To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER QUESTIONS separated from other inventory to the extent that they cannot be used to fill other orders The two general revenue recognition criteria 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 The presumption is that customer acceptance provisions are important to the buyer or else they wouldn’t have been included 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 The four revenue recognition criteria identified in SOP 97−2 are: a Persuasive evidence of an arrangement exists b Delivery has occurred c The vendor's fee is fixed or determinable d Collectibility is probable The first two items relate to whether revenue has been earned, and the last two relate to the realizability of the revenue Up-front, nonrefundable fees are not recognized 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 An element of a multiple-element arrangement is considered to be a unit of accounting if that element has standalone value, meaning that it can be sold separately (by anyone, not necessarily the seller) or the customer can resell it SAB 101 was issued by the SEC to curtail specific abuses in revenue recognition practices Question 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 processing customer contracts, it becomes much easier for company executives to manipulate the reported amount of revenue 10 The three different methods for determining the separate selling price of a single element in a multiple-element transaction are as follows: a Vendor-specific objective evidence (VSOE), which is the price at which the same company sells the same product or service separately b Third-party evidence (TPE), which is the price at which other companies sell the same product or service separately c Best estimate using other data such as cost and profit margin data 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 interestfree financing to the buyer 11 The three basic steps in recognizing revenue under the contract approach are as follows: a Identify the performance obligations accepted by the seller b Allocate transaction prices based on relative separate selling prices of any distinct elements of a multiple-element arrangement c Recognize revenue as the performance obligations are satisfied In a bill-and-hold arrangement, the seller “sells” goods to the buyer but holds the goods for later shipment, either in the seller’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 249 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 250 12 A company would prefer gross revenue reporting over net revenue reporting because the larger total revenue number increases the apparent size of the company’s economic activity If investors use a priceto-sales relationship in valuing the company, gross revenue reporting can lead to a higher stock price 13 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 completion, 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 perform the contractual obligation Because most contractors with significant contract obligations have the experience to make the necessary estimates, it is recommended that they use percentage-ofcompletion accounting rather than the completed-contract method 14 The cost-to-cost method of measuring the percentage of completion is an input method and is computed by relating the costs incurred to date to the total estimated costs The efforts-expended methods are also input methods, but they are based on the ratio of the efforts expended by labor or machines on the contract to the total effort expected 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 15 Output measures of percentage of completion include units produced, contract milestones reached, and values added to the contract Particular examples of output measures include miles of roadway, cubic Chapter yards of dirt removed, or architects' and engineers' estimates of job completion 16 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 recognized 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 17 Some accountants feel 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 percentage of completion to the total contract price 18 Under percentage-of-completion accounting, the difference between recognized revenue 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 19 The major reason for a fluctuating gross profit percentage under the percentage-ofcompletion 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 adjustments can create large changes in the reported gross profit percentage from year to year These fluctuations would also increase if a measure of completion other than cost-to-cost was used and if the minority position of the AICPA Construction Contractor Guide Committee was followed To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 20 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-ofcompletion 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 21 The measures used to compute a percentage 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 number 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 22 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 companies, 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 an acceptable job of predicting the pattern of future cash flows 23 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 251 as income Under the cost recovery method, 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 24 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 25 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 collections by year and to maintain a record of each year's gross profit percentage 26 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 27 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 method might be appropriate To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 252 PRACTICE EXERCISES PRACTICE 8–1 Cash Unearned Service Revenue 1,000 Unearned Service Revenue Service Revenue 1,000 PRACTICE 8–2 2 3 1,000 JOURNAL ENTRIES FOR A CONSIGNMENT 12,000 Accounts Receivable Sales 18,000 Cost of Goods Sold Inventory on Consignment 12,000 12,000 18,000 12,000 JOURNAL ENTRIES FOR A LAYAWAY Cash (2 × $50) Deposits Received from Customers 100 Cash Deposits Received from Customers Sales 300 50 Cost of Goods Sold Inventory 200 Deposits Received from Customers Revenue from Layaway Forfeitures 50 PRACTICE 8–4 1,000 Inventory on Consignment Inventory PRACTICE 8–3 BASIC JOURNAL ENTRIES FOR REVENUE RECOGNITION 100 350 200 50 JOURNAL ENTRIES FOR AN UP-FRONT, NONREFUNDABLE FEE Cash (200 × $360) Unearned Initial Sign-up Fees 72,000 Cash (200 × $50) Monthly Service Revenue 10,000 Unearned Initial Sign-up Fees ($72,000/36 months) Initial Sign-up Fee Revenue 2,000 72,000 10,000 2,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter PRACTICE 8–5 253 REVENUE IN A MULTIPLE-ELEMENT ARRANGEMENT UNDER SUBTOPIC 605-25 Equipment delivery = $280,645 = $300,000 × [$290,000/($290,000 + $20,000)] Installation = $19,355 = $300,000 × [$20,000/($290,000 + $20,000)] The amount of revenue that should be recognized by Seller Company when the equipment is delivered but before it is installed is $280,645 PRACTICE 8–6 Accounts Receivable ($400,000 × 0.03) Commission Revenue 12,000 Cash Accounts Receivable 12,000 Cash Sales 400,000 Cost of Goods Sold Inventory 280,000 Commission Expense Cash 12,000 PRACTICE 8–7 REPORTING REVENUE GROSS AND NET 400,000 280,000 12,000 Percentage of completion: [$100,000/($100,000 + $450,000)] = 18.182% $160,002 $160,002 Percentage of completion: [($100,000 + $150,000)/($100,000 + $150,000 + $280,000)] = 47.170% Cumulative revenue to be recognized: $880,000 × 0.47170 Revenue recognized in previous years Revenue to be recognized in Year 12,000 COST-TO-COST METHOD Cumulative revenue to be recognized: $880,000 × 0.18182 Revenue recognized in previous years Revenue to be recognized in Year 12,000 $415,096 160,002 $255,094 Percentage of completion: 100.000% Cumulative revenue to be recognized: $880,000 × 1.00000 Revenue recognized in previous years Revenue to be recognized in Year $880,000 415,096 $464,904 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 254 PRACTICE 8–8 EFFORTS-EXPENDED METHOD Percentage of completion: [150/(150 + 850)] = 15.000% Cumulative revenue to be recognized: $880,000 × 0.15000 Revenue recognized in previous years Revenue to be recognized in Year Percentage of completion: [(150 + 300)/(150 + 300 + 520)] = 46.392% Cumulative revenue to be recognized: $880,000 × 0.46392 Revenue recognized in previous years Revenue to be recognized in Year PRACTICE 8–9 Percentage of completion: [3,000/(3,000 + 15,200)] = 16.484% $ 145,059 $ 145,059 Percentage of completion: [(3,000 + 7,500)/(3,000 + 7,500 + 8,200)] = 56.150% Cumulative revenue to be recognized: $880,000 × 0.56150 Revenue recognized in previous years Revenue to be recognized in Year $880,000 408,250 $471,750 PERCENTAGE OF COMPLETION BASED ON OUTPUT MEASURES Cumulative revenue to be recognized: $880,000 × 0.16484 Revenue recognized in previous years Revenue to be recognized in Year $408,250 132,000 $276,250 Percentage of completion: 100.000% Cumulative revenue to be recognized: $880,000 × 1.00000 Revenue recognized in previous years Revenue to be recognized in Year $132,000 $132,000 $ 494,120 145,059 $ 349,061 Percentage of completion: 100.000% Cumulative revenue to be recognized: $880,000 × 1.00000 Revenue recognized in previous years Revenue to be recognized in Year $ 880,000 494,120 $ 385,880 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 255 PRACTICE 8–10 BASIC CONSTRUCTION JOURNAL ENTRIES Construction in Progress Materials, Cash, etc 100,000 Accounts Receivable Progress Billings 200,000 Cash Accounts Receivable 180,000 Construction in Progress Materials, Cash, etc 150,000 Accounts Receivable Progress Billings 200,000 Cash Accounts Receivable 170,000 Construction in Progress Materials, Cash, etc 250,000 Accounts Receivable Progress Billings 480,000 Cash Accounts Receivable 530,000 100,000 200,000 180,000 150,000 200,000 170,000 250,000 480,000 530,000 PRACTICE 8–11 COMPLETED-CONTRACT JOURNAL ENTRIES Progress Billings Revenue on Construction Contracts 880,000 Cost of Construction Contracts Construction in Progress 500,000 880,000 500,000 PRACTICE 8–12 PERCENTAGE-OF-COMPLETION JOURNAL ENTRIES Cost of Construction Contracts Construction in Progress Revenue on Construction Contracts 100,000 60,002 Cost of Construction Contracts Construction in Progress Revenue on Construction Contracts 150,000 105,094 Cost of Construction Contracts Construction in Progress Revenue on Construction Contracts 250,000 214,904 160,002 255,094 464,904 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 256 PRACTICE 8–13 CONSTRUCTION CONTRACTS: BALANCE SHEET REPORTING 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 + $480,000 – $530,000 = $0 and For balance sheet reporting purposes, Progress Billings and Construction 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 Progress billings: $200,000 Construction in progress: $100,000 (cost) + $60,002 (profit) = $160,002 Net current liability of $39,998 ($200,000 – $160,002) Year Progress billings: $200,000 beginning balance + $200,000 = $400,000 Construction in progress: $160,002 (beginning balance) + $150,000 (cost) + $105,094 (profit) = $415,096 Net current asset of $15,096 ($400,000 – $415,096) Year Progress billings: $400,000 beginning balance + $480,000 = $880,000 Construction in progress: $415,096 (beginning balance) + $250,000 (cost) + $214,904 (profit) = $880,000 No net amount is reported because both Construction in Progress and Progress Billings are equal to $880,000 It would be appropriate to report the two amounts, netting to zero, in either the Current Asset or Current Liability section of the balance sheet To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 257 PRACTICE 8–14 MULTIPLE YEARS OF REVENUES AND COSTS: COST-TO-COST METHOD Percentage of completion: [$280,000/($280,000 + $760,000)] = 26.9231% Cumulative revenue to be recognized: $1,800,000 × 0.269231 Revenue recognized in previous years Revenue to be recognized in Year $ 484,616 $ 484,616 Cumulative cost to be recognized: ($280,000 + $760,000) × 0.269231 Cost recognized in previous years Cost to be recognized in Year $ 280,000 $ 280,000 Cost of Construction Contracts Construction in Progress Revenue on Construction Contracts 484,616 Percentage of completion: [($280,000 + $390,000)/($280,000 + $390,000 + $380,000)] = 63.8095% Cumulative revenue to be recognized: $1,800,000 × 0.638095 Revenue recognized in previous years Revenue to be recognized in Year $1,148,571 484,616 $ 663,955 Cumulative cost to be recognized: ($280,000 + $390,000 + $380,000) × 0.638095 Cost recognized in previous years Cost to be recognized in Year $ 670,000 280,000 $ 390,000 Cost of Construction Contracts Construction in Progress Revenue on Construction Contracts 280,000 204,616 390,000 273,955 663,955 Percentage of completion: 100.000% Cumulative revenue to be recognized: $1,800,000 × 1.000000 Revenue recognized in previous years Revenue to be recognized in Year $1,800,000 1,148,571 $ 651,429 Cumulative cost to be recognized: ($280,000 + $390,000 + $370,000) × 1.000000 Cost recognized in previous years Cost to be recognized in Year $1,040,000 670,000 $ 370,000 Cost of Construction Contracts Construction in Progress Revenue on Construction Contracts 370,000 281,429 651,429 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 258 PRACTICE 8–15 MULTIPLE YEARS OF REVENUES AND COSTS: OUTPUT MEASURE Percentage of completion: [9,800/(9,800 + 20,300)] = 32.5581% Cumulative revenue to be recognized: $1,800,000 × 0.325581 Revenue recognized in previous years Revenue to be recognized in Year $586,046 $586,046 Cumulative cost to be recognized: ($280,000 + $760,000) × 0.325581 Cost recognized in previous years Cost to be recognized in Year $338,604 $338,604 Cost of Construction Contracts Construction in Progress Revenue on Construction Contracts 586,046 Percentage of completion: [(9,800 + 10,200)/(9,800 + 10,200 + 10,000)] = 66.6667% Cumulative revenue to be recognized: $1,800,000 × 0.666667 Revenue recognized in previous years Revenue to be recognized in Year $1,200,000 586,046 $ 613,954 Cumulative cost to be recognized: ($280,000 + $390,000 + $380,000) × 0.666667 Cost recognized in previous years Cost to be recognized in Year $ 700,000 338,604 $ 361,396 Cost of Construction Contracts Construction in Progress Revenue on Construction Contracts 338,604 247,442 361,396 252,558 613,954 Percentage of completion: 100.000% Cumulative revenue to be recognized: $1,800,000 × 1.000000 Revenue recognized in previous years Revenue to be recognized in Year $1,800,000 1,200,000 $ 600,000 Cumulative cost to be recognized: ($280,000 + $390,000 + $370,000) × 1.000000 Cost recognized in previous years Cost to be recognized in Year $ 1,040,000 700,000 $ 340,000 Cost of Construction Contracts Construction in Progress Revenue on Construction Contracts 340,000 260,000 600,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 286 8–44 Chapter (Concluded) Construction in Progress Materials, Labor, Cash, etc Actual costs incurred 2012 2,800,000 2,800,000 2013 2,200,000 2,200,000 2014 600,000 Accounts Receivable Progress Billings on Construction Contracts To record progress billings 2,600,000 2,100,000 700,000 Cash Accounts Receivable To record collections on progress billings 2,200,000 Cost of Long-Term Construction Contracts Construction in Progress Revenue from Long-Term Construction Contracts To recognize revenue and expense for the period 2,600,000 2,100,000 1,900,000 2,200,000 2,800,000 224,000 600,000 700,000 700,000 1,900,000 2,209,140 3,024,000 2015: Cash Accounts Receivable To record final collections on contracts 600,000 Progress Billings on Construction Contracts Construction in Progress To close out construction accounts 5,400,000 700,000 590,860 324,000 100,000 1,885,140 490,860 600,000 5,400,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 287 8–45 Contract price Costs incurred to date Estimated costs to complete Total estimated costs Total expected profit 2012 $16,700,000 $ 6,400,000 8,700,000 $15,100,000 $ 1,600,000 2013 $16,700,000 $11,600,000 4,600,000 $16,200,000 $ 500,000 Percentage of completion 42.38% 71.60% To Date 2014 $16,700,000 $15,700,000 1,500,000 $17,200,000 $ (500,000) 91.28% 100.00% Recognized in Recognized in Prior Years Current Year 2012: Recognized revenue ($16,700,000 × 0.4238) $ 7,077,460 Cost (actual cost) 6,400,000 Gross profit $ 677,460 2013: Recognized revenue ($16,700,000 × 0.7160) $11,957,200 Cost (actual cost) 11,600,000 Gross profit (loss) $ 357,200 2015 $16,700,000 $16,765,000 $16,765,000 $ (65,000) $7,077,460 6,400,000 $ 677,460 $ 7,077,460 6,400,000 $ 677,460 $4,879,740 5,200,000 $ (320,260) 2014: Recognized revenue ($16,700,000 × 0.9128) $15,243,760 Cost (recognized revenue plus entire anticipated loss) 15,743,760 Gross profit (loss) $ (500,000) $11,957,200 $3,286,560 11,600,000 $ 357,200 4,143,760 $ (857,200) 2015: Recognized revenue $16,700,000 Cost (actual cost) 16,765,000 Gross profit (loss) $ (65,000) $15,243,760 15,743,760 $ (500,000) $1,456,240 1,021,240 $ 435,000 2012 2013 2014 Construction in Progress 6,400,000 5,200,000 4,100,000 Materials, Labor, Cash, etc 6,400,000 5,200,000 4,100,000 Cost of Long-Term Contracts 6,400,000 5,200,000 4,143,760 Construction in Progress 677,460 320,260 857,200 Revenue from LongTerm Contracts 7,077,460 4,879,740 3,286,560 2015 1,065,000 1,065,000 1,021,240 435,000 1,456,240 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 288 8–46 2013 Inventory Cash 45,200 Notes Receivable—2013 ($32,000 + $62,000 + $3,600) Unearned Interest Revenue ($7,167 + $3,600) Installment Sales 97,600 Cost of Installment Sales ($45,200 – $2,000 inventory increase) Inventory 2014 45,200 10,767 86,833 43,200 43,200 Cash Notes Receivable—2013 35,600 Unearned Interest Revenue—2013 Interest Revenue 3,600 Installment Sales Cost of Installment Sales Deferred Gross Profit on Installment Sales—2013 86,833 Deferred Gross Profit on Installment Sales—2013 Realized Gross Profit on Installment Sales *Gross profit percentage: 50.25% ($43,633/$86,833); 0.5025 × $32,000 = $16,080 16,080* Inventory Cash 52,020 Notes Receivable—2014 Unearned Interest Revenue Installment Sales 89,500* 35,600 3,600 43,200 43,633 16,080 52,020 11,955‡ 77,545 *$60,000 + ($50,000 + $5,500) – $26,000† = $89,500 † 2013 Notes receivable collected in 2014 ‡ Interest revenue from 2013 notes: $7,167 – $5,579 = $1,588 Interest revenue from 2014 notes: $5,500 – $1,588 = $3,912 Unearned interest revenue at end of 2014 $ 8,043 Interest revenue from 2014 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 Cash 55,500 Notes Receivable—2013 ($62,000 – $36,000) Notes Receivable—2014 § $89,500 – $60,000 = $29,500 44,020 26,000 29,500§ To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8–46 289 (Concluded) Unearned Interest Revenue—2013 Unearned Interest Revenue—2014 Interest Revenue 1,588 3,912 Installment Sales Cost of Installment Sales Deferred Gross Profit on Installment Sales—2014 77,545 5,500 44,020 33,525 Deferred Gross Profit on Installment Sales—2013 ($26,000 – $1,588 = $24,412; $24,412 × 0.5025) 12,267 Deferred Gross Profit on Installment Sales—2014 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 8–47 Installment A/R—2012 Installment A/R—2013 Installment A/R—2014 Installment Sales 2012 124,000 145,000 124,000 79,360 Cash Installment A/R—2012 Installment A/R—2013 Installment A/R—2014 Interest Revenue 66,400 Installment Sales Cost of Installment Sales Deferred Gross Profit—2012 Deferred Gross Profit—2013 Deferred Gross Profit—2014 124,000 $59,300 × 0.36 = $21,348 $38,200 × 0.36 = $13,752 ‡ $65,400 × 0.39 = $25,506 § $18,500 × 0.36 = $6,660 # $33,700 × 0.39 = $13,143 **$73,450 × 0.38 = $27,911 * † 2014 138,000 Cost of Installment Sales Inventory Deferred Gross Profit—2012 Deferred Gross Profit—2013 Deferred Gross Profit—2014 Realized Gross Profit 2013 138,000 84,180 145,000 89,900 79,360 84,180 122,150 89,900 148,900 59,300 38,200 65,400 7,100 18,550 138,000 18,500 33,700 73,450 23,250 145,000 79,360 44,640 84,180 89,900 53,820 55,100 † 21,348* § 13,752 25,506‡ 21,348 6,660 13,143# 27,911** 39,258 47,714 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 290 8–48 a Percentage of completion (1) Contract price (2) Actual costs incurred to date (3) Estimated cost to complete contract (4) Total estimated cost (5) Total expected profit Period $4,500,000 $ 900,000 Period $4,500,000 $2,100,000 Period $4,500,000 $3,180,000 Period $4,500,000 $3,600,000 2,700,000 $3,600,000 $ 900,000 1,500,000 $3,600,000 $ 900,000 420,000 $3,600,000 $ 900,000 $3,600,000 $ 900,000 Percentage of completion to date [(2)/(4)] 25% 58.33333% 88.33333% 100% To Date Recognized in Recognized in Prior Years Current Year Period 1: 2013—(25% completed) Recognized revenue ($4,500,000 × 0.25) Cost (actual cost) Gross profit $ 1,125,000 900,000 $ 225,000 Period 2: 2013—(58.33333% completed) Recognized revenue ($4,500,000 × 0.5833333) Cost (actual cost) Gross profit $ 2,625,000 2,100,000 $ 525,000 $1,125,000 900,000 $ 225,000 $1,500,000 1,200,000 $ 300,000 Period 3: 2014—(88.33333% completed) Recognized revenue ($4,500,000 × 0.8833333) Cost (actual cost) Gross profit $ 3,975,000 3,180,000 $ 795,000 $2,625,000 2,100,000 $ 525,000 $1,350,000 1,080,000 $ 270,000 Period 4: 2014—(100% completed) Recognized revenue Cost Gross profit $ 4,500,000 3,600,000 $ 900,000 $3,975,000 3,180,000 $ 795,000 $ 525,000 420,000 $ 105,000 — — $1,125,000 900,000 $ 225,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 291 8–48 (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 Anticipated costs Anticipated gross profit Gross profit percentage $4,500,000 3,600,000 $ 900,000 20% Gross Profit $150,000 210,000 390,000 150,000 $900,000 Period 1—0.20 × $750,000 Period 2—0.20 × $1,050,000 Period 3—0.20 × $1,950,000 Period 4—0.20 × $750,000 d Cost recovery Estimated costs: $3,600,000 Period Payment Received $ 750,000 1,050,000 1,950,000 750,000 Costs to Be Recovered $3,600,000 2,850,000 1,800,000 0 Gross Profit $ 0 150,000 750,000 Summary of Gross Profit under Four Different Revenue Recognition Methods Method Period Percentage of completion $225,000 Completed contract — Installment sales 150,000 Cost recovery — Period $300,000 — 210,000 — Period $270,000 — 390,000 150,000 Period $105,000 900,000 150,000 750,000 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 purchaser 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 recovery or the completed-contract method is recommended To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 292 8–49 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 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 revenue To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 293 CASES Discussion Case 8–50 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 Discussion Case 8–51 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 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 Discussion Case 8–52 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 discount, during the term of the membership Doing this would require reliable historical data on which to base the estimates To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 294 Discussion Case 8–52 (Concluded) 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 revenue 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 Discussion Case 8–53 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 estimates 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 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 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Discussion Case 8–53 295 (Concluded) 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 Contingent on payment timing, bad debt expense may still have to be estimated under this method 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 discussed This case could also be used in a debate format One or more students could defend each method, and the class could then identify the most convincing presentation Discussion Case 8–54 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 customer 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 in 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 independent 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 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 296 Chapter Discussion Case 8–55 For money received by the 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 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 Discussion Case 8–56 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 realizable 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 Discussion Case 8–57 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 probability of cash collection and the possibility of return, still exist in arm’s-length sales, but a presumption exists 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 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 297 Case 8–58 Revenue Recognition (from Note 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 programming services are recognized as services are provided Certain of the Company’s existing contracts with cable and satellite operators include annual live programming commitments In these cases, recognition of revenues subject to the commitments is deferred until the annual commitments are satisfied, which generally results in higher revenue recognition in the second half of the year Revenues from advance theme park ticket sales are recognized when the tickets are used For nonexpiring, multi-day tickets, we recognize revenue over a three-year time period based on estimated usage, which is derived from historical usage patterns Revenues from the theatrical distribution of motion pictures are recognized when motion pictures are exhibited Revenues from video and video game sales, net of anticipated returns and customer incentives, are recognized on the date that video units are made available for sale by retailers Revenues from the licensing of feature films and television programming are recorded when the material is available for telecast by the licensee and when certain other conditions are met Merchandise licensing advances and guarantee royalty payments are recognized based on the contractual royalty rate when the licensed product is sold by the licensee Non-refundable advances and minimum guarantee royalty payments in excess of royalties earned are generally recognized as revenue at the end of the contract term Revenues from our internet and mobile operations are recognized as services are rendered Advertising revenues at our internet operations are recognized when advertisements are viewed online Taxes collected from customers and remitted to governmental authorities are presented in the Consolidated Statements of Income on a net basis One possibility would be when the videos and video games were shipped to retailers and a promise of payment was received from retailers 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 8–59 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 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 If the market for gold were to suddenly drop and gold went from selling for $1,200 an ounce to $750 an ounce, then revenues could be greatly overstated To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 298 Chapter Case 8–60 Ben & Jerry’s recognizes revenue on its ice cream when the product is shipped 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 Case 8–61 Lockheed measures the percentage of a contract completed using achievement of performance milestones 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 For cost-reimbursed-type contracts, costs are recorded as incurred, and profits are estimated and included based on a cost-to-cost-type estimate 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 The company generally records revenue from these types of service contracts using the straight-line method over the life of the contract While the company uses the straight-line method to record revenue on these service contracts, costs are expensed as incurred The one exception is that initial set-up costs are capitalized and recognized over the life of the contract Case 8–62 Students should address the following issues as they deal with this revenue recognition assignment: Has the electronics retailer substantially completed its part of the revenue recognition process? Has the electronics retailer received a valid promise of payment? If the electronics retailer 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 reductions 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.” To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 299 Case 8–63 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 determined 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 control, that can significantly affect the firm's financial performance Case 8–64 Solutions to this problem can be found on the Instructor’s Resource CD-ROM or downloaded from the Web at www.cengage.com/accounting/stice To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ... 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. .. held by the seller However, in service contracts with high initial costs and great uncertainty as to collection, the cash method might be appropriate To download more slides, ebook, solutions and. .. the sales agreement is unsigned and yet normal procedure includes the formal signing of the sales agreement by both the buyer and the seller In addition, a bill -and- hold arrangement should not