Mulcahey Builders (MB) remodels office buildings in low-income urban areas that
ID: 2477095 • Letter: M
Question
Mulcahey Builders (MB) remodels office buildings in low-income urban areas that are undergoing economic revitalization. MB typically accepts a 25% down payment when they complete a job and a note that requires that the remainder be paid in three equal installments over the next three years, plus interest. Because of the inherent uncertainty associated with receiving these payments, MB has historically used the cost recovery method to recognize revenue. As of January 1, 2016, MB's outstanding gross installment accounts receivable (not net of deferred gross profit) consist of the following: $416,000 due from the Bluebird Motel. MB completed the Bluebird job in 2014, and estimated gross profit on that job is 25%. $175,000 due from the PitStop Gas and MiniMart. MB completed the PitStop job in 2013, and estimated gross profit on that job is 30%. Dan Mulcahey has been considering switching from the cost recovery method to the installment sales method, because he wants to show the highest possible gross profit in 2016 and he understands that the installment sales method recognizes gross profit sooner than does the cost recovery method. Required: Calculate how much gross profit is expected to be earned on these jobs in 2016 under the cost recovery method, and how much would be earned if MB instead used the installment sales method. Ignore interest.Explanation / Answer
Answer:1 All jobs consists of four equal payments: one payment when the job is completed over the next three years.
Bluebird:
Jobs completed in 2014. so, Down payment made in 2014, another payment in 2015 and two payments remain.
$416000 Gross receivables at 1 jan 2016 implies payment of ($416000/2)=$208000 in 2016 and 2017. Four payments of $208000 implies total revenue of (4*208000=832000) on the job.25% gross profit ratio implies cost of 75% of 832000=$624000
Cost recovery method through gross profit: Payment in 2014 and 2015 have already recovered $416000 of cost, so cost remaining to be recovered as of 1 jan 2016 is $624000 total-$416000 already recovered =$208000. Therefore the entire payment in 2016 of $208000 will be applied to cost recovery and no gross profit is recognised.
Installment sales method through Gross profit:$208000 payment *25% GP Ratio=$52000 of gross profit recognized in 2016.
Pitstop:
Job completed in 2013.so, Down payment made in 2013, another payment in 2014, another payment in 2015 and one payments remain.
$175000 Gross receivables at 1 jan 2016 implies a single payment of $175000 in 2016. Four payments of $175000 implies total revenue of (175000*4=700000) on the job. 30% gross profit ratio implies cost of 70% of 700000=$490000.
Cost recovery method through gross profit: Payment in 2013,2014 and 2015 have already recovered $525000. the entire cost $490000 and allowed recognition of 35000 gross profit. Therefore the entire payment in 2016 of $175000 will be applied to gross profit.
Installment sales method through Gross profit:$175000 payment *30% GP Ratio=$52500 of gross profit recognized in 2016.
Particulars Cost recovery Installment sales Bluebird Motel 0 52000 Pitstop gas and Minimart 175000 52500Related Questions
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