Chapter 18 homework solutions

Chapter 18 homework solutions - EXERCISE 18-6(10—12...

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Unformatted text preview: EXERCISE 18-6 (10—12 minutes) DOUGHERTY INC. Computation of Gross Profit to be Recognized on Uncompleted Contract Year Ended December 31, 2010 Total contract price Estimated contract cost at completion ($800,000 + $1,200,000) ............................................. .. $2,000,000 Fixed fee .......................................................................... .. 450,000 Total ......................................................................... .. 2,450,000 Total estimated cost ....................................................... .. 2,000,000 Gross profit ..................................................................... .. 450,000 Percentage of completion ($800,000 + $2,000,000) ...... .. 40% Gross profit to be recognized ($450,000 X 40%) .......... .. g 180,000 EXERCISE 18-13 (15-20 minutes) Gross Profit Rate—2010: ($750,000 — $510,000) + $750,000 = 32°10 Gross Profit Rate-“2011: ($840,000 -—- $588,000) -2- $840,000 = 30% (a) Balance, December 31, 2010: Deferred Gross Profit Account—4010 Installment Sales Gross profit on installment sales—2010 ($750,000 — $510,000) ........................................................ .. $240,000 Less: Gross profit realized in 2010 ($310,000 X 32%) ....... .. (99,200) Balance at 12/31/10 .................................................... .. $140,800 Balance, December 31, 2011: Deferred Gross Profit Accountw2010 Installment Sales Balance at 12/31/10 ............................................................... .. $140,800 Less: Gross profit realized in 2011 on 2010 sales ($300,000 X 32%) ....................................................... .. (96,000) Balance at 12/31/11 .................................................... .. § 44,800 Deferred Gross Profit Account—2011 installment Sales Gross profit on installment sales—2011 ($340,000 — $533,000) ...................................................... $252,000 Less: Gross profit realized in 2011 on 2011 sales ($400,000 X 30%) ....................................................... .. (120,000) Balance at 12/31/11 .................................................... .. $132,000 EXERCISE 18-13 (Continued) (b) Repossessed Merchandise .................................... .. 8,000 Deferred Gross Profit ($12,000 X 32%) .................. .. 3,840 Loss on Repossession ........................................... .. 160* Installment Accounts Receivable ................... .. 12,000 (To record the default and the repossession of the merchandise) *[$8,000 — ($12,000 —- $3,840)] CA 18-2 (3) (b) The point of sale is the most widely used basis for the timing of revenue recognition because in most cases it provides the degree of objective evidence accountants consider necessary to reliably measure periodic business income. in other words, sales transactions with outsiders represent the point in the revenue-generating process when most of the uncertainty about the finai outcome of business activity has been alleviated. it is also at the point of sale in most cases that substantially ail of the costs of generating reve- nues are known, and they can at this point be matched with the revenues generated to produce a reiiable statement of a firm's effort and accomptishrnent for the period. Any attempt to measure income prior to the point of sate would, in the vast majority of cases, introduce considerabiy more subjectivity in financial reporting than most accountants are willing to accept. 1. Though it is recognized that revenue is earned throughout the entire production process, generally it is not feasibie to measure revenue on the basis of operating activity. it is not feasible because of the absence of suitable criteria for consistently and objectively arriving at a periodic determination of the amount of revenue to recognize. Also, in most situations the sale represents the most important single step in the earnings process. Prior to the sale, the amount of revenue anticipated from the processes of produc— tion is merely prospective revenue; its realization remains to be validated by actual sates. The accumulation of costs during production does not alone generate revenue. Rather, revenues are earned by the completion of the entire process, including making sales. Thus, as a general rule, the sale cannot be regarded as being an unduty conservative basis for the timing of revenue recognition. Except in unusual circumstances, revenue recognition prior to sale wouid be anticipatory in nature and unverifiabie in amount. 2. To criticize the sales basis as not being sufficiently conservative because accounts receiv- able do not represent disposable funds, it is necessary to assume that the collection of receivables is the decisive step in the earnings process and that periodic revenue measure- ment and, therefore, net income shoutd depend on the amount of cash generated during the period. This assumption disregards the fact that the sale usualiy represents the decisive CA 18-2 (Continued) (C) factor in the earnings process and substitutes for it the administrative function of managing and collecting receivabies. in other words, the investment of funds in receivabies shouid be regarded as a policy designed to increase totai revenues, properly recognized at the point of sale, and the cost of managing receivables (e.g., bad debts and collection costs) should be matched with the sales in the proper period. The fact that some revenue adjustments (e.g., sales returns) and some expenses (e.g., bad debts and collection costs) may occur in a period subsequent to the saie does not detract from the overall usefulness of the sales basis for the timing of revenue recognition. Both can be estimated with sufficient accuracy so as not to detract from the reliability of reported net income. Thus, in the vast majority of cases for which the sales basis is used, estimating errors, though unavoidable, wiii be too immaterial in amount to warrant deferring revenue recognition to a later point in time. During production. This basis of recognizing revenue is frequentiy used by firms whose major source of revenue is long-term construction projects. For these firms the point of sate is far tess significant to the earnings process than is production activity because the sale is assured under the contract (except of course where performance is not substantially in ‘ accordance with the contract terms). To defer revenue recognition until the compietion of long—term construction projects could impair significantly the usefulness of the intervening annuai financial statements because the volume of contracts completed during a period is iikely to bear no reiationship to produc- tion voiume. During each year that a project is in process a portion of the contract price is, .therefore, appropriateiy recognized as that year's revenue. The amount of the contract price to be recognized should be proportionate to the year’s production progress on the project. income might be recognized on a production basis for some products whose salability at a known price can be reasonably determined as might be the case with some precious metais and agricuitural products. it should be noted that the use of the production basis in lieu of the sates basis for the timing of revenue recognition is justifiabie oniy when totai profit or loss on the contracts can be estimated with reasonable accuracy and its uitimate realization is reasonably assured. When cash is received. The most common application of this basis for the timing of revenue recognition is in connection with installment-sales contracts. its use is justified on the grounds that, due to the iength of the collection period, increased risks of default, and higher collection costs, there is too much uncertainty to warrant revenue recognition untii cash is received. The mere fact that sales are made on an installment contract basis does not justify using the cash receipts basis of revenue recognition. The justification for this departure from the sales basis depends essentially upon an absence of a reasonabiy objective basis for estimating the amount of coilection costs and bad debts that will be incurred in Eater periods. if these expenses can be estimated with reasonabie accuracy, the sales basis should be used. EXERClSE 18-9 (15-«25 minutes) (a) Computation of Gross Profit to Be Recognized under Completed— Contract Method. No computation necessary. No gross profit to be recognized prior to completion of contract. Computation of Billings on Uncompleted Contract in Excess of Related Costs under Completed-Contract Method. Construction costs incurred during the year ............... .. $ 1,185,800 Partial billings on contract (25% X $6,000,000) ............ .. (1,500,000) § (314E200) EXERCISE 18-9 (Continued) (b) Computation of Gross Profit to Be Recognized under Percentage-of- Comgietion Method. Totai contract price ........................................................... .. $6,000,000 Total estimated cost ($1,185,800 + $4,204,200) .............. .. 5,390,000 Estimated total gross profit from contract ...................... .. 610,000 Percentage-of-completion ($1,185,8001$5,390,000) ........ .. 22% Gross profit to be recognized during the year ($610,000 X 22%) ............................................................ .. § 134,200 Computation of Billings on Uncompleted Contract in Excess of Related Costs and Recognized Profit under Percentage-of-Compietion Method. Construction costs incurred during the year .................. .. $ 1,185,800 Gross profit to be recognized during the year (above) 134,200 Total charged to construction—inuprocess ............... .. 1,320,000 Partial billings on contract (25% X $6,000,000) ............... .. (1,500,000) § (180,000) EXERCISE 18—1 4 (10—15 minutes) BECKER CORPORATION lncome before lncome Taxes on Installment-Sale Contract For the Year Ended December 31, 2010 ___________________________.__——————-——————-- Sales .............................................................................................. .. $586,842 Cost of sales ................................................................................. .. 425,000 Gross profit ................................................................................... .. 161,842 Interest revenue (Schedule 1) ..................................................... .. 24,342 Income before income taxes ....................................................... .. $86,184 Schedule 1 Comgutation of Interest Revenue on installment-Sale Contract Cash selling price ......................................................................... .. $586,842 Deduct payment made July 1, 2010 ............................................ .. 100,000 486,842 interest rate ................................................................................... .. X 10% Annual interest ............................................................................. .. g 48,684 Interest July 1, 2010 to December 31, 2010 ($48,684 X 1/2) ....... .. § 24,342 (a) PROBLEM 18-7 W Computation of Recognizable Profit/Loss Percentage-of—Completion Method 2010 Costs to date (12/31/10) ............................................... .. $ 300,000 Estimated costs to complete ...................................... .. 1,200,000 Estimated total costs ........................................... .. $1,500,000 Percent complete ($300,000 ~E- $1,500,000) ................. .. 20° Revenue recognized ($1,900,000 X 20%) ................... .. $ 380,000 Costs incurred ............................................................. .. 300,000 Profit recognized in 2010 ............................................ .. § 80,000 2011 Costs to date (12]31/11) ............................................... .. $1,200,000 Estimated costs to complete ...................................... .. 800,000 Estimated total costs ........................................... .. 2,000,000 Contract price .............................................................. .. 1,900,000 Total loss ...................................................................... .. § 100,000 Total loss ...................................................................... .. $ 100,000 Plus gross profit recognized in 2010 .......................... .. 80,000 Loss recognized in 2011 ............................................. .. § 180,000 OR Percent complete ($1,200,000 + $2,000,000) .............. .. 60% Revenue recognized in 2011 “$1,900,000 X 60%) - $380,000] ............................. .. $ 760,000 Costs incurred in 2011 ($1,200,000 ~— $300,000) ........................................... .. 900,000 Loss to date ................................................................. .. 140,000 Loss attributable to 2012* ........................................... .. 40,000 Loss recognized in 2011 ............................................. .. g 180,000 PROBLEM 18—7 (Continued) (b) *2012 revenue ($1,900,000 — $380,000 — $760,000) $760,000 2012 estimated costs ................... .. 800,000 2012 loss ....................................... .. §(40,000) 012 Costs to date (12/31/12) ...................................... .. $2,100,000 Estimated costs to complete ............................. .. 0 2,100,000 Contract price ..................................................... .. 1,900,000 Total loss ............................................................. .. § (200,000) Total loss ............................................................. .. $ (200,000) Less: Loss recognized in 2011 ......................... .. $180,000 Gross profit recognized in 2010 ......................... .. (80,000) (100,000) Loss recognized in 2012 ..................................... .. § (100,000) Computation of Recognizable Profit/Loss Completed-Contract Method 2010—NONE 011 Costs to date (12/31/11) ........................................ .. $1,200,000 Estimated costs to complete ............................... .. 800,000 Estimated total costs .................................... .. 2,000,000 Deduct contract price ........................................... .. 1,900,000 Loss recognized in 2011 ...................................... .. § (100,000) 012 Total costs incurred ............................................. .. $2,100,000 Total revenue recognized .................................... .. 1,900,000 Total loss on contract .................................. .. (200,000) Deduct loss recognized in 2011 .......................... .. (100,000) Loss recognized in 2012 ...................................... .. g (100,000) PROBLEM 18—8 (a) 2010 2011 2012 Rate of gross profit (gm—Sfirflmfl) 38% 37% 35% a es Gross profit realized: 38% of $ 75,000 $28,500 38% of $100,000 $38,000 37% of $100,000 37,000 38% of $ 50,000 $19,000 37% of $120,000 44,400 35% of $100,000 ' 35,000 $28,500 $75,000 §98,400 (b) Installment Accounts Receivable—-—2012 ................ .. 280,000 Installment Sales .............................................. .. 280,000 Cash .......................................................................... .. 270,000 _ Installment Accounts Receivabiem2010 ........ .. 50,000 Installment Accounts Receivable—2011 ........ .. 120,000 Installment Accounts Receivable—201 2 ........ .. 100,000 Cost of Installment Sales ........................................ .. 182,000 Inventory ........................................................... .. 182,000 Installment Sales ..................................................... .. 280,000 Cost of Installment Sales ................................. .. 182,000 Deferred Gross Profit on Installment Sales—2012 .................................................. .. 98,000 Deferred Gross Profit on Installment Salesm2010 19,000 Deferred Gross Profit on Installment Sales—2011 44,400 Deferred Gross Profit on Installment Sales—2012 35,000 Realized Gross Profit on Installment Sales ............................................................. .. 98,400 Realized Gross Profit on Installment Sales ........... .. 98,400 Income Summary ............................................. .. 98,400 PROBLEM 18-13 -1- November 1, 2010 Cash ...................................................................................... .. Installment Accounts Receivable ($900 — $300) ................. .. Installment Sales .......................................................... .. -2- December 1, 2010 Cash ...................................................................................... .. Installment Accounts Receivable ................................ .. -3- December 31, 2010 Cost of Installment Sales ..................................................... .. Inventory ....................................................................... .. Installment Sales .................................................................. .. Cost of Installment Sales ............................................. .. Deferred Gross Profit on installment Sales ....... .; ....... .. Deferred Gross Profit on Installment Sales ........................ .. Realized Gross Profit on Installment Sales ($360 + $900 = 40%; 40% of $330 = $132) ................ .. Realized Gross Profit on Installment Sales ........................ .. Income Summary .......................................................... .. -4- January 1 to July 1, 2011 Cash ($30 X 7) ....................................................................... .. Installment Accounts Receivable ................................ .. -5- August, 2011 Repossessed Merchandise ................................................. .. Deferred Gross Profit on Installment Sales ........................ .. Loss on Repossession ........................................................ .. Installment Accounts Receivable [$30 X (20 — 8)] ...... .- 300 600 30 540 900 132 132 210 100 144 116 900 30 540 540 360 132 132 210 360 PROBLEM 18-13 (Continued) Balance at repossession ............ .. {5360* Gross profit (40% X $360) ........... .. M) Book value ................................... .. 216 Value of repossessed merchandise ............................ .. __1_Q_(_)_ Loss on repossession ................ .. fl *$30 X (20 payments — 8 payments) = $360 *EXERCISE 18-21 (15-20 minutes) (a) inventoriable costs: 80 units shipped at cost of $500 each ..................... .. $40,000 Freight ........................................................................ .. 840 Total inventoriable cost .................................... .. £40,840 40 units on hand (40/80 X $40,840) .......................... .. §20,420 (b) Computation of consignment profit: Consignment saies (40 X $750) ................................ .. $30,000 Cost of units sold (40/80 X $40,840) ......................... .. (20,420) Commission charged by consignee (6% X $30,000) ....................................................... ,. (1,800) Advertising cost ........................................................ .. (200) Installation costs ....................................................... .. (320) Profit on consignment sales ............................. .. g 7,260 (c) Remittance of consignee: Consignment sales ................................................ .. $30,000 Less: Commissions .............................................. .. $1,800 Advertising .................................................. .. 200 installation ............. .................................. .. 320 2,320 Remittance from consignee ................... .. §27,680 CA 18-10 (a) Two primary criteria must be met before revenue is recognized: (1) the related earnings process must be substantially completed (the revenue must be earned), and (2) there must be objective evidence of the market value of the output—this often is interpreted to require that an exchange has taken place—arid is usually referred to as realization (often stated as realized or realizable). Severai issues arise when applying these principles in accounting for the initial franchise fee. The first concerns the time of reco...
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