Académique Documents
Professionnel Documents
Culture Documents
com
Chapter 5
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 dont 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
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 5-4
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 5-5
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.
Question 5-6
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
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, its more meaningful to recognize
revenue over time in proportion to the performance of the activity.
Question 5-9
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 projects expected
revenues and costs to each period in which the earnings process takes place, i.e., the construction
period. The fair share means 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.
Question 5-10
The billings on construction contract account is a contra account to the asset, construction in
progress. 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 on the balance sheet as an asset. Conversely, if the net
amount is a credit, it is reported as a liability.
Question 5-11
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 5-12
These SOPs require 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, regardless of any separate prices stated within the contract for each element.
Question 5-14
Receivables turnover ratio
Net sales
Average accounts receivable (net)
Net sales
Average total assets
Net income
Net sales
Return on assets
Net income
Average total assets
Return on shareholders'
equity
Net income
Average shareholders' equity
Question 5-16
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.
BRIEF EXERCISES
Brief Exercise 5-1
2006 gross profit = $3,000,000 1,200,000 = $1,800,000
2007 gross profit = 0
$1,800,000
(90,000)
(90,000)
$1,620,000
The McGraw-Hill Companies, Inc., 2007
5-5
$5,000,000
40%
$2,000,000
$2,000,000
1,000,000
$5,000,000
40%
$2,000,000
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
Net sales
The McGraw-Hill
Companies,
Average accounts
receivable
(net) Inc., 2007
5-7
$600,000
[$100,000 + 120,000] 2
$400,000*
[$80,000 + 60,000] 2
5.71 times
*$600,000 200,000
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%
$500,000
65,000
(20,000)
$545,000
$75,000
Cost of goods sold
= $75,000 x 6.0 = $450,000
Sales
$600,000
EXERCISES
Exercise 5-1
Requirement 1
2006 Cost recovery %:
$234,000
= 65% (gross profit % = 35%)
$360,000
2007 Cost recovery %:
$245,000
= 70% (gross profit % = 30%)
$350,000
2006 gross profit:
Cash collection from 2006 sales of $150,000 x 35% =
$52,500
$ 35,000
36,000
$71,000
Requirement 2
2006 deferred gross profit balance:
2006 initial gross profit ($360,000 - 234,000)
Less: Gross profit recognized in 2006
Balance in deferred gross profit account
$126,000
(52,500)
$73,500
$ 126,000
(52,500)
(35,000)
105,000
(36,000)
$107,500
Exercise 5-2
2006
To record installment sales
Installment receivables .................................................. 360,000
Inventory ...................................................................
234,000
Deferred gross profit .................................................
126,000
2006
To record cash collections from installment sales
Cash .............................................................................. 150,000
Installment receivables ..............................................
150,000
2006
To recognize gross profit from installment sales
Deferred gross profit ..................................................... 52,500
Realized gross profit..................................................
52,500
2007
To record installment sales
Installment receivables .................................................. 350,000
Inventory ...................................................................
245,000
Deferred gross profit .................................................
105,000
2007
To record cash collections from installment sales
Cash .............................................................................. 220,000
Installment receivables ..............................................
220,000
2007
To recognize gross profit from installment sales
Deferred gross profit ..................................................... 71,000
Realized gross profit..................................................
71,000
Exercise 5-3
Requirement 1
Year
2006
2007
2008
2009
Total
Income recognized
$180,000 ($300,000 - 120,000)
-0-0-0$180,000
Requirement 2
Year
2006
2007
2008
2009
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
2006
2007
2008
2009
Totals
Cash Collected
$ 75,000
75,000
75,000
75,000
$300,000
Exercise 5-4
Requirement 1
July 1, 2006
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, 2007
To record cash collection from installment sale
Cash .............................................................................. 75,000
Installment receivables ..............................................
75,000
Exercise 5-5
Requirement 1
Cost of goods sold ($1,000,000 - 600,000)
Add: Gross profit if use cost recovery method
Cash collected
$400,000
100,000
$500,000
Requirement 2
$ 600,000
Gross profit percentage =
= 60%
$1,000,000
Exercise 5-6
Requirement 1
April 1, 2006
To record installment sale
Installment receivables .................................................. 2,400,000
Land ..........................................................................
480,000
Gain on sale of land...................................................
1,920,000
April 1, 2006
To record cash collection from installment sale
Cash .............................................................................. 120,000
Installment receivables ..............................................
120,000
April 1, 2007
To record cash collection from installment sale
Cash .............................................................................. 120,000
Installment receivables ..............................................
120,000
April 1, 2006
To record cash collection from installment sale
Cash .............................................................................. 120,000
Installment receivables ..............................................
120,000
To recognize profit from installment sale
Deferred gain ................................................................
96,000
Gain on sale of land (80% x $120,000)..........................
96,000
April 1, 2007
To record cash collection from installment sale
Cash .............................................................................. 120,000
Installment receivables ..............................................
120,000
To recognize profit from installment sale
Deferred gain ................................................................
96,000
Gain on sale of land (80% x $120,000)..........................
96,000
Exercise 5-7
Requirement 1
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Gross profit (estimated in 2006)
2006
$2,000,000
300,000
1,200,000
1,500,000
$ 500,000
2007
$2,000,000
1,875,000
-01,875,000
$ 125,000
Requirement 2
2006
2007
$
-0$125,000
Requirement 3
Balance Sheet
At December 31, 2006
Current assets:
Accounts receivable
Costs and profit ($400,000*) in excess
of billings ($380,000)
$ 130,000
20,000
$ 130,000
Current liabilities:
Billings ($380,000) in excess of costs ($300,000)
$ 80,000
Exercise 5-8
Requirement 1
($ in millions)
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (actual in 2008)
2006
$220
40
120
160
$ 60
2007
$220
120
60
180
$ 40
2008
$220
170
-0170
$ 50
$40
= 25% x $60 = $15
$160
2007:
$120
= 66.67% x $40 = $26.67 - $15 = $11.67
$180
2008:
Requirement 2
2006:
$220 x 25% = $55
2007:
$220 x 66.67% = $146.67 55 = $91.67
2008:
$220 146.67 = $73.33
Requirement 3
Year
2006
2007
2008
Total project income
Requirement 4
2007:
$120
= 60% x $20* = $12 - 15 = $(3) loss
$200
*$220 ($40 + 80 + 80) = $20
Exercise 5-9
Requirement 1
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)
(actual in 2008)
2006
$8,000,000
2,000,000
4,000,000
6,000,000
2007
$8,000,000
4,500,000
3,600,000
8,100,000
2008
$8,000,000
8,300,000
-08,300,000
$2,000,000
$ (100,000)
$ (300,000)
= $(766,667)
2006
2007
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
(1)
2,544,000
1,777,333
766,667
2006
2007
$250,000 $525,000
166,667
$850,000
Exercise 5-10
Requirement 1
Year
2006
2007
2008
Total project loss
Requirement 2
Construction in progress
Various accounts
To record construction costs.
2006
2007
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
100,000
100,000
2006
$250,000
2007
$525,000
Current liabilities:
Billings ($2,500,000) in excess of costs
($2,000,000)
$500,000
$850,000
Exercise 5-11
Situation 1 - Percentage-of-Completion
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit
(actual in 2008)
2006
$5,000,000
1,500,000
3,000,000
4,500,000
2007
$5,000,000
3,600,000
900,000
4,500,000
2008
$5,000,000
4,500,000
-04,500,000
$ 500,000
$ 500,000
$ 500,000
$1,500,000
= 33.3333% x $500,000 = $166,667
$4,500,000
2007:
$3,600,000
= 80.0% x $500,000 = $400,000 - 166,667 = $233,333
$4,500,000
2008:
2006
$5,000,000
1,500,000
3,000,000
4,500,000
2007
$5,000,000
2,400,000
2,400,000
4,800,000
2008
$5,000,000
4,800,000
-04,800,000
$ 500,000
$ 200,000
$ 200,000
$1,500,000
= 33.3333% x $500,000 = $166,667
$4,500,000
2007:
$2,400,000
= 50.0% x $200,000 = $100,000 - 166,667 = $(66,667)
$4,800,000
2008:
2006
$5,000,000
1,500,000
3,000,000
4,500,000
2007
$5,000,000
3,600,000
1,500,000
5,100,000
2008
$5,000,000
5,200,000
-05,200,000
$ 500,000
$ (100,000)
$ (200,000)
$1,500,000
= 33.3333% x $500,000 = $166,667
$4,500,000
2007:
$(100,000) - 166,667
= $(266,667)
2008:
2006
$5,000,000
500,000
3,500,000
4,000,000
2007
$5,000,000
3,500,000
875,000
4,375,000
2008
$5,000,000
4,500,000
-04,500,000
$1,000,000
$ 625,000
$ 500,000
$ 500,000
= 12.5% x $1,000,000 = $125,000
$4,000,000
2007:
$3,500,000
= 80.0% x $625,000 = $500,000 - 125,000 = $375,000
$4,375,000
2008:
$500,000 - 500,000 = $ - 0 -
2006
$5,000,000
500,000
3,500,000
4,000,000
2007
$5,000,000
3,500,000
1,500,000
5,000,000
2008
$5,000,000
4,800,000
-04,800,000
$1,000,000
$ 200,000
-0-
$ 500,000
= 12.5% x $1,000,000 = $125,000
$4,000,000
2007:
$ 0 - 125,000 = $(125,000)
2008:
$200,000 - 0 = $200,000
2006
$5,000,000
500,000
4,600,000
5,100,000
2007
$5,000,000
3,500,000
1,700,000
5,200,000
2008
$5,000,000
5,300,000
-05,300,000
$ (100,000)
$ (200,000)
$ (300,000)
$(100,000)
2007:
2008:
Exercise 5-12
Requirement 1
Construction in progress = Costs incurred + Profit recognized
$100,000
$20,000
$30,000
Exercise 5-13
Requirement 1
Revenue should be recognized as follows:
Software
date of shipment, July 1, 2006
Technical support evenly over the 12 months of the agreement
Upgrade
date of shipment, January 1, 2007
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
Requirement 2
July 1, 2006
Exercise 5-14
October 1, 2006
To record franchise agreement and down payment
Cash (10% x $300,000) ..................................................... 30,000
Note receivable ............................................................. 270,000
Unearned franchise fee revenue.................................
300,000
Exercise 5-15
1.
2.
3.
4.
c
d
a
b
Exercise 5-16
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
Exercise 5-17
Requirement 1
Inventory turnover ratio
$1,840,000
[$690,000 + 630,000] 2
2.79 times
Requirement 2
By itself, very little. 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.
Its 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.
Exercise 5-18
Turnover ratios for Anderson Medical Supply Company for 2006:
Inventory 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).
Exercise 5-19
Requirement 1
a. Profit margin on sales
b. Return on assets
c. Return on shareholders equity
Requirement 2
Retained earnings beginning of period
Add: Net income
$100,000
180,000
280,000
150,000
$130,000
Exercise 5-20
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.
Exercise 5-21
First
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
Exercise 5-22
Incentive compensation
Depreciation expense
Gain on sale
Exercise 5-23
1st
Advertising
$200,000
Property tax
87,500
Equipment repairs
65,000
Extraordinary casualty loss
0
Research and development
0
2nd
$200,000
87,500
65,000
185,000
32,000
3rd
$200,000
87,500
65,000
0
32,000
4th
$200,000
87,500
65,000
0
32,000
PROBLEMS
Problem 5-1
REAGAN CORPORATION
Income Statement
For the Year Ended December 31, 2006
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
2.21
0.60
$ 2.81
$160,000
(40,000)
$120,000
Problem 5-2
Requirement 1
2006 Cost recovery % :
$180,000
= 60% (gross profit % = 40%)
$300,000
2007 Cost recovery %:
$280,000
= 70% (gross profit % = 30%)
$400,000
2006 gross profit:
Cash collection from 2006 sales = $120,000 x 40% =
$48,000
$ 40,000
45,000
$85,000
Requirement 2
2006
To record installment sales
Installment receivables .................................................. 300,000
Inventory ...................................................................
180,000
Deferred gross profit .................................................
120,000
2006
To record cash collections from installment sales
Cash .............................................................................. 120,000
Installment receivables ..............................................
120,000
2006
To recognize gross profit from installment sales
Deferred gross profit ..................................................... 48,000
Realized gross profit..................................................
48,000
Cash Collected
Cost Recovery
Gross Profit
2006
2006 sales
$120,000
$120,000
-0-
2007
2006 sales
2007 sales
2007 totals
$100,000
150,000
$250,000
$ 60,000
150,000
$210,000
$40,000
-0$40,000
Problem 5-3
Requirement 1
Total profit = $500,000 - 300,000 = $200,000
Installment sales method: Gross profit % = $200,000 $500,000 = 40%
8/31/06
8/31/07
8/31/08
8/31/09
8/31/10
Cash collections
$200,000
-0-
-0-
-0-
-0-
$40,000
-0-
-0-
- 0 - $100,000 $100,000
Installment receivable
Sales revenue
Cost of goods sold
Inventory
To record sale on 8/31/06.
Point of
Delivery
500,000
500,000
300,000
300,000
Installment receivable
Inventory
Deferred gross profit
To record sale on 8/31/06.
Cash
Installment receivable
Entry made each Aug. 31.
Deferred gross profit
Realized gross profit
To record gross profit.
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
Installment
Sales
Cost
Recovery
400,000
400,000
(160,000)
240,000
400,000
(200,000)
200,000
300,000
300,000
(120,000)
180,000
300,000
(200,000)
100,000
Problem 5-4
Requirement 1
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)
(actual in 2008)
2006
$10,000,000
2,400,000
5,600,000
8,000,000
2007
$10,000,000
6,000,000
2,000,000
8,000,000
2008
$10,000,000
8,200,000
-08,200,000
$ 2,000,000
$ 2,000,000
$ 1,800,000
2007
2008
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
$3,000,000
$7,500,000
(3,000,000)
$4,500,000
$10,000,000
(7,500,000)
$2,500,000
Requirement 3
Balance Sheet
Current assets:
Accounts receivable
Construction in progress
Less: Billings
Costs and profit in excess
of billings
2006
2007
$ 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 2008)
2006
$2,400,000
2007
$3,800,000
2008
$3,200,000
5,600,000
3,100,000
2006
$10,000,000
2,400,000
5,600,000
8,000,000
2007
$10,000,000
6,200,000
3,100,000
9,300,000
2008
$10,000,000
9,400,000
-09,400,000
$ 2,000,000
$ 700,000
$ 600,000
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 2008)
2006
$2,400,000
2007
$3,800,000
5,600,000
4,100,000
2006
$10,000,000
2,400,000
5,600,000
8,000,000
2007
$10,000,000
6,200,000
4,100,000
10,300,000
$ 2,000,000
$ (300,000)
2008
$3,900,000
2008
$10,000,000
10,100,000
-010,100,000
$ (100,000)
$2,400,000
= 30.0% x $2,000,000 = $600,000
$8,000,000
2007:
2008:
Problem 5-5
Requirement 1
Year
2006
2007
2008
Total gross profit
Requirement 2
Construction in progress
Various accounts
To record construction costs.
2006
2007
2008
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
1,800,000
8,200,000
10,000,000
(contract price)
Requirement 3
Balance Sheet
Current assets:
Accounts receivable
Construction in progress
Less: Billings
Costs in excess of billings
2006
2007
$ 200,000
$ 600,000
$2,400,000
(2,000,000)
$6,000,000
(6,000,000)
400,000
-0-
2006
$2,400,000
2007
$3,800,000
5,600,000
3,100,000
2008
$3,200,000
-
Requirement 5
Costs incurred during the year
Estimated costs to complete
as of year-end
Year
2006
2007
2008
Total project loss
2006
$2,400,000
2007
$3,800,000
5,600,000
4,100,000
2008
$3,900,000
-
Problem 5-6
Requirement 1
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)
(actual in 2008)
2006
$4,000,000
350,000
3,150,000
3,500,000
2007
$4,000,000
2,500,000
1,700,000
4,200,000
2008
$4,000,000
4,250,000
-04,250,000
$ 500,000
$ (200,000)
$ (250,000)
Year
2006
2007
2008
Total project loss
Requirement 2
Gross profit (loss) recognition:
2006:
2007:
2008:
Requirement 3
Balance Sheet
2006
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)
2007
$ 130,000
$ 320,000
Problem 5-7
Requirement 1
a. January 30, 2006
Cash ............................................................................. 200,000
Note receivable ............................................................ 1,000,000
Unearned franchise fee revenue.................................
1,200,000
b.
September 1, 2006
1,200
1,200
Cash ..............................................................................
Note receivable .........................................................
100,000
100,000
September 1, 2006
200,000
200,000
1,200
1,200
Cash ..............................................................................
Note receivable .........................................................
100,000
100,000
100,000
100,000
Problem 5-8
1.
2.
3.
4.
5.
6.
7.
Problem 5-9
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
365
Receivables turnover
J&J
365
6.37
= 57 days
Pfizer
365
5.15
= 71 days
J&J
$12,176
$3,588
= 3.39 times
Pfizer
$9,832
$5,837
= 1.68 times
365
Inventory turnover
J&J
365
3.39
= 108 days
Pfizer
365
1.68
= 217 days
Net income
Total assets
J&J
$7,197
$48,263
14.9%
Pfizer
$1,639
$116,775
1.4%
Net income
Net sales
$ 7,197
$41,862
$41,862
$48,263
.867 times
=
Pfizer
Profit margin
on sales
17.19%
Asset
turnover
Net sales
Total assets
$ 1,639
$45,188
$45,188
$116,775
3.63%
.387 times
14.9%
1.4%
J&Js 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., 2007
5-58
Net income
Shareholders equity
J&J
$7,197
$26,869
= 26.8%
Pfizer
$1,639
$65,377
= 2.5%
Problem 5-10
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
$ 10
20
30
60
140
$200
Problem 5-11
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%
Net income
Net sales
Metropolitan =
=
Republic =
=
Profit margin
on sales
x
Asset
turnover
Net sales
Total assets
$ 593.8
$5,698.0
$5,698.0
$4,021.5
10.4%
1.42 times =
$ 424.6
$7,768.2
$7,768.2
$4,008.0
5.5%
1.94 times =
14.8%
10.7%
Republics profit margin is much less than that of Metropolitan, but partially
makes up for it with a higher turnover.
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%
Total liabilities
Shareholders equity
Metropolitan
$2,304.4
$144.9 + 2,476.9 - 904.7
= 1.34
Republic
$3,035.2
$335.0 + 1,601.9 - 964.1
= 3.12
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. Republics 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.
Current assets
Current liabilities
Metropolitan
$1,203.0
$1,280.2
.94
Republic
$1,478.7
$1,787.1
.83
Acid-test ratio
Metropolitan
.47
Republic
.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
Metropolitan
$5,698.0
$422.7
= 13.5 times
Republic
$7,768.2
$325.0
= 23.9 times
Metropolitan
$2,909.0
$466.4
= 6.2 times
Republic
$4,481.7
$635.2
= 7.1 times
Metropolitan
= 18.4 times
Republic
= 16.0 times
Problem 5-12
Branson Electronics Company
Income Statement
Revenues
Cost of goods sold
Gross profit
Advertising expense1
Other operating expenses2
Income before income taxes
Income tax expense3
Net income
1$50,000
2$48,000
3$75,500
$180,000
35,000
145,000
(12,500)
(57,000)
75,500
(27,180)
$ 48,320
4 = $12,500
+ [$59,000 50,000]
x 36%
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
companys future earnings. Sunbeams earnings management strategy produced a
1997 earnings figure that was not indicative of the companys future profit-generating
ability.
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.
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.
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.
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
_______
15
_______
______
70 points
Writing (30%)
_______
6
_______
12
_______
12
English
______ Sentences grammatically clear and well organized,
concise.
______ Word selection.
______ Spelling.
______ Grammar and punctuation.
_______
______
30 points
$ 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)
Income Statement
Sales
Cost of goods sold
Gross profit
Operating
expenses
Solutions Manual,
Vol.1, Chapter
5
Interest expense
Tax expense
Net income
$300,000 (a)
(180,000) (c)
120,000
(c)
The McGraw-Hill Companies, Inc., 2007
(96,000) (o)
5-79
(2,000) (m)
(7,000) (n)
$ 15,000 given
$ 6,067
= 25%
$24,710
Requirement 3
($ in millions)
c. Return on assets