Intermediate Accounting Rockhurst Chapter 5

Front 1

percentage of completion method

Back 1

recognize revenue and expenses over time by all0ocating a share of the project's expected revenues and expenses to each period in which the earnings process occurs. The projects expenses are not known until the end of the project. Consequently, it's necessary for the company to estimate the project's future costs at the end of each reporting period in order to estimate total gross profit to be earned on the project

Front 2

which method is required by GAAP for ongoing contracts?

Back 2

GAA requires the use of the percentage of completion method unless it's not possible to make reliable estimates of revenues, expenses, and progress toward completion.

Front 3

Construction costs include

Back 3

labor, materials, and overhead costs directly related to the construction of the bldg.

Front 4

Journal entry to record construction costs:

Back 4

Construction in progress
Cash, materials, ect.

Front 5

Journal entry to record progress billings

Back 5

Accounts receivable
Billings on construction contracts

Front 6

Jounral entry to record cash collections

Back 6

Cash
Accounts receivable.

Front 7

Construction in progress account

Back 7

All costs of construction are recorded in an asset account called construction in progress. This account is equivalent to the asset work in process inventory in a manufacturing co. This is logical because to a contractor the construction project is essentially an inventory item in progress.

Front 8

billings on construction contract account

Back 8

This account is a contra account to the construction in progress asset. At the end of each period, the balances in this account are compared. If the net amount is a debit it is reported in the balance sheet as an asset, conversely if the balance is a credit, it is reported in the balance sheet as a liability.

Front 9

Why is a billings on construction account necessary?

Back 9

Key difference between accounting for a long term contract and a typiucal sale in which revenue is recognized upon delivery. In a typical sale, a company gives up its physical asset (inventory) and recognizes cost of goods sold at the same time it gets an account reveivable and recognizes revenue. So first there's a physical unit in the balance sheet, and then a receivable, but never both at the same time. In long term contracts, we create a physical asset, (construction in progress) and in the same period recognizes a financial asset (first recognizing a/R when the customer is billed and then recognizing cash when the receivable is collected). Having both the physical asset and the financial asset in the balance sheet at the same time constitutes double counting the same arrangement. The billings on construction contract account solves this problem. Whenever an account receivable is recognized, the other side of the journal entry increases the billings on construction contract account which is contra to (and thus reduces) construction in progress. As a result, the financial asset (accounts receivable) increases and the physical asset (the net of construction in progress and billings) decreases, and no double counting occurs.

Front 10

Completed contract journal entry to recognize gross profit

Back 10

Construction in progress (for gross profit amount)
Cost of construction
Revenue from long term contracts

Front 11

Journal entry to record gross profit for long term contracts

Back 11

Construction in progress (gross profit)
Cost of construction
revenue from long term contracts

Front 12

Why do we add gross profit to construction in progress asset?

Back 12

Whey they recognize it it's like they hve sold some portion of the asset to the company but they keep it in their own balance sheet until delivery. Putting recognized Gross profit into construction in progress updates that account to reflect the total value of the customer's asset. However, they bill the customer for the entire sales price of the asset. Therefore at the end of the project, the construction in progres and billings on contract will have equal balances that offset to create a net value of zero.

Front 13

Journal entry to close accounts when contract is complete

Back 13

Billings on construction contract
Construction in progress

Front 14

Timing of gross profit recognition under completed contract

Back 14

as the name implies, all revenues and expenses related to the project are recognized when the contract is complete.

Front 15

Balance sheet format

Back 15

Current assets:
Accounts receivable
costs and profit in excess of billings

Current liabilities
Billings in excess of costs and profit

Front 16

construction in progress in excess of billings

Back 16

represents an unbilled receivable. The construction co is incurring construction costs for which it will be paid by the buyer.

Front 17

Billings in excess of construction in progress

Back 17

overbilled accounts receivable overstates the amount of the claim to cash earned that date and must be reported as a liability. This is similar to the unearned revenue liability that is recorded when a customer pays for a product or service in advance.

Front 18

Periodic loss for profitable project

Back 18

when using percentage of completion method a loss must sometimes be recognized in at least one period even though the project as a whole is expected to be profitable.

Front 19

To record the loss on a project journal entry

Back 19

cost of construction
revenue from long term contracts
construction in progress (loss)

Front 20

Loss on entire project

Back 20

the total anticipated loss must be recognized for both the percentage of completion and conpleted contract method. Why recognize it in the year incurred? Becayse if the loss wasn't recognized construction in progress would be valued at an amount greater than the company expects to realize from the contract.

Front 21

What are the fees usually paid to a franchisor?

Back 21

1. the initial franchise fee
2. continuing franchise fee.

Front 22

initial franchise fee includes

Back 22

the rights to use the business name and sell its products, may include assistance in finding a location, construction the facility, and training employees. May be payble in installments

Front 23

continuing franschise fee

Back 23

paid to franchisor for continuing rights as well as for advertising and promotion and other services provided over the life of the franchise agreement.

Front 24

GAAP guidelines for recognizing initial franchise fee

Back 24

it requires substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue.

Front 25

Initial franchise fee journal entry

Back 25

cash
note receivable
unearned franchise fee revenue

Front 26

unearned franchise fee revenue is a liability

Back 26

this will be reduced to zero and revenue will be recognized when the services have been performed

Front 27

Journal entry to recognize franchise fee revenue

Back 27

Unearned franchise fee revenue
Franchise fee revenue

Front 28

journal entry for continuing franchise fee

Back 28

cash (or accounts reveivable)
service revenue

Front 29

asset turnover ratio

Back 29

Net sales / average total assets
Average total assets is determined by adding beginning and ending total assets divided by 2 this determines how efficiently a company utilitzes all of its assets to generate revenue.

Front 30

receivables turnover ratio

Back 30

Net sales / average accounts receivable (net)
Average account receivable is found by adding beginning and ending net accounts receivable and dividing by 2

Front 31

Average collection period

Back 31

365 / receivables turnover

Front 32

inventory turnover

Back 32

COGS / average inventory
average inventory takes beginning + ending / 2

Front 33

average days in inventory

Back 33

365 / inventory turnover

Front 34

Profit margin on sales

Back 34

Net income / net sales
Indicates the portion of each dollar of revenue avail to cover expenses.

Front 35

return on assets

Back 35

Net income / average total assets
or
PM x Asset turnover

Front 36

ROE

Back 36

Net income / average total equity
or
ROA x equity multiplier

Front 37

what is revenue?

Back 37

revenue is inflows or other enhancements of assets of an entity or settlements of its liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity's major or central operations. REvenue tracks the inflow of net assets that occurs when a business provides goods or services to its customers.

Front 38

realization principle requires 2 criteria be met before revenue can be recognized:

Back 38

1. earnings process is judged to be complete or relatively complete.
2. There is reasonable certainty as to collectibility of the asset to be received.

Front 39

Revenue from the sale of products is typically recognized:

Back 39

when the delivery occurs.

Front 40

If goods are shipped FOB shipping point

Back 40

legal title of the goods changes hands at the point of shipment, when the seller delivers the goods to the common carrier and the purchaser is responsible for shipping costs.

Front 41

If FOB destination

Back 41

Then the seller is responsible for shipping and legal title doesn't pass until goods arrive at the customer's location.

Front 42

Journal entries for revenue on delivery

Back 42

A/R
REvenue

COGS
Inventory

Front 43

Installment sales

Back 43

customers are sometimes allowed to pay for purchases in installments over a long period oftime. Increasing the length of time allowed for payment usually increases the uncertainty of whether the store will collect. This isn't usually reason to delay revenue recognition.

Front 44

Installment sales method

Back 44

recognizes revenue and costs only when cash payments are received. Each payment is assumed to be composed of 2 components:
1. a partial recovery of the cost of the item sold and
2. a gross profit component.
These are determined by gross profit percentage applicable to the sale.

Front 45

Gross profit recognized in an installment sale =

Back 45

gross proft percentage multiplied by cash collection

Front 46

Journal entry to record installment sale

Back 46

Installment receivables
Inventory
Deferred GP

Front 47

Journal entry to record cash collection from installment sale

Back 47

CAsh
Installment receivable

Front 48

Journal entry to record gross profit from installment sales

Back 48

deferred gross profit
realized gross profit

Front 49

How to calculate the gross profit percentage in an installment sale

Back 49

take the sale price - cost = GP
then take GP / sale price gives you the %
You then multiply the cash received by the % to get GP recognized.

Front 50

Cost recovery method

Back 50

ONLY USED IF EXTREMELY HIGH DEGREE OF UNCERTAINTY REGARDING CASH COLLECTION
method defers all gross profit recognitio until the cost of the item sold has been recovered.

Front 51

Right of return

Back 51

Companies can estimate the returns based on past company experience and can therefore record revenue before they are actually paid.

Front 52

Consignment sales

Back 52

The cosignor physically transfers goods to the other company, but thecosignor retains legal title. If the cosignee can't find a buyer within the agreed upon time frame, the cosignee returns the goods to the cosignor. However, if a buyer is found, the cosignee remits the selling price (less commission and approved expenses) to the cosignor. Because the cosignor retains the risks and rewards of ownerhisp of the product and title does not pass to the cosignee, the cosignor doesn't record a sale until the cosignee sells the goods and title passes to the customer. This means goods on consignment are part of the cosignor's inventory.