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Chapter5: Income Measurement and Profitability Analysis

Brief Exercises

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BE 5-1 Point of delivery recognition 
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On July 1, 2011, Apache Company sold a parcel of undeveloped land to a construction company for $3,000,000. The book value of the land on Apache's books was $1,200,000. Terms of the sale required a down payment of $150,000 and 19 annual payments of $150,000 plus interest at an appropriate interest rate due on each July 1 beginning in 2012. Apache has no significant obligations to perform services after the sale. How much gross profit will Apache recognize in both 2011 and 2012 assuming point of delivery profit recognition?

BE 5-2 Installment sales method 
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Refer to the situation described in BE 5-1. How much gross profit will Apache recognize in both 2011 and 2012 applying the installment sales method?

BE 5-3 Cost recovery method 
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Refer to the situation described in BE 5-1. How much gross profit will Apache recognize in both 2011 and 2012 applying the cost recovery method?

BE 5-4 Installment sales method 
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Refer to the situation described in BE 5-1. What should be the balance in the deferred gross profit account at the end of 2012 applying the installment sales method?

BE 5-5 Right of return 
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Meyer Furniture sells office furniture mainly to corporate clients. Customers who return merchandise within 90 days for any reason receive a full refund. Discuss the issues Meyer must consider in determining its revenue recognition policy.

BE 5-6 Percentage-of-completion method; profit recognition 
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A construction company entered into a fixed-price contract to build an office building for $20 million. Construction costs incurred during the first year were $6 million and estimated costs to complete at the end of the year were $9 million. How much gross profit will the company recognize in the first year using the percentage-of-completion method? How much revenue will appear in the company's income statement?

BE 5-7 Percentage-of-completion method; balance sheet 
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Refer to the situation described in BE 5-6. During the first year the company billed its customer $7 million of which $5 million was collected before year-end. What would appear in the year-end balance sheet related to this contract?

BE 5-8 Completed contract method 
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Refer to the situation described in BE 5-6. The building was completed during the second year. Construction costs incurred during the second year were $10 million. How much gross profit will the company recognize in the first year and in the second year applying the completed contract method?

BE 5-9 IFRS; cost recovery method 
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Refer to the situation described in BE 5-8. How much revenue, cost, and gross profit will the company recognize in the first and second year of the contract applying the cost recovery method that is required by IFRS?

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BE 5-10 Percentage-of-completion and completed contract methods; loss on entire project 
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Franklin Construction entered into a fixed-price contract to build a freeway-connecting ramp for $30 million. Construction costs incurred in the first year were $16 million and estimated costs to complete at the end of the year were $17 million. How much gross profit or loss will Franklin recognize the first year applying the percentage-of-completion method? Applying the completed contract method?

BE 5-11 Revenue recognition; software contracts 
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Orange, Inc., sells a LearnIt-Plus software package that consists of their normal LearnIt math tutorial program along with a one-year subscription to the on-line LearnIt Office Hours virtual classroom. LearnIt-Plus retails for $200. When sold separately, the LearnIt math tutorial sells for $150, and access to the LearnIt Office Hours sells for $100 per year. When should Orange recognize revenue for the parts of this arrangement? Would your answer change if Orange did not sell the LearnIt Office Hours separately, but believed it would price it at $100 per year if they ever decided to do so?

BE 5-12 Revenue recognition; software contracts under IFRS 
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Refer to the situation described in BE 5-11. How would your answer change if Orange reported under IFRS?

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BE 5-13 Revenue recognition; franchise sales 
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Collins, Inc., entered into a 10-year franchise agreement with an individual. For an initial franchise fee of $40,000, Collins agrees to assist in design and construction of the franchise location and in all other necessary start-up activities. Also, in exchange for advertising and promotional services, the franchisee agrees to pay continuing franchise fees equal to 5% of revenue generated by the franchise. When should Collins recognize revenue for the initial and continuing franchise fees?

BE 5-14 Receivables and inventory turnover ratios 
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Universal Calendar Company began the year with accounts receivable and inventory balances of $100,000 and $80,000, respectively. Year-end balances for these accounts were $120,000 and $60,000, respectively. Sales for the year of $600,000 generated a gross profit of $200,000. Calculate the receivables and inventory turnover ratios for the year.

BE 5-15 Profitability ratios 
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The 2011 income statement for Anderson TV and Appliance reported sales revenue of $420,000 and net income of $65,000. Average total assets for 2011 was $800,000. Shareholders' equity at the beginning of the year was $500,000 and $20,000 was paid to shareholders as dividends. There were no other shareholders' equity transactions that occurred during the year. Calculate the profit margin on sales, return on assets, and return on shareholders' equity for 2011.

BE 5-16 Profitability ratios 
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Refer to the facts described in BE 5-15. Show the DuPont framework's calculation of the three components of the 2011 return on shareholders' equity for Anderson TV and Appliance.

BE 5-17 Inventory turnover ratio 
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During 2011, Rogue Corporation reported sales revenue of $600,000. Inventory at both the beginning and end of the year totaled $75,000. The inventory turnover ratio for the year was 6.0. What amount of gross profit did the company report in its income statement for 2011?

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