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 recognition of the fee as revenue—to which of several possible periods should it be assigned? The second reiates to the amount of revenue to be recognized and this. in turn, is partiaily a question of the valuation of the notes received. Possible aiternative methods are illustrated and evaluated as follows: *CA 18-10 (Continued) or 1. Cash ............................................................... .. 20,000 20,000 Notes Receivable ........................................... .. 100,000 75,816 Discount on Notes Receivable ($100,000 - $75,816) ............................ .. 24,184 Franchise Fee Revenue ........................... .. 95,816 95,816 This method would be acceptable if (a) the probability of refunding the initial fee was extremely low, and (b) the amount of future services to be provided to the franchisee was minimal; that is, performance by the franchisor is deemed to have taken place. or 2. Cash ............................................................... .. 20,000 20,000 Notes Receivable ........................................... .. 100,000 75,816 Discount on Notes Receivable .................. .. 24,184 Unearned Franchise Fees ........................ .. 95,818 95,816 This method would be appropriate if (a) there was a reasonable expectation that the down payment may be refunded, and (b) substantial future services are to be provided to the franchisee; that is, performance by the franchisor has not yet occurred. or 3. Cash ............................................................... .. 20,000 20,000 Notes Receivable ........................................... .. 100,000 75,816 Discount on Notes Receivable .................. .. 24,184 _ Revenue from Franchise Fees .................. .. 20,000 20,000 Unearned Franchise Fees ........................ .. 75,816 75,816 The assumptions underiying this alternative are that (a) the down payment of $20,000 is not refundable and represents a fair measure of services provided to the franchisee at the time the contract is signed, and (b) a significant amount of service is to be performed by the franchisor in future periods. 4. Cash ............................................................... .. 20,000 Revenue from Franchise Fees .................. .. 20,000 This procedure wouid be consistent with the cash basis of accounting and would be considered appropriate in situations where (a) the initial fee is not refundable, (b) the contract does not call for a substantiai amount of future services to the franchisee, and (c) the collection of any part of the notes is so uncertain that recognition of the notes as assets is unwarranted. 5. Cash ............................................................... .. 20,000 Unearned Franchise Fees ........................ .. 20,000 The assumption underlying this procedure is that either the down payment is refundable or substantial services must be performed by the franchisor before the fee can be considered earned. As in alternative 4., the collection of any portion of the notes receivable is so uncertain that recognition in the accounts cannot be considered appropriate. *CA 18-10 (Continued) (b) 6. Three additional alternatives would parallel the first three alternatives given above, except that the notes would be reported at their face value. These alternatives would be appropriate in situations where the notes bear interest or cali for the payment of interest at the going rate. Because the initial cash collection of $20,000 must be refunded if the franchise fails to open, it is not fully earned until the franchisee begins operations. Thus, Amigos Burrito should record the initial franchise fee as follows: or Cash .................................................................. .. 20,000 20,000 Notes Receivable .............................................. .. 100,000 75,816 Discount on Notes Receivabie ................... .. 24,184 Unearned Franchise Fees ......................... .. 95,816 95,816 (or Advances by Franchisees) When the franchisee begins operations, the $20,000 would be earned and the following entry should be made: Unearned Franchise Fee ................................... .. Revenue from Franchise Fees ................... .. 20,000 20,000 If there is no time lag between the collection of the $20,000 and the opening by the franchisee, then the initial cash collection of $20,000 is earned when it is received and the initiai franchise fee shouid be recorded as follows: Or 20,000 75,816 Cash .................................................................. .. Notes Receivable .............................................. .. 20,000 100,000 Discount on Notes Receivable ................... .. 24,184 Unearned Franchise Fees ......................... .. 75,816 75,816 (or Advances by Franchisees) Revenue from Franchise Fees ................... .. 20,000 20,000 After Amigos Burrito Inc. has experienced the opening of a large number of franchises, it should be possible to develop probability measures so that the expected value of the retained initial franchise fee can be determined and recorded as earned at the time of receipt. The notes receivabie are property recorded at their present value. No more than $75,816, the net present value of the notes, should be reported as an asset. Interest at 10% should be accrued each year by a debit to Discount on Notes Receivabie (or Notes Receivable) and a credit to interest Revenue. Collections are recorded as debits to Cash and credits to Notes Receivable. Each year as the services are rendered, an appropriate amount would be transferred from Unearned Franchise Fees to Revenue from Franchise Fees. Since these annual payments are not refundable, the Revenue from Franchise Fees might be recognized at the time the $20,000 is collected, but this may result in the mismatching of costs and revenues. At the time that a franchise opens, only two steps remain before Amigos Burrito Inc. will have fully earned the entire franchise fee. First, it must provide expert advice over the five-year period. *CA 18-10 (Continued) (C) Second, it must wait until the end of each of the next five years so that it may collect each of the $20,000 notes. Since collection has not been a problem, and since the advice may consist largely of manuals and periodicai service tip fiyers, it could be maintained that a substantial portion of the $75,816, the present value of the notes, should be recognized as revenue when a franchisee begins operations. Although there have been no defaults on the notes, the extent of Amigos Burrito Inc’s experience may be so limited that there may in fact be a substantial collection problem in the future (as has been the actual experience of many franchisors in the recent past). At some time in the future, after Amigos Burrito inc. has experienced a large number of franchises that have opened and operated for five years or more, it should be possible to deveiop probability measures so that the earned portion of the present value of the notes may be recognized as revenue at the time the franchise begins operations. The monthly fee of 2% of sales should be recorded as revenue at the end of each month. This fee is for current services rendered and should be recognized as the services are performed. If the rental portion of the initial franchise fee, $20,000, represents the present value of monthly rentals over a ten~year period, it should be recorded as Unearned Lease Revenue to be recognized on an actuarially sound basis over the periods benefiting from the use of the leased assets. This type of transaction does not necessarily represent a sale of the equipment and immediate recognition of the entire rental as revenue may not be appropriate. if the transaction couid be considered to be a sale of equipment, the entire rental revenue of $20,000 should be recognized immediately upon delivery of the equipment. Since credit risks are no problem, the conditions that must be met to justify recognizing a sales transaction are: (1) whether Amigos Burrito lnc. retains sizabie risks of ownership, and (2) whether there are important uncertainties surrounding the amount of costs yet to be incurred. The fact that no portion of the rental is refundable does not warrant immediate recognition of the entire amount as revenue. The major questions are whether the equipment has a substantial salvage value at the end of the ten years, whether the franchisee or Amigos Burrito Inc. gets the equipment free or for a nominal fee at the end of the ten years, and whether Amigos Burrito Inc. has responsibility for servicing, repairing, and maintaining the equipment during all or part of the ten—year period. Because the data do not provide answers to these questions, a definite recommendation cannot be given to the preferable method of accounting for the "rental" portion of the initial franchise fee. ...
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Chapter 18 homework solutions - EXERCISE 18-6 (10—12...

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