Intermediate Accounting 7e, Chapter 5 Solutions

May 21, 2018 | Author: misterwaterr | Category: Debits And Credits, Revenue, Franchising, Option (Finance), Expense
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Chapter 5Income Measurement and Profitability Analysis AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise, and problem in Intermediate Accounting, 7e, with the following AACSB learning skills: Questions 5–1 5–2 5–3 5–4 5–5 5–6 5–7 5–8 5–9 5–10 5–11 5–12 5–13 5–14 5–15 5–16 5–17 5–18 5–19 5–20 5–21 5–22 5–23 5–24 5–25 5–26 5–27 AACSB Tags Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Diversity, Reflective thinking Reflective thinking Reflective thinking Reflective thinking Diversity, Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Diversity, Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Brief Exercises 5–1 5–2 5–3 5–4 5–5 5–6 5–7 5–8 5–9 5–10 5–11 5–12 5–13 5–14 5–15 5–16 5–17 5–18 5–19 5–20 5–21 5–22 5–23 5–24 5–25 AACSB Tags Analytic Reflective thinking Analytic Analytic Analytic Reflective thinking, Communications Analytic Analytic Analytic Diversity, Analytic Analytic Reflective thinking, Analytic Diversity, Reflective thinking, Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking Reflective thinking Reflective thinking Analytic Analytic Reflective thinking Analytic Solutions Manual, Vol.1, Chapter 5 © The McGraw-Hill Companies, Inc., 2013 5–1 Exercises 5–1 5–2 5–3 5–4 5–5 5–6 5–7 5–8 5–9 5–10 5–11 5–12 5–13 5–14 5–15 5–16 5–17 5–18 5–19 5–20 5–21 5–22 5–23 5–24 5–25 5–26 5–27 5–28 5–29 5–30 5–31 5–32 5–33 5–34 5–35 5–36 5–37 5–38 AACSB Tags Reflective thinking, Analytic Reflective thinking, Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking, Communications Analytic Diversity, Analytic Analytic Analytic Analytic Analytic Reflective thinking, Communications Analytic Analytic Diversity, Analytic Analytic Reflective thinking Analytic, Communications Analytic, Communications Analytic Analytic Analytic Analytic Analytic Diversity, Analytic Reflective thinking, Analytic Reflective thinking, Analytic Reflective thinking Reflective thinking, Analytic Analytic Reflective thinking Reflective thinking Analytic CPA/CMA 1 2 3 4 5 6 7 8 9 10 1 2 3 AACSB Tags Analytic Analytic Analytic Reflective thinking Analytic Analytic Diversity, Reflective thinking Diversity, Analytic Diversity, Reflective thinking Diversity, Reflective thinking Analytic Reflective thinking Analytic Analytic Analytic Analytic Analytic, Communications Analytic Analytic Diversity, Analytic Analytic Analytic, Communications Analytic, Communications Analytic Analytic, Communications Analytic Analytic, Communications Analytic Reflective thinking, Analytic Reflective thinking, Communications Analytic Analytic Problems 5–1 5–2 5–3 5–4 5–5 5–6 5–7 5–8 5–9 5–10 5–11 5–12 5–13 5–14 5–15 5–16 5–17 5–18 5–19 © The McGraw-Hill Companies, Inc., 2013 5–2 Intermediate Accounting, 7/e QUESTIONS FOR REVIEW OF KEY TOPICS Question 5–1 The realization principle requires that two criteria be satisfied before revenue can be recognized: 1. The earnings process is judged to be complete or virtually complete. 2. There is reasonable certainty as to the collectibility of the asset to be received (usually cash). Question 5–2 At the time production is completed, there usually exists significant uncertainty as to the collectibility of the asset to be received. We don’t know if the product will be sold, nor the selling price, nor the buyer if eventually the product is sold. Because of these uncertainties, revenue recognition usually is delayed until the point of product delivery. Question 5–3 A principal has primary responsibility for delivering a product or service, and recognizes as revenue the gross amount received from a customer. An agent doesn’t primarily deliver goods or services, but acts as a facilitator that earns a commission for helping sellers to transact with buyers, and recognizes as revenue only the commission it receives for facilitating the sale. Question 5–4 If the installment sale creates a situation where there is significant uncertainty concerning cash collection and it is not possible to make an accurate assessment of future bad debts, revenue and cost recognition should be delayed beyond the point of delivery. Question 5–5 The installment sales method recognizes gross profit by applying the gross profit percentage on the sale to the amount of cash actually received each period. The cost recovery method defers all gross profit recognition until cash has been received equal to the cost of the item sold. Question 5–6 Deferred gross profit is a contra installment receivable account. The balance in this account is subtracted from gross installment receivables to arrive at installment receivables, net. The net amount of the receivables represents the portion of remaining payments that represent cost recovery. Solutions Manual, Vol.1, Chapter 5 © The McGraw-Hill Companies, Inc., 2013 5–3 the seller must meet certain criteria before revenue is recognized in situations when the right of return exists. In certain situations. the consignor does not record revenue (and related costs) until the consignee sells the goods and title passes to the eventual customer. The completed contract method should only be used when the lack of dependable estimates or inherent hazards cause forecasts of future costs to be doubtful. it’s more meaningful to recognize revenue over time in proportion to the performance of the activity. 7/e . However. Inc. service revenue activities occur over extended periods and recognizing revenue at any single date within that period would be inappropriate. i. Question 5–8 Sometimes a company arranges for another company to sell its product under consignment. On the other hand. revenues and costs are deferred and recognized after this service has been performed. Question 5–10 The completed contract method of recognizing revenues and costs on long-term construction contracts is equivalent to recognizing revenue at point of delivery. in many instances. when the construction project is complete. if there is one final service that is critical to the earnings process. If the consignee can’t find a buyer within an agreed-upon time. Because the consignor retains the risks and rewards of ownership of the product and title does not pass to the consignee.. if a buyer is found. The “consignor” physically transfers the goods to the other company (the consignee). but the consignor retains legal title.. The “fair share” typically is estimated as the project's costs incurred each period as a percentage of the project's total estimated costs.Question 5–7 Because the return of merchandise can retroactively negate the benefits of having made a sale.e. the consignee returns the goods to the consignor. the consignee remits the selling price (less commission and approved expenses) to the consignor. Question 5–9 For service revenue. these criteria are not satisfied at the point of delivery of the product.. Instead. i.e. the construction period. © The McGraw-Hill Companies. The most critical of these criteria is that the seller must be able to make reliable estimates of future returns. The percentage-of-completion method assigns a fair share of the project’s expected revenues and costs to each period in which the earnings process takes place. 2013 5–4 Intermediate Accounting. the installment sales or cost recovery method should be used for profit recognition. IAS No.Question 5–11 The completed contract method recognizes revenue. Conversely. and gross profit at the end of the contract. Question 5–12 The billings on construction contract account is a contra account to the construction in progress asset. it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction” and gives a couple of examples. it is reported as a liability. Question 5–14 This guidance requires that if an arrangement includes multiple elements. If part of an arrangement does not qualify for separate accounting. cost of construction. it is reported in the balance sheet as an asset. In situations when the initial franchise fee is collectible in installments. A key to these guidelines is the concept of substantial performance.S. after the contract has been completed. Chapter 5 © The McGraw-Hill Companies. Assuming that the final costs are incurred just prior to completion of the contract. even after substantial performance has occurred. revenue and cost are recognized earlier under the cost recovery method than under the completed contract method. Therefore. regardless of the revenue recognition method used. 18 simply states that: “…in certain circumstances. if the net amount is a credit. 2013 5–5 . Solutions Manual. Inc. If the net amount is a debit.. Vol. the balances in these two accounts are compared. and then will recognize the remaining revenue and gross profit.1. both approaches should recognize gross profit at the same time. It requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue. Question 5–13 An estimated loss on a long-term contract must be fully recognized in the first period the loss is anticipated. but gross profit recognition is delayed until late in the contract for both approaches. if a reasonable estimate of uncollectibility cannot be made. whereas U. which typically is an amount that exactly offsets costs until all costs have been recovered. The cost recovery method will recognize an amount of revenue equal to the amount of cost that can be recovered. At the end of each reporting period. Question 5–16 Specific guidelines for revenue recognition of the initial franchise fee are provided by FASB ASC 952–605–25–1. The term “substantial” requires professional judgment on the part of the accountant. Question 5–15 IFRS has less specific guidance for recognizing revenue for multiple-deliverable arrangements. the revenue from the arrangement should be allocated to the various elements based on the relative fair values of the individual elements. GAAP provides more restrictive guidance concerning how to allocate revenue to various components and when revenue from components can be recognized. revenue recognition is delayed until revenue is recognized for the other parts. Activity or turnover of certain assets measures the frequency with which those assets are replaced. Profitability ratios provide information about a company’s ability to earn an adequate return relative to sales or resources devoted to operations. and the more cash it can commit to other purposes. Inc. the less cash a company must devote to that asset.. 2013 5–6 Intermediate Accounting. Resources devoted to operations can be defined as total assets or only those assets provided by owners. © The McGraw-Hill Companies. Question 5–18 Profit margin on sales = Net income Net sales Net income Average total assets Net income Average shareholders' equity Return on assets = Return on shareholders' equity = A fundamental element of an analyst’s task is to develop an understanding of a firm’s profitability.Question 5–17 Receivables turnover ratio = Net sales Average accounts receivable (net) Cost of goods sold Average inventory Net sales Average total assets Inventory turnover ratio = Asset turnover ratio = Activity ratios are designed to provide information about a company’s effectiveness in managing assets. depending on the evaluation objective. The greater the number of times an asset turns over. 7/e . Question 5–19 Return on equity Net income Avg. property tax expense.S. etc. extraordinary items. and the equity multiplier (reflecting the extent to which a company has used debt to finance its assets). the expense should be spread among the periods benefited. total equity = = Profit margin Net income Total sales X X Asset turnover Total sales Avg. Most revenues and expenses are recognized in interim periods as incurred. Question 5–21 U. These are assigned to each quarter through the use of accruals and deferrals. total assets Avg. that do not meet the definition of an asset at the end of an interim period are expensed entirely in the period in which they occur.. property taxes. 2013 5–7 . total assets X Equity multiplier X Avg. Inc. and advertising expenses incurred in one quarter that clearly benefit later quarters. Vol. asset turnover (reflecting a company’s effectiveness in using assets to generate sales). and unusual or infrequent items should be reported separately in the interim period in which they occur. However.1. if an expenditure clearly benefits more than just the period in which it is incurred. major events such as discontinued operations. IFRS takes much more of a discrete-period approach than does U. such that costs for repairs.. Question 5–20 These perspectives are referred to as the discrete and integral part approaches. GAAP views interim reports as an integral part of the annual report. However. Solutions Manual. the discrete approach is applied to some items. Chapter 5 © The McGraw-Hill Companies. GAAP. On the other hand.S. Current interim reporting requirements and existing practice generally view interim reports as integral parts of annual statements. Examples include annual repair expenses. so amounts that affect multiple interim periods are accrued or deferred and then charged to each of the periods they affect. total equity The DuPont framework shows return on equity as being driven by profit margin (reflecting a company’s ability to earn income from sales). advertising. that promise gives rise to a separate performance obligation in the contract only if the option provides a material right to the customer that the customer would not receive without entering into the contract.SUPPLEMENT QUESTIONS FOR REVIEW OF KEY TOPICS Question 5–22 The five key steps in recognizing revenue under the new standard are: 1. or 2. 3. If the seller can’t observe actual stand-alone selling prices. 2. if an entity grants a customer the option to acquire additional goods or services. Four key indicators that control of a good has passed from the seller to the buyer are: 1. 2013 5–8 Intermediate Accounting. 7/e . Buyer has physical possession. 4. Buyer has an unconditional obligation to pay. Allocate the transaction price to the separate performance obligations. 4. Inc. The seller regularly sells the good or service separately. Buyer has the risks and rewards of ownership. Question 5–25 Under the proposed ASU. Determine the transaction price. the seller should estimate them. a performance obligation for a good is satisfied when control of the good is transferred to the buyer.. 5. Buyer has legal title. Recognize revenue when (or as) the entity satisfies each performance obligation. Identify the separate performance obligation(s) in the contract. Question 5–26 Under the proposed ASU. the customer in effect pays the entity in advance for future goods or services and the entity recognizes revenue when those future goods or services are transferred or when the option expires. A buyer could use the good or service on its own or in combination with goods or services the buyer could obtain elsewhere. 3. Identify a contract(s) with a customer. If the option provides a material right. which is the case if either: 1. © The McGraw-Hill Companies. Question 5–23 Under the proposed ASU. Question 5–24 Under the proposed ASU. a good or service is a separate performance obligation if it is distinct. 2. the seller allocates the transaction price to the separate performance obligations in proportion to the stand-alone selling prices of the goods or services underlying those performance obligations. if an arrangement has multiple separate performance obligations. 2. if a seller provides the service of integrating products and services into one asset (for example. Chapter 5 © The McGraw-Hill Companies.Question 5–27 Under the proposed ASU. Inc. The performance obligation is viewed as satisfied over time if at least one of two criteria is met: 1.. and at least one of the following conditions hold: a. 2013 5–9 . as is done in the construction industry). the risks of providing the goods and services are not separable. so that arrangement is treated as a single service-related performance obligation. The seller has the right to payment for performance even if the customer could cancel the contract at the customer’s discretion. Solutions Manual. The seller is creating or enhancing an asset that the buyer controls as the service is performed. The customer receives and consumes a benefit as the seller performs. The seller is not creating an asset that the buyer controls or that has alternative use to the seller.1. c. Vol. Another seller would not need to reperform the tasks performed to date if that other seller were to fulfill the remaining obligation. b. 000.200.000 2014 gross profit = 2014 cash collection of $150. In this case..  The company has general inventory risk. In this transaction. so © The McGraw-Hill Companies.800.000 x 60% = $90.000 x 60% = $90. Gross profit will not be recognized until the entire $1.000 Brief Exercise 5–4 No gross profit will be recognized in either 2013 or 2014.000 2013 gross profit = 2013 cash collection of $150.000  $150.200. 7/e . it will take eight payments to recover the cost of the land ($1.000 2014 gross profit = 0 Brief Exercise 5–2 Indicators that the seller is a principal (recognizing gross revenue) as opposed to an agent (recognizing net revenue) include the following:  The company is primarily responsible for providing the product or service to the customer. Amazon appears to be an agent. Therefore.000 = 40% (implying a gross profit % = 60%) $3. 2013 5–10 Intermediate Accounting.000. meaning that the company owns inventory prior to a customer ordering it and after a customer returns it.000 – 1. and would only recognize revenue on the transaction equal to the amount of the commission it receives. Amazon never bears inventory risk.  The company has discretion in setting prices and identifying suppliers.BRIEF EXERCISES Brief Exercise 5–1 2013 gross profit = $3. Brief Exercise 5–3 2013 Cost recovery % = Cost  Sales: $1.200.000 = $1.000 cost of the land is recovered.200.000 = 8). Inc. and is paid a fixed commission such that it has no discretion in setting prices. 000 (90.000 x 60%) Less gross profit recognized in 2014 ($150.800.000.200.000 $5. revenue can be recognized when the product is delivered..000. revenue and related cost recognition is delayed until the uncertainty is resolved.000 x 40% = $8.000. Inc. If Meyer’s management can make reliable estimates of the furniture that will be returned. Chapter 5 © The McGraw-Hill Companies.000 Brief Exercise 5–6 The seller must meet certain criteria before revenue can be recognized in situations when the right of return exists.000) Less gross profit recognized in 2013 ($150. If reliable estimates cannot be made because of significant uncertainty.000.620.000) (90. Brief Exercise 5–5 Initial deferred gross profit ($3.1.000. assuming the company has no additional obligations to the buyer.000) $1. Brief Exercise 5–7 Total estimated cost to complete = $6 million + 9 million = $15 million % of completion = $6 million  $15 million = 40% Total estimated gross profit ($20 million – 15 million) = multiplied by the % of completion Gross profit recognized the first year First year revenue = $20.000 40% $2. 2013 5–11 .000 x 60%) Deferred gross profit at the end of 2014 $1. The most critical of these criteria is that the seller must be able to make reliable estimates of future returns.gross profit recognition will equal 100% of the cash collected beginning with the ninth installment payment. Vol.000 – 1.000 Solutions Manual. 000 40% $2.000. Inc..000. 2013 5–12 Intermediate Accounting.000.000 Brief Exercise 5–9 Year 1 = 0 Year 2 = $4 million Revenue Less: Costs in year 1 Costs in year 2 Actual profit $20.000 (6.000) $ 4. 7/e .000 1. © The McGraw-Hill Companies.000.000 $5.000 Brief Exercise 5–10 Year 1: Revenue: Cost: Gross profit: $6 million $6 million $0 Year 2: Revenue: $14 million ($20 million total – 6 million in year 1) Cost: $10 million Gross profit: $ 4 million Brief Exercise 5–11 The anticipated loss of $3 million ($30 million contract price less total estimated costs of $33 million) must be recognized in the first year applying either method.000.000.000) (10.Brief Exercise 5–8 Assets: Accounts receivable ($7 million – 5 million) Cost plus profit ($6 million + 2 million*) in excess of billings ($7 million) * Total estimated gross profit ($20 million – 15 million) = multiplied by the % of completion Gross profit recognized in the first year $2.000.000. . the accounting would be the same. and that revenue will be recognized upon delivery of the LearnIt software. Solutions Manual. It requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue. In this case. Brief Exercise 5–14 Specific conditions for revenue recognition of the initial franchise fee are provided by FASB ASC 952–605–25–1. the $200 would be deferred and recognized over the life of the one-year period in which the Office Hours are delivered. LearnIt Office Hours will be allocated $200 x [$100 ÷ ($150 + 100)] = $80. so that vendorspecific objective evidence (VSOE) allows them to allocate revenue to those parts according to their relative selling prices.1. Chapter 5 © The McGraw-Hill Companies. (VSOE is not required under IFRS). A key to these conditions is the concept of substantial performance. LearnIt Office Hours will be allocated $200 x [$100 ÷ ($150 + 100)] = $80. Continuing franchise fees are recognized over time as the services are performed. In that case. Brief Exercise 5–13 Orange has separate sales prices for the two parts of LearnIt-Plus.Brief Exercise 5–12 Orange has separate sales prices for the two parts of LearnIt-Plus. and that revenue will be deferred and recognized over the life of the one-year period in which the Office Hours are delivered. 2013 5–13 . Inc. Vol. LearnIt will be allocated $200 x [$150 ÷ ($150 + 100)] = $120. The term “substantial” requires professional judgment on the part of the accountant. and that revenue will be recognized upon delivery of the LearnIt software. If LearnIt were not sold separately. If LearnIt were not sold separately. so the company can base its estimates of the fair value of those parts according to their relative selling prices. LearnIt will be allocated $200 x [$150 ÷ ($150 + 100)] = $120. Often. substantial performance is considered to have occurred when the franchise opens for business. and that revenue will be deferred and recognized over the life of the one-year period in which the Office Hours are delivered. Orange would estimate the fair value of LearnIt Office Hours to be $100 and allocate revenue in the same fashion as it did when that product was sold separately. revenue would be delayed until the later part was delivered. Orange would not have VSOE for all of the parts of the contract. 000] ÷ 2 5.Brief Exercise 5–15 Receivables turnover ratio = Net sales Average accounts receivable (net) $600.000] ÷ 2 5.000 + 60.000* [$80.000 – 200. Inc.000 © The McGraw-Hill Companies. 2013 5–14 Intermediate Accounting. 7/e .45 times Cost of goods sold Average inventory $400.000 + 120.71 times Receivables turnover ratio = = Inventory turnover ratio = Inventory turnover ratio = = *$600..000 [$100. 000 $522. beginning of period Add: Net income Deduct: Dividends Shareholders’ equity.Brief Exercise 5–16 Profit margin = = = Return on assets = = = Return on shareholders’ equity Net income Sales $65. end of period $500..000 $800.000 65.000)  2 = $522.000 *Average shareholders’ equity = ($500.000 8. Inc.500 Solutions Manual. 2013 5–15 .4% = = Shareholders’ equity.000 (20.000 + 545.500* 12. Chapter 5 © The McGraw-Hill Companies.5% Net income Average total assets $65.1. Vol.1% = Net income Average shareholders’ equity $65.000 15.000) $545.000 $420. 000 $420. total assets Avg.525 times © The McGraw-Hill Companies. total assets Avg.Brief Exercise 5–17 Return on equity Net income Avg. total equity = Profit margin X Asset turnover X Equity multiplier = Net income Total sales X Total sales X Avg. 2013 5–16 Intermediate Accounting. 7/e .000 $800. Inc.4% Net income Sales $65.5% Profit margin = = = Asset turnover = = = Sales Average total assets $420.000 ..000 15.500 12. total equity Return on shareholders’ equity = = = Net income Average shareholders’ equity $65.000 $522. 525 times asset turnover x 1. 2013 5–17 ..0 = $450. Inc.000 = $150.5% profit margin x .53 equity multiplier.1. Vol.Brief Exercise 5–17 (concluded) Equity multiplier = Average total assets Average shareholders’ equity $800.000 x 6.000 $522.000 – 450.4% ROE = 15.53 = = Check: 12.0 = x  $75.500 1. Chapter 5 © The McGraw-Hill Companies.000 – Cost of goods sold = Gross profit Sales $600.000 Solutions Manual.000 Cost of goods sold = $75. Brief Exercise 5–18 Inventory turnover ratio = Cost of goods sold  Average inventory 6. Brief Exercise 5–21 Yes. and may not satisfy characteristics 3 and 5 as well. Inc. The terms and manner of payment are specified. The Richter agreement does not satisfy characteristic number 4. 5. these are separate performance obligations. Commercial substance. because each good is sold separately to individual customers.. 3. Brief Exercise 5–20 Yes. 7/e . The renewal option is a material right because it allows the customer to renew at a better price than could be obtained without the right. Therefore. 4. Each party’s rights are specified with respect to the goods and services to be transferred. Approval. Each party to the contract has approved the contract and is committed to satisfying their respective obligations. Rights. it does not qualify as a contract for purposes of recognizing revenue. Payment terms. they are separate. The contract is expected to affect the seller’s future cash flows. Brief Exercise 5–22 Total estimated contract price = $25. 2013 5–18 Intermediate Accounting. A contract does not exist if either party can terminate a wholly unperformed contract without penalty.000) = $30.SUPPLEMENT BRIEF EXERCISES Brief Exercise 5–19 An agreement needs to have the following five characteristics to qualify as a contract for revenue recognition purposes under the proposed ASU: 1. 2.000 © The McGraw-Hill Companies.000 + (50% x $10. Performance. 1. Therefore.000 Brief Exercise 5–24 A performance obligation is satisfied over time if at least one of two criteria is met: 1.000 ÷ ($20. 2013 5–19 .000 ($90.000 Unearned revenue 18. making the following journal entry: Cash 90. and at least one of the following conditions hold: a. the software comprises 80% of the total fair values ($80.000  80%) in revenue up front when the software is delivered. Inc. CyberB would own the partially completed building and could retain another construction company to complete the job.000 ÷ ($20. and defer the remaining $18.000 + 80. criterion 2b is satisfied. Therefore. the seller would recognize $72.Brief Exercise 5–23 Based on relative stand-alone selling prices. Under Estate’s construction agreement with CyberB.000)).000 Revenue 72.000  20%) and recognize it ratably over the next six months as the technical support service is provided. Chapter 5 © The McGraw-Hill Companies. The seller is not creating an asset that the buyer controls or that has alternative use to the seller. b. and the technical support comprises 20% ($20.000 ($90.000 + 80. A new construction contractor would not need to reperform Estate’s work if the new contractor completed the job.000)). The seller is creating or enhancing an asset that the buyer controls as the service is performed. 2. Vol.. c. The seller has the right to payment for performance even if the customer could cancel the contract at the customer’s discretion. The customer receives and consumes a benefit as the seller performs the service. Another seller would not need to reperform the tasks performed to date if that other seller were to fulfill the remaining obligation. if for some reason Estate could not complete construction. Solutions Manual. Therefore. © The McGraw-Hill Companies. and interest expense of ($10. 2013 5–20 Intermediate Accounting. and would recognize that amount as revenue. 7/e .000 + 500 + 525 = $11. Inc.000 + 500) x 5% = $525 in year two of the contract.. in each case debiting interest expense and crediting unearned revenue. it would have unearned revenue totaling $10. at the point in time Patterson delivers the novel.Brief Exercise 5–25 Patterson initially would record the payment as unearned revenue.025. Then Patterson would accrue interest expense of $10.000 x 5% = $500 in year one of the contract. .. Unearned revenue ...................... 90 Revenue .... Chapter 5 © The McGraw-Hill Companies..1......................... 90 Requirement 3 $90 is included in revenue in the 2013 income statement................ in this case as the services are provided during the ski season......................... The $360 remaining balance in unearned revenue is included in the current liability section of the 2013 balance sheet....... Requirement 2 November 6.....EXERCISES Exercise 5–1 Requirement 1 Alpine West should recognize revenue over the ski season on an anticipated usage basis.. To record the cash collection 450 450 December 31........... Solutions Manual. Revenue should be recognized as it is earned..... as season starts on December 1)................. The fact that the $450 price is nonrefundable is not relevant to the revenue recognition decision.... 2013 Unearned revenue ($450 x 1/5) . Vol..................... To recognize revenue earned in December (no revenue earned in November.. Inc.. 2013 5–21 ........................ in this case equally throughout the season......... 2013 Cash ....................................................... 7/e . given that the bicycles are shipped directly from the owner to the customer. Therefore. Requirement 1 AuctionCo is a principal because it obtained control of the used bicycle before the bicycle was sold. Requirement 2 AuctionCo is an agent because it never controlled the product before it was sold. Requirement 3 In this case it appears that AuctionCo is acting as an agent. making the seller an agent. additional aspects of the arrangement could make it more appropriate to treat AuctionCo as a principal. However. AuctionCo should recognize revenue of $30. Therefore.. Inc. if AuctionCo must pay the bicycle owner the $20 wholesale price regardless of whether the bicycle is sold. © The McGraw-Hill Companies. making the seller a principal. then AuctionCo would appear to have purchased the bicycle and should be treated as a principal. 2013 5–22 Intermediate Accounting.Exercise 5–2 When other parties are involved in providing goods or services to a seller’s customer. That determination affects whether the seller recognizes revenue in the amount of consideration received in exchange for those goods or services (if principal) or in the amount of any fee or commission received in exchange for arranging for the other party to provide the goods or services (if agent). For example. or the seller arranges for another party to provide those goods or services. AuctionCo should recognize revenue for the commission fees of $10 retained upon sending $20 to the original owner. the seller has to determine whether its performance obligation is to provide the goods or services itself. 000 x 30% = Total 2014 gross profit Requirement 2 2013 deferred gross profit balance: 2013 initial gross profit ($360.000 = 70% (gross profit % = 30%) $350.000 x 35% = + Cash collection from 2014 sales of $120.500 $ 35.1..Exercise 5–3 Requirement 1 2013 cost recovery %: $234.000 36.000) Less: Gross profit recognized in 2013 Balance in deferred gross profit account 2014 deferred gross profit balance: 2013 initial gross profit ($360.500 Solutions Manual.000 (52.000 $71. Chapter 5 © The McGraw-Hill Companies.000 (52.000 2014 cost recovery %: $245.000) Less: Gross profit recognized in 2013 Gross profit recognized in 2014 2014 initial gross profit ($350. Vol. 2013 5–23 .000 2013 gross profit: Cash collection from 2013 sales of $150.000 – 234.000 = 65% (gross profit % = 35%) $360.500 $ 126.000 x 35% = 2014 gross profit: Cash collection from 2013 sales of $100.000 – 234.500) (35.000) 105.500) $73.000 $126. Inc.000 (36.000) $107.000) Less: Gross profit recognized in 2014 Balance in deferred gross profit account $52.000 – 245. ...... 360.......................................................... 105......... Realized gross profit ......000 Inventory ..................... 2013 5–24 Intermediate Accounting...........................................................000 71..........................................500 52........... Realized gross profit .................. 220... To recognize gross profit from installment sales 52........ 245................. 234......................................... To recognize gross profit from installment sales 71...............000 Deferred gross profit ...................000 Installment receivables ...................000 To record installment sales 2013 Cash .................... Inc..................000 Inventory .................................................................................... 220...................000 To record cash collections from installment sales 2013 Deferred gross profit ................................................................... 350................................000 To record cash collections from installment sales 2014 Deferred gross profit ........................000 To record installment sales 2014 Cash ............................ 150................... 7/e ....500 2014 Installment receivables ..............000 Deferred gross profit ................................ 126..................................... 150..............................................Exercise 5–4 2013 Installment receivables .000 © The McGraw-Hill Companies.............................000 Installment receivables ....... 000 Gross Profit(60%) $ 45.000 75.000 Year 2013 2014 2015 2016 Totals Cash Collected $ 75.1. Chapter 5 © The McGraw-Hill Companies.000 30.000 ($300.000 $180.000 75.000 75.000 75.000 75. 2013 5–25 .000 75.000 $300.000 75.000 ------------.000 $300.000 Solutions Manual.000 Cost Recovery(40%) $ 30.000 – 120..000 Cost Recovery $ 75.000 Gross Profit -0$ 30.000 -0-0$120.000 Requirement 3 Year 2013 2014 2015 2016 Totals Cash Collected $ 75.= 40% (gross profit % = 60%) $300.000 Requirement 2 Cost recovery %: $120.000 45.000 45.000 30.000 75.000 $120.000 $180. Vol.Exercise 5–5 Requirement 1 Year 2013 2014 2015 2016 Total Income recognized $180. Inc.000 30.000) -0-0-0$180.000 45.000 45. .............. Inc........ To record cash collection from installment sale 75.....................000 75.......................................................................................................... 7/e .........000 Sales revenue................................ 2013 Installment receivables ............................000 © The McGraw-Hill Companies...........................................000 75............... 2014 Cash ....... Installment receivables ................................................ 2013 5–26 Intermediate Accounting.. 300............ To record cash collection from installment sale July 1...................... Installment receivables ...000 To record installment sale Cost of goods sold ....000 Inventory ..............................000 To record cost of installment sale Cash ....Exercise 5–6 Requirement 1 July 1........... 120........ 300................................................................... 120...........000 75........... ............................................000 45.................................000 Inventory . Installment receivables ..000 75.........Exercise 5–6 (continued) Requirement 2 July 1................ Inc............................................... 2013 5–27 ................................................................................ Chapter 5 © The McGraw-Hill Companies....................................................................... To recognize gross profit from installment sale 75............000 45......................000 Deferred gross profit..........................1...........................000 75........................ Realized gross profit ....... Installment receivables ............... To record cash collection from installment sale Deferred gross profit. To recognize gross profit from installment sale July 1..... 2013 Installment receivables ....000 45.......................000 75................................................................. 180.................... 2014 Cash ........... To record cash collection from installment sale Deferred gross profit...... Realized gross profit ........000 45....................000 Solutions Manual.... 300......... Vol...000 To record installment sale Cash ........................................ 120.. ..... Installment receivables .......... 2013 5–28 Intermediate Accounting..000 75.........000 Cash collected x Gross profit percentage = Gross profit recognized $500... 120...........................000 gross profit © The McGraw-Hill Companies......000 30.............................000 100............................................ 180...............................000 75............................. 2014 Cash .000 Gross profit percentage = $1...................................... Inc.................. Installment receivables ......................000....000 To record installment sale Cash ...000 75.......000 Inventory .............. To recognize gross profit from installment sale 75....000 Exercise 5–7 Requirement 1 Cost of goods sold ($1.................... 2013 Installment receivables ............. 300...000 x 60% = $300.............................................................000 = 60% .000) Add: Gross profit if using cost recovery method Cash collected Requirement 2 $ 600.....................000 Deferred gross profit .......................000 – 600....000................................................ To record cash collection from installment sale Deferred gross profit ............ Realized gross profit ............000 30.................000 $500....... To record cash collection from installment sale July 1...... 7/e $400........Exercise 5–6 (concluded) Requirement 3 July 1. .......200................................. Inc.......000.................. 2013 5–29 ........ 1..................... 800. Chapter 5 © The McGraw-Hill Companies....000 Inventory ...000 = 55% gross profit percentage Solutions Manual............. 3............................................200.........Exercise 5–8 October 1..000 To record the default and repossession ..000 To recognize gross profit from installment sale October 1.....000 Deferred gross profit............................................................................ 2........ 4....................................... 140................800............. 1.....000 To record the cash down payment from installment sale Deferred gross profit ($800.. 1......760..000 Installment receivable (balance) ..........000 To record the installment sale Cash ...........................................000 Loss on repossession (difference) ...000 Deferred gross profit (balance).......300....000...200....000  $4.... 800.............. Vol.................. 2014 Repossessed inventory (fair value) ....................000 Realized gross profit .000 Installment receivable . 2013 Installment receivable ..........000 x 55%*) ................... 440........................1............ 440.................. *$2....... .....................000 Land......... 2........................000 120........920................ Installment receivables .... To record cash collection from installment sale 120...............................................................920................... Installment receivables ................................... 2013 5–30 Intermediate Accounting........................ 2013 Installment receivables ......... 2013 Cash .............000 120....000 Land.000 To record installment sale © The McGraw-Hill Companies. 480.................400...... 1................................................... 7/e ...Exercise 5–9 Requirement 1 April 1..................................000 Gain on sale of land .........................000 Deferred gain............................... 1.......................................400..................... To record cash collection from installment sale April 1.......................................................... 2014 Cash ....................................................... 2..000 120.. 480.... 2013 Installment receivables ..000 To record installment sale April 1......................................... Inc......000 Requirement 2 April 1...... 1... 2014 Cash ........000 96.....000) .............. To recognize profit from installment sale 120.................. Installment receivables .....................Exercise 5–9 (concluded) When payments are received...... Installment receivables ........................000 120......... gain on sale of land is recognized...... Gain on sale of land (80% x $120...400....... To recognize profit from installment sale April 1.................. To record cash collection from installment sale Deferred gain .... 2013 Cash ........................ Gain on sale of land (80% x $120............920...... 2013 5–31 ........................................... Vol..000 96...................................000).............................000 Solutions Manual..................................... calculated by applying the gross profit percentage ($1...000 ÷ $2. To record cash collection from installment sale Deferred gain ...............000) ........... April 1.......................................000 96...................... Inc..............000 = 80%) to the cash collected (80% x $120..000 96.. Chapter 5 © The McGraw-Hill Companies.000 120..000 120................... The specific citation for each of the following items is: 1.S.” 2. generally accepted accounting principles. 2013 5–32 Intermediate Accounting. When a provision for loss is recognized for a percentage-of-completion contract: FASB ASC 605–35–25–46: “Revenue Recognition–Construction–Type and Production–Type Contracts–Recognition–Provisions for Losses on Contracts. Circumstances indicating when the installment method or cost recovery method is appropriate for revenue recognition: FASB ASC 605–10–25–4: “Revenue Recognition–Overall–Recognition– Installment and Cost Recovery Methods of Revenue Recognition.” (Note: ASC 605–10–25–3 also provides some guidance. © The McGraw-Hill Companies.” 3.. 7/e . as it indicates when installment method is not acceptable). Criteria determining when a seller can recognize revenue at the time of sale from a sales transaction in which the buyer has the right to return the product: FASB ASC 605–15–25–1: “Revenue Recognition–Products–Recognition– General–Sales of Product when Right of Return Exists. Inc.Exercise 5–10 The FASB Accounting Standards Codification represents the single source of authoritative U. 000 Requirement 2 2013 2014 Requirement 3 $ -0$125.000 1.000*) in excess of billings ($380.000 Gross profit recognition: 2013: $ 300.000 300.200.000 Solutions Manual.000 = $100.500.000 $ 125.000. Inc. 2013 Current assets: Accounts receivable Costs and profit ($400. Vol.000 1..000 $ 500.000 1.000) * Costs ($300.Exercise 5–11 Requirement 1 Contract price Actual costs to date Estimated costs to complete Total estimated costs Gross profit (estimated in 2013) 2013 $2.875.000 -01.000) $ 130. Chapter 5 © The McGraw-Hill Companies.000) + profit ($100.000 Balance Sheet At December 31.000 = $25.000 20.875.000 – 100. 2013 5–33 .000 = 20% x $500.000.000 2014: $125.000 $1.500.000 2014 $2.1. 000) in excess of costs ($300..Exercise 5–11 (concluded) Requirement 4 Balance Sheet At December 31. 2013 Current assets: Accounts receivable Current liabilities: Billings ($380. 2013 5–34 Intermediate Accounting.000 $ 80.000) $ 130.000 © The McGraw-Hill Companies. Inc. 7/e . 67 – 15 = $11. Vol. 2013 5–35 .67% = $146. Inc.33 Requirement 2 2013: $220 x 25% = $55 2014: $220 x 66.67 2015: $220 – 146.33 Requirement 3 Year 2013 2014 2015 Total project income Gross profit (loss) recognized -0-050 $50 Solutions Manual.Exercise 5–12 Requirement 1 ($ in millions) Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015) Gross profit (loss) recognition: 2013: $40 2013 $220 40 120 160 $ 60 2014 $220 120 60 180 $ 40 2015 $220 170 -0170 $ 50 = 25% x $60 = $15 $160 2014: $120 = 66.67) = $23.67% x $40 = $26.67 – 55 = $91.67 $180 2015: $220 – 170 = $50 – (15 + 11.. Chapter 5 © The McGraw-Hill Companies.67 = $73.1. 7/e .Exercise 5–12 (concluded) Requirement 4 2013: Revenue: Cost: Gross profit: 2014: Revenue: Cost: Gross profit: 2015: Revenue: Cost: Gross profit: Requirement 5 2014: $120 = 60% x $20* = $12 – 15 = $(3) loss $200 *$220 – (40 + 80 + 80) = $20 $100 ($220 contract price – 40 – 80) 50 $ 50 $80 80 $ 0 $40 40 $ 0 © The McGraw-Hill Companies. Inc.. 2013 5–36 Intermediate Accounting. 000 2.600. 2013 5–37 .000) – 666.000 3.. Inc.000 6.000.000.000 $ (100.667 = $(766.100.000 2014 $8.000) Gross profit (loss) recognition: 2013: $2.300. Vol. Chapter 5 © The McGraw-Hill Companies.000.000) = $(200.000.000.000 $ (300.667 $6.1.000.000 4.500.000 -08.000 4.Exercise 5–13 Requirement 1 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) 2013 $8.000) – (100.300.000 8.000 $2.3333% x $2.667) 2015: $(300.000) Solutions Manual.000 8.000.000 = 33.000 2014: $(100.000) 2015 $8.000 = $666.000.000.000. 333 (1) Plus: Loss recognized in 2014 (prior page) 766. Inc.444.000 2.544.475.475..000 Less: Revenue recognized in 2013 (above) (2.750.667 To record gross profit Cost of construction (2) Revenue from long-term contracts Construction in progress (loss) To record expected loss 2.250.000 2.000 Cost of construction Revenue from long-term contracts (33.500.55% Revenue recognized to date: 55.000.000.000 2.777.000 2.3333% x $8.000 1.750.000 (2) © The McGraw-Hill Companies.000 ÷ $8. 2014 $2.667) Revenue recognized in 2014 1.Exercise 5–13 (continued) Requirement 2 Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress (gross profit) 2013 2014 2. 7/e .100.000 2.000 2.250.000 2.000 2.000.667 (1) (1) and (2): Percent complete = $4.544.666.667 Cost of construction.000.000.333 766.000 = 55.777.500. 2013 5–38 Intermediate Accounting.666.000 2.000 2.000 2.000 = $4.000 2.000) 666.500.500.667 2.55% x $8.500. 000 + 2.400.000) in excess of costs less loss ($4.667) ** Costs ($2.000) Current liabilities: Billings ($5..000) – loss ($100. Chapter 5 © The McGraw-Hill Companies.000 166.667 – 666.500.000 = $766.1. 2013 5–39 .000.000 $525.Exercise 5–13 (concluded) Requirement 3 Balance Sheet Current assets: Accounts receivable Costs and profit ($2. Inc.667) Solutions Manual.000**) 2013 2014 $250.000 * Costs ($2.667 $850. Vol.000) + profit ($666.250.667*) in excess of billings ($2.500.000.666. 000.000 2.500.500..250.000) $(300.000 Gross profit (loss) recognized -0$(100.000 2.250.000) Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Loss on long-term contract Construction in progress To record expected loss 2.000.000 100.Exercise 5–14 Requirement 1 Year 2013 2014 2015 Total project loss Requirement 2 2013 2014 2.000 2.750.000 2.500.000 2.000 2. 7/e .750.000 100.000 2.000 © The McGraw-Hill Companies.500.000) (200.000 2. Inc.000 2.475. 2013 5–40 Intermediate Accounting.475.000 2. 000. Chapter 5 © The McGraw-Hill Companies.000 $500.250.000) – loss ($100. Inc.000) 2013 $250.000 * Costs ($2..000*) $850.000) in excess of costs less loss ($4.500.000 2014 $525.Exercise 5–14 (concluded) Requirement 3 Balance Sheet Current assets: Accounts receivable Current liabilities: Billings ($2. Vol.000) Solutions Manual.400.000 Billings ($5.000.000) in excess of costs ($2.500.000 + 2.1. 2013 5–41 . 000 $(125.000) $(100. 7/e .000) $(100..000 3 $166.000 $0 $0 $200.000) © The McGraw-Hill Companies.000) $0 $(100. 2013 5–42 Intermediate Accounting.000) 4 $125.000 $0 $0 $200. Inc.000 $375.000) $200.667 $233.000) $(100.000) $(100.000 6 $(100.667 $(266.Exercise 5–15 SUMMARY Percentage-of-Completion Completed Contract Situation 2013 2014 2015 2013 2014 2015 1 $166.000 2 $166.000) $(100.000 $0 $0 $500.333 $100.000 $0 $0 $0 $500.000 5 $125.667) $100.667) $(100.667 $(66.000) $(100. Vol.333 $4. Inc.000.500.. Chapter 5 © The McGraw-Hill Companies.000 900.600.000 $500.000 = $400.667 $4.500.000 4. 2013 5–43 .500.000 Situation 1 .000 2014 $5.Completed Contract Year 2013 2014 2015 Total gross profit Gross profit recognized -0-0$500.600.000 – 400.000 = 33.3333% x $500.500.Percentage-of-Completion Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015) 2013 $5.000 3.000.0% x $500.000.000 2015: $500.000 $ 500.667 = $233.1.000 $ 500.500.500.Exercise 5–15 (continued) Situation 1 .000 3.000 = $166.000 4.000 Solutions Manual.000 1.000 2015 $5.000 = 80.000 $ 500.000 = $100.000 – 166.000.000 2014: $3.000 -04.500.500.000 Gross profit (loss) recognized: 2013: $1.000 4. 000 – 100.800.000 © The McGraw-Hill Companies.000 -04.667 $4.667) $4.000 3.000 2014: $2.400.000 $ 200.000 = 50.3333% x $500.400. 2013 5–44 Intermediate Accounting.000.Exercise 5–15 (continued) Situation 2 .000 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015) Gross profit (loss) recognized: 2013: $1.000 2014 $5.800.500.Completed Contract Year 2013 2014 2015 Total gross profit Gross profit recognized -0-0$200..000 $200.800.400.000 = $100.500.000 2015 $5.000.000 $ 200.000 2.000 = $166.000 = 33. Inc.000.500.0% x $200.Percentage-of-Completion 2013 $5.000 – 166.000 4.000 = $100.000.800.000 $ 500.000 2015: $200.000 4.000 1.000 4.667 = $(66.000 Situation 2 .000 2. 7/e .500. 000) $(200.667 $4.100.000) Solutions Manual.600.000 5.000) Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) Gross profit (loss) recognized: 2013: $1.Percentage-of-Completion 2013 $5. Inc.000 4.000 2014: 2015: $(100.000 = $166.667) $(200.Completed Contract Year 2013 2014 2015 Total project loss Gross profit (loss) recognized -0$(100.000 1.500.000.000 $ (100.1.200.000) (100. 2013 5–45 .3333% x $500..000 5.Exercise 5–15 (continued) Situation 3 .000 1.000) – 166.500.000) = $(100.000 3.000 -05. Chapter 5 © The McGraw-Hill Companies.000) – (100. Vol.200.000) 2015 $5.500.000 3.000 = 33.667 = $(266.000.500.500.000.000) Situation 3 .000 $ (200.000.000 $ 500.000 2014 $5. 000.000 = $125.000 © The McGraw-Hill Companies.000 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015) Gross profit (loss) recognized: 2013: $ 500.500.000.0 - Situation 4 .000 $500.500.000 2015 $5.000 $1.500. 7/e .000 -04.000 3.000 = $500.Completed Contract Year 2013 2014 2015 Total gross profit Gross profit recognized -0-0$500.000 875.000 – 125.000 $4.Exercise 5–15 (continued) Situation 4 . 2013 5–46 Intermediate Accounting.000 – 500.500.000 = $375.000 $ 625.000 4.5% x $1..000 $4.000 $ 500.000 2015: $500.500.000 4.000 = 12.000 = $ .000 2014 $5.000.000 500. Inc.000.000 2014: $3.000.000.000 3.375.000.000 = 80.375.000 4.0% x $625.Percentage-of-Completion 2013 $5. 000 $1. 2013 5–47 .000 Situation 5 .000 = 12.800.000 2014: 2015: $0 – 125.800.000.1.000 = $(125.000 3.000 $4.000 4.000 $ 200.000 1. Vol. Inc.000. Chapter 5 © The McGraw-Hill Companies.000 4.500.000 2014 $5.000 $ -02015 $5.Completed Contract Year 2013 2014 2015 Total gross profit Gross profit recognized -0-0$200.500.000.000 3.000.000 – 0 = $200.000.000 -04.000.Exercise 5–15 (continued) Situation 5 .000 $200.500.000 5.000.5% x $1.000 500..Percentage-of-Completion 2013 $5.000.000 Solutions Manual.000 = $125.000 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015) Gross profit (loss) recognized: 2013: $ 500.000) $200. .000 5.000) © The McGraw-Hill Companies.Percentage-of-Completion 2013 $5. Inc.600.000) (100.000 5.300.Exercise 5–15 (concluded) Situation 6 .000 $ (300.000 4.000.000) 2014 $5.000.000) 2015: $(300.000) (100.Completed Contract Year 2013 2014 2015 Total project loss Gross profit (loss) recognized $(100.000) 2015 $5.000) = $(100.000 3.000) – (100.000 $ (100.500.000) 2014: $(200.000 $ (200.300.000 500.000) = $(100.000) $(300.200.000 -05.700. 7/e .000) – (200. 2013 5–48 Intermediate Accounting.000 5.000 1.000) Situation 6 .100.000.000) Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) Gross profit (loss) recognized: 2013: $(100. 1.000 Actual costs incurred in 2013 = $80.000 – A) = $20.000 ($1.000.000 – 80.000.200.000 = ? + $30.600.Exercise 5–16 Requirement 1 Construction in progress = Costs incurred + Profit recognized $100.000 = 6.000 Requirement 3 Let A = Actual cost incurred + Estimated cost to complete Actual cost incurred x (Contract price – A) = Profit recognized A $80.000 Requirement 4 $80.280.000 Solutions Manual. 2013 5–49 .000A = $128.000 Cash collections in 2013 = $64.000A = $20.25% $1. Inc.280.000 = ? + $20.000 Estimated cost to complete = $1.000.000 = $1. Vol.000 A $128.000A $100.000 Requirement 2 Billings = Cash collections + Accounts receivable $94.000.000 – 80..000 A = $1.280. Chapter 5 © The McGraw-Hill Companies. 7/e . c. 2013 5–50 Intermediate Accounting. the consideration to be exchanged. b.. The contractor can be expected to perform all contractual obligations. The buyer can be expected to satisfy all obligations under the contract.Exercise 5–17 Requirement 1 The specific citation that specifies the the circumstances and conditions under which it is appropriate to use the percentage-of-completion method is: FASB ASC 605–35– 25–57: “Revenue Recognition–Construction–Type and Production–Type Contracts– Recognition–Circumstances Appropriate for Using the Percentage-of-Completion Method. Contracts executed by the parties normally include provisions that clearly specify the enforceable rights regarding goods or services to be provided and received by the parties.” Requirement 2 FASB ASC 605–35–25–57 reads as follows: “The percentage-of-completion method is considered preferable as an accounting policy in circumstances in which reasonably dependable estimates can be made and in which all the following conditions exist: a. and the manner and terms of settlement. Inc.” © The McGraw-Hill Companies. .. Inc........000 x $243.............. 243.............000 + 27...............000 ÷ $270.......000 $243.......000 = 27.......000 $30......000 $30.... January 1..000 ÷ $270.. 2013 5–51 ... 189............. Vol........ 2013 Technical support – evenly over the 12 months of the agreement Upgrade – date of shipment.. 2013 Cash ..000 Unearned revenue ($27.................... July 1....000 ÷ $270..000) ..000 Revenue ..... 54.....000 To record sale of software Solutions Manual........ Chapter 5 © The McGraw-Hill Companies..000 = 27....1....Exercise 5–18 Requirement 1 Revenue should be recognized as follows: Software – date of shipment.................000 x $243....000 x $243...000 = $189... 2014 The amounts are determined by an allocation of total contract price in proportion to the individual fair values of the components if sold separately: Software Technical support Upgrade Total Requirement 2 $210.......000 July 1.. 000 ÷ $50.000 ($10.. 7/e .000 = 13. © The McGraw-Hill Companies.000 ($15.500 $45.000 of revenue is delayed until installation of the conveyer.000) x $45.500 ($5.000 ÷ $50.Exercise 5–19 Requirement 1 Conveyer Labeler Filler Capper Total Requirement 2 ($20.000 All $45.000) x $45. because the usefulness of the other elements of the multi-part arrangement is contingent on its delivery.000) x $45.000 = $18.000) x $45. Inc. 2013 5–52 Intermediate Accounting.000 = 9.000 = 4.000 ÷ $50.000 ÷ $50. Vol.Exercise 5–20 Requirement 1 Conveyer Labeler Filler Capper Total Requirement 2 ($20.000 = 4.000 Under IFRS. Chapter 5 © The McGraw-Hill Companies.000) x $45.000 ÷ $50.000 = $18. it is likely that Richardson would recognize revenue the same as in Requirement 1.1. Solutions Manual.000 ($10.500 $45.000 ($15. Inc.000 ÷ $50.000) x $45.500 ($5. because (a) revenue for each part can be estimated reliably and (b) the receipt of economic benefits is probable..000 ÷ $50.000) x $45.000 ÷ $50.000 = 13.000 = 9. 2013 5–53 .000) x $45. . 2013 Cash (10% x $300....000 Note receivable............... List B a.... b.... Return on shareholders' equity c.......... Defers recognition until cash collected equals cost. Net income divided by assets.. Billings on construction contract k.... Completed contract method g... Receivables turnover i....Exercise 5–21 October 1...... Defers recognition until project is complete..000) ......... © The McGraw-Hill Companies.. Recognition is in proportion to work completed...000 To recognize franchise fee revenue Exercise 5–22 List A h d g a b i c k l m f j e 1. Percentage-of-completion method f....... Asset turnover h............. Could cause the deferral of revenue recognition beyond delivery point. 30. 7/e ........... 8. 300........................... Return on assets 3... Recognition is in proportion to cash received. Consignment sales m. Profit margin on sales d... 11.. Cost of goods sold divided by inventory.......000 Franchise fee revenue.. 300....... Net sales divided by assets.. 10. Net income divided by net sales....... Contra account to construction in progress. 2013 5–54 Intermediate Accounting.000 Unearned franchise fee revenue . 4.. Right of return j....... Inventory turnover 2....... Risks and rewards of ownership retained by seller......... Cost recovery method e............ 9... Net sales divided by accounts receivable....... 13...... 300........... 7. 6....... 270.... 12... Inc..... Net income divided by shareholders' equity...................000 To record franchise agreement and down payment January 15.... Installment sales method l.. 2014 Unearned franchise fee revenue ........ 5. 000 + 630. That indicates whether inventory management practices are in line with the competition.1. The ratio also can be useful when assessing the current ratio. The more liquid inventory is. 2013 5–55 .840. This can be costly in terms of stockout costs.000 [$690. Other points of reference should be considered. including the existence of obsolete or overpriced inventory. though. a high turnover can be achieved by maintaining too low inventory levels and restocking only when absolutely necessary. However. the lower the investment must be for a given level of sales.79 times = = Requirement 2 By itself. It’s just one piece in the puzzle. Inc. For instance.. Vol. Solutions Manual. the higher the inventory turnover. this one ratio provides very little information. Chapter 5 © The McGraw-Hill Companies. It indicates how well inventory levels are managed and the quality of inventory. to evaluate the adequacy of this ratio it should be compared with some norm such as the industry average.Exercise 5–23 Requirement 1 Inventory turnover ratio = Cost of goods sold Average inventory $1. the lower the norm should be against which the current ratio should be compared. In general.000] ÷ 2 2. 000] ÷ 2 2 times The company turns its inventory over 6 times per year compared to the industry average of 5 times per year.000.000 [$700.000.4 days $8.8 times).700.Exercise 5–24 Turnover ratios for Anderson Medical Supply Company for 2013: Inventory turnover ratio = = Receivables turnover ratio = = Average collection period = = Asset turnover ratio = = $4. 2013 5–56 Intermediate Accounting. These ratios indicate that Anderson is able to generate more sales per dollar invested in inventory and in total assets than the industry averages. 7/e . The asset turnover ratio also is slightly better than the industry average (2 times per year versus 1.000 + 3. Inc.4 days compared to the industry average of 25 days).000] ÷ 2 6 times $8.33 27.300. © The McGraw-Hill Companies.000] ÷ 2 13.800.000 [$4.. Anderson takes slightly longer to collect its accounts receivable (27.000 [$900.33 times 365 13.000 + 700. However.000 + 500. 000 Quarter Second Third $90. Chapter 5 © The McGraw-Hill Companies.900 + 1.700) ÷ 2] = 2.5% $180 ÷ [($1.200 = 3. Profit margin on sales b.46% b.89 x 3.3% Requirement 2 Profit margin x Asset turnover x Equity multiplier = ROE 3. Return on shareholders’ equity Requirement 2 Retained earnings beginning of period Add: Net income Less: Retained earnings end of period Dividends paid $180 ÷ $5.000 27. Return on assets c.000 150. Vol.200 ÷ [($1.000 68. Profit margin on sales $180 ÷ $5.Exercise 5–25 Requirement 1 a.3% Exercise 5–27 First Cumulative income before taxes $50.43 d.700) ÷ 2] ÷ [($550 + 500) ÷ 2] = 3.000 $130.900 + 1.000 Estimated annual effective tax rate 34% 17.000 $10.200 = 3.400 17.000 180.46% x 2. Inc.000 $ 41. Equity multiplier [($1. Asset turnover $5.3% $100.000 $190.400 Solutions Manual.000 Less: Income tax reported earlier -0Tax expense to be reported $17. Return on shareholders’ equity $180 ÷ [($550 + 500) ÷ 2] = 34.000 280.89 c.000 30% 36% 27.700) ÷ 2] = 10% $180 ÷ [($550 + 500) ÷ 2] = 34.1..43 = 34.000 Exercise 5–26 Requirement 1 a. 2013 5–57 .900 + 1. Exercise 5–28 Incentive compensation Depreciation expense Gain on sale $300 million ÷ 4 = $75 million $60 million ÷ 4 = $15 million $23 million Exercise 5–29 Quarters Ending March 31 June 30 Sept. 30 Dec. 31 Advertising $200,000 $200,000 $200,000 $200,000 Property tax 87,500 87,500 87,500 87,500 Equipment repairs 65,000 65,000 65,000 65,000 Extraordinary casualty loss - 0 - 185,000 -0-0Research and development -096,000 0 0 Note: this solution assumes that advertising, property tax, and equipment repairs are viewed as benefitting all periods following the one in which the expenditure is made, but that the extraordinary casualty loss and the R&D consulting fee only benefit the periods in which they occurred. Exercise 5–30 March 31 Advertising $800,000 Property tax 350,000 Equipment repairs 260,000 Extraordinary casualty loss -0Research and development -0Quarters Ending June 30 Sept. 30 -0-0-0-0-0-0185,000 -096,000 -0Dec. 31 -0-0-0-0-0- © The McGraw-Hill Companies, Inc., 2013 5–58 Intermediate Accounting, 7/e SUPPLEMENT EXERCISES Exercise 5–31 Requirement 1 The discount voucher provides a material right to the customer that the customer would not receive otherwise, because the customer can receive a 30 percent discount with the voucher but only a 10 percent discount without the voucher. That right to receive a discount could be sold separately. Therefore, the discount voucher given by Clarks is a separate performance obligation. Requirement 2 Cash 70,000 Revenue (to balance) Unearned revenue (discount option) (1,000 pairs  (30% – 10% discount)  20% estimated to redeem coupon  $100 average purchase) 66,000 4,000 Note: the accompanying journal entry to record cost of goods sold would be: Cost of goods sold 40,000 Inventory 40,000 To record cost of 1,000 pairs of boots sold Solutions Manual, Vol.1, Chapter 5 © The McGraw-Hill Companies, Inc., 2013 5–59 Exercise 5–32 Requirement 1 Even though Manhattan Today received payments from customers for an annual subscription, the subscription activity does not transfer goods or services to customers. Therefore, the annual fee is viewed as a prepayment for future delivery of goods or services, and would be recognized as unearned revenue when received. Requirement 2 The delivery of newspapers meets the criteria for a separate performance obligation, because it is regularly sold separately. The coupon for a 40 percent discount on a carriage ride is a separate performance obligation. First, it is an option that conveys a material right to the recipient (as opposed to just a general marketing offer). Second, it meets the criteria for a separate performance obligation because the recipient could use it in combination with additional cash to enjoy a carriage ride. Requirement 3 The value of the coupon would be $15.60 (40% discount  $130 carriage fee  30% of customers redeeming coupon). Of the $150 subscription fee, $14.13 ($150  ($15.60  ($15.60 + 150)) would be attributed to the coupon. Requirement 4 Upon receiving the subscription fee, the journal entry should be: Cash Unearned Revenue, subscription Unearned Revenue, coupon 150 135.87 14.13 © The McGraw-Hill Companies, Inc., 2013 5–60 Intermediate Accounting, 7/e 1.000 upon delivery of the plan and wait until receipt of the bonus is reasonably assured (likely waiting until cost saving reaches the prespecified target) before recognizing the bonus.000 Requirement 2 The most likely amount is $50. Requirement 3 Given that the outcome is binary (Thomas either will receive the bonus or not).) Requirement 4 Given that aspects of receipt of the bonus are beyond Thomas’s control (because Bran is responsible for implementation). Thomas would view the bonus as not reasonably assured. and thus over all such contracts is the best estimate of the average amount that will be received.000. Solutions Manual. Rather. Inc. Thomas would recognize only $50. because the probability of exceeding the performance threshold is less than 50%. the most likely amount often would be preferred. (The probability-weighted amount is an expected value. Therefore. Chapter 5 © The McGraw-Hill Companies. The license does not provide utility on its own or together with other goods or services that HealthPro has received previously from Pfizer or that are available from other entities. Exercise 5–34 Requirement 1 $50.000 + ($20.. Vol. 2013 5–61 . the license requires Pfizer’s R&D services and proprietary expertise to be valuable. Therefore.Exercise 5–33 The license granted by Pfizer is not a separate performance obligation. However.000 x 20%) = $54. Pfizer would combine the license with the R&D services to HealthPro and account for them as a single performance obligation. both amounts can be justified theoretically. The only way to exploit the license is via utilizing ongoing R&D services from Pfizer. 000 2. Cash or accounts receivable Revenue 100. 1.000 © The McGraw-Hill Companies. 7/e . Record the first quarterly payment.Exercise 5–35 The transaction price should be limited to the fixed amount of consideration until the end of the year because the asset management company cannot predict the amount of value that the fund will provide by year-end.000 x 10%) Revenue 80.000 80. Inc. Record the amount of additional revenue at the end of year. 2013 5–62 Intermediate Accounting.. Cash or accounts receivable ($800. it would not be able to recognize revenue associated with the bonus because that amount would not be reasonably assured until after year-end. Even if Seneca could predict that amount with some accuracy.000 100. 3. In this case. Vol. Chapter 5 © The McGraw-Hill Companies. McDonald’s has possession of the dolls. 2013 5–63 . Consider the following indicators: 1. and receive the benefit from. The buyer has an unconditional obligation to pay. In this case. The facts do not state whether title transfers. The buyer has the risks and rewards of owndership. and Toys4U should not recognize sales until McDonald’s customers. The customer has physical possession and control of goods. It appears that Toys4U has not transferred control upon delivery McDonald’s has a conditional rather than unconditional obligation to Toys4U appears to retain the risk of ownership. 4. The buyer has the legal title. 2.Exercise 5–36 Determining whether Toys4U satisfies the performance obligation requires consideration of indicators that McDonald’s has obtained control of the dolls. a good or service. A customer is unconditionally obliged to pay for a good or service typically because the customer has obtained control of the good or service in exchange and the passage of time does not remove the obligation. given that McDonald’s returns unsold dolls to Toys4U. so McDonald’s is conditionally (not unconditionally) obliged to pay for the toys.1. Legal title often indicates which party has the ability to direct the use of. This is essentially a arrangement. McDonald’s does not pay Toys4U until the dolls are sold. Inc. McDonald’s does not appear to be holding the risks of ownership. and (2) consignment sells dolls to Solutions Manual. because (1) pay. In this case.. so control over Level II in the software was not transferred to Kerry until January 10. Kerry obtained the access code for Level I in the software on December 1. Cutler should recognize $10 of revenue for Level II on January 10. rather than December 31.Exercise 5–37 In this example. When Tom passed the Level I test on December 31. Therefore. 2013. However. Kerry received the access code for Level II on January 10. Inc.. 2013 5–64 Intermediate Accounting. 2013. © The McGraw-Hill Companies. on that date Cutler should recognize $50 of revenue for Level I. because it did not satisfy a separate performance obligation until the access code was provided to its customer. and purchased access to Level II. Cutler licensed Level II to Kerry on the same day. 2012. 2012. meaning that Kerry has obtained the control of the right to use the software for Level I on that date. 7/e . Therefore. 2013 5–65 . Record interest expense at end of the second year of the contract: Interest expense ({$20. Record interest expense at end of the third year of the contract: Interest expense ({$20.Exercise 5–38 Requirement 1 Record unearned revenue upon receipt of initial payment: Cash Unearned revenue Requirement 2 1. Inc.000 + 800 + 832} x 4%) Unearned revenue Requirement 3 Record revenue upon Stewart’s satisfaction of his performance obligation: Unearned revenue ($20.497 865 865 Solutions Manual. Record interest expense at end of the first year of the contract: Interest expense ($20. Vol.000 + 800 + 832 + 865) Revenue 22.000 + 800} x 4%) Unearned revenue 832 832 3.000 x 4%) Unearned revenue 800 800 20.000 2.497 22.1..000 20. Chapter 5 © The McGraw-Hill Companies. 000 550.000 $ 900. d.000 (300. The deferred gross profit in the balance sheet at December 31.000 $ 220. The earnings process is completed upon delivery of the product. The payment terms do not affect revenue recognition.000 + 220.000 ($30. 2014. in 2014.000 x 40% x 30% $ 30.000) (300.000 gallons at $3 each is recognized on January 15. b. should be the balances in the accounts receivable accounts on that date for 2013 and 2014 sales multiplied by the appropriate gross profit percentage: Accounts receivable: sales in Total sales Less: Collections to date Less: Write-offs to date Accounts receivable balance x Gross profit rate Deferred gross profit 12/31/2014 2014 2013 $ 600.000) (200.CPA / CMA REVIEW QUESTIONS CPA Exam Questions 1. © The McGraw-Hill Companies.000). 2013 5–66 Intermediate Accounting.000) (50.000 The combined deferred gross profit in the balance sheet is $250. revenue for 50..000) 100. 2. Therefore. 7/e . Inc. “Cash collection is at least reasonably possible” is not a requirement for revenue recognition under IFRS. Gross profit realized $240.000).000.000.000.333 2013 actual costs –20.000 Gross profit $13. Year of sale 2013 2014 a.1. Percentage 30% 40% c.000 + 1.000 + 2.500.100. $3. the excess cost of $100. 2013 actual costs $20.333 6. 5.000 ($200..000 ($930.000 2.500.000 Balance uncollected at December 31. 4. Construction-in-progress represents the costs incurred plus the cumulative pro-rata share of gross profit under the percentage-of-completion method of accounting.170.000 must be recognized as a loss in 2013. 2013 5–67 .700.000).000 The total uncollected balance is $1. Collections on sales (a/b) $800. c.000 Revenue 33. d.000 Total estimated costs ÷ 60.000 b. Solutions Manual. is projected to exceed the contract price of $3. c. a. 2014 $200.000 $500.000 $200. d. Inc. Since the total cost of the contract. 7.CPA Review Questions (continued) 3. Vol.000 $1.000. Chapter 5 © The McGraw-Hill Companies.000 Sales 1.000 Ratio = 1/3 Contract price x 100. and not accrue any prepaid expense asset.S. Given that one-third of all costs have already been incurred ($6. However. Under the cost recovery approach.000 as expense in the first period. Therefore.000. such that the expense is recognized in the period in which it occurs rather than being accrued as a prepaid expense asset when an amount is paid and then amortized to expense over the year. On May 28.000 was realizable in the form of a receivable. sometimes neither the sales basis nor the cash basis is appropriate. Revenue is recognized when (1) realized or realizable and (2) earned. a.500 each interim period while recognizing $12.000 of revenue is recognized. contractors ordinarily recognize revenue using the percentage-of-completion method so that some revenue is recognized each year over the life of the contract.S. d. GAAP Barrett would accrue an asset when it made the tax payment and then reduce the asset by $12. Since $1. $1. 3..500 of expense each interim period.000.000 of the sales price was realized while the remaining $500. The costrecovery method is not used because the receivable was not deemed uncollectible until June 10. The revenue was earned on May 28 when the title of the goods passed to the purchaser. IFRS does not provide extensive guidance determining how contracts are to be separated into components for purposes of revenue recognition. 10. IFRS recognizes interim expenses more discretely than does U. an amount of revenue is recognized that is equal to cost incurred. such as when a construction contract extends over several accounting periods.CPA Review Questions (concluded) 8. As a result. d. 7/e . the company should recognize revenue equal to one-third of the contract price. so long as cost incurred is probable to be recovered. under IFRS Barrett would recognize the entire $50. this method is an exception to the general practice of recognizing revenue at the point of sale. occasionally. b. primarily because it better matches revenues and expenses.000). Inc. Hence. Under U. 2. 9. or © The McGraw-Hill Companies. at the time cash is collected. GAAP. a. Revenue is normally recorded at the time of the sale or. CMA Exam Questions 1.000 of cost was incurred. $500. c. 2013 5–68 Intermediate Accounting.000. 2013 5–69 .000. Solutions Manual.000 equals a gross profit of $2.000. Inc. Vol..1.000. Chapter 5 © The McGraw-Hill Companies.000 minus costs of $6. Revenues of $8.000.000.$8.000. ...000) * Adjusted $3...... Net income ..472..................... Net income .000 2...........680.......... 7/e .... Extraordinary item: Gain from settlement of lawsuit (net of $400...........000) Overstated profit © The McGraw-Hill Companies.......000 600......000) Overstated profit on installment sale (120.680...........000) Depreciation expense (2013) (50.........................21 0..000 * Profit recognized ($400..................81 Income from continuing operations before income taxes: Unadjusted $4.......000 Add: Gain from sale of equipment 50.....000) $120...... Extraordinary gain ................000 Deduct: Inventory write-off (400........... Income before extraordinary item ................. 2013 Income before income taxes and extraordinary item .......000 2... Income before extraordinary item ...000 1....000 tax expense) ........ [1] [1] $3........000 $2...000 (40..000 – 240..........60 $ 2.... Income tax expense ... 2013 5–70 Intermediate Accounting..000) Profit that should have been recognized (gross profit ratio of 40% x $100........000 $160............... Inc.............808................200.........208...PROBLEMS Problem 5–1 REAGAN CORPORATION Income Statement For the Year Ended December 31.. ...................... 180......... 120.............000 x 40% = 2014 gross profit: Cash collection from 2013 sales = $100.........000 $ 40............Problem 5–2 Requirement 1 2013 cost recovery % : $180.000 $48..........000 48..... To recognize gross profit from installment sales 48..........................000 Installment receivables ..........000 To record installment sales Cash .......................1................ Inc....... 120...........................000 = 60% (gross profit % = 40%) $300........000 Solutions Manual..............000 Inventory .......... Chapter 5 © The McGraw-Hill Companies..000 45............................000 x 40% = + Cash collection from 2014 sales = $150.........000 Deferred gross profit....... Realized gross profit ............. 2013 5–71 .....000 x 30% = Total 2014 gross profit Requirement 2 2013 Installment receivables .......000 120.................. Vol..000 $85...000 2013 gross profit: Cash collection from 2013 sales = $120............. To record cash collections from installment sales Deferred gross profit........... 300................000 2014 cost recovery %: $280..........000 = 70% (gross profit % = 30%) $400.................................. ...................... 280.................000 © The McGraw-Hill Companies......000 -0$40................................................... 7/e ...................000 $210...000 To record cash collections from installment sales Deferred gross profit ...... To recognize gross profit from installment sales 85... 2013 5–72 Intermediate Accounting...........000 150.......................................000 Requirement 3 Date 2013 2013 sales 2014 2013 sales 2014 sales 2014 totals Cash Collected Cost Recovery Gross Profit $120..........................000 $ 60....Problem 5–2 (continued) 2014 Installment receivables ....000 To record installment sales Cash .........................000 Deferred gross profit .000 -0- $100......... 250....... 400...............................................................000 Inventory ............000 $120.......... Realized gross profit ...........................000 $250..............000 85..............000 $40....000 150. 250.......... 120..........000 Installment receivables ... Inc........ ........................ Chapter 5 © The McGraw-Hill Companies................. Vol......................... 120. Inc... 300......................................000 40......................................000 To record installment sales Cash ................................000 Solutions Manual.............000 Installment receivables ...... 120.................... 2013 5–73 ........... 120........................................................................................ 180............000 Deferred gross profit................1...... 250.................................000 To record cash collection from installment sales 2014 Installment receivables ................... 250....................000 To record installment sales Cash ......................................000 To record cash collection from installment sales Deferred gross profit....................... 400......... To recognize gross profit from installment sales 40.................000 Inventory .........................................................000 Installment receivables ..........................................Problem 5–2 (concluded) 2013 Installment receivables ........................000 Inventory .............................. 280................ 120......................... Realized gross profit ....000 Deferred gross profit.............. 7/e .000 Installment sales method: Gross profit % = $200..000 = $200.000 $100.000 $100.000 c.000 $100.000 $40.Problem 5–3 Requirement 1 Total profit = $500. Cost recovery method .000 $100. Inc.000 -0- $ 40.000 -0- $ 40. 2013 5–74 Intermediate Accounting.000 = 40% 8/31/13 Cash collections a.0 .$100.000 -0-0-0-0- $ 40.000 © The McGraw-Hill Companies.000 ÷ $500.000 $200. Installment sales method (40% x cash collected) 8/31/14 8/31/15 8/31/16 8/31/17 $100.000 $ 40. Point of delivery method b.000 – 300.000 $100. 000 500.000 100.000 100.000 40.000 100.000 Installment Sales Cost Recovery Installment receivable Sales revenue Cost of goods sold Inventory To record sale on 8/31/13 Installment receivable Inventory Deferred gross profit To record sale on 8/31/13 Cash Installment receivable To record cash collections (Entry made each Aug. Vol. 2013 5–75 . 31) Deferred gross profit Realized gross profit To record gross profit (Entry made 8/31/16 & 8/31/17) 500.000 100. Inc.000 300.000 100.000 100.000 40.000 300.000 300.1. Chapter 5 © The McGraw-Hill Companies. 31) Deferred gross profit Realized gross profit To record gross profit (Entry made each Aug.000 500.000 300.000 Solutions Manual.000 200.000 100..000 200.Problem 5–3 (continued) Requirement 2 Point of Delivery 500.000 100. 000 400. 2013 Assets Installment receivables Less: Deferred gross profit Installment receivables.000 300.000 (200.000 300.000) 200. Inc.000 (160.000 © The McGraw-Hill Companies. 2013 5–76 Intermediate Accounting.000) 100.Problem 5–3 (concluded) Requirement 3 Point of Delivery December 31.000 400.000) 240. net Installment Sales Cost Recovery 400.000) 180. net December 31.000 300. 2014 Assets Installment receivables Less: Deferred gross profit Installment receivables. 7/e .000 (120.000 (200.. Problem 5–4 Requirement 1 All jobs consist of four equal payments: one payment when the job is completed and three payments over the next three years. Bluebird: Job completed in 2011, so down payment made in 2011, another payment in 2012, and two payments remain. $400,000 gross receivable at 1/1/2013 implies payments of ($400,000  2) = $200,000 in 2013 and 2014. Four payments of $200,000 implies total revenue of 4 x $200,000 = $800,000 on the job. Twenty-five percent gross profit ratio implies cost of 75% x $800,000 = $600,000. Cost recovery method gross profit: Payments in 2011 and 2012 have already recovered $400,000 of cost, so cost remaining to be recovered as of 1/1/2013 is $600,000 total – $400,000 already recovered = $200,000. Therefore, the entire 2013 payment of $200,000 will be applied to cost recovery, and no gross profit is recognized in 2013. Installment sales method gross profit: $200,000 payment x 25% gross profit ratio = $50,000 of gross profit recognized in 2013. PitStop: Job completed in 2010, so down payment made in 2010, another payment in 2011, another in 2012, and one payment remains. $150,000 gross receivable at 1/1/2013 implies a single payment of $150,000 in 2013. Four payments of $150,000 implies total revenue of 4 x $150,000 = $600,000 on the job. Thirty-five percent gross profit ratio implies cost of 65% x $600,000 = $390,000. Cost recovery method gross profit: Payments in 2010, 2011, and 2012 of a total of $450,000 have already recovered the entire $390,000 of cost and allowed recognition of $60,000 of gross profit. Therefore, the entire 2013 payment of $150,000 will be applied to gross profit. Installment sales method gross profit: $150,000 payment x 35% gross profit ratio = $52,500 of gross profit recognized in 2013. Solutions Manual, Vol.1, Chapter 5 © The McGraw-Hill Companies, Inc., 2013 5–77 Problem 5–4 (concluded) Totals: Cost recovery method: $0 (Bluebird) + 150,000 (PitStop) = $150,000. Installment sales method: $50,000 (Bluebird) + 52,500 (PitStop) = $102,500. Requirement 2 If Dan is focused on 2013, he would not be happy with a switch to the installment sales method, because that would produce gross profit of only $102,500, which is $47,500 less than he would show under the cost recovery method. It is true that the installment sales method recognizes gross profit faster than does the cost recovery method, but the installment sales method also recognizes gross profit more evenly than does the cost recovery method. The timing of these jobs is such that 2013 is a year in which almost all of the gross profit associated with the PitStop job gets recognized, so 2013 looks more profitable under the cost recovery method. © The McGraw-Hill Companies, Inc., 2013 5–78 Intermediate Accounting, 7/e Problem 5–5 Requirement 1 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) 2013 $10,000,000 2,400,000 5,600,000 8,000,000 $ 2,000,000 2014 $10,000,000 6,000,000 2,000,000 8,000,000 $ 2,000,000 2015 $10,000,000 8,200,000 -08,200,000 $ 1,800,000 Gross profit (loss) recognition: 2013: $2,400,000 = 30.0% x $2,000,000 = $600,000 $8,000,000 2014: $6,000,000 = 75.0% x $2,000,000 = $1,500,000 – 600,000 = $900,000 $8,000,000 2015: $1,800,000 – 1,500,000 = $300,000 Solutions Manual, Vol.1, Chapter 5 © The McGraw-Hill Companies, Inc., 2013 5–79 000 (3.000 4.Problem 5–5 (continued) Requirement 2 2013 Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress (gross profit) Cost of construction (cost incurred) Revenue from long-term contracts (1) To record gross profit 2014 2015 2.000) $2.800. 2013 5–80 Intermediate Accounting.000 1.000 2.000 = 2014: 75% x $10.000 300.500.600.000 (1) Revenue recognized: 2013: 30% x $10.500.000 = Less: Revenue recognized in 2013 & 2014 Revenue recognized in 2015 $3.000.000 = Less: Revenue recognized in 2013 Revenue recognized in 2014 2015: 100% x $10.000 2.200.600.600.000.000 3.000 © The McGraw-Hill Companies.000.600.500.400.000 2.000.000.000 1. Inc.200.000 $7.000 2.400.000) $4. 7/e .200.600.000 4.000 4.000.400.000.000.600.000 4.000.000 4.800.000.000 3.000 3.500.000.000.000 600.000 2.600.000 4.000 3.000 3.000 900.000 $10.000.000 (7..000 2.000 2.500.000 2.500.000 4.000 3. 100.000 2015 $10.000 3.000.000 3.000 8.000 9.400.000.000.000 2014 $10.000.000 -09.400.500.000 1..000 Requirement 4 Costs incurred during the year Estimated costs to complete as of year-end Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (actual in 2015) 2013 $2.200.000 5.000 $7.000 $ 600.000.000.000.300.000 (2.000 9.200.000 2015 $3.000 5. Vol.000.000) $600.600.000 Solutions Manual.000 $ 2.000) 1.600.400.Problem 5–5 (continued) Requirement 3 Balance Sheet Current assets: Accounts receivable Construction in progress Less: Billings Costs and profit in excess of billings 2013 2014 $ 200.100.000.000 2. Inc.1.800.400.000 2014 $3.500.000 $3. Chapter 5 © The McGraw-Hill Companies.000 (6.000 2013 $10. 2013 5–81 .000 $ 700.000 6. 000 10.000 = 30.000 = 66.667 = $133.000 = $466.100.000 8.000) 2015 $3.000 $ (100.000 = $600.000 6.200. Inc.000 5.000 $8.000 = $(133.000 2014: 2015: $(300.000 $8.100.0% x $2.400.000 10. 7/e .000.Problem 5–5 (concluded) Gross profit (loss) recognition: 2013: $2.000 -010.000.333) $9.000 $ 2.200.000 2015: $600.300.400.000.000. 2013 5–82 Intermediate Accounting.000 – 466.300.900.000 = $600.000 4.000 2015 $10.600.400.000 2013 $10.800.400.000 $ (300.000) Gross profit (loss) recognition: 2013: $2.000) $(100.000 5.000) – (300.000.000) – 600.000 2014 $10.000.667 – 600.000 = 30.000 2014 $3.333 Requirement 5 Costs incurred during the year Estimated costs to complete as of year-end Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) 2013 $2.100.000.000 2014: $6.000 4.000 © The McGraw-Hill Companies.000.6667% x $700.000 = $(900.600.000 2..000) = $200.000.0% x $2.100. 800.200.000 Solutions Manual.000 2.000.800.000.000 10.000 Gross profit recognized -0-0$1.000 1.000. Vol.600.000.Problem 5–6 Requirement 1 Year 2013 2014 2015 Total gross profit Requirement 2 2013 2014 2015 2.600.000 4. Inc.000 4.000 2.000 3.000 4.000 Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress (gross profit) Cost of construction (costs incurred) Revenue from long-term contracts (contract price) To record gross profit 2.600.200.800.000 4. Chapter 5 © The McGraw-Hill Companies.200.000 3.000 3.400.000.800.600.000 4.1.000 1.000.000 2.400.600.000 4.800.000 $1.600.000 3.000 1..000 8. 2013 5–83 .000.000 2. 800.Problem 5–6 (concluded) Requirement 3 Balance Sheet Current assets: Accounts receivable Construction in progress Less: Billings Costs in excess of billings 2013 $ 200.600.000 $600.000.000) -02014 $ 600.000 (6.000 $2.000 5.000) 200.000 5.000 4.100.400.600.000 (2.000 2015 $3.000.000 - Gross profit recognized -0-0$600.000 2013 $2.800.000 Requirement 4 Costs incurred during the year Estimated costs to complete as of year-end Year 2013 2014 2015 Total gross profit Requirement 5 Costs incurred during the year Estimated costs to complete as of year-end Year 2013 2014 2015 Total project loss 2013 $2.. Inc.900.400.200.000 Gross profit (loss) recognized -0$(300.000 2014 $3.000 2014 $3.000.000) © The McGraw-Hill Companies.000 $6.100. 7/e . 2013 5–84 Intermediate Accounting.000 2015 $3.000) 400.000 3.000 $(100.400. 000 2.000 2.400.000 1.200.000 3.000 1.800.000 4.000.000 $1.000.000 3.000. Chapter 5 © The McGraw-Hill Companies.000 4.200.200.000.000 1.000 4.600.600.000 4.000 Gross profit recognized -0-0$1.000 3. 2013 5–85 .600.400. Vol.400.000 4.000 4. Inc.800.000 2.000 2.000.600.000 3.800.Problem 5–7 Requirement 1 Year 2013 2014 2015 Total gross profit Requirement 2 2013 2014 2015 2.400.000 3.600.600.1.800.000 4.800.000 Construction in progress Various accounts To record construction costs Accounts receivable Billings on construction contract To record progress billings Cash Accounts receivable To record cash collections Construction in progress (gross profit) Cost of construction (costs incurred) Revenue from long-term contracts (contract price) To record gross profit 2.600.000 Solutions Manual.000 3.000..000 2.000 2.000.000 2.600. 600.Problem 5–7 (concluded) Requirement 3 Balance Sheet Current assets: Accounts receivable Construction in progress Less: Billings Costs in excess of billings 2013 $ 200.000 $(100.000 2015 $3.000) 400.000 Gross profit (loss) recognized -0$(300.000.000 2013 $2.000 2014 $3.000 (2.000) 200.000) © The McGraw-Hill Companies.900.600.000 4. 7/e .000 $2.800..000 5.000 Requirement 4 Costs incurred during the year Estimated costs to complete as of year-end Year 2013 2014 2015 Total gross profit Requirement 5 Costs incurred during the year Estimated costs to complete as of year-end Year 2013 2014 2015 Total project loss 2013 $2.800.000 - Gross profit recognized -0-0$600.100.000 $6.100.000.200.000 $600.400.400.000 2015 $3.000) -02014 $ 600.000 3. 2013 5–86 Intermediate Accounting.000 5.000 2014 $3.000.400.000 (6. Inc. 000) $(250.000) = $2.000 2.000 © The McGraw-Hill Companies. Vol.000) 2013 2014 $ 130.000) Requirement 3 Balance Sheet Current assets: Costs less loss ($2.500.000 $ (250.000 $ 320.000 2014 $4.170.700.000 $ (200.000 3.1.000) – (200.000 $(200.200. Inc. Chapter 5 . 2013 5–87 Solutions Manual.000) 2015 $4..000 = $50.250.250.Problem 5–8 Requirement 1 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit (loss) (actual in 2015) Year 2013 2014 2015 Total project loss Requirement 2 Gross profit (loss) recognition: 2013 $4.000.000 *Cumulative costs ($2.500.300.000.000) in excess of costs and profit ($400.000 3.000) (50.000) 2013: 2014: 2015: 10% x $500.000 -04.300.000 1.000) – 50.000 4.000) Current liabilities: Billings ($720.000) $(250.150.000*) in excess of billings ($2.000) Gross profit (loss) recognized -0$(200.000) less cumulative loss recognized ($200.000) = $(50.500.000 4.000 = $(250.000.000 $ 500.000 350. 000 18.500.000.000. 2013 5–88 Intermediate Accounting.000 16. Citation never estimates the Altamont contract will earn a gross loss. Requirement 2 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit a. so never has to recognize one.000.000 $ 4. 2013 $20. when the construction project is complete.000 12. Inc.000 13.000.000.000 4..500.000. The completed contract method should only be used when a lack of dependable estimates or inherent hazards make it difficult to forecast future costs and profits.000. Citation would have to report an overall gross loss on the contract in whatever period it first revises the estimates to determine that an overall loss will eventually occur. Under the completed contract method Citation would not report any revenue in the 2013 or 2014 income statements. The share is estimated based on the project's costs incurred each period as a percentage of the project's total estimated costs.000 $ 2.000 Gross profit recognition: Under the completed contract method Citation would not report gross profit until the project is competed.000.000 4. the construction period. b.Problem 5–9 Requirement 1 The completed contract method of recognizing revenues and costs on long-term construction contracts is equivalent to recognizing revenue at the point of delivery. © The McGraw-Hill Companies. 7/e . that is. that is.000 2014 $20. The percentage-of-completion method assigns a share of the project’s expected revenues and costs to each period in which the earnings process takes place. 2013 Current assets: Accounts receivable Costs ($4.000 Requirement 3 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit a.000 2014: $20.000. Vol.000.000 2014: $13.000.000 2.500.000 18.000 Gross profit recognition: 2013: $ 4.000.000 = $1.000. Chapter 5 .1.000) $10.000 b.000.000.500.000 x 75% = $15.000*) in excess of billings ($2.000 12. 2013 5–89 Solutions Manual.000) $ 200.000.000 $ 4.000. Balance Sheet At December 31.000 13.000.000 * Under the completed contract method.500..000 2014 $20.000 $ 2.000 4.000.000 = $1.000 Less: 2013 revenue (5. 2013 $20.000.000.000.000.500.000 4.000 $16. 2013: $20.000.000 16.000.Problem 5–9 (continued) c.000 Less: 2013 gross profit 2014 gross profit 1.000 = 25% x $4.000. Inc.000 © The McGraw-Hill Companies.000. this account would only include costs of $4.000.000.000 = 75% x $2.000 $ 500.000.000 x 25% = $5.000.000 $18.000.000. 000.000.500. 7/e © The McGraw-Hill Companies. 2013 Current assets: Accounts receivable Costs and profit ($5.000 Revenue recognized this period = total – revenue recognized in prior periods = $12.500. b.000 Total revenue recognized to date = (percentage complete)(total revenue) = ($13.000.000 $7.000.000.000. Balance Sheet At December 31.000 9.000.500.000. 2013 5–90 .000.000) $10.000) = (60%) x ($20.000 Intermediate Accounting.000 2014 $20.000) x ($20.000 16.000 $ 4.500.000.000.000 22.000.000) * Costs ($4.500. Gross profit recognition: 2014: Overall loss of ($2.000..000.000) + profit ($1.000 $3.000 2013 $20.500.000.500.000) Requirement 4 Contract price Actual costs to date Estimated costs to complete Total estimated costs Estimated gross profit a.000.Problem 5–9 (continued) c. 2014: Easiest to solve using a journal entry: Cost of construction (to balance) Revenue from long-term contracts* Construction in progress (loss) * $ 200.000 = $3. Inc.500.500.000*) in excess of billings ($2.000 3.000 – 5.000.000.000 13.000 ($ 2.000.000) – previously recognized gross profit of $1.000) = $12.000 = $7.000.000 ÷ $22.000 12.000.000 4. 000) + 2014 costs ($9..700.000*) $ 1.000 Current liabilities: Customer deposits (or unearned revenue) $300. Requirement 6 Income statement: Sales revenue (3 x $600.000) – 2014 loss ($3.000 * 2013 costs ($4.000.000.000) Requirement 5 Citation should recognize revenue at the point of delivery.Problem 5–9 (continued) c.800.000) Cost of goods sold (3 x $450.500.000) Gross profit $1.000* *$600.000 1.1. and the receipt of the full sales price. when the homes are completed and title is transferred to the buyer.000 Balance sheet: Current assets: Inventory (work in process) $2. 2014 Current assets: Accounts receivable Current liabilities: Billings ($12.500.350.000) in excess of costs and profit ($11. Vol.000 x 5 = $300.000 x 10% = $60. 2013 5–91 .000 $ 450.000. the transfer of title.000. the sales price is not fixed. There is no contract in place and until the completion of the home. Balance Sheet At December 31. The percentage-of-completion method is not appropriate in this case. Also. This is equivalent to the completed contract method for long-term contracts. Chapter 5 © The McGraw-Hill Companies. Inc.000. the earnings process is not virtually complete and there is still significant uncertainty as to cash collection.000 Solutions Manual.600.000 1.000) + 2013 profit ($1. ....................... 1...........200......................................... 100........ 1.........................................000 100.... 1.... January 30..........200 d. September 30.000 Unearned franchise fee revenue ................... 200.............................200...200.....000 c........................................ 2013 Unearned franchise fee revenue ........000 © The McGraw-Hill Companies....................... September 1......... Note receivable ..000 x 3%) ..000 b... Service revenue ................................ January 30...............000 Franchise fee revenue ....... 2013 Accounts receivable ($40............000 Note receivable ............ Inc................000............. 2013 5–92 Intermediate Accounting.............................. 1..... 1....Problem 5–10 Requirement 1 a... 2013 Cash ............................................................. 2014 Cash ..200 1................. 7/e ...... .......................................................................... Vol..............000 Unearned franchise fee revenue ...............000............................000 Deferred franchise fee revenue ..... Franchise fee revenue (cash collected) .... 200.............000 c......................000 200................................................... Inc.... 2013 5–93 ........................ 1......... 1.............................000...............000 Solutions Manual................................................................... 200............. 1...................000 100................................................000 Note: Could also show as: Cash ...............200 d........ September 1........ January 30........... 1.... 2013 Cash ...000 100.200 1.... Service revenue ...200........... 2013 Accounts receivable ($40.......................... September 30............ Note receivable ...000..........................000 100.......... 100.............. January 30....................Problem 5–10 (continued) Requirement 2 a.......... 1.........000 Note receivable ..1..... 2014 Cash ....000 b. 2013 Deferred franchise fee revenue ....................................000 Deferred franchise fee revenue ....... Chapter 5 © The McGraw-Hill Companies. Franchise fee revenue ........................000 Note receivable ............ 200...... Deferred franchise fee revenue .. 200.............................000 x 3%) ................. 33% x 2.600) ÷ 2] = 7.37 x 2.28 days $9.000. Return on shareholders’ equity 9.000 + 3.000 ÷ [($4.37 times = 7. 6.1% © The McGraw-Hill Companies.56 days $9.350) ÷ 2] = 2.000 = 3. 3. DuPont framework $6.0 = 40.350) ÷ 2] = 21.000 + 3. 2013 Current assets: Installment notes receivable ($1. 7/e . In addition. $200.500 + 1. 7.000 ÷ [($600 + 400) ÷ 2] = 18.1% [($4.0 365 ÷ 9.000) less deferred franchise fee revenue ($1. Problem 5–11 1. 2013 5–94 Intermediate Accounting.0 365 ÷ 18.000 + 3.67 = 21.67 3. Equity multiplier 10.89% $300 ÷ [($1.. 5.600) ÷ 2] ÷ [($1.33% $300 ÷ [($4.000 Explanation: Revenue recognition on the entire note receivable is deferred.000.000 of unearned revenue must be shown as a liability.Problem 5–10 (concluded) Requirement 3 Balance Sheet At December 31. 2.000) Current liabilities: Unearned franchise fee revenue $ -0- $200. Inc.0 = 20.33% x 2.300 ÷ [($800 + 600) ÷ 2] = 9. Inventory turnover ratio Average days in inventory Receivables turnover ratio Average collection period Asset turnover ratio Profit margin on sales Return on assets or: 8.89% 3.600) ÷ 2] = 2.500 + 1. 4.37 $300 ÷ $9. . Inc.188 $8.832 $5. Chapter 5 © The McGraw-Hill Companies.588 $9.68 times Average days in inventory = J&J Pfizer = = 365 Inventory turnover 365 3.1.862 $6.775 = 6.68 = 108 days = 217 days On average.39 365 1.15 = 57 days = 71 days On average. Inventory turnover J&J Pfizer = = = Cost of goods sold Inventories $12. J&J collects its receivables in 14 days less than Pfizer. 2013 5–95 . Solutions Manual.15 times Average collection period = J&J Pfizer = = 365 Receivables turnover 365 6.39 times = 1.37 365 5.Problem 5–12 Requirement 1 Receivables turnover J&J Pfizer = = = Net sales Accounts receivable $41. Vol.176 $3.837 = 3. J&J sells its inventory twice as fast as Pfizer.37 times = 5.574 $45. . These differences combine to produce a significantly higher return on assets for J&J. high turnover.263 $1. or a combination of the two.862 17.4% = 14. ignoring specific sources of financing. 2013 5–96 Intermediate Accounting.862 $48.63% Profit margin on sales x x Asset turnover = J&J Net sales Total assets $41. Requirement 3 Profitability can be achieved by a high profit margin.867 times $45. In this regard. © The McGraw-Hill Companies.639 $116.188 $116.Problem 5–12 (continued) Requirement 2 Rate of return on assets J&J Pfizer = = = Net income Total assets $7. the combinations of profit margin and asset turnover are not similar. J&J’s profitability is significantly higher than that of Pfizer.9% 1.387 times = 1.19% $ 1.4% The return on assets indicates a company's overall profitability.263 .197 $41.188 3.775 = = 14. Inc.197 $48. 7/e .775 . Rate of return on assets = Net income Net sales = = Pfizer = $ 7.639 $45. J&J’s profit margin is much higher than that of Pfizer. as is its asset turnover.9% x x x x = No. 263 $26. Vol. Solutions Manual.377 = 1.639 $65.377 = 26. Inc.80 = 1.869 $1.1.Problem 5–12 (concluded) Requirement 4 Rate of return on = shareholders’ equity J&J Pfizer = = Net income Shareholders’ equity $7. indicating that they are using leverage to the same extent to earn a return on equity that is higher than their return on assets.869 $116. Chapter 5 © The McGraw-Hill Companies. 2013 5–97 .5% J&J provided a much greater return to shareholders.775 $65.8% = 2.197 $26. Requirement 5 Equity multiplier = shareholders’ equity J&J Pfizer = = Total Assets Shareholders’ equity $48..79 The two companies have virtually identical equity multipliers. Profit margin on sales = Net income ÷ Sales = 5% Sales = $20 ÷ 5% = $400 d. + Inventory = 2 x (Cash + Accounts receivable) Cash + $20 + 30 = (2 x Cash) + (2 x $20) Cash + $50 = Cash + Cash + $40 Cash = $10 h.0 Current liabilities = ($10 + 20) ÷ 1. Inventory turnover ratio = Cost of goods sold ÷ Inventory = 8 Inventory = $240 ÷ 8 = $30 f. Noncurrent assets = Total assets – Current assets = $200 – ($10 + 20 + 30) = $140 j. 2013 5–98 Intermediate Accounting. 7/e . Times interest earned ratio = (Net income + Interest + Taxes) ÷ Interest = 17 (Net income + $2 + 12) ÷ $2 = 17 Net income + $14 = 17 x $2 Net income = $20 b. Return on assets = Net income ÷ Total assets = 10% Total assets = $20 ÷ 10% = $200 c. rec. Gross profit margin = Gross profit ÷ Sales = 40% Gross profit = $400 x 40% = $160 Cost of goods sold = Sales – Gross profit = $400 – 160 = $240 e.. Inc.0 Current assets ÷ 2 = Current liabilities Quick assets ÷ 1 = Current liabilities Current assets ÷ 2 = Quick assets ÷ 1 Current assets = 2 x Quick assets Cash + Accts.0 Acid-test ratio = Quick assets ÷ Current liabilities = 1. Receivables turnover ratio = Sales ÷ Accounts receivable = 20 Accounts receivable = $400 ÷ 20 = $20 g. Return on shareholders’ equity = Net income ÷ Shareholders’ equity = 20% Shareholders’ equity = $20 ÷ 20% = $100 © The McGraw-Hill Companies. Acid-test ratio = (Cash + Accounts receivable) ÷ Current liabilities = 1.0 = $30 i.Problem 5–13 a. Current ratio = Current assets ÷ Current liabilities = 2. 0 = $100 Long-term liabilities = Total liabilities – Current liabilities = $100 – 30 = $70 CADUX CANDY COMPANY Balance Sheet At December 31. 2013 5–99 . Vol. Inc.Problem 5–13 (concluded) k. and equipment (net) Total assets $ 10 20 30 60 140 $200 Liabilities and Shareholders’ Equity Current liabilities $ 30 Long-term liabilities 70 Shareholders’ equity 100 Total liabilities and shareholders' equity $200 Solutions Manual.. 2013 Assets Current assets: Cash Accounts receivable (net) Inventories Total current assets Property. Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1.1.0 Total liabilities = $100 x 1. Chapter 5 © The McGraw-Hill Companies. plant. 008.5 1.2 $4.6 $4.8 $4. Inc.Problem 5–14 Requirement 1 Rate of return on assets Metropolitan Republic = = = Net income Total assets $ 593.008. but partially makes up for it with a higher turnover. In this regard.5% $5.6 $7.6% The return on assets indicates a company's overall profitability.5 $ 424.768.021. Rate of return on assets = Net income Net sales x x x x Profit margin on sales x x Asset turnover = Net sales Total assets Metropolitan = $ 593.0 = = 14. or a combination of the two. 2013 5–100 Intermediate Accounting.0 $4. 7/e .698.8% 10.0 1.. high turnover. ignoring specific sources of financing.8 $5.94 times = 10.698. Requirement 2 Profitability can be achieved by a high profit margin.42 times = $7. Metropolitan’s profitability exceeds that of Republic.2 = 5.768.4% $ 424.0 = Republic = 10.021.8% Republic’s profit margin is much less than that of Metropolitan. © The McGraw-Hill Companies.7% 14. 7 $424.0 $335.9 + 2. Inc.7 $4.5 $144.7%) the return on assets.476.0 + 1.476.008.34 times (34. Metropolitan increased its return to shareholders 2.021.9 – 904. even though its return on assets is less. Solutions Manual.601.1.12 When the return on shareholders’ equity is greater than the return on assets. Vol. 2013 5–101 . Republic’s higher leverage has been used to provide a higher return to shareholders than Metropolitan.07 times (43. Both firms do this.34 = 4.6% = 43.0 + 1.9 – 904.6% Republic provides a greater return to common shareholders. Republic increased its return to shareholders 4.Problem 5–14 (continued) Requirement 3 Rate of return on shareholders’ equity Metropolitan Republic = = = Net income Shareholders’ equity $593.6 $335.6% ÷ 10. Chapter 5 © The McGraw-Hill Companies.1 = 34.6% ÷ 14..8 $144.8%) the return on assets.9 – 964.9 + 2.9 – 964. Requirement 4 Equity multiplier Metropolitan Republic = = = Total assets Shareholders’ equity $4.1 = 2.601. management is using debt funds to enhance the earnings for stockholders. 2013 5–102 Intermediate Accounting.1 Quick assets Current liabilities $1.2 $1..7 $7.698.2 $1.0 $422. Inc.4 – 134.768.203.7 – 635.2 – 476.1 = = .280.0 $1.787.94 .6 $1.2 $325. The more robust acid-test ratio reveals that Metropolitan is more liquid than Republic.787.21 = = .203.478.83 The current ratios of the two firms are comparable and within the range of the rule-of-thumb standard of 1 to 1.9 times © The McGraw-Hill Companies.5 times = 23.47 .7 $1.280. 7/e .478. Requirement 6 Receivables turnover ratio Metropolitan Republic = = = Sales Accounts receivable $5.0 – 466.7 $1.0 = 13.Problem 5–14 (continued) Requirement 5 Current ratio Metropolitan Republic Acid-test ratio Metropolitan Republic = = = = = = Current assets Current liabilities $1. 6 + 276.0 $466.1. Chapter 5 © The McGraw-Hill Companies. perhaps suggesting that its relative liquidity is not as bad as its acid-test ratio indicated.6 + 46.7 $635.1 times Republic’s receivables turnover is more rapid than Metropolitan’s. Solutions Manual. 2013 5–103 .Problem 5–14 (concluded) Inventory turnover ratio Metropolitan Republic = = = Cost of goods sold Inventory $2.0 times Both firms provide an adequate margin of safety.909.6 = 18.2 times = 7..1 $46.8 $424.8 + 56.481. Requirement 7 Times interest earned ratio Metropolitan Republic = = = Net income plus interest plus taxes Interest $593.8 + 394.7 $56.2 = 6. Vol.4 $4.4 times = 16. Inc. 7/e .180) $ 48.000 + [59.500 x 36% $180.500 (27.000 ÷ 4 = $12.Problem 5–15 Branson Electronics Company Income Statement Revenues Cost of goods sold Gross profit Advertising expense1 Other operating expenses2 Income before income taxes Income tax expense3 Net income 1$50. 2013 5–104 Intermediate Accounting.000 145.000] 3$75.000 (12.000 35.500 2$48.000) 75.320 © The McGraw-Hill Companies.500) (57..000 – 50. Inc. 55 34.1.45 Solutions Manual. Cash Unearned revenue. we should first consider that Fit & Slim would offer a 10 percent discount on the yoga course to all customers as part of a seasonal promotion. Fit & Slim would recognize revenue for the sale of annual membership fee and discount voucher. Vol. a 25 percent discount provides a customer with an incremental value of 15 percent (25% – 10%). the estimated standalone selling price of the course voucher provided by Fit & Slim is $36 ($600 initial price of the course  15% incremental discount  40% likelihood of exercising the option).. Since the discount voucher of the yoga course would be a separate performance obligation. the discount voucher also is a separate performance obligation. Chapter 5 © The McGraw-Hill Companies. The gym membership is one separate performance obligation. 2013 5–105 . To allocate the contract price to the performance obligation. membership fees Unearned revenue. b.SUPPLEMENT PROBLEMS Problem 5–16 Requirement 1 a. Thus. So. Since the discount voucher provides a material right to the customer that the customer would not receive otherwise (a 25 percent discount rather than a 10 percent discount). Fit & Slim would allocate $34. yoga coupon 800 765. Inc.45 {$800  [36 ÷ ($36 + 800)]} of the $800 transaction price to the discount voucher on yoga course. Since the standalone selling price of the annual membership fee is $800. c. it is not a separate performance obligation in the contract. Since the option to visit on additional days is not a separate performance obligation. the entire $500 payment is allocated to the 50 visits associated with the coupon book. since a coupon book yields approximately 40 visits. Therefore. c. The option to pay $15 for additional visits does not constitute a material right. Cash Unearned revenue. Inc. because it is in the range ($12 to $18) of normal fees paid by nonmembers. Alternatively.Problem 5–16 (concluded) Requirement 2 a. Therefore. 7/e . b. coupon book 500 500 F&S could recognize (1/40)  $500 of revenue for each visit. © The McGraw-Hill Companies. 2013 5–106 Intermediate Accounting. F&S could recognize revenue over the year following sale of the coupon book.. F&S should not allocate any of the contract price to it. and if the contract is terminated prior to completion. and receive the benefit from. Crown’s retention of title is a protective right. Consequently. Inc. Although Star does not obtain legal title of the equipment until completion of the job. Scenario 2: The terms of the contract and all the related facts and circumstances indicate that Star does not obtain control of the gym until it is delivered. and the right to a report regardless of contract termination. Crown retains the equipment. The restaurant has an unconditional obligation to pay throughout the contract as evidenced by the nonrefundable progress payments. Crown’s performance obligation is to provide Star with construction services. suggesting that Crown retains control of the equipment throughout the job. Star does not obtain title to the equipment until the job is completed. Scenario 3: The terms of the contract and all the related facts and circumstances indicate that Coco has the ability to direct the use of. and Crown would defer revenue recognition until the end of the construction process. Also. and CostDriver should recognize revenue over the life of the contract.Problem 5–17 Scenario 1: The terms of the contract and all the related facts and circumstances indicate that Star controls the room as it is built. and not an indicator that it has retained control.1. Crown’s performance obligation is to provide Star with a completed gym. Consequently. the customer. Scenario 4: The terms of the contract and all the related facts and circumstances indicate that Edwards. obtains control of the apartment on completion of the contract. 2013 5–107 . and Crown would recognize revenue over time throughout the construction process. Star has an unconditional obligation to pay throughout the contract as evidenced by the required progress payments (with no refund of payment for any work performed to date) and by the requirement to pay for any partially completed work in the event of contract termination. and the Tower should not recognize revenue until delivery of the apartment. Therefore. the CostDriver Company’s performance obligation is to provide the restaurant with services continuously during the three months of the contract. the Tower’s performance obligation is to provide the customer with a completed apartment.. Consequently. the report is not of alternate use to CostDriver. Edwards obtains title and physical possession of the apartment only on completion of the contract. Chapter 5 © The McGraw-Hill Companies. Solutions Manual. Vol. the consulting services as they are performed. 000).000 ([$20. it will record the following entry: Cash Expected bonus receivable Revenue c) 10.000 6. using the following journal entry: Cash Expected bonus receivable Revenue 20. Inc. plus or minus $10.000..000  6] – $10.000 21.000 ([$20. it will record the following entry: Revenue Expected bonus receivable Cash 16.000 at the end of the life of the contract.000) Expected contract price at inception Expected Consideration $104.Problem 5–18 Note: The contract requires 6 payments of $20.000 1.000 If Revis pays the penalty.000 10.000. or [(6  $20. 2013 5–108 Intermediate Accounting. 7/e .000  6] + $10. a) Revis would estimate the transaction price as follows: Possible Prices $130.000) $110.000 (6  $1.000 $126. b) If Revis receives the bonus.000 6.000] = $130.000) – $10.000 22.000 4.000 After six months the Expected bonus receivable will have accumulated to $6.000 ($126.000] = $110. So the contract will provide either [(6  $20.000 ÷ 6) of revenue.000) + $10.000 Probability 80% 20% Each month Revis would recognize $21.000.000 © The McGraw-Hill Companies. 000) 20% Transaction price at contract inception: Velocity would allocate the transaction price. Velocity would recognize revenue of $61.000 ([$60. Chapter 5 © The McGraw-Hill Companies. This is the revenue recognized in excess of its unconditional right to consideration.500 ($492.000 ([$60. 2013 5–109 . Therefore.500 Solutions Manual.500 less than the revenue recognized). Velocity would calculate the transaction price to be the probability-weighted average of the two possible eventual prices: Possible Prices Expected Consideration $400.500 in the first month to reflect the most likely bonus to be received at the end of the contract. But Burger Boy is unconditionally obligated to pay only $60. $492.000  8] + $20. Inc.000 ÷ 8 months = $61. the journal entry to record the revenue that Velocity would recognize each month for the first four months is as follows: Accounts receivable Expected bonus receivable Revenue 60. Because those services are provided evenly over the eight months.000) 80% $460.000..000  8] – $20.500 61.1.000 $492.000 per month ($1.000 1.000 92. so Velocity would recognize an Expected bonus receivable of $1.Problem 5–19 Requirement 1 At the contract’s inception. to the performance obligation to provide consulting services. Vol.000 Probabilities $500.500). Because Burger Boy pays $60.000 (4  $1.000 – [8  $60.000: Possible Prices Expected Probabilities Consideration $300.Problem 5–19 (continued) Requirement 2 The expected bonus receivable would increase to $6.500 Intermediate Accounting. Velocity would recognize revenue of $60.000 per month ($500 less than the revenue recognized).000 500 60. so the estimated transaction price decreases to $484.000 to $2.000 ($492. with the offsetting debit a reduction in revenue.000. Inc. Recording that adjustment requires a reduction of the expected bonus receivable from $6.000 ([$60.000 ($484. as of that date the expected bonus receivable should equal $2. Over the remaining four months..000 – [8  $60.000  8] + $20.000  8] – $20.000.000: Revenue Expected bonus receivable 4. accumulating to $4. expected bonus receivable will increase by $500 each month. After four months. 7/e .000 This entry reduces the expected bonus receivable to $2.000 4.000) 40% $460.000]). Velocity would recognize an expected bonus receivable of $500 each month to reflect the revenue recognized in excess of its unconditional right to $60.000 184.500) by the end of the fourth month.000) Transaction price after four months: Therefore. The journal entry would be: Accounts receivable Expected bonus receivable Revenue © The McGraw-Hill Companies.500) in each of months five through eight. 2013 5–110 60. which is half of the new expected bonus of $4.000 ÷ 8 months = $60.500 ($484. equal to half of the total expected bonus of $12.000 $484.000 ([$60.000]).000 by the end of the contract. Requirement 3 Because services are provided evenly over the eight months.000.000 60% $500. the estimated likelihood of receiving the bonus is revised. Vol. Velocity learns that it will receive the bonus of $20. Therefore.000 4.Problem 5–19 (concluded) Requirement 4 At the end of contract.000.000 16..000 ($20.000 Solutions Manual. Velocity recognizes additional accounts receivable and additional revenue of $16.000 16. It already has recognized revenue of $4. 2013 5–111 .000 20. Chapter 5 © The McGraw-Hill Companies.000 associated with the bonus.1. Inc.000 16.000 – 4. Expected bonus receivable Revenue Accounts receivable Expected bonus receivable OR Accounts receivable Expected bonus receivable Revenue 20.000 20.000). © The McGraw-Hill Companies. Assuming a positive gross profit on these sales.CASES Real World Case 5–1 Requirement 1 A bill and hold strategy accelerates the recognition of revenue. 2013 5–112 Intermediate Accounting. In this case. Sunbeam’s earnings management strategy produced a 1997 earnings figure that was not indicative of the company’s future profit-generating ability. Requirement 3 Sales that would normally have been recorded in 1998 were recorded in 1997. Requirement 2 A customer would probably not be expected to pay for goods purchased using this bill and hold strategy until the goods were actually received.. Receivables would therefore increase. Requirement 4 Earnings quality refers to the ability of reported earnings (income) to predict a company’s future earnings. Inc. sales that would normally have occurred in 1998 were recorded in 1997. earnings in 1997 is inflated. 7/e . This bill and hold strategy shifted sales revenue and therefore earnings from 1998 to 1997. the product has been sold and the price and buyer are known. Usually. But occasionally. These situations involve significant uncertainty as to the collectibility of the cash to be received. Usually. Inc.Judgment Case 5–2 Requirement 1 While revenue often is earned during a period of time. which can usually be accounted for by estimating and recording allowances for possible return of the product and for uncollectibility of the cash. Vol. the possibility of bad debts. significant uncertainties exist at the time products are produced. 2013 5–113 . These criteria usually are satisfied at the point of delivery. The revenue has been earned and there is reasonable certainty as to the collectibility of the asset (cash) to be received. an abnormal degree of uncertainty causes point of delivery revenue recognition not to be appropriate. At the point of delivery. A good example is longterm projects in the construction industry. revenue usually is recognized at a point in time when both revenue recognition criteria are satisfied. Requirement 2 It would be useful to recognize revenue as the productive activity takes place when the earnings process occurs over long periods of time. Solutions Manual. Revenue recognition after delivery sometimes is appropriate for installment sales and when a right of return exists. caused either by the possibility of the product being returned or. The only remaining uncertainty involves the ultimate cash collection. Requirement 3 Some revenue-producing activities call for revenue recognition after the product has been delivered.1.. these remaining uncertainties can be accounted for by estimating and recording allowances for anticipated returns and bad debts. thus allowing revenue and related costs to be recognized at the point of delivery. Chapter 5 © The McGraw-Hill Companies. with credit sales. 500. The monthly fee should be recognized as revenue upon billing. gross profit recognized on the two sales would be as follows: Sales price Cost of goods sold Gross profit Gross profit percentage Original sale $2. Mega would be justified in recognizing only $3 of the initial fee immediately to offset the cost of the membership card.000 1.. © The McGraw-Hill Companies. If. Inc. Since there is no contractual period of service.380.000 1. Using the company's recognition policy. however.000 40% Trade-in sale $2. Judgment Case 5–4 The revenue recognition policy is questionable. it must be estimated.000 $ 880. 2013 5–114 Intermediate Accounting. as long as adequate provision is made for possible uncollectible amounts. Even though the fee is nonrefundable.Judgment Case 5–3 Mega should recognize revenue for the initial fee equally over the estimated average period members will continue to be members. a large percentage of customers do exercise the option. there is no guarantee that the customer will exercise the trade-in option.000 $ 800. The payment option chosen by members does not affect the revenue recognition policy.200.000. 7/e .000 37% Of course. This results from the granting of a trade-in allowance for the old computer that is greater than the old computer's resale value. The liberal trade-in policy causes gross profit to be overstated on the original sale and understated on the trade-in sale. it is not “earned” until services are provided. the company should adopt a revenue recognition policy that results in a more stable gross profit percentage for the two transactions. and the distortion in gross profit is material. . interacting first with other group members. Students should benefit from participating in the process. then with the class as a whole. The process of developing the proposed solutions will likely be more beneficial than the solutions themselves. That company reported using both methods.) 1. The accrual of estimated cost. Inc. Research Case 5–6 (Note: This case requires the student to reference a journal article. In either case. A corresponding liability is recorded which should increase to an amount equal to the cost of the free cone. Students should be encouraged to contribute to the group discussion by (a) offering information on relevant issues. 4. Domination by one or two individuals should be discouraged. 2013 5–115 . The estimated cost of the free cone should be expensed as the 10 required cones are sold. Twenty-seven of the firms are manufacturing companies. or (c) suggesting alternative direction. Only one company uses the completed contract method.1.Communication Case 5–5 The critical question that student groups should address is how to match revenues and expenses. 2. the accounting method must consider the fact that not all customers will take advantage of the free cone award. a portion of the sales price is deferred and a liability is recorded. 2. 3. It is important that each student actively participate in the process. the liability and inventory are reduced. As each ice cream cone is sold. Vol. This liability will then be reduced and revenue recognized when the free ice cream cone is awarded. Fifty-five firms reported the use of one of the two long-term contract accounting methods. Solutions Manual. Deferral of revenue recognition. This direction views the free ice cream cone as a promotional expense. and (b) clarifying or modifying ideas already expressed. When the free cone is awarded. There is no right or wrong answer. Solutions could take one of two directions: 1. The most frequently used approach to estimating a percentage-of-completion is the cost-to-cost method. Chapter 5 © The McGraw-Hill Companies. 3. Bill-and-hold sale 4. 2013 5–116 Intermediate Accounting. These abuses tended to increase income (75% of the time). The auditors tended to require adjustment (56% of the time). Deferring too much or too little revenue 3. © The McGraw-Hill Companies. but it doesn’t defer the revenue. The company records sales even though it hasn’t yet delivered the goods to the customer. 2. a company could defer too much revenue to shift income into future periods.. Manipulating estimates of percentage complete in order to manipulate gross profit recognition. 7/e . The company sells to distributors or other customers and can’t estimate returns with sufficient accuracy due to the nature of the selling relationship. Inc. consistent with auditors being concerned about income-increasing earnings management. Right-of-return sale 2. 4. Abuse 1.) 1. consistent with management generally having an incentive to increase income. Cutoff manipulation Expanation The company either closes their books early (so some current-year revenue is postponed until next year) or leaves them open too long (so some next-year revenue is included in the current year).Research Case 5–7 (Note: This case requires the student to reference a journal article. Or. it should be using the installment sales method). The company has an arrangement under which revenue should be deferred (for example. Facts: Horizon Corporation. Sales. Chapter 5 © The McGraw-Hill Companies. 2013 5–117 .B. The chief financial officer (CFO) circulated a memo suggesting the shipment of computers to J. Inc. reported profits from 2008 through 2011.Ethics Case 5–8 Discussion should include these elements. Ethical Dilemma: Is Jim's obligation to challenge the memo of the CFO and provide useful information to users of the financial statements greater than the obligation to prevent a company loss in 2013 that may lead to bankruptcy? Who is affected? Jim Fielding CFO and other managers Other employees Shareholders Potential shareholders Creditors Auditors Solutions Manual.. Vol.. The CFO is clearly asking Jim Fielding to recognize revenue in 2013 that he knows will be reversed as a sales return in 2014.1. a computer manufacturer. in 2013 with a subsequent return of the merchandise to Horizon in 2014. Inc. Horizon would record a sale for the computers in 2013 and avoid an inventory write-off that would place the company in a loss position for that year. but reported a $20 million loss in 2012 due to increased competition. The installment sales method and the cost recovery method are available to handle such situations. © The McGraw-Hill Companies. If.000 – 40. 2013 5–118 Intermediate Accounting. 7/e .000 50% x $30. and (3) the cost recovery method. however. 2013 gross profit under the three methods: (1) point of delivery: $80. In most situations.000 (cash collected) = $15.000 = 50% = gross profit % $80.000) exceeds cash collected ($30. the increased uncertainty concerning the collection of cash from installment sales can be accommodated satisfactorily by estimating uncollectible amounts. In these situations. Requirement 2 Customers sometimes are allowed to pay for purchases in installments over long periods of time.Judgment Case 5–9 Requirement 1 The three methods that could be used to recognize revenue and costs for this situation are (1) point of delivery. These methods should be used only in situations involving exceptional uncertainty.000 (3) cost recovery method: No gross profit recognized since cost ($40.000 (2) installment sales method: $40.000 = $40. revenue and cost recognition should be delayed.000).. The cost recovery method is the more conservative of the two. the installment sale creates a situation where there is significant uncertainty concerning cash collection making it impossible to make an accurate assessment of future bad debts. (2) the installment sales method. point of delivery revenue recognition should be used. Uncertainty about collection of a receivable normally increases with the length of time allowed for payment. Inc. In addition. it would be inappropriate for Company M to recognize the membership fees as earned revenue upon billing or receipt of the initial fee with a corresponding accrual for estimated costs to provide the membership services. Products delivered to a consignee pursuant to a consignment arrangement are not sales and do not qualify for revenue recognition until a sale occurs. The SEC believes that revenue recognition is not appropriate because the seller retains the risks and rewards of ownership of the product and title usually does not pass to the consignee..Judgment Case 5–10 Note: the SEC guidance on these issues can be found in the FASB’s codification at FASB ASC 605–10–S99: “Revenue Recognition–Overall–SEC Materials. Generally. In the SEC's view.e. [ASC 605–10–S99.] Solutions Manual.2. Inc.” Question 1 No. 2013 5–119 . a. Therefore. SAB Topic 13.4. Vol.A. Fixed or Determinable Sales Price. Chapter 5 © The McGraw-Hill Companies. the ability of the member to receive a full refund of the membership fee up to the last day of the membership term raises an uncertainty as to whether the fee is fixed or determinable at any point before the end of the term. the earnings process. irrespective of whether a cancellation clause exists. the SEC believes that a sales price is not fixed or determinable when a customer has the unilateral right to terminate or cancel the contract and receive a cash refund.1. Persuasive Evidence of an Arrangement. make available and offer products for sale at a discounted price) throughout the membership period. SAB Topic 13. [ASC 605–10–S99. is not complete..A. Refundable fees for services. This conclusion is based on Company M's remaining and unfulfilled contractual obligation to perform services (i.] Question 2 No. Until then. Layaway sales arrangements. SAB Topic 13. Inc. and does not have an enforceable right to the remainder of the purchase price. Delivery and Performance. the SEC believes that Company R should recognize revenue from sales made under its layaway program upon delivery of the merchandise to the customer. e. the amount of cash received should be recognized as a liability entitled such as "deposits received from customers for layaway sales" or a similarly descriptive caption. Because Company R retains the risks of ownership of the merchandise. 7/e ." [ASC 605–10–S99.A. the SEC would object to Company R recognizing any revenue upon receipt of the cash deposit. receives only a deposit from the customer.3. 2013 5–120 Intermediate Accounting.. This is consistent with item two (2) in the SEC's criteria for bill-and-hold transactions that states that "the customer must have made a fixed commitment to purchase the goods.] © The McGraw-Hill Companies.Case 5–10 (concluded) Question 3 Provided that the other criteria for revenue recognition are met. Chapter 5 © The McGraw-Hill Companies. d. The buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product. The seller’s price to the buyer is substantially fixed or determinable at the date of sale. The amount of future returns can be reasonably estimated. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer. e. such as technological obsolescence or changes in demand. 2013 5–121 . c. f.. a. c. Solutions Manual. or inability to apply such experience because of changing circumstances. b. b. Inc. Relatively long periods in which a particular product may be returned. Absence of a large volume of relatively homogeneous transactions. Vol.1.Research Case 5–11 Requirement 1 The relevant literature can be found in the FASB’s codification at FASB ASC 605–15–25–1: “Revenue Recognition–Products–Recognition–General–Sales of Product when Right of Return Exists. The buyer acquiring the product for resale has economic substance apart from that provided by the seller. Requirement 3 The six criteria are: a. The buyer has paid the seller and the obligation is not contingent on resale of the product. Absence of historical experience with similar types of sales of similar products. The susceptibility of the product to significant external factors.” Requirement 2 GAAP lists the following factors that may impair the ability to make a reasonable estimate (see ASC 605–15–25–3). for example. changes in the selling enterprise’s marketing policies or relationships with its customers. d. and the actual agreements with customers. HP recognizes all sales when products are shipped even though it offers price protection as well as the right of return to customers. However. the price is fixed or determinable. 7/e . Requirement 5 The two revenue recognition policies differ with respect to AMD’s sales to distributors.. shipment is made.Case 5–11 (concluded) Requirement 4 Both companies recognize revenues from products sold when persuasive evidence of an arrangement exists. Revenue for these sales is deferred until the merchandise is resold by the distributors. 2013 5–122 Intermediate Accounting. On the other hand. AMD might offer a longer time period for customers to return product than does HP. AMD defers recognition of revenue and related profits until the merchandise is resold by the distributors. Inc. Estimates are recorded for customer returns. the distribution channels. and other offerings. AMD’s sales to distributors might be contingent on resale of the product to end users. Also. It may be more difficult for AMD to see through the distribution channels to reasonably estimate returns. rebates. Also. © The McGraw-Hill Companies. a highly volatile industry. for sales to distributors under terms allowing the distributors certain rights of return and price protection on unsold merchandise held by them. one of the six criteria that must be met before revenue can be recognized when the right of return exists. Reasons for the difference in policies could relate to the types of products sold by the two companies. price protection. For example. AMD sells semiconductors. and collectibility is reasonably assured. the agreements with distributors of AMD’s products may be more liberal than those of HP with respect to things like price protection and returns. Research Case 5–12 Requirement 1 This topic is addressed in EITF Issue No. 99-19 The FASB ASC cross-reference addresses this topic in paragraphs under FASB ASC 605–45. Requirement 2 The relevant literature can be found in the FASB’s codification at FASB ASC 605–45–45–1 through 605–45–45–18: “Revenue Recognition–Principal Agent Considerations–Other Presentation Matters–Overall Considerations of Reporting Revenue Gross as a Principal vs. Net as an Agent.” The Codification lists the following indicators for use of the gross method: 1. The company is the primary obligor in the arrangement. 2. The company has general inventory risk (before customer order is placed or upon customer return). 3. The company has latitude in establishing price. 4. The company changes the product or performs part of the service. 5. The company has discretion in supplier selection. 6. The company is involved in the determination of product or service specifications. 7. The company has physical loss inventory risk (after customer order or during shipping). 8. The company has credit risk. The indicators for the use of the net method are: 1. The supplier (not the company) is the primary obligor in the arrangement. 2. The amount the company earns is fixed. 3. The supplier (and not the company) has credit risk. Requirements 3 and 4 For their AdSense program, Google’s 2010 10K states: “We recognize as revenues the fees charged advertisers each time a user clicks on one of the text-based ads that are displayed next to the search results pages on our website or on the search results pages or content pages of our Google Network members’ websites and, for those advertisers who use our cost-per impression pricing, the fees charged advertisers each time an ad is displayed on our members’ websites. We report our Google AdSense revenues on a gross basis principally because we are the primary obligor to our advertisers.” That is consistent with the first indicator for use of the gross method listed under Requirement 2, so Google’s reasoning appears appropriate. Solutions Manual, Vol.1, Chapter 5 © The McGraw-Hill Companies, Inc., 2013 5–123 Judgment Case 5–13 1. 2. 3. 4. Delta should recognize the $425 as revenue on May 15, the date the flight commences. Revenue should be recognized evenly over the period beginning after Thanksgiving and ending April 30. The $5,000 monthly charge is recognized as revenue each month. The $12,000 fee must be recognized evenly over the 36-month lease period. Janora Hawkins should recognize the $60,000 as revenue on August 28, the date the case is settled successfully. This assumes reasonable certainty as to the collection. Judgment Case 5–14 Bill’s argument is that the completed contract method is preferable because it is analogous to point of delivery revenue recognition. That is, no revenue is recognized until the completed product is delivered. John’s argument is that the important factor is the earnings process and that revenue should be recognized as the process takes place. John’s argument is correct. In situations when the earnings process takes place over long periods of time, like long-term construction contracts, it is preferable to recognize revenue during the earnings process, rather than to wait until the process is complete. © The McGraw-Hill Companies, Inc., 2013 5–124 Intermediate Accounting, 7/e Communication Case 5–15 Suggested Grading Concepts and Grading Scheme: Content (70%) _______ 45 Income differences. _______ Percentage-of-completion recognizes gross profit during construction based on an estimate of percent complete. _______ The completed contract method recognizes no gross profit until project completion. _______ For both methods, estimated losses are fully recognized in the first period the loss is anticipated. Balance sheet differences. The two methods are similar. However, for profitable projects, the construction in progress account during construction will have a higher balance when using the percentage-of-completion method due to the inclusion of gross profit. According to generally accepted accounting principles, the percentage-of-completion method should be used in most situations. The completed contract method distorts income when long-term projects span more than one accounting period. _______ 10 _______ 15 _______ _____ 70 points Writing (30%) _______ 6 Terminology and tone appropriate to the audience of a company controller. Organization permits ease of understanding. ______ Introduction that states purpose. ______ Paragraphs that separate main points. English ______ Sentences grammatically clear and well organized, concise. ______ Word selection. ______ Spelling. ______ Grammar and punctuation. _______ 12 _______ 12 _______ _____ 30 points Solutions Manual, Vol.1, Chapter 5 © The McGraw-Hill Companies, Inc., 2013 5–125 Sales of services are recognized as the services are provided. but the end results. should be similar in most cases. 7/e .S. as compared to U.IFRS Case 5–16 Vodafone’s revenue recognition policies for products and services are similar to revenue recognition policies in the U. The terminology is somewhat different. Sales of products are recorded when goods have been put at the disposal of the customers in accordance with agreed terms of delivery and when the risks and rewards of ownership have been transferred to the buyer. © The McGraw-Hill Companies. policies. 2013 5–126 Intermediate Accounting. Inc..S. contract revenue that is probable to be recovered is recognized to the extent of contract costs incurred..S. Requirement 2 The primary difference is that. which recognizes revenue as performance of the contract progresses. Chapter 5 © The McGraw-Hill Companies. note 1: Summary of Significant Accounting Policies: The company’s normal method for accounting for long-term construction contracts is the percentage of completion method.” (from 2010 Annual report) Note 1: Summary of significant accounting policies The consolidated financial statements have been prepared on a historical cost basis. Solutions Manual. The consolidated financial statements are presented in Euros since this is the currency in which the majority of the Group’s transactions are denominated. it uses the cost recovery method: “…Where the income of a construction contract cannot be estimated reliably. with all amounts rounded to the nearest million except when otherwise indicated.” When the company cannot make accurate estimates of contract income. GAAP. The contract progress is determined based on the percentage of costs incurred to date to total estimated cost for each contract after giving effect to the most recent estimates of total cost.IFRS Case 5–17 Requirement 1 Per the revenue recognition section of ThyssenKrupp’s 2010 annual report. Vol.1. the company would use the completed contract method in circumstances in which it cannot make accurate estimates of contract income. Inc. this may result in differences compared to the unrounded figures. except for certain financial instruments that are stated at fair value. under U. used when it can make accurate estimates of contract income: “… Construction contract revenue and expense are accounted for using the percentage-of-completion method. Trueblood Accounting Case 5–18 A solution and extensive discussion materials can be obtained from the Deloitte Foundation. Contract costs are recognized as expenses in the period in which they are incurred. 2013 5–127 . 2013 5–128 Intermediate Accounting. a. and Wendy’s.Trueblood Accounting Case 5–19 A solution and extensive discussion materials can be obtained from the Deloitte Foundation. Inc. b. These fees are recognized as revenue when the company has substantially performed all of its contractual obligations. Real World Case 5–20 Requirement 3 The following is from the 2010 10K of Jack in the Box. of course. Inc. Requirement 4 Answers to this question will. and Arby’s © The McGraw-Hill Companies. 7/e . Continuing payments are based on a percentage of sales. The responses to the question will vary if the company has since changed its revenue recognition policy. Likely candidates for comparison include most of the fast-food chains such as McDonald’s. vary because students will research financial statements of different companies. This policy agrees with GAAP.. In the merchant model. We recognize net revenue under the merchant model when we have no further obligations to the customer. We recognize net revenue under the retail model when the reservation is made. Under both the merchant and retail models.Real World Case 5–21 Requirement 2 Excerpt from Orbitz’s 2010 Annual Report: Revenue Recognition We recognize revenue when it is earned and realizable. 2013 5–129 . however we are subject to chargebacks and fraud risk which we monitor closely. . . we are not the primary obligor with the customer. secured by a customer with a credit card and we have no further obligations to the customer. Solutions Manual. we record these customer receipts as accrued merchant payables and either deferred income or net revenue.1. Inc. we record revenue earned net of all amounts paid to our suppliers.. hotel room or car rental. Initially. we have no ability to determine or change the products or services delivered. depending on the travel product. . Under the merchant model. we have no ability to determine or change the products or services delivered. Customers generally pay us for reservations at the time of booking. we have the ability to determine the price. we pass reservations booked by our customers to the travel supplier for a commission. we take no inventory risk. we do not take on credit risk with the customer. which we refer to herein as the "merchant" and "retail" models. In the retail model. we generate revenue for our services based on the difference between the total amount the customer pays for the travel product and the negotiated net rate plus estimated taxes that the supplier charges us for that product. we are not responsible for the actual delivery of the flight. Under the retail model. and the customer chooses the supplier. services have been rendered. we take no inventory risk. when persuasive evidence of an arrangement exists. We have two primary types of contractual arrangements with our vendors. the price is fixed or determinable. Chapter 5 © The McGraw-Hill Companies. we do not take on credit risk with the customer. we have no latitude in determining pricing. Vol. and collectability is reasonably assured. and the customer chooses the supplier. . of the travel services and are reported on a gross basis. among other things. Such revenues are generally recognized by the Company when the customers complete their travel.com’s 2010 Annual Report: Merchant Revenues and Cost of Merchant Revenues Name Your Own Price® Services: Merchant revenues for Name Your Own Price® services and related cost of revenues are derived from transactions where the Company is the merchant of record and. customer processing fees and global distribution system (“GDS”) reservation booking fees and are reported at the net amounts received.Case 5–21 (continued) Excerpt from priceline. respectively. without any associated cost of revenue. Inc. © The McGraw-Hill Companies. Agency Revenues Agency revenues are derived from travel related transactions where the Company is not the merchant of record and where the prices of the services sold are determined by third parties. Merchant revenues and cost of merchant revenues include the selling price and cost.. The Company records the difference between the customer selling price and the supplier cost of its merchant price-disclosed reservation services on a net basis in merchant revenue. Merchant Price-Disclosed Hotel Service: Merchant revenues for the Company’s merchant price-disclosed services are derived from transactions where its customers purchase hotel room reservations or rental car reservations from suppliers at disclosed rates which are subject to contractual arrangements. . selects suppliers and determines the price it will accept from the customer. 2013 5–130 Intermediate Accounting. Agency revenues include travel commissions. The Company recognizes such revenues and costs if and when it fulfills the customer’s non-refundable offer. . 7/e . Solutions Manual.” c) priceline.com’s “merchant revenues for ‘Name Your Own Price®’ services” This is reported gross: “Merchant revenues and cost of merchant revenues include the selling price and cost.” d) priceline. it appears that relatively similar services can be accounted for as gross v.com’s agency revenues: This is reported net: “Agency revenues . of the travel services and are reported on a gross basis. Chapter 5 © The McGraw-Hill Companies. Vol. comparability is reduced. Priceline’s “Name your own Price®” service appears similar to services that Orbitz might offer under its merchant model. respectively. .1.. . If similar things are treated differently.com’s “merchant revenues for ‘Price-Disclosed Hotel’ services” This is reported net: “The Company records the difference between the selling price and the cost of the hotel room reservation as merchant revenue.” Requirement 4 Yes.” b) Orbitz’s “retail model” revenues This is reported net: “We record revenue earned net of all amounts paid to our suppliers under both our merchant and retail models. yet Priceline would recognize revenue gross and Orbitz would recognize revenue net. 2013 5–131 . net depending on how they are structured.Case 5–21 (concluded) Requirement 3 a) Orbitz’s “merchant model” revenues This is reported net: “We record revenue earned net of all amounts paid to our suppliers under both our merchant and retail models. are reported at the net amounts received. Inc. without any associated cost of revenue.” e) priceline. Another approach is to divide the class into teams who evaluate reports from a group perspective.Analysis Case 5–22 This case encourages students to obtain hands-on familiarity with an actual annual report and library sources of industry data. Inc. 2013 5–132 Intermediate Accounting. as can be calculated as follows: Return on shareholders’ equity Shareholders’ equity Debt to equity ratio Total liabilities Total assets = Net income ÷ Shareholders’ equity = 14% = $21 million ÷ 14% = $150 million = Total liabilities ÷ Shareholders’ equity = 2 = $150 million x 2 = $300 million = Total liabilities + Shareholders’ equity = $300 million + 150 million = $450 million © The McGraw-Hill Companies. Judgment Case 5–23 Apparently. 7/e . a significant increase in assets occurred during the last quarter.. You may wish to provide students with multiple copies of the same annual reports and compare responses. Total assets were $324 million and now they total $450 million. They also must apply the techniques learned in the chapter. Vol.000) 120.000 $200.000 12.000 60.000 (180.000 $200.1.Integrating Case 5–24 Balance Sheet Assets Cash Accounts receivable (net) Inventory Prepaid expenses and other current assets Current assets Property.000 (a) (c) (c) (o) (m) (n) given $ 15. 2013 5–133 .000 30.000) $ 15.000) (2. plant.000 $ 25.000) (7.000 30.000 3.000 given (e) (d) (i) (h) (j) (b) (g) given (f) (l) (k) (b) Solutions Manual.000 140. Inc.000 5.. Chapter 5 © The McGraw-Hill Companies.000 150.000 (96.000 20. and equipment (net) Liabilities and Shareholders’ Equity Accounts payable Short-term notes Current liabilities Bonds payable Shareholders’ equity Income Statement Sales Cost of goods sold Gross profit Operating expenses Interest expense Tax expense Net income $300. and equipment = Total assets – Current assets = $200 – 60 = $140 k.Case 5–24 (concluded) Calculations ($ in 000s): a. Interest expense = 8% x (Short-term notes + Bonds ) Interest expense = 8% x ($5 + 20) = $2 n Times interest earned ratio = (Net income + Interest +Taxes) ÷ Interest = 12 Times interest earned ratio = ($15 + 2 + Taxes) ÷ 2 = $12 Times interest earned ratio = ($15 + 2 + Taxes) = $24 Tax expense = $24 – (15 + 2) = $7 o.9 = $30 g. Acid-test ratio = Cash + AR + ST Investments ÷ Current liabilities = . Profit margin on sales = Net income ÷ Sales = 5% Sales = $15 ÷ 5% = $300 b..9 Current liabilities = ($15 + 12 + 0) ÷ . plant. Accounts payable = Current liabilities – Short-term notes = $30 – 5 = $25 h. Prepaid expenses and other current assets = Current assets – (Cash + AR + Inventory) = $60 – (15 + 12 + 30) = $3 j. Return on shareholders’ equity = Net income ÷ Shareholders’ equity =10% Shareholders’ equity = $15 ÷ 10% = $150 l. Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1/3 Total liabilities = $150 x 1/3 = $50 Bonds payable = Total liabilities – Current liabilities = $50 – 30 = $20 m. Return on assets = Net income ÷ Total assets = 7. Gross profit margin = Gross profit ÷ Sales = 40% Gross profit = $300 x 40% = $120 Cost of goods sold = Sales – Gross profit = $300 – 120 = $180 d. Inventory turnover ratio = Cost of goods sold ÷ Inventory = 6 Inventory = $180 ÷ 6 = $30 e. 2013 5–134 Intermediate Accounting. Operating expenses = (Sales – Cost of goods sold – Interest expense – Tax expense) – Net income = ($300 – 180 – 2 – 7) – 15 = $96 © The McGraw-Hill Companies.5% Total assets = $15 ÷ 7. Inc. 7/e .5% = $200 c. Property. Current ratio = Current assets ÷ Current liabilities = 2 Current assets = $30 x 2 = $60 i. Receivables turnover ratio = Sales ÷ Accounts receivable = 25 Accounts receivable = $300 ÷ 25 = $12 f. ’ defined as the amount at which the benefits can be sold separately. and then the deferred revenue is reduced and revenue is recognized when the transportation service is provided. Chapter 5 © The McGraw-Hill Companies. While it is possible that AF has some noncurrent deferred revenue on ticket sales. . these ‘miles’ are considered distinct elements from a sale with multiple elements and one part of the price of the initial sale of the airfare is allocated to these ‘miles’ and deferred until the groups commitments relating to these ‘miles’ has been met. b.” Solutions Manual.After taking into account the redemption rate. Inc.S.440 million as of March 31. GAAP. A liability for deferred revenue is recognized when tickets are purchased. none is indicated in note 31 (other noncurrent liabilities).7: “In accordance with the IFRIC 13.440 c. using statistical method. corresponding to the probability that the miles will be used by members. The journal entry would be:   Deferred revenue on ticket sales Sales revenue 2. 2011. 2013 5–135 . AF’s balance sheet indicates current deferred revenue on ticket sales of €2. This seems consistent with U. The deferred amount due in relation to the acquisition of miles by members is estimated: .According to the fair value of ‘miles.. Vol. From note 3.440 2.Air France–KLM Case Requirement 1 a.1. Requirement 2 a. Currently..Air France-KLM Case (concluded) b. Per the balance sheet. Inc. this issue is not included in the scope of guidance about multipledeliverable contracts (see ASC 605–25–15–2A) or customer payments and incentives (see 605–50–15–3). Yet.S. AF has a liability for “Frequent flyer programs” of €806 million. 2013 5–136 Intermediate Accounting. the portion of the sale that is for travel is estimated and recognized as passenger revenue when the transportation is provided. c.S. which does not break out the travel credits as a separate component of revenue and instead only accrues a liability for the estimated incremental cost of providing future travel services. in that the revenue associated with AF miles is deferred and recognized separately from the revenue associated with the flights that customers use to earn the miles. GAAP. GAAP’s accounting for multipleelement contracts (ASC 605–25–15). 7/e . similar to how it would be treated under normal accounting for multiple deliverables. if companies sell “points” in their customer loyalty programs to third parties. AF’s approach is consistent with U. Note: Accounting for customer loyalty programs is unresolved in U. Airlines typically use the “incremental cost” method. © The McGraw-Hill Companies.
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