Long Term Contracts

Question 1

List all the Long Term Contract Methods ?

Answer 1

1: -Percentage of Completion Method
2: - Completed Contract Method
3: - Instalment Sales
4: - Cost Recovery Method

Question 2

When is Instalment Sales and Cost Recovery Method Used ?

Answer 2

Occurs when a firm financed a sale and payments are expected to be recovered over the extended period of time

Question 3

Percentage of Completion Method :- When Used

Answer 3

When estimates of the costs to complete and the extent of progress towards completion are reasonably dependable

Question 4

Completed Contract Method :- When Used

Answer 4

Used when firm can’t reliably measure the outcome of the project .

1: -When the reliable estimates of total costs of the contract does not exists
2: - When Cost estimates are unreliable

Question 5

Instalment Sale :- When Used

Answer 5

Occurs when a firm financed a sale and payments are expected to be recovered over the extended period of time

:- When assurance of payment is there

:- Receiving cash is the key event

Question 6

Cost Recovery Method :- When Used

Answer 6

Occurs when a firm financed a sale and payments are expected to be recovered over the extended period of time

• Future cash collection are not assured even after receipt of partial payment
• Similar to instalment sales method but is more conservative

Question 7

Percentage of Completion Method :- Definition

Answer 7

• It is measured by the total cost incurred to date divided by the total expected cost of the project
• Revenue,expense and therefore profit recognised as the work is performed Extent of progress towards completion

Question 8

Percentage of Completion Method :- When is Revenue Recognized

Is it aggresive or Conservative

Answer 8

• More aggressive as revenue is reported sooner
• Revenue is recognised as cost are incurred

Question 9

Percentage of Completion Method :-

Profit / Income / Earnings

When is Profit Recognized ?

How is the matching of Revenue and Expense ?

Answer 9

• Provides smother earnings and results in better matching of revenue and expense overtime
• Profit is recognised corresponding to the % of the cost incurred to the total estimated

Question 10

Percentage of Completion Method :-

How are the Cost Estimates ?

Answer 10

Estimates of costs to complete More subjctive as it involves cost estimates

Estimates are relaible

Question 11

Percentage of Completion Method :-

How are the Payments ?

Answer 11

When payments are reasonably assured or are dependable

Question 12

Completed Contract Method :- Are the cash flows more conservative than the instalment sales method ?

Answer 12

Cash Flow are same under both method

Completed contract method is More conservative

Question 13

Completed Contract Method :- When is Revenue recognized in completed contract method ?

Answer 13

Does not recognise revenue and expense until contract is completed

Question 14

Completed Contract Method :- If the Loss is expected what must be done in completed contract method ?

Answer 14

If loss is expected it must be immediately recognised under IFRS and US GAAP

Question 15

Instalment Sale Method:- When is Sales ,Revenue and COGS recognized ?

Answer 15

Sales , Revenue , and COGS are recognised only when cash is recieved

Question 16

Instalment Sale Method:- What does gross profit reflect ?

Answer 16

Gross Profit (Sales-COGS) reflects the portion of cash received

Question 17

Instalment Sale Method:- When Used

Answer 17

Occurs when a firm financed a sale and payments are expected to be recovered over the extended period of time

Question 18

If collectivity can’t be reasonably estimated

Answer 18

Instalment Sale Method Profit is recognised as cash is collected Profit is equal to the cash collected during the period multiplied by the total expected profit as a percent of sales It is used in limited circumstances usually involves the sale of real estate or other firm assets

Question 19

If collectivity is highly uncertain which method is used and when Profit is recognized ?

Answer 19

Cost Recovery Method

Profit is recognised only when cash collected exceeds costs incurred

Question 20

Cost Recovery Method :- When is sale recognized and when is recognised is received

Answer 20

Sales are recognised when cash is received but no gross profit is recognised until all of the COGS is collected

Question 21

Cost Recovery Method :- Type of question expected

Answer 21

You can get a numerical where the company does not recognise the profit until the job is complete

Question 22

Cost Recovery Method :- When is the profit recognized

Answer 22

Receiving Cash is the key event But the gross profit is not recognised until all the COGS is collected WHICH is actually the main difference between the Instalment Sales and Cost Recovery Method

Question 23

In accounting for long-term construction contracts, the percentage-of-completion method is preferable to the completed contract method when:

A)the contracts are of a relatively short duration (less than one year).

B)lack of dependable cost estimates cause forecasts to be doubtful.

C)estimates of the costs to complete and the extent of progress toward completion are reasonably dependable.

Answer 23

4. In accounting for long-term construction contracts, the percentage-of-completion method is preferable to the completed contract method when estimates of the costs to complete and the extent of progress toward completion are reasonably dependable. (C)

Question 24

5:-An airplane manufacturing company routinely builds fighter jets for the U.S. armed forces. It takes fourteen months to build one jet, and the government pays for them in installments over the fourteen-month period. Which revenue recognition method should be used?

A) Installment sales method.

B) Percentage-of-completion method.

C) Completed contract method

Answer 24

5. The percentage-of-completion method is appropriate in this case because payment is assured when dealing with the U.S. government, and cost and price estimates are assumed reliable due to the ongoing and routine nature of the contract. (B)

Question 25

6:-If a reliable estimate of total costs of the contract does not exist, which of the following revenue recognition methods should be used?

A) Cost recovery method.

B) Completed contract method.

C) Percentage-of-completion method

Answer 25

• The cost recovery method is used when future cash collections are not assured even after receipt of partial payments.
• Gross profit is not recognized until all of the cost of goods sold is collected
• The percentage-of-completion method is used when ultimate payment is assured and revenue is earned as costs are incurred. Profit is recognized corresponding to the percentage of costs incurred to the total estimated (B)

Question 26

7:- When evaluating the differences between two revenue recognition policies, an analyst should view the policy as more conservative which:

A) results in less leverage on the balance sheet.

B) recognizes revenue later.

C) is more dependent on management estimates.

Answer 26

7. Recognizing revenue later rather than sooner is considered more conservative. More aggressive (less conservative) revenue recognition can result in less leverage by increasing assets (B)

Question 27

8:- Information about a company’s revenue recognition policies is most likely disclosed in:

A) the financial statement notes.

B) the standard auditor’s report.

C) Management’s Discussion and Analysis.

Answer 27

8. Revenue recognition policies are disclosed in the footnotes to the financial statements

Question 28

Jerry Krome, CFA, is an equity analyst. The head of research at Krome’s firm composes a memo that contains the following statements: • To the extent that management has discretion over the firm’s revenue recognition, an analyst should consider policies that recognize revenue later to be more conservative than policies that recognize revenue sooner. • When comparing the performance of companies, an analyst can use the information in the financial statement disclosures to adjust the financial statements for differences in revenue recognition policies. With regard to the implications of revenue recognition policies for financial analysis, Krome should agree with:

A) both of these statements.

B) neither of these statements.

C) only one of these statements.

Answer 28

9. Because revenue recognition often relies on judgment and estimates from management, it is not always possible to calculate the appropriate adjustments that would account for the differences between companies’ revenue recognition policies. An analyst should use the policies disclosed in companies’ financial statement footnotes to understand the degree to which their revenue recognition is conservative or aggressive. In general, recognizing revenue sooner is considered aggressive and recognizing revenue later is considered conservative

Question 29

Which revenue recognition method is used when the payment is assured and revenue is earned as costs are incurred?

A) Percentage-of-completion method.

B) Installment sales method.

C) Cost recovery method.

Answer 29

10. The installment sales method is used when the assurance of payment and estimated bad debts does not exist before cash is collected. Sales revenue and COGS are recognized only when cash is received A

Question 30

11:- An oil exploration company has been contracted to dig 100 exploratory holes for $200,000. The cost to complete this job is estimated to be $150,000, but the company doesn’t recognize any of the $50,000 profit until the job is completed. Which revenue recognition method is being used?

A) Cost recovery method.

B) Completed contract method.

C) Percentage-of-completion method.

Answer 30

11. The cost recovery method is used when future cash collections are not assured even after receipt of partial payments. Gross profit is not recognized until all of the cost of goods sold is collected A

Question 31

12:- Which, if any, of the following statements about the installment sales method and cost recovery method is correct?

Statement 1: The cost recovery method recognizes revenue and associated costs of goods sold only when cash is received, based on gross profit margin.

Statement 2: The installment sales method recognizes sales when cash is received, but no gross profit is recognized until all of the cost of goods sold is collected.

A) Only one of these statements is correct.

B) Neither statement is correct.

C) Both statements are correct.

Answer 31

Neither statement is correct because the definitions are reversed. The installment sales method recognizes revenue and associated cost of goods sold only when cash is received. Gross profit (sales – cost of goods sold) reflects the proportion of cash received The cost recovery method is similar to the installment sales method but is more conservative. Sales are recognized when cash is received, but no gross profit is recognized until all of the cost of goods sold is collected C

Question 32

When a reliable estimate of costs exists, ultimate payment is assured, and revenue is earned as costs are incurred, which of the following revenue recognition methods should be used?

A) Cost recovery method.

B) Installment sales method.

C) Percentage-of-completion method.

Answer 32

16:- The key word is “unreliable.” The completed contract method is used when cost estimates are unreliable. The percentage-of-completion method recognizes profit corresponding to the percentage of cost incurred to total estimated costs associated with long-term construction contracts. Percent-of-completion is used where contracts and cost estimates are reliable.` The cost recovery method is similar to the installment sales method but is more conservative. Sales are recognized when cash is received, but no gross profit is recognized until all of the cost of goods sold is collected. B

Question 33

Cash collection is a critical event for income recognition under the: Cost-Recovery Method Installment Method

A) Yes Yes

B) No Yes

C) Yes No

Answer 33

Recognition of income depends on cash collected under both methods. A

Question 34

According to the installment method of accounting, gross profit on an installment sale is recognized:

A)in proportion to the cash collection.

B)after cash collections equal to the cost of sales have been received.

C)on the date the final cash collection is received.

Answer 34

The installment sales method recognizes sales and COGS in proportion to cash collections A

Question 35

17:-An analyst has gathered the following data pertaining to Hegel Company’s construction projects, which began during 2002: Project 1 Project 2 Contract price $420,000 $300,000 Costs incurred in 2002 240,000 280,000 Estimated costs to complete 120,000 40,000 Billed to customers during 2002 150,000 270,000 Received from customers during 200290,000 250,000 If Hengel used the completed contract method, what amount of gross profit (loss) would Hengel report in its 2002 income statement for:

Project 1 Project 2

A) $0 ($20,000)

B) $0 $0

C) ($20,000) $0

Answer 35

No profit is recognized until the completion of the project, however losses are recognized. Project 2 has an expected loss of $20,000.

Question 36

If Hengel used the percentage-of-completion method, what amount of gross profit (loss) would Hengel report in its 2002 income statement?

A) $22,500.

B) $(20,000).

C) $20,000.

Answer 36

Under the percentage of completion method, $40,000 of profit is recognized for project 1. 120,000 + 240,000 = 360,000 total costs; 240,000 / 360,000 × 60,000 estimated profit = $40,000 profit. Project 2 is running at a $20,000 loss. If the loss can be estimated the loss must be recognized at the time it is estimated. Total revenue for project 2 = 300,000 contract price − 320,000 total costs = -$20,000 estimated loss 40,000 (project 1) − 20,000 (project 2) = $20,000 gross profit in 2002

Question 37

The calculation of the income recognized in the third year of a five-year construction contract accounted for using the percentage-of-completion method includes the ratio of:

A) costs incurred in year 3 to total estimated costs.

B) total costs incurred to total estimated cost.

C) costs incurred in year 3 to total billings.

Answer 37

The percentage of completion method recognizes revenues in proportion to the proportion of expenses incurred. Using only the current year’s costs produces an incorrect result if the estimated total cost has changed. Revenue recognized in any given year is costs to date divided by total estimated costs, times total estimated revenue for the project, minus revenue that has already been recognized B

Question 38

Which of the following statements regarding the methods of revenue recognition is most accurate? In the first year of a long-term contract:

A) the percentage-of-completion method generally results in lower retained earnings than the completed contract method.

B) the completed contract method is used when the selling price or cost estimates are unreliable.

C) the completed contract method, in comparison to the percentage-of-completion method, will generally result in higher net income.

Answer 38

The completed contract method compared to the percentage-of-completion method will result in lower net income in the first year because revenue and profit are recognized later. Hence, retained earnings will also be lower than the percentage-of-completion method. B

Question 39

JME Construction always uses the percentage of completion method of recognizing revenue. During 2004 JME signs a contract in the amount of $10 million with the following data available: Costs incurred to date $2,200,000 Billings to date $2,000,000 Cash collected $1,750,000 Total cost of project $8,800,000 How much gross profit should JME recognize for 2004?

A) -$200,000.

B) $300,000.

C) -$450,000.

Answer 39

stage of completion = 25%(2.2 / 8.8) revenue to be recognized = 0.25 × 10 million = 2.5 million gross profit = 2.5 million − 2.2 million = 300,000 B

Question 40

Walker Company received a letter in November 2003 indicating that Johnson, Inc. would purchase a specialty machine priced at $4,000,000. In February 2004, a binding contract was executed for the machine’s construction. Materials costing $2,000,000 were ordered in December 2003, arrived with an invoice in August 2004, and were used in the manufacturing process in the first quarter of 2005. Walker completed and delivered the machine in December 2006. Johnson received the first invoice in 2007 and paid the $4,000,000 purchase price in 2007. Walker Company uses the accrual method of accounting. Walker should record the materials used to construct the machine as expenses in the year:

A) 2007.

B) 2004.

C) 2006.

Answer 40

Under the accrual concept, income is recognized when the earning activities are substantially completed, risk of ownership has transferred from buyer to seller, and payment is realizable and collectible. Under the matching principle, expenses incurred that directly relate to the sold item are expensed in the same period as the revenue is recognized. C

Question 41

Under the cost recovery method, profit is recognized:

A) at time of delivery.

B) after the amount of cost has been collected.

C) as collection occurs.

Answer 41

The cost recovery method is used when the costs to provide goods or services are not known. Under this method, sales are recognized when cash is received, but no gross profit is recognized until all of the cost of goods sold is collected.

Question 42

Which of the following is NOT a requirement for revenue recognition to occur?

A) Cash must have been received.

B) Earning activities are substantially completed.

C) Transactions giving rise to revenue should be arms-length.

Answer 42

Revenue from credit sales may be recognized when sales are on account. Other conditions when revenues are also considered earned include when: revenue can be measured with reasonable accuracy, transactions are not subject to revocation, it is possible to measure the cost of provided goods (no significant contingent obligation), and there is assurance of payment (cash) or collectability. A

Question 43

Guidance from the U.S. Securities and Exchange Commission regarding the criteria for revenue recognition least likely specifies that there must be:

A) evidence of an arrangement between the buyer and the seller.

B) a determined or determinable price.

C) reasonable assurance that the product will be delivered or the service will be rendered.

Answer 43

One of the SEC’s criteria for revenue recognition is that the product has been delivered or the service has been rendered. The other criteria are evidence of an arrangement between the buyer and seller; the price has been determined or is determinable; and the seller is reasonably assured of collecting money.C

Question 44

As a general rule, revenue is normally recognized when it is:

A) earned.

B) measurable.

C) realizable and earned.

Answer 44

Under the accrual concept, revenue is recognized when the earnings process is completed (earned) and ultimate realization (cash receipt) is assured.C

Question 45

Under the general principles of accrual accounting, revenue is recognized when:

A) earned, and expenses are recognized when incurred.

B) cash is received, and expenses are recognized when cash is paid.

C) the good or service is delivered or cash is received, whichever is earlier.

Answer 45

The principle of accrual accounting is that revenue is recognized when earned, and expenses are recognized when incurred.C

Question 46

When the cost of goods and services used are recognized as an expense in the same period that its generated revenue is recognized, which of the following principle(s) is (are) being described?

A) The matching and accrual principles.

B) The accrual and expense recognition principles.

C) The matching principle for revenue and expense recognition.

Answer 46

The accrual concept states that revenue is recognized when the earnings process is completed and cash receipt is assured.A

Question 47

Under accrual accounting, revenues are recognized in the same period in which the associated:

A) cash is collected.

B) expenses are incurred.

C) invoices are billed.

Answer 47

Accrual accounting is based on the matching principle, under which revenues are recognized in the same period that the expenses are incurred to generate those revenues. B

Question 48

How much profit is recognized in Percentage of Completion method ?

Answer 48

Profit is recognized corresponding to the percentage of costs incurred to the total estimated (B)

Question 49

What are the Key Words for each revenue recognition method ?

Percentage of Completion Method

Answer 49

Extent of project is completed

Question 50

What are the Key Words for each revenue recognition method ?

Completed Contract Method

Question 51

What are the Key Words for each revenue recognition method ?

Installment Sales Method

Answer 51

Extent of Cash Received

Question 52

Cost Recovery Method

Answer 52

No profit recognized until the COGS is received