Chapter 5
Income Measurement and Profitability Analysis
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Reflective thinking
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Diversity, Reflective thinking
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Diversity, Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Diversity, Reflective thinking
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Reflective thinking
Reflective thinking
Reflective thinking
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Reflective thinking
Solutions Manual, Vol.1, Chapter 5
Brief
Exercises
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Analytic
Analytic
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Diversity, Analytic
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Reflective thinking, Analytic
Diversity, Reflective thinking,
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Reflective thinking
Reflective thinking
Reflective thinking
Analytic
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Reflective thinking
Analytic
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5–1
Exercises
AACSB Tags
CPA/CMA
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Reflective thinking, Analytic
Reflective thinking, Analytic
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Analytic
Analytic
Analytic
Analytic
Reflective thinking,
Communications
Analytic
Diversity, Analytic
Analytic
Analytic
Analytic
Analytic
Reflective thinking,
Communications
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Analytic
Diversity, Analytic
Analytic
Reflective thinking
Analytic, Communications
Analytic, Communications
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Analytic
Analytic
Analytic
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Diversity, Analytic
Reflective thinking, Analytic
Reflective thinking, Analytic
Reflective thinking
Reflective thinking, Analytic
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Reflective thinking
Analytic
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Analytic
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Problems
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Analytic
Analytic, Communications
Analytic
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Diversity, Analytic
Analytic
Analytic, Communications
Analytic, Communications
Analytic
Analytic, Communications
Analytic
Analytic, Communications
Analytic
Reflective thinking, Analytic
Reflective thinking,
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Analytic
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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
Question 5–7
Because the return of merchandise can retroactively negate the benefits of having made a sale,
the seller must meet certain criteria before revenue is recognized in situations when the right of
return exists. The most critical of these criteria is that the seller must be able to make reliable
estimates of future returns. In certain situations, these criteria are not satisfied at the point of
delivery of the product.
Question 5–8
Sometimes a company arranges for another company to sell its product under consignment.
The “consignor” physically transfers the goods to the other company (the consignee), but the
consignor retains legal title. If the consignee can’t find a buyer within an agreed-upon time, the
consignee returns the goods to the consignor. However, if a buyer is found, the consignee remits the
selling price (less commission and approved expenses) to the consignor.
Because the consignor retains the risks and rewards of ownership of the product and title does
not pass to the consignee, the consignor does not record revenue (and related costs) until the
consignee sells the goods and title passes to the eventual customer.
Question 5–9
For service revenue, if there is one final service that is critical to the earnings process, revenues
and costs are deferred and recognized after this service has been performed. On the other hand, in
many instances, service revenue activities occur over extended periods and recognizing revenue at
any single date within that period would be inappropriate. Instead, it’s more meaningful to recognize
revenue over time in proportion to the performance of the activity.
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, i.e., when the construction project
is complete. 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, i.e., the construction
period. The “fair share” typically is estimated as the project's costs incurred each period as a
percentage of the project's total estimated costs. 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.
© The McGraw-Hill Companies, Inc., 2013
5–4
Intermediate Accounting, 7/e
Question 5–11
The completed contract method recognizes revenue, cost of construction, and gross profit at
the end of the contract, after the contract has been completed. The cost recovery method will
recognize an amount of revenue equal to the amount of cost that can be recovered, which typically is
an amount that exactly offsets costs until all costs have been recovered, and then will recognize the
remaining revenue and gross profit. Therefore, revenue and cost are recognized earlier under the cost
recovery method than under the completed contract method, but gross profit recognition is delayed
until late in the contract for both approaches. Assuming that the final costs are incurred just prior to
completion of the contract, both approaches should recognize gross profit at the same time.
Question 5–12
The billings on construction contract account is a contra account to the construction in progress
asset. At the end of each reporting period, the balances in these two accounts are compared. If the
net amount is a debit, it is reported in the balance sheet as an asset. Conversely, if the net amount is a
credit, it is reported as a liability.
Question 5–13
An estimated loss on a long-term contract must be fully recognized in the first period the loss
is anticipated, regardless of the revenue recognition method used.
Question 5–14
This guidance requires that if an arrangement includes multiple elements, the revenue from the
arrangement should be allocated to the various elements based on the relative fair values of the
individual elements. If part of an arrangement does not qualify for separate accounting, revenue
recognition is delayed until revenue is recognized for the other parts.
Question 5–15
IFRS has less specific guidance for recognizing revenue for multiple-deliverable arrangements.
IAS No. 18 simply states that: “…in certain circumstances, 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, whereas U.S. GAAP provides more
restrictive guidance concerning how to allocate revenue to various components and when revenue
from components can be recognized.
Question 5–16
Specific guidelines for revenue recognition of the initial franchise fee are provided by FASB
ASC 952–605–25–1. A key to these guidelines is the concept of substantial performance. 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. The term
“substantial” requires professional judgment on the part of the accountant. In situations when the
initial franchise fee is collectible in installments, even after substantial performance has occurred,
the installment sales or cost recovery method should be used for profit recognition, if a reasonable
estimate of uncollectibility cannot be made.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–5
Question 5–17
Receivables turnover ratio
=
Net sales
Average accounts receivable (net)
Inventory turnover ratio
=
Cost of goods sold
Average inventory
Asset turnover ratio
=
Net sales
Average total assets
Activity ratios are designed to provide information about a company’s effectiveness in
managing assets. Activity or turnover of certain assets measures the frequency with which those
assets are replaced. The greater the number of times an asset turns over, the less cash a company
must devote to that asset, and the more cash it can commit to other purposes.
Question 5–18
Profit margin on sales
=
Net income
Net sales
Return on assets
=
Net income
Average total assets
Return on shareholders'
equity
=
Net income
Average shareholders' equity
A fundamental element of an analyst’s task is to develop an understanding of a firm’s
profitability. Profitability ratios provide information about a company’s ability to earn an adequate
return relative to sales or resources devoted to operations. Resources devoted to operations can be
defined as total assets or only those assets provided by owners, depending on the evaluation
objective.
© The McGraw-Hill Companies, Inc., 2013
5–6
Intermediate Accounting, 7/e
Question 5–19
Return on equity
Net income
Avg. total equity
=
Profit margin
=
Net income
Total sales
X
X
Asset turnover
X Equity multiplier
Total sales
Avg. total assets
X
Avg. total assets
Avg. 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), asset turnover (reflecting a company’s effectiveness in
using assets to generate sales), and the equity multiplier (reflecting the extent to which a company
has used debt to finance its assets).
Question 5–20
These perspectives are referred to as the discrete and integral part approaches. Current interim
reporting requirements and existing practice generally view interim reports as integral parts of
annual statements. However, the discrete approach is applied to some items. Most revenues and
expenses are recognized in interim periods as incurred. However, if an expenditure clearly benefits
more than just the period in which it is incurred, the expense should be spread among the periods
benefited. Examples include annual repair expenses, property tax expense, and advertising expenses
incurred in one quarter that clearly benefit later quarters. These are assigned to each quarter through
the use of accruals and deferrals. On the other hand, major events such as discontinued operations,
extraordinary items, and unusual or infrequent items should be reported separately in the interim
period in which they occur.
Question 5–21
U.S. GAAP views interim reports as an integral part of the annual report, so amounts that
affect multiple interim periods are accrued or deferred and then charged to each of the periods they
affect. IFRS takes much more of a discrete-period approach than does U.S. GAAP, such that costs
for repairs, property taxes, advertising, etc., 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.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–7
SUPPLEMENT QUESTIONS FOR REVIEW
OF KEY TOPICS
Question 5–22
The five key steps in recognizing revenue under the new standard are:
1. Identify a contract(s) with a customer.
2. Identify the separate performance obligation(s) in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate performance obligations.
5. Recognize revenue when (or as) the entity satisfies each performance obligation.
Question 5–23
Under the proposed ASU, a good or service is a separate performance obligation if it is
distinct, which is the case if either:
1. The seller regularly sells the good or service separately, or
2. A buyer could use the good or service on its own or in combination with goods or services the
buyer could obtain elsewhere.
Question 5–24
Under the proposed ASU, if an entity grants a customer the option to acquire additional goods
or services, 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. If the option provides a material right, 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.
Question 5–25
Under the proposed ASU, if an arrangement has multiple separate performance obligations,
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 the
seller can’t observe actual stand-alone selling prices, the seller should estimate them.
Question 5–26
Under the proposed ASU, a performance obligation for a good is satisfied when control of the
good is transferred to the buyer. Four key indicators that control of a good has passed from the seller
to the buyer are:
1. Buyer has an unconditional obligation to pay.
2. Buyer has legal title.
3. Buyer has physical possession.
4. Buyer has the risks and rewards of ownership.
© The McGraw-Hill Companies, Inc., 2013
5–8
Intermediate Accounting, 7/e
Question 5–27
Under the proposed ASU, if a seller provides the service of integrating products and services
into one asset (for example, 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 performance obligation is viewed as satisfied over time if at least one of two criteria
is met:
1. The seller is creating or enhancing an asset that the buyer controls as the service is
performed.
2. The seller is not creating an asset that the buyer controls or that has alternative use to the
seller, and at least one of the following conditions hold:
a. The customer receives and consumes a benefit as the seller performs.
b. Another seller would not need to reperform the tasks performed to date if that other
seller were to fulfill the remaining obligation.
c. The seller has the right to payment for performance even if the customer could
cancel the contract at the customer’s discretion.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–9
BRIEF EXERCISES
Brief Exercise 5–1
2013 gross profit = $3,000,000 – 1,200,000 = $1,800,000
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.
 The company has general inventory risk, meaning that the company owns
inventory prior to a customer ordering it and after a customer returns it.
 The company has discretion in setting prices and identifying suppliers.
In this transaction, Amazon never bears inventory risk, and is paid a fixed commission
such that it has no discretion in setting prices. Therefore, Amazon appears to be an
agent, and would only recognize revenue on the transaction equal to the amount of the
commission it receives.
Brief Exercise 5–3
2013 Cost recovery % = Cost  Sales:
$1,200,000
= 40% (implying a gross profit % = 60%)
$3,000,000
2013 gross profit = 2013 cash collection of $150,000 x 60% = $90,000
2014 gross profit = 2014 cash collection of $150,000 x 60% = $90,000
Brief Exercise 5–4
No gross profit will be recognized in either 2013 or 2014. Gross profit will not be
recognized until the entire $1,200,000 cost of the land is recovered. In this case, it will
take eight payments to recover the cost of the land ($1,200,000  $150,000 = 8), so
© The McGraw-Hill Companies, Inc., 2013
5–10
Intermediate Accounting, 7/e
gross profit recognition will equal 100% of the cash collected beginning with the ninth
installment payment.
Brief Exercise 5–5
Initial deferred gross profit ($3,000,000 – 1,200,000)
Less gross profit recognized in 2013 ($150,000 x 60%)
Less gross profit recognized in 2014 ($150,000 x 60%)
Deferred gross profit at the end of 2014
$1,800,000
(90,000)
(90,000)
$1,620,000
Brief Exercise 5–6
The seller must meet certain criteria before revenue can be recognized in
situations when the right of return exists. The most critical of these criteria is that the
seller must be able to make reliable estimates of future returns. If Meyer’s
management can make reliable estimates of the furniture that will be returned, revenue
can be recognized when the product is delivered, assuming the company has no
additional obligations to the buyer. If reliable estimates cannot be made because of
significant uncertainty, revenue and related cost recognition is delayed until the
uncertainty is resolved.
Brief Exercise 5–7
Total estimated cost to complete = $6 million + 9 million = $15 million
% of completion = $6 million  $15 million = 40%
$5,000,000
40%
$2,000,000
Total estimated gross profit ($20 million – 15 million) =
multiplied by the % of completion
Gross profit recognized the first year
First year revenue = $20,000,000 x 40% = $8,000,000
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–11
Brief Exercise 5–8
Assets:
Accounts receivable ($7 million – 5 million)
Cost plus profit ($6 million + 2 million*)
in excess of billings ($7 million)
$2,000,000
1,000,000
* Total estimated gross profit ($20 million – 15 million) =
multiplied by the % of completion
Gross profit recognized in the first year
$5,000,000
40%
$2,000,000
Brief Exercise 5–9
Year 1 = 0
Year 2 = $4 million
Revenue
Less: Costs in year 1
Costs in year 2
Actual profit
$20,000,000
(6,000,000)
(10,000,000)
$ 4,000,000
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.
© The McGraw-Hill Companies, Inc., 2013
5–12
Intermediate Accounting, 7/e
Brief Exercise 5–12
Orange has separate sales prices for the two parts of LearnIt-Plus, so that vendorspecific objective evidence (VSOE) allows them to allocate revenue to those parts
according to their relative selling prices. LearnIt will be allocated $200 x [$150 ÷
($150 + 100)] = $120, and that revenue will be recognized upon delivery of the
LearnIt software. LearnIt Office Hours will be allocated $200 x [$100 ÷ ($150 + 100)]
= $80, and that revenue will be deferred and recognized over the life of the one-year
period in which the Office Hours are delivered.
If LearnIt were not sold separately, Orange would not have VSOE for all of the
parts of the contract. In that case, revenue would be delayed until the later part was
delivered. In this case, the $200 would be deferred and recognized over the life of the
one-year period in which the Office Hours are delivered.
Brief Exercise 5–13
Orange has separate sales prices for the two parts of LearnIt-Plus, 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,
and that revenue will be recognized upon delivery of the LearnIt software. LearnIt
Office Hours will be allocated $200 x [$100 ÷ ($150 + 100)] = $80, and that revenue
will be deferred and recognized over the life of the one-year period in which the
Office Hours are delivered.
If LearnIt were not sold separately, the accounting would be the same. 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. (VSOE is not
required under IFRS).
Brief Exercise 5–14
Specific conditions for revenue recognition of the initial franchise fee are
provided by FASB ASC 952–605–25–1. A key to these conditions is the concept of
substantial performance. 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. The term “substantial” requires
professional judgment on the part of the accountant. Often, substantial performance is
considered to have occurred when the franchise opens for business.
Continuing franchise fees are recognized over time as the services are performed.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–13
Brief Exercise 5–15
Receivables turnover ratio
=
Receivables turnover ratio
=
$600,000
[$100,000 + 120,000] ÷ 2
=
5.45 times
=
Cost of goods sold
Average inventory
=
$400,000*
[$80,000 + 60,000] ÷ 2
=
5.71 times
Inventory turnover ratio
Inventory turnover ratio
Net sales
Average accounts receivable (net)
*$600,000 – 200,000
© The McGraw-Hill Companies, Inc., 2013
5–14
Intermediate Accounting, 7/e
Brief Exercise 5–16
Profit margin
Return on assets
Return on shareholders’
equity
=
Net income
Sales
=
$65,000
$420,000
=
15.5%
=
Net income
Average total assets
=
$65,000
$800,000
=
8.1%
=
Net income
Average shareholders’ equity
=
$65,000
$522,500*
=
12.4%
Shareholders’ equity, beginning of period
Add: Net income
Deduct: Dividends
Shareholders’ equity, end of period
$500,000
65,000
(20,000)
$545,000
*Average shareholders’ equity = ($500,000 + 545,000)  2 = $522,500
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–15
Brief Exercise 5–17
Return on
equity
Net income
Avg. total
equity
=
Profit
margin
X
Asset turnover
= Net income
Total sales
X
Total sales
X Avg. total assets
Avg. total assets
Avg. total equity
Return on shareholders’
equity
Profit margin
Asset turnover
=
Net income
Average shareholders’ equity
=
$65,000
$522,500
=
12.4%
=
Net income
Sales
=
$65,000
$420,000
=
15.5%
=
Sales
Average total assets
=
$420,000
$800,000
=
© The McGraw-Hill Companies, Inc., 2013
5–16
X Equity multiplier
.525 times
Intermediate Accounting, 7/e
Brief Exercise 5–17 (concluded)
Equity multiplier
=
Average total assets
Average shareholders’ equity
=
$800,000
$522,500
=
1.53
Check: 12.4% ROE = 15.5% profit margin x .525 times asset turnover x 1.53 equity
multiplier.
Brief Exercise 5–18
Inventory turnover ratio = Cost of goods sold  Average inventory
6.0
=
x

$75,000
Cost of goods sold
= $75,000 x 6.0 = $450,000
– Cost of goods sold = Gross profit
Sales
$600,000 –
450,000
= $150,000
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–17
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. Commercial substance. The contract is expected to affect the seller’s future
cash flows.
2. Approval. Each party to the contract has approved the contract and is
committed to satisfying their respective obligations.
3. Rights. Each party’s rights are specified with respect to the goods and
services to be transferred.
4. Payment terms. The terms and manner of payment are specified.
5. Performance. A contract does not exist if either party can terminate a wholly
unperformed contract without penalty.
The Richter agreement does not satisfy characteristic number 4, and may not satisfy
characteristics 3 and 5 as well. Therefore, it does not qualify as a contract for purposes
of recognizing revenue.
Brief Exercise 5–20
Yes, these are separate performance obligations, because each good is sold separately
to individual customers.
Brief Exercise 5–21
Yes, they are separate. 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.
Brief Exercise 5–22
Total estimated contract price = $25,000 + (50% x $10,000) = $30,000
© The McGraw-Hill Companies, Inc., 2013
5–18
Intermediate Accounting, 7/e
Brief Exercise 5–23
Based on relative stand-alone selling prices, the software comprises 80% of the
total fair values ($80,000 ÷ ($20,000 + 80,000)), and the technical support
comprises 20% ($20,000 ÷ ($20,000 + 80,000)). Therefore, the seller would
recognize $72,000 ($90,000  80%) in revenue up front when the software is
delivered, and defer the remaining $18,000 ($90,000  20%) and recognize it
ratably over the next six months as the technical support service is provided,
making the following journal entry:
Cash
90,000
Revenue
72,000
Unearned revenue
18,000
Brief Exercise 5–24
A performance obligation is satisfied over time if at least one of two criteria is met:
1. The seller is creating or enhancing an asset that the buyer controls as the service
is performed.
2. The seller is not creating an asset that the buyer controls or that has alternative
use to the seller, and at least one of the following conditions hold:
a. The customer receives and consumes a benefit as the seller performs the
service.
b. Another seller would not need to reperform the tasks performed to date if
that other seller were to fulfill the remaining obligation.
c. The seller has the right to payment for performance even if the customer
could cancel the contract at the customer’s discretion.
Under Estate’s construction agreement with CyberB, if for some reason Estate could
not complete construction, CyberB would own the partially completed building and
could retain another construction company to complete the job. A new construction
contractor would not need to reperform Estate’s work if the new contractor completed
the job. Therefore, criterion 2b is satisfied.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–19
Brief Exercise 5–25
Patterson initially would record the payment as unearned revenue. Then
Patterson would accrue interest expense of $10,000 x 5% = $500 in year one of
the contract, and interest expense of ($10,000 + 500) x 5% = $525 in year two
of the contract, in each case debiting interest expense and crediting unearned
revenue. Therefore, at the point in time Patterson delivers the novel, it would
have unearned revenue totaling $10,000 + 500 + 525 = $11,025, and would
recognize that amount as revenue.
© The McGraw-Hill Companies, Inc., 2013
5–20
Intermediate Accounting, 7/e
EXERCISES
Exercise 5–1
Requirement 1
Alpine West should recognize revenue over the ski season on an anticipated
usage basis, in this case equally throughout the season. The fact that the $450 price is
nonrefundable is not relevant to the revenue recognition decision. Revenue should be
recognized as it is earned, in this case as the services are provided during the ski
season.
Requirement 2
November 6, 2013
Cash ................................................................................
Unearned revenue .......................................................
To record the cash collection
450
December 31, 2013
Unearned revenue ($450 x 1/5) .......................................
90
Revenue ......................................................................
To recognize revenue earned in December (no revenue earned in
November, as season starts on December 1).
450
90
Requirement 3
$90 is included in revenue in the 2013 income statement. The $360 remaining
balance in unearned revenue is included in the current liability section of the 2013
balance sheet.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–21
Exercise 5–2
When other parties are involved in providing goods or services to a seller’s
customer, the seller has to determine whether its performance obligation is to provide
the goods or services itself, making the seller a principal, or the seller arranges for
another party to provide those goods or services, making the seller an agent. 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).
Requirement 1
AuctionCo is a principal because it obtained control of the used bicycle before the
bicycle was sold. Therefore, AuctionCo should recognize revenue of $30.
Requirement 2
AuctionCo is an agent because it never controlled the product before it was sold.
Therefore, AuctionCo should recognize revenue for the commission fees of $10
retained upon sending $20 to the original owner.
Requirement 3
In this case it appears that AuctionCo is acting as an agent, given that the bicycles
are shipped directly from the owner to the customer. However, additional aspects of
the arrangement could make it more appropriate to treat AuctionCo as a principal. For
example, if AuctionCo must pay the bicycle owner the $20 wholesale price regardless
of whether the bicycle is sold, then AuctionCo would appear to have purchased the
bicycle and should be treated as a principal.
© The McGraw-Hill Companies, Inc., 2013
5–22
Intermediate Accounting, 7/e
Exercise 5–3
Requirement 1
2013 cost recovery %:
$234,000
= 65% (gross profit % = 35%)
$360,000
2014 cost recovery %:
$245,000
= 70% (gross profit % = 30%)
$350,000
2013 gross profit:
Cash collection from 2013 sales of $150,000 x 35% =
$52,500
2014 gross profit:
Cash collection from 2013 sales of $100,000 x 35% =
+ Cash collection from 2014 sales of $120,000 x 30% =
Total 2014 gross profit
$ 35,000
36,000
$71,000
Requirement 2
2013 deferred gross profit balance:
2013 initial gross profit ($360,000 – 234,000)
Less: Gross profit recognized in 2013
Balance in deferred gross profit account
$126,000
(52,500)
$73,500
2014 deferred gross profit balance:
2013 initial gross profit ($360,000 – 234,000)
Less: Gross profit recognized in 2013
Gross profit recognized in 2014
$ 126,000
(52,500)
(35,000)
2014 initial gross profit ($350,000 – 245,000)
Less: Gross profit recognized in 2014
Balance in deferred gross profit account
105,000
(36,000)
$107,500
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–23
Exercise 5–4
2013
Installment receivables .................................................... 360,000
Inventory .....................................................................
234,000
Deferred gross profit ...................................................
126,000
To record installment sales
2013
Cash ................................................................................. 150,000
Installment receivables ................................................
150,000
To record cash collections from installment sales
2013
Deferred gross profit .......................................................
Realized gross profit ...................................................
To recognize gross profit from installment sales
52,500
52,500
2014
Installment receivables .................................................... 350,000
Inventory .....................................................................
245,000
Deferred gross profit ...................................................
105,000
To record installment sales
2014
Cash ................................................................................. 220,000
Installment receivables ................................................
220,000
To record cash collections from installment sales
2014
Deferred gross profit .......................................................
Realized gross profit ...................................................
To recognize gross profit from installment sales
© The McGraw-Hill Companies, Inc., 2013
5–24
71,000
71,000
Intermediate Accounting, 7/e
Exercise 5–5
Requirement 1
Year
2013
2014
2015
2016
Total
Income recognized
$180,000 ($300,000 – 120,000)
-0-0-0$180,000
Requirement 2
Cost recovery %:
$120,000
------------- = 40% (gross profit % = 60%)
$300,000
Year
2013
2014
2015
2016
Totals
Cash Collected
$ 75,000
75,000
75,000
75,000
$300,000
Cost Recovery(40%)
$ 30,000
30,000
30,000
30,000
$120,000
Gross Profit(60%)
$ 45,000
45,000
45,000
45,000
$180,000
Cost Recovery
$ 75,000
45,000
-0-0$120,000
Gross Profit
-0$ 30,000
75,000
75,000
$180,000
Requirement 3
Year
2013
2014
2015
2016
Totals
Cash Collected
$ 75,000
75,000
75,000
75,000
$300,000
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–25
Exercise 5–6
Requirement 1
July 1, 2013
Installment receivables .................................................... 300,000
Sales revenue...............................................................
300,000
To record installment sale
Cost of goods sold ........................................................... 120,000
Inventory .....................................................................
120,000
To record cost of installment sale
Cash .................................................................................
Installment receivables ................................................
To record cash collection from installment sale
July 1, 2014
Cash .................................................................................
Installment receivables ................................................
To record cash collection from installment sale
© The McGraw-Hill Companies, Inc., 2013
5–26
75,000
75,000
75,000
75,000
Intermediate Accounting, 7/e
Exercise 5–6 (continued)
Requirement 2
July 1, 2013
Installment receivables ................................................... 300,000
Inventory .....................................................................
120,000
Deferred gross profit...................................................
180,000
To record installment sale
Cash ................................................................................
Installment receivables ...............................................
To record cash collection from installment sale
75,000
Deferred gross profit.......................................................
Realized gross profit ...................................................
To recognize gross profit from installment sale
45,000
July 1, 2014
Cash ................................................................................
Installment receivables ...............................................
To record cash collection from installment sale
Deferred gross profit.......................................................
Realized gross profit ...................................................
To recognize gross profit from installment sale
Solutions Manual, Vol.1, Chapter 5
75,000
45,000
75,000
75,000
45,000
45,000
© The McGraw-Hill Companies, Inc., 2013
5–27
Exercise 5–6 (concluded)
Requirement 3
July 1, 2013
Installment receivables .................................................... 300,000
Inventory .....................................................................
120,000
Deferred gross profit ...................................................
180,000
To record installment sale
Cash .................................................................................
Installment receivables ................................................
To record cash collection from installment sale
July 1, 2014
Cash .................................................................................
Installment receivables ................................................
To record cash collection from installment sale
Deferred gross profit .......................................................
Realized gross profit ...................................................
To recognize gross profit from installment sale
75,000
75,000
75,000
75,000
30,000
30,000
Exercise 5–7
Requirement 1
Cost of goods sold ($1,000,000 – 600,000)
Add: Gross profit if using cost recovery method
Cash collected
$400,000
100,000
$500,000
Requirement 2
$ 600,000
Gross profit percentage =
= 60%
$1,000,000
Cash collected x Gross profit percentage = Gross profit recognized
$500,000 x 60% = $300,000 gross profit
© The McGraw-Hill Companies, Inc., 2013
5–28
Intermediate Accounting, 7/e
Exercise 5–8
October 1, 2013
Installment receivable ...................................................... 4,000,000
Inventory .....................................................................
1,800,000
Deferred gross profit...................................................
2,200,000
To record the installment sale
Cash ................................................................................ 800,000
Installment receivable .................................................
800,000
To record the cash down payment from installment sale
Deferred gross profit ($800,000 x 55%*) ...................... 440,000
Realized gross profit ...................................................
440,000
To recognize gross profit from installment sale
October 1, 2014
Repossessed inventory (fair value) ................................ 1,300,000
Deferred gross profit (balance)....................................... 1,760,000
Loss on repossession (difference) ................................. 140,000
Installment receivable (balance) .................................
3,200,000
To record the default and repossession ......................
*$2,200,000  $4,000,000 = 55% gross profit percentage
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–29
Exercise 5–9
Requirement 1
April 1, 2013
Installment receivables .................................................... 2,400,000
Land.............................................................................
480,000
Gain on sale of land ....................................................
1,920,000
To record installment sale
April 1, 2013
Cash .................................................................................
Installment receivables ................................................
To record cash collection from installment sale
April 1, 2014
Cash .................................................................................
Installment receivables ................................................
To record cash collection from installment sale
120,000
120,000
120,000
120,000
Requirement 2
April 1, 2013
Installment receivables .................................................... 2,400,000
Land.............................................................................
480,000
Deferred gain...............................................................
1,920,000
To record installment sale
© The McGraw-Hill Companies, Inc., 2013
5–30
Intermediate Accounting, 7/e
Exercise 5–9 (concluded)
When payments are received, gain on sale of land is recognized, calculated by
applying the gross profit percentage ($1,920,000 ÷ $2,400,000 = 80%) to the cash
collected (80% x $120,000).
April 1, 2013
Cash ................................................................................
Installment receivables ...............................................
To record cash collection from installment sale
Deferred gain ..................................................................
Gain on sale of land (80% x $120,000) ..........................
To recognize profit from installment sale
April 1, 2014
Cash ................................................................................
Installment receivables ...............................................
To record cash collection from installment sale
Deferred gain ..................................................................
Gain on sale of land (80% x $120,000) ..........................
To recognize profit from installment sale
Solutions Manual, Vol.1, Chapter 5
120,000
120,000
96,000
96,000
120,000
120,000
96,000
96,000
© The McGraw-Hill Companies, Inc., 2013
5–31
Exercise 5–10
The FASB Accounting Standards Codification represents the single source of
authoritative U.S. generally accepted accounting principles. The specific citation for
each of the following items is:
1. 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.”
2.
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, as it indicates when installment
method is not acceptable).
3.
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.”
© The McGraw-Hill Companies, Inc., 2013
5–32
Intermediate Accounting, 7/e
Exercise 5–11
Requirement 1
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Gross profit (estimated in 2013)
2013
$2,000,000
300,000
1,200,000
1,500,000
$ 500,000
2014
$2,000,000
1,875,000
-01,875,000
$ 125,000
Gross profit recognition:
2013: $ 300,000
= 20% x $500,000 = $100,000
$1,500,000
2014:
$125,000 – 100,000 = $25,000
Requirement 2
2013
2014
$ -0$125,000
Requirement 3
Balance Sheet
At December 31, 2013
Current assets:
Accounts receivable
Costs and profit ($400,000*) in excess
of billings ($380,000)
$ 130,000
20,000
* Costs ($300,000) + profit ($100,000)
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–33
Exercise 5–11 (concluded)
Requirement 4
Balance Sheet
At December 31, 2013
Current assets:
Accounts receivable
$ 130,000
Current liabilities:
Billings ($380,000) in excess of costs ($300,000)
$ 80,000
© The McGraw-Hill Companies, Inc., 2013
5–34
Intermediate Accounting, 7/e
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)
2013
$220
40
120
160
$ 60
2014
$220
120
60
180
$ 40
2015
$220
170
-0170
$ 50
Gross profit (loss) recognition:
2013:
$40
= 25% x $60 = $15
$160
2014:
$120
= 66.67% x $40 = $26.67 – 15 = $11.67
$180
2015:
$220 – 170 = $50 – (15 + 11.67) = $23.33
Requirement 2
2013:
$220 x 25% = $55
2014:
$220 x 66.67% = $146.67 – 55 = $91.67
2015:
$220 – 146.67 = $73.33
Requirement 3
Year
2013
2014
2015
Total project income
Solutions Manual, Vol.1, Chapter 5
Gross profit (loss) recognized
-0-050
$50
© The McGraw-Hill Companies, Inc., 2013
5–35
Exercise 5–12 (concluded)
Requirement 4
2013:
Revenue:
Cost:
Gross profit:
$40
40
$ 0
Revenue:
Cost:
Gross profit:
$80
80
$ 0
Revenue:
Cost:
Gross profit:
$100 ($220 contract price – 40 – 80)
50
$ 50
2014:
2015:
Requirement 5
2014:
$120
= 60% x $20* = $12 – 15 = $(3) loss
$200
*$220 – (40 + 80 + 80) = $20
© The McGraw-Hill Companies, Inc., 2013
5–36
Intermediate Accounting, 7/e
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
$8,000,000
2,000,000
4,000,000
6,000,000
2014
$8,000,000
4,500,000
3,600,000
8,100,000
2015
$8,000,000
8,300,000
-08,300,000
$2,000,000
$ (100,000)
$ (300,000)
Gross profit (loss) recognition:
2013: $2,000,000
= 33.3333% x $2,000,000 = $666,667
$6,000,000
2014: $(100,000) – 666,667 = $(766,667)
2015: $(300,000) – (100,000) = $(200,000)
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–37
Exercise 5–13 (continued)
Requirement 2
Construction in progress
Various accounts
To record construction costs
2013
2014
2,000,000
2,500,000
2,000,000
2,500,000
Accounts receivable
Billings on construction contract
To record progress billings
2,500,000
2,750,000
2,500,000
2,750,000
Cash
Accounts receivable
To record cash collections
2,250,000
2,475,000
2,250,000
2,475,000
Construction in progress
(gross profit)
Cost of construction
Revenue from long-term contracts
666,667
2,000,000
(33.3333% x $8,000,000)
2,666,667
To record gross profit
Cost of construction (2)
Revenue from long-term contracts
Construction in progress (loss)
To record expected loss
(1)
2,544,000
1,777,333
766,667
(1) and (2):
Percent complete = $4,500,000 ÷ $8,100,000 = 55.55%
Revenue recognized to date:
55.55% x $8,000,000 =
$4,444,000
Less: Revenue recognized in 2013 (above)
(2,666,667)
Revenue recognized in 2014
1,777,333 (1)
Plus: Loss recognized in 2014 (prior page)
766,667
Cost of construction, 2014
$2,544,000 (2)
© The McGraw-Hill Companies, Inc., 2013
5–38
Intermediate Accounting, 7/e
Exercise 5–13 (concluded)
Requirement 3
Balance Sheet
Current assets:
Accounts receivable
Costs and profit ($2,666,667*) in
excess of billings ($2,500,000)
Current liabilities:
Billings ($5,250,000) in excess
of costs less loss ($4,400,000**)
2013
2014
$250,000 $525,000
166,667
$850,000
* Costs ($2,000,000) + profit ($666,667)
** Costs ($2,000,000 + 2,500,000) – loss ($100,000 = $766,667 – 666,667)
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–39
Exercise 5–14
Requirement 1
Year
2013
2014
2015
Total project loss
Gross profit (loss) recognized
-0$(100,000)
(200,000)
$(300,000)
Requirement 2
Construction in progress
Various accounts
To record construction costs
2013
2014
2,000,000
2,500,000
2,000,000
2,500,000
Accounts receivable
Billings on construction contract
To record progress billings
2,500,000
2,750,000
2,500,000
2,750,000
Cash
Accounts receivable
To record cash collections
2,250,000
2,475,000
2,250,000
2,475,000
Loss on long-term contract
Construction in progress
To record expected loss
© The McGraw-Hill Companies, Inc., 2013
5–40
100,000
100,000
Intermediate Accounting, 7/e
Exercise 5–14 (concluded)
Requirement 3
Balance Sheet
Current assets:
Accounts receivable
2013
$250,000
2014
$525,000
Current liabilities:
Billings ($2,500,000) in excess of costs
($2,000,000)
Billings ($5,250,000) in excess of costs less
loss ($4,400,000*)
$500,000
$850,000
* Costs ($2,000,000 + 2,500,000) – loss ($100,000)
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–41
Exercise 5–15
SUMMARY
Percentage-of-Completion
Completed Contract
Situation 2013
2014
2015
2013
2014
2015
1
$166,667 $233,333 $100,000 $0
$0
$500,000
2
$166,667 $(66,667) $100,000 $0
$0
$200,000
3
$166,667 $(266,667) $(100,000) $0
$(100,000) $(100,000)
4
$125,000 $375,000 $0
$0
$0
$500,000
5
$125,000 $(125,000) $200,000 $0
$0
$200,000
6
$(100,000) $(100,000) $(100,000) $(100,000) $(100,000) $(100,000)
© The McGraw-Hill Companies, Inc., 2013
5–42
Intermediate Accounting, 7/e
Exercise 5–15 (continued)
Situation 1 - Percentage-of-Completion
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit
(actual in 2015)
2013
$5,000,000
1,500,000
3,000,000
4,500,000
2014
$5,000,000
3,600,000
900,000
4,500,000
2015
$5,000,000
4,500,000
-04,500,000
$ 500,000
$ 500,000
$ 500,000
Gross profit (loss) recognized:
2013:
$1,500,000
= 33.3333% x $500,000 = $166,667
$4,500,000
2014:
$3,600,000
= 80.0% x $500,000 = $400,000 – 166,667 = $233,333
$4,500,000
2015:
$500,000 – 400,000 = $100,000
Situation 1 - Completed Contract
Year
2013
2014
2015
Total gross profit
Solutions Manual, Vol.1, Chapter 5
Gross profit recognized
-0-0$500,000
$500,000
© The McGraw-Hill Companies, Inc., 2013
5–43
Exercise 5–15 (continued)
Situation 2 - Percentage-of-Completion
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit
(actual in 2015)
2013
$5,000,000
1,500,000
3,000,000
4,500,000
2014
$5,000,000
2,400,000
2,400,000
4,800,000
2015
$5,000,000
4,800,000
-04,800,000
$ 500,000
$ 200,000
$ 200,000
Gross profit (loss) recognized:
2013:
$1,500,000
= 33.3333% x $500,000 = $166,667
$4,500,000
2014:
$2,400,000
= 50.0% x $200,000 = $100,000 – 166,667 = $(66,667)
$4,800,000
2015:
$200,000 – 100,000 = $100,000
Situation 2 - Completed Contract
Year
2013
2014
2015
Total gross profit
© The McGraw-Hill Companies, Inc., 2013
5–44
Gross profit recognized
-0-0$200,000
$200,000
Intermediate Accounting, 7/e
Exercise 5–15 (continued)
Situation 3 - Percentage-of-Completion
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)
(actual in 2015)
2013
$5,000,000
1,500,000
3,000,000
4,500,000
2014
$5,000,000
3,600,000
1,500,000
5,100,000
2015
$5,000,000
5,200,000
-05,200,000
$ 500,000
$ (100,000)
$ (200,000)
Gross profit (loss) recognized:
2013:
$1,500,000
= 33.3333% x $500,000 = $166,667
$4,500,000
2014:
$(100,000) – 166,667 = $(266,667)
2015:
$(200,000) – (100,000) = $(100,000)
Situation 3 - Completed Contract
Year
2013
2014
2015
Total project loss
Solutions Manual, Vol.1, Chapter 5
Gross profit (loss) recognized
-0$(100,000)
(100,000)
$(200,000)
© The McGraw-Hill Companies, Inc., 2013
5–45
Exercise 5–15 (continued)
Situation 4 - Percentage-of-Completion
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit
(actual in 2015)
2013
$5,000,000
500,000
3,500,000
4,000,000
2014
$5,000,000
3,500,000
875,000
4,375,000
2015
$5,000,000
4,500,000
-04,500,000
$1,000,000
$ 625,000
$ 500,000
Gross profit (loss) recognized:
2013:
$ 500,000
= 12.5% x $1,000,000 = $125,000
$4,000,000
2014:
$3,500,000
= 80.0% x $625,000 = $500,000 – 125,000 = $375,000
$4,375,000
2015:
$500,000 – 500,000 = $ - 0 -
Situation 4 - Completed Contract
Year
2013
2014
2015
Total gross profit
© The McGraw-Hill Companies, Inc., 2013
5–46
Gross profit recognized
-0-0$500,000
$500,000
Intermediate Accounting, 7/e
Exercise 5–15 (continued)
Situation 5 - Percentage-of-Completion
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit
(actual in 2015)
2013
$5,000,000
500,000
3,500,000
4,000,000
2014
$5,000,000
3,500,000
1,500,000
5,000,000
2015
$5,000,000
4,800,000
-04,800,000
$1,000,000
$
$ 200,000
-0-
Gross profit (loss) recognized:
2013:
$ 500,000
= 12.5% x $1,000,000 = $125,000
$4,000,000
2014:
$0 – 125,000 = $(125,000)
2015:
$200,000 – 0 = $200,000
Situation 5 - Completed Contract
Year
2013
2014
2015
Total gross profit
Solutions Manual, Vol.1, Chapter 5
Gross profit recognized
-0-0$200,000
$200,000
© The McGraw-Hill Companies, Inc., 2013
5–47
Exercise 5–15 (concluded)
Situation 6 - Percentage-of-Completion
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)
(actual in 2015)
2013
$5,000,000
500,000
4,600,000
5,100,000
2014
$5,000,000
3,500,000
1,700,000
5,200,000
2015
$5,000,000
5,300,000
-05,300,000
$ (100,000)
$ (200,000)
$ (300,000)
Gross profit (loss) recognized:
2013: $(100,000)
2014: $(200,000) – (100,000) = $(100,000)
2015: $(300,000) – (200,000) = $(100,000)
Situation 6 - Completed Contract
Year
2013
2014
2015
Total project loss
© The McGraw-Hill Companies, Inc., 2013
5–48
Gross profit (loss) recognized
$(100,000)
(100,000)
(100,000)
$(300,000)
Intermediate Accounting, 7/e
Exercise 5–16
Requirement 1
Construction in progress = Costs incurred + Profit recognized
$100,000
=
?
+
$20,000
Actual costs incurred in 2013 = $80,000
Requirement 2
Billings = Cash collections + Accounts receivable
$94,000 =
?
+
$30,000
Cash collections in 2013 = $64,000
Requirement 3
Let A = Actual cost incurred + Estimated cost to complete
Actual cost incurred
x (Contract price – A) = Profit recognized
A
$80,000
($1,600,000 – A) = $20,000
A
$128,000,000,000 – 80,000A = $20,000A
$100,000A = $128,000,000,000
A = $1,280,000
Estimated cost to complete = $1,280,000 – 80,000 = $1,200,000
Requirement 4
$80,000
= 6.25%
$1,280,000
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–49
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.”
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. 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, the consideration to be exchanged, and the manner and terms of
settlement.
b. The buyer can be expected to satisfy all obligations under the contract.
c. The contractor can be expected to perform all contractual obligations.”
© The McGraw-Hill Companies, Inc., 2013
5–50
Intermediate Accounting, 7/e
Exercise 5–18
Requirement 1
Revenue should be recognized as follows:
Software
– date of shipment, July 1, 2013
Technical support – evenly over the 12 months of the agreement
Upgrade
– date of shipment, January 1, 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
$210,000 ÷ $270,000 x $243,000 = $189,000
$30,000 ÷ $270,000 x $243,000 =
27,000
$30,000 ÷ $270,000 x $243,000
= 27,000
$243,000
Requirement 2
July 1, 2013
Cash ................................................................................ 243,000
Revenue ......................................................................
189,000
Unearned revenue ($27,000 + 27,000) ...........................
54,000
To record sale of software
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–51
Exercise 5–19
Requirement 1
Conveyer
Labeler
Filler
Capper
Total
($20,000 ÷ $50,000) x $45,000 = $18,000
($10,000 ÷ $50,000) x $45,000 = 9,000
($15,000 ÷ $50,000) x $45,000 = 13,500
($5,000 ÷ $50,000) x $45,000 = 4,500
$45,000
Requirement 2
All $45,000 of revenue is delayed until installation of the conveyer, because
the usefulness of the other elements of the multi-part arrangement is
contingent on its delivery.
© The McGraw-Hill Companies, Inc., 2013
5–52
Intermediate Accounting, 7/e
Exercise 5–20
Requirement 1
Conveyer
Labeler
Filler
Capper
Total
($20,000 ÷ $50,000) x $45,000 = $18,000
($10,000 ÷ $50,000) x $45,000 = 9,000
($15,000 ÷ $50,000) x $45,000 = 13,500
($5,000 ÷ $50,000) x $45,000 = 4,500
$45,000
Requirement 2
Under IFRS, it is likely that Richardson would recognize revenue the same
as in Requirement 1, because (a) revenue for each part can be estimated
reliably and (b) the receipt of economic benefits is probable.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–53
Exercise 5–21
October 1, 2013
Cash (10% x $300,000) ....................................................... 30,000
Note receivable................................................................ 270,000
Unearned franchise fee revenue ..................................
300,000
To record franchise agreement and down payment
January 15, 2014
Unearned franchise fee revenue ...................................... 300,000
Franchise fee revenue..................................................
300,000
To recognize franchise fee revenue
Exercise 5–22
List A
h
d
1. Inventory turnover
2. Return on assets
g
a
b
3.
4.
5.
i
c
k
l
m
f
j
e
6.
7.
8.
9.
10.
11.
12.
13.
List B
a. Net income divided by net sales.
b. Defers recognition until cash collected equals
cost.
Return on shareholders' equity
c. Defers recognition until project is complete.
Profit margin on sales
d. Net income divided by assets.
Cost recovery method
e. Risks and rewards of ownership retained
by seller.
Percentage-of-completion method f. Contra account to construction in progress.
Completed contract method
g. Net income divided by shareholders' equity.
Asset turnover
h. Cost of goods sold divided by inventory.
Receivables turnover
i. Recognition is in proportion to work completed.
Right of return
j. Recognition is in proportion to cash received.
Billings on construction contract k. Net sales divided by assets.
Installment sales method
l. Net sales divided by accounts receivable.
Consignment sales
m. Could cause the deferral of revenue recognition
beyond delivery point.
© The McGraw-Hill Companies, Inc., 2013
5–54
Intermediate Accounting, 7/e
Exercise 5–23
Requirement 1
Inventory turnover ratio
=
Cost of goods sold
Average inventory
=
$1,840,000
[$690,000 + 630,000] ÷ 2
=
2.79 times
Requirement 2
By itself, this one ratio provides very little information. In general, the higher the
inventory turnover, the lower the investment must be for a given level of sales. It
indicates how well inventory levels are managed and the quality of inventory,
including the existence of obsolete or overpriced inventory.
However, to evaluate the adequacy of this ratio it should be compared with some
norm such as the industry average. That indicates whether inventory management
practices are in line with the competition.
It’s just one piece in the puzzle, though. Other points of reference should be
considered. For instance, a high turnover can be achieved by maintaining too low
inventory levels and restocking only when absolutely necessary. This can be costly in
terms of stockout costs.
The ratio also can be useful when assessing the current ratio. The more liquid
inventory is, the lower the norm should be against which the current ratio should be
compared.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–55
Exercise 5–24
Turnover ratios for Anderson Medical Supply Company for 2013:
Inventory turnover ratio
Receivables turnover ratio
Average collection period
Asset turnover ratio
=
$4,800,000
[$900,000 + 700,000] ÷ 2
=
6 times
=
$8,000,000
[$700,000 + 500,000] ÷ 2
=
13.33 times
=
365
13.33
=
27.4 days
=
$8,000,000
[$4,300,000 + 3,700,000] ÷ 2
=
2 times
The company turns its inventory over 6 times per year compared to the industry
average of 5 times per year. The asset turnover ratio also is slightly better than the
industry average (2 times per year versus 1.8 times). These ratios indicate that
Anderson is able to generate more sales per dollar invested in inventory and in total
assets than the industry averages. However, Anderson takes slightly longer to collect
its accounts receivable (27.4 days compared to the industry average of 25 days).
© The McGraw-Hill Companies, Inc., 2013
5–56
Intermediate Accounting, 7/e
Exercise 5–25
Requirement 1
a. Profit margin on sales
b. Return on assets
c. Return on shareholders’ equity
$180 ÷ $5,200 = 3.5%
$180 ÷ [($1,900 + 1,700) ÷ 2] = 10%
$180 ÷ [($550 + 500) ÷ 2] = 34.3%
Requirement 2
Retained earnings beginning of period
Add: Net income
Less: Retained earnings end of period
Dividends paid
$100,000
180,000
280,000
150,000
$130,000
Exercise 5–26
Requirement 1
a. Profit margin on sales
$180 ÷ $5,200 = 3.46%
b. Asset turnover
$5,200 ÷ [($1,900 + 1,700) ÷ 2] = 2.89
c. Equity multiplier
[($1,900 + 1,700) ÷ 2] ÷ [($550 + 500) ÷ 2] = 3.43
d. Return on shareholders’ equity
$180 ÷ [($550 + 500) ÷ 2] = 34.3%
Requirement 2
Profit margin x Asset turnover x Equity multiplier = ROE
3.46%
x
2.89
x
3.43
= 34.3%
Exercise 5–27
First
Cumulative income before taxes
$50,000
Estimated annual effective tax rate
34%
17,000
Less: Income tax reported earlier
-0Tax expense to be reported
$17,000
Solutions Manual, Vol.1, Chapter 5
Quarter
Second
Third
$90,000 $190,000
30%
36%
27,000
68,400
17,000
27,000
$10,000
$ 41,400
© The McGraw-Hill Companies, Inc., 2013
5–57
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
-0-
© The McGraw-Hill Companies, Inc., 2013
5–58
Quarters Ending
June 30
Sept. 30
-0-0-0-0-0-0185,000
-096,000
-0-
Dec. 31
-0-0-0-0-0-
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
150
Unearned Revenue, subscription
Unearned Revenue, coupon
© The McGraw-Hill Companies, Inc., 2013
5–60
135.87
14.13
Intermediate Accounting, 7/e
Exercise 5–33
The license granted by Pfizer is not a separate performance obligation. The only
way to exploit the license is via utilizing ongoing R&D services from Pfizer. 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.
Rather, the license requires Pfizer’s R&D services and proprietary expertise to be
valuable. Therefore, Pfizer would combine the license with the R&D services to
HealthPro and account for them as a single performance obligation.
Exercise 5–34
Requirement 1
$50,000 + ($20,000 x 20%) = $54,000
Requirement 2
The most likely amount is $50,000, because the probability of exceeding the
performance threshold is less than 50%.
Requirement 3
Given that the outcome is binary (Thomas either will receive the bonus or not),
the most likely amount often would be preferred. However, both amounts can be
justified theoretically. (The probability-weighted amount is an expected value,
and thus over all such contracts is the best estimate of the average amount that
will be received.)
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. Therefore, Thomas would recognize only $50,000 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.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–61
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. Even if Seneca could predict that
amount with some accuracy, it would not be able to recognize revenue associated with
the bonus because that amount would not be reasonably assured until after year-end.
1. Record the first quarterly payment.
Cash or accounts receivable
Revenue
100,000
100,000
2. Record the amount of additional revenue at the end of year.
Cash or accounts receivable ($800,000 x 10%)
Revenue
© The McGraw-Hill Companies, Inc., 2013
5–62
80,000
80,000
Intermediate Accounting, 7/e
Exercise 5–36
Determining whether Toys4U satisfies the performance obligation requires
consideration of indicators that McDonald’s has obtained control of the dolls.
Consider the following indicators:
1. The buyer has an unconditional obligation to pay. 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. In this case, McDonald’s does
not pay Toys4U until the dolls are sold, so McDonald’s is conditionally (not
unconditionally) obliged to pay for the toys.
2. The buyer has the legal title. Legal title often indicates which party has the
ability to direct the use of, and receive the benefit from, a good or service. The
facts do not state whether title transfers.
3. The customer has physical possession and control of goods. In this case,
McDonald’s has possession of the dolls.
4. The buyer has the risks and rewards of owndership. In this case, given that
McDonald’s returns unsold dolls to Toys4U, McDonald’s does not appear to be
holding the risks of ownership.
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. This is essentially a
arrangement, and Toys4U should not recognize sales until McDonald’s
customers.
Solutions Manual, Vol.1, Chapter 5
because (1)
pay, and (2)
consignment
sells dolls to
© The McGraw-Hill Companies, Inc., 2013
5–63
Exercise 5–37
In this example, Kerry obtained the access code for Level I in the software on
December 1, meaning that Kerry has obtained the control of the right to use the
software for Level I on that date. Therefore, on that date Cutler should recognize $50
of revenue for Level I.
When Tom passed the Level I test on December 31, 2012, and purchased access to
Level II, Cutler licensed Level II to Kerry on the same day. However, Kerry received
the access code for Level II on January 10, 2013, so control over Level II in the
software was not transferred to Kerry until January 10. Therefore, Cutler should
recognize $10 of revenue for Level II on January 10, 2013, rather than December 31,
2012, because it did not satisfy a separate performance obligation until the access code
was provided to its customer.
© The McGraw-Hill Companies, Inc., 2013
5–64
Intermediate Accounting, 7/e
Exercise 5–38
Requirement 1
Record unearned revenue upon receipt of initial payment:
Cash
20,000
Unearned revenue
20,000
Requirement 2
1. Record interest expense at end of the first year of the contract:
Interest expense ($20,000 x 4%)
Unearned revenue
800
800
2. Record interest expense at end of the second year of the contract:
Interest expense ({$20,000 + 800} x 4%)
Unearned revenue
832
832
3. Record interest expense at end of the third year of the contract:
Interest expense ({$20,000 + 800 + 832} x 4%)
Unearned revenue
865
865
Requirement 3
Record revenue upon Stewart’s satisfaction of his performance obligation:
Unearned revenue ($20,000 + 800 + 832 + 865)
Revenue
Solutions Manual, Vol.1, Chapter 5
22,497
22,497
© The McGraw-Hill Companies, Inc., 2013
5–65
CPA / CMA REVIEW QUESTIONS
CPA Exam Questions
1. b. The earnings process is completed upon delivery of the product. Therefore,
in 2014, revenue for 50,000 gallons at $3 each is recognized on January 15.
The payment terms do not affect revenue recognition.
2. d. The deferred gross profit in the balance sheet at December 31, 2014, 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 $ 900,000
(300,000) (300,000)
(200,000) (50,000)
100,000
550,000
x 40%
x 30%
$ 30,000 $ 220,000
The combined deferred gross profit in the balance sheet is $250,000
($30,000 + 220,000).
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
CPA Review Questions (continued)
3. a.
Year of sale
2013
2014
a. Gross profit realized
$240,000 $200,000
b. Percentage
30%
40%
c. Collections on sales (a/b) $800,000 $500,000
Sales
1,000,000 2,000,000
Balance uncollected
at December 31, 2014
$200,000 $1,500,000
The total uncollected balance is $1,700,000 ($200,000 + 1,500,000).
4. d. Construction-in-progress represents the costs incurred plus the cumulative
pro-rata share of gross profit under the percentage-of-completion method of
accounting.
5. c.
2013 actual costs
$20,000
Total estimated costs ÷ 60,000
Ratio
= 1/3
Contract price
x 100,000
Revenue
33,333
2013 actual costs
–20,000
Gross profit
$13,333
6. d. Since the total cost of the contract, $3,100,000 ($930,000 + 2,170,000), is
projected to exceed the contract price of $3,000,000, the excess cost of
$100,000 must be recognized as a loss in 2013.
7. c. “Cash collection is at least reasonably possible” is not a requirement for
revenue recognition under IFRS.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–67
CPA Review Questions (concluded)
8. a. Under the cost recovery approach, an amount of revenue is recognized that is
equal to cost incurred, so long as cost incurred is probable to be recovered.
Since $1,000,000 of cost was incurred, $1,000,000 of revenue is recognized.
9. a. IFRS does not provide extensive guidance determining how contracts are to
be separated into components for purposes of revenue recognition.
10. d. IFRS recognizes interim expenses more discretely than does U.S. GAAP,
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. Therefore, under IFRS Barrett
would recognize the entire $50,000 as expense in the first period, and not
accrue any prepaid expense asset. Under U.S. GAAP Barrett would accrue
an asset when it made the tax payment and then reduce the asset by $12,500
each interim period while recognizing $12,500 of expense each interim
period.
CMA Exam Questions
1. c. Revenue is recognized when (1) realized or realizable and (2) earned. On
May 28, $500,000 of the sales price was realized while the remaining
$500,000 was realizable in the form of a receivable. The revenue was earned
on May 28 when the title of the goods passed to the purchaser. The costrecovery method is not used because the receivable was not deemed
uncollectible until June 10.
2. d. Revenue is normally recorded at the time of the sale or, occasionally, at the
time cash is collected. However, sometimes neither the sales basis nor the
cash basis is appropriate, such as when a construction contract extends over
several accounting periods. As a result, contractors ordinarily recognize
revenue using the percentage-of-completion method so that some revenue is
recognized each year over the life of the contract. Hence, this method is an
exception to the general practice of recognizing revenue at the point of sale,
primarily because it better matches revenues and expenses.
3. b. Given that one-third of all costs have already been incurred ($6,000,000), the
company should recognize revenue equal to one-third of the contract price, or
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
$8,000,000. Revenues of $8,000,000 minus costs of $6,000,000 equals a gross
profit of $2,000,000.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–69
PROBLEMS
Problem 5–1
REAGAN CORPORATION
Income Statement
For the Year Ended December 31, 2013
Income before income taxes and
extraordinary item .......................................
Income tax expense .......................................
Income before extraordinary item .................
Extraordinary item:
Gain from settlement of lawsuit (net of
$400,000 tax expense) ..................................
Net income ....................................................
[1] $3,680,000
1,472,000
2,208,000
600,000
$2,808,000
Income before extraordinary item .................
Extraordinary gain .........................................
Net income ....................................................
[1]
2.21
0.60
$ 2.81
Income from continuing operations before income taxes:
Unadjusted
$4,200,000
Add:
Gain from sale of equipment
50,000
Deduct: Inventory write-off
(400,000)
Depreciation expense (2013)
(50,000)
Overstated profit on installment sale
(120,000) *
Adjusted
$3,680,000
* Profit recognized ($400,000 – 240,000)
Profit that should have been recognized
(gross profit ratio of 40% x $100,000)
Overstated profit
© The McGraw-Hill Companies, Inc., 2013
5–70
$160,000
(40,000)
$120,000
Intermediate Accounting, 7/e
Problem 5–2
Requirement 1
2013 cost recovery % :
$180,000
= 60% (gross profit % = 40%)
$300,000
2014 cost recovery %:
$280,000
= 70% (gross profit % = 30%)
$400,000
2013 gross profit:
Cash collection from 2013 sales = $120,000 x 40% =
$48,000
2014 gross profit:
Cash collection from 2013 sales = $100,000 x 40% =
+ Cash collection from 2014 sales = $150,000 x 30% =
Total 2014 gross profit
$ 40,000
45,000
$85,000
Requirement 2
2013
Installment receivables ................................................... 300,000
Inventory .....................................................................
180,000
Deferred gross profit...................................................
120,000
To record installment sales
Cash
................................................... 120,000
Installment receivables ...............................................
To record cash collections from installment sales
Deferred gross profit.......................................................
Realized gross profit ...................................................
To recognize gross profit from installment sales
Solutions Manual, Vol.1, Chapter 5
120,000
48,000
48,000
© The McGraw-Hill Companies, Inc., 2013
5–71
Problem 5–2 (continued)
2014
Installment receivables .................................................... 400,000
Inventory .....................................................................
280,000
Deferred gross profit ...................................................
120,000
To record installment sales
Cash ................................................................................. 250,000
Installment receivables ................................................
250,000
To record cash collections from installment sales
Deferred gross profit .......................................................
Realized gross profit ...................................................
To recognize gross profit from installment sales
85,000
85,000
Requirement 3
Date
Cash Collected
Cost Recovery
Gross Profit
2013
2013 sales
$120,000
$120,000
-0-
2014
2013 sales
2014 sales
2014 totals
$100,000
150,000
$250,000
$ 60,000
150,000
$210,000
$40,000
-0$40,000
© The McGraw-Hill Companies, Inc., 2013
5–72
Intermediate Accounting, 7/e
Problem 5–2 (concluded)
2013
Installment receivables ................................................... 300,000
Inventory .....................................................................
180,000
Deferred gross profit...................................................
120,000
To record installment sales
Cash ................................................................................ 120,000
Installment receivables ...............................................
120,000
To record cash collection from installment sales
2014
Installment receivables ................................................... 400,000
Inventory .....................................................................
280,000
Deferred gross profit...................................................
120,000
To record installment sales
Cash ................................................................................ 250,000
Installment receivables ...............................................
250,000
To record cash collection from installment sales
Deferred gross profit.......................................................
Realized gross profit ...................................................
To recognize gross profit from installment sales
Solutions Manual, Vol.1, Chapter 5
40,000
40,000
© The McGraw-Hill Companies, Inc., 2013
5–73
Problem 5–3
Requirement 1
Total profit = $500,000 – 300,000 = $200,000
Installment sales method: Gross profit % = $200,000 ÷ $500,000 = 40%
8/31/13
8/31/14
8/31/15
8/31/16
8/31/17
Cash collections
$100,000 $100,000 $100,000 $100,000 $100,000
a. Point of delivery method
$200,000
-0-
-0-
-0-
-0-
$ 40,000
$ 40,000
$ 40,000
$ 40,000
$40,000
-0-
-0-
b. Installment sales method
(40% x cash collected)
c. Cost recovery method
© The McGraw-Hill Companies, Inc., 2013
5–74
- 0 - $100,000 $100,000
Intermediate Accounting, 7/e
Problem 5–3 (continued)
Requirement 2
Installment receivable
Sales revenue
Cost of goods sold
Inventory
To record sale on 8/31/13
Point of
Delivery
500,000
500,000
300,000
300,000
Installment receivable
Inventory
Deferred gross profit
To record sale on 8/31/13
Cash
Installment receivable
To record cash collections
(Entry made each Aug. 31)
Deferred gross profit
Realized gross profit
To record gross profit
(Entry made each Aug. 31)
Deferred gross profit
Realized gross profit
To record gross profit
(Entry made 8/31/16 &
8/31/17)
Solutions Manual, Vol.1, Chapter 5
Installment
Sales
500,000
Cost Recovery
500,000
300,000
200,000
100,000
100,000
100,000
300,000
200,000
100,000
100,000
100,000
40,000
40,000
100,000
100,000
© The McGraw-Hill Companies, Inc., 2013
5–75
Problem 5–3 (concluded)
Requirement 3
Point of
Delivery
Installment
Sales
Cost
Recovery
December 31, 2013
Assets
Installment receivables
Less: Deferred gross profit
Installment receivables, net
400,000
400,000
(160,000)
240,000
400,000
(200,000)
200,000
December 31, 2014
Assets
Installment receivables
Less: Deferred gross profit
Installment receivables, net
300,000
300,000
(120,000)
180,000
300,000
(200,000)
100,000
© The McGraw-Hill Companies, Inc., 2013
5–76
Intermediate Accounting, 7/e
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
2014
$10,000,000
6,000,000
2,000,000
8,000,000
2015
$10,000,000
8,200,000
-08,200,000
$ 2,000,000
$ 2,000,000
$ 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
Problem 5–5 (continued)
Requirement 2
2013
2014
2015
Construction in progress
Various accounts
To record construction costs
2,400,000
3,600,000
2,200,000
2,400,000
3,600,000
2,200,000
Accounts receivable
Billings on construction
contract
To record progress billings
2,000,000
4,000,000
4,000,000
2,000,000
4,000,000
4,000,000
Cash
Accounts receivable
To record cash collections
1,800,000
3,600,000
4,600,000
1,800,000
3,600,000
4,600,000
Construction in progress
(gross profit)
Cost of construction
(cost incurred)
Revenue from long-term
contracts (1)
To record gross profit
600,000
900,000
300,000
2,400,000
3,600,000
2,200,000
3,000,000
(1) Revenue recognized:
2013: 30% x $10,000,000 =
2014: 75% x $10,000,000 =
Less: Revenue recognized in 2013
Revenue recognized in 2014
2015: 100% x $10,000,000 =
Less: Revenue recognized in 2013 & 2014
Revenue recognized in 2015
© The McGraw-Hill Companies, Inc., 2013
5–80
4,500,000
2,500,000
$3,000,000
$7,500,000
(3,000,000)
$4,500,000
$10,000,000
(7,500,000)
$2,500,000
Intermediate Accounting, 7/e
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
$ 200,000
$3,000,000
(2,000,000)
$600,000
$7,500,000
(6,000,000)
1,000,000
1,500,000
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)
Solutions Manual, Vol.1, Chapter 5
2013
$2,400,000
2014
$3,800,000
2015
$3,200,000
5,600,000
3,100,000
2013
$10,000,000
2,400,000
5,600,000
8,000,000
2014
$10,000,000
6,200,000
3,100,000
9,300,000
2015
$10,000,000
9,400,000
-09,400,000
$ 2,000,000
$ 700,000
$ 600,000
-
© The McGraw-Hill Companies, Inc., 2013
5–81
Problem 5–5 (concluded)
Gross profit (loss) recognition:
2013: $2,400,000
= 30.0% x $2,000,000 = $600,000
$8,000,000
2014: $6,200,000
= 66.6667% x $700,000 = $466,667 – 600,000 = $(133,333)
$9,300,000
2015:
$600,000 – 466,667 = $133,333
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
$2,400,000
2014
$3,800,000
5,600,000
4,100,000
2013
$10,000,000
2,400,000
5,600,000
8,000,000
2014
$10,000,000
6,200,000
4,100,000
10,300,000
$ 2,000,000
$ (300,000)
2015
$3,900,000
2015
$10,000,000
10,100,000
-010,100,000
$ (100,000)
Gross profit (loss) recognition:
2013:
$2,400,000
= 30.0% x $2,000,000 = $600,000
$8,000,000
2014:
$(300,000) – 600,000 = $(900,000)
2015:
$(100,000) – (300,000) = $200,000
© The McGraw-Hill Companies, Inc., 2013
5–82
Intermediate Accounting, 7/e
Problem 5–6
Requirement 1
Year
2013
2014
2015
Total gross profit
Gross profit recognized
-0-0$1,800,000
$1,800,000
Requirement 2
Construction in progress
Various accounts
To record construction costs
2013
2014
2015
2,400,000
3,600,000
2,200,000
2,400,000
3,600,000
2,200,000
Accounts receivable
Billings on construction
contract
To record progress billings
2,000,000
4,000,000
4,000,000
2,000,000
4,000,000
4,000,000
Cash
Accounts receivable
To record cash collections
1,800,000
3,600,000
4,600,000
1,800,000
3,600,000
4,600,000
Construction in progress
(gross profit)
Cost of construction
(costs incurred)
Revenue from long-term
contracts (contract price)
To record gross profit
Solutions Manual, Vol.1, Chapter 5
1,800,000
8,200,000
10,000,000
© The McGraw-Hill Companies, Inc., 2013
5–83
Problem 5–6 (concluded)
Requirement 3
Balance Sheet
Current assets:
Accounts receivable
Construction in progress
Less: Billings
Costs in excess of billings
2013
2014
$ 200,000
$ 600,000
$2,400,000
(2,000,000)
$6,000,000
(6,000,000)
400,000
-0-
Requirement 4
Costs incurred during the year
Estimated costs to complete
as of year-end
Year
2013
2014
2015
Total gross profit
2013
$2,400,000
2014
$3,800,000
5,600,000
3,100,000
2015
$3,200,000
-
Gross profit recognized
-0-0$600,000
$600,000
Requirement 5
Costs incurred during the year
Estimated costs to complete
as of year-end
Year
2013
2014
2015
Total project loss
© The McGraw-Hill Companies, Inc., 2013
5–84
2013
$2,400,000
2014
$3,800,000
5,600,000
4,100,000
2015
$3,900,000
-
Gross profit (loss) recognized
-0$(300,000)
200,000
$(100,000)
Intermediate Accounting, 7/e
Problem 5–7
Requirement 1
Year
2013
2014
2015
Total gross profit
Gross profit recognized
-0-0$1,800,000
$1,800,000
Requirement 2
Construction in progress
Various accounts
To record construction costs
2013
2014
2015
2,400,000
3,600,000
2,200,000
2,400,000
3,600,000
2,200,000
Accounts receivable
Billings on construction
contract
To record progress billings
2,000,000
4,000,000
4,000,000
2,000,000
4,000,000
4,000,000
Cash
Accounts receivable
To record cash collections
1,800,000
3,600,000
4,600,000
1,800,000
3,600,000
4,600,000
Construction in progress
(gross profit)
Cost of construction
(costs incurred)
Revenue from long-term
contracts (contract price)
To record gross profit
Solutions Manual, Vol.1, Chapter 5
1,800,000
2,400,000
2,400,000
3,600,000
3,600,000
2,200,000
4,000,000
© The McGraw-Hill Companies, Inc., 2013
5–85
Problem 5–7 (concluded)
Requirement 3
Balance Sheet
Current assets:
Accounts receivable
Construction in progress
Less: Billings
Costs in excess of billings
2013
2014
$ 200,000
$ 600,000
$2,400,000
(2,000,000)
$6,000,000
(6,000,000)
400,000
-0-
Requirement 4
Costs incurred during the year
Estimated costs to complete
as of year-end
Year
2013
2014
2015
Total gross profit
2013
$2,400,000
2014
$3,800,000
5,600,000
3,100,000
2015
$3,200,000
-
Gross profit recognized
-0-0$600,000
$600,000
Requirement 5
Costs incurred during the year
Estimated costs to complete
as of year-end
Year
2013
2014
2015
Total project loss
© The McGraw-Hill Companies, Inc., 2013
5–86
2013
$2,400,000
2014
$3,800,000
5,600,000
4,100,000
2015
$3,900,000
-
Gross profit (loss) recognized
-0$(300,000)
200,000
$(100,000)
Intermediate Accounting, 7/e
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)
2013
$4,000,000
350,000
3,150,000
3,500,000
2014
$4,000,000
2,500,000
1,700,000
4,200,000
2015
$4,000,000
4,250,000
-04,250,000
$ 500,000
$ (200,000)
$ (250,000)
Year
2013
2014
2015
Total project loss
Gross profit (loss) recognized
-0$(200,000)
(50,000)
$(250,000)
Requirement 2
Gross profit (loss) recognition:
2013:
10% x $500,000 = $50,000
2014:
$(200,000) – 50,000 = $(250,000)
2015:
$(250,000) – (200,000) = $(50,000)
Requirement 3
Balance Sheet
2013
Current assets:
Costs less loss ($2,300,000*) in
excess of billings ($2,170,000)
Current liabilities:
Billings ($720,000) in excess
of costs and profit ($400,000)
2014
$ 130,000
$ 320,000
*Cumulative costs ($2,500,000) less cumulative loss recognized ($200,000) = $2,300,000
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–87
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,
that is, when the construction project is complete. 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, that is, the construction period. The share is
estimated based on the project's costs incurred each period as a percentage of the
project's total estimated costs. 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.
Requirement 2
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit
2013
$20,000,000
4,000,000
12,000,000
16,000,000
$ 4,000,000
2014
$20,000,000
13,500,000
4,500,000
18,000,000
$ 2,000,000
a.
Gross profit recognition:
Under the completed contract method Citation would not report gross profit until
the project is competed. 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. Citation never estimates the Altamont contract
will earn a gross loss, so never has to recognize one.
b.
Under the completed contract method Citation would not report any revenue in
the 2013 or 2014 income statements.
© The McGraw-Hill Companies, Inc., 2013
5–88
Intermediate Accounting, 7/e
Problem 5–9 (continued)
c.
Balance Sheet
At December 31, 2013
Current assets:
Accounts receivable
Costs ($4,000,000*) in excess
of billings ($2,000,000)
$ 200,000
2,000,000
* Under the completed contract method, this account would only include costs
of $4,000,000
Requirement 3
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit
a.
2013
$20,000,000
4,000,000
12,000,000
16,000,000
$ 4,000,000
2014
$20,000,000
13,500,000
4,500,000
18,000,000
$ 2,000,000
Gross profit recognition:
2013: $ 4,000,000
= 25% x $4,000,000 = $1,000,000
$16,000,000
2014: $13,500,000
= 75% x $2,000,000 = $1,500,000
$18,000,000
Less: 2013 gross profit
2014 gross profit
b.
2013: $20,000,000 x 25% =
1,000,000
$ 500,000
$5,000,000
2014: $20,000,000 x 75% = $15,000,000
Less: 2013 revenue
(5,000,000)
$10,000,000
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–89
Problem 5–9 (continued)
c.
Balance Sheet
At December 31, 2013
Current assets:
Accounts receivable
Costs and profit ($5,000,000*) in excess
of billings ($2,000,000)
$ 200,000
3,000,000
* Costs ($4,000,000) + profit ($1,000,000)
Requirement 4
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit
a.
2013
$20,000,000
4,000,000
12,000,000
16,000,000
$ 4,000,000
2014
$20,000,000
13,500,000
9,000,000
22,500,000
($ 2,500,000)
Gross profit recognition:
2014: Overall loss of ($2,500,000) – previously recognized gross profit of
$1,000,000 = $3,500,000.
b.
2014: Easiest to solve using a journal entry:
Cost of construction (to balance)
Revenue from long-term contracts*
Construction in progress (loss)
$10,500,000
$7,000,000
$3,500,000
*
Total revenue recognized to date = (percentage complete)(total revenue)
= ($13,500,000 ÷ $22,500,000) x ($20,000,000)
= (60%) x ($20,000,000)
= $12,000,000
Revenue recognized this period = total – revenue recognized in prior periods
= $12,000,000 – 5,000,000 = $7,000,000
© The McGraw-Hill Companies, Inc., 2013
5–90
Intermediate Accounting, 7/e
Problem 5–9 (continued)
c.
Balance Sheet
At December 31, 2014
Current assets:
Accounts receivable
Current liabilities:
Billings ($12,000,000) in excess of costs
and profit ($11,000,000*)
$ 1,600,000
1,000,000
* 2013 costs ($4,000,000) + 2013 profit ($1,000,000) + 2014 costs
($9,500,000) – 2014 loss ($3,500,000)
Requirement 5
Citation should recognize revenue at the point of delivery, when the homes are
completed and title is transferred to the buyer. This is equivalent to the completed
contract method for long-term contracts. The percentage-of-completion method is not
appropriate in this case. There is no contract in place and until the completion of the
home, the transfer of title, and the receipt of the full sales price, the earnings process is
not virtually complete and there is still significant uncertainty as to cash collection.
Also, the sales price is not fixed.
Requirement 6
Income statement:
Sales revenue (3 x $600,000)
Cost of goods sold (3 x $450,000)
Gross profit
$1,800,000
1,350,000
$ 450,000
Balance sheet:
Current assets:
Inventory (work in process)
$2,700,000
Current liabilities:
Customer deposits (or unearned revenue)
$300,000*
*$600,000 x 10% = $60,000 x 5 = $300,000
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–91
Problem 5–10
Requirement 1
a.
January 30, 2013
Cash ................................................................................ 200,000
Note receivable ............................................................... 1,000,000
Unearned franchise fee revenue ..................................
1,200,000
b.
September 1, 2013
Unearned franchise fee revenue ...................................... 1,200,000
Franchise fee revenue .................................................
1,200,000
c.
September 30, 2013
Accounts receivable ($40,000 x 3%) .................................
Service revenue ..........................................................
d.
1,200
1,200
January 30, 2014
Cash .................................................................................
Note receivable ...........................................................
© The McGraw-Hill Companies, Inc., 2013
5–92
100,000
100,000
Intermediate Accounting, 7/e
Problem 5–10 (continued)
Requirement 2
a. January 30, 2013
Cash ............................................................................... 200,000
Note receivable .............................................................. 1,000,000
Deferred franchise fee revenue ...................................
1,200,000
Note: Could also show as:
Cash ............................................................................... 200,000
Note receivable .............................................................. 1,000,000
Deferred franchise fee revenue ...................................
1,000,000
Unearned franchise fee revenue .................................
200,000
b.
September 1, 2013
Deferred franchise fee revenue ......................................
Franchise fee revenue (cash collected) ..........................
c.
200,000
September 30, 2013
Accounts receivable ($40,000 x 3%) ................................
Service revenue ..........................................................
d.
200,000
1,200
1,200
January 30, 2014
Cash ................................................................................
Note receivable ..........................................................
100,000
Deferred franchise fee revenue ......................................
Franchise fee revenue ................................................
100,000
Solutions Manual, Vol.1, Chapter 5
100,000
100,000
© The McGraw-Hill Companies, Inc., 2013
5–93
Problem 5–10 (concluded)
Requirement 3
Balance Sheet
At December 31, 2013
Current assets:
Installment notes receivable
($1,000,000) less deferred franchise fee
revenue ($1,000,000)
Current liabilities:
Unearned franchise fee revenue
$ -0-
$200,000
Explanation: Revenue recognition on the entire note receivable is deferred. In
addition, $200,000 of unearned revenue must be shown as a liability.
Problem 5–11
1.
2.
3.
4.
5.
6.
7.
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. Return on
shareholders’ equity
9. Equity multiplier
10. DuPont framework
© The McGraw-Hill Companies, Inc., 2013
5–94
$6,300 ÷ [($800 + 600) ÷ 2] = 9.0
365 ÷ 9.0 = 40.56 days
$9,000 ÷ [($600 + 400) ÷ 2] = 18.0
365 ÷ 18.0 = 20.28 days
$9,000 ÷ [($4,000 + 3,600) ÷ 2] = 2.37
$300 ÷ $9,000 = 3.33%
$300 ÷ [($4,000 + 3,600) ÷ 2] = 7.89%
3.33% x 2.37 times = 7.89%
$300 ÷ [($1,500 + 1,350) ÷ 2] = 21.1%
[($4,000 + 3,600) ÷ 2] ÷ [($1,500 + 1,350) ÷ 2] = 2.67
3.33% x 2.37 x 2.67 = 21.1%
Intermediate Accounting, 7/e
Problem 5–12
Requirement 1
=
Net sales
Accounts receivable
J&J
=
$41,862
$6,574
= 6.37 times
Pfizer
=
$45,188
$8,775
= 5.15 times
Receivables turnover
Average collection period =
365
Receivables turnover
J&J
=
365
6.37
= 57 days
Pfizer
=
365
5.15
= 71 days
On average, J&J collects its receivables in 14 days less than Pfizer.
Inventory turnover
=
Cost of goods sold
Inventories
J&J
=
$12,176
$3,588
= 3.39 times
Pfizer
=
$9,832
$5,837
= 1.68 times
Average days in inventory =
365
Inventory turnover
J&J
=
365
3.39
= 108 days
Pfizer
=
365
1.68
= 217 days
On average, J&J sells its inventory twice as fast as Pfizer.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–95
Problem 5–12 (continued)
Requirement 2
Rate of return on assets
Net income
Total assets
=
J&J
=
$7,197
$48,263
=
14.9%
Pfizer
=
$1,639
$116,775
=
1.4%
The return on assets indicates a company's overall profitability, ignoring specific
sources of financing. In this regard, J&J’s profitability is significantly higher than
that of Pfizer.
Requirement 3
Profitability can be achieved by a high profit margin, high turnover, or a
combination of the two.
Rate of return on assets =
=
J&J
=
Net income
Net sales
x
$ 7,197
$41,862
x
$41,862
$48,263
x
.867 times
=
Pfizer
Profit margin
on sales
17.19%
x
Asset
turnover
Net sales
Total assets
=
$ 1,639
$45,188
x
$45,188
$116,775
=
3.63%
x
.387 times
=
14.9%
=
1.4%
No, the combinations of profit margin and asset turnover are not similar. J&J’s
profit margin is much higher than that of Pfizer, as is its asset turnover. These
differences combine to produce a significantly higher return on assets for J&J.
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
Problem 5–12 (concluded)
Requirement 4
Rate of return on =
shareholders’ equity
Net income
Shareholders’ equity
J&J
=
$7,197
$26,869
= 26.8%
Pfizer
=
$1,639
$65,377
= 2.5%
J&J provided a much greater return to shareholders.
Requirement 5
Equity multiplier =
shareholders’ equity
Total Assets
Shareholders’ equity
J&J
=
$48,263
$26,869
= 1.80
Pfizer
=
$116,775
$65,377
= 1.79
The two companies have virtually identical equity multipliers, indicating that they
are using leverage to the same extent to earn a return on equity that is higher than
their return on assets.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–97
Problem 5–13
a. 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. Profit margin on sales = Net income ÷ Sales = 5%
Sales = $20 ÷ 5% = $400
d. Gross profit margin = Gross profit ÷ Sales = 40%
Gross profit = $400 x 40% = $160
Cost of goods sold = Sales – Gross profit = $400 – 160 = $240
e. Inventory turnover ratio = Cost of goods sold ÷ Inventory = 8
Inventory = $240 ÷ 8 = $30
f. Receivables turnover ratio = Sales ÷ Accounts receivable = 20
Accounts receivable = $400 ÷ 20 = $20
g. Current ratio = Current assets ÷ Current liabilities = 2.0
Acid-test ratio = Quick assets ÷ Current liabilities = 1.0
Current assets ÷ 2 = Current liabilities
Quick assets ÷ 1 = Current liabilities
Current assets ÷ 2 = Quick assets ÷ 1
Current assets = 2 x Quick assets
Cash + Accts. rec. + Inventory = 2 x (Cash + Accounts receivable)
Cash + $20 + 30 = (2 x Cash) + (2 x $20)
Cash + $50 = Cash + Cash + $40
Cash = $10
h. Acid-test ratio = (Cash + Accounts receivable) ÷ Current liabilities = 1.0
Current liabilities = ($10 + 20) ÷ 1.0 = $30
i. Noncurrent assets = Total assets – Current assets
= $200 – ($10 + 20 + 30) = $140
j. Return on shareholders’ equity = Net income ÷ Shareholders’ equity = 20%
Shareholders’ equity = $20 ÷ 20% = $100
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
Problem 5–13 (concluded)
k. Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1.0
Total liabilities = $100 x 1.0 = $100
Long-term liabilities = Total liabilities – Current liabilities = $100 – 30 = $70
CADUX CANDY COMPANY
Balance Sheet
At December 31, 2013
Assets
Current assets:
Cash
Accounts receivable (net)
Inventories
Total current assets
Property, plant, 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, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–99
Problem 5–14
Requirement 1
Rate of return on assets
=
Net income
Total assets
Metropolitan
=
$ 593.8
$4,021.5
=
14.8%
Republic
=
$ 424.6
$4,008.0
=
10.6%
The return on assets indicates a company's overall profitability, ignoring specific
sources of financing. In this regard, Metropolitan’s profitability exceeds that of
Republic.
Requirement 2
Profitability can be achieved by a high profit margin, high turnover, or a
combination of the two.
Rate of return on assets =
=
Net income
Net sales
Metropolitan = $ 593.8
$5,698.0
=
Republic =
Profit margin
on sales
x
Asset
turnover
Net sales
Total assets
x
$5,698.0
$4,021.5
10.4%
x
1.42 times =
$ 424.6
$7,768.2
x
$7,768.2
$4,008.0
x
1.94 times =
= 5.5%
x
14.8%
10.7%
Republic’s profit margin is much less than that of Metropolitan, but partially
makes up for it with a higher turnover.
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
Problem 5–14 (continued)
Requirement 3
Rate of return on
shareholders’ equity
=
Net income
Shareholders’ equity
Metropolitan
=
$593.8
$144.9 + 2,476.9 – 904.7
= 34.6%
Republic
=
$424.6
$335.0 + 1,601.9 – 964.1
= 43.6%
Republic provides a greater return to common shareholders.
Requirement 4
Equity multiplier
=
Total assets
Shareholders’ equity
Metropolitan
=
$4,021.5
$144.9 + 2,476.9 – 904.7
= 2.34
Republic
=
$4,008.0
$335.0 + 1,601.9 – 964.1
= 4.12
When the return on shareholders’ equity is greater than the return on assets,
management is using debt funds to enhance the earnings for stockholders. Both firms
do this. Republic’s higher leverage has been used to provide a higher return to
shareholders than Metropolitan, even though its return on assets is less. Republic
increased its return to shareholders 4.07 times (43.6% ÷ 10.7%) the return on assets.
Metropolitan increased its return to shareholders 2.34 times (34.6% ÷ 14.8%) the
return on assets.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
5–101
Problem 5–14 (continued)
Requirement 5
Current ratio
=
Current assets
Current liabilities
Metropolitan
=
$1,203.0
$1,280.2
=
.94
Republic
=
$1,478.7
$1,787.1
=
.83
Acid-test ratio
=
Metropolitan
=
$1,203.0 – 466.4 – 134.6
$1,280.2
=
.47
Republic
=
$1,478.7 – 635.2 – 476.7
$1,787.1
=
.21
Quick assets
Current liabilities
The current ratios of the two firms are comparable and within the range of the
rule-of-thumb standard of 1 to 1. The more robust acid-test ratio reveals that
Metropolitan is more liquid than Republic.
Requirement 6
Sales
Accounts receivable
Receivables turnover ratio
=
Metropolitan
=
$5,698.0
$422.7
= 13.5 times
Republic
=
$7,768.2
$325.0
= 23.9 times
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
Problem 5–14 (concluded)
Cost of goods sold
Inventory
Inventory turnover ratio
=
Metropolitan
=
$2,909.0
$466.4
= 6.2 times
Republic
=
$4,481.7
$635.2
= 7.1 times
Republic’s receivables turnover is more rapid than Metropolitan’s, perhaps
suggesting that its relative liquidity is not as bad as its acid-test ratio indicated.
Requirement 7
Times interest
earned ratio
=
Net income plus interest plus taxes
Interest
Metropolitan
=
$593.8 + 56.8 + 394.7
$56.8
= 18.4 times
Republic
=
$424.6 + 46.6 + 276.1
$46.6
= 16.0 times
Both firms provide an adequate margin of safety.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
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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
$180,000
35,000
145,000
(12,500)
(57,000)
75,500
(27,180)
$ 48,320
1$50,000 ÷ 4 = $12,500
2$48,000 + [59,000 – 50,000]
3$75,500 x 36%
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
SUPPLEMENT PROBLEMS
Problem 5–16
Requirement 1
a. The gym membership is one separate performance obligation. 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), the discount voucher also is a separate performance obligation.
b. To allocate the contract price to the performance obligation, 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. So, a 25 percent discount
provides a customer with an incremental value of 15 percent (25% – 10%).
Thus, 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 standalone selling price of
the annual membership fee is $800, Fit & Slim would allocate $34.45 {$800 
[36 ÷ ($36 + 800)]} of the $800 transaction price to the discount voucher on
yoga course.
c. Since the discount voucher of the yoga course would be a separate performance
obligation, Fit & Slim would recognize revenue for the sale of annual
membership fee and discount voucher.
Cash
Unearned revenue, membership fees
Unearned revenue, yoga coupon
Solutions Manual, Vol.1, Chapter 5
800
765.55
34.45
© The McGraw-Hill Companies, Inc., 2013
5–105
Problem 5–16 (concluded)
Requirement 2
a. The option to pay $15 for additional visits does not constitute a material right,
because it is in the range ($12 to $18) of normal fees paid by nonmembers.
Therefore, it is not a separate performance obligation in the contract.
b. Since the option to visit on additional days is not a separate performance
obligation, F&S should not allocate any of the contract price to it. Therefore,
the entire $500 payment is allocated to the 50 visits associated with the coupon
book.
c.
Cash
Unearned revenue, coupon book
500
500
F&S could recognize (1/40)  $500 of revenue for each visit, since a coupon
book yields approximately 40 visits. Alternatively, F&S could recognize
revenue over the year following sale of the coupon book.
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
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. 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. Although Star
does not obtain legal title of the equipment until completion of the job, Crown’s
retention of title is a protective right, and not an indicator that it has retained control.
Consequently, Crown’s performance obligation is to provide Star with construction
services, and Crown would recognize revenue over time throughout the construction
process.
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. Star does not
obtain title to the equipment until the job is completed, and if the contract is
terminated prior to completion, Crown retains the equipment, suggesting that Crown
retains control of the equipment throughout the job. Consequently, Crown’s
performance obligation is to provide Star with a completed gym, and Crown would
defer revenue recognition until the end of the construction process.
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 receive the benefit from, the
consulting services as they are performed. The restaurant has an unconditional
obligation to pay throughout the contract as evidenced by the nonrefundable progress
payments, and the right to a report regardless of contract termination. Also, the report
is not of alternate use to CostDriver. Therefore, the CostDriver Company’s
performance obligation is to provide the restaurant with services continuously during
the three months of the contract, and CostDriver should recognize revenue over the
life of the contract.
Scenario 4: The terms of the contract and all the related facts and circumstances
indicate that Edwards, the customer, obtains control of the apartment on completion of
the contract. Edwards obtains title and physical possession of the apartment only on
completion of the contract. Consequently, the Tower’s performance obligation is to
provide the customer with a completed apartment, and the Tower should not recognize
revenue until delivery of the apartment.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
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Problem 5–18
Note: The contract requires 6 payments of $20,000, plus or minus $10,000 at the end
of the life of the contract. So the contract will provide either [(6  $20,000) –
$10,000] = $110,000, or [(6  $20,000) + $10,000] = $130,000.
a)
Revis would estimate the transaction price as follows:
Possible
Prices
Probability
Expected
Consideration
80%
20%
$104,000
22,000
$130,000 ([$20,000  6] + $10,000)
$110,000 ([$20,000  6] – $10,000)
Expected contract price at inception
$126,000
Each month Revis would recognize $21,000 ($126,000 ÷ 6) of revenue,
using the following journal entry:
Cash
Expected bonus receivable
Revenue
20,000
1,000
21,000
After six months the Expected bonus receivable will have accumulated to
$6,000 (6  $1,000).
b)
If Revis receives the bonus, it will record the following entry:
Cash
Expected bonus receivable
Revenue
c)
10,000
6,000
4,000
If Revis pays the penalty, it will record the following entry:
Revenue
Expected bonus receivable
Cash
© The McGraw-Hill Companies, Inc., 2013
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16,000
6,000
10,000
Intermediate Accounting, 7/e
Problem 5–19
Requirement 1
At the contract’s inception, Velocity would calculate the transaction price to be the
probability-weighted average of the two possible eventual prices:
Possible
Prices
Expected
Consideration
Probabilities
$500,000 ([$60,000  8] + $20,000)
80%
$460,000 ([$60,000  8] – $20,000)
20%
Transaction price at contract inception:
$400,000
92,000
$492,000
Velocity would allocate the transaction price, $492,000, to the performance
obligation to provide consulting services. Because those services are provided
evenly over the eight months, Velocity would recognize revenue of $61,500
($492,000 ÷ 8 months = $61,500).
But Burger Boy is unconditionally obligated to pay only $60,000 per month
($1,500 less than the revenue recognized), so Velocity would recognize an
Expected bonus receivable of $1,500 in the first month to reflect the most likely
bonus to be received at the end of the contract. This is the revenue recognized in
excess of its unconditional right to consideration. Therefore, 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
Solutions Manual, Vol.1, Chapter 5
60,000
1,500
61,500
© The McGraw-Hill Companies, Inc., 2013
5–109
Problem 5–19 (continued)
Requirement 2
The expected bonus receivable would increase to $6,000 (4  $1,500) by the end
of the fourth month, equal to half of the total expected bonus of $12,000
($492,000 – [8  $60,000]). After four months, the estimated likelihood of
receiving the bonus is revised, so the estimated transaction price decreases to
$484,000:
Possible
Prices
Expected
Probabilities Consideration
60%
$500,000 ([$60,000  8] + $20,000)
40%
$460,000 ([$60,000  8] – $20,000)
Transaction price after four months:
$300,000
184,000
$484,000
Therefore, as of that date the expected bonus receivable should equal $2,000, which is
half of the new expected bonus of $4,000 ($484,000 – [8  $60,000]). Recording that
adjustment requires a reduction of the expected bonus receivable from $6,000 to
$2,000:
Revenue
Expected bonus receivable
4,000
4,000
This entry reduces the expected bonus receivable to $2,000, with the offsetting debit a
reduction in revenue. Over the remaining four months, expected bonus receivable will
increase by $500 each month, accumulating to $4,000 by the end of the contract.
Requirement 3
Because services are provided evenly over the eight months, Velocity would
recognize revenue of $60,500 ($484,000 ÷ 8 months = $60,500) in each of months
five through eight. Because Burger Boy pays $60,000 per month ($500 less than
the revenue recognized), 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. The journal entry would be:
Accounts receivable
Expected bonus receivable
Revenue
© The McGraw-Hill Companies, Inc., 2013
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60,000
500
60,500
Intermediate Accounting, 7/e
Problem 5–19 (concluded)
Requirement 4
At the end of contract, Velocity learns that it will receive the bonus of $20,000. It
already has recognized revenue of $4,000 associated with the bonus. Therefore,
Velocity recognizes additional accounts receivable and additional revenue of
$16,000 ($20,000 – 4,000).
Expected bonus receivable
Revenue
16,000
Accounts receivable
Expected bonus receivable
20,000
16,000
20,000
OR
Accounts receivable
Expected bonus receivable
Revenue
Solutions Manual, Vol.1, Chapter 5
20,000
4,000
16,000
© The McGraw-Hill Companies, Inc., 2013
5–111
CASES
Real World Case 5–1
Requirement 1
A bill and hold strategy accelerates the recognition of revenue. In this case, sales
that would normally have occurred in 1998 were recorded in 1997. Assuming a
positive gross profit on these sales, earnings in 1997 is inflated.
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 3
Sales that would normally have been recorded in 1998 were recorded in 1997.
This bill and hold strategy shifted sales revenue and therefore earnings from 1998 to
1997.
Requirement 4
Earnings quality refers to the ability of reported earnings (income) to predict a
company’s future earnings. Sunbeam’s earnings management strategy produced a
1997 earnings figure that was not indicative of the company’s future profit-generating
ability.
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
Judgment Case 5–2
Requirement 1
While revenue often is earned during a period of time, revenue usually is
recognized at a point in time when both revenue recognition criteria are satisfied.
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.
Usually, significant uncertainties exist at the time products are produced. At the
point of delivery, the product has been sold and the price and buyer are known. The
only remaining uncertainty involves the ultimate cash collection, which can usually be
accounted for by estimating and recording allowances for possible return of the
product and for uncollectibility of the cash.
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. A good example is longterm projects in the construction industry.
Requirement 3
Some revenue-producing activities call for revenue recognition after the product
has been delivered. These situations involve significant uncertainty as to the
collectibility of the cash to be received, caused either by the possibility of the product
being returned or, with credit sales, the possibility of bad debts. Usually, 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. But occasionally, an abnormal degree of
uncertainty causes point of delivery revenue recognition not to be appropriate.
Revenue recognition after delivery sometimes is appropriate for installment sales and
when a right of return exists.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
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Judgment Case 5–3
Mega should recognize revenue for the initial fee equally over the estimated
average period members will continue to be members. Even though the fee is
nonrefundable, it is not “earned” until services are provided. Since there is no
contractual period of service, it must be estimated. Mega would be justified in
recognizing only $3 of the initial fee immediately to offset the cost of the membership
card. The payment option chosen by members does not affect the revenue recognition
policy.
The monthly fee should be recognized as revenue upon billing, as long as
adequate provision is made for possible uncollectible amounts.
Judgment Case 5–4
The revenue recognition policy is questionable. The liberal trade-in policy causes
gross profit to be overstated on the original sale and understated on the trade-in sale.
This results from the granting of a trade-in allowance for the old computer that is
greater than the old computer's resale value. Using the company's recognition policy,
gross profit recognized on the two sales would be as follows:
Sales price
Cost of goods sold
Gross profit
Gross profit percentage
Original sale
$2,000,000
1,200,000
$ 800,000
Trade-in sale
$2,380,000
1,500,000
$ 880,000
40%
37%
Of course, there is no guarantee that the customer will exercise the trade-in
option. If, however, a large percentage of customers do exercise the option, and the
distortion in gross profit is material, the company should adopt a revenue recognition
policy that results in a more stable gross profit percentage for the two transactions.
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
Communication Case 5–5
The critical question that student groups should address is how to match revenues
and expenses. There is no right or wrong answer. The process of developing the
proposed solutions will likely be more beneficial than the solutions themselves.
Students should benefit from participating in the process, interacting first with other
group members, then with the class as a whole.
Solutions could take one of two directions:
1. Deferral of revenue recognition. As each ice cream cone is sold, a portion of
the sales price is deferred and a liability is recorded. This liability will then be
reduced and revenue recognized when the free ice cream cone is awarded.
2. The accrual of estimated cost. This direction views the free ice cream cone as
a promotional expense. The estimated cost of the free cone should be
expensed as the 10 required cones are sold. A corresponding liability is
recorded which should increase to an amount equal to the cost of the free
cone. When the free cone is awarded, the liability and inventory are reduced.
In either case, the accounting method must consider the fact that not all
customers will take advantage of the free cone award.
It is important that each student actively participate in the process. Domination by
one or two individuals should be discouraged. Students should be encouraged to
contribute to the group discussion by (a) offering information on relevant issues, and
(b) clarifying or modifying ideas already expressed, or (c) suggesting alternative
direction.
Research Case 5–6
(Note: This case requires the student to reference a journal article.)
1.
2.
3.
4.
Fifty-five firms reported the use of one of the two long-term contract accounting
methods.
Twenty-seven of the firms are manufacturing companies.
Only one company uses the completed contract method. That company reported
using both methods.
The most frequently used approach to estimating a percentage-of-completion is
the cost-to-cost method.
Solutions Manual, Vol.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
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Research Case 5–7
(Note: This case requires the student to reference a journal article.)
1.
Abuse
1. Cutoff manipulation
2. Deferring too much
or too little revenue
3. Bill-and-hold sale
4. Right-of-return sale
2.
3.
4.
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).
The company has an arrangement under which
revenue should be deferred (for example, it should be
using the installment sales method), but it doesn’t
defer the revenue. Or, a company could defer too
much revenue to shift income into future periods.
The company records sales even though it hasn’t yet
delivered the goods to the customer.
The company sells to distributors or other customers
and can’t estimate returns with sufficient accuracy
due to the nature of the selling relationship.
Manipulating estimates of percentage complete in order to manipulate gross
profit recognition.
These abuses tended to increase income (75% of the time), consistent with
management generally having an incentive to increase income.
The auditors tended to require adjustment (56% of the time), consistent with
auditors being concerned about income-increasing earnings management.
© The McGraw-Hill Companies, Inc., 2013
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Intermediate Accounting, 7/e
Ethics Case 5–8
Discussion should include these elements.
Facts:
Horizon Corporation, a computer manufacturer, reported profits from 2008
through 2011, but reported a $20 million loss in 2012 due to increased competition.
The chief financial officer (CFO) circulated a memo suggesting the shipment of
computers to J.B. Sales, Inc., in 2013 with a subsequent return of the merchandise to
Horizon in 2014. 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.
The CFO is clearly asking Jim Fielding to recognize revenue in 2013 that he
knows will be reversed as a sales return in 2014.
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.1, Chapter 5
© The McGraw-Hill Companies, Inc., 2013
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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, (2) the installment sales method, and (3) the cost
recovery method.
2013 gross profit under the three methods:
(1) point of delivery:
$80,000 – 40,000 = $40,000
(2) installment sales method:
$40,000
= 50% = gross profit %
$80,000
50% x $30,000 (cash collected) = $15,000
(3) cost recovery method:
No gross profit recognized since cost ($40,000) exceeds cash collected ($30,000).
Requirement 2
Customers sometimes are allowed to pay for purchases in installments over long
periods of time. Uncertainty about collection of a receivable normally increases with
the length of time allowed for payment. In most situations, the increased uncertainty
concerning the collection of cash from installment sales can be accommodated
satisfactorily by estimating uncollectible amounts. In these situations, point of
delivery revenue recognition should be used.
If, however, 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, revenue and cost recognition should be delayed. The
installment sales method and the cost recovery method are available to handle such
situations. These methods should be used only in situations involving exceptional
uncertainty. The cost recovery method is the more conservative of the two.
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Intermediate Accounting, 7/e
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.”
Question 1
No. In the SEC's view, 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. This
conclusion is based on Company M's remaining and unfulfilled contractual obligation
to perform services (i.e., make available and offer products for sale at a discounted
price) throughout the membership period. Therefore, the earnings process, irrespective
of whether a cancellation clause exists, is not complete.
In addition, 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. Generally, 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.
[ASC 605–10–S99, SAB Topic 13.A.4, Fixed or Determinable Sales Price, a.
Refundable fees for services.]
Question 2
No. 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. [ASC 605–10–S99, SAB Topic 13.A.2, Persuasive Evidence of an
Arrangement.]
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Case 5–10 (concluded)
Question 3
Provided that the other criteria for revenue recognition are met, the SEC believes
that Company R should recognize revenue from sales made under its layaway
program upon delivery of the merchandise to the customer. Until then, 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, receives only a deposit
from the customer, and does not have an enforceable right to the remainder of the
purchase price, the SEC would object to Company R recognizing any revenue upon
receipt of the cash deposit. 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." [ASC 605–10–S99, SAB Topic 13.A.3, Delivery
and Performance, e. Layaway sales arrangements.]
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Intermediate Accounting, 7/e
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.”
Requirement 2
GAAP lists the following factors that may impair the ability to make a reasonable
estimate (see ASC 605–15–25–3).
a.
The susceptibility of the product to significant external factors, such as
technological obsolescence or changes in demand.
b. Relatively long periods in which a particular product may be returned.
c.
Absence of historical experience with similar types of sales of similar
products, or inability to apply such experience because of changing
circumstances, for example, changes in the selling enterprise’s marketing
policies or relationships with its customers.
d. Absence of a large volume of relatively homogeneous transactions.
Requirement 3
The six criteria are:
a.
The seller’s price to the buyer is substantially fixed or determinable at the
date of sale.
b. The buyer has paid the seller and the obligation is not contingent on resale
of the product.
c.
The buyer’s obligation to the seller would not be changed in the event of
theft or physical destruction or damage of the product.
d. The buyer acquiring the product for resale has economic substance apart
from that provided by the seller.
e.
The seller does not have significant obligations for future performance to
directly bring about resale of the product by the buyer.
f.
The amount of future returns can be reasonably estimated.
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Case 5–11 (concluded)
Requirement 4
Both companies recognize revenues from products sold when persuasive
evidence of an arrangement exists, the price is fixed or determinable, shipment is
made, and collectibility is reasonably assured. However, for sales to distributors under
terms allowing the distributors certain rights of return and price protection on unsold
merchandise held by them, AMD defers recognition of revenue and related profits
until the merchandise is resold by the distributors.
Requirement 5
The two revenue recognition policies differ with respect to AMD’s sales to
distributors. Revenue for these sales is deferred until the merchandise is resold by the
distributors. On the other hand, HP recognizes all sales when products are shipped
even though it offers price protection as well as the right of return to customers.
Estimates are recorded for customer returns, price protection, rebates, and other
offerings. Reasons for the difference in policies could relate to the types of products
sold by the two companies, the distribution channels, and the actual agreements with
customers. AMD sells semiconductors, a highly volatile industry. It may be more
difficult for AMD to see through the distribution channels to reasonably estimate
returns. Also, 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. For
example, AMD might offer a longer time period for customers to return product than
does HP. Also, AMD’s sales to distributors might be contingent on resale of the
product to end users, one of the six criteria that must be met before revenue can be
recognized when the right of return exists.
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Intermediate Accounting, 7/e
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.
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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.
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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.
_______
10
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.
_______
15
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.
_______
_____
70 points
Writing (30%)
_______ 6
Terminology and tone appropriate to the audience of a company
controller.
_______
12
Organization permits ease of understanding.
______ Introduction that states purpose.
______ Paragraphs that separate main points.
_______
12
English
______ Sentences grammatically clear and well organized,
concise.
______ Word selection.
______ Spelling.
______ Grammar and punctuation.
_______
_____
30 points
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IFRS Case 5–16
Vodafone’s revenue recognition policies for products and services are similar to
revenue recognition policies in the U.S. 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. Sales of services are recognized as the services are provided. The terminology
is somewhat different, but the end results, as compared to U.S. policies, should be
similar in most cases.
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Intermediate Accounting, 7/e
IFRS Case 5–17
Requirement 1
Per the revenue recognition section of ThyssenKrupp’s 2010 annual report, 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, used when it can make
accurate estimates of contract income: “… Construction contract revenue and
expense are accounted for using the percentage-of-completion method, which
recognizes revenue as performance of the contract progresses. 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.”
When the company cannot make accurate estimates of contract income, it
uses the cost recovery method: “…Where the income of a construction contract
cannot be estimated reliably, contract revenue that is probable to be recovered is
recognized to the extent of contract costs incurred. Contract costs are recognized
as expenses in the period in which they are incurred.”
(from 2010 Annual report) Note 1: Summary of significant accounting
policies
The consolidated financial statements have been prepared on a historical cost
basis, except for certain financial instruments that are stated at fair value. The
consolidated financial statements are presented in Euros since this is the currency
in which the majority of the Group’s transactions are denominated, with all
amounts rounded to the nearest million except when otherwise indicated; this
may result in differences compared to the unrounded figures.
Requirement 2
The primary difference is that, under U.S. GAAP, the company would use the
completed contract method in circumstances in which it cannot make accurate
estimates of contract income.
Trueblood Accounting Case 5–18
A solution and extensive discussion materials can be obtained from the Deloitte
Foundation.
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Trueblood Accounting Case 5–19
A solution and extensive discussion materials can be obtained from the Deloitte
Foundation.
Real World Case 5–20
Requirement 3
The following is from the 2010 10K of Jack in the Box, Inc. The responses to the
question will vary if the company has since changed its revenue recognition policy.
a. These fees are recognized as revenue when the company has substantially
performed all of its contractual obligations. This policy agrees with GAAP.
b. Continuing payments are based on a percentage of sales.
Requirement 4
Answers to this question will, of course, vary because students will research
financial statements of different companies. Likely candidates for comparison include
most of the fast-food chains such as McDonald’s, and Wendy’s, and Arby’s
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Intermediate Accounting, 7/e
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, when persuasive evidence of
an arrangement exists, services have been rendered, the price is fixed or determinable,
and collectability is reasonably assured. We have two primary types of contractual
arrangements with our vendors, which we refer to herein as the "merchant" and
"retail" models. Under both the merchant and retail models, we record revenue earned
net of all amounts paid to our suppliers.
Under the merchant 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.
Customers generally pay us for reservations at the time of booking. Initially, we
record these customer receipts as accrued merchant payables and either deferred
income or net revenue, depending on the travel product. In the merchant model, we do
not take on credit risk with the customer, however we are subject to chargebacks and
fraud risk which we monitor closely; we have the ability to determine the price; we are
not responsible for the actual delivery of the flight, hotel room or car rental; we take
no inventory risk; we have no ability to determine or change the products or services
delivered; and the customer chooses the supplier. We recognize net revenue under the
merchant model when we have no further obligations to the customer. . . .
Under the retail model, we pass reservations booked by our customers to the travel
supplier for a commission. In the retail model, we do not take on credit risk with the
customer; we are not the primary obligor with the customer; we have no latitude in
determining pricing; we take no inventory risk; we have no ability to determine or
change the products or services delivered; and the customer chooses the supplier. We
recognize net revenue under the retail model when the reservation is made, secured by
a customer with a credit card and we have no further obligations to the customer.
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Case 5–21 (continued)
Excerpt from priceline.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, among other things, selects suppliers and
determines the price it will accept from the customer. The Company recognizes such
revenues and costs if and when it fulfills the customer’s non-refundable offer.
Merchant revenues and cost of merchant revenues include the selling price and cost,
respectively, of the travel services and are reported on a gross basis. . . .
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. 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.
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. Agency revenues include travel commissions, customer
processing fees and global distribution system (“GDS”) reservation booking fees and
are reported at the net amounts received, without any associated cost of revenue. Such
revenues are generally recognized by the Company when the customers complete their
travel.
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Intermediate Accounting, 7/e
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.”
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.”
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, respectively, of the travel services and are
reported on a gross basis.”
d) priceline.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.”
e) priceline.com’s agency revenues:
This is reported net: “Agency revenues . . . are reported at the net amounts
received, without any associated cost of revenue.”
Requirement 4
Yes, it appears that relatively similar services can be accounted for as gross v. net
depending on how they are structured. Priceline’s “Name your own Price®” service
appears similar to services that Orbitz might offer under its merchant model, yet
Priceline would recognize revenue gross and Orbitz would recognize revenue net.
If similar things are treated differently, comparability is reduced.
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Analysis Case 5–22
This case encourages students to obtain hands-on familiarity with an actual
annual report and library sources of industry data. They also must apply the
techniques learned in the chapter. You may wish to provide students with multiple
copies of the same annual reports and compare responses. Another approach is to
divide the class into teams who evaluate reports from a group perspective.
Judgment Case 5–23
Apparently, a significant increase in assets occurred during the last quarter. Total
assets were $324 million and now they total $450 million, as can be calculated as
follows:
Return on shareholders’ equity
Shareholders’ equity
Debt to equity ratio
Total liabilities
Total assets
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= 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
Intermediate Accounting, 7/e
Integrating Case 5–24
Balance Sheet
Assets
Cash
Accounts receivable (net)
Inventory
Prepaid expenses and other current assets
Current assets
Property, plant, and equipment (net)
Liabilities and Shareholders’ Equity
Accounts payable
Short-term notes
Current liabilities
Bonds payable
Shareholders’ equity
$ 15,000
12,000
30,000
3,000
60,000
140,000
$200,000
given
(e)
(d)
(i)
(h)
(j)
(b)
$ 25,000
5,000
30,000
20,000
150,000
$200,000
(g)
given
(f)
(l)
(k)
(b)
$300,000
(180,000)
120,000
(96,000)
(2,000)
(7,000)
$ 15,000
(a)
(c)
(c)
(o)
(m)
(n)
given
Income Statement
Sales
Cost of goods sold
Gross profit
Operating expenses
Interest expense
Tax expense
Net income
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Case 5–24 (concluded)
Calculations ($ in 000s):
a. Profit margin on sales = Net income ÷ Sales = 5%
Sales = $15 ÷ 5% = $300
b. Return on assets = Net income ÷ Total assets = 7.5%
Total assets = $15 ÷ 7.5% = $200
c. 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. Receivables turnover ratio = Sales ÷ Accounts receivable = 25
Accounts receivable = $300 ÷ 25 = $12
f. Acid-test ratio = Cash + AR + ST Investments ÷ Current liabilities = .9
Current liabilities = ($15 + 12 + 0) ÷ .9 = $30
g. Accounts payable = Current liabilities – Short-term notes = $30 – 5 = $25
h. Current ratio = Current assets ÷ Current liabilities = 2
Current assets = $30 x 2 = $60
i. Prepaid expenses and other current assets =
Current assets – (Cash + AR + Inventory) = $60 – (15 + 12 + 30) = $3
j. Property, plant, and equipment = Total assets – Current assets = $200 – 60 = $140
k. 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. 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. Operating expenses = (Sales – Cost of goods sold – Interest expense – Tax
expense) – Net income = ($300 – 180 – 2 – 7) – 15 = $96
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Intermediate Accounting, 7/e
Air France–KLM Case
Requirement 1
a. AF’s balance sheet indicates current deferred revenue on ticket sales of
€2,440 million as of March 31, 2011. While it is possible that AF has some
noncurrent deferred revenue on ticket sales, none is indicated in note 31 (other
noncurrent liabilities).
b. The journal entry would be:
Deferred revenue on ticket sales
Sales revenue
2,440
2,440
c. This seems consistent with U.S. GAAP. A liability for deferred revenue is
recognized when tickets are purchased, and then the deferred revenue is
reduced and revenue is recognized when the transportation service is
provided.
Requirement 2
a. From note 3.7: “In accordance with the IFRIC 13, 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.
The deferred amount due in relation to the acquisition of miles by members is
estimated:
- According to the fair value of ‘miles,’ defined as the amount at which the
benefits can be sold separately.
- After taking into account the redemption rate, corresponding to the
probability that the miles will be used by members, using statistical
method.”
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Air France-KLM Case (concluded)
b. Per the balance sheet, AF has a liability for “Frequent flyer programs” of €806
million.
c. AF’s approach is consistent with U.S. GAAP’s accounting for multipleelement contracts (ASC 605–25–15), 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.
Note: Accounting for customer loyalty programs is unresolved in U.S. GAAP.
Currently, 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). Airlines typically use the “incremental cost” method, 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. Yet, if companies sell “points” in their customer loyalty programs to third
parties, the portion of the sale that is for travel is estimated and recognized as
passenger revenue when the transportation is provided, similar to how it would be
treated under normal accounting for multiple deliverables.
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Intermediate Accounting, 7/e