The company collects the other installments when due so it receives a total of

The company collects the other installments when due

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The company collects the other installments when due so it receives a total of USD 350 in 2011 from 2010 installment sales. The gross margin to recognize in 2011 on these cash collections is as follows: 2011 cash collections from 2010 installment sales X Gross margin percentage on 2010 installment sales = 2011 gross margin recognized on 2011 cash collections from 2010 installment sales USD 350 X 40 per cent = USD 140 In summary, the total receipts and gross margin recognized in the two years are as follows: Total Amount of Gross Margin Year Cash Recognized Recognized 2010 $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 is acceptable for accounting purposes only when considerable doubt exists as to collectibility of the installments . Revenue recognition on long-term construction projects Companies recognize revenue from a long-term construction project under two different methods: (1) the completed-contract method or (2) the percentage-of-completion method. The completed-contract method does not recognize any revenue until the project is completed. In that period, they recognize all revenue even though the contract may have required three years to complete. Thus, the completed-contract method recognizes revenues at the time of sale, as is true for most sales transactions. Companies carry costs incurred on the project forward in an inventory account (Construction in Process) and charge 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. They believe that because revenue-producing activities have been performed during each year of construction, revenue should be recognized in each year of construction even if estimates are needed. The percentage-of-completion method recognizes revenue based on the estimated stage of completion of a long-term project. To measure the stage of completion, firms compare actual costs 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. The estimated construction cost is USD 40 million. You calculate the estimated gross margin as follows: Sales price of dam Estimated costs of construct dam Estimated gross margin (sales price – estimated costs) USD 44 million USD 40 million (44 million – 40 million) – 4 million The firm recognizes the USD 4 million gross margin in the financial statements by recording the assigned revenue for the year and then deducting actual costs incurred that year. The formula to recognize revenue is:
Actualconstructioncostsincurredduringtheperiod Totalestimatedconstructioncostsfortheentireproject xTotalsalesprice = Revenuerecognizedforperiod Suppose that by the end of the first year (2010), the company had incurred actual construction costs of USD 30 million. These costs are 75 per cent of the total estimated construction costs (USD 30 million/USD 40 million = 75 per cent). Under the percentage-of-completion method, the firm

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