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The company collects the other installments when due so it receives a total of USD 350 in 2011from 2010 installment sales. The gross margin to recognize in 2011 on these cash collections is asfollows:2011 cash collections from 2010 installment salesXGross margin percentage on 2010 installment sales= 2011 gross margin recognized on 2011 cash collections from 2010 installment salesUSD 350X40 per cent= USD 140In summary, the total receipts and gross margin recognized in the two years are as follows:Total Amount ofGross MarginYearCash RecognizedRecognized2010$150 30%$ 60 30%2011.....350 70%140 70%$500 100%$200 100%Because the installment basis delays some revenue recognition beyond the time of sale, it isacceptable for accounting purposes only when considerable doubt exists as to collectibility of theinstallments.Revenue recognition on long-term construction projectsCompanies recognize revenuefrom a long-term construction project under two different methods: (1) the completed-contractmethod or (2) the percentage-of-completion method. The completed-contract methoddoes notrecognize any revenue until the project is completed. In that period, they recognize all revenueeven though the contract may have required three years to complete. Thus, the completed-contractmethod recognizes revenues at the time of sale, as is true for most sales transactions. Companiescarry costs incurred on the project forward in an inventory account (Construction in Process) andcharge them to expense in the period in which the revenue is recognized.Some accountants argue that waiting so long to recognize any revenue is unreasonable. Theybelieve that because revenue-producing activities have been performed during each year ofconstruction, revenue should be recognized in each year of construction even if estimates areneeded. The percentage-of-completion methodrecognizes revenue based on the estimated stageof completion of a long-term project. To measure the stage of completion, firms compare actualcosts incurred in a period with the total estimated costs to be incurred on the project.To illustrate, assume that a company has a contract to build a dam for USD 44 million. Theestimated construction cost is USD 40 million. You calculate the estimated gross margin as follows:Sales price of damEstimated costs of construct damEstimated gross margin (sales price – estimated costs)USD 44 millionUSD 40 million(44 million – 40 million) – 4 millionThe firm recognizes the USD 4 million gross margin in the financial statements by recording theassigned revenue for the year and then deducting actual costs incurred that year. The formula torecognize revenue is:
ActualconstructioncostsincurredduringtheperiodTotalestimatedconstructioncostsfortheentireprojectxTotalsalesprice=RevenuerecognizedforperiodSuppose that by the end of the first year (2010), the company had incurred actual constructioncosts of USD 30 million. These costs are 75 per cent of the total estimated construction costs (USD30 million/USD 40 million = 75 per cent). Under the percentage-of-completion method, the firm