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Chapter 5

Income Measurement and Profitability Analysis

EXERCISES
Exercise 5-1
Year
2013
2014
2015
2016
2017
Total

Requirement 1
Income recognized
$250,000 ($400,000 - 150,000)
0
0
0
0
$250,000

Requirement 2
Year
2013
2014
2015
2016
2017
Totals

Cash Collected
$100,000
75,000
75,000
75,000
75,000
$400,000

Cost Recovery(37.5%)
$ 37,500
28,125
28,125
28,125
28,125
$150,000

Gross Profit(62.5%)
$ 62,500
46,875
46,875
46,875
46,875
$250,000

Cost Recovery
$100,000
50,000
-0-0-0$150,000

Gross Profit
-0$ 25,000
75,000
75,000
75,000
$250,000

Requirement 3
Year
2013
2014
2015
2016
2017
Totals

Cash Collected
$100,000
75,000
75,000
75,000
75,000
$400,000

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2013


5-1

Exercise 5-2

Requirement 1

Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated (actual) gross profit

2013
$2,600,000
360,000
1,560,000
1,920,000
$ 680,000

2014
$2,600,000
2,010,000
-02,010,000
$ 590,000

Gross profit recognition:


2013: $ 360,000
= 18.75% x $680,000 = $127,500
$1,920,000
2014:

$590,000 - 127,500 = $462,500

Requirement 2
2013
2014

$
-0$590,000

Requirement 3
Balance Sheet
At December 31, 2013
Current assets:
Accounts receivable
Costs and profit ($487,500)* in excess
of billings ($430,000)

$ 110,000
57,500

* Costs ($360,000) + profit ($127,500)

The McGraw-Hill Companies, Inc., 2013


5-2

Intermediate Accounting, 7/e

Exercise 5-2 (concluded)


Requirement 4
Balance Sheet
At December 31, 2013
Current assets:
Accounts receivable

$ 110,000

Current liabilities:
Billings ($430,000) in excess of costs ($360,000)

$ 70,000

Exercise 5-3

Requirement 1

Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)

2013
$12,000,000
3,000,000
6,000,000
9,000,000
$ 3,000,000

2014
$12,000,000
7,000,000
5,600,000
12,600,000
$ (600,000)

2015
$12,000,000
12,800,000
-012,800,000
$ (800,000)

Gross profit (loss) recognition:


2013: $3,000,000
= 33.3333% x $3,000,000 = $1,000,000
$9,000,000
2014: $(600,000) - 1,000,000

= $(1,600,000)

2015: $(800,000) - (600,000) = $(200,000)

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2013


5-3

Exercise 5-3 (continued)


Requirement 2
Construction in progress
Various accounts
To record construction costs.

2013
2014
3,000,000
4,000,000
3,000,000
4,000,000

Accounts receivable
Billings on construction contract
To record progress billings.

3,800,000
3,500,000
3,800,000
3,500,000

Cash
Accounts receivable
To record cash collections.

3,250,000
3,600,000
3,250,000
3,600,000

Construction in progress
(gross profit)

Cost of construction
Revenue from long-term contracts

1,000,000
3,000,000
4,000,000

(33.3333% x $12,000,000)

To record gross profit.


Cost of construction (2)
Revenue from long-term contracts
Construction in progress (loss)
To record expected loss.

(1)

4,266,667
2,666,667
1,600,000

(1) and (2):


Percent complete = $7,000,000 $12,600,000 = 55.55%
Revenue recognized to date:
55.55% x $12,000,000 =
$6,666,667
Less: Revenue recognized in 2013 (above)
(4,000,000)
Revenue recognized in 2014
2,666,667 (1)
Plus: Loss recognized in 2014 (above)
1,600,000
Cost of construction, 2014
$4,266,667 (2)

The McGraw-Hill Companies, Inc., 2013


5-4

Intermediate Accounting, 7/e

Exercise 5-3 (concluded)


Requirement 3
Balance Sheet

2013

Current assets:
Accounts receivable
Costs and profit ($4,000,000)* in
excess of billings ($3,800,000)

2014

$550,000 $450,000
200,000

Current liabilities:
Billings ($7,300,000) in excess
of costs less loss ($6,400,000)

$900,000

* Costs ($3,000,000) + profit ($1,000,000)

Exercise 5-4
November 15, 2013 To record franchise agreement and down payment
Cash (50% x $25,000)........................................................ 12,500
Note receivable............................................................... 12,500
Unearned franchise fee revenue..................................
25,000

February 15, 2014 To recognize franchise fee revenue


Unearned franchise fee revenue...................................... 25,000
Franchise fee revenue..................................................

Exercise 5-5

25,000

Turnover ratios for Garret & Sons Music Company for 2013:

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2013


5-5

Inventory turnover ratio

Receivables turnover ratio

Average collection period

Asset turnover ratio

$6,000,000
[$850,000 + 700,000] 2

7.74 times

$10,000,000
[$800,000 + 600,000] 2

14.29 times

365
14.29

25.5 days

$10,000,000
[$4,490,000 + 4,100,000]

2.33 times

The company turns its inventory over 7 times per year compared to the industry
average of 6 times per year. The asset turnover ratio also is slightly better than the
industry average (2.33 times per year versus 2 times). These ratios indicate that Garret
& Sons is able to generate more sales per dollar invested in inventory and in total assets
than the industry averages. The company also is able to collect its receivables quicker
than the industry average (25.5 days compared to the industry average of 28 days).

Exercise 5-6

Requirement 1

a. Profit margin on sales


b. Return on assets
c. Return on shareholders equity

$360 $7,200 = 5%
$360 [($2,900 + 2,700) 2] = 12.86%
$360 [($1,700 + 1,550) 2] = 22.2%

Requirement 2
a. Profit margin on sales
$360 $7,200 = 5%
b. Asset turnover
$7200 [($2,900 + 2,700) 2] = 2.57
c. Equity multiplier
[($2,900 + 2,700) 2] [($1,700 + 1,550) 2] = 1.72
d. Return on shareholders equity
$360 [($1,700 + 1,550) 2] = 22.2%
5% x 2.57 x 1.72 = 22.1%
The McGraw-Hill Companies, Inc., 2013
5-6

Intermediate Accounting, 7/e

Requirement 3
Retained earnings beginning of period
Add: Net income
Less: Retained earnings end of period
Dividends paid

$550,000
360,000
910,000
700,000
$210,000

Exercise 5-7Requirement 1
$30,000 + ($10,000 x 35%) = $33,500
Requirement 2
The most likely amount is $30,000, because the probability of exceeding the
performance threshold is less than 50%.
Requirement 3
Given that the outcome is binary (Mohan 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 Mohans control (because
Fisher is responsible for implementation), Mohan would view the bonus as not
reasonably assured. Therefore, Mohan would recognize only $30,000 upon
delivery of the plan and wait until receipt of the bonus is reasonably assured
(likely waiting until cost saving reaches the pre-specified target) before
recognizing the bonus.

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2013


5-7

PROBLEMS
Problem 5-1

Requirement 1

Total profit = $800,000 - 400,000 = $400,000


Installment sales method: Gross profit % = $400,000 $800,000 = 50%
10/31/13 10/31/14 10/31/15 10/31/16
Cash collections

$200,000 $200,000 $200,000 $200,000

a. Point of delivery method

$400,000

-0-

-0-

-0-

b. Installment sales method


(50% x cash collected)

c. Cost recovery method

The McGraw-Hill Companies, Inc., 2013


5-8

$100,000 $100,000 $100,000 $100,000


-0-

- 0 - $200,000 $200,000

Intermediate Accounting, 7/e

Problem 5-1 (continued)


Requirement 2

Installment receivable
Sales revenue
Cost of goods sold
Inventory
To record sale on 10/31/13.

Point of
Delivery
800,000
800,000
400,000
400,000

Installment receivable
Inventory
Deferred gross profit
To record sale on 10/31/14.
Cash
Installment receivable
Entry made each Oct. 31.
Deferred gross profit
Realized gross profit
To record gross profit.
Entry made each Oct. 31.
Deferred gross profit
Realized gross profit
To record gross profit.
Entry made 10/31/15 &
10/31/16.

Alternate Exercise and Problem Solutions

Installment
Sales

800,000

Cost Recovery

800,000
400,000
400,000

200,000

200,000
200,000

400,000
400,000
200,000

200,000

200,000

100,000
100,000

200,000
200,000

The McGraw-Hill Companies, Inc., 2013


5-9

Problem 5-1 (concluded)


Requirement 3
Point of
Delivery

Installment
Sales

Cost
Recovery

December 31, 2013


Assets
Installment receivables
Less: Deferred gross profit
Installment receivables, net

600,000

600,000
(300,000)
300,000

600,000
(400,000)
200,000

December 31, 2014


Assets
Installment receivable
Less: Deferred gross profit
Installment receivables, net

400,000

400,000
(200,000)
200,000

400,000
(400,000)
-0-

Problem 5-2Requirement 1
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)

2013
$15,000,000
4,000,000
8,000,000
12,000,000
$ 3,000,000

2014
$15,000,000
8,800,000
4,000,000
12,800,000
$ 2,200,000

2015
$15,000,000
13,000,000
-013,000,000
$ 2,000,000

Gross profit (loss) recognition:


2013: $4,000,000
= 33.33% x $3,000,000 = $1,000,000
$12,000,000
2014: $8,800,000
= 68.75% x $2,200,000 = $1,512,500 - 1,000,000 = $512,500
$12,800,000
2015: $2,000,000 - 1,512,500 = $487,500
Requirement 2
The McGraw-Hill Companies, Inc., 2013
5-10

Intermediate Accounting, 7/e

2013

2014

2015

Construction in progress
Various accounts
To record construction costs.

4,000,000
4,800,000
4,200,000
4,000,000
4,800,000
4,200,000

Accounts receivable
Billings on construction contract
To record progress billings.

3,500,000
5,000,000
6,500,000
3,500,000
5,000,000
6,500,000

Cash
Accounts receivable
To record cash collections.

2,800,000
5,600,000
6,600,000
2,800,000
5,600,000
6,600,000

Construction in progress (gross profit) 1,000,000


512,500
487,500
Cost of construction (cost incurred)
4,000,000
4,800,000
4,200,000
Revenue from long-term contracts (1)
5,000,000
5,312,500
4,687,500
To record gross profit.

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2013


5-11

Problem 5-2 (continued)


(1) Revenue recognized:
2013: 33.33% x $15,000,000 =
2014: 68.75% x $15,000,000 =
Less: Revenue recognized in 2013
Revenue recognized in 2014
2015: 100% x $15,000,000 =
Less: Revenue recognized in 2013 & 2014
Revenue recognized in 2015

$5,000,000
$10,312,500
(5,000,000)
$5,312,500
$15,000,000
(10,312,500)
$4,687,500

Requirement 3
Balance Sheet
Current assets:
Accounts receivable
Construction in progress
Less: Billings
Costs and profit in excess
of billings

2013

2014

$ 700,000
$5,000,000
(3,500,000)

$100,000
$10,312,500
(8,500,000)

1,500,000

1,812,500

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 (loss)

The McGraw-Hill Companies, Inc., 2013


5-12

2013
$4,000,000

2014
$4,200,000

8,000,000

7,100,000

2013
$15,000,000
4,000,000
8,000,000
12,000,000
$ 3,000,000

2014
$15,000,000
8,200,000
7,100,000
15,300,000
$ (300,000)

2015
$7,200,000
2015
$15,000,000
15,400,000
-015,400,000
$ (400,000)

Intermediate Accounting, 7/e

Problem 5-2 (concluded)


Gross profit (loss) recognition:
2013: $4,000,000
= 33.33% x $3,000,000 = $1,000,000
$12,000,000
2014: 100% x $(300,000) = $(300,000) - 1,000,000 = $(1,300,000)
2015:

$(400,000) (300,000) = $(100,000)

Problem 5-3Requirement 1
a.

The gym membership is one distinct performance obligation. Since the


discount voucher provides a material right to the customer that the customer
would not receive otherwise (a 35 percent discount rather than a 15 percent
discount), with its own pattern of delivery and distinct function, the discount
voucher also is a distinct performance obligation.

b.

To allocate the contract price to the performance obligation, we should first


consider that SZ would offer a 15 percent discount on the yoga course to all
customers as part of a seasonal promotion. So, a 35 percent discount provides a
customer with an incremental value of 20 percent (35%-15%). Thus, the
estimated standalone selling price of the course voucher provided by SZ is $20
($400 initial price of the course 20% incremental discount 25% likelihood of
exercising the option). Since the standalone selling price of the annual
membership fee is $500, SZ would allocate $19.23 {$500 [20 (20+500)]} of
the $500 transaction price to the discount voucher on yoga course.

c.

Since the discount voucher of the yoga course would be a distinct performance
obligation, SZ would recognize revenue for the sale of annual membership fee
and discount voucher.
Cash
Unearned revenue, membership fees
Unearned revenue, yoga coupon

Alternate Exercise and Problem Solutions

$500
$480.77
19.23

The McGraw-Hill Companies, Inc., 2013


5-13

Problem 5-3 (concluded)


Requirement 2
a.

The option to pay $12 for additional visits does not constitute a material right,
because it is in the range ($10-$14) of normal fees paid by non-members.
Therefore, it is not a distinct performance obligation in the contract.

b.

Since the option to visit on additional days is not a distinct performance


obligation, SZ should not allocate any of the contract price to it. Therefore the
entire $400 payment is allocated to the 40 visits associated with the coupon
book.

c.

Cash
Unearned revenue, coupon book

$400
$400

SZ could recognize (1/30) $400 of revenue over time for each visit, since a
coupon book yields approximately 30 visits and the services are simultaneously
received and consumed by the buyer. Alternatively, SZ could recognize revenue
over the year following sale of a coupon book according to the passage of time
as an approximation of consumptions of visits.

The McGraw-Hill Companies, Inc., 2013


5-14

Intermediate Accounting, 7/e