Accounting 300b CH 18

When using the percentage of completion method, the company

recognizes revenues and gross profit each period during the contract.

Bret Company sold 3,000 Holsks during 2017 at a total price of $12,000,000, with a warranty guarantee that the product was free of any defects. The cost of Holsks sold is $7,200,000. The term of the assurance warranty is two years, with an estimated cost of $80,000. In addition, Bret sold extended warranties related to 1,100 Holsks for 3 years beyond the 2-year period for $110,000. Bret should recognize Unearned Warranty Revenue in 2017 of

Bret should record a Warranty Liability of $80,000 on the assurance warranty, and Unearned Warranty Revenue of $110,000 on the extended warranties.

In a principal-agent relationship, the agent should use the gross method to recognize revenue.

False

On January 1, 2017, Purdy Company enters into a contract to transfer Blue and Rain to Georgia Co. for $300,000. The contract specifies that payment for Blue will not occur until Rain is also delivered. In other words, payment will not occur until both Blue and Rain are transferred to Georgia. Purdy determines that standalone prices are $110,000 for Blue and $190,000 for Rain. Purdy delivers Blue to Georgia on February 10, 2017. On March 15, 2017, Purdy delivers Rain to Georgia. Purdy should record

Conditional rights to receive consideration are reported as contract assets rather than as receivables. Thus, a contract asset of $110,000 would be reported on February 10.

Pizza Factory enters into a franchise agreement on 11/1/16 giving Mow's House the right to operate as a franchisee of Pizza Factory for 5 years. Pizza Factory prepared this entry on 11/1/16: Cash40,000Notes Receivable60,000 Discount on Notes Receivable12,086 Unearned Franchise Revenue40,000 Unearned Service Revenue (training)19,914 Unearned Sales Revenue (equipment)28,000 Pizza Factory satisfies the performance obligations related to the elements above when the franchise opens on 3/1/17. Other than interest, how much revenue should Pizza factory recognize on 3/1/17?

Since Pizza Factory satisfies the performance obligations related to the elements above when the franchise opens on 3/1/17, all of the Unearned Revenue amounts are recognized. Total revenue to be recognized is computed as follows: Unearned Franchise Revenue, $40,000 + Unearned Service Revenue (Training), $19,914 + Unearned Sales Revenue (Equipment), $28,000 = $87,914.

Which method of measuring the fair value of a performance obligation is dependent on the standalone selling prices of other goods or services promised in the contract?

The residual value method of measuring the fair value of a performance obligation is dependent on the standalone selling prices of other goods or services promised in the contract.

A contract is an agreement between two parties that creates enforceable rights or obligations.

True

A performance obligation may be based on customary business practice.

True

Companies recognize revenue over a period of time if (1) the customer controls the asset as it is created or (2) the company does not have an alternative use for the asset, with the following conditions: (a) the customer receives benefits as the company performs, and (b) the company has a right to payment.

True

The new standard, Revenue from Contracts with Customers,

adopts an asset-liability approach for revenue recognition.

One criteria that indicates that a company should disregard revenue guidance for contracts is when

each party can unilaterally terminate the contract without compensation.

Under the completed contract method, the Construction in Process account balance will consist of

construction costs only.

An indication that the customer has not taken control of the good or service is

the customer has no significant risks or rewards of ownership.

Pizza Factory enters into a franchise agreement on 11/1/16 giving Mow's House the right to operate as a franchisee of Pizza Factory for 5 years. The initial franchise fee is $100,000. Of this amount, $40,000 is payable when Mow's House signs the agreement, and the balance is payable in five annual payments of $12,000 each on 12/31. Pizza Factory helps locate the site, negotiate the lease or purchase of the site, supervise the construction activity, and provide employee training and the equipment necessary to be a distributor of its products. Similar training services and equipment are sold separately. Mow's House also promises to pay ongoing royalty payments of 1% of its annual sales (payable each January 31 of the following year) and is obliged to purchase products from Pizza Factory at its current standalone selling prices at the time of purchase. The credit rating of Mow's House indicates that money can be borrowed at 8%. The present value of an ordinary annuity of five annual receipts of $12,000 each discounted at 8% is $47,914. Training services and equipment are distinct because similar services and equipment are sold separately. Pizza Factory satisfies those performance obligations when it transfers the services and equipment to Mow's House. The values assigned to the performance obligations are: Rights to the trade name, market area, and proprietary know-how$40,000Training services19,914Equipment (cost of $10,000)28,000Total transaction price$ 87,914 Training is completed in November and December 2016, the equipment is installed in December 2016, and Mow's House holds a grand opening on January 2, 2017. What amount of revenue should Pizza Factory recognize at 11/1/16?

$0. Pizza Factory does not satisfy any of its performance obligations until the grand opening on 1/2/17. Each of the three amounts is initially recorded as unearned revenue, not revenue.

The Billings on Construction in Process account is reported:

in either the current asset or current liability section.

A nonrefundable upfront fee is generally recorded as revenue when received.

False

Companies expense incremental costs if these costs are incurred to obtain a contract with a customer.

False. Companies capitalize incremental costs if these costs are incurred to obtain a contract with a customer. They do not expense incremental contract costs.

Conditional rights should be reported separately on the balance sheet as contract liabilities.

False. Conditional rights should be reported separately on the balance sheet as contract assets, not contract liabilities.

Franchise companies derive their revenue primarily from the sale of initial franchises

False. Franchise companies derive their revenue from one or both of two sources: (1) from the sale of initial franchises and related assets or services, and (2) from continuing fees based on the operations of franchises.

The principal advantage of the completed-contract method is that reported revenue reflects estimates rather than waiting for final results.

False. The principal advantage of the completed-contract method is that reported revenue reflects final results rather than estimates.

On January 1, 2017, Fullbright Company sold goods to Blue Dirt Company for $400,000 in exchange for a 4-year, zero-interest-bearing note with a face amount of $629,406 (imputed rate of 12%). The goods have an inventory cost on Fullbright's books of $240,000. What amount of Sales Revenue should Fullbright recognize in 2017?

Fullbright should record Sales Revenue of $400,000 on January 1, 2017, which is the fair value of the inventory.

On January 1, 2017, Fullbright Company sold goods to Blue Dirt Company for $400,000 in exchange for a 4-year, zero-interest-bearing note with a face amount of $629,406 (imputed rate of 12%). The goods have an inventory cost on Fullbright's books of $240,000. What amount of Interest Revenue should Fullbright recognize in 2017?

Fullbright should record interest revenue of $48,000 in 2017 ($400,000, Carrying value of note X 12%, Imputed rate).

ELO Construction Co. began operations in 2017. Construction activity for 2017 is shown below. ELO uses the completed-contract method. ContractContract PriceBillings Through 12/31/17Collections Through 12/31/17Costs to 12/31/17Estimated Costs to Complete1$4,650,000$4,450,000$3,900,000$3,700,000-2 3,600,000 1,800,000 1,600,000 870,000$2,030,0003 3,100,000 1,860,000 1,600,000 1,680,000 1,120,000 What amount of gross profit should be reported on the income statement for 2017?

Gross profit is recognized only on the completed contract (Contract 1). Contract 1 Price, $4,650,000 - Contract 1 Costs, $3,700,000 = Contract 1 Gross Profit, $950,000.

Which type of revenue or gain is generally recognized with the passage of time?

Long-term construction contracts.

Under the percentage-of-completion method, how should the balances of Billings on Construction in Process and Construction in Process be reported prior to the completion of a long-term contract?

Net, as a current asset if a debit balance, and as a current liability if a credit balance.

Sufjan Company has a contract to sell 200 units to a customer for $14,000. After 140 units have been delivered, Sufjan modifies the contact by promising to deliver 30 more units for an additional $60 per unit (the standalone selling price at the time of the contract modification). What is the additional revenue to be earned after the modification?

Revenue earned after the modification is $6,000 computed as follows: [(60 units remaining from the original contract X $70) + (30 more units from the modification X $60)].

Stossel Company sells 300 units for $200 each to Liberty Inc. for cash. Stossel allows Liberty to return any unused product within 30 days and receive a full refund. The cost of each product is $120. To determine the transaction price, Stossel decides that the approach that is most predictive of the amount of consideration to which it will be entitled is the most likely amount. Using the most likely amount, Stossel estimates that ten (10) units will be returned, the costs of recovering the units will be immaterial, and the returned units are expected to be resold at a profit. What amount of refund liability should Stossel record at the time of sale?

Stossel should record a refund liability of $2,000 (10 estimated units to be returned X $200 selling price).

Mocha purchases equipment, installation, and training from Lynne for a price of $1,000,000 and chooses Lynne to do the installation. Lynne charges the same price for the equipment irrespective of whether it does the installation or not. (Some companies do the installation themselves because they either prefer their own employees to do the work or because of relationships with other customers.) The price of the installation service is estimated to have a fair value of $20,000. The fair value of the training sessions is estimated at $40,000. Other companies can also provide these training services. Mocha is obligated to pay Lynne the $1,000,000 upon the delivery and installation of the equipment. Lynne delivers the equipment on May 1, 2017, and completes the installation of the equipment on July 1, 2017. Training related to the equipment starts once the installation is completed and lasts for 1 year. The equipment has a useful life of 8 years. What amount is recorded by Lynne as Unearned Service Revenue at 7/1/17?

The allocation of the revenue for this transaction follows the residual value allocation approach. As such, the standalone price of each performance obligation determines the base for the allocation as follows: (Fair value of the training session, $40,000 + Fair value of the installation, $20,000 + Fair value of equipment, $1,000,000 = $1,060,000). At July 1, revenue associated with the equipment sale and the installation would be recognized since these performance obligations have been satisfied. Lynne should record Unearned Service Revenue related to the training as it will be provided over a one-year period of $37,736 at 7/1/15 [($40,000 Fair value of training /$1,060,000 Base) X $1,000,000 total price] related to the training.

Black Sea Construction Company has a contract to construct a $6,000,000 oil rig at an estimated cost of $5,300,000. The contract is to start in July 2017, and the oil rig is to be completed in October 2019. The following data pertain to the construction period. 2017 2018 2019Costs to date$1,325,000$3,720,000$6,300,000Estimated costs to complete 3,975,000 2,480,000 —Progress billings during the year 1,200,000 3,200,000 1,600,000Cash collected during the year 1,000,000 2,340,000 2,660,000 What amount of gross profit (loss) should Black Sea recognize in 2018 using the percentage-of-completion method?

The entire $200,000 loss must be recognized in addition to offsetting any previously recognized gross profit. Gross profit recognized in 2017 is computed as follows: Gross Profit recognized in 2017: [(Costs to date for 2017, $1,325.000 / Cost to date for 2017, $1,325,000 + Estimated costs to complete for 2017, $3,975,000) = 25% X (Contract Price, $6,000,000 - Total estimated costs at 2017, $5,300,000)] = 25% X $700,000 = $175,000. ($175,000) + ($200,000) = ($375,000).

Black Bear Construction Company has a contract to construct a $6,000,000 bridge at an estimated cost of $5,300,000. The contract is to start in July 2017, and the bridge is to be completed in October 2019. The following data pertain to the construction period. (Note that by the end of 2018, Black Bear has revised the estimated total cost from $5,300,000 to $5,400,000.) 201720182019Costs to date$1,325,000$3,780,000$5,430,000Estimated costs to complete 3,975,000 1,620,000 —Progress billings during the year 1,200,000 3,200,000 1,600,000Cash collected during the year 1,000,000 2,340,000 2,660,000 What amount of gross profit should Black Bear recognize in 2018 using the percentage-of-completion method?

The gross profit to be recognized in 2018 is computed as follows: 2018 Total Gross Profit to date [(Costs to date for 2018, $3,780.000 / Cost to date for 2018, $3,780,000 + Estimated costs to complete for 2018, $1,620,000) = 70% X (Contract Price, $6,000,000 - Total estimated contract costs at 2018, $5,400,000)] - Gross Profit recognized in 2017: [(Costs to date for 2017, $1,325.000 / Cost to date for 2017, $1,325,000 + Estimated costs to complete for 2017, $3,975,000) = 25% X (Contract Price, $6,000,000 - Total estimated costs at 2017, $5,300,000)] = $245,000 gross profit to be recognized for 2018.

In a bill-and-hold arrangement, which of the following is not one of the criteria which must be met for the customer to have obtained control of the product

The product must be physically located in the seller's warehouse.

Hendrix Inc., an equipment dealer, sells equipment on January 1, 2016, to Jimi Company for $200,000. Also, on January 1, 2016, Hendrix agrees to repurchase this equipment from Jimi Company on December 31, 2017, for a price of $233,280. At 1/1/16, Hendrix should record

This transaction represents a repurchase agreement. At 1/1/16, Hendrix should record a liability of $200,000 because this agreement is a financing transaction and not a sale.

Black Bear Construction Company has a contract to construct a $6,000,000 bridge at an estimated cost of $5,300,000. The contract is to start in July 2017, and the bridge is to be completed in October 2019. The following data pertain to the construction period. 201720182019Costs to date$1,325,000$3,780,000$5,430,000Estimated costs to complete 3,975,000 1,620,000 —Progress billings during the year 1,200,000 3,200,000 1,600,000Cash collected during the year 1,000,000 2,340,000 2,660,000 What amount of gross profit should Black Bear recognize in 2019 using the percentage-of-completion method?

Total Gross Profit in 2019: (Contract Price, $6,000,000 - Costs to date for 2019, $5,430,000) - Gross Profit recognized to date for 2018: [(Costs to date for 2018, $3,780.000 / Cost to date for 2018, $3,780,000 + Estimated costs to complete for 2018, $1,620,000) = 70% X (Contract Price, $6,000,000 - Total estimated contract costs at 2018, $5,400,000)] = $150,000.

Sherman Company enters into a contract with a customer to build a warehouse for $400,000, with a performance bonus of $100,000 that will be paid based on the timing of completion. The amount of the performance bonus decreases by 20% per week for every week beyond the agreed-upon completion date. The contract requirements are similar to contracts that Sherman has performed previously, and management believes that such experience is predictive for this contract. Management estimates that there is a 50% probability that the contract will be completed by the agreed-upon completion date, a 30% probability that it will be completed 1 week late, and a 20% probability that it will be completed 2 weeks late. What is the total transaction price for this revenue arrangement?

Total transaction price is $486,000 [($500,000 X 50%) + (($500,000 - $20,000 = $480,000 X 30%) + ($500,000 - $40,000 = $460,000 X 20%)]

In situations where the franchisor provides access to the rights rather than transferring control of the franchise rights, the franchise rights' revenue is recognized over a period of time rather than at a point in time.

True

Most revenue transactions pose few problems for revenue recognition because often the transaction is initiated and completed at the same time.

True

Reedy Builders, Inc. is using the completed-contract method for a $12,400,000 contract that will take three years to complete. Data at December 31, 2017, the end of the first year, are as follows: Costs incurred to date$5,200,000Estimated costs to complete7,800,000Billings to date4,920,000Collections to date4,540,000 The gross profit or loss that should be recognized for 2017 is

Under both the percentage-of-completion and the completed-contract methods, the company must recognize in the current period the entire loss immediately. The entire contract loss is computed as follows: Contract Price, $12,400,000 - (Costs incurred to date, $5,200,000 + Estimated costs to complete, $7,800,000) = $600,000 loss.

The seller of a good or service should recognize revenue when

each performance obligation is satisfied.

A loss in the current period on a contract expected to be profitable upon completion in a later year is:

recognized only under the percentage-of-completion method.

In a consignment sale, the consignee

records a payable when consigned merchandise is sold.

In determining the transaction price, the company must consider:

variable consideration, non-cash consideration, time value of money, and consideration payable.

Companies should use the percentage-of completion method to account for long-term construction contracts

unless required to use the completed-contract method.