Revenue Recogniition

Question 1

Installment Method vs Cost Recovery Method

Answer 1

1. Cost Recovery: Recognize only once Collections surpass Cost.
2. Installment: Start Recognizing a % (% of GP) for each Collection

Question 2

Completion of Production Method

Answer 2

The “completion-of-production” method is appropriate when the sale of the output is assured and a definite price is also assured. Revenue is recognized at production, because there is no uncertainty as to the ultimate sale. Typically, the price used to measure the revenue is a market price that cannot be influenced by the producer, which is the case here.

A price of at least $.70 is assured. The additional $.02 received by Amar in 2006 is credited to revenue in that year.

Question 3

% of Completion Method

Answer 3

The proportion of completion at the end of any year for a construction contract is the amount of work done, divided by the total amount of work required for the contract. Typically, cost is the measure of “work done.” At the end of year three, the numerator is the cost incurred for all three years. The denominator is the total estimated cost of the project, which is the sum of

(1) the cost incurred for all three years so far, plus
(2) estimated costs to complete as of the end of year three.

The percentage of completion changes each year, because both the numerator and denominator change. The gross profit to be reported for year three is the profit for all three years (using the proportion of completion just computed), less the profit already reported in the first two years.

Question 4

Installment Method Set Up

Answer 4

1. A/R and Sales start at Normal Amounts and then set up the DGP Account (Contra A/R) and close out the Original Sales and COGS (Dr Sales, Cr COGS, Cr DGP)
2. DGP is the Gross Profit % of Sales (Sales - COGS)/Sales.
3. This leaves a Net Amount in A/R (not gross) that is COGS or Cost.
4. Recognize Income into RGP at the DGP % as the money comes in (Dr DGP, Cr RGP) and (Dr Cash, Cr A/R)
5. Be able to back into Amount Collected if given Realized Gross Profit etc.

The CPA exam frequently asks for the amount of deferred gross profit on the installment sales method. Also, the gross profit percentage often changes each year. When sales from more than one period are given, be sure to apply the gross margin method that applies to each year’s sales.

Question 5

Installment Method in Multi Year Example

Answer 5

NEEDS REVIEW