sticechap08

263

CHAPTER 8

QUESTIONS

1. The two general revenue recognition crite-ria are that revenue should be recognized when it is realized or realizable and it has been earned through substantial completion of the activities involved in the earnings process.

2. The four revenue recognition criteria identi-

fied in SOP 972 are:

a. Persuasive evidence of an arrangement exists.

b. Delivery has occurred.

c. The vendor's fee is fixed or determina-ble.

d. Collectibility is probable.

The first two items relate to whether reve-nue has been earned, and the last two relate to the realizability of the revenue.

3. SAB 101 was issued by the SEC to curtail

specific abuses in revenue recognition practices.

4. Question 1 of SAB 101 emphasizes the

proper signing of sales agreements to encourage companies to implement good internal controls surrounding revenue recognition. If a company does not have good internal controls in place for pro-cessing customer contracts, it becomes much easier for company executives to manipulate the reported amount of reve-nue.

5. A sale can be turned into a consignment

through a liberal return policy that does not require the buyer to pay for the product until the buyer in turn sells it to a customer. A sale can also be turned into a consignment if the seller agrees to repurchase the product at the same price and provides interest-free financing to the buyer.

6. In a bill-and-hold arrangement, the seller “sells” goods to the buyer but holds the goods for later shipment, either in the sell-er’s own warehouse or in a third-party warehouse. A bill-and-hold arrangement is a sale when the arrangement comes about upon the written request of the buyer, the goods are ready to ship, and the goods are

separated from other inventory to the extent that they cannot be used to fill other orders.

7. The presumption is that customer ac-ceptance provisions are important to the buyer or else they wouldn’t have been in-cluded in the sales agreement in the first place. Accordingly, the seller has not completed the earnings process until the customer acceptance provisions have been satisfied.

8. Up-front, nonrefundable fees are not rec-ognized as revenue immediately because the earnings process is not complete. The buyer is not paying for the initiation of the service, but instead is paying for the service itself.

9. Revenue shouldn’t be recognized until the transaction price can be definitely deter-mined because it is less likely that an arm’s-length market transaction has occurred when the parties have not even agreed upon the final price and because the associated measurement uncertainty means that the information is not reliable enough for recognition and inclusion in the financial statements.

10. A refundable fee can be recognized as rev-enue month-by-month before the refund pe-riod is over when the seller can make a re-liable estimate about the number of refunds that will be requested. Reliable estimates are possible when the seller has at least two years’ past experience with a large pool of similar transactions.

11. Contingent rent can’t be estimated and rec-

ognized on a straight-line basis over the course of a year because to do so would involve recognizing the future impact of future events. No contingent rent should be recognized until the contingency threshold has been reached.

12. A company can reliably estimate product

returns if the company has substantial past experience with a large pool of similar transactions. Also, the return period should be short and demand for the product should be fairly stable. Also, a company can relia-bly estimate product returns when there

Chapter 8

264

have been no large inventory increases for either the company or its customers.

13. A company would prefer gross revenue

reporting over net revenue reporting because the larger total revenue number increases the apparent size of the compa-ny’s economic activity. If investors use a price-to-sales relationship in valuing the company, gross revenue reporting can lead to a higher stock price.

14. If percentage-of-completion accounting is to

be used by construction contractors, the following elements should be present in the transaction.

a. Dependable estimates can be made of the extent of progress toward comple-tion, contract revenues, and contract costs.

b. The contract should 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.

c. The buyer can be expected to satisfy obligations under the contract.

d. The contractor can be expected to per-form the contractual obligation.

Because most contractors with significant contract obligations have the experience to make the necessary estimates, it is rec-ommended that they use percentage-of-completion accounting rather than the completed-contract method.

15. The cost-to-cost method of measuring the percentage of completion is an input meth-od and is computed by relating the costs in-curred to date to the total estimated costs. The efforts-expended methods are also in-put methods, but they are based on the ra-tio of the efforts expended by labor or ma-chines on the contract to the total effort ex-pected to be expended. They include labor hours, labor dollars, machine hours, or even material quantities. The percentage computed is then applied to revenue and costs to determine the amount reported for the period.

16. Output measures of percentage of com-pletion include units produced, contract milestones reached, and values added to

the contract. Particular examples of output measures include miles of roadway, cubic yards of dirt removed, or architects' and engineers' estimates of job completion.

17. The construction in progress account is

used to accumulate all costs directly chargeable to a contract, including a share of indirect overhead costs and the recog-nized gross profit earned to date if the company is using the percentage-of-completion method. The progress billings on construction contracts account is used to accumulate the total progress billings made on a contract, including any billed retainer fees. These accounts are offset against each other on the balance sheet. If Construction in Progress is the larger of the two accounts, both are reported in the Current Asset section. If Progress Billings on Construction Contracts is larger, both are reported in the Current Liability section.

18. A minority of the members of the Construc-

tion Contractor Guide Committee of the AICPA feels that the costs reported under the percentage-of-completion method should always be the costs incurred to date. If the method of arriving at the percentage of completion is other than the cost-to-cost method, the only way this could occur would be to compute revenue as the sum of costs incurred and the computed gross profit rather than by applying the percent-age of completion to the total contract price.

19. Under percentage-of-completion account-

ing, the difference between recognized rev-enue and recognized costs, or the recognized gross profit, is added to the costs incurred in arriving at the balance reported in the construction in progress account.

20. The major reason for a fluctuating gross

profit percentage under the percentage- of-completion method is the revision of estimates that is inherent in this type of contract. As costs incurred differ from those anticipated, and as expectations of future costs change over the contract time period, the total gross profit to be earned on the project also changes. When some profit has already been recognized, these ad-justments can create large changes in the reported gross profit percentage from year

Chapter 8 265

to year. These fluctuations would also increase if a measure of completion other than cost-to-cost was used and if the minor-ity position of the AICPA Construction Contractor Guide Committee was followed.

21. If a loss is anticipated on a contract, the entire loss should be recognized in the period when the loss is first anticipated. This is true under both the completed-contract and the percentage-of-completion methods. Under the completed-contract method, the amount of the expected loss is charged to a loss account and credited to Construction in Progress. Under the percentage-of-completion method, however, the amount of the loss plus any profit recognized in prior periods on the contract must be recognized and reported as a loss. Under either method, the balance reported in Construction in Progress will be the same.

22. The measures used to compute a percent-age of performance in long-term service contracts depend on the nature of the acts of service to be performed. If the acts of service are identical or similar in nature, an output measure derived by relating the number of acts performed to the total num-ber of acts to be performed over the contract life is recommended. If the acts are defined, but are not identical, the sales value of the acts performed to date related to the total contract sales value is used.

23. When a service company is organized and its activities grow rapidly in the early years of its life, the deferral of all revenue over the service life fails to recognize any profit on the sale of the contracts. Because the sale is the critical event in many service compa-nies, failure to recognize profit in the early years of a company results in both direct and indirect costs being charged against very little revenue. Thus, in a newly formed company, large losses will often be shown even if the company may be profitable over time. The deferred revenue recognition method may not do an acceptable job of predicting the pattern of future cash flows.

24. The three methods of revenue recognition that await the receipt of cash are (a)

installment sales, (b) cost recovery, and (c) cash. Under the installment sales method, a portion of each cash receipt is recognized as income. Under the cost recovery meth-od, no income is recognized until all costs are recovered. Under the cash method, all costs incurred are expensed immediately, and all cash receipts are recognized as revenue. Costs incurred are deferred and matched against cash received under both the installment sales and cost recovery methods. As indicated previously, under the cash method all costs are expensed immediately.

25. The installment sales method of accounting

is preferred over the full accrual method if cash collection is highly uncertain and if the amount of loss due to uncollectible accounts cannot be reasonably estimated. This can occur if the sales transaction is unusual in nature and involves a customer in a way that default carries little cost or penalty.

26. Installment sales accounting requires

recognition of gross profit as the cash is collected. The amount to be recognized is based on the gross profit percentage of the sales year. Because these percentages can vary from year to year, it is necessary to maintain records that identify sales and col-lections by year and to maintain a record of each year's gross profit percentage.

27. Interest on installment sales contracts

should be recognized each period as earned. Each cash collection, therefore, should be reduced by the interest earned before the gross profit percentage is applied to the balance of the collection to determine the gross profit earned.

28. The cash method of recognizing revenue

would be acceptable for reporting purposes only if the probability of recovery of product or service costs is slight. Seldom would the method be appropriate for product or real estate sales because of repossession rights held by the seller. However, in service contracts with high initial costs and great uncertainty as to collection, the cash meth-od might be appropriate.

Chapter 8

266

PRACTICE EXERCISES

PRACTICE 8–1 BASIC JOURNAL ENTRIES FOR REVENUE RECOGNITION

1. Cash ................................................................................... 1,000

Unearned Service Revenue ......................................... 1,000

2. Unearned Service Revenue .............................................. 1,000

Service Revenue .......................................................... 1,000

PRACTICE 8–2 JOURNAL ENTRIES FOR A CONSIGNMENT

1. Inventory on Consignment ............................................... 10,000

Inventory ....................................................................... 10,000

2. Accounts Receivable ........................................................ 16,000

Sales ............................................................................. 16,000

Cost of Goods Sold ........................................................... 10,000

Inventory on Consignment.......................................... 10,000

PRACTICE 8–3 JOURNAL ENTRIES FOR A LAYAWAY

1. Cash (2 $50) .................................................................... 100

Deposits Received from Customers ........................... 100

2. Cash ................................................................................... 300

Deposits Received from Customers ................................ 50

Sales ............................................................................. 350

Cost of Goods Sold ........................................................... 200

Inventory ....................................................................... 200

3. Deposits Received from Customers ................................ 50

Revenue from Layaway Forfeitures ............................ 50

PRACTICE 8–4 JOURNAL ENTRIES FOR AN UP-FRONT, NONREFUNDABLE FEE

1. Cash (200 $360) .............................................................. 72,000

Unearned Initial Sign-up Fees .................................... 72,000

2. Cash (200 $50) ................................................................ 10,000

Monthly Service Revenue ............................................ 10,000

3. Unearned Initial Sign-up Fees ($72,000/36 months) ....... 2,000

Initial Sign-up Fee Revenue ........................................ 2,000

Chapter 8 267

PRACTICE 8–5 JOURNAL ENTRIES FOR AN UP-FRONT, REFUNDABLE FEE

1. Cash (1,500 $1,000) .................................................... 1,500,000

Customers’ Refundable Fees (30%) ....................... 450,000

Unearned Membership Fees (70%) ......................... 1,050,000

2. Unearned Membership Fees ($1,050,000/12 months) . 87,500

Membership Fee Revenue ....................................... 87,500

Cost of Membership Fee Revenue (70%) ..................... 10,500

Administrative Expense (30%) ...................................... 4,500

Cash [($120/12 months) 1,500 customers] .......... 15,000

3. Unearned Membership Fees ($1,050,000/12 months) . 87,500

Membership Fee Revenue ....................................... 87,500

Cost of Membership Fee Revenue (70%) ..................... 10,500

Administrative Expense (30%) ...................................... 4,500

Cash [($120/12 months) 1,500 customers] .......... 15,000

Customers’ Refundable Fees ....................................... 450,000

Cash .......................................................................... 450,000

PRACTICE 8–6 JOURNAL ENTRIES FOR CONTINGENT RENT

1. Cash ................................................................................... 40,000

Rent Revenue ............................................................... 40,000

2. Cash ................................................................................... 40,000

Rent Revenue ............................................................... 40,000

Contingent Rent Receivable ............................................. 100,000

Contingent Rent Revenue ........................................... 100,000

($55,000,000 – $50,000,000) 0.02 = $100,000

3. Cash ................................................................................... 40,000

Rent Revenue ............................................................... 40,000

Contingent Rent Receivable ............................................. 240,000

Contingent Rent Revenue ........................................... 240,000

$12,000,000 0.02 = $240,000

Cash ................................................................................... 600,000

Contingent Rent Receivable ....................................... 600,000

($80,000,000 – $50,000,000) 0.02 = $600,000

Chapter 8

268

PRACTICE 8–7 REPORTING REVENUE GROSS AND NET

1. Accounts Receivable ($300,000 0.02)........................ 6,000

Commission Revenue ............................................. 6,000

Cash ............................................................................... 6,000

Accounts Receivable ............................................... 6,000

2. Cash ............................................................................... 300,000

Sales ......................................................................... 300,000

Cost of Goods Sold ....................................................... 210,000

Inventory ................................................................... 210,000

Commission Expense ................................................... 6,000

Cash .......................................................................... 6,000

PRACTICE 8–8 COST-TO-COST METHOD

1. Percentage of completion: [$100,000/($100,000 + $450,000)] = 18.182%

Cumulative revenue to be recognized:

$800,000 0.18182 ...................................... $ 145,456

Revenue recognized in previous years .......... 0

Revenue to be recognized in Year 1 ............... $ 145,456

2. Percentage of completion: [($100,000 + $150,000)/($100,000 + $150,000 +

$280,000)] = 47.170%


$800,000 0.47170 ...................................... $ 377,360

Revenue recognized in previous years .......... 145,456


3. Percentage of completion: 100.000%


$800,000 1.00000 ...................................... $ 800,000



Chapter 8 269

PRACTICE 8–9 EFFORTS-EXPENDED METHOD

1. Percentage of completion: [150/(150 + 850)] = 15.000%


$800,000 0.15000 ...................................... $ 120,000



2. Percentage of completion: [(150 + 300)/(150 + 300 + 520)] = 46.392%


$800,000 0.46392 ...................................... $ 371,136





$800,000 1.00000 ...................................... $ 800,000



PRACTICE 8–10 PERCENTAGE OF COMPLETION BASED ON OUTPUT MEASURES

1. Percentage of completion: [3,000/(3,000 + 15,200)] = 16.484%


$800,000 0.16484 ...................................... $ 131,872



2. Percentage of completion: [(3,000 + 7,500)/(3,000 + 7,500 + 8,200)] =

56.150%


$800,000 0.56150 ...................................... $ 449,200





$800,000 1.00000 ...................................... $ 800,000



Chapter 8

270

PRACTICE 8–11 BASIC CONSTRUCTION JOURNAL ENTRIES

1. Construction in Progress ....................................... 100,000

Materials, Cash, etc. .......................................... 100,000

Accounts Receivable .............................................. 200,000

Progress Billings ............................................... 200,000

Cash ......................................................................... 180,000

Accounts Receivable ......................................... 180,000





Cash ......................................................................... 170,000






Cash ......................................................................... 450,000


PRACTICE 8–12 COMPLETED-CONTRACT JOURNAL ENTRIES

Progress Billings .......................................................... 800,000

Revenue on Construction Contracts ..................... 800,000

Cost of Construction Contracts ................................... 500,000

Construction in Progress ....................................... 500,000

PRACTICE 8–13 PERCENTAGE-OF-COMPLETION JOURNAL ENTRIES

1. Cost of Construction Contracts ............................. 100,000


Revenue on Construction Contracts ................ 145,456







Chapter 8 271

PRACTICE 8–14 CONSTRUCTION CONTRACTS: BALANCE SHEET REPORTING

1. Accounts receivable is reported as a current asset. The balance at the

end of each year is computed as follows:

Year 1: $200,000 – $180,000 = $20,000

Year 2: $20,000 + $200,000 – $170,000 = $50,000

Year 3: $50,000 + $400,000 – $450,000 = $0

2. and 3.

For balance sheet reporting purposes, Progress Billings and Construc-

tion in Progress are netted against one another. If the cumulative

amount of Progress Billings is larger, the net amount is reported as a

current liability. If the cumulative amount of Construction in Progress is

larger, the net amount is reported as a current asset.

Year 1

Progress billings: $200,000

Construction in progress: $100,000 (cost) + $45,456 (profit) = $145,456

Net current liability of $54,544 ($200,000 – $145,456)

Year 2

Progress billings: $200,000 beginning balance + $200,000 = $400,000

Construction in progress: $145,456 (beginning balance) + $150,000

(cost) + $81,904 (profit) = $377,360

Net current liability of $22,640 ($400,000 – $377,360)

Year 3

Progress billings: $400,000 beginning balance + $400,000 = $800,000

Construction in progress: $377,360 (beginning balance) + $250,000

(cost) + $172,640 (profit) = $800,000

No net amount is reported because both Construction in Progress and

Progress Billings are equal to $800,000. It would be appropriate to re-

port the two amounts, netting to zero, in either the Current Asset or

Current Liability section of the balance sheet.

Chapter 8

272

PRACTICE 8–15 MULTIPLE YEARS OF REVENUES AND COSTS: COST-TO-COST

METHOD

1. Percentage of completion: [$200,000/($200,000 + $550,000)] = 26.6667%


$1,200,000 0.266667 ................................. $ 320,000



Cumulative cost to be recognized:

($200,000 + $550,000) 0.266667 ............... $ 200,000

Cost recognized in previous years ................. 0

Cost to be recognized in Year 1 ...................... $ 200,000


Construction in Progress ............................................. 120,000

Revenue on Construction Contracts ...................... 320,000


$280,000)] = 66.2651%


$1,200,000 0.662651 ................................. $ 795,181




($200,000 + $350,000 + $280,000) 0.662651 $ 550,000

Cost recognized in previous years ................. 200,000







$1,200,000 1.000000 ................................. $ 1,200,000




($200,000 + $350,000 + $250,000) 1.000000 $ 800,000

Cost recognized in previous years ................. 550,000





Chapter 8 273

PRACTICE 8–16 MULTIPLE YEARS OF REVENUES AND COSTS: OUTPUT MEASURE

1. Percentage of completion: [8,000/(8,000 + 16,200)] = 33.0579%


$1,200,000 0.330579 ........................................ $ 396,695

Revenue recognized in previous years ................. 0

Revenue to be recognized in Year 1 ...................... $ 396,695


($200,000 + $550,000) 0.330579 ...................... $ 247,934

Cost recognized in previous years ........................ 0

Cost to be recognized in Year 1 ............................. $ 247,934




2. Percentage of completion: [(8,000 + 12,500)/(8,000 + 12,500 + 4,100)] =

83.3333%


$1,200,000 0.833333 ........................................ $ 1,000,000

Revenue recognized in previous years ................. 396,695



($200,000 + $350,000 + $280,000) 0.833333 ... $ 691,666

Cost recognized in previous years ........................ 247,934







$1,200,000 1.000000 ........................................ $ 1,200,000

Revenue recognized in previous years ................. 1,000,000



($200,000 + $350,000 + $250,000) 1.000000 ... $ 800,000






Chapter 8

274

PRACTICE 8–17 MULTIPLE YEARS OF REVENUES AND COSTS: ANTICIPATED

LOSS

1. Percentage of completion: [$200,000/($200,000 + $1,150,000)] = 14.8148%


$1,500,000 0.148148 ........................................ $ 222,222

Revenue recognized in previous years ................. 0


With the cost-to-cost method, the percentage of cost and the actual

cost are the same, unless the contract has an anticipated loss as illus-

trated in Year 2.





$1,020,000)] = 35.0319%

However, the contract now has a total anticipated loss of $70,000

[$1,500,000 – ($200,000 + $350,000 + $1,020,000)].


$1,500,000 0.350319 ........................................ $ 525,479




($525,479 + $70,000 anticipated loss) ............... $ 595,479




Construction in Progress ........................................ 92,222




$1,500,000 1.000000 ........................................ $ 1,500,000




($200,000 + $350,000 + $900,000) 1.000000 ... $1,450,000






Chapter 8 275

PRACTICE 8–18 JOURNAL ENTRIES FOR THE PROPORTIONAL PERFORMANCE

METHOD

1. Cash (2,000 $500) .................................................... 1,000,000

Unearned Season Ticket Revenue ....................... 1,000,000

2. Deferred Initial Season Ticket Costs......................... 150,000

Cash ....................................................................... 150,000

3. Unearned Season Ticket Revenue ............................ 383,333

Season Ticket Revenue [$1,000,000 (23/60)] .... 383,333

Season Ticket Game Costs ........................................ 92,000

Cash (2,000 $2 23) ........................................... 92,000

Initial Season Ticket Costs [$150,000 (23/60)] ....... 57,500

Deferred Initial Season Ticket Costs ................... 57,500

PRACTICE 8–19 INSTALLMENT SALES: BASIC JOURNAL ENTRIES

Installment Accounts Receivable ................................... 350,000

Installment Sales ........................................................ 350,000

Cost of Installment Sales ($350,000 0.80) ................... 280,000

Inventory .................................................................... 280,000

Cash ($350,000 0.40) ..................................................... 140,000

Installment Accounts Receivable .............................. 140,000

Installment Sales .............................................................. 350,000

Cost of Installment Sales ........................................... 280,000

Deferred Gross Profit ................................................. 70,000

Deferred Gross Profit....................................................... 28,000

Realized Gross Profit on Installment Sales .............. 28,000

($140,000 collected 20% profit margin = $28,000)

or ($70,000 deferred gross profit 40% cash collected = $28,000)

PRACTICE 8–20 INSTALLMENT SALES: FINANCIAL STATEMENT REPORTING

Installment sales receivable: $350,000 – $140,000 = $210,000

Deferred gross profit: $70,000 – $28,000 = $42,000

Balance sheet reporting:

Installment sales receivable ..................................... $ 210,000

Less deferred gross profit ........................................ (42,000)

Net installment sales receivable .............................. $ 168,000

Chapter 8

276

PRACTICE 8–21 INSTALLMENT SALES: INTEREST ON RECEIVABLES

1. Installments Receivable .................................................... 100,000

Installment Sales ......................................................... 100,000


Inventory ....................................................................... 60,000

Cash ................................................................................... 40,000

Installments Receivable .............................................. 22,000

Interest Revenue ($100,000 0.18) ............................. 18,000

Installment Sales ............................................................... 100,000

Cost of Goods Sold ..................................................... 60,000

Deferred Gross Profit .................................................. 40,000

Deferred Gross Profit ........................................................ 8,800

Realized Gross Profit ................................................... 8,800

($22,000/$100,000) $40,000

2. Installments Receivable .................................................... 120,000



Inventory ....................................................................... 80,000

Cash ................................................................................... 140,000

Installments Receivable .............................................. 104,360

Interest Revenue .......................................................... 35,640

From Year 1: ($100,000 – $22,000) 0.18 = $14,040

From Year 2: $120,000 0.18 = $21,600

$14,040 + $21,600 = $35,640



Deferred Gross Profit .................................................. 40,000

Deferred Gross Profit ........................................................ 37,184

Realized Gross Profit ................................................... 37,184

From Year 1: Principal cash collections = $50,000 – $14,040 = $35,960

From Year 2: Principal cash collections = $90,000 – $21,600 = $68,400

From Year 1: Realized gross profit = ($35,960/$100,000) $40,000 = $14,384

From Year 2: Realized gross profit = ($68,400/$120,000) $40,000 = $22,800

$14,384 + $22,800 = $37,184

Chapter 8 277

PRACTICE 8–22 COST RECOVERY METHOD: BASIC JOURNAL ENTRIES

Year 1 Year 2 Year 3 Cash Gross Profit Cash Gross Profit Cash Gross Profit Collected Recognized Collected Recognized Collected Recognized

Year 1 $140,000 $175,000 $ 0 Sales = $350,000 $ 0 $35,000 $ 0 Gross Profit % = 20% COGS = $280,000 Year 2 108,000 135,000 Sales = $270,000 0 40,500 Gross Profit % = 25% COGS = $202,500 Year 3 84,000 Sales = $210,000 0 Gross Profit % = 30% COGS = $147,000

1. Installments Receivable—Year 1 .......................................... 350,000

Installment Sales ............................................................. 350,000

Cost of Goods Sold ............................................................... 280,000

Inventory........................................................................... 280,000

Cash ....................................................................................... 140,000

Installments Receivable—Year 1 .................................... 140,000

Installment Sales ................................................................... 350,000

Cost of Goods Sold ......................................................... 280,000

Deferred Gross Profit—Year 1 ........................................ 70,000




Inventory........................................................................... 202,500

Cash ....................................................................................... 108,000





Cash ....................................................................................... 175,000


Deferred Gross Profit—Year 1 .............................................. 35,000

Realized Gross Profit ...................................................... 35,000

Chapter 8

278

PRACTICE 8–22 (Concluded)




Inventory........................................................................... 147,000

Cash ....................................................................................... 84,000





Cash ....................................................................................... 135,000


Deferred Gross Profit—Year 2 .............................................. 40,500

Realized Gross Profit ...................................................... 40,500

Chapter 8 279

EXERCISES

8–23. 2009 Inventory on Consignment...................................... 45,000

Retained Earnings (0.30 $45,000) ........................ 13,500

Accounts Receivable ........................................... 58,500

To correct error made in 2008.

Receivable from Consignee ($12,000 1.3) ........... 15,600

Consignment Sales ............................................. 15,600

Cost of Consignment Goods Sold ......................... 12,000

Inventory on Consignment ................................. 12,000

Inventory ................................................................... 33,000

Inventory on Consignment ................................. 33,000

Commission Expense ($15,600 0.15) ................... 2,340

Cash .......................................................................... 13,260

Receivable from Consignee ................................ 15,600

8–24.

a. No entry. Tricky has received no order from Tracking, so no sale

should be recognized no matter how much Tricky segregates the

inventory.

b. No entry. As explained in Question 1 of SAB 101, no sale should be

recognized if the sales agreement is unsigned and yet normal proce-

dure includes the formal signing of the sales agreement by both the

buyer and the seller. In addition, a bill-and-hold arrangement should

not be recognized as a sale in the absence of a written request from

the buyer.

c. This scenario describes a case in which a bill-and-hold arrangement

can be recognized as a sale. The appropriate journal entry is as

follows:

Accounts Receivable ................................................... 210,000

Sales ......................................................................... 210,000


Inventory ................................................................... 145,000

d. No entry. No sale should be recognized until all substantive customer

acceptance provisions have been satisfied.

Chapter 8

280

8–25.

Cash (300 $2,000) .......................................................... 600,000

Unearned Lifetime Membership Fees ....................... 488,372

Unearned Wellness Evaluation Fees ........................ 111,628

Lifetime membership fees: [$1,750/($1,750 + $400)] $600,000 = $488,372

Wellness evaluation fees: [$400/($1,750 + $400)] $600,000 = $111,628

Unearned Wellness Evaluation Fees .............................. 111,628

Wellness Evaluation Fees .......................................... 111,628

Cost of Wellness Evaluation Fees .................................. 21,000

Cash (300 $70) ......................................................... 21,000

Unearned Lifetime Membership Fees ............................. 97,674

Lifetime Membership Fees ($488,372/5 years) ......... 97,674

Cost of Lifetime Membership Fees ................................. 75,000

Cash (300 $250) ....................................................... 75,000

8–26.

1. Cash (20,000 $200) .................................................. 4,000,000

Customers’ Refundable Fees (20%) .................... 800,000

Unearned Subscriber Fees (80%) ........................ 3,200,000

Deferred Initial Subscriber Costs (80%) ................... 640,000

Administrative Expense (20%) ................................... 160,000

Cash (20,000 $40) ............................................... 800,000

2. Unearned Subscriber Fees ($3,200,000/4 quarters) . 800,000

Subscriber Fee Revenue ...................................... 800,000

Initial Setup Expense ($640,000 3/12) .................... 160,000

Deferred Initial Subscriber Costs ........................ 160,000

Cost of Subscriber Fee Revenue (80%) .................... 320,000


Cash [($80/4 quarters) 20,000 customers] ....... 400,000

Chapter 8 281

8–26. (Concluded)






















Customers’ Refundable Fees .................................... 760,000

Cash (3,800 $200) ............................................... 760,000

Customers’ Refundable Fees .................................... 40,000


This final entry is necessary to close out the remaining balance in the

estimated amount of fees to be refunded. One could also make entries

to retroactively reclassify some administrative expense as cost of sub-

scriber fee revenue; in this example, this reclassification would impact

the classification of expenses but not the amount of total expenses for

the year.

Chapter 8

282

8–27.

2008 2009

Construction in Progress ................ 1,790,000 2,090,000

Materials, Labor, Cash, etc. ........ 1,790,000 2,090,000

To record costs incurred

on contract.

Accounts Receivable ....................... 1,750,000 2,520,000

Progress Billings on

Construction Contracts............. 1,750,000 2,520,000

To record contract billings.

Cash................................................... 1,050,000 3,220,000

Accounts Receivable .................. 1,050,000 3,220,000

To record collections on

contract.


Construction Contracts .................. 4,270,000

Revenue from Long-Term

Construction Contracts............. no entry 4,270,000

To record recognition

of revenue.

Cost of Long-Term

Construction Contracts ................. no entry 3,880,000

Construction in Progress ........... 3,880,000

To record recognition

of expenses.

8–28. 1. Total gross profit recognized on contract: 2007 .......................................... $ 75,000

2008 .......................................... 140,000

2009 .......................................... (20,000)

$195,000

Total cost incurred on contract:

Contract price ............................................ $2,000,000

Less gross profit recognized .................... 195,000

Total cost incurred ........................................... $1,805,000

Total cost incurred in 2008:

Total cost incurred—contract ................... $1,805,000

Less cost incurred:

2007 ........................................................ $ 360,000

2009 ........................................................ 820,000 1,180,000

Total cost incurred—2008 ................................ $ 625,000

Chapter 8 283

8–28. (Concluded)

2. Total cost incurred and gross profit recognized to the end of 2008:

Cost Gross Profit

Incurred Recognized Total 2007 .................................... $ 360,000 $ 75,000 $ 435,000

2008 .................................... 625,000 140,000 765,000

$ 985,000 $ 215,000 $1,200,000

Percentage of job completed at the end of 2008:

Total cost incurred and gross profit recognized

to end of 2008 ................................................................... $1,200,000

Total contract price ............................................................. 2,000,000

Percentage of project completed by the end of 2008 ...... 60%

3. Total gross profit recognized to end of 2008........................... $ 215,000

Percentage of project completed by end of 2008 .................... ÷ 60%

Total estimated gross profit on project as of end of 2008 ... $ 358,333

4. Total cost incurred to end of 2008 ............................................ $ 985,000

Percentage of project completed by end of 2008 .................... ÷ 60%

Total estimated cost on contract as of end of 2008 ............. $1,641,667

Less cost incurred to date ........................................................ 985,000

Estimated cost to complete contract as of end of 2008 ....... $ 656,667

8–29. 2007 2008 2009 1. Actual cost incurred to date ......... $ 2,500,000 $ 5,800,000 $6,210,000

2. Estimated cost to complete

contract ........................................ 3,500,000 400,000 0

3. Total estimated cost ...................... $ 6,000,000 $ 6,200,000 $6,210,000

Percentage of completion

to date [(1)/(3)] ............................. 41.67% 93.55% 100% Recognized Recognized in in To Date Prior Years Current Year 2007—(41.67% completed):

Recognized revenue

($7,000,000 41.67%) .............. $ 2,916,900 $2,916,900

Cost (rounded to actual cost) ....... 2,500,000 2,500,000

Gross profit ................................. $ 416,900 $ 416,900

2008—(93.55% completed):

Recognized revenue

($6,700,000 93.55%) .............. $ 6,267,850 $ 2,916,900 $3,350,950

Cost (rounded to actual cost) ....... 5,800,000 2,500,000 3,300,000

Gross profit ................................. $ 467,850 $ 416,900 $ 50,950

Chapter 8

284

8–29. (Concluded)

2009—(100% completed):

Recognized revenue ...................... $ 6,700,000 $ 6,267,850 $ 432,150

Cost ................................................. 6,210,000 5,800,000 410,000

Gross profit ................................. $ 490,000 $ 467,850 $ 22,150

8–30. 1. $20,000 ($220,000 – $200,000)

2. $260,000 ($250,000 + $10,000)

3. $370,000 [$850,000 – ($220,000 + $260,000)]

4. $380,000 ($370,000 + $10,000)

5. $830,000 ($200,000 + $250,000 + $380,000)

6. $86,095

2008: 450/640 = 0.7031; 0.7031 $850,000 = $ 597,635 Cumulative revenue

less cumulative costs (450,000)

Cumulative gross profit 147,635

2007: 200/650 = 0.3077; 0.3077 $200,000 = (61,540) Gross profit recognized—2007 $ 86,095 Gross profit recognized—2008

8–31. 1. Percentage-of-completion method:

2008 Contract price ............................................ $170,000

Less estimated cost:

Cost to date ........................................... $ 60,000

Estimated cost to complete project ..... 59,000 119,000

Estimated gross profit ........................... $ 51,000

Percentage completed ($60,000/$119,000) 50.42%

Estimated gross profit—2008

($51,000 50.42%) ................................. $ 25,714

Balance sheet:

Current assets:

Accounts receivable

($80,000 billed – $55,000 received) $ 25,000

Construction in progress .................. $ 85,714*

Less: Progress billings on

construction contracts ................... 80,000 5,714

*$60,000 cost to date + $25,714 income = $85,714

Income statement:

Revenue ($170,000 0.5042) ................. $85,714

Cost of construction .............................. 60,000

Gross profit ............................................ $ 25,714

Chapter 8 285

8–31. (Concluded)

2. Completed-contract method:

Balance sheet:

Current assets:

Accounts receivable .................................. $ 25,000

Current liabilities:

Progress billings on construction

contracts ................................................. $ 80,000

Less: Construction in progress ............... 60,000 20,000

Income statement:

Nothing reported. No contract was completed.

8–32. 2007 Construction in Progress .................................. 3,200,000

Materials, Labor, Cash, etc. .......................... 3,200,000

Accounts Receivable ......................................... 3,300,000

Progress Billings on Construction

Contracts ..................................................... 3,300,000

Cash .................................................................... 3,100,000

Accounts Receivable ..................................... 3,100,000

Cost of Long-Term Construction Contracts .... 2,300,000*

Construction in Progress .................................. 200,000†

Revenue from Long-Term Construction

Contracts ..................................................... 2,500,000

*0.25 $9,200,000 = $2,300,000

†0.25 $800,000 ($10,000,000 – $9,200,000) = $200,000

2008 Construction in Progress .................................. 4,300,000




Contracts ..................................................... 4,500,000

Cash .................................................................... 2,700,000



Construction in Progress .................................. 475,000†


Contracts ..................................................... 5,000,000

*0.75 $9,100,000 = $6,825,000;

$6,825,000 – $2,300,000 = $4,525,000

†0.75 ($10,000,000 – $9,100,000) = $675,000;

$675,000 – $200,000 = $475,000

Chapter 8

286

8–32. (Concluded)





Contracts ..................................................... 2,200,000

Cash .................................................................... 4,200,000



Construction in Progress .................................. 275,000


Contracts ..................................................... 2,500,000

*$9,050,000 – ($4,525,000 + $2,300,000) = $2,225,000

Progress Billings on Construction Contracts . 10,000,000

Construction in Progress .............................. 10,000,000

8–33. 2007 Construction in Progress .................................. 7,200,000




Contracts ..................................................... 7,200,000

Cash .................................................................... 6,500,000






Contracts ..................................................... 6,500,000

Cash .................................................................... 6,400,000


Anticipated Loss on Long-Term Construction

Contracts ........................................................... 700,000*

Construction in Progress .............................. 700,000

$700,000 of loss recognized in 2008.

*Contract price .................................... $ 21,000,000

Costs incurred 2007–2008 .............. $13,900,000

Estimated cost to complete ........... 7,800,000 21,700,000

Estimated loss ................................ $ (700,000)

Chapter 8 287

8–33. (Concluded)





Contracts ..................................................... 7,300,000

Cash .................................................................... 8,100,000


Progress Billings on Construction Contracts . 21,000,000


Construction Contracts .............................. 21,000,000

Cost of Long-Term Construction Contracts .... 21,100,000

Construction in Progress .............................. 21,100,000

8–34. Costs— Estimated Cost Estimated Contract

2008 to Complete Total Cost Price

Basic contract ................ $ 8,000,000 $ 28,000,000 $36,000,000 $42,000,000

Change Order 1 .............. 50,000 50,000 100,000 125,000

Change Order 2 .............. — 50,000 50,000 —

Change Order 3 .............. 300,000 300,000 600,000 600,000

Change Order 4 .............. 125,000 — 125,000 100,000

$ 8,475,000 $ 28,400,000 $36,875,000 $42,825,000

Percentage completed:

$8,475,000/$36,875,000 = 22.98%

Revenues: 22.98% $42,825,000 ................................. $ 9,841,185

Costs actually incurred................................................. 8,475,000

Gross profit to be recognized in 2008 ......................... $ 1,366,185

8–35. 2008

Apr. 1 Cash .................................................................... 600

Unearned Equipment Use Fees .................... 505

Unearned Evaluation Fees ............................ 72

Unearned Magazine Fees .............................. 23

To record receipt of cash and establish

liabilities for services owed.

Unearned equipment use fee: [$700/($700 + $100 + $32)] $600 = $505

Unearned evaluation fee: [$100/($700 + $100 + $32)] $600 = $72

Unearned magazine fee: [$32/($700 + $100 + $32)] $600 = $23

Chapter 8

288

8–35. (Concluded)

Apr. 1 Deferred Initial Equipment Use Cost ................ 101

Deferred Initial Evaluation Cost ........................ 14

Deferred Initial Magazine Cost .......................... 5

Cash ................................................................ 120

To record prepayment of costs.

Deferred initial equipment use cost: [$700/($700 + $100 + $32)] $120 = $101

Deferred initial evaluation cost: [$100/($700 + $100 + $32)] $120 = $14

Deferred initial magazine cost: [$32/($700 + $100 + $32)] $120 = $5

1 Initial Evaluation Costs ...................................... 64

Deferred Initial Evaluation Cost .................... 14

Cash ................................................................ 50

To record costs of initial fitness

evaluation.

1 Unearned Evaluation Fees ................................ 72

Fitness Evaluation Fees ................................ 72

To recognize revenue from fitness

evaluation.

Apr.– Equipment Use Costs ........................................ 129

Dec. Magazine Costs .................................................. 6

Cash ................................................................ 135

Total direct costs of rendering equipment and

magazine service: 9 months $15 = $135.

Equipment use costs: [$700/($700 + $32)] $135 = $129

Magazine costs: [$32/($700 + $32)] $135 = $6

Dec. 31 Unearned Magazine Fees ................................... 17

Magazine Fees ............................................... 17

To recognize 9 months’ revenue on magazine;

$23 (9/12) = $17.

31 Unearned Equipment Use Fees ......................... 379

Equipment Use Fees ...................................... 379

To recognize 9 months’ revenue from equipment

use; $505 (9/12) = $379.

31 Equipment Use Costs ........................................ 76

Deferred Initial Equipment Use Cost ............ 76

To recognize 9 months’ cost of equipment use;

$101 (9/12) = $76.

31 Magazine Costs .................................................. 4

Deferred Initial Magazine Cost ...................... 4

To recognize 9 months’ cost of magazines;

$5 (9/12) = $4.

Chapter 8 289

8–36. 2007 2008 2009

Installment Accounts Receivable—2007............. 150,000



Installment Sales ............................................. 150,000 180,000 225,000

Cost of Installment Sales* .................................... 111,000 127,800 153,000

Inventory .......................................................... 111,000 127,800 153,000

Cash† ..................................................................... 30,000 96,000 147,000

Installment Accounts Receivable—2007 ....... 30,000 60,000 30,000

Installment Accounts Receivable—2008 ....... 36,000 72,000

Installment Accounts Receivable—2009 ....... 45,000

Installment Sales .................................................. 150,000 180,000 225,000

Cost of Installment Sales ............................... 111,000 127,800 153,000

Deferred Gross Profit—2007 .......................... 39,000



Deferred Gross Profit—2007‡ .............................. 7,800 15,600 7,800

Deferred Gross Profit—2008§ .............................. 10,440 20,880

Deferred Gross Profit—2009# .............................. 14,400

Realized Gross Profit on Installment Sales .. 7,800 26,040 43,080

COMPUTATIONS:

2007 2008 2009

*$150,000 0.74 = $111,000 $180,000 0.71 = $127,800 $225,000 0.68 = $153,000

†0.20 $150,000 = $30,000 0.40 $150,000 = $60,000 0.20 $150,000 = $30,000

0.20 $180,000 = $36,000 0.40 $180,000 = $72,000

0.20 $225,000 = $45,000

‡$30,000 0.26 = $7,800 $60,000 0.26 = $15,600 $30,000 0.26 = $7,800

§$36,000 0.29 = $10,440 $72,000 0.29 = $20,880

#$45,000 0.32 = $14,400

290 Chapter 8

8–37. The key to this solution is solving the gross profit percentage for

2007 (3).

1. $39,000 ($50,000 – $11,000)

2. $11,000 ($50,000 0.22)

3. 22%: 2008 realized gross profit on 2008 cash collections, $5,000

($20,000 0.25)

2008 realized gross profit on 2007 cash collections, $5,500

($10,500 – $5,000)

Gross profit percentage—2007, 22% ($5,500/$25,000

cash collections)

4. $5,000 ($1,100/0.22)

5. $60,000 ($80,000 – $20,000)

6. $20,000 ($80,000 0.25)

7. $120,000 ($91,800 + $28,200)

8. 23.5% ($28,200/$120,000)

9. $25,275: 2009 realized gross profit on 2007 cash collections,

($10,000 0.22) $ 2,200

2009 realized gross profit on 2008 cash collections,

($50,000 0.25) 12,500

2009 realized gross profit on 2009 cash collections,

($45,000 0.235) 10,575

$25,275

Chapter 8 291

8–38. 2007 2008 2009 2010

Installment Accounts Receivable—2007........... 47,000




Installment Sales ........................................... 47,000 45,000 58,000 61,000

Cost of Installment Sales ................................... 25,850 26,100 30,740 31,110

Inventory ........................................................ 25,850 26,100 30,740 31,110

Cash ..................................................................... 25,850 38,850 50,100 55,450

Installment Accounts Receivable—2007 ..... 25,850 14,100 4,700

Installment Accounts Receivable—2008 ..... 24,750 13,500 4,500

Installment Accounts Receivable—2009 ..... 31,900 17,400

Installment Accounts Receivable—2010 ..... 33,550

Installment Sales ................................................ 47,000 45,000 58,000 61,000

Cost of Installment Sales ............................. 25,850 26,100 30,740 31,110

Deferred Gross Profit—2007 ........................ 21,150




Deferred Gross Profit—2007 .............................. 14,100* 4,700

Deferred Gross Profit—2008 .............................. 12,150† 4,500

Deferred Gross Profit—2009 .............................. 1,160‡ 17,400

Deferred Gross Profit—2010 .............................. 2,440§

Realized Gross Profit .................................... 14,100 18,010 24,340

COMPUTATIONS:

*Cost recovered in 2007 ‡$31,900 – $30,740 = $1,160

†$26,100 – $24,750 = $1,350 cost to recover after 2008

§$33,550 – $31,110 = $2,440

$13,500 – $1,350 = $12,150

Gross profit recognized 2007 2008 2009 2010

Full accrual ................................................................................................... $21,150 $18,900 $27,260 $29,890

Cost recovery method ................................................................................. 0 14,100 18,010 24,340

292 Chapter 8

8–39. 2007 2008 2009

Installment sales ............................................ $92,000 $103,000 $115,000*

Cost of installment sales .............................. 58,880† 62,830 74,750

Gross profit percentage ................................ 36% 39%‡ 35%

Cash collections:

2007 sales .................................................. 27,200 48,300 12,200

2008 sales .................................................. 36,600 33,280§

2009 sales .................................................. 43,450

Realized gross profit on installment sales .. 0# 16,620** 19,250

††

COMPUTATIONS: *$74,750/0.65 = $115,000

†$92,000 0.64 = $58,880

‡1 – ($62,830/$103,000) = 39%

§Gross profit recognized in 2009 ........................... $19,250

All costs from 2007 sales are recovered

Cash received equals gross profit ....................... 12,200

All costs from 2009 sales are not recovered

Cash received goes to recover costs—gross

profit .................................................................. 0

Gross profit reported in 2009 from 2008 sales ... $ 7,050

Cost of 2008 sales ................................................. $ 62,830

Costs recovered in 2008 ....................................... 36,600

Costs to be recovered in 2009 ........................ 26,230

Cash received related to 2008 sales ..................... $33,280

#Cash collections in 2007 do not exceed cost of sales

Realized gross profit in 2007 = $0 **Cash collections for 2007 sales

($27,200 + $48,300) ...................................... $75,500

Cost of 2007 sales ........................................... 58,880

Realized gross profit in 2008 .......................... $16,620

††

Cash collections for 2007 sales ........................... $12,200

Cash collections for 2008 sales ..........................

($36,600 + $33,280) ...................................... $ 69,880

Cost of 2008 sales ........................................... 62,830

7,050

Realized gross profit in 2009 .......................... $19,250

Chapter 8 293

PROBLEMS

8–40.

1. Consignor books:

Inventory on Consignment ................................................ 250,000

Inventory ....................................................................... 250,000

Commission Expense ($220,000 0.10) ........................... 22,000

Receivable from Consignee ............................................... 198,000

Consignment Sales ....................................................... 220,000

Cost of Consignment Goods Sold .................................... 176,000*

Inventory on Consignment ........................................... 176,000

*Cost of goods sold: $220,000/1.25 = $176,000

Cash..................................................................................... 139,000

Receivable from Consignee ......................................... 139,000

2. Consignee books:

Cash..................................................................................... 220,000

Payable to Consignor ................................................... 220,000

Payable to Consignor ......................................................... 22,000

Commission Revenue ................................................... 22,000

Payable to Consignor ......................................................... 139,000

Cash ............................................................................... 139,000

3. Consignor financial statements:

Balance Sheet—Asset section

Receivable from consignee ................................................... $ 59,000

Inventory on consignment ..................................................... 74,000

Income Statement

Consignment sales ................................................................. $220,000

Less cost of consignment sales ........................................... 176,000 $44,000

Commission expense ............................................................ 22,000

Profit from consignments ...................................................... $22,000

Chapter 8

294

8–41.

1. Cash..................................................................................... 15,000

Rent Revenue ................................................................ 15,000

Contingent Rent Receivable .............................................. 4,000

Contingent Rent Revenue ............................................ 4,000

2. Cash..................................................................................... 15,000

Rent Revenue ................................................................ 15,000



Contingent rent revenue: ($300,000 – $250,000) 0.04 =

$2,000

3. Cash..................................................................................... 15,000

Rent Revenue ................................................................ 15,000

Contingent Rent Revenue .................................................. 6,000

Contingent Rent Receivable ($4,000 + $2,000) ........... 6,000

4. Cash..................................................................................... 15,000

Rent Revenue ................................................................ 15,000



Total renter sales for the year: $350,000 + $300,000 +

$340,000 + $400,000 = $1,390,000

Contingent rent revenue: ($1,390,000 – $1,000,000)

0.04 = $15,600

Cash..................................................................................... 15,600

Contingent Rent Receivable ........................................ 15,600

Chapter 8 295

8–42. 1. Project A Project B Project C Project D

2008 2009 2008 2009 2008 2009 2008 2009

(1) Contract price ........................... $ 1,450,000 $ 1,450,000 $ 1,700,000 $ 1,700,000 $ 850,000 $ 850,000 $ 1,000,000

(2) Actual cost incurred to date .... $ 840,000 $ 1,320,000 $ 720,000 $ 1,060,000 $ 160,000 $ 591,500 $ 280,000

(3) Estimated cost to complete ..... 560,000 0 880,000 650,000 480,000 58,500 520,000

(4) Total estimated cost [(2) + (3)] $ 1,400,000 $ 1,320,000 $ 1,600,000 $ 1,710,000 $ 640,000 $ 650,000 $ 800,000

(5) Total estimated gross profit .... $ 50,000 $ 130,000 $ 100,000 $ (10,000) $ 210,000 $ 200,000 $ 200,000

(6) Percentage completed

[(2)/(4)] ..................................... 60% 100% 45% 62% 25% 91% 35%

(7) Recognized revenue to date

[(1) (6)] .................................. $ 870,000 $ 1,450,000 $ 765,000 $ 1,054,000 $ 212,500 $ 773,500 $ 350,000

(8) Recognized revenue

recovered in prior years ....... — 870,000 — 765,000 — 212,500 —

(9) Recognized revenue

current year [(7) – (8)] ............ $ 870,000 $ 580,000 $ 765,000 $ 289,000 $ 212,500 $ 561,000 $ 350,000

(10) Cost to date (2).......................... $ 840,000 $ 1,320,000 $ 720,000 $ 1,064,000* $ 160,000 $ 591,500 $ 280,000

(11) Cost—prior years ..................... — 840,000 — 720,000 — 160,000 —

(12) Cost—current year [(10) – (11)] $ 840,000 $ 480,000 $ 720,000 $ 344,000 $ 160,000 $ 431,500 $ 280,000

(13) Gross profit (loss) [(9) – (12)] .. $ 30,000 $ 100,000 $ 45,000 $ (55,000) $ 52,500 $ 129,500 $ 70,000 2008 2009

Total gross profit .................................................. $ 127,500 $ 244,500

Less general and admin. expenses .................... 60,000 60,000

Net income ............................................................. $ 67,500 $ 184,500 *$1,054,000 (cumulative revenue) + $10,000 (full amount of loss) = $1,064,000 2. Completed contract—2009

Project A ................................................................................................................................................................................. $ 130,000

Project B (loss deducted in year it is determined) ............................................................................................................ (10,000)

Total income ....................................................................................................................................................................... $ 120,000

General and administrative expenses ................................................................................................................................ 60,000

Income using completed-contract method ..................................................................................................................... $ 60,000

296 Chapter 8

8–43.

1. a. 2006 2007 2008 2009 (1) Contract price .............. $60,000,000 $60,000,000 $60,000,000 $60,000,000

(2) Actual cost incurred

to date ....................... $12,000,000 $30,160,000 $45,000,000 $55,000,000

(3) Estimated cost to

complete ................... 38,000,000 27,840,000 10,555,555 0

(4) Total estimated cost ... $50,000,000 $58,000,000 $55,555,555 $55,000,000

Percentage of

completion (2)/(4) .... 24% 52% 81% 100%

To Recognized in Recognized in

Date Prior Years Current Year

2006:

Recognized revenue

($60,000,000 0.24) ................... $14,400,000 — $14,400,000

Cost (actual cost) ...................... 12,000,000 — 12,000,000

Gross profit ................................ $ 2,400,000 $ 2,400,000 2007:

Recognized revenue

($60,000,000 0.52) ................... $31,200,000 $14,400,000 $16,800,000

Cost (actual cost) ...................... 30,160,000 12,000,000 18,160,000

Gross profit (loss) ..................... $ 1,040,000 $ 2,400,000 $ (1,360,000) 2008:

Recognized revenue

($60,000,000 0.81) ................... $48,600,000 $31,200,000 $17,400,000

Cost (actual cost) ...................... 45,000,000 30,160,000 14,840,000

Gross profit ................................ $ 3,600,000 $ 1,040,000 $ 2,560,000 2009:

Recognized revenue .................. $60,000,000 $48,600,000 $11,400,000

Cost ............................................ 55,000,000 45,000,000 10,000,000

Gross profit ................................ $ 5,000,000 $ 3,600,000 $ 1,400,000 2010: No gross profit recognized, only cash collection.

b. No revenue, cost, or gross profit recognized for years 2006–2008.

In 2009:

Gross revenue ......................... $60,000,000

Cost of earned revenue .......... 55,000,000

Gross profit .......................... $ 5,000,000

None in 2010.

Chapter 8 297

8–43. (Concluded)

2. 2006 2007 2008 2009

Construction in Progress.................. 12,000,000 18,160,000 14,840,000 10,000,000

Materials, Labor, Cash, etc. ........ 12,000,000 18,160,000 14,840,000 10,000,000

Accounts Receivable ......................... 13,000,000 15,500,000 17,000,000 14,500,000


Construction Contracts ........... 13,000,000 15,500,000 17,000,000 14,500,000

Cash..................................................... 12,000,000 13,500,000 15,000,000 15,000,000

Accounts Receivable................... 12,000,000 13,500,000 15,000,000 15,000,000

Cost of Long-Term Construction

Contracts ......................................... 12,000,000 18,160,000 14,840,000 10,000,000

Construction in Progress.................. 2,400,000 1,360,000 2,560,000 1,400,000


Construction Contracts ........... 14,400,000 16,800,000 17,400,000 11,400,000


Contracts ......................................... 60,000,000

Construction in Progress ........... 60,000,000

2010 Journal Entry:

Cash .............................................. 4,500,000

Accounts Receivable ............ 4,500,000

298 Chapter 8

8–44.

1. a. Percentage of Completion: Project A Project B Project C Project D

(1) Contract price .................................... $ 310,000 $ 415,000 $ 350,000 $ 300,000 (2) Actual cost incurred to date ............. $ 187,500 $ 195,000 $ 310,000 $ 16,500

(3) Estimated cost to complete .............. 12,500 255,000 0 183,500

(4) Total estimated cost [(2) + (3)] .......... $ 200,000 $ 450,000 $ 310,000 $ 200,000 (5) Total estimated gross profit (loss)

[(1) – (4)] ......................................... $ 110,000 $ (35,000) $ 40,000 $ 100,000 (6) Percentage completed [(2)/(4)] ......... 93.75% 43.33% 100% 8.25% (7) Earned revenue in current period

[(1) (6)] ......................................... $ 290,625 $ 179,820 $ 350,000 $ 24,750 (8) Cost of earned revenue in current

period (2)........................................ 187,500 214,820* 310,000 16,500

(9) Gross profit (loss) [(7) – (8)] ............. $ 103,125 $ (35,000) $ 40,000 $ 8,250

*$179,820 + $35,000 loss = $214,820

b. Completed Contract:

Project C ........................................................... $ 350,000

Less: Cost incurred ......................................... 310,000 $ 40,000 Project B ........................................................... $ 415,000

Less: Total estimated cost .............................. 450,000 (35,000) Total gross profit—2008 ............................... $ 5,000

2. Costs in Excess of Billings and

Billings in Excess of Costs

Under the Completed-Contract Method

a. b.

Construction Related Costs in Excess Billings in Excess

Project in Progress Billings of Billings of Costs

A $187,500 $155,000 $32,500 —

B 160,000 249,000 — $89,000

D 16,500 4,000 12,500 —

Total $364,000 $408,000 $45,000 $89,000

Chapter 8 299

8–44. (Concluded)

3. Costs and Estimated Earnings

in Excess of Billings and Billings in Excess of

Costs and Estimated Earnings

Under the Percentage-of-Completion Method

a. b.

Costs and Billings

Estimated in Excess of

Earnings in Costs and

Costs and Related Excess of Estimated

Project Estimated Earnings Billings Billings Earnings

A $290,625 $155,000 $135,625 —

B 160,000 249,000 — $89,000

D 24,750 4,000 20,750 —

Total $475,375 $408,000 $156,375 $89,000

8–45.

1. To Recognized in Recognized in


2007:

Recognized revenue

($14,000,000 0.33) ........................ $ 4,620,000 — $ 4,620,000

Cost [($4,300,000 + $8,560,000)

0.33] ......................................... 4,243,800 — 4,243,800

Gross profit ..................................... $ 376,200 $ 376,200

2008:

Recognized revenue

($14,000,000 0.62)...................... $ 8,680,000 $ 4,620,000 $ 4,060,000

Cost [($4,300,000 + $4,100,000 +

$4,700,000) 0.62] ..................... 8,122,000 4,243,800 3,878,200

Gross profit ..................................... $ 558,000 $ 376,200 $ 181,800

2009:

Recognized revenue ....................... $14,000,000 $ 8,680,000 $ 5,320,000

Cost (actual cost) ........................... 12,950,000 8,122,000 4,828,000

Gross profit .................................. $ 1,050,000 $ 558,000 $ 492,000

300 Chapter 8

8–45. (Continued)

2. 2007 2008 2009

Construction in Progress ......................... 4,300,000 4,100,000 4,550,000

Materials, Labor, Cash, etc. ................ 4,300,000 4,100,000 4,550,000

Accounts Receivable ................................ 4,000,000 5,000,000 5,000,000


Construction Contracts ................... 4,000,000 5,000,000 5,000,000

Cash ........................................................... 3,600,000 5,100,000 5,300,000

Accounts Receivable .......................... 3,600,000 5,100,000 5,300,000


Contracts ................................................ 4,243,800 3,878,200 4,828,000

Construction in Progress ......................... 376,200 181,800 492,000




Contracts ................................................ No entry No entry 14,000,000

Construction in Progress ................... 14,000,000

3. 2009: Construction in Progress................................................................................................ 4,550,000

Materials, Labor, Cash, etc. ....................................................................................... 4,550,000

Accounts Receivable ....................................................................................................... 5,000,000

Progress Billings on Construction Contracts ......................................................... 5,000,000

Cash .................................................................................................................................. 5,300,000

Accounts Receivable ................................................................................................. 5,300,000

Cost of Long-Term Construction Contracts .................................................................. 12,950,000

Construction in Progress .......................................................................................... 12,950,000

Progress Billings on Construction Contracts ............................................................... 14,000,000

Revenue from Long-Term Construction Contracts ................................................. 14,000,000

Chapter 8 301

8–45. (Concluded)

4. The following entry would be the only one different from (2):

2007 2008 2009


Contracts ................................................ 4,300,000 4,100,000 4,550,000




8–46.

1. Building 1 Building 2 Building 3 Building 4

Prior Prior Prior

to 2008 2008 to 2008 2008 to 2008 2008 2008

a. Contract price ................................. $ 4,000,000 $ 4,000,000 $ 9,000,000 $ 9,000,000 $13,150,000 $13,150,000 $ 2,500,000

b. Actual cost incurred to date .......... $ 2,070,000 $ 3,000,000 $ 6,318,000 $ 8,118,000 $ 3,000,000 $10,400,000 $ 800,000

c. Estimated cost to complete ........... 1,380,000 750,000 1,782,000 — 9,000,000 2,800,000 1,200,000

d. Total estimated cost ...................... $ 3,450,000 $ 3,750,000 $ 8,100,000 $ 8,118,000 $12,000,000 $13,200,000 $ 2,000,000

e. Total estimated gross profit (loss)

[(a) – (d)] ....................................... $ 550,000 $ 250,000 $ 900,000 $ 882,000 $ 1,150,000 $ (50,000) $ 500,000

f. Percentage of completion

[(b)/(d)] .......................................... 60% 80% 78% 100% 25% 78.79% 40%

g. Recognized revenue to date

[(a) (f)] ........................................ $ 2,400,000 $ 3,200,000 $ 7,020,000 $ 9,000,000 $ 3,287,500 $10,360,885 $ 1,000,000

h. Recognized revenue

recovered in prior periods .......... — 2,400,000 — 7,020,000 — 3,287,500 —

i. Revenue recognized in

current period .............................. $ 2,400,000 $ 800,000 $ 7,020,000 $ 1,980,000 $ 3,287,500 $ 7,073,385 $ 1,000,000

j. Cost to date (b) ............................... $ 2,070,000 $ 3,000,000 $ 6,318,000 $ 8,118,000 $ 3,000,000 $10,410,885* $ 800,000

k. Cost recognized in prior periods .. — 2,070,000 — 6,318,000 — 3,000,000 —

l. Cost recognized in current period $ 2,070,000 $ 930,000 $ 6,318,000 $ 1,800,000 $ 3,000,000 $ 7,410,885 $ 800,000

m. Gross profit (loss) [(i) – (l)] ............ $ 330,000 $ (130,000) $ 702,000 $ 180,000 $ 287,500 $ (337,500) $ 200,000 *$10,360,885 + $50,000 = $10,410,885

302 Chapter 8

8–46. (Concluded)

Prior to

2008 2008

Total revenue all buildings ................................ $12,707,500 $ 10,853,385

Total cost—all buildings ................................... 11,388,000 10,940,885

Total gross profit—all buildings .................... $ 1,319,500 $ (87,500)

2. Completed contract: 2008

Revenue—Building 2 ............................................. $ 9,000,000

Cost—Building 2 .................................................... 8,118,000

Gross profit ............................................................ $ 882,000

Less anticipated loss on Building 3 ..................... (50,000)

Adjusted gross profit .......................................... $ 832,000

8–47.

1. 2007 2008 2009

a. Actual costs incurred to date .............. $ 3,400,000 $5,950,000 $ 6,150,000

b. Estimated cost to complete contract .. 2,100,000 150,000 —

c. Total estimated cost .......................... $ 5,500,000 $ 6,100,000* $ 6,150,000 Percentage of completion to date

[(a)/(c)] ................................................ 61.82% 97.54% 100% *Results in contract loss of $100,000.



2007—(61.82% completed):

Recognized revenue

($6,000,000 0.6182) .................... $ 3,709,200 — $ 3,709,200

Cost (actual cost) ........................... 3,400,000 — 3,400,000

Gross profit .................................. $ 309,200 $ 309,200

2008—(97.54% completed):

Recognized revenue

($6,000,000 0.9754) .................... $ 5,852,400 $ 3,709,200 $ 2,143,200

Cost (recognized revenue plus

anticipated loss) .......................... 5,952,400 3,400,000 2,552,400

Gross profit (loss) .......................... $ (100,000) $ 309,200 $ (409,200)

2009—(100% completed):

Recognized revenue ....................... $ 6,000,000 $ 5,852,400 $ 147,600

Cost (actual cost) ........................... 6,150,000 5,952,400 197,600

Gross profit (loss) ........................ $ (150,000) $ (100,000) $ (50,000)

Chapter 8 303

8–47. (Concluded)

2. 2007 2008 2009

Construction in Progress ......................... 3,400,000 2,550,000 200,000

Materials, Labor, Cash, etc. ................ 3,400,000 2,550,000 200,000

Actual costs incurred.

Accounts Receivable ................................ 3,200,000 2,000,000 800,000


Construction Contracts ................... 3,200,000 2,000,000 800,000

To record progress billings.

Cash ........................................................... 3,000,000 2,000,000 600,000

Accounts Receivable .......................... 3,000,000 2,000,000 600,000

To record collections on

progress billings.


Contracts ................................................ 3,400,000 2,552,400 197,600



Construction Contracts ................... 3,709,200 2,143,200 147,600

To recognize revenue and

expense for the period.

3. 2010: Cash .............................................................................. 400,000

Accounts Receivable ............................................. 400,000

To record final collections on contracts.

Progress Billings on Construction Contracts ........... 6,000,000

Construction in Progress ...................................... 6,000,000

To close out construction accounts.

304 Chapter 8

8–48.

1. 2007 2008 2009 2010 Contract price .......................... $17,000,000 $ 17,000,000 $17,000,000 $17,000,000

Costs incurred to date ............. $ 6,400,000 $ 11,600,000 $15,700,000 $16,700,000

Estimated costs to complete .. 8,700,000 4,600,000 1,500,000 0

Total estimated costs .............. $ 15,100,000 $ 16,200,000 $17,200,000 $16,700,000

Total expected profit ............. $ 1,900,000 $ 800,000 $ (200,000) $ 300,000

Percentage of completion ....... 42.38% 71.60% 91.28% 100.00%



2007:

Recognized revenue

($17,000,000 0.4238) ....................... $ 7,204,600 $7,204,600

Cost (actual cost) ................................. 6,400,000 6,400,000

Gross profit ......................................... $ 804,600 $ 804,600

2008:

Recognized revenue

($17,000,000 0.7160) ....................... $12,172,000 $ 7,204,600 $4,967,400

Cost (actual cost) ................................. 11,600,000 6,400,000 5,200,000

Gross profit (loss) ................................ $ 572,000 $ 804,600 $ (232,600)

2009:

Recognized revenue

($17,000,000 0.9128) ....................... $15,517,600 $12,172,000 $3,345,600

Cost (recognized revenue plus

entire anticipated loss) ..................... 15,717,600 11,600,000 4,117,600

Gross profit (loss) ................................ $ (200,000) $ 572,000 $ (772,000)

2010:

Recognized revenue ............................ $17,000,000 $15,517,600 $1,482,400

Cost (actual cost) ................................. 16,700,000 15,717,600 982,400

Gross profit (loss) ................................ $ 300,000 $ (200,000) $ 500,000

2. 2007 2008 2009 2010

Construction in Progress 6,400,000 5,200,000 4,100,000 1,000,000

Materials, Labor,

Cash, etc. .................. 6,400,000 5,200,000 4,100,000 1,000,000 Cost of Long-Term

Contracts ..................... 6,400,000 5,200,000 4,117,600 982,400

Construction in Progress 804,600 232,600 772,000 500,000

Revenue from Long-

Term Contracts ........ 7,204,600 4,967,400 3,345,600 1,482,400

Chapter 8 305

8–49.

2008 Inventory ............................................................................ 45,200

Cash .............................................................................. 45,200

Notes Receivable—2008 ($32,000 + $62,000 + $3,600) ... 97,600

Unearned Interest Revenue ($7,167 + $3,600) ........... 10,767


Cost of Installment Sales ($45,200 – $2,000 inventory

increase) .......................................................................... 43,200

Inventory ....................................................................... 43,200

Cash ................................................................................... 35,600

Notes Receivable—2008 .............................................. 35,600

Unearned Interest Revenue—2008 ................................... 3,600

Interest Revenue .......................................................... 3,600


Cost of Installment Sales ............................................ 43,200

Deferred Gross Profit on Installment Sales—2008 .... 43,633

Deferred Gross Profit on Installment Sales—2008 ......... 16,080*

Realized Gross Profit on Installment Sales ............... 16,080

*Gross profit percentage: 50.25% ($43,633/$86,833);

0.5025 $32,000 = $16,080

2009 Inventory ............................................................................ 52,020

Cash .............................................................................. 52,020

Notes Receivable—2009 ................................................... 89,500*

Unearned Interest Revenue ......................................... 11,955‡


*$60,000 + ($50,000 + $5,500) – $26,000† = $89,500

†2008 Notes receivable collected in 2009.

‡Interest revenue from 2008 notes: $7,167 – $5,579 = $1,588

Interest revenue from 2009 notes: $5,500 – $1,588 = $3,912

Unearned interest revenue at end of 2009 ..................... $ 8,043

Interest revenue from 2009 notes (see above) ............... 3,912

Total unearned interest revenue at time of sale ............ $11,955

Cost of Installment Sales ($52,020 – $8,000) ................... 44,020

Inventory ....................................................................... 44,020

Cash ................................................................................... 55,500

Notes Receivable—2008 ($62,000 – $36,000) ............. 26,000

Notes Receivable—2009 .............................................. 29,500§

§$89,500 – $60,000 = $29,500

Chapter 8

306

8–49. (Concluded)

Unearned Interest Revenue—2008 ........................................ 1,588

Unearned Interest Revenue—2009 ........................................ 3,912

Interest Revenue................................................................ 5,500

Installment Sales ..................................................................... 77,545

Cost of Installment Sales .................................................. 44,020

Deferred Gross Profit on Installment Sales—2009 ......... 33,525

Deferred Gross Profit on Installment Sales—2008

($26,000 – $1,588 = $24,412; $24,412 0.5025) .................... 12,267

Deferred Gross Profit on Installment Sales—2009 ............... 11,062*

Realized Gross Profit on Installment Sales ..................... 23,329

*Gross profit percentage: 43.23% ($33,525/$77,545);

0.4323 ($29,500 – $3,912) = $11,062

8–50.

2007 2008 2009 Installment A/R—2007 ................ 102,000

Installment A/R—2008 ................ 111,000

Installment A/R—2009 ................ 124,000

Installment Sales ................... 102,000 111,000 124,000

Cost of Installment Sales ........... 64,260 66,600 75,640

Inventory ................................ 64,260 66,600 75,640

Cash ............................................. 58,320 117,380 147,280

Installment A/R—2007 ........... 51,600 30,150 16,000

Installment A/R—2008 ........... 68,520 30,200

Installment A/R—2009 ........... 75,130

Interest Revenue ................... 6,720 18,710 25,950

Installment Sales ........................ 102,000 111,000 124,000

Cost of Installment Sales...... 64,260 66,600 75,640

Deferred Gross Profit—2007 37,740



Deferred Gross Profit—2007 ...... 19,092* 11,156† 5,920

§

Deferred Gross Profit—2008 ...... 27,408‡ 12,080

#

Deferred Gross Profit—2009 ...... 29,301**

Realized Gross Profit ............ 19,092 38,564 47,301 *

$51,600 0.37 = $19,092 †

$30,150 0.37 = $11,156 ‡

$68,520 0.40 = $27,408 §

$16,000 0.37 = $5,920 #

$30,200 0.40 = $12,080 **$75,130 0.39 = $29,301

Chapter 8 307

8–51.

1. a. Percentage of completion Period 1 Period 2 Period 3 Period 4 (1) Contract price ........................... $ 4,500,000 $ 4,500,000 $ 4,500,000 $ 4,500,000

(2) Actual costs incurred to date ... $ 900,000 $ 2,100,000 $ 3,180,000 $ 3,600,000

(3) Estimated cost to complete

contract .................................... 2,700,000 1,500,000 420,000 0

(4) Total estimated cost ................. $ 3,600,000 $ 3,600,000 $ 3,600,000 $ 3,600,000

(5) Total expected profit .............. $ 900,000 $ 900,000 $ 900,000 $ 900,000

Percentage of completion to date

[(2)/(4)] ............................................... 25% 58.33333% 88.33333% 100%



Period 1:

2008—(25% completed)

Recognized revenue

($4,500,000 0.25) ....................... $ 1,125,000 — $1,125,000

Cost (actual cost) ........................... 900,000 — 900,000

Gross profit .................................. $ 225,000 $ 225,000

Period 2:

2008—(58.33333% completed)

Recognized revenue

($4,500,000 0.5833333) .............. $ 2,625,000 $ 1,125,000 $1,500,000

Cost (actual cost) ........................... 2,100,000 900,000 1,200,000

Gross profit .................................. $ 525,000 $ 225,000 $ 300,000

Period 3:

2009—(88.33333% completed)

Recognized revenue

($4,500,000 0.8833333) .............. $ 3,975,000 $ 2,625,000 $1,350,000

Cost (actual cost) ........................... 3,180,000 2,100,000 1,080,000

Gross profit .................................. $ 795,000 $ 525,000 $ 270,000

Period 4:

2009—(100% completed)

Recognized revenue ....................... $ 4,500,000 $ 3,975,000 $ 525,000

Cost ................................................. 3,600,000 3,180,000 420,000

Gross profit .................................. $ 900,000 $ 795,000 $ 105,000

Chapter 8

308

8–51. (Concluded)

b. Completed contract

Periods 1, 2, and 3—No revenue, costs, or gross profit. Period 4:

Revenue ............................................ $4,500,000

Costs ................................................. 3,600,000

Gross profit ...................................... $ 900,000

c. Installment sales

Anticipated revenues .................................................. $4,500,000

Anticipated costs ......................................................... 3,600,000

Anticipated gross profit .............................................. $ 900,000 Gross profit percentage .............................................. 20% Gross Profit

Period 1—0.20 $750,000 ........................................... $150,000

Period 2—0.20 $1,050,000 ........................................ 210,000

Period 3—0.20 $1,950,000 ........................................ 390,000

Period 4—0.20 $750,000 ........................................... 150,000

$900,000

d. Cost recovery

Estimated costs: $3,600,000

Payment Costs to Be Gross

Period Received Recovered Profit $ 3,600,000

1 $ 750,000 2,850,000 $ 0

2 1,050,000 1,800,000 0

3 1,950,000 0 150,000

4 750,000 0 750,000

Summary of Gross Profit under

Four Different Revenue Recognition Methods Method Period 1 Period 2 Period 3 Period 4 Percentage of completion ................. $ 225,000 $ 300,000 $ 270,000 $105,000

Completed contract ........................... — — — 900,000

Installment sales ................................ 150,000 210,000 390,000 150,000

Cost recovery ..................................... — — 150,000 750,000

2. Because the probability of collection is high for most municipalities, the

percentage-of-completion method would best reflect the gross profit in this case.

As the uncertainty of the contract increases, either as to payment by the pur-

chaser or as to future costs, methods that defer recognition of gross profit until

later would be preferred. If only collection is doubtful, the installment sales

method is recommended. If the future costs are uncertain, either the cost recov-

ery or the completed-contract method is recommended.

Chapter 8 309

8–52.

1. The correct answer is a. To calculate the income in the fourth and final year of a

contract accounted for by the percentage-of-completion method, the total profit

would first be calculated by comparing the contract price to actual total costs.

The amount would then be reduced by the income previously recognized to give

the amount to be recognized in the fourth year.

2. The correct answer is d. A nonrefundable lease bonus should be recognized as

revenue over the lease term. The receipt of the lease bonus creates deferred rev-

enue.

Chapter 8

310

CASES

Discussion Case 8–53

This case is designed to contrast the point of revenue recognition with respect to the completed-contract method of accounting and the percentage-of-completion method. The discussion should focus on the appropriateness and advantages and disadvantages of each method in terms of reporting a realistic income figure. The previous accountant's policy of deferring all expenses and revenues to the period of completion conforms to the concept that revenue is not recognized until an actual exchange has taken place. The argument is that revenue emerges from sales, not production. Actually, revenue is earned continuously. The question is when to recognize it. If there are significant uncertainties involved as to the actual sales price or collectibility, the completed-contract method followed by the previous accountant has merit. By contrast, the percentage-of-completion method recognizes revenues as they are earned over the period of the projects instead of at completion. This method is acceptable, and generally preferable, when a firm contract for a sale exists, and the costs remaining to be incurred on the project can be estimated with reasonable accuracy.


This case can be used to discuss the rationale underlying percentage-of-completion accounting and to explore areas not specifically included in the identified questions. It should be emphasized that the tax method used does not have to coincide with the book method and that the completed-contract method is available for tax purposes with some limitations. Income tax allocation procedures would be necessary if the methods do not agree. This topic is covered in a later chapter. The requirement to recognize losses entirely in the period when first identified is the same regardless of the accounting method used. It is based on the valuation principle that inventory should not be valued at more than its net realizable value. If the costs to date plus expected future costs exceed the contract price, the excess must be deducted from the cost incurred to date if the net realizable value principle is to be followed. Discussion could include rationale for this approach, including the historical tendency to be conservative in applying the percentage-of-completion method. The discussion could also focus on the uncertainty that often arises when applying this method and the extreme care that is necessary in computing the percentage of completion and the estimation of future costs.


1. The revenue recognized on a long-term contract under the percentage-of-completion method is determined by applying a percentage representing the degree of completion to the total contract price at the end of the accounting period. The percentage is derived by dividing the costs incurred to date by the total estimated costs of the entire contract based on the most recent information. The percent-age may also be derived by other input or output measures of progress, such as engineering or architectural estimates, the ratio of direct labor costs incurred to date to total estimated labor costs, or the ratio of direct labor hours incurred to estimated total direct labor hours.

If the cost-to-cost method is used, the costs incurred are deducted from the recognized revenue to

determine the recognized gross profit. If another measure is used, the percentage of completion is applied to the total estimated costs to determine the costs to be recognized in the current period. As an alternative, the costs incurred may be increased by the gross profit earned on the contract in the period to determine total revenues. If it is anticipated that a loss will occur on the contract, the full amount of the expected loss is recognized in the period it is first determined.

Chapter 8 311

Discussion Case 8–55 (Concluded)

In subsequent periods, because the percentage-of-completion method described produces cumulative results, gross profit recognized in prior periods must be subtracted to obtain current earnings to be recognized.

Under the completed-contract method, no earnings are recognized until the contract is substantially

completed. For the period in which completion occurs, gross revenues include the total contract price. Total job costs incurred are deducted from gross revenues, resulting in recognition of the entire amount of gross profit in the completion period. If it is expected that a loss will occur on the contract, a provision for loss should be recognized immediately.

2. The percentage-of-completion method is preferable when estimates of the bases upon which pro-

gress is measured are reasonably dependable. The completed-contract method is preferable when inherent hazards or lack of dependable estimates cause the forecasts to be of doubtful value.

3. Interim billings on long-term contracts are not generally accepted as a method of recognizing earnings

because such billings often do not bear a meaningful relationship to the work performed on the con-tract. Typically, billings may be accelerated in the early stages of the contract to provide the contractor with the working capital needed to begin performance. If earnings were recognized on a billings basis, it would be possible for a contractor to materially distort the contractor's earnings merely by rendering billings without regard to any degree of progress on the contract.


This case can be used to introduce the very difficult revenue recognition problems that face companies in service industries. The membership fee should not be recognized immediately because there has not been substantial completion of the earnings process. In addition, no separate chunk of revenue should be allocated to the initial sign-up process and recognized immediately because customers are not willing to pay merely to be signed up for a membership; they are paying the initial fee to receive future membership services. Instead, the membership fee should be recognized on a straight-line basis for the economic life of the agreement. A very difficult question is whether some of the initial fee revenue should be separately deferred and allocated to the special courses and programs that a customer is expected to take, at a dis-count, during the term of the membership. Doing this would require reliable historical data on which to base the estimates. This case is based on the experience of an actual company. In the actual case situation, the studios recognized the entire membership fee as revenue at the time of the initial contract. Little or no provision was made for future membership services. In the initial promotion, memberships were sold easily to those most interested in the services rendered by such institutions. This made the revenue and income for newly opened studios high. As the particular studios matured and settled into more normal operations, the reve-nue and income slowed down to a more stable state. The overall company statements continued to show increasing revenue and income by opening new studios at an accelerated rate. This had its eventual limits. The sale of the company was near completion when the impact of these facts was understood by the prospective purchaser. Preparation of revised statements disclosed the real conditions existing and led to a withdrawal, with penalty, of the offer to buy. Although not part of the revenue recognition problem, further analysis indicated that some mortgages, especially second mortgages, had not been properly recorded, which added to the unattractiveness of the studios to potential buyers.

Chapter 8

312


This case provides a basis for a class discussion on the difficulty of being precise in determining when revenue is to be recognized. The following points concerning each of the four methods enumerated in the case will be helpful in conducting a discussion of this case. Method 1: Recognize revenue when advance billing is made. Strengths The advertising contract stresses the development of the advertising copy as a principal service. Because of past experience, it apparently has been possible to estimate the costs to develop the copy, the media cost, and possible loss from uncollectible accounts at the time the contract is signed. The critical event under this revenue recognition method is signing the contract. Adjustments to the esti-mates are small, and thus a very early revenue recognition point is possible. Weaknesses The revenue recognition criteria state that there should be substantial performance of all services before revenue is recognized. At the signing of the contract, the service to be performed is still in the future. Being able to estimate costs is only one of the prerequisites for revenue recognition. Accurate past estimates do not guarantee accurate future estimates. It is unacceptable to recognize revenue for services to be rendered on the basis of only a signed contract. Method 2: Recognize revenue when payment is received from the client. Strengths The receipt of payment from the client adds one objective dimension to recognizing revenue. One less item must be estimated: the possible uncollectible accounts. Receipt of cash in this case assures the agency that the contract is firm and that there is no misunderstanding as to the contractual payment terms. Weaknesses Depending on what services are performed before the payment is received, this method has many of the same weaknesses as the first method. There is not necessarily a connection between the timing of cash receipts and the performance of advertising services. The services may be substantially performed prior to cash collection, in which case collection may be too late to properly recognize revenue. On the other hand, collection may be made before the services are rendered, in which case cash collection is too early. Method 3: Recognize revenue in the month when advertising appears in the media. Strengths By the time the advertisement appears in the media, there is no doubt that the agency has delivered the contracted services. The advertisement has been designed and has been placed in the media. This point of revenue recognition is more closely aligned with traditional revenue recognition practices. Students who like to follow a majority position will probably favor this method. Weaknesses Even though services have been rendered, there is still uncertainty as to the cost of the media services. This may or may not be serious, depending on the variability and predictability of the media costs. Contin-gent on payment timing, bad debt expense may still have to be estimated under this method.

Chapter 8 313

Discussion Case 8–57 (Concluded)

Method 4: Recognize revenue when the bill for advertising is received from the media. Strengths At this point, all costs and revenues should be known in amount, and revenue recognition should be free of estimates and uncertainties, especially if the client paid the advance billing as has been the practice. This method should lead to high verifiability of the revenue and cost to be reported. Weaknesses This method may defer recognition of revenue too far beyond the critical performance of services. The revenue recognition principle does not require 100% certainty before revenue and costs are recognized. Income statements should reflect the efforts expended in the period of reporting, not in some later period when all uncertainties are resolved. Estimates and judgments must be applied to enhance relevance and timeliness. It is usually interesting to have students vote for their preference after all four methods have been dis-cussed. This case could also be used in a debate format. One or more students could defend each meth-od, and the class could then identify the most convincing presentation.


This case illustrates that the use of differing revenue recognition methods can affect materially a firm’s reported performance. When the uncertainty of cash collection is high and there is little penalty to the cus-tomer when default occurs, revenue recognition may be more appropriate at the point of cash collection rather than at the point of sale. In this case, there appears to be substantial doubt as to the collectibility of receivables. If 1 in 5 sales dollars is not being collected, it appears the earnings process is not complete at the point of sale. While it is unfortunate that the restated financial statements result in a significantly lower net income, the inde-pendent auditor has a responsibility to the users of the financial statements to ensure that those financial statements accurately reflect the financial position of the company.


1. Numerous possibilities exist for recognizing revenue, though not all are acceptable. One possibility is to recognize revenue when the agreement is made with partnerships to purchase the plant. Another is to recognize some revenue at the point of sale and to recognize the remainder as the notes are paid off. Midwestern elected to recognize all the revenue at the point of sale.

2. As mentioned in the case, on a cash basis, Midwestern actually had negative cash flows from opera-

tions. Thus, while the income statement reported a profit margin of 66%, the firm was actually losing cash.

3. In this case, there was substantial doubt as to whether the $45,000 partnership notes would be col-

lected. Although the plant was guaranteed to be profitable, Midwestern was overly optimistic as to the demand for ethanol gas. Midwestern should have used a revenue recognition method that related revenue recognition with cash collection. Either the installment sales method or the cost recovery method would have been appropriate.

Chapter 8

314


1. If the loan origination fee relates to work done in processing the loan, such as title and credit checks and other loan-related efforts, the firm might argue that the services related to that fee are complete once the loan is made. In 1986, the FASB released SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.” In paragraph 5 of this Statement, the FASB clearly states that “Loan origination fees shall be deferred and recognized over the life of the loan.”

2. If the collectibility of the loans is questionable, the accrual method of accounting would not be appro-priate. As discussed in the text, the likelihood of cash collections dictates whether the installment sales, cost recovery, or cash method would be most appropriate.

3. In the case of savings and loans, the deposits were federally insured by the government. Thus,

investors could make deposits in the high-risk investments knowing that they stood a chance of reap-ing a large return with very little downside risk. The government would make sure that they received their original investment back.

4. Whether or not external auditors are responsible for evaluating a firm's lending practices is to be

decided by the courts. The Federal Savings and Loan Insurance Corporation (FSLIC) filed suit against 6 of the then 8 largest CPA firms in the late 1980s, alleging negligence in conducting their audits. At least one of the major firms, Ernst & Young, settled its case out of court. The settlement was for $400 million.


1. For money received by home office from test centers, the journal entry to book the receipt of cash as revenue would be:

Cash ............................................................. XXX Revenue ................................................ XXX

However, if that money was subsequently "churned" back to the test site, a second journal entry would have to be made. The credit would be to Cash and the debit should be made to a receivable account. Any subsequent receipts of cash from the test center would then have to be analyzed to determine if the cash is revenue or a repayment of the receivable. One can see that if "churning" is occurring, the receivables account will continue to increase as revenue increases.

2. If the test center site transferring the money has an established receivable with the home office, the

accountant at the home office would have to determine if the money received was a payment on the receivable or the recognition of revenue. The answer would depend on supporting documentation. However, if the remittances increase and no payments are being made to reduce the receivable, then the accountant at the home office should begin to question why loans are not being repaid.


This case examines the issue of shipping inventory in anticipation of an order. The revenue recognition criteria require the customer to provide an asset (an accounts receivable) in order for revenue to be real-izable. In the instance where the customer has not ordered the inventory, it would be difficult to claim that the customer has provided an asset. The situation could be different if the customer has issued an open purchase order to Datarite. In this case, Datarite could argue that an open purchase order results in an accounts receivable once inventory is shipped. Such an arrangement should be very carefully scrutinized by the company’s auditor. If the company president includes the extra inventory shipments as revenue, then the debt covenants will be satisfied. Thus, in this instance, the existence of debt covenants will have resulted in the company’s performing business activities only to satisfy debt restrictions. If the sales are subsequently returned by dealers, the company will have, in effect, violated its debt covenants but will have avoided disclosing this fact to debt holders.

Chapter 8 315


This case describes a typical franchise arrangement. An initial fee is involved that covers services to be rendered before the franchise outlet is opened and some services to be recognized subsequent to the opening. Because this franchise arrangement involves installment payments, the interest implicit in the initial fee must be removed and recognized over the period of payment, in this case 5 years. Thus, the notes receivable, face value $20,000, should be reported at $15,163, the net present value of the notes at 10% interest rate. The management of Magleby would argue that because at least $5,000 worth of services are rendered at the time the contract is signed, at least this amount should be recognized as revenue at the time of open-ing. In fact, Magleby’s management would argue that at the time that a franchise opens, only two steps remain before Magleby Inn will have fully earned the entire franchise fee. First, it must provide expert advice over the 5-year period. Second, it must wait until the end of each of the next 5 years so that it may collect each of the $4,000 notes. Because collection has not been a problem and the advice may consist largely of manuals and periodical service tip fliers, it could be maintained that a substantial portion of the $15,163, the present value of the notes, should be recognized as revenue when a franchisee begins operation. The revenue recognition practice described in the previous paragraph is acceptable only if Magleby can demonstrate that the initial services provided in supervising construction, arranging financing, and so forth are a separate product. If Magleby can demonstrate that these services are a separate product, the earn-ings process for this separate product is substantially complete when a franchise opens. A portion of the initial fee could be allocated to this separate product and recognized as revenue at that time. Magleby would have to show that it, or some other firm in the same industry, offers these initial setup services as a separate product, independent of the continuing advisory services over the 5-year period. Even if it can be demonstrated that the initial services are a separate product, there is still the issue of collectibility to be considered. Although there have been no defaults on the notes, the extent of Magleby Inn’s experience may be so limited that there may in fact be a substantial collection problem in the future (as has been the actual experience of many franchisers in the recent past). At some time in the future, after Magleby Inn has experienced a large number of franchises that have opened and operated for 5 years or more, it should be possible to develop probability measures so that the earned portion of the present value of the notes may be recognized as revenue at the time the franchise begins operation. For the present, however, it might be necessary to recognize the $4,000 revenue only as the notes are collected. The monthly fee of 2% of sales should be recorded as revenue at the end of each month. This fee is for current services rendered and should be recognized as the services are performed.


The sales being made by Rain-Soft are in reality consignments and, as such, are not generally recognized as sales until they have been sold to an outside party. This case is an example of a situation in which a transaction might be labeled a sale but the terms of the side agreements between the “seller” and the “buyer” convert the transaction into a consignment arrangement. Using past experience as a guide is risky because a change in economic conditions can make past experience irrelevant to actual experience. Class discussion could focus on the legal differences between a consignment sale to a dealer, who is in reality an agent of the selling company, and an actual arm’s-length sale. Uncertainties, such as the proba-bility of cash collection and the possibility of return, still exist in arm’s-length sales, but a presumption ex-ists under these conditions that an exchange has taken place and the revenue can be recognized. A change in accounting policy is probably required in the case as described for the company to be keeping its records in accordance with GAAP. As part of this case, it is instructive to look at SFAS No. 48, “Revenue Recognition when Right of Return Exists.”

Chapter 8

316

Case 8–65

1. Revenue Recognition (from Note 2 Summary of Significant Accounting Policies)

Broadcast advertising revenues are recognized when commercials are aired. Revenues from television subscription services related to the Company's primary cable program-ming services are recognized as services are provided. Certain of the Company’s contracts with cable service providers include annual programming commitments. In the-se cases, revenue subject to the commitment is deferred until the annual commitments are satisfied which generally results in revenue shifting from the first half of the year to the second.

Revenues from advance theme park ticket sales are recognized when the tickets are used. Revenues from corporate sponsors at the theme parks are generally recognized over the period of the applicable agreements commencing with the opening of the related attraction.

Revenues from the theatrical distribution of motion pictures are recognized when motion pictures are exhibited. Revenues from video sales are recognized on the date that video units are made widely available for sale by retailers. Revenues from the licensing of feature films and television programming are recorded when the material is available for telecasting by the licensee and when certain other conditions are met.

Merchandise licensing advance and guarantee payments are recognized when the under-lying royalties are earned.

2. One possibility would be when the videos were shipped to retailers and a promise of payment was

received from retailers. 3. One possibility would be when Disney contracted with theaters to release the motion picture and the

theaters gave a promise to pay for the right to exhibit the motion picture. However, until the movie is exhibited, the promised service has not been delivered by Disney.

Case 8–66

1. Siskon recognizes revenue from its gold operations when it pours the gold—not when the gold is sold. This is an exception to the general rule of revenue recognition, but it is acceptable because of the readily available market for gold.

2. This method of revenue recognition might be a problem if the market for gold were highly volatile. As

long as the price of gold is fairly stable, this method of revenue recognition should result in a fairly stated picture of a firm's income.

3. If the market for gold were to suddenly drop and gold went from selling for $400 an ounce to $150 an

ounce, then revenues could be greatly overstated.

Case 8–67

1. Ben & Jerry’s recognizes revenue on its ice cream when the product is shipped. 2. Ben & Jerry’s sells two different types of franchises. The first is a franchise for an individual store, and

the second is a franchise for a geographical area. Revenue from franchise fees for an individual store is recognized when the services outlined in the franchise agreement have been substantially performed and the store has opened for business. Revenue relating to area franchises is recognized based on the proportion of the number of stores opened in the geographical area relative to the number of stores expected to be opened.

Chapter 8 317

Case 8–68

1. Lockheed measures the percentage of a contract completed using achievement of performance mile-stones or the cost-to-cost method. When the cost-to-cost method is used, revenues and profits are recorded based on the ratio of costs incurred to estimated total costs—just as is illustrated in the chapter.

2. For cost-reimbursed-type contracts, costs are recorded as incurred, and profits are estimated and

included based on a cost-to-cost-type estimate. 3. If changes are made to long-term contracts, those changes are reflected in the current and future

periods. Prior-period financial statements are not restated. 4. Again, any changes in estimates are reflected in the current period. 5. Students should realize that a loss for the period is accounted for differently from a loss for the con-

tract. Lockheed accounts for losses on contracts in the period in which that loss is identified.

Case 8–69

Students should address the following issues as they deal with this revenue recognition assignment: 1. Has Mitsubishi substantially completed its part of the revenue recognition process? 2. Has Mitsubishi received a valid promise of payment? 3. If Mitsubishi has received a valid promise, should it include the entire selling price as revenue in the

period of the sale, or should part of the selling price be allocated to interest and recognized over time? Ford Motor Company disclosed the following about the accounting for its 0.0% financing program:

“Costs for customer and dealer cash incentives and costs for special financing and leasing programs that we sponsor through Ford Credit (e.g., 0.0% financing program) are recognized as sales reduc-tions at the later of the date the related vehicle sales are recorded or at the date the incentive program is both approved and communicated. In general, the amount of financing cost that we provide to Ford Credit is the difference between the amounts offered to retail customers and a market-based interest or lease rate.”

Case 8–70

1. For revenues to be realized, an exchange has to have taken place. That is, the seller must have pro-

vided goods or services and the buyer must have provided cash or a claim to cash.

2. Earning revenues tends to involve a process. Revenue is recognized when that earnings process is

substantially complete. In the case of gains, there is generally not an earnings “process.” Instead,

gains (which involve peripheral activities) often involve a transaction that resolves itself over a very

short period of time.

Chapter 8

318

Case 8–71

The point of this exercise is to drive home the two basic revenue recognition criteria—realizability and substantial completion. For most companies, the substantial completion criterion is not satisfied until the point of sale because significant effort must occur to sell the product. Because gold is a commodity and has a rather sophisticated market associated with it, the substantial completion criterion has been deter-mined to be satisfied when the gold has been mined and processed and is ready for sale. But prior to this point, substantial completion has not been achieved. As a result of this case, students should realize that events can occur, over which a firm may have no con-trol, that can significantly affect the firm's financial performance.

Case 8–72

Solutions to this problem can be found on the Instructor’s Resource CD-ROM or downloaded from the Web at http://stice.swlearning.com.

sticechap08

Documents