Chapter 6 - textbook Flashcards
Core concept in the earnings approach
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
Methods for LT construction (and other service contracts) under ASPE
- % of completion 2. completed contract method
% of completion
- revenues and gross profit are recognized each period based on progress made to a specific point in time - many ongoing acts;
completed contract method
- 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
zero-profit method (IFRS)
earlier (?) recognition of recoverable revenues equal to costs incurred where the outcome is NOT RELIABLY MEASURABLE
Ending inventory - understated
COGS - Overstated
Net income - understated
- Ending inventory - understated => What happens next year?
- Correcting entry in 2015 (after 2 years)
- Both net income figures are misstated, but the total for the two years is correct as the two errors will be counterbalanced (or offset)
- 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.
Omitting both the purchase of goods and the inventory results in ….
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.
Gross method of reporting inventory
(purchases when you buy inventory)
(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.
Journal entries for gross method
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
Journal entries for the net method
Purchases
Accounts Payable
Accounts Payable
Cash
Accounts Payable
DR. Purchase Discounts Lost
Cash
What method IFRS uses under the earnings approach?
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.
ASPE approach for recognizing revenue
Under ASPE, if the outcome were not deter- minable, the accounting would default to the completed contract method.
billings are more than the costs incurred and gross profit to date
“Billings in Excess of Recognized Revenues.” - liability account
zero profit method - journal entries
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.
Zero Profit Method - what is it?
recoverable revenues equal to costs
incurred would be recognized under IFRS.
Recognizing a loss on a contract:
- % of completion
- completed contract method
- 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)
- dr. Loss from Long· Term Contracts
cr, Construction in Process
reporting a contract loss on the B/S
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.
cost recovery method - journal entries
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)
instalment method - journal entries
- 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
If outcome cannot be reliably measured what each method stipulates:
- IFRS
- ASPE
- zero-profit method - recoverable revenue equal to costs are recognized:
dr. CIP (the amount provided)
cr. Revenue from LT Contracts - if we can not estimate, we use complted contract method - we wait until the end
