1215

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.

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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.

1215

When an unreliable estimate of costs exists and ultimate payment is assured, which of the following revenue recognition methods should be used?

A) Percentage-of-completion method.

B) Cost recovery method.

C) Completed contract method.

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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.

1215

Which of the following statements regarding the methods of revenue recognition is most accurate?

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.

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The completed contract method compared to the percentage-of-completion method will result in lower net income since revenue is recognized later. Hence, retained earnings will also be lower than the percentage-of-completion method.

1215

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.

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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, minus revenue that has already been recognized.

1215

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

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

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

C) in proportion to the cash collection.

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

1215

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

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Recognition of income depends on cash collected under both methods.

1215

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:

A) $20,000.

B) $10,000.

C) -$10,000.

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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.

1215

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.

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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.

1215

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.

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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.

1215

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?

A) $960,000.

B) $720,000.

C) $1,200,000.

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(1,200 × $1,000 × 12/20) = $720,000