Intermediate accounting answer chapter5
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? The McGraw-Hill Companies, Inc., 2009
Solutions Manual, Vol.1, Chapter 5
5-1
AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise and problem in Intermediate Accounting, 5e with the following AACSB learning skills:
Questions
AACSB Tags
Exercises (cont.)
AACSB Tags
5-1 Reflective thinking 5-9 Analytic 5-2 Reflective thinking 5-10 Analytic 5-3 Reflective thinking 5-11 Analytic 5-4 Reflective thinking 5-12 Analytic 5-5 Reflective thinking 5-13 Analytic 5-6 Reflective thinking 5-14 Analytic 5-7 Reflective thinking 5-15 Analytic 5-8 Reflective thinking 5-16 Analytic 5-9 Reflective thinking 5-17 Analytic
5-10 Reflective thinking
5-18 Reflective thinking 5-11 Reflective thinking, Communications
5-19 Analytic, Communications
5-12 Reflective thinking 5-20 Analytic 5-13 Reflective thinking 5-21 Analytic 5-14 Reflective thinking 5-22 Analytic 5-15 Reflective thinking 5-23 Analytic 5-16 Reflective thinking 5-24 Analytic 5-17 Reflective thinking 5-25 Analytic
5-18
Reflective thinking
Brief Exercises
CPA/CMA
5-1 Analytic 5-1 Analytic 5-2 Analytic 5-2 Analytic 5-3 Analytic 5-3 Analytic
5-4 Analytic
5-4 Reflective thinking
5-5 Reflective thinking, Communications
5-5 Analytic 5-6 Analytic 5-6 Analytic
5-7 Analytic 5-1 Reflective thinking 5-8 Analytic 5-2 Reflective thinking
5-9 Analytic
5-3
Analytic
5-10 Reflective thinking
Problems
5-11 Reflective thinking
5-1 Analytic 5-12 Analytic 5-2 Analytic 5-13 Analytic 5-3 Analytic
5-14 Analytic 5-4 Communications, Analytic
5-15
Analytic
5-5 Analytic Exercises
5-6 Analytic
5-1
Analytic
5-7
Analytic
Chapter 5 Income Measurement and Profitability Analysis
? The McGraw-Hill Companies, Inc., 2009 5-2
Intermediate Accounting, 5/e
5-2
Analytic
5-8
Analytic, Reflective thinking
Exercises (cont.)
Problems (cont.)
5-3 Analytic 5-9 Analytic 5-4 Analytic 5-10 Analytic 5-5 Analytic 5-11 Analytic 5-6 Analytic 5-12 Analytic 5-7 Analytic 5-13 Analytic 5-8
Analytic
5-14
Analytic
Question 5-1
The realization principle requires that two criteria be satisfied before revenue can be recognized:
1. The earnings process is judged to be complete or virtually complete.
2. There is reasonable certainty as to the collectibility of the asset to be received (usually cash).
Question 5-2
At the time production is completed, there usually exists significant uncertainty as to the collectibility of the asset to be received . We don’t know if the product will be sold, nor the selling price, nor the buyer if eventually the product is sold. Because of these uncertainties, revenue recognition usually is delayed until the point of product delivery.
Question 5-3
If the installment sale creates a situation where there is significant uncertainty concerning cash collection and it is not possible to make an accurate assessment of future bad debts, revenue and cost recognition should be delayed beyond the point of delivery.
Question 5-4
The installment sales method recognizes gross profit by applying the gross profit percentage on the sale to the amount of cash actually received each period. The cost recovery method defers all gross profit recognition until cash has been received equal to the cost of the item sold.
Question 5-5
Deferred gross profit is a contra installment receivable account. The balance in this account is subtracted from gross installment receivables to arrive at installment receivables, net. The net amount of the receivables represents the portion of remaining payments that represent cost recovery.
QUESTIONS FOR REVIEW OF KEY TOPICS
Question 5-6
Because the return of merchandise can retroactively negate the benefits of having made a sale, the seller must meet certain criteria before revenue is recognized in situations when the right of return exists. The most critical of these criteria is that the seller must be able to make reliable estimates of future returns. In certain situations, these criteria are not satisfied at the point of delivery of the product.
Question 5-7
Sometimes a company arranges for another company to sell its product under consignment. The “consignor” physically transfers the goods to the other company (the consignee), but the consignor retains legal title. If the consignee can’t find a buyer within an agreed-upon time, the consignee returns the goods to the consignor. However, if a buyer is found, the consignee remits the selling price (less commission and approved expenses) to the consignor.
Because the consignor retains the risks and rewards of ownership of the product and title does not pass to the consignee, the consignor does not record revenue (and related costs) until the consignee sells the goods and title passes to the eventual customer.
Question 5-8
For service revenue, if there is one final service that is critical to the earnings process, revenues and costs are deferred and recognized after this service has been performed. On the other hand, in many instances, service revenue activities occur over extended periods and recognizing revenue at any single date within that period would be inappropriate. Instead, it’s more meaningful to recognize revenue over time in proportion to the performance of the activity.
Question 5-9
The completed contract method of recognizing revenues and costs on long-term construction contracts is equivalent to recognizing revenue at point of delivery, i.e., when the construction project is complete. The percentage-of-completion method assigns a fair share of the project’s expected revenues and costs to each period in which the earnings process takes place, i.e., the construction period. The “fair share” typically is estimated as the project's costs in curred each period as a percentage of the project's total estimated costs. The completed contract method should only be used when the lack of dependable estimates or inherent hazards cause forecasts of future costs to be doubtful.
? The McGraw-Hill Companies, Inc., 2009 Solutions Manual, Vol.1, Chapter 5 5-3
Question 5-10
The completed contract method recognizes revenue, cost of construction, and gross profit at the end of the contract, after the contract has been completed. The cost recovery method will recognize an amount of revenue that exactly offsets costs until all costs have been incurred, and then will recognize revenue and gross profit. Therefore, revenue and cost are recognized earlier under the cost recovery method than under the completed contract method. Assuming that the final costs are incurred just prior to completion of the contract, both approaches should recognize gross profit at the same time.
Question 5-11
The billings on construction contract account is a contra account to the construction in progress asset. At the end of each reporting period, the balances in these two accounts are compared. If the net amount is a debit, it is reported on the balance sheet as an asset. Conversely, if the net amount is a credit, it is reported as a liability.
Question 5-12
An estimated loss on a long-term contract must be fully recognized in the first period the loss is anticipated, regardless of the revenue recognition method used.
Question 5-13
This guidance requires that if an arrangement includes multiple elements, the revenue from the arrangement should be allocated to the various elements based on the relative fair values of the individual elements. If part of an arrangement does not qualify for separate accounting, revenue recognition is delayed until revenue is recognized for the other parts.
Question 5-14
Specific guidelines for revenue recognition of the initial franchise fee are provided by SFAS 45.
A key to these guidelines is the concept of substantial performance. It requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue. The term “substantial” requires professional judgment on the part of the accountant. In situations when the initial franchise fee is collectible in installments, even after substantial performance has occurred, the installment sales or cost recovery method should be used for profit recognition, if a reasonable estimate of uncollectibility cannot be made.
? The McGraw-Hill Companies, Inc., 2009
5-4 Intermediate Accounting, 5/e
Question 5-15
Activity ratios are designed to provide information about a company’s effectiveness in managing assets. Activity or turnover of certain assets measures the frequency with which those assets are replaced. The greater the number of times an asset turns over, the less cash a company must devote to that asset, and the more cash it can commit to other purposes.
Question 5-16
A fundamental element of an analyst’s task is to develop an understanding of a firm’s profitability. Profitability ratios provide information about a company’s ability to earn an adequate return relative to sales or resources devoted to operations. Resources devoted to operations can be defined as total assets or only those assets provided by owners, depending on the evaluation objective.
? The McGraw-Hill Companies, Inc., 2009 Solutions Manual, Vol.1, Chapter 5 5-5
? The McGraw-Hill Companies, Inc., 2009
5-6 Intermediate Accounting, 5/e Question 5-17
Return on equity
= Profit margin X Asset turnover X Equity multiplier
Net income Ave. total equity = Net income Total sales X Total sales Ave. total assets X Ave. total assets
Ave. total equity
The DuPont framework shows return on equity as being driven by profit margin (reflecting a company’s ability to earn income from sales), asset turnover (reflecting a company’s effectiveness in using assets to generate sales), and the equity multiplier (reflecting the extent to which a company has used debt to finance its assets).
Question 5-18
These perspectives are referred to as the discrete and integral part approaches. Current interim reporting requirements and existing practice generally view interim reports as integral parts of annual statements. However, the discrete approach is applied to some items. Most revenues and expenses are recognized in interim periods as incurred. However, if an expenditure clearly benefits more than just the period in which it is incurred, the expense should be spread among the periods benefited. Examples include annual repair expenses, property tax expense, and advertising expenses incurred in one quarter that clearly benefit later quarters. These are assigned to each quarter through the use of accruals and deferrals. On the other hand, major events such as discontinued operations, extraordinary items, and unusual or infrequent items should be reported separately in the interim period in which they occur.
BRIEF EXERCISES
Brief Exercise 5-1
2009 gross profit = $3,000,000 – 1,200,000 = $1,800,000
2010 gross profit = 0
Brief Exercise 5-2
2009 Cost recovery % = Cost ÷ Sales:
$1,200,000
= 40% (implying a gross profit % = 60%)
$3,000,000
2009 gross profit = 2009 cash collection of $150,000 x 60% = $90,000
2010 gross profit = 2010 cash collection of $150,000 x 60% = $90,000 Brief Exercise 5-3
No gross profit will be recognized in either 2009 or 2010. Gross profit will not be recognized until the entire $1,200,000 cost of the land is recovered. In this case, it
will take 8 payments to recover the cost of the land ($1,200,000 ÷ $150,000 = 8), so gross profit recognition will equal 100% of the cash collected beginning with the ninth installment payment.
Brief Exercise 5-4
Initial deferred gross profit ($3,000,000 – 1,200,000)$1,800,000
Less gross profit recognized in 2009 ($150,000 x 60%)(90,000)
Less gross profit recognized in 2010 ($150,000 x 60%) (90,000)
Deferred gross profit at the end of 2010 $1,620,000 Brief Exercise 5-5
The seller must meet certain criteria before revenue can be recognized in situations when the right of return exists. The most critical of these criteria is that the
seller must be able to make reliable estimates of future returns. If Meyer’s
? The McGraw-Hill Companies, Inc., 2009 Solutions Manual, Vol.1, Chapter 5 5-7
management can make reliable estimates of the furniture that will be returned, revenue can be recognized when the product is delivered, assuming the company has no additional obligations to the buyer. If reliable estimates cannot be made because of significant uncertainty, revenue and related cost recognition is delayed until the uncertainty is resolved.
Brief Exercise 5-6
Total estimated cost to complete = $6 million + $9 million = $15 million
% of completion = $6 million $15 million = 40%
Total estimated gross profit ($20 million – 15 million) =$5,000,000
multiplied by the % of completion 40%
Gross profit recognized the first year $2,000,000
First year revenue = $20,000,000 x 40% = $8,000,000
Brief Exercise 5-7
Assets:
Accounts receivable ($7 million – 5 million)$2,000,000
Cost plus profit ($6 million + $2 million*)
in excess of billings ($7 million)1,000,000
* Total estimated gross profit ($20 million – 15 million) =$5,000,000
multiplied by the % of completion 40%
Gross profit recognized in the first year $2,000,000
Brief Exercise 5-8
Year 1 = 0
Year 2 = $4 million
Revenue $20,000,000
Less: Costs in year 1 (6,000,000)
Costs in year 2 (10,000,000)
? The McGraw-Hill Companies, Inc., 2009
5-8 Intermediate Accounting, 5/e
Actual profit $ 4,000,000
Brief Exercise 5-9
Year 1:
Revenue: $6 million
Cost: $6 million
Gross profit: $0
Year 2:
Revenue: $14 million ($20 million total - $6 million in year 1)
Cost: $10 million
Gross profit: $ 4 million
Brief Exercise 5-10
The anticipated loss of $3 million ($30 million contract price less total estimated costs of $33 million) must be recognized in the first year applying either method. Brief Exercise 5-11
Specific conditions for revenue recognition of the initial franchise fee are provided by SFAS 45. A key to these conditions is the concept of substantial performance. It requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue. The term “substantial” requires pro fessional judgment on the part of the accountant. Often, substantial performance is considered to have occurred when the franchise opens for business.
Continuing franchise fees are recognized over time as the services are performed.
? The McGraw-Hill Companies, Inc., 2009 Solutions Manual, Vol.1, Chapter 5 5-9
Brief Exercise 5-12
Receivables turnover ratio =Net sales
Average accounts receivable (net) Receivables turnover ratio =$600,000
[$100,000 + 120,000] ÷ 2
= 5.45 times
Inventory turnover ratio =Cost of goods sold
Average inventory
Inventory turnover ratio =$400,000*
[$80,000 + 60,000] ÷ 2
= 5.71 times
*$600,000 – 200,000
? The McGraw-Hill Companies, Inc., 2009
5-10 Intermediate Accounting, 5/e
? The McGraw-Hill Companies, Inc., 2009
Solutions Manual, Vol.1, Chapter 5
5-11
Brief Exercise 5-13
Profit margin
= Net income
Sales = $65,000
$420,000
= 15.5%
Return on assets = Net income Average total assets
= $65,000
$800,000
=
8.1%
Return on shareholders’ equity = Net income Average shareholders’ equity = $65,000
$522,500* = 12.4%
Shareholders’ equity, beginning of period $500,000 Add: Net income 65,000 Deduct: Dividends (20,000) Shareholders’ equity, end of period $545,000
*Average shareholders equity = ($500,000 + 545,000) 2 = $522,500
? The McGraw-Hill Companies, Inc., 2009
5-12 Intermediate Accounting, 5/e Brief Exercise 5-14
Return on
equity
= Profit margin X Asset turnover X Equity multiplier
Net income
Ave. total
equity = Net income Total sales X Total sales Ave. total assets X Ave. total assets Ave. total equity Return on shareholders’
equity =
Net income
Average shareholders’ equity = $65,000
$522,500
= 12.4%
Profit margin
= Net income
Sales
= $65,000
$420,000 =
15.5% Asset Turnover =
Sales
Average total assets =
$420,000
$800,000 = 52.5%
? The McGraw-Hill Companies, Inc., 2009 Solutions Manual, Vol.1, Chapter 5 5-13 Brief Exercise 5-14 (concluded)
Equity Multiplier
= Average total assets
Average shareholders’ equity
= $800,000
$522,500 = 1.53
Check: 12.4% ROE = 15.5% profit margin x 52.5% asset turnover x 1.53 equity multiplier.
Brief Exercise 5-15
Inventory turnover ratio = Cost of goods sold ÷ Average inventory
6.0 = x ÷ $75,000
Cost of goods sold = $75,000 x 6.0 = $450,000
Sales - Cost of goods sold = Gross profit
$600,000 - $450,000 = $150,000
EXERCISES
Exercise 5-1
Requirement 1
Alpine West should recognize revenue over the ski season on an anticipated usage basis, in this case equally throughout the season. The fact that the $450 price is nonrefundable is not relevant to the revenue recognition decision. Revenue should be recognized as it is earned, in this case as the services are provided during the ski season.
Requirement 2
Requirement 3
$90 is included in revenue in the 2009 income statement. The $360 remaining balance in unearned revenue is included in the current liability section of the 2009 balance sheet.
? The McGraw-Hill Companies, Inc., 2009
5-14 Intermediate Accounting, 5/e
Exercise 5-2
Requirement 1
2009 Cost recovery %:
$234,000
= 65% (gross profit % = 35%)
$360,000
2010 Cost recovery %:
$245,000
= 70% (gross profit % = 30%)
$350,000
2009 gross profit:
Cash collection from 2009 sales of $150,000 x 35% = $52,500
2010 gross profit:
Cash collection from 2009 sales of $100,000 x 35% = $ 35,000
+ Cash collection from 2010 sales of $120,000 x 30% = 36,000 Total 2010 gross profit $71,000 Requirement 2
2009 deferred gross profit balance:
2009 initial gross profit ($360,000 - 234,000)$126,000
Less: Gross profit recognized in 2009 (52,500)
Balance in deferred gross profit account $73,500
2010 deferred gross profit balance:
2009 initial gross profit ($360,000 - 234,000)$ 126,000
Less: Gross profit recognized in 2009 (52,500)
Gross profit recognized in 2010 (35,000)
2010 initial gross profit ($350,000 - 245,000)105,000
Less: Gross profit recognized in 2010 (36,000)
Balance in deferred gross profit account $107,500
? The McGraw-Hill Companies, Inc., 2009 Solutions Manual, Vol.1, Chapter 5 5-15
Exercise 5-3
? The McGraw-Hill Companies, Inc., 2009
5-16 Intermediate Accounting, 5/e
Exercise 5-4
Requirement 1
Year Income recognized
2009 $180,000 ($300,000 - 120,000)
2010 - 0 -
2011 - 0 -
2012 - 0 -
Total $180,000
Requirement 2
Cost recovery %:
$120,000
------------- = 40% (gross profit % = 60%)
$300,000
Requirement 3
? The McGraw-Hill Companies, Inc., 2009 Solutions Manual, Vol.1, Chapter 5 5-17
Exercise 5-5
Requirement 1
? The McGraw-Hill Companies, Inc., 2009
5-18 Intermediate Accounting, 5/e
Exercise 5-5 (continued)
Requirement 2
? The McGraw-Hill Companies, Inc., 2009 Solutions Manual, Vol.1, Chapter 5 5-19
Exercise 5-5 (concluded)
Requirement 3
Exercise 5-6
Requirement 1
Cost of goods sold ($1,000,000 - 600,000)$400,000
Add: Gross profit if using cost recovery method 100,000
Cash collected $500,000 Requirement 2
$ 600,000
Gross profit percentage = = 60%
$1,000,000
Cash collected x Gross profit percentage = Gross profit recognized
$500,000 x 60% = $300,000gross profit
? The McGraw-Hill Companies, Inc., 2009
5-20 Intermediate Accounting, 5/e
Exercise 5-7
*$2,200,000 $4,000,000 = 55% gross profit percentage
? The McGraw-Hill Companies, Inc., 2009 Solutions Manual, Vol.1, Chapter 5 5-21
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