chap 005

The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 5 51

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 AACSB Tags 51 Reflective thinking 52 Reflective thinking 53 Reflective thinking 54 Reflective thinking 55 Reflective thinking 56 Reflective thinking 57 Reflective thinking 58 Reflective thinking 59 Reflective thinking 510 Reflective thinking 511 Diversity, Reflective thinking 512 Reflective thinking 513 Reflective thinking 514 Reflective thinking 515 Diversity, Reflective thinking 516 Reflective thinking 517 Reflective thinking 518 Reflective thinking 519 Reflective thinking 520 Reflective thinking 521 Diversity, Reflective thinking 522 Reflective thinking 523 Reflective thinking 524 Reflective thinking 525 Reflective thinking 526 Reflective thinking 527 Reflective thinking

Brief Exercises

AACSB Tags

51 Analytic 52 Reflective thinking 53 Analytic 54 Analytic 55 Analytic 56 Reflective thinking,

Communications 57 Analytic 58 Analytic 59 Analytic 510 Diversity, Analytic 511 Analytic 512 Reflective thinking, Analytic 513 Diversity, Reflective thinking,

Analytic 514 Analytic 515 Analytic 516 Analytic 517 Analytic 518 Analytic 519 Reflective thinking 520 Reflective thinking 521 Reflective thinking 522 Analytic 523 Analytic 524 Reflective thinking 525 Analytic

Chapter 5 Income Measurement and Profitability Analysis

The McGraw-Hill Companies, Inc., 2013 52 Intermediate Accounting, 7/e

Exercises AACSB Tags 51 Reflective thinking, Analytic 52 Reflective thinking, Analytic 53 Analytic 54 Analytic 55 Analytic 56 Analytic 57 Analytic 58 Analytic 59 Analytic 510 Reflective thinking,

Communications 511 Analytic 512 Diversity, Analytic 513 Analytic 514 Analytic 515 Analytic 516 Analytic 517 Reflective thinking,

Communications 518 Analytic 519 Analytic 520 Diversity, Analytic 521 Analytic 522 Reflective thinking 523 Analytic, Communications 524 Analytic, Communications 525 Analytic 526 Analytic 527 Analytic 528 Analytic 529 Analytic 530 Diversity, Analytic 531 Reflective thinking, Analytic 532 Reflective thinking, Analytic 533 Reflective thinking 534 Reflective thinking, Analytic 535 Analytic 536 Reflective thinking 537 Reflective thinking 538 Analytic

CPA/CMA AACSB Tags 1 Analytic 2 Analytic

3 Analytic 4 Reflective thinking 5 Analytic 6 Analytic 7 Diversity, Reflective thinking 8 Diversity, Analytic 9 Diversity, Reflective thinking 10 Diversity, Reflective thinking 1 Analytic 2 Reflective thinking 3 Analytic

Problems 51 Analytic 52 Analytic

53 Analytic 54 Analytic, Communications 55 Analytic 56 Analytic 57 Diversity, Analytic 58 Analytic 59 Analytic, Communications 510 Analytic, Communications 511 Analytic 512 Analytic, Communications 513 Analytic 514 Analytic, Communications 515 Analytic 516 Reflective thinking, Analytic 517 Reflective thinking,

Communications 518 Analytic 519 Analytic


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.

QUESTIONS FOR REVIEW OF KEY TOPICS


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.


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.


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

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 Return on assets = Net income Average total assets Return on shareholders' = Net income equity Average 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.


Question 519

Return on equity = Profit margin X Asset turnover X Equity multiplier

Net income Avg. total equity

= Net income Total sales

X Total sales Avg. total assets

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.


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.


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.


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


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) $1,800,000 Less gross profit recognized in 2013 ($150,000 x 60%) (90,000) Less gross profit recognized in 2014 ($150,000 x 60%) (90,000) Deferred gross profit at the end of 2014 $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) = $5,000,000 multiplied by the % of completion 40% Gross profit recognized the first year $2,000,000 First year revenue = $20,000,000 x 40% = $8,000,000


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

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

Brief Exercise 510 Year 1:

Revenue: $6 million Cost: $6 million Gross profit: $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.


Brief Exercise 512 Orange has separate sales prices for the two parts of LearnIt-Plus, so that vendor-

specific 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.


Brief Exercise 515

*$600,000 200,000

Receivables turnover ratio = Net sales Average accounts receivable (net) Receivables turnover ratio = $600,000 [$100,000 + 120,000] 2 = 5.45 times

Inventory turnover ratio = Cost of goods sold Average inventory

Inventory turnover ratio = $400,000* [$80,000 + 60,000] 2 = 5.71 times


Brief Exercise 516

Profit margin = Net income Sales

= $65,000 $420,000

= 15.5%

Return on assets = Net income Average total assets

= $65,000 $800,000

= 8.1%

Return on shareholders equity = Net income Average shareholders equity

= $65,000 $522,500*

= 12.4%

Shareholders equity, beginning of period $500,000 Add: Net income 65,000 Deduct: Dividends (20,000) Shareholders equity, end of period $545,000 *Average shareholders equity = ($500,000 + 545,000) 2 = $522,500


Brief Exercise 517

Return on equity

= Profit margin

X Asset turnover X Equity multiplier

Net income Avg. total

equity

= Net income Total sales

X Total sales Avg. total assets

X Avg. total assets Avg. total equity

Return on shareholders equity = Net income Average shareholders equity

= $65,000 $522,500

= 12.4%

Profit margin = Net income Sales

= $65,000 $420,000

= 15.5% Asset turnover = Sales

Average total assets

= $420,000 $800,000

= .525 times


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 Sales Cost of goods sold = Gross profit $600,000 450,000 = $150,000


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


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.


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.


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

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.

EXERCISES


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.


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% = $52,500 2014 gross profit: Cash collection from 2013 sales of $100,000 x 35% = $ 35,000 + Cash collection from 2014 sales of $120,000 x 30% = 36,000 Total 2014 gross profit $71,000 Requirement 2 2013 deferred gross profit balance: 2013 initial gross profit ($360,000 234,000) $126,000 Less: Gross profit recognized in 2013 (52,500) Balance in deferred gross profit account $73,500 2014 deferred gross profit balance: 2013 initial gross profit ($360,000 234,000) $ 126,000 Less: Gross profit recognized in 2013 (52,500) Gross profit recognized in 2014 (35,000) 2014 initial gross profit ($350,000 245,000) 105,000 Less: Gross profit recognized in 2014 (36,000) Balance in deferred gross profit account $107,500


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 ....................................................... 52,500 Realized gross profit ................................................... 52,500 To recognize gross profit from installment sales

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 ....................................................... 71,000 Realized gross profit ................................................... 71,000 To recognize gross profit from installment sales


Exercise 55 Requirement 1 Year Income recognized 2013 $180,000 ($300,000 120,000) 2014 - 0 - 2015 - 0 - 2016 - 0 - Total $180,000 Requirement 2 Cost recovery %: $120,000 ------------- = 40% (gross profit % = 60%) $300,000

Year Cash Collected Cost Recovery(40%) Gross Profit(60%) 2013 $ 75,000 $ 30,000 $ 45,000 2014 75,000 30,000 45,000 2015 75,000 30,000 45,000 2016 75,000 30,000 45,000

Totals $300,000 $120,000 $180,000

Requirement 3

Year Cash Collected Cost Recovery Gross Profit 2013 $ 75,000 $ 75,000 - 0 - 2014 75,000 45,000 $ 30,000 2015 75,000 - 0 - 75,000 2016 75,000 - 0 - 75,000

Totals $300,000 $120,000 $180,000



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 ................................................................................. 75,000 Installment receivables ................................................ 75,000 To record cash collection from installment sale July 1, 2014 Cash ................................................................................. 75,000 Installment receivables ................................................ 75,000 To record cash collection from installment sale


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 ................................................................................ 75,000 Installment receivables ............................................... 75,000 To record cash collection from installment sale Deferred gross profit ....................................................... 45,000 Realized gross profit ................................................... 45,000 To recognize gross profit from installment sale July 1, 2014 Cash ................................................................................ 75,000 Installment receivables ............................................... 75,000 To record cash collection from installment sale Deferred gross profit ....................................................... 45,000 Realized gross profit ................................................... 45,000 To recognize gross profit from installment sale


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 ................................................................................. 75,000 Installment receivables ................................................ 75,000 To record cash collection from installment sale July 1, 2014 Cash ................................................................................. 75,000 Installment receivables ................................................ 75,000 To record cash collection from installment sale Deferred gross profit ....................................................... 30,000 Realized gross profit ................................................... 30,000 To recognize gross profit from installment sale

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


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



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 ................................................................................. 120,000 Installment receivables ................................................ 120,000 To record cash collection from installment sale April 1, 2014 Cash ................................................................................. 120,000 Installment receivables ................................................ 120,000 To record cash collection from installment sale

Requirement 2

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


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 ................................................................................ 120,000 Installment receivables ............................................... 120,000 To record cash collection from installment sale Deferred gain .................................................................. 96,000 Gain on sale of land (80% x $120,000) .......................... 96,000 To recognize profit from installment sale April 1, 2014 Cash ................................................................................ 120,000 Installment receivables ............................................... 120,000 To record cash collection from installment sale Deferred gain .................................................................. 96,000 Gain on sale of land (80% x $120,000) .......................... 96,000 To recognize profit from installment sale


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).

3. 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.


Exercise 511 Requirement 1 2013 2014 Contract price $2,000,000 $2,000,000 Actual costs to date 300,000 1,875,000 Estimated costs to complete 1,200,000 - 0 - Total estimated costs 1,500,000 1,875,000 Gross profit (estimated in 2013) $ 500,000 $ 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 $ - 0 - 2014 $125,000 Requirement 3

Balance Sheet

At December 31, 2013

Current assets: Accounts receivable $ 130,000 Costs and profit ($400,000*) in excess of billings ($380,000)

20,000

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



Balance Sheet

At December 31, 2013

Current assets: Accounts receivable $ 130,000

Current liabilities:

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


Exercise 512 Requirement 1 ($ in millions) 2013 2014 2015 Contract price $220 $220 $220 Actual costs to date 40 120 170 Estimated costs to complete 120 60 - 0 - Total estimated costs 160 180 170 Estimated gross profit (actual in 2015) $ 60 $ 40 $ 50 Gross profit (loss) recognition: 2013: $40 = 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 Gross profit (loss) recognized2013 - 0 - 2014 - 0 - 2015 50

Total project income $50



2013:

Revenue: $40 Cost: 40 Gross profit: $ 0

2014: Revenue: $80 Cost: 80 Gross profit: $ 0

2015: Revenue: $100 ($220 contract price 40 80) Cost: 50 Gross profit: $ 50

Requirement 5 2014: $120 = 60% x $20* = $12 15 = $(3) loss $200 *$220 (40 + 80 + 80) = $20


Exercise 513 Requirement 1 2013 2014 2015 Contract price $8,000,000 $8,000,000 $8,000,000 Actual costs to date 2,000,000 4,500,000 8,300,000 Estimated costs to complete 4,000,000 3,600,000 - 0 - Total estimated costs 6,000,000 8,100,000 8,300,000 Estimated gross profit (loss) (actual in 2015) $2,000,000 $ (100,000) $ (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)


Exercise 513 (continued) Requirement 2

2013 2014 Construction in progress 2,000,000 2,500,000 Various accounts 2,000,000 2,500,000To record construction costs Accounts receivable 2,500,000 2,750,000 Billings on construction contract 2,500,000 2,750,000To record progress billings Cash 2,250,000 2,475,000 Accounts receivable 2,250,000 2,475,000To record cash collections Construction in progress (gross profit)

666,667

Cost of construction 2,000,000 Revenue from long-term contracts (33.3333% x $8,000,000) 2,666,667To record gross profit Cost of construction (2) 2,544,000 Revenue from long-term contracts (1) 1,777,333 Construction in progress (loss) 766,667To record expected loss

(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)



Balance Sheet 2013 2014 Current assets: Accounts receivable $250,000 $525,000Costs and profit ($2,666,667*) in excess of billings ($2,500,000)

166,667

Current liabilities: Billings ($5,250,000) in excess

of costs less loss ($4,400,000**)

$850,000

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



Year Gross profit (loss) recognized 2013 - 0 - 2014 $(100,000) 2015 (200,000)

Total project loss $(300,000) Requirement 2

2013 2014 Construction in progress 2,000,000 2,500,000 Various accounts 2,000,000 2,500,000To record construction costs Accounts receivable 2,500,000 2,750,000 Billings on construction contract 2,500,000 2,750,000To record progress billings Cash 2,250,000 2,475,000 Accounts receivable 2,250,000 2,475,000To record cash collections Loss on long-term contract 100,000 Construction in progress 100,000To record expected loss



Balance Sheet 2013 2014Current assets: Accounts receivable $250,000 $525,000 Current liabilities: Billings ($2,500,000) in excess of costs ($2,000,000)

$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)


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)


Exercise 515 (continued) Situation 1 - Percentage-of-Completion 2013 2014 2015 Contract price $5,000,000 $5,000,000 $5,000,000 Actual costs to date 1,500,000 3,600,000 4,500,000 Estimated costs to complete 3,000,000 900,000 - 0 - Total estimated costs 4,500,000 4,500,000 4,500,000 Estimated gross profit (actual in 2015) $ 500,000 $ 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 Gross profit recognized2013 - 0 - 2014 - 0 - 2015 $500,000

Total gross profit $500,000


Exercise 515 (continued) Situation 2 - Percentage-of-Completion 2013 2014 2015 Contract price $5,000,000 $5,000,000 $5,000,000 Actual costs to date 1,500,000 2,400,000 4,800,000 Estimated costs to complete 3,000,000 2,400,000 - 0 - Total estimated costs 4,500,000 4,800,000 4,800,000 Estimated gross profit (actual in 2015) $ 500,000 $ 200,000 $ 200,000 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 Gross profit recognized 2013 - 0 - 2014 - 0 - 2015 $200,000



Exercise 515 (continued) Situation 3 - Percentage-of-Completion 2013 2014 2015 Contract price $5,000,000 $5,000,000 $5,000,000 Actual costs to date 1,500,000 3,600,000 5,200,000 Estimated costs to complete 3,000,000 1,500,000 -0- Total estimated costs 4,500,000 5,100,000 5,200,000 Estimated gross profit (loss) (actual in 2015) $ 500,000 $ (100,000) $ (200,000) Gross profit (loss) recognized: 2013: $1,500,000 = 33.3333% x $500,000 = $166,667 $4,500,000 2014: $(100,000) 166,667 = $(266,667) 2015: $(200,000) (100,000) = $(100,000) Situation 3 - Completed Contract

Year Gross profit (loss) recognized2013 - 0 - 2014 $(100,000) 2015 (100,000)

Total project loss $(200,000)


Exercise 515 (continued) Situation 4 - Percentage-of-Completion 2013 2014 2015 Contract price $5,000,000 $5,000,000 $5,000,000 Actual costs to date 500,000 3,500,000 4,500,000 Estimated costs to complete 3,500,000 875,000 - 0 - Total estimated costs 4,000,000 4,375,000 4,500,000 Estimated gross profit (actual in 2015) $1,000,000 $ 625,000 $ 500,000 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 Gross profit recognized 2013 - 0 - 2014 - 0 - 2015 $500,000



Exercise 515 (continued) Situation 5 - Percentage-of-Completion 2013 2014 2015 Contract price $5,000,000 $5,000,000 $5,000,000 Actual costs to date 500,000 3,500,000 4,800,000 Estimated costs to complete 3,500,000 1,500,000 - 0 - Total estimated costs 4,000,000 5,000,000 4,800,000 Estimated gross profit (actual in 2015) $1,000,000 $ - 0 - $ 200,000 Gross profit (loss) recognized: 2013: $ 500,000 = 12.5% x $1,000,000 = $125,000 $4,000,000 2014: $0 125,000 = $(125,000) 2015: $200,000 0 = $200,000 Situation 5 - Completed Contract

Year Gross profit recognized2013 - 0 - 2014 - 0 - 2015 $200,000



Exercise 515 (concluded) Situation 6 - Percentage-of-Completion 2013 2014 2015 Contract price $5,000,000 $5,000,000 $5,000,000 Actual costs to date 500,000 3,500,000 5,300,000 Estimated costs to complete 4,600,000 1,700,000 - 0 - Total estimated costs 5,100,000 5,200,000 5,300,000 Estimated gross profit (loss) (actual in 2015) $ (100,000) $ (200,000) $ (300,000) 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 Gross profit (loss) recognized 2013 $(100,000) 2014 (100,000) 2015 (100,000)

Total project loss $(300,000)


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


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 605352557: Revenue RecognitionConstructionType and ProductionType ContractsRecognitionCircumstances 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.


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 $210,000 $270,000 x $243,000 = $189,000 Technical support $30,000 $270,000 x $243,000 = 27,000 Upgrade $30,000 $270,000 x $243,000 = 27,000 Total $243,000 Requirement 2

July 1, 2013 Cash ................................................................................ 243,000 Revenue ...................................................................... 189,000 Unearned revenue ($27,000 + 27,000) ........................... 54,000 To record sale of software



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

Requirement 2

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.



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

Requirement 2

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.


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 List B h 1. Inventory turnover a. Net income divided by net sales. d 2. Return on assets b. Defers recognition until cash collected equals cost. g 3. Return on shareholders' equity c. Defers recognition until project is complete. a 4. Profit margin on sales d. Net income divided by assets. b 5. Cost recovery method e. Risks and rewards of ownership retained by seller. i 6. Percentage-of-completion method f. Contra account to construction in progress. c 7. Completed contract method g. Net income divided by shareholders' equity. k 8. Asset turnover h. Cost of goods sold divided by inventory. l 9. Receivables turnover i. Recognition is in proportion to work completed. m 10. Right of return j. Recognition is in proportion to cash received. f 11. Billings on construction contract k. Net sales divided by assets. j 12. Installment sales method l. Net sales divided by accounts receivable. e 13. Consignment sales m. Could cause the deferral of revenue recognition beyond delivery point.



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.

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


Exercise 524 Turnover ratios for Anderson Medical Supply Company for 2013:

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).

Inventory turnover ratio = $4,800,000 [$900,000 + 700,000] 2 = 6 times

Receivables turnover ratio = $8,000,000 [$700,000 + 500,000] 2 = 13.33 times

Average collection period = 365 13.33 = 27.4 days

Asset turnover ratio = $8,000,000 [$4,300,000 + 3,700,000] 2 = 2 times



a. Profit margin on sales $180 $5,200 = 3.5% b. Return on assets $180 [($1,900 + 1,700) 2] = 10% c. Return on shareholders equity $180 [($550 + 500) 2] = 34.3%

Requirement 2 Retained earnings beginning of period $100,000 Add: Net income 180,000 280,000 Less: Retained earnings end of period 150,000 Dividends paid $130,000


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

Quarter First Second Third

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


Exercise 528 Incentive compensation $300 million 4 = $75 million Depreciation expense $60 million 4 = $15 million Gain on sale $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 - - 0 - Research and development - 0 - 96,000 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 Quarters Ending March 31 June 30 Sept. 30 Dec. 31

Advertising $800,000 - 0 - - 0 - - 0 - Property tax 350,000 - 0 - - 0 - - 0 - Equipment repairs 260,000 - 0 - - 0 - - 0 - Extraordinary casualty loss - 0 - 185,000 - 0 - - 0 - Research and development - 0 - 96,000 - 0 - - 0 -


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) 66,000 Unearned revenue (discount option) 4,000 (1,000 pairs (30% 10% discount) 20% estimated to redeem coupon $100 average purchase)

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


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 150 Unearned Revenue, subscription 135.87 Unearned Revenue, coupon 14.13


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.


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 100,000

Revenue 100,000 2. Record the amount of additional revenue at the end of year.

Cash or accounts receivable ($800,000 x 10%) 80,000 Revenue 80,000


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 because (1) McDonalds has a conditional rather than unconditional obligation to pay, and (2) Toys4U appears to retain the risk of ownership. This is essentially a consignment arrangement, and Toys4U should not recognize sales until McDonalds sells dolls to customers.


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.


Exercise 538 Requirement 1 Record unearned revenue upon receipt of initial payment:

Cash 20,000

Unearned revenue 20,000

Requirement 2 1. Record interest expense at end of the first year of the contract:

Interest expense ($20,000 x 4%) 800

Unearned revenue 800

2. Record interest expense at end of the second year of the contract:

Interest expense ({$20,000 + 800} x 4%) 832 Unearned revenue 832

3. Record interest expense at end of the third year of the contract:

Interest expense ({$20,000 + 800 + 832} x 4%) 865

Unearned revenue 865 Requirement 3 Record revenue upon Stewarts satisfaction of his performance obligation:

Unearned revenue ($20,000 + 800 + 832 + 865) 22,497

Revenue 22,497


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 2013 2014 Total sales $ 600,000 $ 900,000 Less: Collections to date (300,000) (300,000) Less: Write-offs to date (200,000) (50,000) Accounts receivable balance 100,000 550,000 x Gross profit rate x 30% x 40% Deferred gross profit 12/31/2014 $ 30,000 $ 220,000

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


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 $20,000Total estimated costs 60,000Ratio = 1/3Contract price x 100,000Revenue 33,3332013 actual costs 20,000Gross 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.


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 cost-recovery 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


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


Problem 51

REAGAN CORPORATION Income Statement

For the Year Ended December 31, 2013

Income before income taxes and extraordinary item .......................................

[1] $3,680,000

Income tax expense ....................................... 1,472,000 Income before extraordinary item ................. 2,208,000 Extraordinary item: Gain from settlement of lawsuit (net of $400,000 tax expense) ..................................

600,000 Net income .................................................... $2,808,000

Income before extraordinary item ................. 2.21 Extraordinary gain ......................................... 0.60 Net income .................................................... $ 2.81

[1] 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

* Profit recognized ($400,000 240,000) $160,000 Profit that should have been recognized (gross profit ratio of 40% x $100,000) (40,000) Overstated profit $120,000

PROBLEMS


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% = $48,000 2014 gross profit: Cash collection from 2013 sales = $100,000 x 40% = $ 40,000 + Cash collection from 2014 sales = $150,000 x 30% = 45,000 Total 2014 gross profit $85,000 Requirement 2

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 collections from installment sales Deferred gross profit ....................................................... 48,000 Realized gross profit ................................................... 48,000 To recognize gross profit from installment sales


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 ....................................................... 85,000 Realized gross profit ................................................... 85,000 To recognize gross profit from installment sales

Requirement 3

Date Cash Collected Cost Recovery Gross Profit

2013

2013 sales $120,000 $120,000 - 0 -

2014 2013 sales $100,000 $ 60,000 $40,000 2014 sales 150,000 150,000 - 0 -

2014 totals $250,000 $210,000 $40,000


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 ....................................................... 40,000 Realized gross profit ................................................... 40,000 To recognize gross profit from installment sales


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 8/31/14 8/31/15 8/31/16 8/31/17 Cash collections $100,000 $100,000 $100,000 $100,000 $100,000 a. Point of delivery method $200,000 - 0 - - 0 - - 0 - - 0 - b. Installment sales method (40% x cash collected)

$ 40,000

$ 40,000

$ 40,000

$ 40,000

$40,000

c. Cost recovery method - 0 - - 0 - - 0 - $100,000 $100,000


Problem 53 (continued) Requirement 2

Point of

Delivery Installment

Sales

Cost RecoveryInstallment receivable 500,000 Sales revenue 500,000 Cost of goods sold 300,000 Inventory 300,000 To record sale on 8/31/13 Installment receivable 500,000 500,000 Inventory 300,000 300,000 Deferred gross profit To rec

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