tbch07

Test Bank, Intermediate Accounting, 14th ed.

229

 CHAPTER 7  Complexities of Revenue Recognition MULTIPLE CHOICE QUESTIONS Theory/Definitional Questions 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

Revenue recognition criteria Revenue recognition criteria International revenue recognition criteria Proportional performance method of revenue recognition Proportional performance method of revenue recognition Use of percentage-of-completion method Presentation of progress billings and construction in progress Applying percentage-of-completion method Applying completed-contract method Applying percentage-of-completion method Use of installment method Disclosure of earned but unbilled revenues Gross profit deferred under the installment sales method Uses of completed-contract method Elements necessary for use of percentage-of-completion method Percentage-of-completion and completed-contract methods of accounting Percentage-of-completion method of accounting for long-term construction Percentage-of-completion method of accounting for long-term construction Percentage-of-completion method of accounting for long-term construction Percentage-of-completion and completed-contract methods of accounting Use of cost recovery method Recognition of franchise fees Goods on consignment-inventory of consignor Recognition of sales and cost of goods sold of consigned goods Recognition of progress billings under percentage-of-completion method Comparison of asset balances under percentage-of-completion and completed- contract methods

Computational Questions

230

Chapter 7  Complexities of Revenue Recognition

27 28 29 30 31 32 33 34 35 36

Computation of contract costs under percentage-of-completion method Computation of recognized income under percentage-of-completion method Computation of loss recognized under percentage-of-completion method Computation of recognized income under percentage-of-completion method Reporting assets/liabilities under completed-contract method Computation of gross profit using percentage-of-completion method Computation of gross profit using percentage-of-completion method Computation of gross profit under completed-contract method Computation of gross profit under percentage-of-completion method Computation of balance in Construction in Progress using percentage-ofcompletion method Computation of loss using percentage-of-completion method Computation of gross profit using installment sales method Computation of balance in Construction in Progress using completedcontract method Computation of cash collected on contract given balances Computation of realized gross profit under installment method Computation of total installment sales for year Computation of balance of deferred gross profit account Computation of revenue from franchise fees Computation of realized gross profit under installment method Computation of amount of consignment sales revenue Computation of contract costs under percentage-of-completion method Computation of realized gross profit under installment method Computation of amount of consigned inventory

37 38 39 40 41 42 43 44 45 46 47 48 49

PROBLEMS 1 2 3 4 5 6 7 8 9 10 11

Journalize construction under completed-contract and percentage-ofcompletion methods Journalize construction under percentage-of-completion method Journalize gross profit under completed-contract and percentage-ofcompletion method Computation of income/loss under installment or cost recovery methods Computation of gross profit under cost recovery method Journalize sales of maintenance contracts Determine cash collected and estimated income under percentage-ofcompletion method Journalize consignment transactions Journalize installment sales transactions Journalize franchise fees under variety of circumstances Computation of revenue, gross profit, balance of Construction in Progress account, and balance of Progress Billings account using percentage-ofcompletion cost-to-cost method


12 13 14 15

231

Computation of revenue, gross profit, balance of Construction in Progress account, and balance of Progress Billings account using percentage-ofcompletion cost-to-cost method FASB definition of revenue Measuring percentage of completion Proportional revenue recognition

MULTIPLE CHOICE QUESTIONS a LO1

b LO1

1. An adjusting entry in which revenue is recognized and a receivable is established indicates that revenue has been Earned Collected a. Yes No b. Yes Yes c. No Yes d. No No 2. Which of the following best describes the condition(s) that must be present for the recognition of revenue? a. The revenue must be earned, measurable, and collected. b. The revenue must be earned, measurable, and collectible. c. The revenue must be earned and collectible. d. The revenue must be measurable and collectible.

c LO1

3. Which of the following is true regarding the International Accounting Standards Board revenue recognition principles? a. The international standards do not address the issue of substantial completion of the earnings process. b. The international standards do not address the issue of revenue being realized or realizable. c. The international standards do not address the peculiarities of revenue recognition in specific industries. d. The international standards do not address the measurability of revenue prior to recognition.

b

4. A company providing maintenance services on equipment for a fixed periodic fee would

LO4

232


a. recognize an equal amount of service revenue for each act. b. recognize service revenue over the fixed period by the straight-line method. c. recognize service revenue in proportion to the direct costs to the provider of the services to perform each act. d. recognize service revenue only when the fixed period has ended. b LO4

b LO2

d LO3

5. Which of the following types of service transactions is most likely to require the proportional performance method of revenue recognition based on the seller’s direct costs to perform each act? a. Processing of monthly mortgage payments by a mortgage banker. b. Providing lessons, examinations, and grading by a correspondence school. c. Providing maintenance services on equipment for a fixed periodic fee. d. Delivering freight (by a trucking firm). 6. Dilla Construction Company’s projects extend over several years and collection of receivables is reasonably certain. Each project has a contract that specifies a price and the rights and obligations of all parties. Both the contractor and the customer are expected to fulfill their contractual obligations on each project. Reliable estimates can be made of the extent of progress and cost to complete each project. The method that the company should use to account for construction revenue is a. installment sales. b. percentage-of-completion. c. completed-contract. d. cost recovery. 7. How should the balances of Progress Billings and Construction in Progress be shown at reporting dates prior to the completion of a long-term contract? a. Progress Billings as income, Construction in Progress as inventory. b. Net, as income from construction if credit balance, and loss from construction if debit balance. c. Progress Billings as deferred income, Construction in Progress as a current asset. d. Net, as a current asset if debit balance and current liability if credit balance.


233

c LO3

8. If the percentage-of-completion method is used, what is the basis for determining the gross profit to be recognized in the second year of a threeyear contract? a. Cumulative actual costs incurred only. b. Incremental cost for the second year only. c. Cumulative actual costs and estimated costs to complete. d. No gross profit would be recognized in year 2.

d

9. If the completed-contract method is used, what is the basis for determining the income to be recognized in the second year of a three-year contract? a. Cumulative actual costs incurred only. b. Incremental cost for the second year only. c. Latest available estimated costs. d. No income would be recognized in year 2.

LO3

b LO3

10. Which of the following would be used in the calculation of the gross profit recognized in the third and final year of a construction contract that is accounted for using the percentage-of-completion method? Actual Income Contract Total Previously Price Costs Recognized a. Yes Yes No b. Yes Yes Yes c. Yes No Yes d. No Yes Yes

a LO5

11. The installment method of recognizing revenue a. should be used only in cases in which no reasonable basis exists for estimating the collectibility of receivables. b. is not a generally accepted accounting principle under any circumstances. c. should be used for book purposes only if it is used for tax purposes. d. is an acceptable alternative accounting principle for a firm that makes installment sales.

234


c

12. Assume the percentage-of-completion method of revenue recognition is used on a long-term construction contract. Under this method, revenues that are earned but unbilled at the balance sheet date should be disclosed a. as a long-term receivable in the noncurrent assets section of the balance sheet. b. only as a footnote disclosure until the customer is billed for the percentage of work completed. c. as construction in progress in the current assets section of the balance sheet. d. as construction in progress in the noncurrent assets section of the balance sheet.

LO3

d LO5

13. When using the installment sales method, a. gross profit is deferred until all cash is received, but revenues and costs are recognized in proportion to the cash collected from the sale. b. gross profit is recognized only after the amount of cash collected exceeds the cost of the item sold. c. revenue, costs, and gross profit are recognized proportionally as the cash is received from the sale of product. d. total revenues and costs are recognized at the point of sale, but gross profit is deferred in proportion to the cash that is uncollected from the sale.

d

14. The completed-contract method of accounting for long-term constructiontype contracts is preferable when a. a contractor is involved in numerous projects. b. the contracts are of a relatively long duration. c. estimates of costs to complete and extent of progress toward completion are reasonably dependable. d. there are inherent uncertainties in the contract beyond normal business risks.

LO2

a LO2

15. Which of the following is not an element identified by the AICPA as being necessary in order to use percentage-of-completion accounting? a. The construction period can be reasonably estimated. b. The buyer can be expected to satisfy obligations under the contract. c. Dependable estimates can be made of the extent of progress toward completion. d. Dependable estimates can be made of contract costs.


235

c LO2

16. Which of the following is not a difference between the percentage-of completion and completed-contract methods of accounting for long-term construction contracts? a. They report different amounts for inventory during the construction period. b. They report different amounts for progress billings during the construction period. c. They cause a different cash inflow during the construction period. d. They report different amounts for accounts receivable during the construction period.

d LO2

17. The theoretical support for using the percentage-of-completion method of accounting for long-term construction projects is that it a. is more conservative than the completed-contract method. b. reports a lower Net Income figure than the completed-contract method. c. more closely conforms to the cost principle. d. produces a realistic matching of expenses with revenues.

c LO2

b LO2

18. If a company uses the completed-contract method of accounting for longterm construction contracts, then during the period of construction, financial information related to a long-term contract will a. appear on both the income statement and balance sheet during the construction period. b. appear only on the income statement during the period of construction. c. appear only on the balance sheet during the period of construction. d. not appear on the financial statements. 19. When the percentage-of-completion method of accounting for long-term construction projects is used, why is Construction in Progress increased by the annual recognized gross profit on long-term construction contracts? a. The cost of the contract has increased. b. The project’s value has increased above cost. c. The economy experiences inflation over the construction period. d. Construction in Progress is not increased by the annual recognized

profit. a LO3

20. When comparing the percentage-of-completion and completed-contract methods of accounting for long-term construction contracts, both methods will report a. the same balances each period in the Progress Billings account.

236


b. the same expense for cost of construction each year. c. the same amount of income in the year of completion. d. the same inventory carrying value each year during the construction period. a LO5

21. The cost recovery method a. is used only when circumstances surrounding a sale are so uncertain that earlier recognition is impossible. b. is the most common method of accounting for real estate sales. c. is similar to percentage-of-completion accounting. d. is never acceptable under generally accepted accounting principles.

d LO6

22. Franchise fees are properly recognized as revenue a. when received in cash. b. when a contractual agreement has been signed. c. after the franchise business has begun operations. d. after the franchiser has substantially performed its service.

a LO6

23. Goods on consignment should be included in the inventory of a. the consignor but not the consignee. b. both the consignor and the consignee. c. the consignee but not the consignor. d. neither the consignor nor the consignee.

c LO6

d LO3

c

24. In accounting for sales on consignment, sales revenue and the related cost of goods sold should be recognized by the a. consignor when the goods are shipped to the consignee. b. consignee when the goods are shipped to the third party. c. consignor when notification is received the consignee has sold the goods. d. consignee when cash is received from the customer. 25. A company uses the percentage-of-completion method to account for a four year construction contract. Progress billings sent in the second year that were collected in the third year would a. be included in the calculation of the income recognized in the second year. b. be included in the calculation of the income recognized in the third year. c. be included in the calculation of the income recognized in the fourth year. d. not be included in the calculation of the income recognized in any year. 26. In accounting for a long-term construction contract for which there is a


237

LO3

projected profit, the balance in the Construction in Progress account at the end of the first year of work using the percentage-of-completion method would be a. zero. b. the same as the completed-contract method. c. higher than the completed-contract method. d. lower than the completed-contract method.

c LO3

27. On May 1, 2002, Green Construction Company entered into a fixed-price contract to construct an apartment building for $3,000,000. Green appropriately accounts for this contract under the percentage-of-completion method. Information relating to the contract is as follows: 2002 2003 At December 31: Percentage of completion................................ 20% 60% Estimated costs at completion......................... $2,250,000 $2,400,000 Income recognized (cumulative)..................... $150,000 $360,000 What is the amount of contract costs incurred during the year ended December 31, 2003? a. $600,000 b. $960,000 c. $990,000 d. $1,440,000

b LO3

28. C & J Construction, Inc. has consistently used the percentage-ofcompletion method of recognizing income. Last year C & J started work on a $4,500,000 construction contract, which was completed this year. The accounting records disclosed the following data for last year: Progress billings.................................................................... $1,650,000 Costs incurred....................................................................... 1,350,000 Collections............................................................................. 1,050,000 Estimated cost to complete................................................... 2,700,000 How much income should C & J have recognized on this contract last year? a. $105,000 b. $150,000 c. $300,000 d. $350,000

238


c

29. Jessup Construction, Inc. has consistently used the percentage-ofcompletion method of recognizing income. During 2002, Jessup started work on a $1,500,000 fixed-price construction contract. The accounting records disclosed the following data for the year ended December 31, 2002: Costs incurred....................................................................... $ 465,000 Estimated cost to complete................................................... 1,085,000 Progress billings.................................................................... 550,000 Collections............................................................................. 350,000

LO3

How much loss should Jessup have recognized in 2002? a. $15,000 b. $35,000 c. $50,000 d. $115,000 a LO3

30. Shepard Construction Company has consistently used the percentage-ofcompletion method. On January 10, 2002, Shepard began work on a $3,000,000 construction contract. At the inception date, the estimated cost of construction was $2,250,000. The following data relate to the progress of the contract: Gross profit recognized at December 31, 2002.................... $ 300,000 Costs incurred Jan. 10, 1999, through Dec. 31, 2003.......... 1,800,000 Estimated cost to complete at December 31, 2003.............. 600,000 How much gross profit should Shepard recognize for the year ended December 31, 2003? a. $150,000 b. $262,500 c. $300,000 d. $450,000

d LO3

31. For a construction firm using the completed-contract method, if costs exceed billings on some contracts by $1,000,000 and billings exceed costs by $800,000 on others, the contracts should ordinarily be reported as a a. current asset of $200,000. b. current liability of $200,000. c. current asset of $1,000,000 less a contra-current asset of $800,000. d. current asset of $1,000,000 and a current liability of $800,000.

239


b LO3

32. Salmon Construction Company uses the percentage-of-completion method of accounting. In 2002, Salmon began work on a project which had a contract price of $1,600,000 and estimated costs of $1,200,000. Additional information is as follows: 2002 2003 Costs incurred during the year............................. Estimated costs to complete, as of 12/31/02........ Billings during the year......................................... Collections during the year...................................

$240,000 $1,060,000 960,000 290,000 1,310,000 250,000 1,200,000

The amount of gross profit Salmon should recognize on this contract during 2002 is a. $40,000. b. $80,000. c. $100,000. d. $200,000. b LO3

33. Brown Construction Company uses the percentage-of-completion method for long-term construction contracts. A specific job was begun in 2002 and completed in 2004. The contract price was $1,400,000 and cost information as of each year-end is given below: End of year estimated cost to complete................................ Annual cost incurred.......................

2002

2003

$400,000 400,000

$200,000 400,000

2004 $

0 120,000

Assuming Brown correctly recorded gross profit in 2002, how much gross profit should the company record in 2003? a. $0 b. $20,000 c. $300,000 d. $320,000

240 a LO3


34. The following data relate to a construction job started by Worthington Co. during 2002: Total contract price................................................................ $300,000 Actual costs incurred during 2002........................................ 60,000 Estimated remaining costs.................................................... 120,000 Billed to customer during 2002............................................. 90,000 Received from customer during 2003................................... 30,000 Under the completed-contract method, how much should Worthington recognize as gross profit for 2002? a. $0 b. $30,000 c. $40,000 d. $90,000

b LO3

35. The following data relate to a construction job started by Worthington Co. during 2002: Total contract price................................................................ $300,000 Actual costs incurred during 2002........................................ 60,000 Estimated remaining costs.................................................... 120,000 Billed to customer during 2002............................................. 90,000 Received from customer during 2002................................... 30,000 Under the percentage-of-completion method, Worthington recognize as gross profit for 2002? a. $0 b. $40,000 c. $80,000 d. $100,000

how

much

should

c 36. Rainbow Construction Company uses the percentage-of-completion method LO3 ............................................................................................for long-term construction contracts. The company started a project with a contract price of $2,750 in 2002. Given the following data, what is the balance in Construction in Progress for this contract at the end of 2002? 2002 2003 Costs incurred this year...................................................$ 400 $ 500 Total estimated costs remaining at end of year......... 1,600 1,000 a. b. c. d.

$150 $400 $550 $1,750


c LO3

241

37. Lake Construction Company uses the percentage-of-completion method for long-term construction contracts. The company has a project with a contract price of $7,000 on which $600 of gross profit has been recognized in prior years. Information for the current year is as follows: Total cost incurred through current year............................... $5,000 Estimated costs remaining at end of current year................ 2,800 What is the loss that Lake should recognize in the current year? a. $600 b. $800 c. $1,400 d. No loss should be recognized.

b LO5

38. Brooke Company began operations on January 1, 2002, and uses the installment sales method of accounting. The company has the following information available for 2002 and 2003: 2002 2003 Installment sales................................................. $4,500,000 $5,400,000 Gross profit on sales.......................................... 30% 40% Cash collections on 2002 sales......................... 1,500,000 3,600,000 Cash collections on 2003 sales......................... 4,200,000 The realized gross profit for 2003 would be a. $1,680,000. b. $2,760,000. c. $3,120,000. d. $4,320,000.

c LO3

39. Lake Construction Company uses the completed-contract method for longterm construction contracts. The information for a specific contract as of January 1, 2002, is shown below. Costs incurred to date........................................................... $ 700,000 Contract price........................................................................ 2,000,000 Estimated remaining cost to complete.................................. 800,000 $600,000 of cost was incurred during 2002 and on December 31, 2002, the estimated remaining cost to complete was still $800,000. The correct balance for the Construction in Progress at December 31, 2002 is a. $600,000. b. $700,000. c. $1,200,000. d. $1.300,000.

a LO3

40. In 2002, Aldaus Corp. began construction work under a three-year contract. The contract price is $800,000. Aldaus used the percentage-of-completion method for financial accounting purposes. The income to be recognized each year is based on the proportion of costs incurred to total estimated costs for completing the contract. The financial presentations relating to this contract at December 31, 2002, appear below. Balance Sheet Accounts receivable--construction contract billings........ $15,000 Construction in progress.................................................. $50,000 Less contract billings....................................................... (47,000) Cost of uncompleted contract in excess of billings......... 3,000 Income Statement Income (before tax) on the contract recognized in year 1

$10,000

How much cash was collected in 2002 on this contract? a. $32,000 b. $35,000 c. $47,000 d. $50,000 c LO5

41. Paral Company began operations on January 2, 1999, and appropriately used the installment sales method of accounting. The following data are available for 2002 and 2003: 2002 2003 Installment sales............................................. $3,000,000 $3,600,000 Gross profit on sales...................................... 30% 40% Cash collections from: 2002 sales............................................ $1,000,000 $1,200,000 2003 sales............................................ -- $1,400,000 The realized gross profit for 2003 is a. $1,440,000. b. $1,040,000. c. $920,000. d. $780,000.

d LO5

42. Wedtec Enterprises, which began operations on January 1, appropriately uses the installment method of accounting. The following information is available for its first year: Gross profit on sales............................................................. 40% Deferred gross profit at December 31................................... $120,000 Cash collected, including down payments............................ $225,000 What is the total amount of Wedtec’s installment sales for the first year? a. $300,000 b. $345,000 c. $425,000 d. $525,000

b LO5

43. Leno Distributing, which began operating on January 1, appropriately uses the installment method of accounting. The following information pertains to Leno’s operations for the first year: Installment sales.................................................................... $1,000,000 Cost of installment sales....................................................... 600,000 General and administrative expenses................................... 100,000 Collections on installment sales............................................ 200,000 The balance in the deferred gross profit account at December 31 should be a. $400,000. b. $320,000. c. $240,000. d. $200,000.

a LO6

44. On January 3, 2002, Lincoln Services, Inc., signed an agreement authorizing Lisa Company to operate as a franchisee over a 20-year period for an initial franchise fee of $100,000 received when the agreement was signed. Lisa commenced operations on July 1, 2002, at which date all of the initial services required of Lincoln had been performed. The agreement also provides that Lisa must pay a continuing franchise fee equal to 5% of the revenue from the franchise annually to Lincoln. Lisa’s franchise revenue for 2002 was $800,000. For the year ended December 31, 2002, how much should Lincoln record as revenue from franchise fees in respect of the Lisa franchise? a. $140,000 b. $90,000 c. $45,000 d. $42,500

a LO5

45. Assume the Randall Corporation sold $30,000 worth of merchandise on the installment basis. The cost of the merchandise was $24,000, and collectibility of the receivable is uncertain. Collection in the current year on the account is $8,000. How much gross profit should be reported as realized? a. $1,600 b. $2,000 c. $6,000 d. $8,000

a LO6

46. On November 30, Northrup Company consigned 90 freezers to Watson Company for sale at $1,600 each and paid $1,200 in transportation costs. A report of sales was received on December 30 from Watson reporting the sale of 20 freezers, together with a remittance of the $27,200 balance due. The remittance was net of the agreed 15% commission. How much, and in what month, should Northrup recognize as consignment sales revenue? November December a. $0 $32,000 b. $0 $27,200 c. $144,000 $0 d. $142,800 $0

b LO3

47. Layton Construction Company has consistently used the percentage-of completion method of recognizing income. During 2003, Layton entered into a fixed-price contract to construct an office building for $10,000,000. Information relating to the contract is as follows: December 31 2002 2003 Percentage of completion........................ 20% 60% Estimated total cost at completion.......... $7,500,000 $8,000,000 Income recognized (cumulative)............. 500,000 1,200,000 Contract costs incurred during 2003 were a. $3,200,000. b. $3,300,000. c. $3,500,000. d. $4,800,000.

b

48. Hillson Company began operations on January 1, 2002, and appropriately

LO5

uses the installment method of accounting. The following data are available for 2002 and 2003: 2002 2003 Installment sales...................................... $1,200,000 $1,500,000 Cash collections from: 2002 sales.......................................... 400,000 500,000 2003 sales.......................................... -600,000 Gross profit on sales............................... 30% 40% The realized gross profit for 2003 is a. $240,000. b. $390,000. c. $440,000. d. $600,000.

a LO6

49. Seahawks, Inc. had the following consignment transactions during December: Inventory shipped on consignment to Ashe Company.......... $18,000 Freight paid by Seahawks..................................................... 900 Inventory received on consignment from Fenn Company.... 12,000 Freight paid by Fenn............................................................. 500 No sales of consigned goods were made through December 31. Seahawks' December 31 balance sheet should include consigned inventory at a. $18,900. b. $18,000. c. $12,500. d. $12,000.

PROBLEMS Problem 1 In 2002, Fayette Engineering entered into an agreement to construct an office building at a contract price of $5,100,000. Construction data were as follows: 2002 2003 2004 Construction costs incurred.................. $ 750,000 $2,700,000 $ 630,000 Estimated costs to complete................. 3,000,000 862,500 -Progress billings................................... 570,000 3,600,000 930,000

Collections from client..........................

450,000

3,300,000

1,350,000

Prepare the necessary entries for each year, assuming the firm uses the: (1) completed-contract method (2) percentage-of-completion method. Solution 1 LO3 (1) 2002 Construction in Progress............................................ Materials, Cash, etc...........................................

750,000 750,000

Accounts Receivable.................................................. Progress Billings on Construction Contracts.....

570,000

Cash............................................................................ Accounts Receivable..........................................

450,000

2003 Construction in Progress............................................ Materials, Cash, etc. .........................................

570,000 450,000 2,700,000 2,700,000


3,600,000


3,300,000

2004 Construction in Progress............................................ Materials, Cash, etc. .........................................

3,600,000 3,300,000 630,000 630,000


930,000


1,350,000

930,000 1,350,000

Progress Billings on Construction Contracts............. 5,100,000 Revenue from Long-Term Construction Contracts.

5,100,000

Cost of Long-Term Construction Contracts................ Construction in Progress....................................

4,080,000

4,080,000

(2) 2002 Construction in Progress............................................ Materials, Cash, etc. .........................................

750,000 750,000


570,000


450,000

Cost of Long-Term Construction Contracts................ Construction in Progress............................................ Revenue from Long-Term Construction Contracts.

750,000 270,000

2003 Construction in Progress............................................ Materials, Cash, etc ..........................................

570,000 450,000

1,020,000 2,700,000 2,700,000


3,600,000


3,300,000

3,600,000 3,300,000

Cost of Long-Term Construction Contracts................ 2,700,000 Construction in Progress............................................ 360,000 Revenue from Long-Term Construction Contracts. 2004 Construction in Progress............................................ Materials, Cash, etc. .........................................

630,000 630,000


930,000


1,350,000

Cost of Long-Term Construction Contracts................ Construction in Progress............................................ Revenue from Long-Term Construction Contracts. Progress Billings on Construction Contracts............. Construction in Progress.................................... Problem 2

3,060,000

930,000 1,350,000 630,000 390,000 1,020,000 5,100,000 5,100,000

Bywater Construction contracted to build a ship over a two year period. The contract price was $21,000,000 with an estimate total cost of $18,400,000. The following cost data relate to the construction period. Year

Costs Incurred in Year

Estimated Cost to Complete

Billings

Cash Collected

2002 2003 2004

$9,000,000 9,500,000 0

$10,000,000 0 0

$11,000,000 8,000,000 2,000,000

$7,500,000 9,000,000 4,500,000

Prepare the necessary journal entries for 2002, 2003, and 2004 assuming Bywater uses the percentage-of-completion method. Solution 2 LO3 2002 Construction in Progress............................................ Materials, Cash, etc...........................................

9,000,000 9,000,000


11,000,000


7,500,000

11,000,000 7,500,000

Cost of Long-Term Construction Contracts................ 9,000,000 Construction in Progress ($9,000,000 / $19,000,000) x $2,000,000...................................................................... 947,368 Revenue from Long-Term Construction Contracts.

9,947,368

2003 Construction in Progress............................................ Materials, Cash, etc...........................................

9,500,000

9,500,000


8,000,000


9,000,000

8,000,000

Cost of Long-Term Construction Contracts................ 9,500,000 Construction in Progress ($21,000,000 - $18,500,000 total costs) - $947,368................................................ 1,552,632 Revenue from Long-Term Construction Contracts.

9,000,000

11,052,632

2004 Accounts Receivable.................................................. Progress Billings on Construction Contracts..... Cash............................................................................ Accounts Receivable..........................................

2,000,000 2,000,000 4,500,000 4,500,000

Progress Billings on Construction Contracts............. 21,000,000 Construction in Progress.................................... 21,000,000 Problem 3 Lytherma Construction entered into a contract to construct a floating bridge across a lake. The contract price for the bridge is $7,500,000. During 2002, costs of $1,800,000 were incurred representing 30% of total expected costs. Prepare the necessary entries for 2002 to recognize gross profit for the year assuming the firm uses the (1) completed-contract method. (2) percentage-of-completion method. Solution 3 LO3 (1) Using the completed-contract method, no gross profit is recognized on the contract until the bridge is completed. Thus, no entry is needed. (2) Cost of Long-Term Construction Contracts................ 1,800,000 Construction in Progress............................................ 450,000 * Revenue from Long-Term Construction Contracts. 2,250,000 *

$1,800,000 / 30% = $6,000,000 $7,500,000 - $6,000,000 = $1,500,000 $1,500,000 x 30% = $450,000

Problem 4 Tappan Industrial sells machinery on the installment plan. On September 1, 2002, Tappan entered into an installment sale contract with Western Productions for a six-year period. Equal annual payments under the installment sale are $187,500 and are due on August 31 of each year beginning in 2003. Additional information: (a) The cost of the machinery sold to Western was $637,500. (b) The implicit interest rate on the installment sale is 10%. Compute the income or loss before taxes that Tappan should record for the year ended December 31, 2002, as a result of the above transaction, assuming that circumstances are such that the collection of the installments due under the contract (1) is reasonably assured. (2) cannot be reasonably assured. Solution 4 LO5 (1) Accrual basis: full gross profit recognized in the year of the sale. Determination of selling price: PVn = R(PVAFn/i) Table IV PVn = $187,500 x 4.3553 PVn = $816,619 (rounded)

n = 6, i = 10%

Gross profit on sale: Sale..................................................................... Cost of sales....................................................... Gross profit......................................................... Interest revenue--4 months: $816,619 x 10% x 4/12 = Total income for 2002 = $179,119 + $27,221 = (2) Installment sale: Gross profit ($179,119/$816,619) = Gross profit earned in 2002 ($0 x 22%)......................... Interest revenue.............................................................. Total income for 2002.....................................................

$816,619 637,500 $179,119 $27,221 $206,340 22% (rounded) $

0 27,221 $27,221

Problem 5 Kamus Medical Center uses the cost recovery method in accounting for recognizing revenue. The following information is available:

Sales.....................................................

2002 $45,000

2003 $60,000

2004 $85,000

Gross profit percentage........................ Cash collections: 2002.............................................. 2003.............................................. 2004..............................................

37%

41%

40%

$24,000

$19,000 40,000

$ 2,000 17,000 53,000

Determine the amount of gross profit to be recognized for 2002, 2003, and 2004. Solution 5 LO5 When the cost recovery method is used, gross profit is recognized only after all costs have been recovered. 2002 $45,000 x 63% = $28,350 $28,350 - $24,000 = $4,350 2003 Relating to 2002 sales: $19,000 - $4,350 = Relating to 2003 sales: $60,000 x 59% = $35,400 $40,000 - $35,400 =

Cost of sale No gross profit is recognized in 2002. Costs still to be recovered.

$14,650 Gross profit recognized Cost of sale 4,600 Gross profit recognized $19,250 Recognized in 2003

2004 Relating to 2002 sales: Since all costs have been recovered, all cash collected is recognized as gross profit......... $ 2,000 Relating to 2003 sales: Since all costs have been recovered, all cash collected is recognized as gross profit......... 17,000 Relating to 2004 sales: $85,000 x 60% = $51,000 Cost of sale $53,000 - $51,000 =...................................... 2,000 Gross profit recognized $21,000 Recognized in 2004

Problem 6 The Winimucca Supply Company sells maintenance contracts to the purchasers of the equipment they sell. The cost of the contract is $1,450, payable at the signing of the contract. The contract covers a three-year period with regularly scheduled inspection visits (every six months) plus any emergency visits. Experience shows that, on the average, one emergency visit per contract is required each year. Assume that 2,200 contracts were sold in 2002 and that contract sales were made evenly over the year. Give the entries required for 2002 and 2003 to account for the 2,200 contracts. Solution 6 LO4 2002 Cash ($1,450 x 2,200)................................................ Deferred Maintenance Contract Revenue....

3,190,000 3,190,000

Deferred Maintenance Contract Revenue............ Maintenance Contract Revenue................... *

354,444 *

First 1,100 contracts sold--one regularly scheduled inspection per contract..... Average 1,100 contracts in force during 2002--one emergency visit per contract.............................................. Total visits expected--2002......................

1,100 2,200

Total expected visits over life of contract (9 visits x 2,200).........................

19,800

(2,200/19,800) x $3,190,000 = 2003 Deferred Maintenance Contract Revenue............ Maintenance Contract Revenue................... *

354,444

1,100

$ 354,444 1,063,333

Contracts in effect for the entire year x Average visits per year = Expected visits during 2000 2,200 contracts x 3 average visits = 6,600 Proportion of visits in 2003: 6,600/19,800 = 1/3 Recognized revenue: $3,190,000 x 1/3 = $1,063,333

1,063,333 *

Problem 7 In 2002, Johnson Builders began construction work under a three-year contract at a price of $7,525,000. The firm uses the percentage-of-completion method for financial accounting purposes. The income to be recognized each year is based on the proportion of cost incurred to the total estimated costs for completing the contract. The financial statement presentations relating to this contract on December 31, 2002, are: Balance Sheet Accounts receivable.............................................. Construction in progress....................................... Less progress billings...........................................

$150,500 $602,000 562,000

Income Statement Gross profit on construction contracts..................

40,000 $301,000

Determine the (1) cash collected in 2002. (2) estimated income on the construction contract. Solution 7 LO3 (1) Progress billings on construction contract............ Less accounts receivable..................................... Cash collected in 2002.........................................

$562,000 150,500 $411,500

(2) Gross profit from construction contract + Construction in progress = Revenue for 2002 $301,000 + $602,000 = $903,000 $903,000/$7,525,000 = 12% Percentage completed in 2002 $301,000/.12 = $2,508,333 Estimated income on construction contract Problem 8 Summit Electronics Company sends appliances to dealers on a consignment basis. The selling price per unit is $920 and the dealer earns a 30% commission. The manufacturing cost of the appliance to Summit Electronics is $570. Assume that in 2002, 800 units were sent on consignment to Farley Hardware. Four hundred of these units were sold for cash, and by December 31, 2002, remittance had been made to Summit Electronics for 380 units. Prepare the required journal entries on the books of Summit Electronics Company and Farley Hardware for the transactions in 2002. Solution 8 LO6

Summit Electronics Company Inventory on Consignment (800 @ $570)................. Finished Goods Inventory.............................

456,000 456,000

Consignment Expense ($368,000 x 30%).................. Accounts Receivable--Consignee Sales.............. Sales Revenue--Consignment ($920 x 400).....

110,400 257,600

Cost of Consigned Goods Sold ($570 x 400)........... Inventory on Consignment............................

228,000

Cash [($920 x 70%) x 380]........................................... Accounts Receivable--Consignee Sales......

244,720

368,000 228,000 244,720

Farley Hardware No entry upon receipt of consigned merchandise. Cash ($920 x 400)..................................................... Consignor Payable....................................... Commission Revenue...................................

368,000

Consignor Payable................................................ Cash..............................................................

244,720

257,600 110,400 244,720

Problem 9 The Abbott Corporation sells merchandise on the installment basis, and the uncertainties of cash collection make the use of the installment sales method of accounting acceptable. The following data relate to two years of operations. Installment sales................................................... Cost of installment sales....................................... Gross profit............................................................ Gross profit percentage........................................ Cash collections: 2002 Sales.................................................... 2003 Sales....................................................

2002 $480,000 300,000 180,000 37.5%

2003 $560,000 364,000 196,000 35%

$190,000 --

$210,000 235,000

Record the transactions related to installment sales for 2002 and 2003. Solution 9 LO5 2002 Installment Accounts Receivable--2002.................. Installment Sales.............................................

480,000 480,000

Cost of Installment Sales......................................... Inventory..........................................................

300,000

Cash......................................................................... Installment Accounts Receivable--2002..........

190,000

Installment Sales..................................................... Cost of Installment Sales................................. Deferred Gross Profit--2002............................

480,000

Deferred Gross Profit--2002.................................... Realized Gross Profit on Installment Sales ($190,000 x 37.5%)................................................

71,250

2003 Installment Accounts Receivable--2003.................. Installment Sales.............................................

300,000 190,000 300,000 180,000

71,250 560,000 560,000

Cost of Installment Sales......................................... Inventory..........................................................

364,000

Cash......................................................................... Installment Accounts Receivable--2002.......... Installment Accounts Receivable--2003..........

445,000

Installment Sales..................................................... Cost of Installment Sales................................. Deferred Gross Profit--2003............................

560,000

Deferred Gross Profit--2002.................................... Deferred Gross Profit--2003.................................... Realized Gross Profit on Installment Sales....

78,750 82,250

2002: 2003:

$210,000 x 37.5% = $235,000 x 35% =

364,000 210,000 235,000 364,000 196,000

161,000

$ 78,750 82,250 $161,000

Problem 10 Ajax Dry Cleaners, Inc. charges an initial franchise fee of $195,000. When the agreement is signed, a payment of $75,000 is due, followed by four annual payments of $30,000 at the end of each period. Ajax’s normal borrowing rate is 12%. Prepare the entries to record the initial franchise fee on the books of Ajax under each of the following circumstances. (1) The franchiser has substantial services to perform and the collection of the note is extremely uncertain.

(2) The down payment is nonrefundable, collection of the note is reasonably assured, and the franchiser has performed substantially all of the services required by the initial fee. (3) The down payment is nonrefundable, collection of the note is reasonably assured, the franchiser has performed services equivalent to the down payment, but substantial services remain to be performed. Solution 10 LO6 (1) Cash...................................................................... Unearned Franchise Fee.............................. (2) Cash...................................................................... Note Receivable.................................................... Discount on Note Receivable....................... Revenue from Franchise Fee.......................

75,000 75,000 75,000 120,000 28,881 166,119

[$75,000 + ($30,000 x 3.0373)] = $116,119 (Table IV n = 4, i = 12%)

(3) Cash...................................................................... Note Receivable.................................................... Discount on Note Receivable....................... Revenue from Franchise Fee....................... Unearned Franchise Fee..............................

75,000 120,000 28,881 75,000 91,119

Problem 11 On January 1, 2002, Cleveland Enterprises obtained a contract to construct a building. It was estimated at the beginning of the contract that it would take three years to complete the project at an expected cost of $200,000. The contract price was $250,000. The following information describes the status of the job at the close of production each year: 2002 2003 2004 Actual costs incurred............................ $110,000 $120,000 $15,000 Estimated costs to complete................. 100,000 20,000 0 Billings on contract............................... 125,000 125,000 0 Collections on contract......................... 120,000 120,000 10,000 Compute the items listed below for each year assuming the use of the percentageof- completion cost-to-cost method. (Round all percentages to two decimals). 2002

2003

2004

1.Revenue recognized during the year.............. 2.Gross profit recognized during the year ...................................................... 3.Balance in the construction in progress account at December 31 (after closing entries).................................................. 4.Balance in the progress billings account at December 31 (after closing entries). Solution 11 LO3 Contract price.............................................. Current year costs....................................... Costs to date................................................ Estimated cost to complete......................... Estimated total cost..................................... Estimated total gross profit..........................

2002 $250,000 110,000 110,000 100,000 210,000 40,000

2003 $250,000 115,000 225,000 20,000 245,000 5,000

2004 $250,000 15,000 240,000 0 240,000 10,000

Percent complete.........................................

52%

92%

100%

Revenue to date..........................................

$130,000

$230,000

$250,000

To Date at December 31

Previous Years

Current Year

2002:

Revenue..................... $130,000 Costs..................... 110,000 Gross profit..................... $ 20,000

2003:


$130,000 110,000 $ 20,000

$100,000 115,000 $ (15,000)

2004:

Revenue..................... Costs..................... Gross profit.....................

$250,000 240,000 $ 10,000

$230,000 225,000 $ 5,000

$20,000 15,000 $ 5,000

2002

2003

$130,000

$100,000

1.Revenue recognized during the year.............. 2.Gross profit recognized during the year....................................................... 3.Balance in the construction in progress account at December 31....... 4.Balance in the progress billings account at December 31.......................

$130,000 110,000 $ 20,000

2004 $20,000

20,000

(15,000)

5,000

130,000

230,000

0

125,000

250,000

0

Problem 12 On January 1, 2002, Edwards Inc. obtained a contract to construct a building. It was estimated at the beginning of the contract that it would take 3 years to complete the project at an expected cost of $200,000. The contract price was $250,000. The following information describes the status of the job at the close of production each year: 2002 2003 2004 Actual costs incurred............................ Estimated costs to complete................. Billings on contract............................... Collections on contract.........................

$150,000 90,000 110,000 100,000

$100,000 20,000 120,000 120,000

$15,000 0 20,000 30,000

Compute the items listed below for each year assuming the use of the percentageof- completion cost-to-cost method. (Round all percentages to two decimals.) 2002 1.Construction costs (expense) recognized during the year...................

2003

2004

2.Gross profit recognized during the year....................................................... 3.Balance in the construction in progress account at December 31 (after closing entries)............................ 4.Balance in accounts receivable at December 31 (after closing entries)..... Solution 12 LO3 2002

2003

2004

Contract price....................................... $250,000 Current year costs................................ 150,000 Costs to date......................................... 150,000 Estimated cost to complete................... 90,000 Estimated total cost.............................. 240,000 Estimated total gross profit................... 10,000

$250,000 100,000 250,000 20,000 270,000 (20,000)

$250,000 15,000 265,000 0 265,000 (15,000)

63%

93%

100%

Revenue to date................................... $157,500

$232,500

$250,000

Previous Years

Current Year

Percent complete..................................

To Date at December 31 2002:


$157,500 150,000 $ 7,500

2003:

Revenue..................... $232,500 Costs..................... 252,500 Gross profit..................... $ (20,000)

$157,500 150,000 $ 7,500

$ 75,000 102,500 $ (27,500)

2004:

Revenue..................... $250,000 Costs..................... 265,000 Gross profit..................... $ (15,000)

$232,500 252,500 $ (20,000)

$17,500 12,500 $ 5,000

2002 2003 2004 1.Construction costs (expense) recognized during the year................................................. $150,000 $102,500 $12,500 2.

Gross profit recognized during the year..........

3.Balance in the construction in progress account at December 31 (after closing entries)............................................................. 4.

Balance in accounts receivable at December 31 (after closing entries)................

7,500

(27,500)

5,000

157,500 230,000

0

10,000

10,000

0

Problem 13 The importance of revenue to a business enterprise has caused much discussion among accountants as to how the term “revenue” should be defined. The FASB in Statement of Financial Accounting Concepts No. 6, “Elements of Financial Statements,” defines revenue as “inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.” Evaluate the soundness of the definition of the term “revenue” provided by the FASB in Statement of Financial Accounting Concepts No. 6. Solution 13 LO1 Critics of the FASB’s definition have suggested that the inflow concept used by the FASB in defining revenue confuses the measurement and timing of revenue with the actual revenue process. Revenue is viewed by some as a product of the firm resulting from the creation of goods or services by an enterprise during a given period of time. Defining revenue in terms of inflows of assets imposes upon revenues the measurement criteria for assets. The concept of revenue is broader than the measurement criteria for some other financial statement element. The inflow approach requires a careful statement of which inflows are to be considered revenues and which are not. Assets may increase and liabilities may decrease for a number of reasons other than revenues. Exceptions to the inflow criteria also must be clearly stated. Revenue may be reported prior to a sale occurring with the associated inflow of assets.

Problem 14 Measuring progress toward completion of long-term construction projects can be accomplished in a number of ways. Nonetheless, all of these measurements can be classified into two basic groups: input measures and output measures. Input measures attempt to measure the effort devoted to a project to date compared to the total effort expected to be required in order to complete the project. A common input measure is the ratio of costs incurred to date to total estimated costs for the project. Output measures attempt to measure the results to date compared to total results when the project is completed. A common output measure would be the number of stories of a building completed compared to the total number of stories to be built. Identify the general problems associated with input and output measures in determining the level of completion of a long-term construction project. Solution 14 LO2 Several general problems exist with input and output measures generally, regardless of the specific methods used to operationalize these measures. Input measures are misleading if a relatively constant relationship does not exist between the input measure and productivity. A construction company building a large multi-story building may first need to excavate 100 feet into the ground in order to construct the appropriate foundation for the building. The excavation may proceed quite smoothly for the first 50 feet but may become more difficulty as hard bedrock is encountered. Costs per foot of excavation may increase. If the higher excavation cost associated with greater depths was not included in the original cost estimates, then the use of a cost as a measure of progress will overstate the progress actually made. Cost incurred also poses problems as a measure of progress when large amounts of expenditures for materials and supplies are made at the inception of the project for use throughout the project. A distinction thus should be made between costs incurred and cost actually contributing to progress. Costs incurred also may pose a problem due to the learning curve effect: As more units are produced, construction can become less costly because the contractor learns the most efficient procedures and methods of construction for the project. Use of the cost of earlier units to measure the cost of all units may also tend to overstate the actual cost of the progress made. Output measures also pose problems, particularly when different output units require different amounts of input effort to complete. The first floor of a multi-story building may require more input effort to complete as a result of foundation and subsurface construction than the second floor. Use of floors completed may understate the actual rate of progress.

Problem 15 The percentage-of-completion method is used to recognize revenue and gross profit for construction and other types of projects that extend beyond one accounting period. A problem similar to long-term construction projects exists in accounting for service revenue that is earned for more than one performance act where such activity extends beyond one accounting period. Provide examples of service activities that might extend beyond one accounting period and propose means of recognizing revenues for such activities. Solution 15 LO4 A proportional measurement approach similar to the percentage-of-completion approach may be adopted for recognizing service revenues. Under the proportional measurement approach, revenue is recognized on the proportional performance of each act. Service transactions may take several different forms, however. If the service transaction involves a specified number of identical or similar acts, then an equal amount of revenue should be recorded for each act performed. A refuse disposal company, for example, would recognize an equal amount of revenue for each weekly removal of a customer’s garbage. A service transaction may involve a specified number of defined but not identical or similar acts. In this case, revenue recognized for each act should be based on the ratio of the direct cost of the individual act to the total estimated direct costs of the transaction times the total revenues from the complete transaction. A correspondence school, for example, may provide lessons, examinations, and grading as part of total package of educational services. These are different acts that are part of the same service transaction. Finally, a service transaction may involve an unspecified number of acts over a fixed time period for performance. In this situation, revenue should be recognized over the period during which the acts will be performed by using the straight-line method unless a better method of relating revenue and performance is appropriate.

CHAPTER 7 -- QUIZ A

Name _________________________ Section ________________________

T F

1. Revenues and gains are generally recognized when they are realized or realizable and they have been earned through substantial completion of the activities involved in the earnings process.

T F

2. The proportional performance method has been developed to reflect revenue earned on service contracts under which many acts of service are to be performed before the contract is completed.

T F

3. The completed-contract method was developed to relate recognition of revenue on long-term construction-type contracts to the activities of a firm in fulfilling these contracts.

T F

4. Beginning with the Tax Reform Act of 1986, the tax laws eliminated the use of the completed-contract method.

T F

5. The most popular input measure under percentage-of-completion accounting is the cost-to-cost method.

T F

6. Estimates of architects and engineers of percentage-of-completion are not acceptable under generally accepted accounting principles.

T F

7. At the conclusion of a construction contract, the balance in Construction in Progress will be exactly equal to the amount in Progress Billings on Construction Contracts when using the percentage-of-completion method.

T F

8. If analysis of construction contracts indicates that there will be an overall loss on the contract, the loss should immediately be recognized in full under the completed-contract method and the percentage-of-completion method.

T F

9. As construction contract estimates change, retroactive adjustments are required if the amount is material.

T F 10. Change orders are modifications of an original contract that effectively change the provisions of the contract, only at the option of the contractor.

263

CHAPTER 7 -- QUIZ B

Name _________________________ Section ________________________

T F

1. Revenue should be recognized under the proportional performance method unless the final act of service to be performed is so vital to the contract that earlier acts are relatively insignificant.

T F

2. If no pattern of performance can be determined on a service contract, revenue recognition should be deferred until all services have been rendered.

T F

3. Accounting for service contracts using the cost-to-cost method of input measurement requires inclusion of only direct costs related to the acts of service.

T F

4. Accounting for installment sales using the deferred gross profit approach requires determining a gross profit rate for the sales of each year, and establishing an accounts receivable and a deferred revenue account identified by the year of the sale.

T F

5. The deferred gross profit accounts are reported as liabilities under the installment sale method.

T F

6. Under the cost recovery method, no income is recognized on a sale until the cost of the item sold is recovered through cash receipts with all subsequent receipts reported as revenues.

T F

7. The cost recovery method is the most conservative revenue recognition method.

T F

8. The cost recovery method is often used when the circumstances surrounding a sale are too uncertain to use the installment sale method.

T F

9. If a company is heavily involved in installment sales, the operating cycle of the business is normally defined as the average period of the installment contracts.

T F 10. The cash method might be appropriate for service contracts with high initial costs and considerable uncertainty as to the ultimate collection of the contract price.

264

CHAPTER 7 -- QUIZ C

A. B. C. D. E. F.

Name _________________________ Section ________________________

Installment sales method Consignment sales Change orders Substantial performance Input measures Efforts-expended methods

G. H. I. J. K. L.

Cost recovery method Completed-contract method Proportional performance method Percentage-of-completion method Deposit method Output measures

Select the term that best fits each of the following definitions and descriptions. Indicate your answer by placing the appropriate letter in the space provided. ____ 1. A revenue recognition method that recognizes gross profit as cash is received. ____ 2. An accounting method that recognizes revenues and expenses on long-term construction contracts only when completed. ____ 3. An accounting method that recognizes the receipt of cash and the unearned revenue prior to beginning work on the contract. ____ 4. Modifications to the terms of agreement of an original contract. ____ 5. Measures of the earning process in percentage-of-completion accounting based on cost or efforts devoted to a contract. ____ 6. A revenue recognition method that requires the recovery of cost (investment) prior to the recognition of revenue. ____ 7. Measures of the earnings process in percentage-of-completion accounting based on units produced, contract milestones reached, or values added. ____ 8. A transfer of property without a transfer of title and risk of ownership. ____ 9. An accounting method for recording service revenue and related expenses prior to completion of the service contract. ____ 10. A criterion for recognizing revenue from a franchising agreement which requires that all provisions of the contract agreement have to be substantially complete before revenue and related expense may be recognized.

265

CHAPTER 7 -- QUIZ SOLUTIONS Quiz A 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

T T F F T F T T F F

Quiz B 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

T F T T F T F T T T

Quiz C 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

A H K C E G L B I D

tbch07

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