25C Calculate revenue given information that might influence the choice of revenue recognition method.

Question 1

Explain

Answer 1

A firm using a revenue recognition method that is aggressive will inflate current period earnings at a minimum and perhaps inflate overall earnings. Because of the estimates involved, the percentage-of-completion method is more aggressive than the completed-contract method. Also, the installment method is more aggressive than the cost recovery method.

Question 2

CPP Corporation has a contract to build a custom test chamber for a client for $100,000. CPP Corporation uses the percentage-of-completion method for accounting and estimates the total costs for the project to be equal to $80,000. CPP Corporation has promised to complete the project within three years. At year-end the customer has paid $60,000, equaling the total amount billed for the year, and total costs incurred to date are $40,000. On the income statement, net income for the year-end will be:

Answer 2

Under the percentage-of-completion method, one-half of the total revenue is recognized because one-half of the costs have been incurred ($40,000 / $80,000). Therefore, revenue will be equal to $50,000, expenses are $40,000, and net income will be $10,000.

Question 3

The JME Jumpers, a professional volleyball team, sells season tickets to all home games. The cost of a season ticket is $1,000 and the team plays 20 home games, which run from April through August. For the year ended June 30, 2005, JME sold 1,200 tickets, collected 80 percent of the amount owed, and played 12 home games. How much revenue should JME recognize?

Answer 3

(1,200 × $1,000 × 12/20) = $720,000

Question 4

The Better Building Company has a contract to build a building for $100 million. The estimate of the cost of the project is $75 million. In the first year of the project, BB had costs of $30 million. The Better Building Company’s reported profit for the first year of the contract, using the percentage-of-completion method, is:

Answer 4

Reported profit (in millions) = ($30 / $75)($100 − 75) = $10.

Question 5

At the beginning of 2007, Thunderbird Company started a 3-year construction project. The following data relates to the project:

Contract price

$100 million

Costs incurred in 2007

$50 million

Progress billings

$40 million

Collection of progress billings

$37 million

Because of cost overruns, Thunderbird cannot reliably estimate the total cost of the project. However, Thunderbird expects that its costs incurred so far are recoverable. What amount of revenue should Thunderbird recognize for the year ended 2007 under U.S. Generally Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRS)?

Answer 5

$0 UNDER US GAAP, $50 MIL IFRS

The completed-contract method must be used under U.S. GAAP since Thunderbird cannot reliably estimate the project’s cost. Under the completed-contract method, no revenue is recognized until the project is complete. Under IFRS, when total cost cannot be reliably estimated, revenue is recognized to the extent that recovering contract costs is probable. Since Thunderbird incurred $50 million of cost in 2007, $50 million of revenue is recognized.

Question 6

The Kammel Building Company has a contract to build a building for $100 million. The estimate of the cost of the project is $75 million. In the first year of the project, Kammel had costs of $30 million. Kammel’s reported profit for the first year of the contract, using the completed contract method, is:

Answer 6

Under the completed contract method, profit is only reported upon completion of the contract.