A.
$ 600,000
B.
$ 500,000
C.
$1,200,000
D.
$1,000,000
E.
$ 360,000
F.
$ 300,000
G.
$ 240,000
H.
$ 200,000
I.
$2,400,000
J.
$2,000,000
K.
$ 0
L.
$ 0
M.
$ 600,000
N.
$ 500,000
O.
$1,200,000
P.
$1,000,000
Q.
$ 600,000
R.
$ 500,000
S.
$2,400,000
T.
$2,000,000
121. The life of a construction contract is 4 years. The firm used the percentage-of-completion method. Under
this method, cash collected and revenues recognized are shown below. Total cost of the project was $800,000.
What portion of the total cost was incurred each year?
Cash
Revenue
Cost
Year
Collected
Recognized
Incurred
1
$ 100,000
$ 300,000
A
2
200,000
300,000
B
3
200,000
150,000
C
4
500,000
250,000
D
Total
$1,000,000
$1,000,000
$800,000
A.
$240,000
B.
$240,000
C.
$120,000
D.
$200,000
122. Furmanov Company started business on January 1, Year 7. It recognizes revenue and expense at the time
of sale for financial reporting and uses the installment method for income tax reporting. Under the installment
method, the firm recognizes revenue when it receives cash, and matches expenses with revenues based on the
average cost of goods sold to sales percentage for the year in which the firm made the sale. The income tax rate
is 30%. Data for Year 7 and Year 8 as reported to shareholders, appear below:
Year 7
Year 8
Net sales on account
$2,400,000
$3,000,000
Cash collections of Year 7 sales
1,620,000
480,000
Cash collections of Year 8 sales
–
2,040,000
Cost of merchandise sold
1,440,000
1,920,000
All other (period) expenses
240,000
360,000
Required:
a.
Compute the amount of net income after taxes for financial reporting for Year 7 and Year 8.
b.
Compute the amount of taxable income for Year 7 and Year 8.
a.
Year 7
Year 8
Sales revenue
$2,400,000
$3,000,000
Cost of goods sold
(1,440,000)
(1,920,000)
Gross profit
$ 960,000
$1,080,000
Other expenses
(240,000)
(360,000)
Net income before taxes
$ 720,000
$ 720,000
Income tax expense
(216,000)
(216,000)
Net income
$ 504,000
$ 504,000
b.
Year 7
Year 8
Sales revenue-Year 7
$1,620,000
$ 480,000
Sales revenue-Year 8
–
2,040,000
Cost of goods sold-Year 7
$ (972,000)
$ (288,000)
Cost of goods sold-Year 8
–
(1,305,600)
Gross profit
$ 648,000
$ 926,400
Other expenses
(240,000)
(360,000)
Taxable income
$ 408,000
$ 566,400
123. A construction firm enters a long-term contract to build a bridge. The expected and actual cash receipts and
disbursements for the project are as follows:
Period
Receipts
Expenditures
1
$1,000
$4,000
2
2,000
2,000
3
3,000
1,000
4
4,000
1,000
Required:
What is the revenue during each of the following periods under each of the specified methods of revenue
recognition?
Period
Method
a.
1
Completed Contract
b.
4
Completed Contract
c.
1
Percentage of Completion
d.
4
Percentage of Completion
e.
1
Installment Method
f.
4
Installment Method
g.
1
Cost Recovery First
h.
4
Cost Recovery First
a.
0
b.
10,000
c.
5,000
d.
1,250
e.
1,000
f.
4,000
g.
1,000
h.
4,000
124. A construction firm enters a long-term contract to build a bridge. The expected and actual cash receipts and
disbursements for the project are as follows:
Period
Receipts
Expenditures
1
$1,000
$4,000
2
2,000
2,000
3
3,000
1,000
4
4,000
1,000
Required:
What is the income before taxes during each of the following periods under each of the specified methods of
revenue recognition?
Period
Method
a.
1
Completed Contract
b.
4
Completed Contract
c.
1
Percentage of Completion
d.
4
Percentage of Completion
e.
1
Installment Method
f.
4
Installment Method
g.
1
Cost Recovery First
h.
4
Cost Recovery First
a.
0
b.
2,000
c.
1,000
d.
250
e.
200
f.
800
g.
0
h.
2,000
125. The sales, all on account, of Thread Company in Year 1, its first year of operations, were $800,000.
Collections totaled $600,000. On December 31, Year 1, Thread Company estimated that 3 percent of all sales
would probably be uncollectible. On that date, specific accounts in the amount of $18,000 were written off.
Thread Company’s unadjusted trial balance (after all nonadjusting entries were made and after all write-offs of
specific accounts receivable identified during Year 2 as being uncollectible) on December 31, Year 2, includes
the following accounts and balances:
Accounts Receivable
500,000
Allowance for Uncollectibles
16,000
Other Debits
1,484,000
Sales
900,000
Other Credits
1,100,000
On December 31, Year 2, Thread Company carried out an aging of its accounts receivable balances and
estimated that the Year 2 ending balance of accounts receivable contained $26,000 of probable uncollectibles. It
made adjusting entries appropriate for this estimate. Some of the $900,000 sales during Year 2 were for cash
and some were on account; these data purposefully omit the amounts.
Required:
a.
What was the balance in the Accounts Receivable account at the end of Year 1? Give the amount and
whether debit or credit.
b.
What was the balance in the Allowance for Uncollectible Accounts at the end of Year 1? Give the
amount and whether debit or credit.
c.
What was bad debt expense (Revenue Contra for Uncollectibles) for Year 2?
d.
What was the amount of specific accounts receivable written off as being uncollectible during Year 2?
e.
What were total cash collections in Year 2 from customers (for cash sales and collections from
customers who had purchased on account in either Year 1 or Year 2)?
f.
What was the net balance of accounts receivable included in the balance sheet asset total for
December 31, Year 2?
a.
182,000 Dr.
b.
6,000 Cr.
c.
42,000
d.
22,000
e.
560,000
f.
474,000
126. Sears reports in millions of dollars on its balance sheet for year-end Year 6 and Year 5 as follows:
Year 6
Year 5
Credit Card Receivables
27,371
24,932
Less: Allowance for Uncollectibles
(821)
(808)
It reports charge-offs [synonym for write-offs] of accounts receivable during Year 6 of 4.5 percent of its average
gross receivables of $26,000 million and that Bad Debt Expense is 3.5 percent of credit card sales. What were
Sears’ credit card sales for Year 6?
127. Describe the income recognition principles and how they are applied.
REVIEW AND APPLICATION OF INCOME RECOGNITION PRINCIPLES
Under accrual accounting, revenue increases income and the related expenses decrease income. Authoritative
guidance contains specific criteria for recognizing both revenue and expenses. These criteria in U.S. GAAP and
IFRS are broadly similar.
Revenue Recognition
128. Describe the accounts receivable recognition process.
ACCOUNTS RECEIVABLE
Accounts receivable (or trade receivables) is the amount owed to a seller by customers who have purchased
goods and services on credit. Typically, the seller expects to collect cash within a reasonably short time, such as
30 days, so an account receivable is usually a current asset. Receivables with terms greater than one year are
noncurrent assets.
Not all customers ultimately pay the amounts owed. An account receivable that the seller never collects is an
129. Describe the allowance method for uncollectible accounts.
ALLOWANCE METHOD FOR UNCOLLECTIBLE ACCOUNTS
The two accounting issues for accounts receivable are (1) measurement of the amount on the balance sheet and
(2) timing of recognition of the reduction in income caused by the uncollectibility of some accounts. With
regard to measurement, both U.S. GAAP and IFRS require that sellers report accounts receivable net of the
Recognizing bad debt expense matches the amount the firm does not expect to collect in cash from that period’s
credit sales with that period’s credit sales. The firm making the entry is not writing off specific customers’
accounts as uncollectible; rather, the firm is measuring accounts receivable at the amount it expects to collect. It
does not yet know which accounts it will need to write off because they have not yet proved to be uncollectible.
Allowance for Uncollectibles contra account appears among the assets on a firm’s balance sheet as a
subtraction. It typically has a credit balance which, netted against the debit balance in the asset account, reduces
asset totals. A credit to the Allowance for Uncollectibles contra account increases the amount subtracted from
Accounts Receivable, Gross, reducing the net debit balance in Accounts Receivable,
statements to calculate Accounts Receivable, Gross, Allowance for Uncollectibles, and Accounts Receivable,
Net.
ESTIMATING THE AMOUNT OF UNCOLLECTIBLE ACCOUNTS
AGING-OF-ACCOUNTS-RECEIVABLE PROCEDURE
The aging-of-accounts-receivable procedure involves two steps:
1. Estimating the amount that the firm does not expect to collect from existing accounts receivable, and
percentage method.
DEALING WITH CHANGES IN ESTIMATES OF UNCOLLECTIBLE ACCOUNTS
Changes in economic conditions, changes in credit-granting policies, changes in collection efforts, and other
similar factors cause differences between estimated and actual uncollectible amounts. These differences
130. Discuss how accounts receivable can be analyzed.
ANALYZING ACCOUNTS RECEIVABLE
The following considers financial statement presentation of accounts receivable, common financial ratios
involving accounts receivable, and transfers of accounts receivable in exchange for cash.
Financial Statement Presentation
Most firms that sell on account to other businesses, as opposed to consumers, collect cash within 30 to 90 days.
Interpreting a firm’s accounts receivable turnover and days receivables outstanding requires knowing the terms
of sale. If the terms of sale are “net 30 days” and the firm collects its accounts receivable in 45 days, collections
do not accord with the stated terms. This could be a signal that management should review and possibly change
the firm’s credit–granting policy and collection activity. If the firm offers terms of “net 60 days,” a value of 45
for days receivables outstanding indicates that the firm is collecting its receivables faster than indicated by its
contractual terms.
131. Discuss the application of the allowance method for sales returns.
SALES RETURNS: AN APPLICATION OF THE ALLOWANCE METHOD
Accountants use the allowance method when, at the time of sale, they can estimate with reasonable reliability
the effects of events that will affect future cash flows. Application of the allowance method reduces reported
earnings in the period of sale to reflect expected net cash collections.
Sales returns affect net cash collections when a customer has the right to return a product for a refund, and the
firm can reasonably estimate the amount of returns at the time of sale, U.S. GAAP and IFRS require that the
firm use the allowance method to estimate and recognize the effects of returns.Specifically, the selling firm
debits a revenue contra account for expected returns to reduce current period revenues to the estimated amount
that will not be returned. By reducing current period revenues, the firm measures revenues based on the amount
of cash it expects to collect from current period sales. Both U.S. GAAP and IFRS preclude revenue recognition
when customers have the right to return goods unless the firm can reasonably estimate the amount of returns
and it uses an allowance method to incorporate those estimates into income computations.
132. Describe income recognition after the sale when substantial performance remains.
INCOME RECOGNITION AFTER THE SALE
Some businesses provide substantial services after the time of sale, while other businesses involve considerable
uncertainty about cash collections. Both of these conditions introduce uncertainty. Under some circumstances
this uncertainty is sufficient to preclude the firm’s recognizing revenue at the time of sale; instead, it recognizes
revenue sometime after the sale.
The two criteria for revenue recognition are:
Cost Recovery Method
The cost recovery method matches the costs of generating revenue with cash receipts until the seller recovers all
its costs. That is, the seller sets expenses equal to revenue in each period until it recovers all its costs. The seller
does not recognize gross margin in income until it has recovered all of the costs of the sale. After cumulative
An example of such an arrangement is a long-term contract. Long-term contracts (for example, producing or
constructing airplanes, trains, ships, or buildings) typically have three characteristics:
When the arrangement meets these criteria, U.S. GAAP and IFRS require firms to recognize income using the
percentage-of-completion method. When the arrangement does not meet the criteria, U.S. GAAP requires firms
to recognize income using the completed contract method; IFRS does not permit the completed contract method
and instead specifies a variant of the cost recovery method.
PERCENTAGE-OF-COMPLETION METHOD
The percentage-of-completion method recognizes a portion of the contract price as revenue during each
accounting period of construction or production, based on the proportion of total work performed during the
accounting period. One commonly used measure of the proportion of total work performed during the
COMPLETED CONTRACT METHOD
The completed contract method postpones revenue recognition until the seller completes all construction or
production and transfers the finished item to the customer. U.S. GAAP specifies the completed contract method
generally easier to implement and there are no substantial differences in income relative to the
percentage-of-completion method. Because persuasive evidence of an arrangement must exist as a condition for
recognizing revenue, firms use the completed contract method if there is no contract with a specific customer,
as for example, in the construction of residential housing on speculation. These situations require future