You are on page 1of 40

# A construction company entered into a fixed-price contract to build an office building for \$23.0 million.

Construction costs incurred during the first year were \$7.1 million and estimated costs to complete at the end of the
year were \$9 million. The building was completed during the second year. Construction costs incurred during the
second year were \$10.4 million.

How much gross profit will the company recognize in the first year and in the second year applying the completed
contract method? (Leave no cells blank - be certain to enter "0" wherever required. Enter your answers in

Year 1 Year 2
0 5,500,000
Gross profit
\$ \$

Explanation:

Revenue \$ 23,000,000

Less : Costs in
(7,100,000)
year 1

Costs in
(10,400,000)
year 2

## Actual profit \$ 5,500,000

Charter Corporation, which began business in 2011, appropriately uses the installment sales method of accounting
for its installment sales. The following data were obtained for sales made during 2011 and 2012:

2011 2012
364,00 347,00
Installment sales \$ \$
0 0
231,00 245,00
Cost of installment sales
0 0
Cash collections on installment sales during:
152,00 104,00
2011
0 0
121,00
2012 —
0

Required:
(1)How much gross profit should Charter recognize in 2011 and 2012 from installment sales? (Round Gross Profit
Gross Profit
56,240
2011
\$
73,570
2012
\$

(2)What should be the balance in the deferred gross profit account at the end of 2011 and 2012? (Round Gross

2011 2012
76,760 105,190
Balance in deferred gross profit account
\$ \$

Explanation:
(1)

## 2011 Cost recovery %:

\$231,000
= 63% (gross profit % = 37%)
\$364,000

## 2012 Cost recovery %:

\$245,000
= 71% (gross profit % = 29%)
\$347,000

## 2012 gross profit:

Cash collection
from 2011 sales of = \$ 38,480
\$104,000 × 37%
Cash collection
from 2012 sales of = 35,090
\$121,000 × 29%

Total 2012
\$73,570
gross profit
(2)

## 2011 deferred gross profit balance:

2011 initial gross profit (\$364,000 – 231,000) \$ 133,000
Less: Gross profit recognized in 2011 (56,240)

## 2012 deferred gross profit balance:

2011 initial gross profit (\$364,000 – 231,000) \$ 133,000
Less: Gross profit recognized in 2011 (56,240)
Gross profit recognized in 2012 (38,480)
2012 initial gross profit (\$347,000 – 245,000) 102,000
Less: Gross profit recognized in 2012 (35,090)

## Balance in deferred gross profit account \$ 105,190

On July 1, 2011, the Foster Company sold inventory to the Slate Corporation for \$300,000. Terms of the sale called
for a down payment of \$75,000 and three annual installments of \$75,000 due on each July 1, beginning July 1,
2012. Each installment also will include interest on the unpaid balance applying an appropriate interest rate. The
inventory cost Foster \$120,000. The company uses the perpetual inventory system.

Required:

(1) Prepare the necessary journal entries for 2011 and 2012 using point of delivery revenue recognition. Ignore

## Date General Journal Debit Credit

July 1, 2011 To record installment sale
300,000
Installment receivables

300,000
Sales revenue

120,000
Cost of goods sold

120,000
Inventory

## To record cash collection from installment sale

75,000
Cash

75,000
Installment receivables
July 1, 2012 To record cash collection from installment sale
75,000
Cash

75,000
Installment receivables

(2) Prepare the necessary journal entries for 2011 and 2012, applying the installment sales method. (Omit the "\$"

## Date General Journal Debit Credit

July 1, 2011 To record installment sale
300,000
Installment receivables

120,000

Inventory
2

180,000

2

## To record cash collection from installment sale

75,000
Cash

75,000
Installment receivables

## To recognize gross profit from installment sale

45,000
Deferred gross profit

45,000
Realized gross profit

## July 1, 2012 To record cash collection from installment sale

75,000
Cash

75,000
Installment receivables

## To recognize gross profit from installment sale

45,000
Deferred gross profit
45,000
Realized gross profit

(3) Prepare the necessary journal entries for 2011 and 2012, applying the cost recovery method. (Omit the "\$" sign

## July 1, 2011 To record installment sale

300,000
Installment receivables

120,000

Inventory
2

180,000

2

## To record cash collection from installment sale

75,000
Cash

75,000
Installment receivables

## July 1, 2012 To record cash collection from installment sale

75,000
Cash

75,000
Installment receivables

## To recognize gross profit from installment sale

30,000
Deferred gross profit

30,000
Realized gross profit
Assume Nortel Networks contracted to provide a customer with Internet infrastructure for \$2,000,000. The
project began in 2011 and was completed in 2012. Data relating to the contract are summarized below:

2011 2012
1,575,00
Costs incurred during the year \$ 300,000 \$
0
1,200,00
Estimated costs to complete as of 12/31 0
0
1,620,00
Billings during the year 380,000
0
1,750,00
Cash collections during the year 250,000
0

Required:
(1)
Compute the amount of gross profit or loss to be recognized in 2011 and 2012 using the percentage-of-

## Gross Profit (Loss)

100,000
2011
\$
25,000
2012
\$

(2) Compute the amount of gross profit or loss to be recognized in 2011 and 2012 using the completed contract
method. (Leave no cells blank - be certain to enter "0" wherever required. Omit the "\$" sign in your
response.)

## Gross Profit (Loss)

0
2011
\$
125,000
2012
\$

(3) Prepare a partial balance sheet to show how the information related to this contract would be presented at the
end of 2011 using the percentage-of-completion method. (Enter assets in the order of their liquidity. Omit

Balance Sheet
At December 31, 2011
Current Assets:
130,000
Accounts receivable
\$
20,000
Costs and profit in excess of billings
\$

(4) Prepare a partial balance sheet to show how the information related to this contract would be presented at the

Balance Sheet
At December 31, 2011
Current Assets:
130,000
Accounts receivable
\$
Current liabilities:
80,000
Billing in excess of costs
\$

Explanation:
(1)

2011 2012
Cont
ract \$ 2,000,000 \$ 2,000,000
price

Actu
al
300,000 1,875,000
costs
to date
Esti
mated
costs
1,200,000 0
to
compl
ete

Total
estima
1,500,000 1,875,000
ted
costs

Gros
s
profit
500,000 125,000
(estim
ated in
2011)
\$300,000
2011: = 20% × \$500,000 = \$100,000
\$1,500,000

(3)

## Costs and profit (\$400,000*) in excess of billings (\$380,000) = \$20,000

* Costs (\$300,000) + profit (\$100,000)

(4)

## Billings (\$380,000) in excess of costs (\$300,000) = \$80,000

On June 15, 2011, Sanderson Construction entered into a long-term construction contract to build a baseball
stadium in Washington D.C. for \$218 million. The expected completion date is April 1 of 2013, just in time for the
2013 baseball season. Costs incurred and estimated costs to complete at year-end for the life of the contract are as
follows (\$ in millions):

## 2011 2012 2013

8 5
Costs incurred during the year \$ 40 \$ \$
0 0
12 6
Estimated costs to complete as of 12/31 —
0 0

Required:
(1) Determine the amount of gross profit or loss to be recognized in each of the three years using the percentage-of-
completion method. (Enter your answers in millions. Do not round intermediate calculations. Round final
answers to 2 decimal places. Loss amounts should be indicated with a minus sign. Omit the "\$" sign in

## Year Gross Profit (Loss)

(\$ in millions)
14.50 ± .05
2011
\$
10.83 ± .05
2012
\$
22.67 ± .05
2013
\$

(2) How much revenue will Sanderson report in its 2011 and 2012 income statements related to this contract using
the percentage-of-completion method? (Enter your answers in millions. Do not round intermediate
Year Revenue
(\$ in millions)
54.50 ± .05
2011
\$
90.83 ± .05
2012
\$
72.67 ± .05
2013
\$

(3) Determine the amount of gross profit or loss to be recognized in each of the three years using the completed
contract method. (Enter your answers in millions. Leave no cells blank - be certain to enter "0" wherever
required. Loss amounts should be indicated with a minus sign. Omit the "\$" sign in your response.)

## Year Gross Profit (Loss)

0
2011

0
2012

48
2013

48
Total project income
\$

(4) Determine the amount of revenue, cost, and gross profit or loss to be recognized in each of the three years using
the cost recovery method that is required by IFRS. (Enter your answers in millions. Leave no cells blank - be
certain to enter "0" wherever required. Input all amounts as positive number except "Loss", loss

## 2011 2012 2013

40 80 98
Revenue
\$ \$ \$
40 80 50
Cost

0 0 48
Gross profit (loss)
\$ \$ \$
(5) Suppose the estimated costs to complete at the end of 2012 are \$80 million instead of \$60 million. Determine
the amount of gross profit or loss to be recognized in 2012 using the percentage-of-completion method. (Enter
your answer in millions. Loss amount should be indicated with a minus sign. Do not round intermediate

2012
-3.70 ± .05
Gross profit (loss)
\$

Explanation:
(1)

(\$
in
2011 2012 2013
milli
ons)
Con
tract \$ 218 \$ 218 \$ 218
price

Act
ual
costs 40 120 170
to
date
Esti
mate
d
costs 120 60 0
to
comp
lete

Tot
al
estim 160 180 170
ated
costs

Esti
mate
d
gross
profit \$ 58 \$ 38 \$ 48
(actu
al in
2013
)

## Gross profit (loss) recognition:

\$40
= 25% × \$58 =
2011:
\$14.50
\$160

\$120
= 66.67% × \$38 = \$25.33 – \$14.50 =
2012:
\$10.83
\$180

(2)

## 2011: \$218 × 25% = \$54.50

2012: \$218 × 66.67% = \$145.33 – 54.50 = \$90.83
2013: \$218 – 145.33 = \$72.67

(4)

2013:
Revenue: \$98 (\$218 contract price – \$40 – \$80)

(5)

\$120
= 60% × \$18* = \$10.80 – 14.50 = \$(3.70)
2012:
loss
\$200

## *\$218 – (\$40 + 80 + 80) = \$18

On October 1, 2011, the Submarine Sandwich Company entered into a franchise agreement with an individual. In
exchange for an initial franchise fee of \$300,000, Submarine will provide initial services to the franchisee to
include assistance in design and construction of the building, help in training employees, and help in obtaining
financing. 10% of the initial franchise fee is payable on October 1, 2011, with the remaining \$270,000 payable in
nine equal annual installments beginning on October 1, 2012. These installments will include interest at an
appropriate rate. The franchise opened for business on January 15, 2012.

Required:
Assume that the initial services to be performed by Submarine Sandwich subsequent to October 1, 2011, are
substantial and that collectibility of the installment receivable is reasonably certain. Substantial performance of the
initial services is deemed to have occurred when the franchise opened. Prepare the necessary journal entries for the

## Date General Journal Debit Credit

Oct. 1, 2011 To record franchise agreement and down payment
30,000

Cash
2
270,000

Note receivable
2

300,000
Unearned franchise fee revenue

## Jan. 15, 2012 To recognize franchise fee revenue

300,000
Unearned franchise fee revenue

300,000
Franchise fee revenue

Explanation:
Cash (10% × \$300,000) = 30,000

Ajax Company appropriately accounts for certain sales using the installment sales method. The perpetual inventory
system is used. Information related to installment sales for 2011 and 2012 is as follows:

2011 2012
250,00 350,00
Sales \$ \$
0 0
150,00 280,00
Cost of sales
0 0
Customer collections on:
120,00 100,00
2011 sales
0 0
150,00
2012 sales
0

Required:

(1) Calculate the amount of gross profit that would be recognized each year from installment sales. (Omit the "\$"

2011 2012
48,000 70,000
Gross profit
\$ \$

## Date General Journal Debit Credit

2011 To record installment sales
250,000
Installment receivables

150,000

Inventory
2

100,000

2

## To record cash collections from installment sales

120,000
Cash

120,000
Installment receivables

## To recognize gross profit from installment sales

48,000
Deferred gross profit

48,000
Realized gross profit

## 2012 To record installment sales

350,000
Installment receivables

280,000

Inventory
2

70,000

2

## To record cash collections from installment sales

250,000
Cash

250,000
Installment receivables

## To recognize gross profit from installment sales

70,000
Deferred gross profit
70,000
Realized gross profit

(3-a) Compute the following table, assuming that Ajax uses the cost recovery method to account for its installment
sales. (Leave no cells blank - be certain to enter "0" wherever required. Omit the "\$" sign in your
response.)

## Date Cash Collected Cost Recovery Gross Profit

2011
120,000 120,000 0
2011 sales
\$ \$ \$

2012
100,000 30,000 70,000
2011 sales
\$ \$ \$
150,000 150,000 0
2012 sales

2012 totals
\$ \$ \$

## Date General Journal Debit Credit

2011 To record installment sales
250,000
Installment receivables

150,000

Inventory
2

100,000

2

## To record cash collections from installment sales

120,000
Cash
120,000
Installment receivables

## 2012 To record installment sales

350,000
Installment receivables

280,000

Inventory
2

70,000

2

## To record cash collections from installment sales

250,000
Cash

250,000
Installment receivables

## To recognize gross profit from installment sales

70,000
Deferred gross profit

70,000
Realized gross profit

Explanation:
(1)

## 2011 Cost recovery %:

\$150,000
= 60% (gross profit % =
40%)
\$250,000

## 2012 Cost recovery %:

\$280,000
= 80% (gross profit % =
20%)
\$350,000

## Cash collection from 2011 sales = \$120,000 × 40% = \$48,000

2012 gross profit:

Cash collection
from 2011 sales = \$ 40,000
\$100,000 × 40%
Cash collection
from 2012 sales = 30,000
\$150,000 × 20%

Total 2012
\$ 70,000
gross profit

In 2011, the Westgate Construction Company entered into a contract to construct a road for Santa Clara County for
\$8,750,000. The road was completed in 2013. Information related to the contract is as follows:

## 2011 2012 2013

2,100,00 3,150,00 1,875,00
Cost incurred during the year \$ \$ \$
0 0 0
4,900,00 1,750,00
Estimated costs to complete as of year-end 0
0 0
1,750,00 3,500,00 3,500,00
Billings during the year
0 0 0
1,575,00 3,150,00 4,025,00
Cash collections during the year
0 0 0

Westgate uses the percentage-of-completion method of accounting for long-term construction contracts.

Required:

(1) Calculate the amount of gross profit to be recognized in each of the three years. (Do not round intermediate

## 2011 2012 2013

525,000 787,500 312,500
Gross profit
\$ \$ \$

(2) In the journal below, complete the necessary journal entries for each of the years (credit various accounts for

2011 2012
General Journal Debit Credit Debit Credit
To record construction costs.
2,100,000 3,150,000
Construction in progress

2,100,000 3,150,000
Various accounts

## To record progress billings.

1,750,000 3,500,000
Accounts receivable

1,750,000 3,500,000
Billings on construction contract

## To record cash collections.

1,575,000 3,150,000
Cash

1,575,000 3,150,000
Accounts receivable

## To record gross profit.

525,000 787,500
Construction in progress

2,100,000 3,150,000
Cost of construction

2,625,000 3,937,500
Revenue from long-term contracts

(3) Complete the information required below to prepare a partial balance sheet for 2011 and 2012 showing any
items related to the contract. (Do not round intermediate calculations. Amounts to be deducted should be

## Balance sheet 2011 2012

Current assets:
175,000 52
Accounts receivable
\$ \$
2,625,000 6,562,500
Construction in progress
\$ \$
-1,750,000 -5,250,000
Less: Billings

875,000 1,31
Costs and profit in excess of billings

(4) Calculate the amount of gross profit to be recognized in each of the three years, assuming the following costs
incurred and costs to complete information. (Do not round intermediate calculations. Round your answers
to the nearest dollar amount. Loss amounts should be indicated with a minus sign. Omit the "\$" sign in

## 2011 2012 2013

2,100,00 3,350,00 2,875,00
Costs incurred during the year \$ \$ \$
0 0 0
4,900,00 2,850,00
Estimated costs to complete as of year-end 0
0 0

## 2011 2012 2013

525,000 -229,518 129,518
Gross profit (loss)
\$ \$ \$

(5) Calculate the amount of gross profit to be recognized in each of the three years, assuming the following costs
incurred and costs to complete information. (Do not round intermediate calculations. Loss amounts should

## 2011 2012 2013

2,100,00 3,350,00 3,575,00
Costs incurred during the year \$ \$ \$
0 0 0
4,900,00 3,850,00
Estimated costs to complete as of year-end 0
0 0

## 2011 2012 2013

525,000 -1,075,000 275,000
Gross profit (loss)
\$ \$ \$

Explanation:
(1)

## 2011 2012 2013

Con
8,750,00 8,750,00 8,750,00
tract \$ \$ \$
0 0 0
price

Act
ual
2,100,00 5,250,00 7,125,00
costs
0 0 0
to
date
Esti 4,900,00 1,750,00 0
mate 0 0
d
costs
to
comp
lete

Tota
l
7,000,00 7,000,00 7,125,00
estim
0 0 0
ated
costs

Esti
mate
d
gross
profit
(loss)
(ac
tual
in 1,750,00 1,750,00 1,625,00
2013) \$ 0 \$ 0 \$ 0

## Gross profit (loss) recognition:

\$2,100,000
2011: = 30.00% × \$1,750,000 = \$525,000
\$7,000,000

\$5,250,000
2012: = 75.00% × \$1,750,000 = \$1,312,500 – 525,000 = \$787,500
\$7,000,000

(2)

## 2011 2012 2013

Revenue from long-term contracts (1) 2,625,000 3,937,500 2,187,500

(1)
Revenue
recognize
d:
2011:
30.00% ×
\$ 2,625,000
\$8,750,00
0

2012: \$ 6,562,500
75.00% ×
\$8,750,00
0
Le
ss:
Revenue (2,625,000)
recognize
d in 2011

Reve
nue
\$ 3,937,500
recognize
d in 2012

2013:
100% ×
\$ 8,750,000
\$8,750,00
0
Le
ss:
Revenue
(6,562,500)
recognize
d in 2011
& 2012

Reve
nue
\$ 2,187,500
recognize
d in 2013

(4)

## 2011 2012 2013

Con
8,750,00 8,750,00 8,750,00
tract \$ \$ \$
0 0 0
price

Act
ual
2,100,00 5,450,00 8,325,00
costs
0 0 0
to
date
Esti
mate
d
4,900,00 2,850,00
costs 0
0 0
to
comp
lete

## Tota 7,000,00 8,300,00 8,325,00

l 0 0 0
estim
ated
costs

Esti
mate
d
gross
profit
(loss)
(ac
tual
in 1,750,00
2013) \$ 0 \$ 450,000 \$ 425,000

## Gross profit (loss) recognition:

\$2,100,000
2011: = 30.00% × \$1,750,000 = \$525,000
\$7,000,000

\$5,450,000
2012: = 65.6627% × \$450,000 = \$295,482 – 525,000 = \$(229,518)
\$8,300,000

(5)

## 2011 2012 2013

Con
8,750,00 8,750,00 8,750,00
tract \$ \$ \$
0 0 0
price

Act
ual
2,100,00 5,450,00 9,025,00
costs
0 0 0
to
date
Esti
mate
d
4,900,00 3,850,00
costs 0
0 0
to
comp
lete

Tota
l
7,000,00 9,300,00 9,025,00
estim
0 0 0
ated
costs

mate
d
gross
profit
(loss)
(ac
tual
in
2013) 0 0

## Gross profit (loss) recognition:

\$2,100,000
2011: = 30.00% × \$1,750,000 = \$525,000
\$7,000,000

## 2013: ( 275,000) – (550,000) = \$275,000

-2-2 http://ezto.mhhm.

In 2011, the Westgate Construction Company entered into a contract to construct a road for Santa Clara County for
\$10,000,000. The road was completed in 2013. Information related to the contract is as follows:

## 2011 2012 2013

2,400,00 3,600,00 2,100,00
Cost incurred during the year \$ \$ \$
0 0 0
5,600,00 2,000,00
Estimated costs to complete as of year-end 0
0 0
2,000,00 4,000,00 4,000,00
Billings during the year
0 0 0
1,800,00 3,600,00 4,600,00
Cash collections during the year
0 0 0

Westgate uses the completed contract method of accounting for long-term construction contracts.

Required:

(1) Calculate the amount of gross profit to be recognized in each of the three years. (Leave no cells blank - be
2011 2012 2013
Gross Profit
\$ n/r \$ n/r \$ n/r

(2) In the journal below, complete the necessary journal entries for each of the years (credit various accounts for
construction costs incurred). (Leave no cells blank - be certain to enter "0" wherever required. Omit the

2011 2012
General Journal Debit Credit Debit Credit
To record construction costs.

## n/r n/r n/r

(3) Complete the information required below to prepare a partial balance sheet for 2011 and 2012 showing any
items related to the contract. (Leave no cells blank - be certain to enter "0" wherever required. Amounts to

Current assets:

n/r \$ n/r

## Less: n/r n/r n/r

n/r n/r

(4) Calculate the amount of gross profit to be recognized in each of the three years assuming the following costs
incurred and costs to complete information. (Leave no cells blank - be certain to enter "0" wherever
required. Loss amounts should be indicated with a minus sign. Omit the "\$" sign in your response.)

## 2011 2012 2013

2,400,00 3,800,00 3,100,00
Costs incurred during the year \$ \$ \$
0 0 0
5,600,00 3,100,00
Estimated costs to complete as of year-end 0
0 0

## 2011 2012 2013

Gross profit (loss)
\$ n/r \$ n/r \$ n/r

(5) Calculate the amount of gross profit to be recognized in each of the three years assuming the following costs
incurred and costs to complete information. (Leave no cells blank - be certain to enter "0" wherever
required. Loss amounts should be indicated with a minus sign. Omit the "\$" sign in your response.)

## 2011 2012 2013

2,400,00 3,800,00 3,800,00
Costs incurred during the year \$ \$ \$
0 0 0
5,600,00 4,100,00
Estimated costs to complete as of year-end 0
0 0

## 2011 2012 2013

Gross profit (loss)
\$ n/r \$ n/r \$ n/r

## Learning Objective: 05-04 Identify

situations that call for the
recognition of revenue over time
and distinguish between the
Worksheet
percentage-of-completion and
completed contract methods of
recognizing revenue for long-term
contracts.
-2-2

In 2011, the Westgate Construction Company entered into a contract to construct a road for Santa Clara County for
\$10,000,000. The road was completed in 2013. Information related to the contract is as follows:

## 2011 2012 2013

2,400,00 3,600,00 2,100,00
Cost incurred during the year \$ \$ \$
0 0 0
5,600,00 2,000,00
Estimated costs to complete as of year-end 0
0 0
2,000,00 4,000,00 4,000,00
Billings during the year
0 0 0
1,800,00 3,600,00 4,600,00
Cash collections during the year
0 0 0

Westgate uses the completed contract method of accounting for long-term construction contracts.

Required:

(1) Calculate the amount of gross profit to be recognized in each of the three years. (Leave no cells blank - be

## 2011 2012 2013

0 0 1,900,000
Gross Profit
\$ \$ \$

(2) In the journal below, complete the necessary journal entries for each of the years (credit various accounts for
construction costs incurred). (Leave no cells blank - be certain to enter "0" wherever required. Omit the

2011 2012
General Journal Debit Credit Debit Credit
To record construction costs.
2,400,000 3,600,000
Construction in progress

2,400,000 3,600,000
Various accounts

## To record progress billings.

2,000,000 4,000,000
Accounts receivable
2,000,000 4,000,000
Billings on construction contract

## To record cash collections.

1,800,000 3,600,000
Cash

1,800,000 3,600,000
Accounts receivable

## To record gross profit.

0 0
Construction in progress

0 0
Cost of construction

0 0
Revenue from long-term contracts

(3) Complete the information required below to prepare a partial balance sheet for 2011 and 2012 showing any
items related to the contract. (Leave no cells blank - be certain to enter "0" wherever required. Amounts to

## Balance sheet 2011 2012

Current assets:
200,000
Accounts receivable
\$
2,400,000 6,000,000
Construction in progress
\$ \$
-2,000,000 -6,000,000
Less: Billings

400,000
Costs in excess of billings

(4) Calculate the amount of gross profit to be recognized in each of the three years assuming the following costs
incurred and costs to complete information. (Leave no cells blank - be certain to enter "0" wherever
required. Loss amounts should be indicated with a minus sign. Omit the "\$" sign in your response.)

## 2011 2012 2013

2,400,00 3,800,00 3,100,00
Costs incurred during the year \$ \$ \$
0 0 0
5,600,00 3,100,00
Estimated costs to complete as of year-end 0
0 0
2011 2012 2013
0 700,000 700,000
Gross profit (loss)
\$ \$ \$

(5) Calculate the amount of gross profit to be recognized in each of the three years assuming the following costs
incurred and costs to complete information. (Leave no cells blank - be certain to enter "0" wherever
required. Loss amounts should be indicated with a minus sign. Omit the "\$" sign in your response.)

## 2011 2012 2013

2,400,00 3,800,00 3,800,00
Costs incurred during the year \$ \$ \$
0 0 0
5,600,00 4,100,00
Estimated costs to complete as of year-end 0
0 0

## 2011 2012 2013

0 -300,000 300,000
Gross profit (loss)
\$ \$ \$

Explanation:
(1)

2011 0
2012 0
2013 \$ 1,900,000

Tota
l
gros
\$ 1,900,000
s
profi
t

(4)

2011 0
2012 0
2013 \$ 700,000

Tota \$ 700,000
l
gros
s
profi
t

(5)

## Year Gross profit (loss) recognized

2011 0
2012 \$ (300,000)
2013 300,000

Total
project \$ 0
loss

-2-2 http://ezto.mhhm.

Presented below are condensed financial statements adapted from those of two actual companies competing in the
pharmaceutical industry—Johnson and Johnson (J&J) and Pfizer, Inc. (\$ in millions, except per share amounts).

Note: Because two-year comparative statements are not provided, you should use year-end balances in place of
average balances as appropriate.

Balance Sheets
(\$ in millions, except per share data)
J&J Pfizer
Assets
Cash \$ 5,377 \$ 1,520
Short-
term
4,146 10,432
investment
s
Accounts
receivable 6,574 8,775
(net)
Inventori
3,588 5,837
es
Other
current 3,310 3,177
assets

Curre
22,995 29,741
nt assets
Property,
plant, and
9,846 18,287
equipment
(net)
Intangibl
es and
15,422 68,747
other
assets

## Tota \$ 48,263 \$ 116,775

l assets

Liabilitie
s and
Sharehold
ers' Equity
Accounts
\$ 4,966 \$ 2,601
payable
Short-
1,139 8,818
term notes
Other
current 7,343 12,238
liabilities

Curre
nt 13,448 23,657
liabilities
Long-
2,955 5,755
term debt
Other
long-term 4,991 21,986
liabilities

Tota
21,394 51,398
l liabilities

Common
stock (par
and
3,120 67,050
paid-in
capital)
Retained
30,503 29,382
earnings
Accumul
ated other
comprehen
(590) 195
sive
income
(loss)
Less:
treasury
stock and
other (6,164) (31,250)
equity
s

Tota
l
26,869 65,377
shareholde
rs' equity

To \$ 48,263 \$ 116,775
tal
liabilities
and
shareholde
rs' equity

Income Statements
Net sales \$ 41,862 \$ 45,188
Cost of
12,176 9,832
goods sold

Gross
29,686 35,356
profit
Operatin
19,763 28,486
g expenses
Other
(income)
(385) 3,610
expense—
net

Income
before 10,308 3,260
taxes
Tax
3,111 1,621
expense

Net
\$ 7,197 \$ 1,639*
income

Basic net
income \$ 2.42 \$ 0.22
per share

*This is before income from discontinued operations. There were no other separately reported items for either
company. Evaluate and compare the two companies by responding to the following questions.

Required:

(1-a) Compute the receivables turnover for both the companies. (Round your answers to 2 decimal places.)

Receivables Turnover
J&J
n/r times
Pfizer
n/r times

(1-b) Compute the average collection for both the companies. (Consider 365 days a year. Round your answers to
the nearest whole days.)
Average Collection
Period
J&J
n/r days
Pfizer
n/r days

(1-c) Which of the two companies appears more efficient in collecting its accounts receivable?

n/r

(1-d) Compute the inventory turnover for both the companies. (Round your answers to 2 decimal places.)

Inventory Turnover
J&J
n/r times
Pfizer
n/r times

(1-e) Compute the average days in inventory for both the companies. (Consider 365 days a year. Round your
answers to the nearest whole number.)

## Average Days in Inventory

J&J
n/r days
Pfizer
n/r days

(1-f) Which of the two companies appears more efficient in managing its inventory?

n/r

(2-a) Compute the rate of return on assets for both the companies. (Round your answers to 1 decimal place. Omit

## Rate of Return on Assets

J&J
n/r %
Pfizer
n/r %
(2-b) Which of the two firms had greater earnings relative to resources available?

n/r

(3-a) Compute the profit margin, asset turnover and return on assets.(Round your answers to 2 decimal

## Profit Margin Asset Turnover Return on Assets

J&J
n/r % n/r times n/r %
Pfizer
n/r % n/r times n/r %

(3-b) Have the two companies achieved their respective rates of return on assets with similar combinations of profit
margin and turnover?

n/r

(4-a) Compute the rate of return on shareholders’ equity for both the companies. (Round your answers to 1

Shareholders’ Equity
J&J
n/r %
Pfizer
n/r %

(4-b) From the perspective of a common shareholder, which of the two firms provided a greater rate of return?

n/r

(5) Compute the equity multiplier shareholders’ equity for both the companies. (Round your answers to 2 decimal
places.)

Equity multiplier
J&J
n/r
Pfizer
n/r

## Learning Objective: 05-06 Identify

Worksheet and calculate the common ratios
used to assess profitability.

-2-2

Presented below are condensed financial statements adapted from those of two actual companies competing in the
pharmaceutical industry—Johnson and Johnson (J&J) and Pfizer, Inc. (\$ in millions, except per share amounts).

Note: Because two-year comparative statements are not provided, you should use year-end balances in place of
average balances as appropriate.

Balance Sheets
(\$ in millions, except per share data)
J&J Pfizer
Assets
Cash \$ 5,377 \$ 1,520
Short-
term
4,146 10,432
investment
s
Accounts
receivable 6,574 8,775
(net)
Inventori
3,588 5,837
es
Other
current 3,310 3,177
assets

Curre
22,995 29,741
nt assets
Property,
plant, and
9,846 18,287
equipment
(net)
Intangibl
es and
15,422 68,747
other
assets

Tota
\$ 48,263 \$ 116,775
l assets

Liabilitie
s and
Sharehold
ers' Equity
Accounts
\$ 4,966 \$ 2,601
payable
Short-
1,139 8,818
term notes
Other
current 7,343 12,238
liabilities

Curre
nt 13,448 23,657
liabilities
Long-
2,955 5,755
term debt
Other
long-term 4,991 21,986
liabilities

Tota
21,394 51,398
l liabilities

Common
stock (par
and
3,120 67,050
paid-in
capital)
Retained
30,503 29,382
earnings
Accumul
ated other
comprehen
(590) 195
sive
income
(loss)
Less:
treasury
stock and
other (6,164) (31,250)
equity
s

Tota
l
26,869 65,377
shareholde
rs' equity

To
tal
liabilities
\$ 48,263 \$ 116,775
and
shareholde
rs' equity
Income Statements
Net sales \$ 41,862 \$ 45,188
Cost of
12,176 9,832
goods sold

Gross
29,686 35,356
profit
Operatin
19,763 28,486
g expenses
Other
(income)
(385) 3,610
expense—
net

Income
before 10,308 3,260
taxes
Tax
3,111 1,621
expense

Net
\$ 7,197 \$ 1,639*
income

Basic net
income \$ 2.42 \$ 0.22
per share

*This is before income from discontinued operations. There were no other separately reported items for either
company. Evaluate and compare the two companies by responding to the following questions.

Required:

(1-a) Compute the receivables turnover for both the companies. (Round your answers to 2 decimal places.)

Receivables Turnover
6.37
J&J
times
5.15
Pfizer
times

(1-b) Compute the average collection for both the companies. (Consider 365 days a year. Round your answers to
the nearest whole days.)

Average Collection
Period
57
J&J
days
71
Pfizer
days

(1-c) Which of the two companies appears more efficient in collecting its accounts receivable?

J&J

(1-d) Compute the inventory turnover for both the companies. (Round your answers to 2 decimal places.)

Inventory Turnover
3.39
J&J
times
1.68
Pfizer
times

(1-e) Compute the average days in inventory for both the companies. (Consider 365 days a year. Round your
answers to the nearest whole number.)

## Average Days in Inventory

108
J&J
days
217
Pfizer
days

(1-f) Which of the two companies appears more efficient in managing its inventory?

J&J

(2-a) Compute the rate of return on assets for both the companies. (Round your answers to 1 decimal place. Omit

## Rate of Return on Assets

14.9
J&J
%
1.4
Pfizer
%
(2-b) Which of the two firms had greater earnings relative to resources available?

J&J

(3-a) Compute the profit margin, asset turnover and return on assets.(Round your answers to 2 decimal

## Profit Margin Asset Turnover Return on Assets

17.19 .87 14.9
J&J
% times %
3.63 .39 1.4
Pfizer
% times %

(3-b) Have the two companies achieved their respective rates of return on assets with similar combinations of profit
margin and turnover?

J&J

(4-a) Compute the rate of return on shareholders’ equity for both the companies. (Round your answers to 1

Shareholders’ Equity
26.8
J&J
%
2.5
Pfizer
%

(4-b) From the perspective of a common shareholder, which of the two firms provided a greater rate of return?

J&J

(5) Compute the equity multiplier shareholders’ equity for both the companies. (Round your answers to 2 decimal
places.)

Equity multiplier
1.80
J&J

1.79
Pfizer
Explanation:
(1)

Net sales
Receivables turnover =
Accounts receivable

\$41,862
J&J = = 6.37 times
\$6,574

\$45,188
Pfizer = = 5.15 times
\$8,775

365
Average collection period =
Receivables turnover

365
J&J = = 57 days
6.37

365
Pfizer = = 71 days
5.15

## Cost of goods sold

Inventory turnover =
Inventories

\$12,176
J&J = = 3.39 times
\$3,588

\$9,832
Pfizer = = 1.68 times
\$5,837

365
Average days in inventory =
Inventory turnover

365
J&J = = 108 days
3.39

365
Pfizer = = 217 days
1.68

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

(2)

Net income
Rate of return on assets =
Total assets

\$7,197
J&J = = 14.9%
\$48,263

\$1,639
Pfizer = = 1.4%
\$116,775

The return on assets indicates a company's overall profitability, ignoring specific sources of financing. In this
regard, J&J's profitability is significantly higher than that of Pfizer.

(3)

Profitability can be achieved by a high profit margin, high turnover, or a combination of the two.

## Profit margin Asset

Rate of return on assets = ×
on sales turnover

## Net income Net sales

= ×
Net sales Total assets

\$7,197 \$41,862
J&J = ×
\$41,862 \$48,263

\$1,639 \$45,188
Pfizer = ×
\$45,188 \$116,775

## = 3.63% × .387 times = 1.4%

J&J's 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.

(4)

Net income
Rate of return on shareholders’ equity =
Shareholders’ equity

\$7,197
J&J = = 26.8%
\$26,869
\$1,639
Pfizer = = 2.5%
\$65,377

(5)

Net income
Equity multiplier shareholders’ equity =
Shareholders’ equity

\$48,263
J&J = = 1.80
\$26,869

\$116,775
Pfizer = = 1.79
\$65,377