Chapter 6 - textbook

Question 1

Core concept in the earnings approach

Answer 1

risk and rewards (benefits) of ownership As a general rule, the entity that has the risks (risk of loss) and rewards treats the goods as an asset

Question 2

Methods for LT construction (and other service contracts) under ASPE

Answer 2

1. % of completion 2. completed contract method

Question 3

% of completion

Answer 3

• revenues and gross profit are recognized each period based on progress made to a specific point in time - many ongoing acts;

Question 4

completed contract method

Answer 4

• revenues and gross profit are recognized ONLY when the contract is completed (ex: a homebuilder transfers the title to the buyer at the end) - single act (=a discrete earnings process) OR WHEN the progress towards completion IS NOT MEASURABLE

Question 5

zero-profit method (IFRS)

Answer 5

earlier (?) recognition of recoverable revenues equal to costs incurred where the outcome is NOT RELIABLY MEASURABLE

Question 6

Ending inventory - understated

Answer 6

COGS - Overstated

Net income - understated

Question 7

1. Ending inventory - understated => What happens next year?
2. Correcting entry in 2015 (after 2 years)

Answer 7

1. Both net income figures are misstated, but the total for the two years is correct as the two errors will be counterbalanced (or offset)
2. If the error is discovered after the books for 2015 are closed, no entry is required as the error is self-correcting over the two-year period. The inventory on the statement of financial position at the end of 2015 is correct, as is the total amount of retained earn- ings. However, whenever comparative financial statements are prepared that include 2014 or 2015, the inventory and net income for those years are restated and reported at the correct figures.

Question 8

Omitting both the purchase of goods and the inventory results in ….

Answer 8

understated inventory and accounts payable on the statement of financial position, and understated purchases and ending inventory on the income statement.

Net income for the period is not affected by omitting such goods, because purchases and ending inventory are both understated by the same amount; that is, the error offsets itself in cost of goods sold.

Total working capital is unchanged, but the current ratio is overstated (assuming it was greater than 1 to 1) because equal amounts were omitted from inventory and accounts payable.

Question 9

Gross method of reporting inventory

(purchases when you buy inventory)

Answer 9

(what you would do normally)

both the purchases and payables are recorded at the gross amount of the invoice, and any purchase discounts that are later taken are
credited to a Purchase Discounts account. This account is reported as a contra account to Purchases, as a reduction in the cost of the period’s purchases.

Question 10

Journal entries for gross method

Answer 10

Purchase cost of $10,000, terms 2/10, net 30: Purchases 10,000

   Accounts Payable 10,000 Invoices of $4,000 are paid within discount period:

Accounts Payable 4,000

      Purchase Discounts 80

      Cash  3,920

Invoices of $6,000 are paid after discount period: Accounts Payable 6,000

     Cash 6,000

Question 11

Journal entries for the net method

Answer 11

Purchases

      Accounts Payable

Accounts Payable

       Cash

Accounts Payable

DR. Purchase Discounts Lost

                Cash

Question 12

What method IFRS uses under the earnings approach?

Answer 12

IFRS allows the use of the percentage-of-completion and the zero-profit method, but does not preclude the use of the completed-contract method.

Question 13

ASPE approach for recognizing revenue

Answer 13

Under ASPE, if the outcome were not deter- minable, the accounting would default to the completed contract method.

Question 14

billings are more than the costs incurred and gross profit to date

Answer 14

“Billings in Excess of Recognized Revenues.” - liability account

Question 15

zero profit method - journal entries

Answer 15

IFRS - 4th entry - to recognize current period revenue and gross profit:
dr. Construction Expenses 1,000,000
cr. Revenue from
Long-Term Contracts 1,000,000

ASPE
No JE; the completed contract method would
dictate that no revenue or expense be
recognized untiI the end of the contract.

Question 16

Zero Profit Method - what is it?

Answer 16

recoverable revenues equal to costs
incurred would be recognized under IFRS.

Question 17

Recognizing a loss on a contract:

1. % of completion
2. completed contract method

Answer 17

1. dr. Construction Expenses 1000
   cr. Construction in Process 200
   cr. Revenue from Long-Term Contracts 800

(credit the CIP as the gross profit and expenses go in CIP)

2. dr. Loss from Long· Term Contracts
   cr, Construction in Process

Question 18

reporting a contract loss on the B/S

Answer 18

under both the percentage-of-completion and
completed-contract methods, the amount of the loss of $56,250, as estimated in 2015,
would be taken from the Construction in Process account and reported separately as a
current liability entitled Estimated Liability from Long-Term Contracts.

Question 19

cost recovery method - journal entries

Answer 19

You don’t recognize revenue until you recover all the costs

• if you buy Inventory that you will sell:
  dr. Inventory 10,000
  cr. Cash 10,0000
• when you receive partial payment (4,000)
  dr. Cash 4,000
  dr. COGS 4,000
  cr. Inventory 4,000
  cr. Sales 4,000

and so on until you recover you costs (you put all the entries in COGS and Invetory)

Question 20

instalment method - journal entries

Answer 20

• conservative

dr. Instalment AR 200
cr. Inventory 160

cr. Deferred gros profit 40 * (which is 20%)*

• when cash is received:
  dr. Cash 40
  cr. Instalment AR 40
• recognition of revenue (gross margin rate 20%)

dr. Deferred gross profit 8

dr. COGS 32
cr. Sales 40

Question 21

If outcome cannot be reliably measured what each method stipulates:

1. IFRS
2. ASPE

Answer 21

1. zero-profit method - recoverable revenue equal to costs are recognized:
   dr. CIP (the amount provided)
   cr. Revenue from LT Contracts
2. if we can not estimate, we use complted contract method - we wait until the end