Concepts for Analysis CA18-1 (Revenue Recognition—Alternative Methods) Alexsandr
ID: 2348339 • Letter: C
Question
Concepts for AnalysisCA18-1
(Revenue Recognition—Alternative Methods) Alexsandra Isosev Industries has three operating divisions—Falilat Mining, Mourning Paperbacks, and Osygus Protection Devices. Each division maintains its own accounting system and method of revenue recognition.
Falilat Mining
Falilat Mining specializes in the extraction of precious metals such as silver, gold, and platinum. During the fiscal year ended November 30, 2007, Falilat entered into contracts worth $2,250,000 and shipped metals worth $2,000,000. A quarter of the shipments were made from inventories on hand at the beginning of the fiscal year, and the remainder were made from metals that were mined during the year. Mining totals for the year, valued at market prices, were: silver at $750,000, gold at $1,300,000, and platinum at $490,000. Falilat uses the completion-of-production method to recognize revenue, because its operations meet the specified criteria—i.e., reasonably assured sales prices, interchangeable units, and insignificant distribution costs.
Mourning Paperbacks
Mourning Paperbacks sells large quantities of novels to a few book distributors that in turn sell to several national chains of bookstores. Mourning allows distributors to return up to 30% of sales, and distributors give the same terms to bookstores. While returns from individual titles fluctuate greatly, the returns from distributors have averaged 20% in each of the past 5 years. A total of $8,000,000 of paperback novel sales were made to distributors during the fiscal year. On November 30, 2007, $3,200,000 of fiscal 2007 sales were still subject to return privileges over the next 6 months. The remaining $4,800,000 of fiscal 2007 sales had actual returns of 21%. Sales from fiscal 2006 totaling $2,500,000 were collected in fiscal 2007, with less than 18% of sales returned. Mourning records revenue according to the method referred to as revenue recognition when the right of return exits, because all applicable criteria for use of this method are met by Mourning's operations.
Osygus Protection Devices
Osygus Protection Devices works through manufacturers' agents in various cities. Orders for alarm systems and down payments are forwarded from agents, and Osygus ships the goods f.o.b. shipping point. Customers are billed for the balance due plus actual shipping costs. The firm received orders for $6,000,000 of goods during the fiscal year ended November 30, 2007. Down payments of $600,000 were received, and $5,000,000 of goods were billed and shipped. Actual freight costs of $100,000 were also billed. Commissions of 10% on product price were paid to manufacturers' agents after the goods were shipped to customers. Such goods are warranted for 90 days after shipment, and warranty returns have been about 1% of sales. Revenue is recognized at the point of sale by Osygus.
Instructions
There are a variety of methods for revenue recognition. Define and describe each of the following methods of revenue recognition, and indicate whether each is in accordance with generally accepted accounting principles.
Completion-of-production method.
Percentage-of-completion method.
Installment-sales method.
Compute the revenue to be recognized in the fiscal year ended November 30, 2007, for
Falilat Mining.
Mourning Paperbacks.
Osygus Protection Devices.
Explanation / Answer
The completed-contract method recognizes income only on completion, or substantial completion, of the contract. A contract is considered substantially complete if the remaning costs left to finish the project are insignificant. The comleted contract method can be used when:
1. It is difficult to estimate the costs of a contract in progress
2. There are many contracts in progress so that about an equal number are completed each year.
3. The projects are short and collections are not assured.
When using the completed-contract method costs are charged to a construction in progress acount as well as the billings or cash received for the project. The completed contract method is in accordance with U.S. GAAP but only if the percentage of completion method cannot be used.
The percentage of completion method is used when collection is assured and profitability as well as determining the progress towards completion can be reasonably estimated. Income is recognized as work progresses on the project regardless of whether payments have been received. The amount of income recognized is determined by estimating the total gross profit for the contract and multiplying that amount by the % deemed to be completed on the project. This method is in accordance with U.S. GAAP and is the preferred method but it is an exception to the basic realization principle and instead complies with the matching principle so that the revenue can be better matched with the construction expenses.
The installment sales method is only used when there is no reasonable basis for estimateding the degree of collectibility. Revenue is not recognized when the sale is made but when the cash is actually collected. Gross Profit % is calculated and multipled by the amount of cash received to determine the gain or loss to be recorded when a payment is received. The installment sales method is in accordance with GAAP but only when there is no reasonable basis for estimating the degree of collectibility.
Falilat Mining:
Revenue recognized would be at the time of completion so $2,250,000
Mourning Paperbacks
4,800,000*.79 = 3,972,000
3,200,000-80 = 2,560,000
3,972,000+2,560,000= 6,352,000
The 2006 income collected in 2007 would have already been recorded and adjusted for the estimated returns.
Osygus Protection Devices
5,000,000 + 100,000 would be recognized as they are considered sold after they have been shipped.
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