000 $200,000 $200,000 $200,000 Property tax 87,500 87,500 87,500 87,500 Equipment repairs 65,000 65,000 65,000 65,000 Extraordinary casualty loss - 0 - 185,000 -0-0Research and development -096,000 0 0 Note: this solution assumes that advertising, property tax, and equipment repairs are viewed as benefitting all periods following the one in which the expenditure is made, but that the extraordinary casualty loss and the R&D consulting fee only benefit the periods in which they occurred.

Exercise 530
March 31 Advertising $800,000 Property tax 350,000 Equipment repairs 260,000 Extraordinary casualty loss -0Research and development -0Quarters Ending June 30 Sept. 30 -0-0-0-0-0-0185,000 -096,000 -0Dec. 31 -0-0-0-0-0-

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SUPPLEMENT EXERCISES
Exercise 531
Requirement 1 The discount voucher provides a material right to the customer that the customer would not receive otherwise, because the customer can receive a 30 percent discount with the voucher but only a 10 percent discount without the voucher. That right to receive a discount could be sold separately. Therefore, the discount voucher given by Clarks is a separate performance obligation. Requirement 2 Cash 70,000 Revenue (to balance) Unearned revenue (discount option) (1,000 pairs (30% 10% discount) 20% estimated to redeem coupon $100 average purchase)

66,000 4,000

Note: the accompanying journal entry to record cost of goods sold would be: Cost of goods sold 40,000 Inventory 40,000 To record cost of 1,000 pairs of boots sold

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Exercise 532
Requirement 1 Even though Manhattan Today received payments from customers for an annual subscription, the subscription activity does not transfer goods or services to customers. Therefore, the annual fee is viewed as a prepayment for future delivery of goods or services, and would be recognized as unearned revenue when received. Requirement 2 The delivery of newspapers meets the criteria for a separate performance obligation, because it is regularly sold separately. The coupon for a 40 percent discount on a carriage ride is a separate performance obligation. First, it is an option that conveys a material right to the recipient (as opposed to just a general marketing offer). Second, it meets the criteria for a separate performance obligation because the recipient could use it in combination with additional cash to enjoy a carriage ride. Requirement 3 The value of the coupon would be $15.60 (40% discount $130 carriage fee 30% of customers redeeming coupon). Of the $150 subscription fee, $14.13 ($150 ($15.60 ($15.60 + 150)) would be attributed to the coupon. Requirement 4 Upon receiving the subscription fee, the journal entry should be: Cash Unearned Revenue, subscription Unearned Revenue, coupon 150 135.87 14.13

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Exercise 533
The license granted by Pfizer is not a separate performance obligation. The only way to exploit the license is via utilizing ongoing R&D services from Pfizer. The license does not provide utility on its own or together with other goods or services that HealthPro has received previously from Pfizer or that are available from other entities. Rather, the license requires Pfizers R&D services and proprietary expertise to be valuable. Therefore, Pfizer would combine the license with the R&D services to HealthPro and account for them as a single performance obligation.

Exercise 534
Requirement 1 $50,000 + ($20,000 x 20%) = $54,000 Requirement 2 The most likely amount is $50,000, because the probability of exceeding the performance threshold is less than 50%. Requirement 3 Given that the outcome is binary (Thomas either will receive the bonus or not), the most likely amount often would be preferred. However, both amounts can be justified theoretically. (The probability-weighted amount is an expected value, and thus over all such contracts is the best estimate of the average amount that will be received.) Requirement 4 Given that aspects of receipt of the bonus are beyond Thomass control (because Bran is responsible for implementation), Thomas would view the bonus as not reasonably assured. Therefore, Thomas would recognize only $50,000 upon delivery of the plan and wait until receipt of the bonus is reasonably assured (likely waiting until cost saving reaches the prespecified target) before recognizing the bonus.

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Exercise 535
The transaction price should be limited to the fixed amount of consideration until the end of the year because the asset management company cannot predict the amount of value that the fund will provide by year-end. Even if Seneca could predict that amount with some accuracy, it would not be able to recognize revenue associated with the bonus because that amount would not be reasonably assured until after year-end. 1. Record the first quarterly payment. Cash or accounts receivable Revenue 100,000 100,000

2. Record the amount of additional revenue at the end of year. Cash or accounts receivable ($800,000 x 10%) Revenue 80,000 80,000

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Exercise 536
Determining whether Toys4U satisfies the performance obligation requires consideration of indicators that McDonalds has obtained control of the dolls. Consider the following indicators: 1. The buyer has an unconditional obligation to pay. A customer is unconditionally obliged to pay for a good or service typically because the customer has obtained control of the good or service in exchange and the passage of time does not remove the obligation. In this case, McDonalds does not pay Toys4U until the dolls are sold, so McDonalds is conditionally (not unconditionally) obliged to pay for the toys. 2. The buyer has the legal title. Legal title often indicates which party has the ability to direct the use of, and receive the benefit from, a good or service. The facts do not state whether title transfers. 3. The customer has physical possession and control of goods. In this case, McDonalds has possession of the dolls. 4. The buyer has the risks and rewards of owndership. In this case, given that McDonalds returns unsold dolls to Toys4U, McDonalds does not appear to be holding the risks of ownership. It appears that Toys4U has not transferred control upon delivery McDonalds has a conditional rather than unconditional obligation to Toys4U appears to retain the risk of ownership. This is essentially a arrangement, and Toys4U should not recognize sales until McDonalds customers. because (1) pay, and (2) consignment sells dolls to

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Exercise 537
In this example, Kerry obtained the access code for Level I in the software on December 1, meaning that Kerry has obtained the control of the right to use the software for Level I on that date. Therefore, on that date Cutler should recognize $50 of revenue for Level I. When Tom passed the Level I test on December 31, 2012, and purchased access to Level II, Cutler licensed Level II to Kerry on the same day. However, Kerry received the access code for Level II on January 10, 2013, so control over Level II in the software was not transferred to Kerry until January 10. Therefore, Cutler should recognize $10 of revenue for Level II on January 10, 2013, rather than December 31, 2012, because it did not satisfy a separate performance obligation until the access code was provided to its customer.

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Exercise 538
Requirement 1 Record unearned revenue upon receipt of initial payment: Cash Unearned revenue Requirement 2 1. Record interest expense at end of the first year of the contract: Interest expense ($20,000 x 4%) Unearned revenue 800 800 20,000 20,000

2. Record interest expense at end of the second year of the contract: Interest expense ({$20,000 + 800} x 4%) Unearned revenue 832 832

3. Record interest expense at end of the third year of the contract: Interest expense ({$20,000 + 800 + 832} x 4%) Unearned revenue Requirement 3 Record revenue upon Stewarts satisfaction of his performance obligation: Unearned revenue ($20,000 + 800 + 832 + 865) Revenue 22,497 22,497 865 865

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CPA / CMA REVIEW QUESTIONS


CPA Exam Questions
1. b. The earnings process is completed upon delivery of the product. Therefore, in 2014, revenue for 50,000 gallons at $3 each is recognized on January 15. The payment terms do not affect revenue recognition. 2. d. The deferred gross profit in the balance sheet at December 31, 2014, should be the balances in the accounts receivable accounts on that date for 2013 and 2014 sales multiplied by the appropriate gross profit percentage: Accounts receivable: sales in Total sales Less: Collections to date Less: Write-offs to date Accounts receivable balance x Gross profit rate Deferred gross profit 12/31/2014 2014 2013 $ 600,000 $ 900,000 (300,000) (300,000) (200,000) (50,000) 100,000 550,000 x 40% x 30% $ 30,000 $ 220,000

The combined deferred gross profit in the balance sheet is $250,000 ($30,000 + 220,000).

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CPA Review Questions (continued) 3. a. Year of sale 2013 2014 a. Gross profit realized $240,000 $200,000 b. Percentage 30% 40% c. Collections on sales (a/b) $800,000 $500,000 Sales 1,000,000 2,000,000 Balance uncollected at December 31, 2014 $200,000 $1,500,000 The total uncollected balance is $1,700,000 ($200,000 + 1,500,000). 4. d. Construction-in-progress represents the costs incurred plus the cumulative pro-rata share of gross profit under the percentage-of-completion method of accounting. 5. c. 2013 actual costs $20,000 Total estimated costs 60,000 Ratio = 1/3 Contract price x 100,000 Revenue 33,333 2013 actual costs 20,000 Gross profit $13,333 6. d. Since the total cost of the contract, $3,100,000 ($930,000 + 2,170,000), is projected to exceed the contract price of $3,000,000, the excess cost of $100,000 must be recognized as a loss in 2013.

7. c. Cash collection is at least reasonably possible is not a requirement for revenue recognition under IFRS.

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The McGraw-Hill Companies, Inc., 2013 567

CPA Review Questions (concluded) 8. a. Under the cost recovery approach, an amount of revenue is recognized that is equal to cost incurred, so long as cost incurred is probable to be recovered. Since $1,000,000 of cost was incurred, $1,000,000 of revenue is recognized. 9. a. IFRS does not provide extensive guidance determining how contracts are to be separated into components for purposes of revenue recognition. 10. d. IFRS recognizes interim expenses more discretely than does U.S. GAAP, such that the expense is recognized in the period in which it occurs rather than being accrued as a prepaid expense asset when an amount is paid and then amortized to expense over the year. Therefore, under IFRS Barrett would recognize the entire $50,000 as expense in the first period, and not accrue any prepaid expense asset. Under U.S. GAAP Barrett would accrue an asset when it made the tax payment and then reduce the asset by $12,500 each interim period while recognizing $12,500 of expense each interim period.

CMA Exam Questions


1. c. Revenue is recognized when (1) realized or realizable and (2) earned. On May 28, $500,000 of the sales price was realized while the remaining $500,000 was realizable in the form of a receivable. The revenue was earned on May 28 when the title of the goods passed to the purchaser. The costrecovery method is not used because the receivable was not deemed uncollectible until June 10. 2. d. Revenue is normally recorded at the time of the sale or, occasionally, at the time cash is collected. However, sometimes neither the sales basis nor the cash basis is appropriate, such as when a construction contract extends over several accounting periods. As a result, contractors ordinarily recognize revenue using the percentage-of-completion method so that some revenue is recognized each year over the life of the contract. Hence, this method is an exception to the general practice of recognizing revenue at the point of sale, primarily because it better matches revenues and expenses. 3. b. Given that one-third of all costs have already been incurred ($6,000,000), the company should recognize revenue equal to one-third of the contract price, or
The McGraw-Hill Companies, Inc., 2013 568 Intermediate Accounting, 7/e

$8,000,000. Revenues of $8,000,000 minus costs of $6,000,000 equals a gross profit of $2,000,000.

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The McGraw-Hill Companies, Inc., 2013 569

PROBLEMS
Problem 51
REAGAN CORPORATION Income Statement For the Year Ended December 31, 2013 Income before income taxes and extraordinary item ....................................... Income tax expense ....................................... Income before extraordinary item ................. Extraordinary item: Gain from settlement of lawsuit (net of $400,000 tax expense) .................................. Net income .................................................... Income before extraordinary item ................. Extraordinary gain ......................................... Net income ....................................................
[1] [1] $3,680,000

1,472,000 2,208,000

600,000 $2,808,000 2.21 0.60 $ 2.81

Income from continuing operations before income taxes: Unadjusted $4,200,000 Add: Gain from sale of equipment 50,000 Deduct: Inventory write-off (400,000) Depreciation expense (2013) (50,000) Overstated profit on installment sale (120,000) * Adjusted $3,680,000 $160,000 (40,000) $120,000

* Profit recognized ($400,000 240,000) Profit that should have been recognized (gross profit ratio of 40% x $100,000) Overstated profit

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Problem 52
Requirement 1 2013 cost recovery % : $180,000 = 60% (gross profit % = 40%) $300,000 2014 cost recovery %: $280,000 = 70% (gross profit % = 30%) $400,000 2013 gross profit: Cash collection from 2013 sales = $120,000 x 40% = 2014 gross profit: Cash collection from 2013 sales = $100,000 x 40% = + Cash collection from 2014 sales = $150,000 x 30% = Total 2014 gross profit Requirement 2 2013 Installment receivables ................................................... 300,000 Inventory ..................................................................... 180,000 Deferred gross profit................................................... 120,000 To record installment sales Cash ................................................... 120,000 Installment receivables ............................................... To record cash collections from installment sales Deferred gross profit....................................................... Realized gross profit ................................................... To recognize gross profit from installment sales 48,000 48,000 $ 40,000 45,000 $85,000 $48,000

120,000

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Problem 52 (continued)

2014 Installment receivables .................................................... 400,000 Inventory ..................................................................... 280,000 Deferred gross profit ................................................... 120,000 To record installment sales Cash ................................................................................. 250,000 Installment receivables ................................................ 250,000 To record cash collections from installment sales Deferred gross profit ....................................................... Realized gross profit ................................................... To recognize gross profit from installment sales 85,000 85,000

Requirement 3 Date 2013 2013 sales 2014 2013 sales 2014 sales 2014 totals Cash Collected Cost Recovery Gross Profit

$120,000

$120,000

-0-

$100,000 150,000 $250,000

$ 60,000 150,000 $210,000

$40,000 -0$40,000

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Problem 52 (concluded) 2013 Installment receivables ................................................... 300,000 Inventory ..................................................................... 180,000 Deferred gross profit................................................... 120,000 To record installment sales Cash ................................................................................ 120,000 Installment receivables ............................................... 120,000 To record cash collection from installment sales 2014 Installment receivables ................................................... 400,000 Inventory ..................................................................... 280,000 Deferred gross profit................................................... 120,000 To record installment sales Cash ................................................................................ 250,000 Installment receivables ............................................... 250,000 To record cash collection from installment sales Deferred gross profit....................................................... Realized gross profit ................................................... To recognize gross profit from installment sales 40,000 40,000

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The McGraw-Hill Companies, Inc., 2013 573

Problem 53
Requirement 1 Total profit = $500,000 300,000 = $200,000 Installment sales method: Gross profit % = $200,000 $500,000 = 40%
8/31/13 Cash collections a. Point of delivery method b. Installment sales method
(40% x cash collected)

8/31/14

8/31/15

8/31/16

8/31/17

$100,000 $100,000 $100,000 $100,000 $100,000 $200,000 -0-0-0-0-

$ 40,000 -0-

$ 40,000 -0-

$ 40,000

$ 40,000

$40,000

c. Cost recovery method

- 0 - $100,000 $100,000

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Problem 53 (continued) Requirement 2


Point of Delivery 500,000 500,000 300,000 300,000 Installment Sales

Cost Recovery

Installment receivable Sales revenue Cost of goods sold Inventory To record sale on 8/31/13 Installment receivable Inventory Deferred gross profit To record sale on 8/31/13 Cash Installment receivable To record cash collections (Entry made each Aug. 31) Deferred gross profit Realized gross profit To record gross profit (Entry made each Aug. 31) Deferred gross profit Realized gross profit To record gross profit (Entry made 8/31/16 & 8/31/17)

500,000 300,000 200,000

500,000 300,000 200,000

100,000 100,000

100,000 100,000

100,000 100,000

40,000 40,000

100,000 100,000

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The McGraw-Hill Companies, Inc., 2013 575

Problem 53 (concluded) Requirement 3 Point of Delivery December 31, 2013 Assets Installment receivables Less: Deferred gross profit Installment receivables, net December 31, 2014 Assets Installment receivables Less: Deferred gross profit Installment receivables, net Installment Sales Cost Recovery

400,000

400,000 (160,000) 240,000

400,000 (200,000) 200,000

300,000

300,000 (120,000) 180,000

300,000 (200,000) 100,000

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Problem 54
Requirement 1 All jobs consist of four equal payments: one payment when the job is completed and three payments over the next three years. Bluebird: Job completed in 2011, so down payment made in 2011, another payment in 2012, and two payments remain. $400,000 gross receivable at 1/1/2013 implies payments of ($400,000 2) = $200,000 in 2013 and 2014. Four payments of $200,000 implies total revenue of 4 x $200,000 = $800,000 on the job. Twenty-five percent gross profit ratio implies cost of 75% x $800,000 = $600,000. Cost recovery method gross profit: Payments in 2011 and 2012 have already recovered $400,000 of cost, so cost remaining to be recovered as of 1/1/2013 is $600,000 total $400,000 already recovered = $200,000. Therefore, the entire 2013 payment of $200,000 will be applied to cost recovery, and no gross profit is recognized in 2013. Installment sales method gross profit: $200,000 payment x 25% gross profit ratio = $50,000 of gross profit recognized in 2013. PitStop: Job completed in 2010, so down payment made in 2010, another payment in 2011, another in 2012, and one payment remains. $150,000 gross receivable at 1/1/2013 implies a single payment of $150,000 in 2013. Four payments of $150,000 implies total revenue of 4 x $150,000 = $600,000 on the job. Thirty-five percent gross profit ratio implies cost of 65% x $600,000 = $390,000. Cost recovery method gross profit: Payments in 2010, 2011, and 2012 of a total of $450,000 have already recovered the entire $390,000 of cost and allowed recognition of $60,000 of gross profit. Therefore, the entire 2013 payment of $150,000 will be applied to gross profit. Installment sales method gross profit: $150,000 payment x 35% gross profit ratio = $52,500 of gross profit recognized in 2013.

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The McGraw-Hill Companies, Inc., 2013 577

Problem 54 (concluded) Totals: Cost recovery method: $0 (Bluebird) + 150,000 (PitStop) = $150,000. Installment sales method: $50,000 (Bluebird) + 52,500 (PitStop) = $102,500. Requirement 2 If Dan is focused on 2013, he would not be happy with a switch to the installment sales method, because that would produce gross profit of only $102,500, which is $47,500 less than he would show under the cost recovery method. It is true that the installment sales method recognizes gross profit faster than does the cost recovery method, but the installment sales method also recognizes gross profit more evenly than does the cost recovery method. The timing of these jobs is such that 2013 is a year in which almost all of the gross profit associated with the PitStop job gets recognized, so 2013 looks more profitable under the cost recovery method.

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Problem 55
Requirement 1 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) 2013 $10,000,000 2,400,000 5,600,000 8,000,000 $ 2,000,000 2014 $10,000,000 6,000,000 2,000,000 8,000,000 $ 2,000,000 2015 $10,000,000 8,200,000 -08,200,000 $ 1,800,000

Gross profit (loss) recognition: 2013: $2,400,000 = 30.0% x $2,000,000 = $600,000 $8,000,000 2014: $6,000,000 = 75.0% x $2,000,000 = $1,500,000 600,000 = $900,000 $8,000,000 2015: $1,800,000 1,500,000 = $300,000

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The McGraw-Hill Companies, Inc., 2013 579

Problem 55 (continued) Requirement 2 2013 Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress (gross profit) Cost of construction (cost incurred) Revenue from long-term contracts (1) To record gross profit 2014 2015

2,400,000 3,600,000 2,200,000 2,400,000 3,600,000 2,200,000

2,000,000 4,000,000 4,000,000 2,000,000 4,000,000 4,000,000

1,800,000 3,600,000 4,600,000 1,800,000 3,600,000 4,600,000

600,000 2,400,000 3,000,000

900,000 3,600,000 4,500,000

300,000 2,200,000 2,500,000

(1) Revenue recognized: 2013: 30% x $10,000,000 = 2014: 75% x $10,000,000 = Less: Revenue recognized in 2013 Revenue recognized in 2014 2015: 100% x $10,000,000 = Less: Revenue recognized in 2013 & 2014 Revenue recognized in 2015

$3,000,000 $7,500,000 (3,000,000) $4,500,000 $10,000,000 (7,500,000) $2,500,000

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Problem 55 (continued) Requirement 3 Balance Sheet Current assets: Accounts receivable Construction in progress Less: Billings Costs and profit in excess of billings 2013 2014

$ 200,000 $3,000,000 (2,000,000) 1,000,000 $7,500,000 (6,000,000)

$600,000

1,500,000

Requirement 4 Costs incurred during the year Estimated costs to complete as of year-end Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015) 2013 $2,400,000 5,600,000 2013 $10,000,000 2,400,000 5,600,000 8,000,000 $ 2,000,000 2014 $3,800,000 3,100,000 2014 $10,000,000 6,200,000 3,100,000 9,300,000 $ 700,000 2015 $3,200,000 2015 $10,000,000 9,400,000 -09,400,000 $ 600,000

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The McGraw-Hill Companies, Inc., 2013 581

Problem 55 (concluded) Gross profit (loss) recognition: 2013: $2,400,000 = 30.0% x $2,000,000 = $600,000 $8,000,000 2014: $6,200,000 = 66.6667% x $700,000 = $466,667 600,000 = $(133,333) $9,300,000 2015: $600,000 466,667 = $133,333

Requirement 5 Costs incurred during the year Estimated costs to complete as of year-end Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) 2013 $2,400,000 5,600,000 2013 $10,000,000 2,400,000 5,600,000 8,000,000 $ 2,000,000 2014 $3,800,000 4,100,000 2014 $10,000,000 6,200,000 4,100,000 10,300,000 $ (300,000) 2015 $3,900,000 2015 $10,000,000 10,100,000 -010,100,000 $ (100,000)

Gross profit (loss) recognition: 2013: $2,400,000 = 30.0% x $2,000,000 = $600,000 $8,000,000 2014: 2015: $(300,000) 600,000 = $(900,000) $(100,000) (300,000) = $200,000

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Problem 56
Requirement 1 Year 2013 2014 2015 Total gross profit Requirement 2 2013 2014 2015 2,400,000 3,600,000 2,200,000 2,400,000 3,600,000 2,200,000 Gross profit recognized -0-0$1,800,000 $1,800,000

Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress (gross profit) Cost of construction (costs incurred) Revenue from long-term contracts (contract price) To record gross profit

2,000,000 4,000,000 4,000,000 2,000,000 4,000,000 4,000,000

1,800,000 3,600,000 4,600,000 1,800,000 3,600,000 4,600,000

1,800,000 8,200,000 10,000,000

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The McGraw-Hill Companies, Inc., 2013 583

Problem 56 (concluded) Requirement 3 Balance Sheet Current assets: Accounts receivable Construction in progress Less: Billings Costs in excess of billings 2013 $ 200,000 $2,400,000 (2,000,000) 400,000 $6,000,000 (6,000,000) -02014 $ 600,000

Requirement 4 Costs incurred during the year Estimated costs to complete as of year-end Year 2013 2014 2015 Total gross profit Requirement 5 Costs incurred during the year Estimated costs to complete as of year-end Year 2013 2014 2015 Total project loss 2013 $2,400,000 5,600,000 2014 $3,800,000 4,100,000 2015 $3,900,000 2013 $2,400,000 5,600,000 2014 $3,800,000 3,100,000 2015 $3,200,000 -

Gross profit recognized -0-0$600,000 $600,000

Gross profit (loss) recognized -0$(300,000) 200,000 $(100,000)

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Problem 57
Requirement 1 Year 2013 2014 2015 Total gross profit Requirement 2 2013 2014 2015 2,400,000 3,600,000 2,200,000 2,400,000 3,600,000 2,200,000 Gross profit recognized -0-0$1,800,000 $1,800,000

Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress (gross profit) Cost of construction (costs incurred) Revenue from long-term contracts (contract price) To record gross profit

2,000,000 4,000,000 4,000,000 2,000,000 4,000,000 4,000,000

1,800,000 3,600,000 4,600,000 1,800,000 3,600,000 4,600,000

1,800,000 2,400,000 2,400,000 3,600,000 3,600,000 2,200,000 4,000,000

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The McGraw-Hill Companies, Inc., 2013 585

Problem 57 (concluded) Requirement 3 Balance Sheet Current assets: Accounts receivable Construction in progress Less: Billings Costs in excess of billings 2013 $ 200,000 $2,400,000 (2,000,000) 400,000 $6,000,000 (6,000,000) -02014 $ 600,000

Requirement 4 Costs incurred during the year Estimated costs to complete as of year-end Year 2013 2014 2015 Total gross profit Requirement 5 Costs incurred during the year Estimated costs to complete as of year-end Year 2013 2014 2015 Total project loss 2013 $2,400,000 5,600,000 2014 $3,800,000 4,100,000 2015 $3,900,000 2013 $2,400,000 5,600,000 2014 $3,800,000 3,100,000 2015 $3,200,000 -

Gross profit recognized -0-0$600,000 $600,000

Gross profit (loss) recognized -0$(300,000) 200,000 $(100,000)

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Problem 58
Requirement 1 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) Year 2013 2014 2015 Total project loss Requirement 2
Gross profit (loss) recognition:

2013 $4,000,000 350,000 3,150,000 3,500,000 $ 500,000

2014 $4,000,000 2,500,000 1,700,000 4,200,000 $ (200,000)

2015 $4,000,000 4,250,000 -04,250,000 $ (250,000)

Gross profit (loss) recognized -0$(200,000) (50,000) $(250,000)

2013: 2014: 2015:

10% x $500,000 = $50,000 $(200,000) 50,000 = $(250,000) $(250,000) (200,000) = $(50,000)

Requirement 3 Balance Sheet Current assets: Costs less loss ($2,300,000*) in excess of billings ($2,170,000) Current liabilities: Billings ($720,000) in excess of costs and profit ($400,000) 2013 2014

$ 130,000

$ 320,000

*Cumulative costs ($2,500,000) less cumulative loss recognized ($200,000) = $2,300,000


The McGraw-Hill Companies, Inc., 2013 587

Solutions Manual, Vol.1, Chapter 5

Problem 59
Requirement 1 The completed contract method of recognizing revenues and costs on long-term construction contracts is equivalent to recognizing revenue at the point of delivery, that is, when the construction project is complete. The percentage-of-completion method assigns a share of the projects expected revenues and costs to each period in which the earnings process takes place, that is, the construction period. The share is estimated based on the project's costs incurred each period as a percentage of the project's total estimated costs. The completed contract method should only be used when a lack of dependable estimates or inherent hazards make it difficult to forecast future costs and profits. Requirement 2 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit a. 2013 $20,000,000 4,000,000 12,000,000 16,000,000 $ 4,000,000 2014 $20,000,000 13,500,000 4,500,000 18,000,000 $ 2,000,000

Gross profit recognition: Under the completed contract method Citation would not report gross profit until the project is competed. Citation would have to report an overall gross loss on the contract in whatever period it first revises the estimates to determine that an overall loss will eventually occur. Citation never estimates the Altamont contract will earn a gross loss, so never has to recognize one. Under the completed contract method Citation would not report any revenue in the 2013 or 2014 income statements.

b.

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Problem 59 (continued) c. Balance Sheet At December 31, 2013 Current assets: Accounts receivable Costs ($4,000,000*) in excess of billings ($2,000,000) $ 200,000 2,000,000

* Under the completed contract method, this account would only include costs of $4,000,000 Requirement 3 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit a. 2013 $20,000,000 4,000,000 12,000,000 16,000,000 $ 4,000,000 2014 $20,000,000 13,500,000 4,500,000 18,000,000 $ 2,000,000

Gross profit recognition: 2013: $ 4,000,000 = 25% x $4,000,000 = $1,000,000 $16,000,000 2014: $13,500,000 = 75% x $2,000,000 = $1,500,000 $18,000,000 Less: 2013 gross profit 2014 gross profit 1,000,000 $ 500,000

b.

2013: $20,000,000 x 25% =

$5,000,000

2014: $20,000,000 x 75% = $15,000,000 Less: 2013 revenue (5,000,000) $10,000,000


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Problem 59 (continued) c. Balance Sheet At December 31, 2013 Current assets: Accounts receivable Costs and profit ($5,000,000*) in excess of billings ($2,000,000) * Costs ($4,000,000) + profit ($1,000,000) Requirement 4 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit a. Gross profit recognition: 2014: Overall loss of ($2,500,000) previously recognized gross profit of $1,000,000 = $3,500,000. b. 2014: Easiest to solve using a journal entry: Cost of construction (to balance) Revenue from long-term contracts* Construction in progress (loss)
*

$ 200,000 3,000,000

2013 $20,000,000 4,000,000 12,000,000 16,000,000 $ 4,000,000

2014 $20,000,000 13,500,000 9,000,000 22,500,000 ($ 2,500,000)

$10,500,000 $7,000,000 $3,500,000

Total revenue recognized to date = (percentage complete)(total revenue) = ($13,500,000 $22,500,000) x ($20,000,000) = (60%) x ($20,000,000) = $12,000,000 Revenue recognized this period = total revenue recognized in prior periods = $12,000,000 5,000,000 = $7,000,000
Intermediate Accounting, 7/e

The McGraw-Hill Companies, Inc., 2013 590

Problem 59 (continued) c. Balance Sheet At December 31, 2014 Current assets: Accounts receivable Current liabilities: Billings ($12,000,000) in excess of costs and profit ($11,000,000*) $ 1,600,000

1,000,000

* 2013 costs ($4,000,000) + 2013 profit ($1,000,000) + 2014 costs ($9,500,000) 2014 loss ($3,500,000) Requirement 5 Citation should recognize revenue at the point of delivery, when the homes are completed and title is transferred to the buyer. This is equivalent to the completed contract method for long-term contracts. The percentage-of-completion method is not appropriate in this case. There is no contract in place and until the completion of the home, the transfer of title, and the receipt of the full sales price, the earnings process is not virtually complete and there is still significant uncertainty as to cash collection. Also, the sales price is not fixed. Requirement 6 Income statement: Sales revenue (3 x $600,000) Cost of goods sold (3 x $450,000) Gross profit

$1,800,000 1,350,000 $ 450,000

Balance sheet: Current assets: Inventory (work in process) $2,700,000 Current liabilities: Customer deposits (or unearned revenue) $300,000* *$600,000 x 10% = $60,000 x 5 = $300,000

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Problem 510
Requirement 1 a. January 30, 2013

Cash ................................................................................ 200,000 Note receivable ............................................................... 1,000,000 Unearned franchise fee revenue .................................. 1,200,000

b.

September 1, 2013

Unearned franchise fee revenue ...................................... 1,200,000 Franchise fee revenue ................................................. 1,200,000

c.

September 30, 2013

Accounts receivable ($40,000 x 3%) ................................. Service revenue ..........................................................

1,200 1,200

d.

January 30, 2014

Cash ................................................................................. Note receivable ...........................................................

100,000 100,000

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Problem 510 (continued) Requirement 2 a. January 30, 2013 Cash ............................................................................... 200,000 Note receivable .............................................................. 1,000,000 Deferred franchise fee revenue ................................... 1,200,000 Note: Could also show as: Cash ............................................................................... 200,000 Note receivable .............................................................. 1,000,000 Deferred franchise fee revenue ................................... 1,000,000 Unearned franchise fee revenue ................................. 200,000

b.

September 1, 2013

Deferred franchise fee revenue ...................................... Franchise fee revenue (cash collected) ..........................

200,000 200,000

c.

September 30, 2013

Accounts receivable ($40,000 x 3%) ................................ Service revenue ..........................................................

1,200 1,200

d.

January 30, 2014

Cash ................................................................................ Note receivable .......................................................... Deferred franchise fee revenue ...................................... Franchise fee revenue ................................................

100,000 100,000 100,000 100,000

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Problem 510 (concluded) Requirement 3

Balance Sheet At December 31, 2013 Current assets: Installment notes receivable ($1,000,000) less deferred franchise fee revenue ($1,000,000) Current liabilities: Unearned franchise fee revenue $ -0-

$200,000

Explanation: Revenue recognition on the entire note receivable is deferred. In addition, $200,000 of unearned revenue must be shown as a liability.

Problem 511
1. 2. 3. 4. 5. 6. 7. Inventory turnover ratio Average days in inventory Receivables turnover ratio Average collection period Asset turnover ratio Profit margin on sales Return on assets or: 8. Return on shareholders equity 9. Equity multiplier 10. DuPont framework $6,300 [($800 + 600) 2] = 9.0 365 9.0 = 40.56 days $9,000 [($600 + 400) 2] = 18.0 365 18.0 = 20.28 days $9,000 [($4,000 + 3,600) 2] = 2.37 $300 $9,000 = 3.33% $300 [($4,000 + 3,600) 2] = 7.89% 3.33% x 2.37 times = 7.89% $300 [($1,500 + 1,350) 2] = 21.1% [($4,000 + 3,600) 2] [($1,500 + 1,350) 2] = 2.67 3.33% x 2.37 x 2.67 = 21.1%

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Problem 512
Requirement 1 Receivables turnover J&J Pfizer = = = Net sales Accounts receivable $41,862 $6,574 $45,188 $8,775 = 6.37 times = 5.15 times

Average collection period = J&J Pfizer = =

365 Receivables turnover 365 6.37 365 5.15 = 57 days = 71 days

On average, J&J collects its receivables in 14 days less than Pfizer. Inventory turnover J&J Pfizer = = = Cost of goods sold Inventories $12,176 $3,588 $9,832 $5,837 = 3.39 times = 1.68 times

Average days in inventory = J&J Pfizer = =

365 Inventory turnover 365 3.39 365 1.68 = 108 days = 217 days

On average, J&J sells its inventory twice as fast as Pfizer.


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Problem 512 (continued) Requirement 2 Rate of return on assets J&J Pfizer = = = Net income Total assets $7,197 $48,263 $1,639 $116,775 = = 14.9% 1.4%

The return on assets indicates a company's overall profitability, ignoring specific sources of financing. In this regard, J&Js profitability is significantly higher than that of Pfizer. Requirement 3 Profitability can be achieved by a high profit margin, high turnover, or a combination of the two. Rate of return on assets = Net income Net sales = = Pfizer = $ 7,197 $41,862 17.19% $ 1,639 $45,188 3.63% Profit margin on sales x x Asset turnover

= J&J

Net sales Total assets $41,862 $48,263 .867 times $45,188 $116,775 .387 times = 1.4% = 14.9%

x x x x

No, the combinations of profit margin and asset turnover are not similar. J&Js profit margin is much higher than that of Pfizer, as is its asset turnover. These differences combine to produce a significantly higher return on assets for J&J.
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Problem 512 (concluded) Requirement 4 Rate of return on = shareholders equity J&J Pfizer = = Net income Shareholders equity $7,197 $26,869 $1,639 $65,377 = 26.8% = 2.5%

J&J provided a much greater return to shareholders.

Requirement 5 Equity multiplier = shareholders equity J&J Pfizer = = Total Assets Shareholders equity $48,263 $26,869 $116,775 $65,377 = 1.80 = 1.79

The two companies have virtually identical equity multipliers, indicating that they are using leverage to the same extent to earn a return on equity that is higher than their return on assets.

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Problem 513
a. Times interest earned ratio = (Net income + Interest + Taxes) Interest = 17 (Net income + $2 + 12) $2 = 17 Net income + $14 = 17 x $2 Net income = $20 b. Return on assets = Net income Total assets = 10% Total assets = $20 10% = $200 c. Profit margin on sales = Net income Sales = 5% Sales = $20 5% = $400 d. Gross profit margin = Gross profit Sales = 40% Gross profit = $400 x 40% = $160 Cost of goods sold = Sales Gross profit = $400 160 = $240 e. Inventory turnover ratio = Cost of goods sold Inventory = 8 Inventory = $240 8 = $30 f. Receivables turnover ratio = Sales Accounts receivable = 20 Accounts receivable = $400 20 = $20 g. Current ratio = Current assets Current liabilities = 2.0 Acid-test ratio = Quick assets Current liabilities = 1.0 Current assets 2 = Current liabilities Quick assets 1 = Current liabilities Current assets 2 = Quick assets 1 Current assets = 2 x Quick assets Cash + Accts. rec. + Inventory = 2 x (Cash + Accounts receivable) Cash + $20 + 30 = (2 x Cash) + (2 x $20) Cash + $50 = Cash + Cash + $40 Cash = $10 h. Acid-test ratio = (Cash + Accounts receivable) Current liabilities = 1.0 Current liabilities = ($10 + 20) 1.0 = $30 i. Noncurrent assets = Total assets Current assets = $200 ($10 + 20 + 30) = $140 j. Return on shareholders equity = Net income Shareholders equity = 20% Shareholders equity = $20 20% = $100

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Problem 513 (concluded) k. Debt to equity ratio = Total liabilities Shareholders equity = 1.0 Total liabilities = $100 x 1.0 = $100 Long-term liabilities = Total liabilities Current liabilities = $100 30 = $70 CADUX CANDY COMPANY Balance Sheet At December 31, 2013 Assets Current assets: Cash Accounts receivable (net) Inventories Total current assets Property, plant, and equipment (net) Total assets $ 10 20 30 60 140 $200

Liabilities and Shareholders Equity Current liabilities $ 30 Long-term liabilities 70 Shareholders equity 100 Total liabilities and shareholders' equity $200

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Problem 514
Requirement 1 Rate of return on assets Metropolitan Republic = = = Net income Total assets $ 593.8 $4,021.5 $ 424.6 $4,008.0 = = 14.8% 10.6%

The return on assets indicates a company's overall profitability, ignoring specific sources of financing. In this regard, Metropolitans profitability exceeds that of Republic. Requirement 2 Profitability can be achieved by a high profit margin, high turnover, or a combination of the two. Rate of return on assets = Net income Net sales x x x x Profit margin on sales x x Asset turnover

Net sales Total assets

Metropolitan = $ 593.8 $5,698.0 = Republic = 10.4% $ 424.6 $7,768.2 = 5.5%

$5,698.0 $4,021.5 1.42 times = $7,768.2 $4,008.0 1.94 times = 10.7% 14.8%

Republics profit margin is much less than that of Metropolitan, but partially makes up for it with a higher turnover.

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Problem 514 (continued) Requirement 3 Rate of return on shareholders equity Metropolitan Republic = = = Net income Shareholders equity $593.8 $144.9 + 2,476.9 904.7 $424.6 $335.0 + 1,601.9 964.1 = 34.6% = 43.6%

Republic provides a greater return to common shareholders. Requirement 4 Equity multiplier Metropolitan Republic = = = Total assets Shareholders equity $4,021.5 $144.9 + 2,476.9 904.7 $4,008.0 $335.0 + 1,601.9 964.1 = 2.34 = 4.12

When the return on shareholders equity is greater than the return on assets, management is using debt funds to enhance the earnings for stockholders. Both firms do this. Republics higher leverage has been used to provide a higher return to shareholders than Metropolitan, even though its return on assets is less. Republic increased its return to shareholders 4.07 times (43.6% 10.7%) the return on assets. Metropolitan increased its return to shareholders 2.34 times (34.6% 14.8%) the return on assets.

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Problem 514 (continued) Requirement 5 Current ratio Metropolitan Republic Acid-test ratio Metropolitan Republic = = = = = = Current assets Current liabilities $1,203.0 $1,280.2 $1,478.7 $1,787.1 Quick assets Current liabilities $1,203.0 466.4 134.6 $1,280.2 $1,478.7 635.2 476.7 $1,787.1 = = .47 .21 = = .94 .83

The current ratios of the two firms are comparable and within the range of the rule-of-thumb standard of 1 to 1. The more robust acid-test ratio reveals that Metropolitan is more liquid than Republic. Requirement 6 Receivables turnover ratio Metropolitan Republic = = = Sales Accounts receivable $5,698.0 $422.7 $7,768.2 $325.0 = 13.5 times = 23.9 times

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Problem 514 (concluded) Inventory turnover ratio Metropolitan Republic = = = Cost of goods sold Inventory $2,909.0 $466.4 $4,481.7 $635.2 = 6.2 times = 7.1 times

Republics receivables turnover is more rapid than Metropolitans, perhaps suggesting that its relative liquidity is not as bad as its acid-test ratio indicated. Requirement 7 Times interest earned ratio Metropolitan Republic = = = Net income plus interest plus taxes Interest $593.8 + 56.8 + 394.7 $56.8 $424.6 + 46.6 + 276.1 $46.6 = 18.4 times = 16.0 times

Both firms provide an adequate margin of safety.

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Problem 515
Branson Electronics Company Income Statement Revenues Cost of goods sold Gross profit Advertising expense1 Other operating expenses2 Income before income taxes Income tax expense3 Net income
1$50,000 4 = $12,500 2$48,000 + [59,000 50,000] 3$75,500 x 36%

$180,000 35,000 145,000 (12,500) (57,000) 75,500 (27,180) $ 48,320

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SUPPLEMENT PROBLEMS
Problem 516
Requirement 1 a. The gym membership is one separate performance obligation. Since the discount voucher provides a material right to the customer that the customer would not receive otherwise (a 25 percent discount rather than a 10 percent discount), the discount voucher also is a separate performance obligation. b. To allocate the contract price to the performance obligation, we should first consider that Fit & Slim would offer a 10 percent discount on the yoga course to all customers as part of a seasonal promotion. So, a 25 percent discount provides a customer with an incremental value of 15 percent (25% 10%). Thus, the estimated standalone selling price of the course voucher provided by Fit & Slim is $36 ($600 initial price of the course 15% incremental discount 40% likelihood of exercising the option). Since the standalone selling price of the annual membership fee is $800, Fit & Slim would allocate $34.45 {$800 [36 ($36 + 800)]} of the $800 transaction price to the discount voucher on yoga course. c. Since the discount voucher of the yoga course would be a separate performance obligation, Fit & Slim would recognize revenue for the sale of annual membership fee and discount voucher. Cash Unearned revenue, membership fees Unearned revenue, yoga coupon 800 765.55 34.45

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Problem 516 (concluded) Requirement 2 a. The option to pay $15 for additional visits does not constitute a material right, because it is in the range ($12 to $18) of normal fees paid by nonmembers. Therefore, it is not a separate performance obligation in the contract. b. Since the option to visit on additional days is not a separate performance obligation, F&S should not allocate any of the contract price to it. Therefore, the entire $500 payment is allocated to the 50 visits associated with the coupon book. c. Cash Unearned revenue, coupon book 500 500

F&S could recognize (1/40) $500 of revenue for each visit, since a coupon book yields approximately 40 visits. Alternatively, F&S could recognize revenue over the year following sale of the coupon book.

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Problem 517
Scenario 1: The terms of the contract and all the related facts and circumstances indicate that Star controls the room as it is built. Star has an unconditional obligation to pay throughout the contract as evidenced by the required progress payments (with no refund of payment for any work performed to date) and by the requirement to pay for any partially completed work in the event of contract termination. Although Star does not obtain legal title of the equipment until completion of the job, Crowns retention of title is a protective right, and not an indicator that it has retained control. Consequently, Crowns performance obligation is to provide Star with construction services, and Crown would recognize revenue over time throughout the construction process. Scenario 2: The terms of the contract and all the related facts and circumstances indicate that Star does not obtain control of the gym until it is delivered. Star does not obtain title to the equipment until the job is completed, and if the contract is terminated prior to completion, Crown retains the equipment, suggesting that Crown retains control of the equipment throughout the job. Consequently, Crowns performance obligation is to provide Star with a completed gym, and Crown would defer revenue recognition until the end of the construction process. Scenario 3: The terms of the contract and all the related facts and circumstances indicate that Coco has the ability to direct the use of, and receive the benefit from, the consulting services as they are performed. The restaurant has an unconditional obligation to pay throughout the contract as evidenced by the nonrefundable progress payments, and the right to a report regardless of contract termination. Also, the report is not of alternate use to CostDriver. Therefore, the CostDriver Companys performance obligation is to provide the restaurant with services continuously during the three months of the contract, and CostDriver should recognize revenue over the life of the contract. Scenario 4: The terms of the contract and all the related facts and circumstances indicate that Edwards, the customer, obtains control of the apartment on completion of the contract. Edwards obtains title and physical possession of the apartment only on completion of the contract. Consequently, the Towers performance obligation is to provide the customer with a completed apartment, and the Tower should not recognize revenue until delivery of the apartment.

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Problem 518
Note: The contract requires 6 payments of $20,000, plus or minus $10,000 at the end of the life of the contract. So the contract will provide either [(6 $20,000) $10,000] = $110,000, or [(6 $20,000) + $10,000] = $130,000. a) Revis would estimate the transaction price as follows: Possible Prices $130,000 ([$20,000 6] + $10,000) $110,000 ([$20,000 6] $10,000) Expected contract price at inception Expected Consideration $104,000 22,000 $126,000

Probability 80% 20%

Each month Revis would recognize $21,000 ($126,000 6) of revenue, using the following journal entry: Cash Expected bonus receivable Revenue 20,000 1,000 21,000

After six months the Expected bonus receivable will have accumulated to $6,000 (6 $1,000). b) If Revis receives the bonus, it will record the following entry: Cash Expected bonus receivable Revenue c) 10,000 6,000 4,000

If Revis pays the penalty, it will record the following entry: Revenue Expected bonus receivable Cash 16,000 6,000 10,000

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Problem 519
Requirement 1 At the contracts inception, Velocity would calculate the transaction price to be the probability-weighted average of the two possible eventual prices: Possible Prices Expected Consideration $400,000 92,000 $492,000

Probabilities

$500,000 ([$60,000 8] + $20,000) 80% $460,000 ([$60,000 8] $20,000) 20% Transaction price at contract inception:

Velocity would allocate the transaction price, $492,000, to the performance obligation to provide consulting services. Because those services are provided evenly over the eight months, Velocity would recognize revenue of $61,500 ($492,000 8 months = $61,500). But Burger Boy is unconditionally obligated to pay only $60,000 per month ($1,500 less than the revenue recognized), so Velocity would recognize an Expected bonus receivable of $1,500 in the first month to reflect the most likely bonus to be received at the end of the contract. This is the revenue recognized in excess of its unconditional right to consideration. Therefore, the journal entry to record the revenue that Velocity would recognize each month for the first four months is as follows: Accounts receivable Expected bonus receivable Revenue 60,000 1,500 61,500

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Problem 519 (continued) Requirement 2 The expected bonus receivable would increase to $6,000 (4 $1,500) by the end of the fourth month, equal to half of the total expected bonus of $12,000 ($492,000 [8 $60,000]). After four months, the estimated likelihood of receiving the bonus is revised, so the estimated transaction price decreases to $484,000: Possible Prices Expected Probabilities Consideration $300,000 184,000 $484,000

60% $500,000 ([$60,000 8] + $20,000) 40% $460,000 ([$60,000 8] $20,000) Transaction price after four months:

Therefore, as of that date the expected bonus receivable should equal $2,000, which is half of the new expected bonus of $4,000 ($484,000 [8 $60,000]). Recording that adjustment requires a reduction of the expected bonus receivable from $6,000 to $2,000: Revenue Expected bonus receivable 4,000 4,000

This entry reduces the expected bonus receivable to $2,000, with the offsetting debit a reduction in revenue. Over the remaining four months, expected bonus receivable will increase by $500 each month, accumulating to $4,000 by the end of the contract. Requirement 3 Because services are provided evenly over the eight months, Velocity would recognize revenue of $60,500 ($484,000 8 months = $60,500) in each of months five through eight. Because Burger Boy pays $60,000 per month ($500 less than the revenue recognized), Velocity would recognize an expected bonus receivable of $500 each month to reflect the revenue recognized in excess of its unconditional right to $60,000. The journal entry would be: Accounts receivable Expected bonus receivable Revenue
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60,000 500 60,500


Intermediate Accounting, 7/e

Problem 519 (concluded) Requirement 4 At the end of contract, Velocity learns that it will receive the bonus of $20,000. It already has recognized revenue of $4,000 associated with the bonus. Therefore, Velocity recognizes additional accounts receivable and additional revenue of $16,000 ($20,000 4,000). Expected bonus receivable Revenue Accounts receivable Expected bonus receivable OR Accounts receivable Expected bonus receivable Revenue 20,000 4,000 16,000 16,000 16,000 20,000 20,000

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CASES
Real World Case 51
Requirement 1 A bill and hold strategy accelerates the recognition of revenue. In this case, sales that would normally have occurred in 1998 were recorded in 1997. Assuming a positive gross profit on these sales, earnings in 1997 is inflated. Requirement 2 A customer would probably not be expected to pay for goods purchased using this bill and hold strategy until the goods were actually received. Receivables would therefore increase. Requirement 3 Sales that would normally have been recorded in 1998 were recorded in 1997. This bill and hold strategy shifted sales revenue and therefore earnings from 1998 to 1997. Requirement 4 Earnings quality refers to the ability of reported earnings (income) to predict a companys future earnings. Sunbeams earnings management strategy produced a 1997 earnings figure that was not indicative of the companys future profit-generating ability.

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Judgment Case 52
Requirement 1 While revenue often is earned during a period of time, revenue usually is recognized at a point in time when both revenue recognition criteria are satisfied. These criteria usually are satisfied at the point of delivery. The revenue has been earned and there is reasonable certainty as to the collectibility of the asset (cash) to be received. Usually, significant uncertainties exist at the time products are produced. At the point of delivery, the product has been sold and the price and buyer are known. The only remaining uncertainty involves the ultimate cash collection, which can usually be accounted for by estimating and recording allowances for possible return of the product and for uncollectibility of the cash. Requirement 2 It would be useful to recognize revenue as the productive activity takes place when the earnings process occurs over long periods of time. A good example is longterm projects in the construction industry. Requirement 3 Some revenue-producing activities call for revenue recognition after the product has been delivered. These situations involve significant uncertainty as to the collectibility of the cash to be received, caused either by the possibility of the product being returned or, with credit sales, the possibility of bad debts. Usually, these remaining uncertainties can be accounted for by estimating and recording allowances for anticipated returns and bad debts, thus allowing revenue and related costs to be recognized at the point of delivery. But occasionally, an abnormal degree of uncertainty causes point of delivery revenue recognition not to be appropriate. Revenue recognition after delivery sometimes is appropriate for installment sales and when a right of return exists.

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Judgment Case 53
Mega should recognize revenue for the initial fee equally over the estimated average period members will continue to be members. Even though the fee is nonrefundable, it is not earned until services are provided. Since there is no contractual period of service, it must be estimated. Mega would be justified in recognizing only $3 of the initial fee immediately to offset the cost of the membership card. The payment option chosen by members does not affect the revenue recognition policy. The monthly fee should be recognized as revenue upon billing, as long as adequate provision is made for possible uncollectible amounts.

Judgment Case 54
The revenue recognition policy is questionable. The liberal trade-in policy causes gross profit to be overstated on the original sale and understated on the trade-in sale. This results from the granting of a trade-in allowance for the old computer that is greater than the old computer's resale value. Using the company's recognition policy, gross profit recognized on the two sales would be as follows: Sales price Cost of goods sold Gross profit Gross profit percentage Original sale $2,000,000 1,200,000 $ 800,000 40% Trade-in sale $2,380,000 1,500,000 $ 880,000 37%

Of course, there is no guarantee that the customer will exercise the trade-in option. If, however, a large percentage of customers do exercise the option, and the distortion in gross profit is material, the company should adopt a revenue recognition policy that results in a more stable gross profit percentage for the two transactions.

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Communication Case 55
The critical question that student groups should address is how to match revenues and expenses. There is no right or wrong answer. The process of developing the proposed solutions will likely be more beneficial than the solutions themselves. Students should benefit from participating in the process, interacting first with other group members, then with the class as a whole. Solutions could take one of two directions: 1. Deferral of revenue recognition. As each ice cream cone is sold, a portion of the sales price is deferred and a liability is recorded. This liability will then be reduced and revenue recognized when the free ice cream cone is awarded. 2. The accrual of estimated cost. This direction views the free ice cream cone as a promotional expense. The estimated cost of the free cone should be expensed as the 10 required cones are sold. A corresponding liability is recorded which should increase to an amount equal to the cost of the free cone. When the free cone is awarded, the liability and inventory are reduced. In either case, the accounting method must consider the fact that not all customers will take advantage of the free cone award. It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged. Students should be encouraged to contribute to the group discussion by (a) offering information on relevant issues, and (b) clarifying or modifying ideas already expressed, or (c) suggesting alternative direction.

Research Case 56
(Note: This case requires the student to reference a journal article.)

1. 2. 3. 4.

Fifty-five firms reported the use of one of the two long-term contract accounting methods. Twenty-seven of the firms are manufacturing companies. Only one company uses the completed contract method. That company reported using both methods. The most frequently used approach to estimating a percentage-of-completion is the cost-to-cost method.

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Research Case 57
(Note: This case requires the student to reference a journal article.)

1. Abuse 1. Cutoff manipulation Expanation The company either closes their books early (so some current-year revenue is postponed until next year) or leaves them open too long (so some next-year revenue is included in the current year). The company has an arrangement under which revenue should be deferred (for example, it should be using the installment sales method), but it doesnt defer the revenue. Or, a company could defer too much revenue to shift income into future periods. The company records sales even though it hasnt yet delivered the goods to the customer. The company sells to distributors or other customers and cant estimate returns with sufficient accuracy due to the nature of the selling relationship.

2. Deferring too much or too little revenue

3. Bill-and-hold sale 4. Right-of-return sale

2. 3. 4.

Manipulating estimates of percentage complete in order to manipulate gross profit recognition. These abuses tended to increase income (75% of the time), consistent with management generally having an incentive to increase income. The auditors tended to require adjustment (56% of the time), consistent with auditors being concerned about income-increasing earnings management.

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Ethics Case 58
Discussion should include these elements. Facts: Horizon Corporation, a computer manufacturer, reported profits from 2008 through 2011, but reported a $20 million loss in 2012 due to increased competition. The chief financial officer (CFO) circulated a memo suggesting the shipment of computers to J.B. Sales, Inc., in 2013 with a subsequent return of the merchandise to Horizon in 2014. Horizon would record a sale for the computers in 2013 and avoid an inventory write-off that would place the company in a loss position for that year. The CFO is clearly asking Jim Fielding to recognize revenue in 2013 that he knows will be reversed as a sales return in 2014. Ethical Dilemma: Is Jim's obligation to challenge the memo of the CFO and provide useful information to users of the financial statements greater than the obligation to prevent a company loss in 2013 that may lead to bankruptcy? Who is affected? Jim Fielding CFO and other managers Other employees Shareholders Potential shareholders Creditors Auditors

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Judgment Case 59
Requirement 1 The three methods that could be used to recognize revenue and costs for this situation are (1) point of delivery, (2) the installment sales method, and (3) the cost recovery method. 2013 gross profit under the three methods: (1) point of delivery: $80,000 40,000 = $40,000 (2) installment sales method: $40,000 = 50% = gross profit % $80,000 50% x $30,000 (cash collected) = $15,000 (3) cost recovery method: No gross profit recognized since cost ($40,000) exceeds cash collected ($30,000). Requirement 2 Customers sometimes are allowed to pay for purchases in installments over long periods of time. Uncertainty about collection of a receivable normally increases with the length of time allowed for payment. In most situations, the increased uncertainty concerning the collection of cash from installment sales can be accommodated satisfactorily by estimating uncollectible amounts. In these situations, point of delivery revenue recognition should be used. If, however, the installment sale creates a situation where there is significant uncertainty concerning cash collection making it impossible to make an accurate assessment of future bad debts, revenue and cost recognition should be delayed. The installment sales method and the cost recovery method are available to handle such situations. These methods should be used only in situations involving exceptional uncertainty. The cost recovery method is the more conservative of the two.

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Judgment Case 510


Note: the SEC guidance on these issues can be found in the FASBs codification at FASB ASC 60510S99: Revenue RecognitionOverallSEC Materials. Question 1 No. In the SEC's view, it would be inappropriate for Company M to recognize the membership fees as earned revenue upon billing or receipt of the initial fee with a corresponding accrual for estimated costs to provide the membership services. This conclusion is based on Company M's remaining and unfulfilled contractual obligation to perform services (i.e., make available and offer products for sale at a discounted price) throughout the membership period. Therefore, the earnings process, irrespective of whether a cancellation clause exists, is not complete. In addition, the ability of the member to receive a full refund of the membership fee up to the last day of the membership term raises an uncertainty as to whether the fee is fixed or determinable at any point before the end of the term. Generally, the SEC believes that a sales price is not fixed or determinable when a customer has the unilateral right to terminate or cancel the contract and receive a cash refund. [ASC 60510S99, SAB Topic 13.A.4, Fixed or Determinable Sales Price, a. Refundable fees for services.] Question 2 No. Products delivered to a consignee pursuant to a consignment arrangement are not sales and do not qualify for revenue recognition until a sale occurs. The SEC believes that revenue recognition is not appropriate because the seller retains the risks and rewards of ownership of the product and title usually does not pass to the consignee. [ASC 60510S99, SAB Topic 13.A.2, Persuasive Evidence of an Arrangement.]

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Case 510 (concluded) Question 3 Provided that the other criteria for revenue recognition are met, the SEC believes that Company R should recognize revenue from sales made under its layaway program upon delivery of the merchandise to the customer. Until then, the amount of cash received should be recognized as a liability entitled such as "deposits received from customers for layaway sales" or a similarly descriptive caption. Because Company R retains the risks of ownership of the merchandise, receives only a deposit from the customer, and does not have an enforceable right to the remainder of the purchase price, the SEC would object to Company R recognizing any revenue upon receipt of the cash deposit. This is consistent with item two (2) in the SEC's criteria for bill-and-hold transactions that states that "the customer must have made a fixed commitment to purchase the goods." [ASC 60510S99, SAB Topic 13.A.3, Delivery and Performance, e. Layaway sales arrangements.]

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Intermediate Accounting, 7/e

Research Case 511


Requirement 1 The relevant literature can be found in the FASBs codification at FASB ASC 60515251: Revenue RecognitionProductsRecognitionGeneralSales of Product when Right of Return Exists. Requirement 2 GAAP lists the following factors that may impair the ability to make a reasonable estimate (see ASC 60515253). a. The susceptibility of the product to significant external factors, such as technological obsolescence or changes in demand. b. Relatively long periods in which a particular product may be returned. c. Absence of historical experience with similar types of sales of similar products, or inability to apply such experience because of changing circumstances, for example, changes in the selling enterprises marketing policies or relationships with its customers. d. Absence of a large volume of relatively homogeneous transactions. Requirement 3 The six criteria are: a. The sellers price to the buyer is substantially fixed or determinable at the date of sale. b. The buyer has paid the seller and the obligation is not contingent on resale of the product. c. The buyers obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product. d. The buyer acquiring the product for resale has economic substance apart from that provided by the seller. e. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer. f. The amount of future returns can be reasonably estimated.

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Case 511 (concluded) Requirement 4 Both companies recognize revenues from products sold when persuasive evidence of an arrangement exists, the price is fixed or determinable, shipment is made, and collectibility is reasonably assured. However, for sales to distributors under terms allowing the distributors certain rights of return and price protection on unsold merchandise held by them, AMD defers recognition of revenue and related profits until the merchandise is resold by the distributors. Requirement 5 The two revenue recognition policies differ with respect to AMDs sales to distributors. Revenue for these sales is deferred until the merchandise is resold by the distributors. On the other hand, HP recognizes all sales when products are shipped even though it offers price protection as well as the right of return to customers. Estimates are recorded for customer returns, price protection, rebates, and other offerings. Reasons for the difference in policies could relate to the types of products sold by the two companies, the distribution channels, and the actual agreements with customers. AMD sells semiconductors, a highly volatile industry. It may be more difficult for AMD to see through the distribution channels to reasonably estimate returns. Also, the agreements with distributors of AMDs products may be more liberal than those of HP with respect to things like price protection and returns. For example, AMD might offer a longer time period for customers to return product than does HP. Also, AMDs sales to distributors might be contingent on resale of the product to end users, one of the six criteria that must be met before revenue can be recognized when the right of return exists.

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Research Case 512


Requirement 1 This topic is addressed in EITF Issue No. 99-19 The FASB ASC cross-reference addresses this topic in paragraphs under FASB ASC 60545. Requirement 2 The relevant literature can be found in the FASBs codification at FASB ASC 60545451 through 605454518: Revenue RecognitionPrincipal Agent ConsiderationsOther Presentation MattersOverall Considerations of Reporting Revenue Gross as a Principal vs. Net as an Agent. The Codification lists the following indicators for use of the gross method: 1. The company is the primary obligor in the arrangement. 2. The company has general inventory risk (before customer order is placed or upon customer return). 3. The company has latitude in establishing price. 4. The company changes the product or performs part of the service. 5. The company has discretion in supplier selection. 6. The company is involved in the determination of product or service specifications. 7. The company has physical loss inventory risk (after customer order or during shipping). 8. The company has credit risk. The indicators for the use of the net method are: 1. The supplier (not the company) is the primary obligor in the arrangement. 2. The amount the company earns is fixed. 3. The supplier (and not the company) has credit risk. Requirements 3 and 4 For their AdSense program, Googles 2010 10K states: We recognize as revenues the fees charged advertisers each time a user clicks on one of the text-based ads that are displayed next to the search results pages on our website or on the search results pages or content pages of our Google Network members websites and, for those advertisers who use our cost-per impression pricing, the fees charged advertisers each time an ad is displayed on our members websites. We report our Google AdSense revenues on a gross basis principally because we are the primary obligor to our advertisers. That is consistent with the first indicator for use of the gross method listed under Requirement 2, so Googles reasoning appears appropriate.

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Judgment Case 513


1. 2. 3. 4. Delta should recognize the $425 as revenue on May 15, the date the flight commences. Revenue should be recognized evenly over the period beginning after Thanksgiving and ending April 30. The $5,000 monthly charge is recognized as revenue each month. The $12,000 fee must be recognized evenly over the 36-month lease period. Janora Hawkins should recognize the $60,000 as revenue on August 28, the date the case is settled successfully. This assumes reasonable certainty as to the collection.

Judgment Case 514


Bills argument is that the completed contract method is preferable because it is analogous to point of delivery revenue recognition. That is, no revenue is recognized until the completed product is delivered. Johns argument is that the important factor is the earnings process and that revenue should be recognized as the process takes place. Johns argument is correct. In situations when the earnings process takes place over long periods of time, like long-term construction contracts, it is preferable to recognize revenue during the earnings process, rather than to wait until the process is complete.

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Communication Case 515


Suggested Grading Concepts and Grading Scheme:
Content (70%) _______ 45 Income differences. _______ Percentage-of-completion recognizes gross profit during construction based on an estimate of percent complete. _______ The completed contract method recognizes no gross profit until project completion. _______ For both methods, estimated losses are fully recognized in the first period the loss is anticipated. Balance sheet differences. The two methods are similar. However, for profitable projects, the construction in progress account during construction will have a higher balance when using the percentage-of-completion method due to the inclusion of gross profit. According to generally accepted accounting principles, the percentage-of-completion method should be used in most situations. The completed contract method distorts income when long-term projects span more than one accounting period.

_______

10

_______

15

_______

_____ 70 points

Writing (30%) _______ 6

Terminology and tone appropriate to the audience of a company controller. Organization permits ease of understanding. ______ Introduction that states purpose. ______ Paragraphs that separate main points. English ______ Sentences grammatically clear and well organized, concise. ______ Word selection. ______ Spelling. ______ Grammar and punctuation.

_______

12

_______

12

_______

_____ 30 points

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IFRS Case 516


Vodafones revenue recognition policies for products and services are similar to revenue recognition policies in the U.S. Sales of products are recorded when goods have been put at the disposal of the customers in accordance with agreed terms of delivery and when the risks and rewards of ownership have been transferred to the buyer. Sales of services are recognized as the services are provided. The terminology is somewhat different, but the end results, as compared to U.S. policies, should be similar in most cases.

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IFRS Case 517


Requirement 1 Per the revenue recognition section of ThyssenKrupps 2010 annual report, note 1: Summary of Significant Accounting Policies: The companys normal method for accounting for long-term construction contracts is the percentage of completion method, used when it can make accurate estimates of contract income: Construction contract revenue and expense are accounted for using the percentage-of-completion method, which recognizes revenue as performance of the contract progresses. The contract progress is determined based on the percentage of costs incurred to date to total estimated cost for each contract after giving effect to the most recent estimates of total cost. When the company cannot make accurate estimates of contract income, it uses the cost recovery method: Where the income of a construction contract cannot be estimated reliably, contract revenue that is probable to be recovered is recognized to the extent of contract costs incurred. Contract costs are recognized as expenses in the period in which they are incurred. (from 2010 Annual report) Note 1: Summary of significant accounting policies The consolidated financial statements have been prepared on a historical cost basis, except for certain financial instruments that are stated at fair value. The consolidated financial statements are presented in Euros since this is the currency in which the majority of the Groups transactions are denominated, with all amounts rounded to the nearest million except when otherwise indicated; this may result in differences compared to the unrounded figures.

Requirement 2 The primary difference is that, under U.S. GAAP, the company would use the completed contract method in circumstances in which it cannot make accurate estimates of contract income.

Trueblood Accounting Case 518


A solution and extensive discussion materials can be obtained from the Deloitte Foundation.

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Trueblood Accounting Case 519


A solution and extensive discussion materials can be obtained from the Deloitte Foundation.

Real World Case 520


Requirement 3 The following is from the 2010 10K of Jack in the Box, Inc. The responses to the question will vary if the company has since changed its revenue recognition policy. a. These fees are recognized as revenue when the company has substantially performed all of its contractual obligations. This policy agrees with GAAP. b. Continuing payments are based on a percentage of sales. Requirement 4 Answers to this question will, of course, vary because students will research financial statements of different companies. Likely candidates for comparison include most of the fast-food chains such as McDonalds, and Wendys, and Arbys

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Real World Case 521


Requirement 2 Excerpt from Orbitzs 2010 Annual Report: Revenue Recognition We recognize revenue when it is earned and realizable, when persuasive evidence of an arrangement exists, services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. We have two primary types of contractual arrangements with our vendors, which we refer to herein as the "merchant" and "retail" models. Under both the merchant and retail models, we record revenue earned net of all amounts paid to our suppliers. Under the merchant model, we generate revenue for our services based on the difference between the total amount the customer pays for the travel product and the negotiated net rate plus estimated taxes that the supplier charges us for that product. Customers generally pay us for reservations at the time of booking. Initially, we record these customer receipts as accrued merchant payables and either deferred income or net revenue, depending on the travel product. In the merchant model, we do not take on credit risk with the customer, however we are subject to chargebacks and fraud risk which we monitor closely; we have the ability to determine the price; we are not responsible for the actual delivery of the flight, hotel room or car rental; we take no inventory risk; we have no ability to determine or change the products or services delivered; and the customer chooses the supplier. We recognize net revenue under the merchant model when we have no further obligations to the customer. . . . Under the retail model, we pass reservations booked by our customers to the travel supplier for a commission. In the retail model, we do not take on credit risk with the customer; we are not the primary obligor with the customer; we have no latitude in determining pricing; we take no inventory risk; we have no ability to determine or change the products or services delivered; and the customer chooses the supplier. We recognize net revenue under the retail model when the reservation is made, secured by a customer with a credit card and we have no further obligations to the customer.

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Case 521 (continued) Excerpt from priceline.coms 2010 Annual Report: Merchant Revenues and Cost of Merchant Revenues Name Your Own Price Services: Merchant revenues for Name Your Own Price services and related cost of revenues are derived from transactions where the Company is the merchant of record and, among other things, selects suppliers and determines the price it will accept from the customer. The Company recognizes such revenues and costs if and when it fulfills the customers non-refundable offer. Merchant revenues and cost of merchant revenues include the selling price and cost, respectively, of the travel services and are reported on a gross basis. . . . Merchant Price-Disclosed Hotel Service: Merchant revenues for the Companys merchant price-disclosed services are derived from transactions where its customers purchase hotel room reservations or rental car reservations from suppliers at disclosed rates which are subject to contractual arrangements. The Company records the difference between the customer selling price and the supplier cost of its merchant price-disclosed reservation services on a net basis in merchant revenue. Agency Revenues Agency revenues are derived from travel related transactions where the Company is not the merchant of record and where the prices of the services sold are determined by third parties. Agency revenues include travel commissions, customer processing fees and global distribution system (GDS) reservation booking fees and are reported at the net amounts received, without any associated cost of revenue. Such revenues are generally recognized by the Company when the customers complete their travel.

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Case 521 (concluded) Requirement 3 a) Orbitzs merchant model revenues This is reported net: We record revenue earned net of all amounts paid to our suppliers under both our merchant and retail models. b) Orbitzs retail model revenues This is reported net: We record revenue earned net of all amounts paid to our suppliers under both our merchant and retail models. c) priceline.coms merchant revenues for Name Your Own Price services This is reported gross: Merchant revenues and cost of merchant revenues include the selling price and cost, respectively, of the travel services and are reported on a gross basis. d) priceline.coms merchant revenues for Price-Disclosed Hotel services This is reported net: The Company records the difference between the selling price and the cost of the hotel room reservation as merchant revenue. e) priceline.coms agency revenues: This is reported net: Agency revenues . . . are reported at the net amounts received, without any associated cost of revenue. Requirement 4 Yes, it appears that relatively similar services can be accounted for as gross v. net depending on how they are structured. Pricelines Name your own Price service appears similar to services that Orbitz might offer under its merchant model, yet Priceline would recognize revenue gross and Orbitz would recognize revenue net. If similar things are treated differently, comparability is reduced.

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Analysis Case 522


This case encourages students to obtain hands-on familiarity with an actual annual report and library sources of industry data. They also must apply the techniques learned in the chapter. You may wish to provide students with multiple copies of the same annual reports and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective.

Judgment Case 523


Apparently, a significant increase in assets occurred during the last quarter. Total assets were $324 million and now they total $450 million, as can be calculated as follows: Return on shareholders equity Shareholders equity Debt to equity ratio Total liabilities Total assets = Net income Shareholders equity = 14% = $21 million 14% = $150 million = Total liabilities Shareholders equity = 2 = $150 million x 2 = $300 million = Total liabilities + Shareholders equity = $300 million + 150 million = $450 million

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Intermediate Accounting, 7/e

Integrating Case 524


Balance Sheet Assets Cash Accounts receivable (net) Inventory Prepaid expenses and other current assets Current assets Property, plant, and equipment (net) Liabilities and Shareholders Equity Accounts payable Short-term notes Current liabilities Bonds payable Shareholders equity Income Statement Sales Cost of goods sold Gross profit Operating expenses Interest expense Tax expense Net income $300,000 (180,000) 120,000 (96,000) (2,000) (7,000) $ 15,000 (a) (c) (c) (o) (m) (n) given

$ 15,000 12,000 30,000 3,000 60,000 140,000 $200,000 $ 25,000 5,000 30,000 20,000 150,000 $200,000

given (e) (d) (i) (h) (j) (b) (g) given (f) (l) (k) (b)

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Case 524 (concluded) Calculations ($ in 000s): a. Profit margin on sales = Net income Sales = 5% Sales = $15 5% = $300 b. Return on assets = Net income Total assets = 7.5% Total assets = $15 7.5% = $200 c. Gross profit margin = Gross profit Sales = 40% Gross profit = $300 x 40% = $120 Cost of goods sold = Sales Gross profit = $300 120 = $180 d. Inventory turnover ratio = Cost of goods sold Inventory = 6 Inventory = $180 6 = $30 e. Receivables turnover ratio = Sales Accounts receivable = 25 Accounts receivable = $300 25 = $12 f. Acid-test ratio = Cash + AR + ST Investments Current liabilities = .9 Current liabilities = ($15 + 12 + 0) .9 = $30 g. Accounts payable = Current liabilities Short-term notes = $30 5 = $25 h. Current ratio = Current assets Current liabilities = 2 Current assets = $30 x 2 = $60 i. Prepaid expenses and other current assets = Current assets (Cash + AR + Inventory) = $60 (15 + 12 + 30) = $3 j. Property, plant, and equipment = Total assets Current assets = $200 60 = $140 k. Return on shareholders equity = Net income Shareholders equity =10% Shareholders equity = $15 10% = $150 l. Debt to equity ratio = Total liabilities Shareholders equity = 1/3 Total liabilities = $150 x 1/3 = $50 Bonds payable = Total liabilities Current liabilities = $50 30 = $20 m. Interest expense = 8% x (Short-term notes + Bonds ) Interest expense = 8% x ($5 + 20) = $2 n Times interest earned ratio = (Net income + Interest +Taxes) Interest = 12 Times interest earned ratio = ($15 + 2 + Taxes) 2 = $12 Times interest earned ratio = ($15 + 2 + Taxes) = $24 Tax expense = $24 (15 + 2) = $7 o. Operating expenses = (Sales Cost of goods sold Interest expense Tax expense) Net income = ($300 180 2 7) 15 = $96

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Air FranceKLM Case


Requirement 1 a. AFs balance sheet indicates current deferred revenue on ticket sales of 2,440 million as of March 31, 2011. While it is possible that AF has some noncurrent deferred revenue on ticket sales, none is indicated in note 31 (other noncurrent liabilities). b. The journal entry would be: Deferred revenue on ticket sales Sales revenue

2,440 2,440

c. This seems consistent with U.S. GAAP. A liability for deferred revenue is recognized when tickets are purchased, and then the deferred revenue is reduced and revenue is recognized when the transportation service is provided. Requirement 2 a. From note 3.7: In accordance with the IFRIC 13, these miles are considered distinct elements from a sale with multiple elements and one part of the price of the initial sale of the airfare is allocated to these miles and deferred until the groups commitments relating to these miles has been met. The deferred amount due in relation to the acquisition of miles by members is estimated: - According to the fair value of miles, defined as the amount at which the benefits can be sold separately. - After taking into account the redemption rate, corresponding to the probability that the miles will be used by members, using statistical method.

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Air France-KLM Case (concluded) b. Per the balance sheet, AF has a liability for Frequent flyer programs of 806 million. c. AFs approach is consistent with U.S. GAAPs accounting for multipleelement contracts (ASC 6052515), in that the revenue associated with AF miles is deferred and recognized separately from the revenue associated with the flights that customers use to earn the miles. Note: Accounting for customer loyalty programs is unresolved in U.S. GAAP. Currently, this issue is not included in the scope of guidance about multipledeliverable contracts (see ASC 60525152A) or customer payments and incentives (see 60550153). Airlines typically use the incremental cost method, which does not break out the travel credits as a separate component of revenue and instead only accrues a liability for the estimated incremental cost of providing future travel services. Yet, if companies sell points in their customer loyalty programs to third parties, the portion of the sale that is for travel is estimated and recognized as passenger revenue when the transportation is provided, similar to how it would be treated under normal accounting for multiple deliverables.

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