Solution Manual

CHAPTER 8
QUESTIONS
1. The two general revenue recognition
criteria are that revenue should be
recognized when it is realized or realizable
and it has been earned through substantial
completion of the activities involved in the
earnings process.
extent that they cannot be used to fill other

orders.
7. The presumption is that customer
acceptance provisions are important to the
buyer or else they wouldnt have been
included in the sales agreement in the first
place. Accordingly, the seller has not
completed the earnings process until the
customer acceptance provisions have been
satisfied.
2. The four revenue recognition criteria

identified in SOP 972 are:
a. Persuasive evidence of an arrangement
exists.
b. Delivery has occurred.
c. The vendor's fee is fixed or
determinable.
d. Collectibility is probable.
The first two items relate to whether
revenue has been earned, and the last two
relate to the realizability of the revenue.
8. Up-front, non-refundable fees are not

recognized as revenue immediately
because the earnings process is not
complete. The buyer is not paying for the
initiation of the service, but instead is
paying for the service itself.
9. Revenue shouldnt be recognized until the
transaction price can be definitely
determined because it is less likely that an
arms-length market transaction has
occurred when the parties have not even
agreed upon the final price and because
the associated measurement uncertainty
means that the information is not reliable
enough for recognition and inclusion in the
financial statements.
3. SAB 101 was issued by the SEC to curtail

specific abuses in revenue recognition
practices.
4. Question 1 of SAB 101 emphasizes the
proper signing of sales agreements to
encourage companies to implement good
internal controls surrounding revenue
recognition. If a company does not have
good internal controls in place for
processing customer contracts, it becomes
much easier for company executives to
manipulate the reported amount of
revenue.
10. A refundable fee can be recognized as

revenue month-by-month before the refund
period is over when the seller can make a
reliable estimate about the number of
refunds that will be requested. Reliable
estimates are possible when the seller has
at least two years past experience with a
large pool of similar transactions.
5. A sale can be turned into a consignment

through a liberal return policy that does not
require the buyer to pay for the product
until the buyer in turn sells it to a customer.
A sale can also be turned into a
consignment if the seller agrees to
repurchase the product at the same price
and provides interest-free financing to the
buyer.
11. Contingent rent cant be estimated and

recognized on a straight-line basis over the
course of a year because to do so would
involve recognizing the future impact of
future events. No contingent rent should be
recognized until the contingency threshold
has been reached.
6. In a bill-and-hold arrangement, the seller

sells goods to the buyer but holds the
goods for later shipment, either in the
sellers own warehouse or in a third-party
warehouse. A bill-and-hold arrangement is
a sale when the arrangement comes about
upon the written request of the buyer, the
goods are ready to ship, and the goods are
separated from other inventory to the
12. A company can reliably estimate product

returns if the company has substantial past
experience with a large pool of similar
transactions. Also, the return period should
be short and demand for the product
should be fairly stable. Also, a company
can reliably estimate product returns when
49
50
there have been no large inventory

increases for either the company or its
customers.
13. A company would prefer gross revenue
reporting over net revenue reporting
because the larger total revenue number
increases the apparent size of the
companys economic activity. If investors
use a price-to-sales relationship in valuing
the company, gross revenue reporting can
lead to a higher stock price.
14. If percentage-of-completion accounting is
to be used by construction contractors, the
following elements should be present in the
transaction.
a. Dependable estimates can be made of
the extent of progress toward
completion, contract revenues, and
contract costs.
b. The contract should clearly specify the
enforceable rights regarding goods or
services to be provided and received
by the parties, the consideration to be
exchanged, and the manner and terms
of settlement.
c. The buyer can be expected to satisfy
obligations under the contract.
d. The contractor can be expected to
perform the contractual obligation.
Because most contractors with significant
contract obligations have the experience to
make the necessary estimates, it is
recommended that they use percentage-ofcompletion accounting rather than the
completed-contract method.
15. The cost-to-cost method of measuring the
percentage of completion is an input
method and is computed by relating the
costs incurred to date to the total estimated
costs. The efforts-expended methods are
also input methods, but they are based on
the ratio of the efforts expended by labor or
machines on the contract to the total effort
expected to be expended. They include
labor hours, labor dollars, machine hours,
or
even
material
quantities.
The
percentage computed is then applied to
revenue and costs to determine the
amount reported for the period.
16. Output measures of percentage of
completion include units produced, contract
milestones reached, and values added to
the contract. Particular examples of output
measures include miles of roadway, cubic
Chapter 8
yards of dirt removed, or architects' and

engineers' estimates of job completion.
17. The construction in progress account is
used to accumulate all costs directly
chargeable to a contract, including a share
of indirect overhead costs and the
recognized gross profit earned to date if
the company is using the percentage-ofcompletion method. The progress billings
on construction contracts account is used
to accumulate the total progress billings
made on a contract, including any billed
retainer fees. These accounts are offset
against each other on the balance sheet. If
Construction in Progress is the larger of the
two accounts, both are reported in the
Current Asset section. If Progress Billings
on Construction Contracts is larger, both
are reported in the Current Liability section.
18. A minority of the members of the
Construction Contractor Guide Committee
of the AICPA feels that the costs reported
under
the
percentage-of-completion
method should always be the costs
incurred to date. If the method of arriving
at the percentage of completion is other
than the cost-to-cost method, the only way
this could occur would be to compute
revenue as the sum of costs incurred and
the computed gross profit rather than by
applying the percentage of completion to
the total contract price.
19. Under
accounting,
the
difference
between
recognized revenue and recognized costs,
or the recognized gross profit, is added to
the costs incurred in arriving at the balance
reported in the construction in progress
account.
20. The major reason for a fluctuating gross
profit percentage under the percentage-ofcompletion method is the revision of
estimates that is inherent in this type of
contract. As costs incurred differ from those
anticipated, and as expectations of future
costs change over the contract time period,
the total gross profit to be earned on the
project also changes. When some profit
has already been recognized, these
adjustments can create large changes in
the reported gross profit percentage from
year to year. These fluctuations would also
increase if a measure of completion other
than cost-to-cost was used and if the
21.
22.
23.
24.
minority position of the AICPA Construction

Contractor Guide Committee was followed.
If a loss is anticipated on a contract, the
entire loss should be recognized in the
period when the loss is first anticipated.
This is true under both the completedcontract and the percentage-of-completion
methods. Under the completed-contract
method, the amount of the expected loss is
charged to a loss account and credited to
Construction in Progress. Under the
method,
however, the amount of the loss plus any
profit recognized in prior periods on the
contract must be recognized and reported
as a loss. Under either method, the
balance reported in Construction in
Progress will be the same.
The measures used to compute a
percentage of performance in long-term
service contracts depend on the nature of
the acts of service to be performed. If the
acts of service are identical or similar in
nature, an output measure derived by
relating the number of acts performed to
the total number of acts to be performed
over the contract life is recommended. If
the acts are defined, but are not identical,
the sales value of the acts performed to
date related to the total contract sales
value is used.
When a service company is organized and
its activities grow rapidly in the early years
of its life, the deferral of all revenue over
the service life fails to recognize any profit
on the sale of the contracts. Because the
sale is the critical event in many service
companies, failure to recognize profit in the
early years of a company results in both
direct and indirect costs being charged
against very little revenue. Thus, in a newly
formed company, large losses will often be
shown even if the company may be
profitable over time. The deferred revenue
recognition method may not do an
acceptable job of predicting the pattern of
future cash flows.
The three methods of revenue recognition
that await the receipt of cash are (a)
installment sales, (b) cost recovery, and (c)
cash. Under the installment sales method,
a portion of each cash receipt is recognized
as income. Under the cost recovery

method, no income is recognized until all
costs are recovered. Under the cash
method, all costs incurred are expensed
immediately, and all cash receipts are
recognized as revenue. Costs incurred are
deferred and matched against cash
received under both the installment sales
and cost recovery methods. As indicated
previously, under the cash method all costs
are expensed immediately.
25. The installment sales method of accounting
is preferred over the full accrual method if
cash collection is highly uncertain and if
the amount of loss due to uncollectible
accounts cannot be reasonably estimated.
This can occur if the sales transaction is
unusual in nature and involves a customer
in a way that default carries little cost or
penalty.
26. Installment sales accounting requires
recognition of gross profit as the cash is
collected. The amount to be recognized is
based on the gross profit percentage of the
sales year. Because these percentages can
vary from year to year, it is necessary to
maintain records that identify sales and
collections by year and to maintain a
record of each year's gross profit
percentage.
27. Interest on installment sales contracts
should be recognized each period as
earned. Each cash collection, therefore,
should be reduced by the interest earned
before the gross profit percentage is
applied to the balance of the collection to
determine the gross profit earned.
28. The cash method of recognizing revenue
would be acceptable for reporting purposes
only if the probability of recovery of product
or service costs is slight. Seldom would the
method be appropriate for product or real
estate sales because of repossession rights
held by the seller. However, in service
contracts with high initial costs and great
uncertainty as to collection, the cash
method might be appropriate.
51
PRACTICE EXERCISES
PRACTICE 81
BASIC JOURNAL ENTRIES FOR REVENUE RECOGNITION
1.
Cash
1,000
Unearned Service Revenue
1,000
2.
Unearned Service Revenue
Service Revenue
PRACTICE 82
1,000
1,000
JOURNAL ENTRIES FOR A CONSIGNMENT
1.
Inventory on Consignment
Inventory
10,000
Accounts Receivable
Sales
16,000
Cost of Goods Sold

Inventory on Consignment
10,000
10,000
2.
PRACTICE 83
16,000
10,000
JOURNAL ENTRIES FOR A LAYAWAY
1.
Cash (2 $50)
Deposits Received from Customers
100
Cash
Sales
300
50
Cost of Goods Sold

Inventory
200
100
2.
350
200
3.
Revenue from Layaway Forfeitures
50
50
Chapter 8
PRACTICE 84
1.
2.
3.
53
JOURNAL ENTRIES FOR AN UP-FRONT, NONREFUNDABLE FEE
Cash (200 $360)

Unearned Initial Sign-up Fees
72,000
Cash (200 $50)

Monthly Service Revenue
10,000
72,000
10,000
Unearned Initial Sign-up Fees ($72,000/36 months)

Initial Sign-up Fee Revenue
PRACTICE 85
2,000
2,000
JOURNAL ENTRIES FOR AN UP-FRONT, REFUNDABLE FEE
1.
Cash (1,500 $1,000)

1,500,000
Customers Refundable Fees (30%)
450,000
Unearned Membership Fees (70%)
1,050,000
2.
Unearned Membership Fees ($1,050,000/12 months) 87,500

Membership Fee Revenue
87,500
Cost of Membership Fee Revenue (70%)
10,500
Administrative Expense (30%)
4,500
Cash [($120/12 months) 1,500 customers] 15,000
3.
Unearned Membership Fees ($1,050,000/12 months)87,500

Membership Fee Revenue
87,500
Cost of Membership Fee Revenue (70%)
10,500
Administrative Expense (30%)
4,500
Cash [($120/12 months) 1,500 customers] 15,000
Customers Refundable Fees
Cash
PRACTICE 86
1.
450,000
450,000
JOURNAL ENTRIES FOR CONTINGENT RENT
Cash
40,000
Rent Revenue
2.
Cash
40,000
40,000
Rent Revenue
40,000
Contingent Rent Receivable

100,000
Contingent Rent Revenue
100,000
($55,000,000 $50,000,000) 0.02 = $100,000
PRACTICE 86 (Concluded)
3.
Cash
40,000
Rent Revenue

Contingent Rent Revenue
$12,000,000 0.02 = $240,000
40,000
240,000
240,000
Cash
600,000
600,000
($80,000,000 $50,000,000) 0.02 = $600,000
PRACTICE 87
1.
2.
REPORTING REVENUE GROSS AND NET
Cash ($300,000 0.02)

Commission Revenue
Cash
6,000
6,000
300,000
Sales
Cost of Goods Sold
Inventory
Commission Expense
Cash
PRACTICE 88
300,000
210,000
210,000
6,000
6,000
COST-TO-COST METHOD
1.
Percentage of completion: [$100,000/($100,000 + $450,000)] = 18.182%
Cumulative revenue to be recognized:
$800,000 0.18182
Revenue recognized in previous years
Revenue to be recognized in Year 1
$145,456
0
$145,456
2.
Percentage of completion: [($100,000 + $150,000)/($100,000 + $150,000 + $280,000)] =
47.170%
$800,000 0.47170
$377,360
145,456
$231,904
3.
Percentage of completion: 100.000%
$800,000 1.00000
$800,000
377,360
Chapter 8
55
$422,640
PRACTICE 89
EFFORTS-EXPENDED METHOD
1.
Percentage of completion: [150/(150 + 850)] = 15.000%
$800,000 0.15000
$120,000
0
$120,000
2.
Percentage of completion: [(150 + 300)/(150 + 300 + 520)] = 46.392%
$800,000 0.46392
$371,136
120,000
$251,136
3.
$800,000 1.00000
PRACTICE 810
$800,000
371,136
$428,864
PERCENTAGE OF COMPLETION BASED ON OUTPUT MEASURES
1.
Percentage of completion: [3,000/(3,000 + 15,200)] = 16.484%
$800,000 0.16484
$131,872
0
$131,872
2.
Percentage of completion: [(3,000 + 7,500)/(3,000 + 7,500 + 8,200)] = 56.150%
$800,000 0.56150
$449,200
131,872
$317,328
3.
$800,000 1.00000
$800,000
449,200
$350,800
Chapter 8
57
PRACTICE 811
1.
BASIC CONSTRUCTION JOURNAL ENTRIES
Construction in Progress
Materials, Cash, etc.
100,000
Accounts Receivable
Progress Billings
200,000
Cash
180,000
100,000
200,000
Accounts Receivable
2.
180,000
150,000
Accounts Receivable
Progress Billings
200,000
Cash
170,000
150,000
200,000
Accounts Receivable
3.
170,000
250,000
Accounts Receivable
Progress Billings
400,000
Cash
450,000
250,000
400,000
Accounts Receivable
PRACTICE 812
450,000
COMPLETED-CONTRACT JOURNAL ENTRIES
Progress Billings
800,000
Revenue on Construction Contracts
800,000
Cost of Construction Contracts
PRACTICE 813
500,000
500,000
PERCENTAGE-OF-COMPLETION JOURNAL ENTRIES
1.

100,000
45,456
145,456
2.

150,000
81,904
231,904
3.

250,000
172,640
422,640
PRACTICE 814
CONSTRUCTION CONTRACTS: BALANCE SHEET REPORTING
1.
Accounts receivable is reported as a current asset. The balance at the end of each year is
computed as follows:
Year 1: $200,000 $180,000 = $20,000
Year 2: $20,000 + $200,000 $170,000 = $50,000
Year 3: $50,000 + $400,000 $450,000 = $0
2. and 3.
For balance sheet reporting purposes, Progress Billings and Construction in Progress are
netted against one another. If the cumulative amount of Progress Billings is larger, the net
amount is reported as a current liability. If the cumulative amount of Construction in
Progress is larger, the net amount is reported as a current asset.
Year 1
Progress billings: $200,000
Construction in progress: $100,000 (cost) + $45,456 (profit) = $145,456
Net current liability of $54,544 ($200,000 $145,456)
Year 2
Progress billings: $200,000 beginning balance + $200,000 = $400,000
Construction in progress: $145,456 (beginning balance) + $150,000 (cost) + $81,904
(profit) = $377,360
Net current liability of $22,640 ($400,000 $377,360)
Year 3
Progress billings: $400,000 beginning balance + $400,000 = $800,000
Construction in progress: $377,360 (beginning balance) + $250,000 (cost) + $172,640
(profit) = $800,000
No net amount is reported because both Construction in Progress and Progress Billings are
equal to $800,000. It would be appropriate to report the two amounts, netting to zero, in
either the Current Asset or Current Liability section of the balance sheet.
PRACTICE 815
MULTIPLE YEARS OF REVENUES AND COSTS: COST-TO-COST METHOD
1.
Percentage of completion: [$200,000/($200,000 + $550,000)] = 26.6667%
$1,200,000 0.266667
$320,000
0
$320,000
Cumulative cost to be recognized:

($200,000 + $550,000) 0.266667
Cost recognized in previous years
Cost to be recognized in Year 1
$200,000
0
$200,000

200,000
120,000
320,000
Chapter 8
59
PRACTICE 815
(Concluded)
2.
Percentage of completion: [($200,000 + $350,000)/($200,000 + $350,000 + $280,000)] =
66.2651%
$1,200,000 0.662651
$795,181
320,000
$475,181

($200,000 + $350,000 + $280,000) 0.662651$550,000
200,000
$350,000
350,000
125,181
475,181
3.
$1,200,000 1.000000
$1,200,000
795,181
$ 404,819

($200,000 + $350,000 + $250,000) 1.000000$800,000
550,000
$250,000
250,000
154,819
404,819
PRACTICE 816
MULTIPLE YEARS OF REVENUES AND COSTS: OUTPUT MEASURE
1.
Percentage of completion: [8,000/(8,000 + 16,200)] = 33.0579%
$1,200,000 0.330579
$396,695
0
$396,695

($200,000 + $550,000) 0.330579
$247,934
0
$247,934
247,934
Chapter 8
61
148,761
396,695
PRACTICE 816 (Concluded)
2.
Percentage of completion: [(8,000 + 12,500)/(8,000 + 12,500 + 4,100)] = 83.3333%
$1,200,000 0.833333
$1,000,000
396,695
$ 603,305

($200,000 + $350,000 + $280,000) 0.833333$ 691,666
247,934
$ 443,732
443,732
159,573
603,305
3.
$1,200,000 1.000000
$1,200,000
1,000,000
$ 200,000

($200,000 + $350,000 + $250,000) 1.000000$ 800,000
691,666
$ 108,334
108,334
91,666
200,000
PRACTICE 817
MULTIPLE YEARS OF REVENUES AND COSTS: ANTICIPATED LOSS
1.
Percentage of completion: [$200,000/($200,000 + $1,150,000)] = 14.8148%
$1,500,000 0.148148
$222,222
0
$222,222
With the cost-to-cost method, the percentage of cost and the actual cost are the same,
unless the contract has an
anticipated loss as illustrated in Year 2.
200,000
22,222

PRACTICE 817
222,222
(Concluded)
2.
Percentage of completion: [($200,000 + $350,000)/($200,000 + $350,000 + $1,020,000)]
= 35.0319%
However, the contract now has a total anticipated loss of $70,000 [$1,500,000 ($200,000
+ $350,000 + $1,020,000)].
$1,500,000 0.350319
$525,479
222,222
$303,257

($525,479 + $70,000 anticipated loss) $595,479
200,000
$395,479
395,479
92,222
303,257
3.
$1,500,000 1.000000
$1,500,000
525,479
$ 974,521

($200,000 + $350,000 + $900,000) 1.000000$1,450,000
595,479
$ 854,521
854,521
120,000
974,521
PRACTICE 818
JOURNAL ENTRIES FOR THE PROPORTIONAL PERFORMANCE METHOD
1.
Cash (2,000 $500)

1,000,000
Unearned Season Ticket Revenue
1,000,000
2.
Deferred Initial Season Ticket Costs

Cash
3.
150,000
150,000
Unearned Season Ticket Revenue

383,333
Season Ticket Revenue [$1,000,000 (23/60)]
Season Ticket Game Costs
92,000
383,333
Chapter 8
63
Cash (2,000 $2 23)
92,000
Initial Season Ticket Costs [$150,000 (23/60)]57,500

Deferred Initial Season Ticket Costs
57,500
PRACTICE 819 INSTALLMENT SALES: BASIC JOURNAL ENTRIES
Installment Accounts Receivable
Installment Sales
350,000
Cost of Installment Sales ($350,000 0.80)

Inventory
280,000
Cash ($350,000 0.40)

Installment Accounts Receivable
140,000
Installment Sales
Cost of Installment Sales
Deferred Gross Profit
350,000
350,000
280,000
140,000

Realized Gross Profit on Installment Sales
28,000
280,000
70,000
28,000
($140,000 collected 20% profit margin = $28,000)

or ($70,000 deferred gross profit 40% cash collected = $28,000)
PRACTICE 820
INSTALLMENT SALES: FINANCIAL STATEMENT REPORTING
Installment sales receivable: $350,000 $140,000 = $210,000

Deferred gross profit: $70,000 $28,000 = $42,000
Balance sheet reporting:
Installment sales receivable
$210,000
Less deferred gross profit
(42,000)
Net installment sales receivable$168,000
PRACTICE 821
1.
INSTALLMENT SALES: INTEREST ON RECEIVABLES
Installments Receivable
Installment Sales
100,000
Cost of Goods Sold

Inventory
60,000
Cash
40,000
Interest Revenue ($100,000 0.18)
100,000
60,000
Installment Sales
Cost of Goods Sold
100,000

Realized Gross Profit
8,800
22,000
18,000
60,000
40,000
8,800
($22,000/$100,000) $40,000
Chapter 8
65
PRACTICE 821
2.
(Concluded)
Installment Sales
120,000
120,000
Cost of Goods Sold

Inventory
80,000
Cash
80,000
140,000
Interest Revenue
104,360
35,640
From Year 1: ($100,000 $22,000) 0.18 = $14,040

From Year 2: $120,000 0.18 = $21,600
$14,040 + $21,600 = $35,640
Installment Sales
Cost of Goods Sold
120,000

37,184
80,000
40,000
37,184
From Year 1: Principal cash collections = $50,000 $14,040 = $35,960

From Year 2: Principal cash collections = $90,000 $21,600 = $68,400
From Year 1: Realized gross profit = ($35,960/$100,000) $40,000 = $14,384
From Year 2: Realized gross profit = ($68,400/$120,000) $40,000 = $22,800
$14,384 + $22,800 = $37,184
PRACTICE 822
COST RECOVERY METHOD: BASIC JOURNAL ENTRIES
Cash
Collected
$140,000
Year 1
Sales = $350,000
Gross Profit % = 20%
COGS = $280,000
Year 2
Sales = $270,000
COGS = $202,500
Year 3
Sales = $210,000
COGS = $147,000
Year 1
Gross Profit
Recognized
$175,000
$
0
108,000
Year 2
Cash
Gross Profit
Collected
Recognized
$
0
$35,000
Year 3
Cash
Gross Profit
Collected Recognized
$
135,000
84,000
40,500
PRACTICE 822
1.
(Concluded)
Installments Receivable Year 1

Installment Sales
350,000
Cost of Goods Sold

Inventory
280,000
350,000
Cash
140,000
Installment Sales
Cost of Goods Sold
2.
Year 1
140,000
350,000
Year 1

Installment Sales
270,000
Cost of Goods Sold

Inventory
202,500
Cash
108,000
Installment Sales
Cost of Goods Sold
280,000
70,000
270,000
202,500
Year 2
108,000
270,000
Year 2
Cash
202,500
67,500
175,000
3.
280,000
Year 1
175,000
Deferred Gross Profit Year 1

35,000

Installment Sales
210,000
Cost of Goods Sold

Inventory
147,000
35,000
210,000
147,000
Cash
84,000
Installment Sales
Cost of Goods Sold
Year 3
84,000
210,000
Year 3
Cash
147,000
63,000
135,000
Deferred Gross Profit Year 2

Year 2
135,000
40,500
40,500
Chapter 8
67
EXERCISES
823.
2006 Inventory on Consignment......................................

Retained Earnings (0.30 $45,000).........................
Accounts Receivable............................................
To correct error made in 2005.
45,000
13,500
Receivable from Consignee ($12,000 1.3)...........

Consignment Sales..............................................
15,600
Cost of Consignment Goods Sold...........................

Inventory on Consignment..................................
12,000
Inventory....................................................................
Inventory on Consignment..................................
33,000
Commission Expense ($15,600 0.15)...................

Cash...........................................................................
Receivable from Consignee................................
2,340
13,260
58,500
15,600
12,000
33,000
15,600
824.
a. No entry. Deception has received no order from Tally, so no sale should be
recognized no matter how much Deception segregates the inventory.
b. No entry. As explained in Question 1 of SAB 101, no sale should be recognized if
the sales agreement is unsigned and yet normal procedure includes the formal
signing of the sales agreement by both the buyer and the seller. In addition, a billand-hold arrangement should not be recognized as a sale in the absence of a
written request from the buyer.
c. This scenario describes a case in which a bill-and-hold arrangement can be
recognized as a sale. The appropriate journal entry is as follows:
Accounts Receivable.........................
Sales.........................................
175,000
Cost of Goods Sold............................

Inventory..................................
100,000
175,000
100,000
d. No entry. No sale should be recognized until all substantive customer acceptance

provisions have been satisfied.
825.
Cash (300 $2,000)........................................................

Unearned Lifetime Membership Fees...............
Unearned Wellness Evaluation Fees.................
600,000
488,372
111,628
Lifetime membership fees: [$1,750/($1,750 + $400)] $600,000 = $488,372

Wellness evaluation fees: [$400/($1,750 + $400)] $600,000 = $111,628
Unearned Wellness Evaluation Fees............................
Wellness Evaluation Fees..................................
111,628
Cost of Wellness Evaluation Fees................................

Cash (300 $70)..................................................
21,000
Unearned Lifetime Membership Fees...........................

Lifetime Membership Fees ($488,372/5 years).
97,674
Cost of Lifetime Membership Fees...............................

Cash (300 $250)................................................
75,000
111,628
21,000
97,674
75,000
826.
1.
2.
Cash (20,000 $200)...................................................... 4,000,000

Customers Refundable Fees (20%)..................
800,000
Unearned Subscriber Fees (80%)......................
3,200,000
Deferred Initial Subscriber Costs (80%).......................
Administrative Expense (20%)......................................
Cash (20,000 $40).............................................
640,000
160,000
Unearned Subscriber Fees ($3,200,000/4 quarters)....

Subscriber Fee Revenue....................................
800,000
Initial Setup Expense ($640,000 3/12)........................

Deferred Initial Subscriber Costs......................
160,000
Cost of Subscriber Fee Revenue (80%)........................

Cash [($80/4 quarters) 20,000 customers].....
320,000
80,000
800,000
800,000
160,000
400,000
Chapter 8
826.
3.
4.
5.
69
(Concluded)
800,000

160,000

320,000
80,000

800,000

160,000

320,000
80,000

800,000

160,000

320,000
80,000
Customers Refundable Fees........................................

Cash (3,800 $200).............................................
760,000
Customers Refundable Fees........................................

40,000
800,000
160,000
400,000
800,000
160,000
400,000
800,000
160,000
400,000
760,000
40,000
This final entry is necessary to close out the remaining balance in the estimated
amount of fees to be refunded. One could also make entries to retroactively
reclassify some administrative expense as cost of subscriber fee revenue; in this
example this reclassification would impact the classification of expenses but not the
amount of total expenses for the year.
827.
2005
Construction in Progress.................
Materials, Labor, Cash, etc.........
To record costs incurred
on contract.
1,720,000
Accounts Receivable .......................

Progress Billings on
Construction Contracts.............
To record contract billings.
1,350,000
Cash...................................................
Accounts Receivable..................
To record collections on
contract.
950,000
828.
2,020,000
1,720,000
2,020,000
2,630,000
1,350,000
2,630,000
3,030,000
950,000
Construction Contracts..................
Revenue from Long-Term
Construction Contracts.............
To record recognition
of revenue.
Cost of Long-Term
Construction Contracts.................
Construction in Progress...........
To record recognition
of expenses.
2006
3,030,000
3,980,000
no entry
no entry
3,980,000
3,740,000
3,740,000
1. Total gross profit recognized on contract:

2004.......................................... $ 75,000
2005..........................................
140,000
2006..........................................
(20,000)
$195,000
Total cost incurred on contract:
Contract price.............................................
Less gross profit recognized.....................
Total cost incurred.............................................
Total cost incurred in 2005:
Total cost incurredcontract....................
1,805,000
Less cost incurred:
2004..........................................................
2006..........................................................
Total cost incurred2005.................................
$2,000,000
195,000
$1,805,000
$
$ 360,000
820,000
1,180,000
$ 625,000
Chapter 8
828.
71
(Concluded)
2. Total cost incurred and gross profit recognized to the end of 2005:
2004....................................
2005....................................
Cost
Incurred
$360,000
625,000
$ 985,000
Gross Profit
Recognized
Total
$ 75,000
$ 435,000
140,000
765,000
$ 215,000
$1,200,000
Percentage of job completed at the end of 2005:

Total cost incurred and gross profit recognized
to end of 2005....................................................................
1,200,000
Total contract price..............................................................
2,000,000
829.
Percentage of project completed by the end of 2005.......
60%
3. Total gross profit recognized to end of 2005 ..........................

Percentage of project completed by end of 2005 ...................
Total estimated gross profit on project as of end of 2005....
$ 215,000
60%
$ 358,333
4. Total cost incurred to end of 2005.............................................

Percentage of project completed by end of 2005 ...................
Total estimated cost on contract as of end of 2005..............
1,641,667
Less cost incurred to date.........................................................
Estimated cost to complete contract as of end of 2005.......
$ 985,000
60%
$
2004
1. Actual cost incurred to date.......... $2,500,000
2. Estimated cost to complete
contract........................................ 3,500,000
3. Total estimated cost....................... $ 6,000,000
Percentage of completion
to date [(1)/(3)].............................
41.67%
To Date
2004(41.67% completed):
Recognized revenue
($7,000,000 41.67%)............. $2,916,900
Cost (rounded to actual cost)....... 2,500,000
Gross profit.................................. $ 416,900
2005(93.55% completed):
Recognized revenue
($6,700,000 93.55%)............. $6,267,850
Cost (rounded to actual cost)....... 5,800,000
Gross profit.................................. $ 467,850
985,000
$ 656,667
2005
$5,800,000
2006
$6,210,000
400,000
$ 6,200,000
0
$6,210,000
93.55%
100%
Recognized Recognized
in
in
Prior Years Current Year
$2,916,900
2,500,000
$ 416,900
$2,916,900
2,500,000
$ 416,900
$3,350,950
3,300,000
$ 50,950
829.
(Concluded)
2006(100% completed):
Recognized revenue...................... $6,700,000
Cost................................................. 6,210,000
Gross profit.................................. $ 490,000
830.
1.
2.
3.
4.
5.
6.
$6,267,850
5,800,000
$ 467,850
$ 432,150
410,000
$ 22,150
$20,000 ($220,000 $200,000)

$260,000 ($250,000 + $10,000)
$370,000 [$850,000 ($220,000 + $260,000)]
$380,000 ($370,000 + $10,000)
$830,000 ($200,000 + $250,000 + $380,000)
$226,092
2005: 450/640 = 0.7031; 0.7031 $210,000 = $147,651
Cumulative gross
profit
2004: 200/650 = 0.3077; 0.3077 $200,000 = (61,540) Gross profit
recognized2004
$ 86,111 Gross profit
recognized2005
831.
1. Percentage-of-completion method:
2005 Contract price.............................................
Less estimated cost:
Cost to date ............................................
Estimated cost to complete project......
Estimated gross profit...........................
Percentage completed ($59,000/$100,000)
Estimated gross profit2005
($20,000 59%).......................................
Balance sheet:
Current assets:
Accounts receivable
($70,000 billed $45,000 received)
Construction in progress..................
Less: Progress billings on
construction contracts....................
$120,000
$59,000
41,000
100,000
$ 20,000
59%
$ 11,800
$25,000
$70,800*
70,000
800
*$59,000 cost to date + $11,800 income = $70,800

Income statement:
Revenue ($120,000 0.59).....................
Cost of construction...............................
Gross profit.............................................
$70,800
59,000
$11,800
Chapter 8
831.
73
(Concluded)
2. Completed-contract method:
Balance sheet:
Current assets:
Accounts receivable...................................
Current liabilities:
Progress billings on construction
contracts................................................... $70,000
Less: Construction in progress................
59,000
Income statement:
Nothing reported. No contract was completed.
832.
2004 Construction in Progress...................................

Materials, Labor, Cash, etc.............................
3,200,000
Accounts Receivable..........................................
Progress Billings on Construction
Contracts......................................................
3,300,000
Cash.....................................................................
Accounts Receivable......................................
3,100,000
$25,000
11,000
3,200,000
3,300,000
3,100,000
Cost of Long-Term Construction Contracts..... 2,300,000*

Construction in Progress...................................
200,000
Revenue from Long-Term Construction
Contracts......................................................
2,500,000
*0.25 $9,200,000 = $2,300,000
0.25 $800,000 ($10,000,000 $9,200,000) = $200,000

4,300,000
Contracts......................................................
4,500,000
Cash.....................................................................
2,700,000
4,300,000
4,500,000
2,700,000

475,000
Contracts......................................................
5,000,000
*0.75 $9,100,000 = $6,825,000;
$6,825,000 $2,300,000 = $4,525,000
0.75 ($10,000,000 $9,100,000) = $675,000;

$675,000 $200,000 = $475,000
832.
(Concluded)
1,550,000
Contracts......................................................
2,200,000
Cash.....................................................................
4,200,000
1,550,000
2,200,000
4,200,000

275,000
Contracts......................................................
2,500,000
*$9,050,000 ($4,525,000 + $2,300,000) = $2,225,000
Progress Billings on Construction Contracts. . 10,000,000
Construction in Progress...............................
10,000,000
833.

6,000,000
Contracts......................................................
6,800,000
Cash.....................................................................
6,000,000

5,300,000
Contracts......................................................
5,200,000
Cash.....................................................................
5,400,000
Anticipated Loss on Long-Term Construction

Contracts............................................................
$700,000 of loss recognized in 2005.
*Contract price.....................................
Costs incurred 20042005..............
Estimated cost to complete............
Estimated loss.................................
6,000,000
6,800,000
6,000,000
5,300,000
5,200,000
5,400,000
700,000*
700,000
$18,000,000
$11,300,000
7,400,000
18,700,000
$ (700,000)
Chapter 8
833.
75
(Concluded)
7,650,000
Contracts......................................................
6,000,000
Cash.....................................................................
6,600,000
7,650,000
6,000,000
6,600,000
Progress Billings on Construction Contracts. . 18,000,000

Construction Contracts...............................
18,000,000
Cost of Long-Term Construction Contracts..... 18,250,000
18,250,000
834.
Costs
2005
Basic contract................. $8,000,000
42,000,000
Change Order 1...............
50,000
Change Order 2...............
Change Order 3...............

300,000
Change Order 4...............
125,000
$8,475,000
42,825,000
Estimated Cost Estimated

Contract
to Complete
Total Cost
Price
$28,000,000
$36,000,000 $
50,000
50,000
300,000
$ 28,400,000
Percentage completed:
$8,475,000/$36,875,000 = 22.98%
Revenues: 22.98% $42,825,000..................................
Costs actually incurred..................................................
Gross profit to be recognized in 2005..........................
835.
2005
Apr. 1
100,000
50,000
600,000
125,000
$36,875,000 $
125,000
600,000
100,000
$9,841,185
8,475,000
$ 1,366,185
Cash ....................................................................
Unearned Equipment Use Fees.....................
Unearned Evaluation Fees.............................
Unearned Magazine Fees...............................
600
505
72
23
Unearned equipment use fee: [$700/($700 + $100 + $32)] $600 = $505

Unearned evaluation fee: [$100/($700 + $100 + $32)] $600 = $72
Unearned magazine fee: [$32/($700 + $100 + $32)] $600 = $23
To record receipt of cash and establish
liabilities for services owed.
835.
(Concluded)
1 Deferred Initial Equipment Use Cost.................
Deferred Initial Evaluation Cost.........................
Deferred Initial Magazine Cost...........................
Cash.................................................................
To record prepayment of costs.
101
14
5
120
Deferred initial equipment use cost: [$700/($700 + $100 + $32)] $120 = $101
Deferred initial evaluation cost: [$100/($700 + $100 + $32)] $120 = $14
Deferred initial magazine cost: [$32/($700 + $100 + $32)] $120 = $5
Apr.
Dec.
1 Initial Evaluation Costs.......................................

64
Deferred Initial Evaluation Cost.....................
Cash.................................................................
To record costs of initial fitness evaluation.
14
50
1 Unearned Evaluation Fees................................

72
Fitness Evaluation Fees.................................
To recognize revenue from fitness evaluation.
72
Equipment Use Costs......................................... 129

Magazine Costs...................................................
6
Cash.................................................................
Total direct costs of rendering equipment and
magazine service: 9 months $15 = $135.
135
Equipment use costs: [$700/($700 + $32)] $135 = $129

Magazine costs: [$32/($700 + $32)] $135 = $6
Dec. 31
31
31
31
Unearned Magazine Fees...................................

17
Magazine Fees ................................................
To recognize 9 months revenue on magazine;
$23 (9/12) = $17.
Unearned Equipment Use Fees......................... 379
Equipment Use Fees.......................................
To recognize 9 months revenue from equipment
use; $505 (9/12) = $379.
Equipment Use Costs.........................................
76
Deferred Initial Equipment Use Cost.............
To recognize 9 months cost of equipment use;
$101 (9/12) = $76.
Magazine Costs...................................................
Deferred Initial Magazine Cost.......................
To recognize 9 months cost of magazines;
$5 (9/12) = $4.
17
379
76
4
4
77
Chapter 8
836.
Installment Accounts Receivable2004.............
Installment Sales..............................................
Cost of Installment Sales*.....................................
Inventory...........................................................
Cash.......................................................................
Installment Accounts Receivable2004........
Installment Sales....................................................
Cost of Installment Sales.................................
Deferred Gross Profit2004...........................
Deferred Gross Profit2004 ...............................
Deferred Gross Profit2005 ...............................
Deferred Gross Profit2006 #...............................
Realized Gross Profit on Installment Sales. . .
2004
210,000
2005
2006
270,000
350,000
210,000
157,500
270,000
191,700
157,500
21,000
255,500
191,700
111,000
21,000
210,000
350,000
255,500
206,000
84,000
27,000
270,000
157,500
52,500
63,000
108,000
35,000
350,000
191,700
255,500
78,300
94,500
5,250
21,000
7,830
5,250
15,750
31,320
9,450
28,830
56,520
COMPUTATIONS:
2004
*$210,000 0.75 = $157,500
0.10 $210,000 = $21,000
$21,000 0.25
$5,250
2005
$270,000 0.71 = $191,700
0.40 $210,000 = $84,000
0.10 $270,000 = $27,000
$84,000 0.25 = $21,000
$27,000 0.29 = $7,830
2006
$350,000 0.73 = $255,500
0.30 $210,000 = $63,000
0.40 $270,000 = $108,000
0.10 $350,000 = $35,000
$63,000 0.25 = $15,750
$108,000 0.29 = $31,320
#
$35,000 0.27 = $9,450
Chapter 8
78
Chapter 8
837.
The key to this solution is solving the gross profit percentage for 2004
(3).
1.
$39,000 ($50,000 $11,000)
2.
$11,000 ($50,000 0.22)
3.
22%:
4.
$5,000 ($1,100/0.22)
5.
$60,000 ($80,000 $20,000)
6.
$20,000 ($80,000 0.25)
7.
$120,000 ($91,800 + $28,200)
8.
23.5% ($28,200/$120,000)
9.
$25,275:
2005 realized gross profit on 2005 cash collections, $5,000

($20,000 0.25)
2005 realized gross profit on 2004 cash collections, $5,500
($10,500 $5,000)
Gross profit percentage2004, 22% ($5,500/$25,000
cash collections)
2006 realized gross profit on 2004 cash collections,

($10,000 0.22)
($50,000 0.25)
($45,000 0.235)
$ 2,200
12,500
10,575
$25,275
79
Chapter 8
838.
2004
2005
2006
2007
Installment Accounts Receivable2004........... 47,000
Installment Accounts Receivable2005...........
45,000
58,000
61,000
Installment Sales...........................................
47,000
45,000
58,000
61,000
Cost of Installment Sales.................................... 25,850
26,100
30,740
31,110
Inventory........................................................
25,850
26,100
30,740
31,110
Cash..................................................................... 25,850
38,850
50,100
55,450
Installment Accounts Receivable2004.....
25,850
14,100
4,700
24,750
13,500
4,500
31,900
17,400
33,550
Installment Sales................................................. 47,000
45,000
58,000
61,000
Cost of Installment Sales..............................
25,850
26,100
30,740
31,110
Deferred Gross Profit2004........................
21,150
18,900
27,260
29,890
Deferred Gross Profit2004..............................
14,100*
4,700
12,150
4,500

1,160
17,400
2,440
Realized Gross Profit....................................
14,100
18,010
24,340
COMPUTATIONS:
*Cost recovered in 2004

$31,900 $30,740 = $1,160
$26,100 $24,750 = $1,350 cost to recover after 2005

$33,550 $31,110 = $2,440
$13,500 $1,350 = $12,150
Gross profit recognized
2004
2005
2006
2007
Full accrual....................................................................................................
$21,150
$18,900
$27,260
$29,890
Cost recovery method..................................................................................
0
14,100
18,010
24,340
Chapter 8
839.
80
2004
2005
2006
Installment sales............................................ $80,000 $95,000 $105,000*
Cost of installment sales............................... 49,600 56,050
68,250
Gross profit percentage................................
38%
41%
35%
Cash collections:
2004 sales.................................................. 25,600
46,400
5,600
2005 sales..................................................
22,800
43,700
2006 sales..................................................
32,550
Realized gross profit on installment sales. .
0# 22,400** 16,050
COMPUTATIONS:
*$68,250/0.65 = $105,000
$80,000 0.62 = $49,600
1 ($56,050/$95,000) = 41%
Gross profit recognized in 2006............................

All costs from 2004 sales are recovered
Cash received equals gross profit.......................
All costs from 2006 sales are not recovered
Cash received goes to recover costsgross profit
Gross profit reported in 2006 from 2005 sales....
Cost of 2005 sales..................................................
$56,050
Costs recovered in 2005........................................
22,800
Costs to be recovered in 2006........................
Cash received related to 2005 sales......................
#
$16,050
5,600
0
$10,450
33,250
$43,700
Cash collections in 2004 do not exceed cost of sales

Realized gross profit in 2004 = $0
**Cash collections for 2004 sales ($25,600 + $46,400)

Cost of 2004 sales............................................
Realized gross profit in 2005...........................
$72,000
49,600
$22,400
$ 5,600
Cash collections for 2004 sales............................

Cash collections for 2005 sales ($22,800 + $43,700) $66,500
Cost of 2005 sales............................................
56,050
Realized gross profit in 2006...........................
10,450
$16,050
Chapter 8
81
PROBLEMS
840.
1.
Consignor books:
Inventory on Consignment..................................................
Inventory .........................................................................
Commission Expense ($220,000 0.10)............................
Receivable from Consignee................................................
Consignment Sales........................................................
Cost of Consignment Goods Sold......................................
Inventory on Consignment............................................
*Cost of goods sold: $220,000/1.25 = $176,000
Cash......................................................................................
Receivable from Consignee..........................................
2.
3.
250,000
250,000
22,000
198,000
220,000
176,000*
176,000
139,000
139,000
Consignee books:
Cash......................................................................................
Payable to Consignor.....................................................
220,000
Payable to Consignor..........................................................
Commission Revenue....................................................
22,000
Payable to Consignor..........................................................
Cash.................................................................................
139,000
220,000
22,000
139,000
Consignor financial statements:

Balance SheetAsset section
Receivable from consignee.....................................................
Inventory on consignment.......................................................
$ 59,000
74,000
Income Statement
Consignment sales..................................................................
Less cost of consignment sales ............................................
Commission expense .............................................................
Profit from consignments........................................................
$220,000
176,000 $44,000
22,000
$22,000
82
841.
1.
2.
Chapter 8
Cash ....................................................................................
Rent Revenue............................................................
10,000
Contingent Rent Receivable...............................................

Contingent Rent Revenue........................................
2,500
Cash ....................................................................................
Rent Revenue............................................................
10,000

1,500
10,000
2,500
10,000
1,500
Contingent rent revenue: ($280,000 $250,000) 0.05 = $1,500

3.
4.
Cash......................................................................................
Rent Revenue............................................................
10,000
Contingent Rent Revenue...................................................

Contingent Rent Receivable ($2,500 + $1,500)......
4,000
Cash......................................................................................
Rent Revenue............................................................
10,000

16,500
10,000
4,000
10,000
16,500
Total renter sales for the year: $300,000 + $280,000 + $350,000 + $400,000 =
$1,330,000
Contingent rent revenue: ($1,330,000 $1,000,000) 0.05 = $16,500
Cash......................................................................................
Contingent Rent Receivable....................................
16,500
16,500
83
Chapter 8
842.
1.
(1)
(2)
(3)
(4)
(5)
(6)
Project A
2005
2006
$ 1,450,000 $ 1,450,000
$ 840,000 $ 1,320,000
560,000
0
$ 1,400,000 $ 1,320,000
$
50,000 $ 130,000
Contract price............................
Actual cost incurred to date....
Estimated cost to complete.....
Total estimated cost [(2) + (3)].
Total estimated gross profit.....
Percentage completed
[(2)/(4)].....................................
(7) Recognized revenue to date
[(1) (6)].................................. $
(8) Recognized revenue
recovered in prior years........
60%
Project B
2005
2006
$ 1,700,000 $ 1,700,000
$ 720,000 $ 1,060,000
880,000
650,000
$ 1,600,000 $ 1,710,000
$ 100,000 $ (10,000)
100%
870,000 $ 1,450,000 $
870,000
45%
62%
Project C
2005
2006
$ 850,000 $ 850,000
$ 160,000 $ 591,500
480,000
58,500
$ 640,000 $ 650,000
$ 210,000 $ 200,000
25%
2005
Project D
2006
$ 1,000,000
$ 280,000
520,000
$ 800,000
$ 200,000
91%
765,000 $ 1,054,000 $ 212,500 $ 773,500
765,000
35%
$
212,500
350,000
(9) Recognized revenue

current year [(7) (8)]............ $
(10) Cost to date (2).......................... $
(11) Costprior years......................
870,000 $ 580,000 $
840,000 $ 1,320,000 $
840,000
765,000 $ 289,000 $ 212,500 $ 561,000

720,000 $ 1,064,000* $ 160,000 $ 591,500
720,000
160,000
$
$
350,000
280,000
(12) Costcurrent year [(10) (11)] $

(13) Gross profit (loss) [(9) (12)]. . $
840,000 $
30,000 $
720,000 $
45,000 $
$
$
280,000
70,000
480,000 $
100,000 $
344,000 $ 160,000 $ 431,500

(55,000) $ 52,500 $ 129,500
2005
Total gross profit...................................................
$ 127,500
Less general and admin. expenses.....................
60,000
Net income.............................................................
$ 67,500
*$1,054,000 (cumulative revenue) + $10,000 (full amount of loss) = $1,064,000
2.
2006
$ 244,500
60,000
$ 184,500
Completed contract2006
Project A................................................................................................................................................................................
Project B (loss deducted in year it is determined)............................................................................................................
Total income.......................................................................................................................................................................
General and administrative expenses................................................................................................................................
Income using completed-contract method....................................................................................................................
$ 130,000
(10,000)
$ 120,000
60,000
$ 60,000
Chapter 8
84
84
843.
1. a.
(1) Contract price..............
60,000,000
(2) Actual cost incurred
to date........................
55,000,000
(3) Estimated cost to
complete....................
(4) Total estimated cost....
55,000,000
Percentage of
completion (2)/(4).....
2003
$60,000,000
2004
$60,000,000
2005
$60,000,000
$12,000,000
$30,160,000
$45,000,000
38,000,000
$50,000,000
27,840,000
$58,000,000
10,555,555
$55,555,555
24%
52%
81%
To
Date
Recognized in
Prior Years
2003:
Recognized revenue
($60,000,000 0.24)................... $14,400,000
Cost (actual cost).......................

12,000,000
Gross profit................................ $ 2,400,000

2004:
Recognized revenue
($60,000,000 0.52)................... $31,200,000 $14,400,000
Cost (actual cost).......................
30,160,000
12,000,000
Gross profit (loss)...................... $ 1,040,000
$ 2,400,000
2005:
Recognized revenue
($60,000,000 0.81)................... $48,600,000 $31,200,000
Cost (actual cost).......................
45,000,000
30,160,000
Gross profit................................ $ 3,600,000
$ 1,040,000
2006:
Recognized revenue.................. $60,000,000 $48,600,000
Cost .............................................
55,000,000
45,000,000
Gross profit................................ $ 5,000,000
$ 3,600,000
2007: No gross profit recognized, only cash collection.
b.
None in 2007.
$60,000,000
55,000,000
$ 5,000,000
100%
Recognized in
Current Year
$14,400,000
12,000,000
$ 2,400,000
$16,800,000
18,160,000
$ (1,360,000)
$17,400,000
14,840,000
$ 2,560,000
$11,400,000
10,000,000
$ 1,400,000
No revenue, cost, or gross profit recognized for years 20032005.

In 2006:
Gross revenue.........................
Cost of earned revenue..........
Gross profit...........................
2006
85
Chapter 8
843.
(Concluded)
2.
2003
2004
2005
2006
Construction in Progress.................. 12,000,000

18,160,000
14,840,000
10,000,000
Materials, Labor, Cash, etc..........
12,000,000
18,160,000
14,840,000
10,000,000
Accounts Receivable......................... 13,000,000
15,500,000
17,000,000
14,500,000
Construction Contracts............
13,000,000
15,500,000
17,000,000
14,500,000
Cash..................................................... 12,000,000
13,500,000
15,000,000
15,000,000
Accounts Receivable...................
12,000,000
13,500,000
15,000,000
15,000,000
Cost of Long-Term Construction
Contracts.......................................... 12,000,000
18,160,000
14,840,000
10,000,000
Construction in Progress.................. 2,400,000
1,360,000 2,560,000
1,400,000
Construction Contracts............
14,400,000
16,800,000
17,400,000
11,400,000
Contracts..........................................
Construction in Progress............
60,000,000
60,000,000
2007 Journal Entry:

Cash...............................................
Accounts Receivable.............
4,500,000
4,500,000
Chapter 8
844.
1. a.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
b.
2.
Project
A
B
D
Total
86
Percentage of Completion:
Contract price....................................
Actual cost incurred to date..............
Estimated cost to complete..............
Total estimated cost [(2) + (3)]..........
Total estimated gross profit (loss)
[(1) (4)].........................................
Percentage completed [(2)/(4)] .......
Earned revenue in current period
[(1) (6)].........................................
Project A Project B Project C Project D

$ 310,000 $ 415,000 $ 350,000 $ 300,000
$ 187,500 $ 195,000 $ 310,000 $ 16,500
12,500
255,000
0
183,500
$ 200,000 $ 450,000 $ 310,000 $ 200,000
$ 110,000 $ (35,000) $ 40,000 $ 100,000

93.75%
43.33%
100%
8.25%
$ 290,625 $ 179,820 $ 350,000 $ 24,750
Cost of earned revenue in current

period (2)........................................ 187,500
214,820* 310,000
16,500
Gross profit (loss) [(7) (8)].............. $ 103,125 $ (35,000) $ 40,000 $ 8,250
*$179,820 + $35,000 loss = $214,820
Completed Contract:
Project C............................................................ $350,000
Less: Cost incurred.......................................... 310,000 $ 40,000
Project B............................................................ $415,000
Less: Total estimated cost.............................. 450,000
(35,000)
Total gross profit2005................................
$ 5,000
Costs in Excess of Billings and
Billings in Excess of Costs
under the Completed-Contract Method
a.
Construction
Related
Costs in Excess
in Progress
Billings
of Billings
$187,500
$155,000
$32,500
160,000
249,000
16,500
4,000
12,500
$364,000
$408,000
$45,000
b.
Billings in Excess
of Costs
$89,000
$89,000
Chapter 8
844.
3.
Project
A
B
D
Total
87
(Concluded)
Costs and Estimated Earnings
in Excess of Billings and Billings in Excess of
Costs and Estimated Earnings
under the Percentage-of-Completion Method
a.
Costs and
Estimated
Earnings in
Costs and
Related
Excess of
Estimated Earnings
Billings
Billings
$290,625
$155,000
$135,625
160,000
249,000
24,750
4,000
20,750
$475,375
$408,000
$156,375
b.
Billings
in Excess of
Costs and
Estimated
Earnings
$89,000
$89,000
845.
1.
To
Date
2004:
Recognized revenue
($16,000,000 0.31)......................... $ 4,960,000
Cost [($4,600,000 + $9,640,000)
0.31] .......................................... 4,414,400
Gross profit...................................... $ 545,600
2005:
Recognized revenue
($16,000,000 0.58)...................... $ 9,280,000
Cost [($4,600,000 + $4,500,000 +
$5,100,000) 0.58]...................... 8,236,000
Gross profit...................................... $ 1,044,000
2006:
Recognized revenue........................ $16,000,000
Cost (actual cost)............................ 14,350,000
Gross profit................................... $ 1,650,000
Recognized in
Prior Years
Recognized in
Current Year
$4,960,000
4,414,400
$ 545,600
$4,960,000
$4,320,000
4,414,400
$ 545,600
3,821,600
$ 498,400
$9,280,000
8,236,000
$ 1,044,000
$6,720,000
6,114,000
$ 606,000
Chapter 8
845.
88
(Continued)
2.
2004
4,600,000
4,600,000
2005
4,500,000
4,500,000
2006
5,250,000
5,250,000
Accounts Receivable................................
Construction Contracts....................
5,000,000
6,000,000
5,000,000
Cash............................................................
Accounts Receivable...........................
4,500,000
Construction in Progress.........................
Materials, Labor, Cash, etc.................

Contracts.................................................
Contracts.................................................
Construction in Progress....................
5,000,000
6,000,000
5,400,000
4,500,000
4,414,400
545,600
6,100,000
5,400,000
3,821,600
498,400
4,960,000
No entry
5,000,000
6,100,000
6,114,000
606,000
4,320,000
No entry
6,720,000
16,000,000
16,000,000
3. 2006: Construction in Progress.................................................................................................

Materials, Labor, Cash, etc.........................................................................................
5,250,000
Accounts Receivable........................................................................................................
Progress Billings on Construction Contracts..........................................................
5,000,000
Cash...................................................................................................................................
Accounts Receivable..................................................................................................
6,100,000
5,250,000
5,000,000
6,100,000
Cost of Long-Term Construction Contracts................................................................... 14,350,000

Construction in Progress...........................................................................................
14,350,000
Progress Billings on Construction Contracts................................................................ 16,000,000
Revenue from Long-Term Construction Contracts..................................................
16,000,000
Chapter 8
845.
4.
89
(Concluded)
The following entry would be the only one different from (2):
2004

Contracts.................................................
4,600,000
545,600
2005
4,500,000
498,400
5,145,600
2006
5,250,000
606,000
4,998,400
5,856,000
846.
1.
a.
b.
c.
d.
e.
Building 1
Building 2
Building 3
Prior
Prior
Prior
to 2005
2005
to 2005
2005
to 2005
2005
$ 4,000,000 $ 4,000,000 $ 9,000,000 $ 9,000,000 $ 13,150,000 $ 13,150,000
$ 2,070,000 $ 3,000,000 $ 6,318,000 $ 8,118,000 $ 3,000,000 $10,400,000
1,380,000
750,000
1,782,000
9,000,000
2,800,000
$ 3,450,000 $ 3,750,000 $ 8,100,000 $ 8,118,000 $ 12,000,000 $ 13,200,000
Contract price..................................
Actual cost incurred to date...........
Estimated cost to complete...........
Total estimated cost .......................
Total estimated gross profit (loss)
[(a) (d)]........................................ $ 550,000 $ 250,000 $ 900,000 $ 882,000 $ 1,150,000 $
(50,000)
f. Percentage of completion
[(b)/(d)]..........................................
60%
80%
78%
100%
25%
78.79%
g. Recognized revenue to date
[(a) (f)]......................................... $ 2,400,000 $ 3,200,000 $ 7,020,000 $ 9,000,000 $ 3,287,500 $10,360,885
h. Recognized revenue
recovered in prior periods...........
2,400,000
7,020,000
3,287,500
Building 4
2005
$ 2,500,000
$ 800,000
1,200,000
$ 2,000,000
$
500,000
40%
$ 1,000,000
i. Revenue recognized in
current period............................... $ 2,400,000 $ 800,000 $ 7,020,000 $ 1,980,000 $ 3,287,500 $ 7,073,385 $ 1,000,000
j. Cost to date (b)................................ $ 2,070,000 $ 3,000,000 $ 6,318,000 $ 8,118,000 $ 3,000,000 $10,410,885* $ 800,000
k. Cost recognized in prior periods...
2,070,000
6,318,000
3,000,000
l. Cost recognized in current period $ 2,070,000 $ 930,000 $ 6,318,000 $ 1,800,000 $ 3,000,000 $ 7,410,885 $
m. Gross profit (loss) [(i) (l)]............. $ 330,000 $ (130,000) $ 702,000 $ 180,000 $ 287,500 $ (337,500) $
*$10,360,885 + $50,000 = $10,410,885
800,000
200,000
Chapter 8
846.
90
(Concluded)
Total revenue all buildings.................................

Total costall buildings.....................................
Total gross profitall buildings......................
2.
Prior to
2005
$12,707,500
11,388,000
$ 1,319,500
Completed contract: 2005

RevenueBuilding 2...............................................
CostBuilding 2......................................................
Gross profit..............................................................
Less anticipated loss on Building 3.......................
Adjusted gross profit............................................
847.
1.
a.
b.
c.
2005
$10,853,385
10,940,885
$
(87,500)
$ 9,000,000
8,118,000
$ 882,000
(50,000)
$ 832,000
2004
2005
2006
Actual costs incurred to date............... $3,400,000 $5,950,000 $6,150,000
Estimated cost to complete contract... 2,100,000
150,000
Total estimated cost........................... $ 5,500,000 $ 6,100,000* $ 6,150,000

Percentage of completion to date
[(a)/(c)].................................................
61.82%
97.54%
100%
*Results in contract loss of $100,000.
To
Date
2004(61.82% completed):
Recognized revenue
($6,000,000 0.6182)....................
Cost (actual cost)............................
Gross profit...................................
2005(97.54% completed):
Recognized revenue
($6,000,000 0.9754)....................
Cost (recognized revenue plus
anticipated loss)...........................
Gross profit (loss)...........................
2006(100% completed):
Recognized revenue........................
Cost (actual cost)............................
Gross profit (loss).........................
Recognized in Recognized in
Prior Years
Current Year
$ 3,709,200
3,400,000
$ 309,200
$3,709,200
3,400,000
$ 309,200
$5,852,400
$3,709,200
$2,143,200
5,952,400
$ (100,000)
3,400,000
$ 309,200
2,552,400
$ (409,200)
$6,000,000
6,150,000
$ (150,000)
$5,852,400
5,952,400
$ (100,000)
$ 147,600
197,600
$ (50,000)
91
847.
Chapter 8
(Concluded)
2.
2004
3,400,000
3,400,000
2005
2,550,000
2,550,000
2006
200,000
Accounts Receivable................................
To record progress billings.
3,200,000
2,000,000
800,000
Cash............................................................
Accounts Receivable...........................
To record collections on
progress billings.
3,000,000
Materials, Labor, Cash, etc.................
Actual costs incurred.

Contracts.................................................
To recognize revenue and
expense for the period.
3,200,000
2,000,000
2,000,000
3,000,000
3,400,000
309,200
200,000
800,000
600,000
2,000,000
2,552,400
3,709,200
3. 2007: Cash...............................................................................
Accounts Receivable..............................................
To record final collections on contracts.
400,000
Progress Billings on Construction Contracts............

Construction in Progress.......................................
To close out construction accounts.
6,000,000
600,000
197,600
409,200
50,000
2,143,200
147,600
400,000
6,000,000
Chapter 8
92
848.
1.
Contract price...........................
14,000,000
Costs incurred to date.............
13,900,000
Estimated costs to complete...
Total estimated costs...............
13,900,000
Total expected profit..............
Percentage of completion........
2004
2005
$14,000,000 $14,000,000
2006
$14,000,000 $
$ 6,500,000
$ 9,800,000
$12,200,000 $
6,800,000
$13,300,000
3,900,000
$13,700,000
1,900,000
$14,100,000 $
$ (100,000) $
100,000
700,000
48.87%
300,000
71.53%
To
Date
86.52%
2006:
Recognized revenue
($14,000,000 0.8652)........................ $12,112,800
Cost (recognized revenue plus
entire anticipated loss)...................... 12,212,800
Gross profit (loss)................................. $ (100,000)
2007:
Recognized revenue............................. $14,000,000
Cost (actual cost).................................. 13,900,000
Gross profit (loss)................................. $ 100,000
100.00%
Prior Years
Current Year
2004:
Recognized revenue
($14,000,000 0.4887)........................ $ 6,841,800
Cost (actual cost)..................................
6,500,000
Gross profit .......................................... $ 341,800
2005:
Recognized revenue
($14,000,000 0.7153)........................ $10,014,200
Cost (actual cost)..................................
9,800,000
Gross profit (loss)................................. $ 214,200
2007
$6,841,800
6,500,000
$ 341,800
$ 6,841,800
6,500,000
$ 341,800
$3,172,400
3,300,000
$ (127,600)
$10,014,200
$2,098,600
9,800,000
214,200
2,412,800
$ (314,200)
$12,112,800
12,212,800
$ (100,000)
$1,887,200
1,687,200
$ 200,000
2.
2004
2005
2006
Construction in Progress 6,500,000
3,300,000
2,400,000
Materials, Labor,
Cash, etc...................
6,500,000
3,300,000
2,400,000
Cost of Long-Term
Contracts..................... 6,500,000
3,300,000
2,412,800
Construction in Progress 341,800
127,600
314,200
Revenue from LongTerm Contracts.........
6,841,800
3,172,400
2,098,600
2007
1,700,000
1,700,000
1,687,200
200,000
1,887,200
Chapter 8
93
849.
2005
Inventory .............................................................................
Cash..........................................................................
45,200
Notes Receivable2005 ($32,000 + $62,000 + $3,600). . .

Unearned Interest Revenue ($7,167 + $3,600) ...........
Installment Sales...........................................................
97,600
Cost of Installment Sales ($45,200 $2,000 inventory

increase)...........................................................................
Inventory........................................................................
2006
45,200
10,767
86,833
43,200
43,200
Cash.....................................................................................
Notes Receivable2005..............................................
35,600
Unearned Interest Revenue2005...................................

Interest Revenue...........................................................
3,600
Installment Sales................................................................
Cost of Installment Sales.............................................
Deferred Gross Profit on Installment Sales2005....
86,833
Deferred Gross Profit on Installment Sales2005..........

Realized Gross Profit on Installment Sales................
*Gross profit percentage: 50.25% ($43,633/$86,833);
0.5025 $32,000 = $16,080
16,080*
Inventory..............................................................................
Cash...............................................................................
52,020
Notes Receivable2006....................................................
Unearned Interest Revenue.........................................
Installment Sales...........................................................
89,500*
35,600
3,600
43,200
43,633
16,080
52,020
11,955
77,545
*$60,000 + ($50,000 + $5,500) $26,000 = $89,500
2005 Notes receivable collected in 2006.
Interest revenue from 2005 notes: $7,167 $5,579 = $1,588

Interest revenue from 2006 notes: $5,500 $1,588 = $3,912
Unearned interest revenue at end of 2006...................... $ 8,043
Interest revenue from 2006 notes (see above)............... 3,912
Total unearned interest revenue at time of sale............. $11,955
Cost of Installment Sales ($52,020 $8,000)................... 44,020
Inventory........................................................................
44,020
Cash..................................................................................... 55,500
Notes Receivable2005 ($62,000 $36,000).............
26,000
Notes Receivable2006..............................................
29,500
$89,500 $60,000 = $29,500
94
849.
Chapter 8
(Concluded)
Unearned Interest Revenue2005.........................................
Unearned Interest Revenue2006.........................................
Interest Revenue.................................................................
1,588
3,912
Installment Sales......................................................................
Cost of Installment Sales...................................................
Deferred Gross Profit on Installment Sales2006..........
77,545
Deferred Gross Profit on Installment Sales2005

($26,000 $1,588 = $24,412; $24,412 0.5025)....................
Deferred Gross Profit on Installment Sales2006...............
Realized Gross Profit on Installment Sales......................
*Gross profit percentage: 43.23% ($33,525/$77,545);
0.4323 ($29,500 $3,912) = $11,062
5,500
44,020
33,525
12,267
11,062*
23,329
850.
2004
2005
2006
Installment A/R2004..................... 104,000
Installment A/R2005.....................
116,000
Installment A/R2006.....................
121,000
Installment Sales.......................
104,000
116,000
121,000
Cost of Installment Sales................ 64,480
Inventory....................................
Cash................................................. 66,980
Installment A/R2004...............
Installment A/R2005...............
Installment A/R2006...............
Interest Revenue.......................
Installment Sales............................. 104,000
Cost of Installment Sales..........
Deferred Gross Profit2004....
Deferred Gross Profit2004..........
Realized Gross Profit................
$57,200 0.38 = $21,736
$29,120 0.38 = $11,066
$71,920 0.41 = $29,487
$15,000 0.38 = $5,700

#
$26,680 0.41 = $10,939
**$76,230 0.39 = $29,730
*
68,440
73,810
64,480
68,440
125,520
73,810
145,460
57,200
29,120
71,920
9,780
24,480
116,000
15,000
26,680
76,230
27,550
121,000
64,480
39,520
68,440
73,810
47,560
47,190
21,736*
11,066
29,487
21,736
5,700
10,939 #
29,730**
40,553
46,369
Chapter 8
95
851.
1.
a. Percentage of completion
Period 1
Period 2
Period 3
(1) Contract price............................ $ 4,500,000 $ 4,500,000 $ 4,500,000
4,500,000
(2) Actual costs incurred to date... $ 900,000 $ 2,100,000 $ 3,180,000
3,600,000
(3) Estimated cost to complete
contract....................................
2,700,000
1,500,000
420,000
(4) Total estimated cost.................. $ 3,600,000 $ 3,600,000 $ 3,600,000
3,600,000
(5)
Total expected profit.............. $ 900,000 $ 900,000 $ 900,000
Percentage of completion to date
[(2)/(4)]...............................................
25% 58.33333%
To
Date
88.33333%
Period 4
$
$
0
$
$
900,000
100%
Prior Years
Current Year
Period 1:
2005(25% completed)
Recognized revenue
($4,500,000 0.25)........................
Cost (actual cost)............................
Gross profit...................................
$ 1,125,000
900,000
$ 225,000
Period 2:
2005(58.33333% completed)
Recognized revenue
($4,500,000 0.5833333)..............
Cost (actual cost)............................
Gross profit...................................
$2,625,000
2,100,000
$ 525,000
$1,125,000
900,000
$ 225,000
$1,500,000
1,200,000
$ 300,000
Period 3:
2006(88.33333% completed)
Recognized revenue
($4,500,000 0.8833333)..............
Cost (actual cost)............................
Gross profit...................................
$3,975,000
3,180,000
$ 795,000
$2,625,000
2,100,000
$ 525,000
$1,350,000
1,080,000
$ 270,000
Period 4:
2006(100% completed)
Recognized revenue........................
Cost ..................................................
Gross profit...................................
$4,500,000
3,600,000
$ 900,000
$3,975,000
3,180,000
$ 795,000
$ 525,000
420,000
$ 105,000
$1,125,000
900,000
$ 225,000
96
Chapter 8
851.
(Concluded)
b.
Completed contract
Periods 1, 2, and 3No revenue, costs, or gross profit.
Period 4:
Revenue.............................................
$4,500,000
Costs..................................................
3,600,000
Gross profit.......................................
$ 900,000
c.
Installment sales
Anticipated revenues....................................................
Anticipated costs..........................................................
Anticipated gross profit................................................
Gross profit percentage...............................................
Period 10.20 $750,000............................................
Period 20.20 $1,050,000.........................................
Period 30.20 $1,950,000.........................................
Period 40.20 $750,000............................................
d.
$4,500,000
3,600,000
$ 900,000
20%
Gross Profit
$150,000
210,000
390,000
150,000
$900,000
Cost recovery
Estimated costs: $3,600,000
Period
Payment
Received
1
2
3
4
$ 750,000
1,050,000
1,950,000
750,000
Costs to Be
Recovered
$3,600,000
2,850,000
1,800,000
0
0
Gross
Profit
$
0
0
150,000
750,000
Summary of Gross Profit under

Four Different Revenue Recognition Methods
Method
Period 1
Period 2
Period 3
Percentage of completion................. $225,000
$300,000
$270,000
Completed contract............................
Installment sales................................ 150,000

210,000
390,000
Cost recovery.....................................
150,000
2.
Period 4
$105,000
900,000
150,000
750,000
Because the probability of collection is high for most municipalities, the

percentage-of-completion method would best reflect the gross profit in this case.
As the uncertainty of the contract increases, either as to payment by the
purchaser or as to future costs, methods that defer recognition of gross profit
until later would be preferred. If only collection is doubtful, the installment sales
method is recommended. If the future costs are uncertain, either the cost
recovery or the completed-contract method is recommended.
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97
DISCUSSION CASES
Discussion Case 852
This case is designed to contrast the point of revenue recognition with respect to the completed-contract
method of accounting and the percentage-of-completion method. The discussion should focus on the
appropriateness and advantages and disadvantages of each method in terms of reporting a realistic
income figure.
The previous accountant's policy of deferring all expenses and revenues to the period of completion
conforms to the concept that revenue is not recognized until an actual exchange has taken place. The
argument is that revenue emerges from sales, not production. Actually, revenue is earned continuously.
The question is when to recognize it. If there are significant uncertainties involved as to the actual sales
price or collectibility, the completed-contract method followed by the previous accountant has merit.
By contrast, the percentage-of-completion method recognizes revenues as they are earned over the
period of the projects instead of at completion. This method is acceptable, and generally preferable,
when a firm contract for a sale exists, and the costs remaining to be incurred on the project can be
estimated with reasonable accuracy.
Discussion Case 853
This case can be used to discuss the rationale underlying percentage-of-completion accounting and to
explore areas not specifically included in the identified questions. It should be emphasized that the tax
method used does not have to coincide with the book method and that the completed-contract method is
available for tax purposes with some limitations. Income tax allocation procedures would be necessary if
the methods do not agree. This topic is covered in a later chapter. The requirement to recognize losses
entirely in the period when first identified is the same regardless of the accounting method used. It is
based on the valuation principle that inventory should not be valued at more than its net realizable value.
If the costs to date plus expected future costs exceed the contract price, the excess must be deducted
from the cost incurred to date if the net realizable value principle is to be followed. Discussion could
include rationale for this approach, including the historical tendency to be conservative in applying the
percentage-of-completion method. The discussion could also focus on the uncertainty that often arises
when applying this method and the extreme care that is necessary in computing the percentage of
completion and the estimation of future costs.
Discussion Case 854
1. The revenue recognized on a long-term contract under the percentage-of-completion method is
determined by applying a percentage representing the degree of completion to the total contract
price at the end of the accounting period. The percentage is derived by dividing the costs incurred to
date by the total estimated costs of the entire contract based on the most recent information. The
percentage may also be derived by other input or output measures of progress, such as engineering
or architectural estimates, the ratio of direct labor costs incurred to date to total estimated labor
costs, or the ratio of direct labor hours incurred to estimated total direct labor hours.
If the cost-to-cost method is used, the costs incurred are deducted from the recognized revenue to
determine the recognized gross profit. If another measure is used, the percentage of completion is
applied to the total estimated costs to determine the costs to be recognized in the current period. As
an alternative, the costs incurred may be increased by the gross profit earned on the contract in the
period to determine total revenues. If it is anticipated that a loss will occur on the contract, the full
amount of the expected loss is recognized in the period it is first determined.
In subsequent periods, because the percentage-of-completion method described produces
cumulative results, gross profit recognized in prior periods must be subtracted to obtain current
earnings to be recognized.
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Discussion Case 854 (Concluded)

Under the completed-contract method, no earnings are recognized until the contract is substantially
completed. For the period in which completion occurs, gross revenues include the total contract
price. Total job costs incurred are deducted from gross revenues, resulting in recognition of the entire
amount of gross profit in the completion period. If it is expected that a loss will occur on the contract,
a provision for loss should be recognized immediately.
2. The percentage-of-completion method is preferable when estimates of the bases upon which
progress is measured are reasonably dependable. The completed-contract method is preferable
when inherent hazards or lack of dependable estimates cause the forecasts to be of doubtful value.
3. Interim billings on long-term contracts are not generally accepted as a method of recognizing
earnings because such billings often do not bear a meaningful relationship to the work performed on
the contract. Typically, billings may be accelerated in the early stages of the contract to provide the
contractor with the working capital needed to begin performance. If earnings were recognized on a
billings basis, it would be possible for a contractor to materially distort the contractor's earnings
merely by rendering billings without regard to any degree of progress on the contract.
Discussion Case 855
This case can be used to introduce the very difficult revenue recognition problems that face companies
in service industries. The membership fee should not be recognized immediately because there has not
been substantial completion of the earnings process. In addition, no separate chunk of revenue should
be allocated to the initial sign-up process and recognized immediately because customers are not willing
to pay merely to be signed up for a membership; they are paying the initial fee to receive future
membership services. Instead, the membership fee should be recognized on a straight-line basis for the
economic life of the agreement. A very difficult question is whether some of the initial fee revenue should
be separately deferred and allocated to the special courses and programs that a customer is expected to
take, at a discount, during the term of the membership. Doing this would require reliable historical data
on which to base the estimates.
This case is based on the experience of an actual company. In the actual case situation, the studios
recognized the entire membership fee as revenue at the time of the initial contract. Little or no provision
was made for future membership services. In the initial promotion, memberships were sold easily to
those most interested in the services rendered by such institutions. This made the revenue and income
for newly opened studios high. As the particular studios matured and settled into more normal operations,
the revenue and income slowed down to a more stable state. The overall company statements continued
to show increasing revenue and income by opening new studios at an accelerated rate. This had its
eventual limits. The sale of the company was near completion when the impact of these facts was
understood by the prospective purchaser. Preparation of revised statements disclosed the real conditions
existing and led to a withdrawal, with penalty, of the offer to buy. Although not part of the revenue
recognition problem, further analysis indicated that some mortgages, especially second mortgages, had
not been properly recorded, which added to the unattractiveness of the studios to potential buyers.
Discussion Case 856
This case provides a basis for a class discussion on the difficulty of being precise in determining when
revenue is to be recognized. The following points concerning each of the four methods enumerated in
the case will be helpful in conducting a discussion of this case.
Method 1: Recognize revenue when advance billing is made.
Strengths
The advertising contract stresses the development of the advertising copy as a principal service.
Because of past experience, it apparently has been possible to estimate the costs to develop the copy,
the media cost, and possible loss from uncollectible accounts at the time the contract is signed.
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99
Discussion Case 856 (Concluded)

The critical event under this revenue recognition method is signing the contract. Adjustments to the
estimates are small, and thus a very early revenue recognition point is possible.
Weaknesses
The revenue recognition criteria state that there should be substantial performance of all services before
revenue is recognized. At the signing of the contract, the service to be performed is still in the future.
Being able to estimate costs is only one of the prerequisites for revenue recognition. Accurate past
estimates do not guarantee accurate future estimates. It is unacceptable to recognize revenue for
services to be rendered on the basis of only a signed contract.
Method 2: Recognize revenue when payment is received from the client.
Strengths
The receipt of payment from the client adds one objective dimension to recognizing revenue. One less
item must be estimated: the possible uncollectible accounts. Receipt of cash in this case assures the
agency that the contract is firm and that there is no misunderstanding as to the contractual payment
terms.
Weaknesses
Depending on what services are performed before the payment is received, this method has many of the
same weaknesses as the first method. There is not necessarily a connection between the timing of cash
receipts and the performance of advertising services. The services may be substantially performed prior
to cash collection, in which case collection may be too late to properly recognize revenue. On the other
hand, collection may be made before the services are rendered, in which case cash collection is too
early.
Method 3: Recognize revenue in the month when advertising appears in the media.
Strengths
By the time the advertisement appears in the media, there is no doubt that the agency has delivered the
contracted services. The advertisement has been designed and has been placed in the media. This point
of revenue recognition is more closely aligned with traditional revenue recognition practices. Students
who like to follow a majority position will probably favor this method.
Weaknesses
Even though services have been rendered, there is still uncertainty as to the cost of the media services.
This may or may not be serious, depending on the variability and predictability of the media costs.
Contingent on payment timing, bad debt expense may still have to be estimated under this method.
Method 4: Recognize revenue when the bill for advertising is received from the media.
Strengths
At this point, all costs and revenues should be known in amount, and revenue recognition should be free
of estimates and uncertainties, especially if the client paid the advance billing as has been the practice.
This method should lead to high verifiability of the revenue and cost to be reported.
Weaknesses
This method may defer recognition of revenue too far beyond the critical performance of services. The
revenue recognition principle does not require 100% certainty before revenue and costs are recognized.
Income statements should reflect the efforts expended in the period of reporting, not in some later period
when all uncertainties are resolved. Estimates and judgments must be applied to enhance relevance and
timeliness.
It is usually interesting to have students vote for their preference after all four methods have been
discussed. This case could also be used in a debate format. One or more students could defend each
method, and the class could then identify the most convincing presentation.
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Chapter 8
Discussion Case 857

This case illustrates that the use of differing revenue recognition methods can affect materially a firms
reported performance. When the uncertainty of cash collection is high and there is little penalty to the
customer when default occurs, revenue recognition may be more appropriate at the point of cash
collection rather than at the point of sale.
In this case, there appears to be substantial doubt as to the collectibility of receivables. If 1 in 5 sales
dollars is not being collected, it appears the earnings process is not complete at the point of sale. While it
is unfortunate that the restated financial statements result in a significantly lower net income, the
independent auditor has a responsibility to the users of the financial statements to ensure that those
financial statements accurately reflect the financial position of the company.
Discussion Case 858
1.
2.
3.
Numerous possibilities exist for recognizing revenue, though not all are acceptable. One possibility
is to recognize revenue when the agreement is made with partnerships to purchase the plant.
Another is to recognize some revenue at the point of sale and to recognize the remainder as the
notes are paid off. Midwestern elected to recognize all the revenue at the point of sale.
As mentioned in the case, on a cash basis, Midwestern actually had negative cash flows from
operations. Thus, while the income statement reported a profit margin of 66%, the firm was actually
losing cash.
In this case, there was substantial doubt as to whether the $45,000 partnership notes would be
collected. Although the plant was guaranteed to be profitable, Midwestern was overly optimistic as
to the demand for ethanol gas. Midwestern should have used a revenue recognition method that
related revenue recognition with cash collection. Either the installment sales method or the cost
recovery method would have been appropriate.
Discussion Case 859

1.
2.
3.
4.
If the loan origination fee relates to work done in processing the loan, such as title and credit checks
and other loan-related efforts, the firm might argue that the services related to that fee are complete
once the loan is made. In 1986, the FASB released SFAS No. 91, Accounting for Nonrefundable
Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.
In paragraph 5 of this Statement, the FASB clearly states that Loan origination fees shall be
deferred and recognized over the life of the loan.
If the collectibility of the loans is questionable, the accrual method of accounting would not be
appropriate. As discussed in the text, the likelihood of cash collections dictates whether the
installment sales, cost recovery, or cash method would be most appropriate.
In the case of savings and loans, the deposits were federally insured by the government. Thus,
investors could make deposits in the high-risk investments knowing that they stood a chance of
reaping a large return with very little downside risk. The government would make sure that they
received their original investment back.
Whether or not external auditors are responsible for evaluating a firm's lending practices is to be
decided by the courts. The Federal Savings and Loan Insurance Corporation (FSLIC) filed suit
against 6 of the then 8 largest CPA firms in the late 1980s, alleging negligence in conducting their
audits. At least one of the major firms, Ernst & Young, settled its case out of court. The settlement
was for $400 million.
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101
Discussion Case 860

1. For money received by home office from test centers, the journal entry to book the receipt of cash as
revenue would be:
Cash............................................................
xxx
Revenue................................................
xxx
However, if that money was subsequently "churned" back to the test site, a second journal entry
would have to be made. The credit would be to Cash and the debit should be made to a receivable
account. Any subsequent receipts of cash from the test center would then have to be analyzed to
determine if the cash is revenue or a repayment of the receivable. One can see that if "churning" is
occurring, the receivables account will continue to increase as revenue increases.
2. If the test center site transferring the money has an established receivable with the home office, the
accountant at the home office would have to determine if the money received was a payment on the
receivable or the recognition of revenue. The answer would depend on supporting documentation.
However, if the remittances increase and no payments are being made to reduce the receivable,
then the accountant at the home office should begin to question why loans are not being repaid.
Discussion Case 861
This case examines the issue of shipping inventory in anticipation of an order. The revenue recognition
criteria require the customer to provide an asset (an accounts receivable) in order for revenue to be
realizable. In the instance where the customer has not ordered the inventory, it would be difficult to claim
that the customer has provided an asset. The situation could be different if the customer has issued an
open purchase order to Datarite. In this case, Datarite could argue that an open purchase order results in
an accounts receivable once inventory is shipped. Such an arrangement should be very carefully
scrutinized by the companys auditor.
If the company president includes the extra inventory shipments as revenue, then the debt covenants will
be satisfied. Thus, in this instance, the existence of debt covenants will have resulted in the companys
performing business activities only to satisfy debt restrictions. If the sales are subsequently returned by
dealers, the company will have, in effect, violated its debt covenants but will have avoided disclosing this
fact to debt holders.
Discussion Case 862
This case describes a typical franchise arrangement. An initial fee is involved that covers services to be
rendered before the franchise outlet is opened and some services to be recognized subsequent to the
opening. Because this franchise arrangement involves installment payments, the interest implicit in the
initial fee must be removed and recognized over the period of payment, in this case 5 years. Thus, the
notes receivable, face value $20,000, should be reported at $15,163, the net present value of the notes
at 10% interest rate.
The management of Magleby would argue that because at least $5,000 worth of services are rendered at
the time the contract is signed, at least this amount should be recognized as revenue at the time of
opening. In fact, Maglebys management would argue that at the time that a franchise opens, only two
steps remain before Magleby Inn will have fully earned the entire franchise fee. First, it must provide
expert advice over the 5-year period. Second, it must wait until the end of each of the next 5 years so
that it may collect each of the $4,000 notes. Because collection has not been a problem and the advice
may consist largely of manuals and periodical service tip fliers, it could be maintained that a substantial
portion of the $15,163, the present value of the notes, should be recognized as revenue when a
franchisee begins operation.
The revenue recognition practice described in the previous paragraph is acceptable only if Magleby can
demonstrate that the initial services provided in supervising construction, arranging financing, and so
forth are a separate product. If Magleby can demonstrate that these services are a separate product, the
earnings process for this separate product is substantially complete when a franchise opens. A portion of
the initial fee could be allocated to this separate product and recognized as revenue at that time.
Magleby would have to show that it, or some other firm in the same industry, offers these initial setup
services as a separate product, independent of the continuing advisory services over the 5-year period.
102
Discussion Case 862
Chapter 8
(Concluded)
Even if it can be demonstrated that the initial services are a separate product, there is still the issue of
collectibility to be considered. Although there have been no defaults on the notes, the extent of Magleby
Inns experience may be so limited that there may in fact be a substantial collection problem in the future
(as has been the actual experience of many franchisers in the recent past). At some time in the future,
after Magleby Inn has experienced a large number of franchises that have opened and operated for 5
years or more, it should be possible to develop probability measures so that the earned portion of the
present value of the notes may be recognized as revenue at the time the franchise begins operation. For
the present, however, it might be necessary to recognize the $4,000 revenue only as the notes are
collected.
The monthly fee of 2% of sales should be recorded as revenue at the end of each month. This fee is for
current services rendered and should be recognized as the services are performed.
Discussion Case 863
The sales being made by Rain-Soft are in reality consignments and, as such, are not generally
recognized as sales until they have been sold to an outside party. This case is an example of a situation
in which a transaction might be labeled a sale but the terms of the side agreements between the seller
and the buyer convert the transaction into a consignment arrangement. Using past experience as a
guide is risky because a change in economic conditions can make past experience irrelevant to actual
experience. Class discussion could focus on the legal differences between a consignment sale to a
dealer, who is in reality an agent of the selling company, and an actual arms-length sale. Uncertainties,
such as the probability of cash collection and the possibility of return, still exist in arms-length sales, but
a presumption exists under these conditions that an exchange has taken place and the revenue can be
recognized. A change in accounting policy is probably required in the case as described for the company
to be keeping its records in accordance with GAAP. As part of this case, it is instructive to look at SFAS
No. 48, Revenue Recognition when Right of Return Exists.
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103
SOLUTIONS TO STOP & THINK

Stop & Think (p. 436): How would a contract's percentage of completion be measured? What methods
can you come up with to determine how complete a contract is?
There is a variety of methods for determining a contract's percentage of completion. This text will discuss
the cost-to-cost method, engineer's estimates, and other input and output measures. Before students
read on to find out what the answer is, they should spend a little time thinking about it. They will soon
realize that they will come up with the same methods that are commonly used.
Stop & Think (p. 439): Progress Billings on Construction Contracts is offset against the construction in
progress account. What does the resulting net figure represent?
When the progress billings on construction contracts account is netted against the construction in
progress account, the resulting net figure represents the amount of the construction (which includes costs
as well as a portion of expected profits) for which the customer has not yet been billed.
Stop & Think (p. 443): What circumstances would give rise to a loss being reported on a profitable
contract? In other words, what does a loss being reported for this period tell us about last year's profit?
If our estimates in prior periods were off by a significant amount, we could end up recording too much
revenue (and profit) in the early periods. This error would require us to record a loss for this period so
that the revenue (and profit) recognized to date would be correct.
Stop & Think (p. 449): If the collection of cash is uncertain, when and how should revenue and profits
be recognized?
There are several methods available for recognizing revenue when the receipt of cash is uncertain. The
text will soon discuss several of those methods. This question is inserted at this point to cause students
to realize that, if they stop and think for just a minute, they will come up with the same methods that are
actually employed in practice.
Stop & Think (p. 451): What does the $80,000 net amount represent?
This amount represents the cost of the inventory associated with the $120,000 in sales that is reflected in
the accounts receivable balance. Because collection of the receivable balance is uncertain, it is recorded
at a lesser amount. This $80,000 number assumes that if worse came to worst and customers didn't pay,
the seller could at least get the inventory back.
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Chapter 8
SOLUTIONS TO STOP & RESEARCH

Stop & Research (p. 423): MicroStrategy isnt the only company that has been subjected to unpleasant
public scrutiny because of a restatement associated with SAB 101. In fact, in 2002 a contract
management company called diCarta was sponsoring a Web site specifically devoted to SAB 101 issues.
The Web address is http://www.sab101.org. Access this Web site and compile a list of three additional
companies impacted by SAB 101.
The following summaries come from the News & Analysis section of http://www.sab101.org:
MAR 9, 2001 Teradyne Hurting (MotleyFool.com)
Semiconductor testing equipment manufacturer Teradyne warned that first-quarter results would be lower
than expected, due in part to SAB 101, an accounting change Teradyne recently made, dictating it
recognize revenue once a customer accepts a machine. Prior to the change, Teradyne recognized
revenue once a machine was shipped.
http://www.biz.yahoo.com/mf/010309/news01_010309.html
MAR 15, 2001 SCI, Stewart Still On Life Support (CBS MarketWatch.com)
Service Corp. International and Stewart Enterprises, two of the country's largest funeral home/cemetery
operators, have reported significant losses due to SAB 101, designed primarily to curb the funeral
industry's tendency to immediately book 100 percent of revenue from sales of multi-year installment
plans.
http://www.cbs.marketwatch.com/news/story.asp?guid=%7B0F041FAD
%2DBE08%2D4968%2D99B9%2D380392E540AE%7D&siteid=mktw
APR 23, 2001 Covad Receives Nasdaq Delisting Notice (Yahoo! Technology News, Reuters)
Nasdaq has threatened to delist Covad Communications for not yet filing its earnings report for the
quarter ending Dec. 31. The company has said a new federal accounting regulation, known as SAB 101,
would result in reduced revenue for 2000 of about $52 million.
http://www.dailynews.yahoo.com/h/nm/20010423/tc/tech_covad_dc_1.html
Stop & Research (p. 435): Access the FASBs Web site at http://www.fasb.org, and determine the
current status of the revenue recognition project.
On June 21, 2002, the FASB posted the following update on the progress of the revenue recognition
project:
The Board anticipates that this project will take two to three years to complete. The Board is exploring
the possibility of working jointly on this project with the International Accounting Standards Board. The
staff has also begun the top-down development of conceptual guidance and the bottom-up inventory of
accounting literature. The AICPAs Accounting Standards Executive Committee has agreed to assist the
Board in developing the inventory of relevant AICPA literature.
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105
SOLUTIONS TO BOXED ITEMS

McKesson Accounting Scandals: 1937 and 1999 (pp. 446447)
1. At first glance, the 47.5% stock price drop, resulting in lost market value of $8.8 billion, seems out of
proportion to the $42 million revenue overstatement. However, this announcement probably caused
investors to doubt the integrity of McKessons management. Accordingly, the stock price would drop
in anticipation of the uncovering of even more bad news. And in this case, that skepticism turned out
to be justified.
2. The fact that the overstatement of revenue at HBO & Company coincided with the period in which
the company was an acquisition target is probably not a coincidence. When a company is preparing
to issue stock, to apply for a major loan, or to be acquired, it is very important for the companys
reported financial performance to look as solid as possible. In this case, the reported financial
performance of HBO & Company directly impacted the acquisition price. Thus, there is a temptation
to overstate revenues in order to fluff up reported performance.
3. Both the 1937 McKesson & Robbins case and the 1999 McKesson HBOC case involved collusion
among top managers. Because top managers can circumvent internal control systems, fraud
perpetrated by top managers is difficult to detect. In fact, a determined set of top managers can
almost always get away with fraud, at least in the short run. The difficulty is in continuing to hide the
fraud as it grows larger, which always seems to happen.
Soft Revenue for Software Companies (pp. 452453)
1. The primary difficulty associated with allocating a software packages purchase price over the
earnings process is in determining the amount and timing of revenue recognition. For example, how
much of the $500 selling price would be recognized at the point of sale, how much would be
recognized at installation, how much revenue should be associated with the upgrade, and are there
other points in the earnings process to which should be attributed a portion of the revenue?
While these issues may be difficult to address, other industries have faced similar issues. The health
fitness industry, for example, must allocate initial membership fees over the life of a fitness contract.
The software industry has had to develop revenue recognition methods for allocating revenue.
2. Microsofts revenues have increased at a substantial rate over the past several years. The company
does not need to use accounting methods to accelerate sales. Microsofts competitors, on the other
hand, need all the help they can get as they try to compete against Microsoft. Thus, Microsoft would
support a rule that slows the recognition of revenue because such a rule would affect Microsofts
competitors more than it would Microsoft itself. In addition, Microsoft has been accused of deferring
revenue in boom years just in case the company needs to bolster sagging revenues in future years.
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Chapter 8
COMPETENCY ENHANCEMENT OPPORTUNITIES

Deciphering 81 (The Walt Disney Company)
1. Revenue Recognition (from Note 1 Description of the Business and Summary of Significant
Accounting Policies)
Revenues from the theatrical distribution of motion pictures are recognized
when motion pictures are exhibited. Revenues from video sales are recognized on
the date that video units are made widely available for sale by retailers.
Revenues from the licensing of feature films and television programming are
recorded when the material is available for telecasting by the licensee and
when certain other conditions are met.
Broadcast advertising revenues are recognized when commercials are aired.
Revenues from television subscription services related to the Company's primary
cable programming services are recognized as services are provided.
Internet advertising revenues are recognized on the basis of impression
views in the period the advertising is displayed, provided that no significant
obligations remain and collection of the resulting receivable is probable.
Direct marketing and Internet-based merchandise revenues are recognized upon
shipment to customers.
Merchandise licensing advance and guarantee payments are recognized when the
underlying royalties are earned.
Revenues from advance theme park ticket sales are recognized when the
tickets are used. Revenues from participants at the theme parks are generally
recorded over the period of the applicable agreements commencing with the
opening of the related attraction.
2. One possibility would be when the videos were shipped to retailers and a promise of payment was
received from retailers.
3. One possibility would be when Disney contracted with theaters to release the motion picture and the
theaters gave a promise to pay for the right to exhibit the motion picture. However, until the movie is
exhibited, the promised service has not been delivered by Disney.
Deciphering 82 (Siskon Gold Corporation)
1. Siskon recognizes revenue from its gold operations when it pours the goldnot when the gold is
sold. This is an exception to the general rule of revenue recognition, but it is acceptable because of
the readily available market for gold.
2. This method of revenue recognition might be a problem if the market for gold were highly volatile. As
long as the price of gold is fairly stable, this method of revenue recognition should result in a fairly
stated picture of a firm's income.
3. If the market for gold were to suddenly drop and gold went from selling for $400 an ounce to $150 an
ounce, then revenues could be greatly overstated.
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107
Deciphering 83 (Ben & Jerrys Homemade, Inc.)

1. Ben & Jerry's recognizes revenue on its ice cream when the product is shipped.
2. Ben & Jerry's sells two different types of franchises. The first is a franchise for an individual store,
and the second is a franchise for a geographical area. Revenue from franchise fees for an individual
store is recognized when the services outlined in the franchise agreement have been substantially
performed and the store has opened for business. Revenue relating to area franchises is recognized
based on the proportion of the number of stores opened in the geographical area relative to the
number of stores expected to be opened.
Deciphering 84 (Lockheed Martin Corporation)
1. Lockheed measures the percentage of a contract completed using achievement of performance
milestones or the cost-to-cost method. When the cost-to-cost method is used, revenues and profits
are recorded based on the ratio of costs incurred to estimated total costsjust as is illustrated in the
chapter.
2. For cost-reimbursed-type contracts, costs are recorded as incurred, and profits are estimated and
included based on a cost-to-cost-type estimate.
3. If changes are made to long-term contracts, those changes are reflected in the current and future
periods. Prior period financial statements are not restated.
4. Again, any changes in estimates are reflected in the current period.
5. Students should realize that a loss for the period is accounted for differently from a loss for the
contract. Lockheed accounts for losses on contracts in the period in which that loss is identified.
Sample CPA Exam Questions

1. The correct answer is a. To calculate the income in the fourth and final year of a contract accounted
for by the percentage-of-completion method, the total profit would first be calculated by comparing
the contract price to actual total costs. The amount would then be reduced by the income previously
recognized to give the amount to be recognized in the fourth year.
2. The correct answer is d. A nonrefundable lease bonus should be recognized as revenue over the
lease term. The receipt of the lease bonus creates deferred revenue.
Writing Assignment: Credit terms and revenue recognition
Students should address the following issues as they deal with this revenue recognition assignment:
1. Has Mitsubishi substantially completed its part of the revenue recognition process?
2. Has Mitsubishi received a valid promise of payment?
3. If Mitsubishi has received a valid promise, should it include the entire selling price as revenue in the
period of the sale, or should part of the selling price be allocated to interest and recognized over
time?
Ford Motor Company disclosed the following about the accounting for its 0.0% financing program:
Costs for customer and dealer cash incentives and costs for special financing and leasing
programs that we sponsor through Ford Credit (e.g., 0.0% financing program) are recognized as
sales reductions at the later of the date the related vehicle sales are recorded or at the date the
incentive program is both approved and communicated. In general, the amount of financing cost
that we provide to Ford Credit is the difference between the amounts offered to retail customers
and a market-based interest or lease rate.
108
Chapter 8
Research Project: Revenue recognition for the medical profession

The medical profession has traditionally had a hard time with recognizing revenue because of the
difficulty of collecting after a service has been provided. As a result of this research experience, students
should learn that the profession now goes to great lengths to ensure that a customer will be able to pay
prior to the service being provided. Because hospitals deal with more patients than do small medical
practices, it is more likely that hospitals have a formalized method for ensuring that payment will be
made.
The Debate: Health clubs and revenue recognition
The point of this exercise is to help students realize that there are incentives that can affect one's
perspective. An investor, an auditor, and a creditor can look at the same set of facts and reach different
conclusions based on their motivation. This experience should help students to realize that there may not
always be friendly agreement about the answer to an accounting question. The current and the potential
investors might make arguments like the following:
Current Investors
Signing up new members is an important part of our business. In fact, one of our most important
economic assets is our membership base.
Recall that this accounting issue revolves around how to classify cash that we have already
received. This is not a question of inventing fictitious transactions.
The proper revenue recognition policy should reflect the economics of our business.
We think that deferring all of the up-front fee, as is required in many cases under SAB 101, is
overly conservative.
In order to be able to recognize a substantial portion of the up-front fee, we intend to restructure
the sign-up process so that customers get an extensive physical examination and evaluation as
part of the initial sign-up. We will also sell this examination separately. By so doing, we can
immediately recognize as revenue the portion of the up-front fee that can be allocated to the
evaluation.
Note: The final bullet point sounds like manipulation of the accounting rules in order to accelerate the
recognition of revenue. The health club owners would have to demonstrate that actual customers were
willing to pay the stated amount for the physical examination and evaluation without also receiving club
membership.
Potential Investors
We really dont care how the up-front fee is accounted for in terms of revenue recognition.
What we care about is the future growth prospects of the health club.
To us, the most important information is week-by-week data on how many people sign up for
membership and how heavily new and old members use the club facilities.
The week-by-week sign-up data will allow us to see the trend in whether the number of new
members is increasing or decreasing. This will help us forecast future revenues.
The club usage data will help us more accurately forecast the future operating costs of the clubs.
Ethical Dilemma
The point of this exercise is to drive home the two basic revenue recognition criteriarealizability and
substantial completion. For most companies, the substantial completion criterion is not satisfied until the
point of sale because significant effort must occur to sell the product. Because gold is a commodity and
has a rather sophisticated market associated with it, the substantial completion criterion has been
determined to be satisfied when the gold has been mined and processed and is ready for sale. But prior
to this point, substantial completion has not been achieved.
As a result of this case, students should realize that events can occur, over which a firm may have no
control, that can significantly affect the firm's financial performance.
Chapter 8
109
Cumulative Spreadsheet Analysis

See Cumulative Spreadsheet Analysis solutions CD-ROM, provided with this manual.
Internet Search
1. a. MAX overstated sales for the first two quarters of fiscal year 2000 by 98%. These inflated sales
figures prompted a 600% spike in MAX's stock price in only three months (from $4.44 to more
than $28).
b. This order came in after MAX Brazil was formed and shipped just before [its fiscal first] quarter
end, on September 29, 1999. However, the product only shipped to MAX Brazil, not to the
ultimate customer . On November 17, 1999, only two days after [a] glowing press release
about MAX's first quarter results, the Brazilian customer cancelled the entire transaction and
returned what units it had. MAX did not disclose this fact to the public until May 2000, when it
restated the first quarter financial statements.
c. On December 28, 1999, MAX received a supposed order from a Chilean company. The goods
for this order never left Dallas. On December 29, 1999, a shipment to fill the order was prepared
and picked up by MAX's Dallas-based shipping agent. However, MAX directed the shipping agent
to hold the goods until payment was received. MAX never received payment and the goods
remained at the shipping agent's Dallas warehouse until many months later, when MAX finally
retook possession . GAAP generally precludes recognizing revenue from a sale of goods until
delivery to the ultimate customer has occurred. Delivery of this order had not occurred by
December 31, 1999; indeed, MAX always retained title to and constructive possession of the
goods. Nevertheless, MAX's second quarter 10-Q and accompanying press release
misrepresented that the Chilean sale was complete.
2. a. In the summer of 1998, Telxon negotiated a sale to a company that operated a chain of
hardware stores. Telxon's competitors were also seeking the business, and it was well known at
the time that the hardware chain was in very poor financial condition. On September 30, 1998,
Telxon shipped the product to the hardware chain and recognized revenue of approximately $7
million. Title to the goods transferred to a leasing company, and the hardware chain signed a
long-term lease with the leasing company. Without the hardware chain's knowledge, however,
Telxon also signed a separate agreement with the leasing company on September 29, by which
Telxon guaranteed the hardware chain's lease payments to the leasing company (a credit
enhancement agreement). The leasing company paid cash to Telxon for the product, pursuant to
the lease contract with the hardware chain. The hardware chain filed a bankruptcy petition and
defaulted on the lease within months, and the leasing company demanded full payment on the
lease from Telxon . Telxon's recognition of this revenue was not in conformity with GAAP,
which require that the sale of property [subject to a lease] shall not be treated as a sale if the
seller . . . retains substantial risks of ownership in the leased property. See, SFAS No. 13,
Accounting for Leases (November 1976), 21-22. Since Telxon guaranteed the lease payments
to the leasing company, Telxon retained substantial risks of ownership.
b. One of Telxon's biggest customers was a company that operated a nationwide chain of retail
stores. In late September 1998, James Cleveland and Telxon's chief technical officer proposed a
sale of customized AirBeam software to the retail chain. The software was designed to upgrade
existing software and to provide a Y2K fix. The retail chain agreed to the purchase in principle
and negotiated a price of $2 million, but first required that its technicians prepare detailed
specifications for upgrades that would be needed to Telxon's base software. The retail chain
provided those specifications to Telxon by facsimile dated October 2, 1998; Telxon agreed to the
specifications and the retail chain issued a purchase order (p/o) for the software on October 5,
1998. The p/o stated that the price included all future updates and maintenance, and that
payment was contingent upon (i) fault free performance, (ii) complete installation . . . in all
110
Chapter 8
[chain] business units, and (iii) the requirements noted in Attachment 'A' [that is, the
specifications dated October 2]. Telxon's chief technical officer estimated that his department
needed three to six months to write the software code for the upgrades specified by the retail
chain. Cleveland, Haver, Grand and others met shortly after the retail chain's p/o arrived on
October 5, 1998. At the meeting, the group discussed the state of completion of the software
and, at or following the meeting, it was decided that Telxon would recognize the full $2 million in
revenue as of September 30, 1998. Telxon assigned no related cost-of-goods-sold to the
revenues and its pre-tax profits were thereby increased by the entire $2 million. Telxon delivered
the AirBeam product to the retail chain without the requested modifications, and the retail chain
did not pay. Recognition of this revenue was not in conformity with GAAP. For software sales
GAAP require, inter alia, persuasive evidence of an arrangement and delivery of the software
as of the date of recognition. Also, if uncertainty exists about customer acceptance after
delivery, revenue should not be recognized.

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CHAPTER 8

extent that they cannot be used to fill other

2. The four revenue recognition criteria

8. Up-front, non-refundable fees are not

3. SAB 101 was issued by the SEC to curtail

10. A refundable fee can be recognized as

5. A sale can be turned into a consignment

11. Contingent rent cant be estimated and

6. In a bill-and-hold arrangement, the seller

12. A company can reliably estimate product

there have been no large inventory

yards of dirt removed, or architects' and

minority position of the AICPA Construction

as income. Under the cost recovery

BASIC JOURNAL ENTRIES FOR REVENUE RECOGNITION

JOURNAL ENTRIES FOR A CONSIGNMENT

Cost of Goods Sold

JOURNAL ENTRIES FOR A LAYAWAY

Cost of Goods Sold

JOURNAL ENTRIES FOR AN UP-FRONT, NONREFUNDABLE FEE

Cash (200 $360)

Cash (200 $50)

Unearned Initial Sign-up Fees ($72,000/36 months)

JOURNAL ENTRIES FOR AN UP-FRONT, REFUNDABLE FEE

Cash (1,500 $1,000)

Unearned Membership Fees ($1,050,000/12 months) 87,500

Unearned Membership Fees ($1,050,000/12 months)87,500

JOURNAL ENTRIES FOR CONTINGENT RENT

Contingent Rent Receivable

Contingent Rent Receivable

REPORTING REVENUE GROSS AND NET

Cash ($300,000 0.02)

Revenue to be recognized in Year 3

PERCENTAGE OF COMPLETION BASED ON OUTPUT MEASURES

BASIC CONSTRUCTION JOURNAL ENTRIES

COMPLETED-CONTRACT JOURNAL ENTRIES

PERCENTAGE-OF-COMPLETION JOURNAL ENTRIES

Cost of Construction Contracts

Cost of Construction Contracts

Cost of Construction Contracts

CONSTRUCTION CONTRACTS: BALANCE SHEET REPORTING

MULTIPLE YEARS OF REVENUES AND COSTS: COST-TO-COST METHOD

Cumulative cost to be recognized:

Cost of Construction Contracts

Cumulative cost to be recognized:

Cumulative cost to be recognized:

MULTIPLE YEARS OF REVENUES AND COSTS: OUTPUT MEASURE

Cumulative cost to be recognized:

Cost of Construction Contracts

Cumulative cost to be recognized:

Cumulative cost to be recognized:

MULTIPLE YEARS OF REVENUES AND COSTS: ANTICIPATED LOSS

Revenue on Construction Contracts

Cumulative cost to be recognized:

Cumulative cost to be recognized:

JOURNAL ENTRIES FOR THE PROPORTIONAL PERFORMANCE METHOD

Cash (2,000 $500)

Deferred Initial Season Ticket Costs

Unearned Season Ticket Revenue

Cash (2,000 $2 23)

Initial Season Ticket Costs [$150,000 (23/60)]57,500

Cost of Installment Sales ($350,000 0.80)

Cash ($350,000 0.40)