Accounting 381 Practice Midterm Two Solution

Name _____________________________________

Section ____________________________________ General Instructions: 1. Please observe the Portland State University Code of Conduct. 2. This exam packet should have 14 pages. Please confirm that you have all of the pages. 3. Review the complete exam in order to allocate your time appropriately. You will have one hour and 50 minutes to complete the exam. 4. In fairness to all students, questions will not be answered during the exam, except to explain words or phrases. If a question is ambiguous, write your assumptions on the exam along with your answer. You will receive credit provided your assumptions are necessary and reasonable. 5. Write your answers neatly in the space provided. 6. Monitor your time and good luck!

Points Available Question I Question II Question III Question IV 19 21 30 30

Points Received

TOTAL

100

Question I: Long term Construction Contracts 1. (15 points) Salerno Construction, Inc. has consistently used the percentage-of-completion method to recognize revenue on its long-term construction contracts. During 2004, Salerno started work on a $1,200,000 construction contract, which it plans to complete in 2006. The following information was taken from Salernos accounting records: 2004 204,000 816,000 1,020,000 400,000 300,000 2005 812,500 203,125 1,015,625 400,000 500,000

Cumulative costs incurred as of year-end Estimated costs to complete at year-end Total estimated costs at year-end Progress billings during year Collections during year

a. What amount of revenue, expense, and gross profit should Salerno have recognized on this contract for the year ended 12/31/04? 2004 Revenue: ___________240,000______________

2004 Expense: ___________204,000_______________

2004 Gross Profit: __________36,000_______________

b. Prepare the December 31, 2004 balance sheet disclosure of construction in process and related billings. Be sure to indicate whether the amount is an asset or a liability. Billings in excess of CIP (400K 240K) = 160,000

Question I, continued c. Calculate the amount of revenue, expense, and gross profit that Salerno will report in 2005.

2005 Revenue: __________720,000_______________

2005 Expense: __________608,500_______________

2005 Gross Profit: __________111,500_______________

d. What would be the effect on income (if any) for 2005 if Salerno used the Completed Contract Method to account for its long-term construction contracts instead of the Percent Completion Method?

If Salerno used the Completed Contract Method, they would not report any revenue or expense in 2005. They would have reported net income $111,500 less than if they had used the % completion method. Completed contract 0 % completion 111,500

Net loss 2005

Question I, continued 2. Dalton Construction Co. contracted to build a bridge for $5,000,000. Construction began in 2010 and was completed in 2011. Data relating to the construction are (4 pts): Costs incurred Estimated costs to complete Dalton uses the percentage-of-completion method. Instructions (a) How much revenue should be reported for 2010? Show your computation. (b) Make the entry to record the revenue and gross profit for 2010. 2010 $1,650,000 1,350,000 2011 $1,375,000

(a)

$1,650,000 $5,000,000 = $2,750,000 $3,000,000

(b)

Construction Expenses .................................................................... 1,650,000 Construction in Process................................................................... 1,100,000 Revenue from Long-Term Contracts ..................................

2,750,000

Question II Installment Sales and Cost Recovery (21 pts) 1. (13 points) Riccolo, Inc. makes all sales on installment. The following information is provided for Riccolo, Inc. in 2007: $ 120,000 $ 325,000 $1,000,000 $ 580,000 $ 300,000

Inventory on hand at end of year Inventory on hand, beginning of year Installment sales in 2007 2007 Collections on 2007 installment sales 2007 Purchases

Instructions i) Calculate the Realized Gross Profit recognized during the year under the installment-sales method:

2007 Realized Gross Profit _________________________________ 1,000,000 505,000** = 495,000 495,000/1,000,000 = 49.5% 580,000 287,100 **BI + Purch EI = COGS 325 + 300 120 = 505

ii)

Under the installment sales method, what is the balance in the Unrealized Gross Profit account at the end of the year? 495,000 287,100 = 207,900

iii)

Calculate the Realized Gross Profit recognized during the year under the costrecovery method:

2007 Realized Gross Profit _________________________________ Cash collected Cost of goods sold 580,000 505,000 = 75,000

Question II (cntd.)
2. Johnboy Inc. manufactures and sells farm equipment and machinery. For most of its sales, revenue and cost of sales are recognized at the delivery date. In 2010, it sold a tractor to a new customer for $100,000. The cost of the machinery was $60,000. Payment will be made in five annual installments of $20,000 each, with the first payment due in 2010. Johnboy Inc. usually does not allow its customers to pay in installments. Due to the unusual nature of the payment terms and the uncertainty of collection of the installment payments, Johnboy Inc. is considering alternative methods of recognizing profit on this sale (8 pts). Required: Ignoring interest charges, prepare a table showing the gross profit to be recognized from 2010 through 2014 on the sale using the following three methods: a. Point of delivery revenue recognition b. The installment sales method c. The cost recovery method

Point of Delivery 2010 2011 2012 2013 2014 Totals $40,000 0 0 0 0 40,000

Installment Sales Method Cost Recovery Method (40% X cash collection) $8,000 $0 8,000 0 8,000 0 8,000 20,000 8,000 20,000 40,000 40,000

Question III: Statement of Cash Flows (30 points) The following financial statements are available for Cook Island Divers Inc. on December 31, 2006. Cook Island Divers Inc. Comparative Balance Sheets As of December 31, 2005 and 2006 Dec. 31, 2005 Assets Current Assets: Cash and cash equivalents Accounts Receivable, Net Inventory Total Current Assets Investments Property & Equipment Less Accumulated depreciation Total Assets Liabilities and Equity Current Liabilities: Accounts payable Interest Payable Total Current Liabilities Notes payable Total Liabilities Common Stock Retained Earnings Total Equity Total Liabilities and Stockholders' Equity Dec. 31, 2006

$18,400 49,000 61,900 129,300 100,000 220,000 -50,000 $399,300

$134,800 83,200 92,500 310,500 90,000 240,000 -30,000 $610,500

$67,000 300 67,300 73,500 $140,800 125,000 133,500 $258,500

$100,000 0 100,000 50,000 $150,000 175,000 285,500 $460,500

$399,300

$610,500

Question III, continued

Cook Island Divers Inc. Income Statement For the Year Ended December 31, 2006

Sales Interest and other revenue Less: Cost of goods sold Selling and administrative expenses Depreciation expense Income tax expense Interest expense Loss on sale of plant assets Net income

$300,000 10,000

310,000

100,000 10,000 22,000 $5,000 3,000 8,000

148,000 162,000

Other available information: New plant assets costing $80,000 were purchased during the year. Investments were sold at book value. No new debt was issued in 2005. Dividends of $10,000 were declared and paid during the year.

Required: a. Prepare the Statement of Cash Flows for Cook Island Divers Inc. for the year ended December 31, 2006 using the direct method to calculate cash flows from operations. Please use the template provided on page X for your answer. You may use the space provided on page Y for other calculations however, please note that only the statement of cash flows provided on page X will be graded. b. Prepare a reconciliation of net income to cash from operations (the indirect method) for Cook Island Divers for the year ended December 31, 2006. Please use the space on page 5 for your answer.

Question III, continued Cook Island Divers Inc. Statement of Cash Flows Direct Method For year ended December 31, 2006 SEE SOLUTION BELOW Cash from Operating Activities: Cash Collections from Customers Cash Provided from interest revenue and other sources Cash Paid to Suppliers for Inventory Cash Paid for Other Expenses Cash Paid for Interest Cash Paid for Taxes Total Cash from Operations ______________________ ______________________ ______________________ ______________________ ______________________ ______________________ ______________________

Cash from Investing Activities:

Total Cash from Investing Activities

______________________

Cash from Financing Activities:

Total Cash from Financing Activities

______________________

Net Change in Cash

______________________ ______________________ _______________________

Solution:
STATEMENT OF CASH FLOWS - Direct Method Cash flow from operations Cash provided by customers Cash provided by interest and other Cash used for merchandise Cash used for SG&A expenses (other) Cash used for interest payments Cash used for tax payments Cash from operations Investing

265,800 10,000 (97,600) (10,000) (3,300) (5,000) 159,900 Sale PPE Purch PPE Sale Investments Cash inves 10,000 (80,000) 10,000 (60,000)

Fin

Issue CS Repay NP Div pymt Cash fin

50,000 (23,500) (10,000) 16,500

Net cash Cash beg Cash end

116,400 18,400 134,800

Direct Worksheet: Interest and other revenue Subtract Incr in Int rec. (or + Decr in Int. rec.) Cash received from customers 10,000 10,000

Revenues Subtract Incr in AR (or + Decr in AR) Cash received from customers

300,000 (34,200) 265,800

COGS Add Incr in Inven (- decr) Subtract Incr in AP (+ decr) Cash paid for merchandise

100,000 30,600 (33,000) 97,600

Other Expense Prepaids Subtract Incr in Acc. Liab. (+decr) Cash paid for Other expenses

10,000 10,000

Tax Exp Subtract Incr in Accrued tax liab. (+ decr) Cash paid for taxes

5,000 5,000

Interest Subtract Incr in Int pay. (+ decr) Cash paid for taxes

3,000 300 3,300

Question III, continued Reconciliation of Net Income to Cash from Operations (Indirect Method):
Indirect: Ops NI + Depn + loss - Incr AR -Incr Inv +Incr AP -Decr IP Cash ops 162,000 22,000 8,000 (34,200) (30,600) 33,000 (300) 159,900

Question IV: Multiple choice and short answer (30 points) 1. For the two situations described below, indicate if it is reported in the operating investing or financing section of the statement of cashflows or in the schedule of noncash investing and financing activities. Also, indicate the amount reported and if it is a cash inflow or outflow. a. A company purchased a machine for $100,000. Of that amount, $80,000 was obtained by borrowing from a local bank. During the same year, principal payments of $12,000 and interest payments of $7,000 were made to the bank on this loan. b. A company purchased a $90,000 plot of land by issuing a note payable to the seller for $90.000.

Operating

Investing

Financing

Schedule of non-cash investing and financing activities

a.

Outflow of $7,000

Outflow of $100,000

Inflow of $80,000; Outflow of $12,000 Acquisition of land by the issuance of a note payable for $90,000.

b.

2. Revenue is recognized by the consignor when the a. goods are shipped to the consignee. b. consignee receives the goods. c. consignor receives an advance from the consignee. d. consignor receives an account sales from the consignee. 3. The FASB concluded that if a company sells its product but gives the buyer the right to return the product, revenue from the sales transaction shall be recognized at the time of sale only if all of six conditions have been met. Which of the following is not one of these six conditions? a. The amount of future returns can be reasonably estimated. b. The seller's price is substantially fixed or determinable at time of sale. c. The buyer's obligation to the seller would not be changed in the event of theft or damage of the product. d. The buyer is obligated to pay the seller upon resale of the product. 4. The revenue recognition principle provides that revenue is recognized when a. it is realized. b. it is realizable. c. it is realized or realizable and it is earned. d. none of these. 5. Deferred gross profit on installment sales is generally treated as a(n) a. deduction from installment accounts receivable.

b. deduction from installment sales. c. unearned revenue and classified as a current liability. d. deduction from gross profit on sales. 6. Inventory is reported at cost plus gross profit recognized to date under which of the following revenue recognition methods? a. completed contract b. installment method c. cost recovery d. percentage of completion 7. Under the completed-contract method a. revenue, cost, and gross profit are recognized during the production cycle. b. revenue and cost are recognized during the production cycle, but gross profit recognition is deferred until the contract is completed. c. revenue, cost, and gross profit are recognized at the time the contract is completed. d. none of these. 8. How should the balances of progress billings and construction in process be shown at reporting dates prior to the completion of a long-term contract? a. Progress billings as deferred income, construction in progress as a deferred expense. b. Progress billings as income, construction in process as inventory. c. Net, as a current asset if debit balance, and current liability if credit balance. d. Net, as income from construction if credit balance, and loss from construction if debit balance. Use the following information for questions 9 and 10. Gorman Construction Co. began operations in 2010. Construction activity for 2010 is shown below. Gorman uses the completed-contract method. Billings Collections Estimated Contract Through Through Costs to Costs to Contract Price 12/31/10 12/31/10 12/31/10 Complete 1 $3,200,000 $3,150,000 $2,600,000 $2,150,000 2 3,600,000 1,500,000 1,000,000 820,000 $1,880,000 9. Which of the following should be shown on the income statement for 2010 related to Contract 1? a. Gross profit, $450,000 b. Gross profit, $1,000,000 c. Gross profit, $1,050,000 d. Gross profit, $600,000 $3,200,000 $2,150,000 = $1,050,000. 10. Which of the following should be shown on the balance sheet at December 31, 2010 related to Contract 2? a. CIP in excess of Billings, $680,000 b. CIP in excess of Billings, $820,000 c. Billings in excess of CIP, $680,000 d. Billings in excess of CIP, $1,500,000 $1,500,000 $820,000 = $680,000.

11. In 2003 a construction company began work on a contract with a price of $875,000 and estimated costs of $625,000. Data for each year of the contract are as follows: 2003 2004 2005 $187,500 $302,500 $210,000 Costs incurred during the year 437,500 210,000 -0Estimated costs to complete 150,000 312,500 412,500 Billings 125,000 325,000 425,000 Collections Under the percentage-of-completion method of revenue recognition, the balance of the Construction in Progress account at the end of 2004 would be a. $612,500 b. $490,000 c. $150,000 d. $ 27,500 Use the following information for questions 12 and 13. Coaster manufactures and sells logging equipment. Due to the nature of its business, Coaster is unable to reliably predict bad debts. During 2010, Coaster sold equipment costing $2,400,000 for $3,600,000. The terms of the sale were 20% down, with equal payments due quarterly over the next 3 years. All payments for 2010 were made on schedule. Round answers to two places. 12. Assuming that Coaster uses the installment method of accounting for its installment sales, what amount of realized gross profit will Coaster report in its income statement for the year ended December 31, 2010? a. $1,680,000 b. $1,120,000 c. $560,000 d. $369,600

($3,600,000 $2,400,000) $3,600,000 = 33 1/3% ($3,600,000 .20) + [(3,600,000 .80) 4/12)] = $1,680,000 $1,680,000 33 1/3% = $560,000.
13. Assuming that Coaster uses the cost-recovery method of accounting for its installment sales, what amount of realized gross profit will Coaster report in its income statement for the year ended December 31, 2011? a. $0 b. $240,000 c. $316,800 d. $960,000

[($3,600,000 .20) + ($3,600,000 .80 8/12] $2,400,000 = $240,000.