Chapter 5 Solutions

Chapter 05 - Income Measurement and Profitability Analysis

5-1

Chapter 5 Income Measurement and Profitability

Analysis

Exercise 5-5

Requirement 1

July 1, 2011 To record installment sale

Installment receivables ................................................... 300,000

Sales revenue .............................................................. 300,000

Cost of goods sold .......................................................... 120,000

Inventory ..................................................................... 120,000

To record cash collection from installment sale

Cash ................................................................................ 75,000

Installment receivables ............................................... 75,000

July 1, 2012 To record cash collection from installment sale

Cash ................................................................................ 75,000


Requirement 2



Inventory ..................................................................... 120,000

Deferred gross profit .................................................. 180,000


Cash ................................................................................ 75,000


To recognize gross profit from installment sale

Deferred gross profit ...................................................... 45,000


5-2

Realized gross profit................................................... 45,000


Cash ................................................................................ 75,000





Requirement 3



Inventory ..................................................................... 120,000

Deferred gross profit .................................................. 180,000


Cash ................................................................................ 75,000



Cash ................................................................................ 75,000






5-3

Exercise 5-9

Requirement 1

2011 2012

Contract price $2,000,000 $2,000,000

Actual costs to date 300,000 1,875,000

Estimated costs to complete 1,200,000 - 0 -

Total estimated costs 1,500,000 1,875,000

Gross profit (estimated in 2011) $ 500,000 $ 125,000

Gross profit recognition:

2011: $ 300,000

= 20% x $500,000 = $100,000

$1,500,000

2012: $125,000 – $100,000 = $25,000

Requirement 2

2011 $ - 0 -

2012 $125,000

Requirement 3

Balance Sheet

At December 31, 2011

Current assets:

Accounts receivable $ 130,000

Costs and profit ($400,000*) in excess

of billings ($380,000)

20,000

* Costs ($300,000) + profit ($100,000)


5-4

Requirement 4

Balance Sheet

At December 31, 2011

Current assets:

Accounts receivable $ 130,000

Current liabilities:

Billings ($380,000) in excess of costs ($300,000) $ 80,000

Exercise 5-11

Requirement 1

2011 2012 2013

Contract price $8,000,000 $8,000,000 $8,000,000

Actual costs to date 2,000,000 4,500,000 8,300,000

Estimated costs to complete 4,000,000 3,600,000 - 0 -

Total estimated costs 6,000,000 8,100,000 8,300,000

Estimated gross profit (loss)

(actual in 2013) $2,000,000 $ (100,000) $ (300,000)

Gross profit (loss) recognition:

2011: $2,000,000

= 33.3333% x $2,000,000 = $666,667

$6,000,000

2012: $(100,000) – 666,667 = $(766,667)

2013: $(300,000) – (100,000) = $(200,000)


5-5

Requirement 2

2011 2012

Construction in progress 2,000,000 2,500,000

Various accounts 2,000,000 2,500,000

To record construction costs.

Accounts receivable 2,500,000 2,750,000

Billings on construction contract 2,500,000 2,750,000

To record progress billings.

Cash 2,250,000 2,475,000


To record cash collections.

Construction in progress (gross profit)

666,667

Cost of construction 2,000,000

Revenue from long-term contracts (33.3333% x $8,000,000)

2,666,667

To record gross profit.

Cost of construction (2) 2,544,000

Revenue from long-term contracts (1) 1,777,333

Construction in progress (loss) 766,667

To record expected loss.

(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 2011 (above) (2,666,667)

Revenue recognized in 2012 1,777,333 (1)

Plus: Loss recognized in 2012 (above) 766,667

Cost of construction, 2012 $2,544,000 (2)


5-6

Requirement 3

Balance Sheet 2011 2012

Current assets:

Accounts receivable $250,000 $525,000

Costs and profit ($2,666,667*) in

excess of billings ($2,500,000)

166,667


Billings ($5,250,000) in excess

of costs less loss ($4,400,000**)

$850,000

* Costs ($2,000,000) + profit ($666,667)

** Costs ($2,000,000 + $2,500,000) – loss ($100,000 = $766,667 – $666,667)

Exercise 5-12

Requirement 1

Year Gross profit (loss) recognized

2011 - 0 -

2012 $(100,000)

2013 (200,000)

Total project loss $(300,000)

Requirement 2

2011 2012

Construction in progress 2,000,000 2,500,000

Various accounts 2,000,000 2,500,000



Billings on construction contract 2,500,000 2,750,000


Cash 2,250,000 2,475,000




5-7

Loss on long-term contract 100,000

Construction in progress 100,000

To record an expected loss.

Exercise 5-12 (concluded)

Requirement 3


Current assets:

Accounts receivable $250,000 $525,000


Billings ($2,500,000) in excess of costs ($2,000,000)

$500,000

Billings ($5,250,000) in excess of costs less

loss ($4,400,000*)

$850,000

* Costs ($2,000,000 + $2,500,000) – loss ($100,000)

Exercise 5-14

Requirement 1

Construction in progress = Costs incurred + Profit recognized

$100,000 = ? + $20,000

Actual costs incurred in 2011 = $80,000

Requirement 2

Billings = Cash collections + Accounts Receivable

$94,000 = ? + $30,000

Cash collections in 2011 = $64,000


5-8

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

Exercise 5-15

Requirement 1

Revenue should be recognized as follows:

Software - date of shipment, July 1, 2011

Technical support - evenly over the 12 months of the agreement

Upgrade - date of shipment, January 1, 2012

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 $210,000 ÷ $270,000 x $243,000 = $189,000

Technical support $30,000 ÷ $270,000 x $243,000 = 27,000

Upgrade $30,000 ÷ $270,000 x $243,000 = 27,000

Total $243,000


5-9

Requirement 2

July 1, 2011 To record sale of software Cash ................................................................................ 243,000

Revenue ...................................................................... 189,000

Unearned revenue ($27,000 + 27,000) ........................... 54,000

Exercise 5-16

Requirement 1

Conveyer ($20,000 ÷ $50,000) x $45,000 = $18,000

Labeler ($10,000 ÷ $50,000) x $45,000 = 9,000

Filler ($15,000 ÷ $50,000) x $45,000 = 13,500

Capper ($5,000 ÷ $50,000) x $45,000 = 4,500

total $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.

Exercise 5-17

Requirement 1

Conveyer ($20,000 ÷ $50,000) x $45,000 = $18,000

Labeler ($10,000 ÷ $50,000) x $45,000 = 9,000

Filler ($15,000 ÷ $50,000) x $45,000 = 13,500

Capper ($5,000 ÷ $50,000) x $45,000 = 4,500

total $45,000


5-10

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.

Problem 5-5

Requirement 1

2011 2012 2013

Contract price $10,000,000 $10,000,000 $10,000,000





(actual in 2013) $ 2,000,000 $ 2,000,000 $ 1,800,000


2011: $2,400,000

= 30.0% x $2,000,000 = $600,000

$8,000,000

2012: $6,000,000

= 75.0% x $2,000,000 = $1,500,000 – 600,000 = $900,000

$8,000,000

2013: $1,800,000 – 1,500,000 = $300,000

Requirement 2

2011 2012 2013

Construction in progress 2,400,000 3,600,000 2,200,000

Various accounts 2,400,000 3,600,000 2,200,000


Accounts receivable 2,000,000 4,000,000 4,000,000


5-11

Billings on construction

contract

2,000,000 4,000,000 4,000,000


Cash 1,800,000 3,600,000 4,600,000



Construction in progress

(gross profit)

600,000 900,000 300,000

Cost of construction

(cost incurred)

2,400,000 3,600,000 2,200,000

Revenue from long-term

contracts (1)

3,000,000 4,500,000 2,500,000


(1) Revenue recognized:

2011: 30% x $10,000,000 = $3,000,000

2012: 75% x $10,000,000 = $7,500,000

Less: Revenue recognized in 2011 (3,000,000)

Revenue recognized in 2012 $4,500,000

2013: 100% x $10,000,000 = $10,000,000

Less: Revenue recognized in 2011 & 2012 (7,500,000)

Revenue recognized in 2013 $2,500,000

Requirement 3


Current assets:

Accounts receivable $ 200,000 $600,000

Construction in progress $3,000,000 $7,500,000

Less: Billings (2,000,000) (6,000,000)

Costs and profit in excess

of billings

1,000,000

1,500,000


5-12

Requirement 4

2011 2012 2013

Costs incurred during the year $2,400,000 $3,800,000 $3,200,000

Estimated costs to complete

as of year-end 5,600,000 3,100,000 -

2011 2012 2013

Contract price $10,000,000 $10,000,000 $10,000,000




Estimated gross profit

(actual in 2013) $ 2,000,000 $ 700,000 $ 600,000


2011: $2,400,000

= 30.0% x $2,000,000 = $600,000

$8,000,000

2012: $6,200,000

= 66.6667% x $700,000 = $466,667 – 600,000 = $(133,333)

$9,300,000

2013: $600,000 – 466,667 = $133,333

Requirement 5

2011 2012 2013



as of year-end 5,600,000 4,100,000 -

2011 2012 2013

Contract price $10,000,000 $10,000,000 $10,000,000





5-13


(actual in 2013) $ 2,000,000 $ (300,000) $ (100,000)


2011: $2,400,000

= 30.0% x $2,000,000 = $600,000

$8,000,000

2012: $(300,000) – 600,000 = $(900,000)

2013: $(100,000) – (300,000) = $200,000

Problem 5-7

Requirement 1

Year Gross profit recognized

2011 - 0 -

2012 - 0 -

2013 $1,800,000

Total gross profit $1,800,000


5-14

Requirement 2

2011 2012 2013

Construction in progress 2,400,000 3,600,000 2,200,000

Various accounts 2,400,000 3,600,000 2,200,000



Billings on construction

contract

2,000,000 4,000,000 4,000,000


Cash 1,800,000 3,600,000 4,600,000



Construction in progress

(gross profit)

1,800,000

Cost of construction

(costs incurred)

2,400,000 3,600,000 2,200,000

Revenue from long-term

contracts (contract price)

2,400,000 3,600,000 4,000,000



5-15

Problem 5-7 (concluded)

Requirement 3


Current assets:

Accounts receivable $ 200,000 $ 600,000

Construction in progress $2,400,000 $6,000,000

Less: Billings (2,000,000) (6,000,000)

Costs in excess of billings 400,000 - 0 -

Requirement 4

2011 2012 2013



as of year-end 5,600,000 3,100,000 -

Year Gross profit recognized

2011 - 0 -

2012 - 0 -

2013 $600,000

Total gross profit $600,000

Requirement 5

2011 2012 2013



as of year-end 5,600,000 4,100,000 -

Year Gross profit (loss) recognized

2011 - 0 -

2012 $(300,000)

2013 200,000

Total project loss $(100,000)


5-16

CPA Exam Questions

1. b. The earnings process is completed upon delivery of the product. Therefore,

in 2011, revenue for 50,000 gallons at $3 each is recognized. The payment

terms do not affect revenue recognition.

2. d. The deferred gross profit in the balance sheet at December 31, 2012 should

be the balances in the accounts receivable accounts for 2011 and 2012

multiplied times the appropriate gross profit percentage:

Accounts Receivable 2011 2012

Total Sales 600,000 900,000

Less: Collections (300,000) (300,000)

Less: Write Offs (200,000) (50,000)

Accounts Receivable Balance 100,000 550,000

x Gross Profit Rate x 30% x 40%

Deferred Gross Profit

12/31/2012 30,000 220,000

The Combined Deferred Gross Profit in the Balance Sheet is $250,000

($220,000 + $30,000).

3. a. Year of sale

2011 2012

a. Gross profit realized $240,000 $200,000

b. Percentage 30% 40%

c. Collections on sales (a/b) $800,000 $500,000

Total sales 1,000,000 2,000,000

Balance uncollected $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. Construction-in-progress does not include the cumulative

effect of gross profit recognition under the completed contract method.


5-17

5. c.

2011 actual costs

$20,000

Total estimated costs ÷ 60,000

Ratio = 1/3

Contract Price x 100,000

Revenue 33,333

2011 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 2011.

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

since the title of the goods passed to the purchaser. The cost-recovery method

is not used because the receivable was not deemed uncollectible until June 10.

2. d. Based on the revenue recognition principle, 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 principle of

revenue recognition, 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

$8,000,000. Revenues of $8,000,000 minus costs of $6,000,000 equals a gross

profit of $2,000,000.

Chapter 5 Solutions

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