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.

---

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.

---

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.

---

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

---

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.

---

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

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 2002	90,000	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

---

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

---

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

A) $20,000.

B) $22,500.

C) $(20,000).

---

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

1215

Football Contractors, Inc. has contracted to build a stadium for the City of Washburn. The contract price is $100 million and costs are estimated at $60 million. Costs are not assured, however, because there is a material risk, which Football Contractors has assumed, that ground water problems might slow construction and increase costs by as much as $40 million. In 2004, the first year of the agreement, Football Contractors, Inc. billed $30 million, received a $20 million payment, and incurred $15 million in costs. For 2004 Football Contractors, Inc. should recognize revenue from the City of Washburn transaction in the amount of:

A) $0.

B) $30 million.

C) $20 million.

---

The completed contract method is used when a reliable estimate of the total costs cannot be determined until the contract is finished. Because of the significant uncertainty surrounding the ground water costs, the completed contract method should be used in this transaction, and no revenue should be recognized in 2004 or any later year until the contract is completed or the cost uncertainty is resolved.

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.

---

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.

---

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

The Better Building Company has a contract to build a building for $100 million. The estimate of the cost of the project is $75 million. In the first year of the project, BB had costs of $30 million. The Better Building Company’s reported profit for the first year of the contract, using the percentage-of-completion method, is:

A) $0.

B) $20 million.

C) $10 million.

---

Reported profit (in millions) = ($30 / $75)($100 ? 75) = $10.