CH 5 Solution

Chapter 05 - Income Measurement and Profitability Analysis
Chapter 5 Income Measurement and Profitability

Analysis
Brief Exercise 5-1

2011 gross profit = $3,000,000 – 1,200,000 = $1,800,000
2012 gross profit = 0
Brief Exercise 5-2

2011 Cost recovery % = Cost  Sales:
$1,200,000
= 40% (implying a gross profit % = 60%)
$3,000,000
2011 gross profit = 2011 cash collection of $150,000 x 60% = $90,000

2012 gross profit = 2012 cash collection of $150,000 x 60% = $90,000
Brief Exercise 5-3

No gross profit will be recognized in either 2011 or 2012. Gross profit will not
be recognized until the entire $1,200,000 cost of the land is recovered. In this case, it
will take 8 payments to recover the cost of the land ($1,200,000  $150,000 = 8), so
gross profit recognition will equal 100% of the cash collected beginning with the
ninth installment payment.
Brief Exercise 5-4

Initial deferred gross profit ($3,000,000 – 1,200,000) $1,800,000
Less gross profit recognized in 2011 ($150,000 x 60%) (90,000)
Less gross profit recognized in 2012 ($150,000 x 60%) (90,000)
Deferred gross profit at the end of 2012 $1,620,000
5-1
Brief Exercise 5-5

The seller must meet certain criteria before revenue can be recognized in
situations when the right of return exists. The most critical of these criteria is that the
seller must be able to make reliable estimates of future returns. If Meyer’s
management can make reliable estimates of the furniture that will be returned,
revenue can be recognized when the product is delivered, assuming the company has
no additional obligations to the buyer. If reliable estimates cannot be made because
of significant uncertainty, revenue and related cost recognition is delayed until the
uncertainty is resolved.
Brief Exercise 5-6

Total estimated cost to complete = $6 million + $9 million = $15 million
% of completion = $6 million  $15 million = 40%
Total estimated gross profit ($20 million – 15 million) = $5,000,000

multiplied by the % of completion 40%
Gross profit recognized the first year $2,000,000
First year revenue = $20,000,000 x 40% = $8,000,000
Brief Exercise 5-7

Assets:
Accounts receivable ($7 million – 5 million) $2,000,000
Cost plus profit ($6 million + $2 million*)
in excess of billings ($7 million) 1,000,000
* Total estimated gross profit ($20 million – 15 million) = $5,000,000

multiplied by the % of completion 40%
Gross profit recognized in the first year $2,000,000
5-2
Brief Exercise 5-8

Year 1 = 0
Year 2 = $4 million
Revenue $20,000,000
Less: Costs in year 1 (6,000,000)
Costs in year 2 (10,000,000)
Actual profit $ 4,000,000
Brief Exercise 5-9

Year 1:
Revenue: $6 million
Cost: $6 million
Gross profit: $0
Year 2:
Revenue: $14 million ($20 million total – $6 million in year 1)
Cost: $10 million
Gross profit: $ 4 million
Brief Exercise 5-10

The anticipated loss of $3 million ($30 million contract price less total estimated
costs of $33 million) must be recognized in the first year applying either method.
5-3
Brief Exercise 5-11

Orange has separate sales prices for the two parts of LearnIt-Plus, so that vendor-
specific objective evidence (VSOE) allows them to allocate revenue to those parts
according to their relative selling prices. LearnIt will be allocated $200 x [$150 ÷
($150 + $100)] = $120, and that revenue will be recognized upon delivery of the
LearnIt software. LearnIt Office Hours will be allocated $200 x [$100 ÷ ($150 +
$100)] = $80, and that revenue will be deferred and recognized over the life of the
one-year period in which the Office Hours are delivered.
If LearnIt were not sold separately, Orange would not have VSOE for all of the
parts of the contract. In that case, revenue would be delayed until the later part was
delivered. In this case, the $200 would be deferred and recognized over the life of the
one-year period in which the Office Hours are delivered.
Brief Exercise 5-12

Orange has separate sales prices for the two parts of LearnIt-Plus, so the
company can base its estimates of the fair value of those parts according to their
relative selling prices. LearnIt will be allocated $200 x [$150 ÷ ($150 + $100)] =
$120, and that revenue will be recognized upon delivery of the LearnIt software.
LearnIt Office Hours will be allocated $200 x [$100 ÷ ($150 + $100)] = $80, and that
revenue will be deferred and recognized over the life of the one-year period in which
the Office Hours are delivered.
If LearnIt were not sold separately, the accounting would be the same. Orange
would estimate the fair value of LearnIt Office Hours to be $100 and allocate revenue
in the same fashion as it did when that product was sold separately. (VSOE is not
required under IFRS).
Brief Exercise 5-13

Specific conditions for revenue recognition of the initial franchise fee are
provided by FASB ASC 952-605–25–1. A key to these conditions is the concept of
substantial performance. It requires that 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. The term “substantial” requires
professional judgment on the part of the accountant. Often, substantial performance
is considered to have occurred when the franchise opens for business.
Continuing franchise fees are recognized over time as the services are performed.
5-4
EXERCISES
Exercise 5-1
Requirement 1
Alpine West should recognize revenue over the ski season on an anticipated
usage basis, in this case equally throughout the season. The fact that the $450 price is
nonrefundable is not relevant to the revenue recognition decision. Revenue should be
recognized as it is earned, in this case as the services are provided during the ski
season.
Requirement 2
November 6, 2011 To record the cash collection

Cash ................................................................................ 450
Unearned revenue ....................................................... 450
December 31, 2011 To recognize revenue earned in December (no

revenue earned in November, as season starts on December 1).
Unearned revenue ($450 x 1/5) ....................................... 90
Revenue ...................................................................... 90
Requirement 3
$90 is included in revenue in the 2011 income statement. The $360 remaining
balance in unearned revenue is included in the current liability section of the 2011
balance sheet.
5-5
Exercise 5-2
Requirement 1
2011 Cost recovery %:
$234,000
= 65% (gross profit % = 35%)
$360,000
2012 Cost recovery %:

$245,000
= 70% (gross profit % = 30%)
$350,000
2011 gross profit:

Cash collection from 2011 sales of $150,000 x 35% = $52,500
2012 gross profit:

Cash collection from 2011 sales of $100,000 x 35% = $ 35,000
+ Cash collection from 2012 sales of $120,000 x 30% = 36,000
Total 2012 gross profit $71,000
Requirement 2
2011 deferred gross profit balance:
2011 initial gross profit ($360,000 – 234,000) $126,000
Less: Gross profit recognized in 2011 (52,500)
Balance in deferred gross profit account $73,500
2012 deferred gross profit balance:

2011 initial gross profit ($360,000 – 234,000) $ 126,000
Gross profit recognized in 2012 (35,000)
2012 initial gross profit ($350,000 – 245,000) 105,000

Balance in deferred gross profit account $107,500
5-6
Exercise 5-3
2011 To record installment sales

Installment receivables ................................................... 360,000
Inventory..................................................................... 234,000
Deferred gross profit .................................................. 126,000
2011 To record cash collections from installment sales

Cash ................................................................................ 150,000
Installment receivables ............................................... 150,000
2011 To recognize gross profit from installment sales

Deferred gross profit ...................................................... 52,500
Realized gross profit................................................... 52,500
2012 To record installment sales

Inventory..................................................................... 245,000
2012 To record cash collections from installment sales

Cash ................................................................................ 220,000
2012 To recognize gross profit from installment sales

5-7
Exercise 5-4
Requirement 1
Year Income recognized
2011 $180,000 ($300,000 – 120,000)
2012 -0-
2013 -0-
2014 -0-
Total $180,000
Requirement 2
Cost recovery %:
$120,000
------------- = 40% (gross profit % = 60%)
$300,000
Year Cash Collected Cost Recovery(40%) Gross Profit(60%)

2011 $ 75,000 $ 30,000 $ 45,000
2012 75,000 30,000 45,000
2013 75,000 30,000 45,000
2014 75,000 30,000 45,000
Totals $300,000 $120,000 $180,000
Requirement 3
Year Cash Collected Cost Recovery Gross Profit

2011 $ 75,000 $ 75,000 -0-
2012 75,000 45,000 $ 30,000
2013 75,000 -0- 75,000
2014 75,000 -0- 75,000
Totals $300,000 $120,000 $180,000
5-8
Exercise 5-5
Requirement 1
July 1, 2011 To record installment sale

Sales revenue .............................................................. 300,000
Cost of goods sold .......................................................... 120,000

Inventory..................................................................... 120,000
To record cash collection from installment sale

Cash ................................................................................ 75,000
July 1, 2012 To record cash collection from installment sale

Cash ................................................................................ 75,000
5-9
Exercise 5-5 (continued)

Requirement 2

Inventory..................................................................... 120,000

Cash ................................................................................ 75,000
To recognize gross profit from installment sale


Cash ................................................................................ 75,000

5-10
Exercise 5-5 (concluded)

Requirement 3

Inventory..................................................................... 120,000

Cash ................................................................................ 75,000

Cash ................................................................................ 75,000

Exercise 5-6
Requirement 1
Cost of goods sold ($1,000,000 – 600,000) $400,000
Add: Gross profit if using cost recovery method 100,000
Cash collected $500,000
Requirement 2
$ 600,000
Gross profit percentage = = 60%
$1,000,000
Cash collected x Gross profit percentage = Gross profit recognized
$500,000 x 60% = $300,000 gross profit
5-11
Exercise 5-7
October 1, 2011
To record the installment sale
Installment receivable .................................................... 4,000,000
Inventory..................................................................... 1,800,000
Deferred gross profit .................................................. 2,200,000
To record the cash down payment from installment sale

Cash ................................................................................ 800,000
Installment receivable ................................................ 800,000

Deferred gross profit ($800,000 x 55%*) ...................... 440,000
October 1, 2012
To record the default and repossession
Repossessed inventory (fair value) ............................... 1,300,000
Deferred gross profit (balance) ...................................... 1,760,000
Loss on repossession (difference) ................................. 140,000
Installment receivable (balance) ................................ 3,200,000
*$2,200,000  $4,000,000 = 55% gross profit percentage
5-12
Exercise 5-8
Requirement 1
April 1, 2011 To record installment sale

Installment receivables ................................................... 2,400,000
Land ............................................................................ 480,000
Gain on sale of land .................................................... 1,920,000
April 1, 2011 To record cash collection from installment sale

Cash ................................................................................ 120,000

Cash ................................................................................ 120,000
Requirement 2
April 1, 2011 To record installment sale

Installment receivables ................................................... 2,400,000
Land ............................................................................ 480,000
Deferred gain .............................................................. 1,920,000
5-13
When payments are received, gain on sale of land is recognized, calculated by

applying the gross profit percentage ($1,920,000 ÷ $2,400,000 = 80%) to the cash
collected (80% x $120,000).

Cash ................................................................................ 120,000
To recognize profit from installment sale

Deferred gain .................................................................. 96,000
Gain on sale of land (80% x $120,000) .......................... 96,000

Cash ................................................................................ 120,000
To recognize profit from installment sale

Deferred gain .................................................................. 96,000
Gain on sale of land (80% x $120,000) .......................... 96,000
5-14
Exercise 5-10
Requirement 1
($ in millions) 2011 2012 2013
Contract price $220 $220 $220
Actual costs to date 40 120 170
Estimated costs to complete 120 60 -0-
Total estimated costs 160 180 170
Estimated gross profit (actual in 2013) $ 60 $ 40 $ 50
Gross profit (loss) recognition:
2011: $40
= 25% x $60 = $15
$160
2012: $120
= 66.67% x $40 = $26.67 – $15 = $11.67
$180
2013: $220 – 170 = $50 – ($15 + 11.67) = $23.33
Requirement 2
2011: $220 x 25% = $55
2012: $220 x 66.67% = $146.67 – 55 = $91.67
2013: $220 – 146.67 = $73.33
Requirement 3
Year Gross profit (loss) recognized

2011 -0-
2012 -0-
2013 50
Total project income $50
5-15

Requirement 4
2011:
Revenue: $40
Cost: $40
Gross profit: $ 0
2012:
Revenue: $80
Cost: $80
Gross profit: $ 0
2013:
Revenue: $100 ($220 contract price – $40 – $80)
Cost: $ 50
Gross profit: $ 50
Requirement 5
2012: $120
= 60% x $20* = $12 – 15 = $(3) loss
$200
*$220 – ($40 + 80 + 80) = $20
5-16
Exercise 5-11
Requirement 1
2011 2012 2013
Contract price $8,000,000 $8,000,000 $8,000,000
Actual costs to date 2,000,000 4,500,000 8,300,000
Estimated costs to complete 4,000,000 3,600,000 -0-
Total estimated costs 6,000,000 8,100,000 8,300,000
Estimated gross profit (loss)
(actual in 2013) $2,000,000 $ (100,000) $ (300,000)
Gross profit (loss) recognition:
2011: $2,000,000
= 33.3333% x $2,000,000 = $666,667
$6,000,000
2012: $(100,000) – 666,667 = $(766,667)
2013: $(300,000) – (100,000) = $(200,000)
5-17

Requirement 2
2011 2012
Construction in progress 2,000,000 2,500,000
Various accounts 2,000,000 2,500,000
To record construction costs.
Accounts receivable 2,500,000 2,750,000

Billings on construction contract 2,500,000 2,750,000
To record progress billings.
Cash 2,250,000 2,475,000

To record cash collections.
Construction in progress
(gross profit) 666,667
Cost of construction 2,000,000
Revenue from long-term contracts
(33.3333% x $8,000,000) 2,666,667
To record gross profit.
Cost of construction (2) 2,544,000

Revenue from long-term contracts (1) 1,777,333
Construction in progress (loss) 766,667
To record expected loss.
(1) and (2):

Percent complete = $4,500,000 ÷ $8,100,000 = 55.55%
Revenue recognized to date:
55.55% x $8,000,000 = $4,444,000
Less: Revenue recognized in 2011 (above) (2,666,667)
Revenue recognized in 2012 1,777,333 (1)
Plus: Loss recognized in 2012 (above) 766,667
Cost of construction, 2012 $2,544,000 (2)
5-18

Requirement 3
Balance Sheet 2011 2012
Current assets:
Accounts receivable $250,000 $525,000
Costs and profit ($2,666,667*) in
excess of billings ($2,500,000) 166,667
Current liabilities:
Billings ($5,250,000) in excess
of costs less loss ($4,400,000**) $850,000
* Costs ($2,000,000) + profit ($666,667)

** Costs ($2,000,000 + $2,500,000) – loss ($100,000 = $766,667 – $666,667)
5-19
Exercise 5-12
Requirement 1
2011 -0-
2012 $(100,000)
2013 (200,000)
Total project loss $(300,000)
Requirement 2
2011 2012
Construction in progress 2,000,000 2,500,000
Various accounts 2,000,000 2,500,000
To record construction costs.

Billings on construction contract 2,500,000 2,750,000
To record progress billings.
Cash 2,250,000 2,475,000

To record cash collections.
Loss on long-term contract 100,000

Construction in progress 100,000
To record an expected loss.
5-20

Requirement 3
Balance Sheet 2011 2012

Current assets:
Accounts receivable $250,000 $525,000
Current liabilities:
Billings ($2,500,000) in excess of costs
($2,000,000) $500,000
Billings ($5,250,000) in excess of costs less

loss ($4,400,000*) $850,000
* Costs ($2,000,000 + $2,500,000) – loss ($100,000)
5-21
Exercise 5-13
Situation 1 - Percentage-of-Completion
2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000
Estimated costs to complete 3,000,000 900,000 -0-
Estimated gross profit
(actual in 2013) $ 500,000 $ 500,000 $ 500,000
Gross profit (loss) recognized:
2011: $1,500,000
= 33.3333% x $500,000 = $166,667
$4,500,000
2012: $3,600,000
= 80.0% x $500,000 = $400,000 – 166,667 = $233,333
$4,500,000
2013: $500,000 – 400,000 = $100,000
Situation 1 - Completed Contract
Year Gross profit recognized

2011 -0-
2012 -0-
2013 $500,000
Total gross profit $500,000
5-22
2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000
(actual in 2013) $ 500,000 $ 200,000 $ 200,000
2011: $1,500,000
= 33.3333% x $500,000 = $166,667
$4,500,000
2012: $2,400,000
= 50.0% x $200,000 = $100,000 – 166,667 = $(66,667)
$4,800,000
2013: $200,000 – 100,000 = $100,000

2011 -0-
2012 -0-
2013 $200,000
5-23
2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000
(actual in 2013) $ 500,000 $ (100,000) $ (200,000)
2011: $1,500,000
= 33.3333% x $500,000 = $166,667
$4,500,000
2012: $(100,000) – 166,667 = $(266,667)
2013: $(200,000) – (100,000) = $(100,000)

2011 -0-
2012 $(100,000)
2013 (100,000)
5-24
2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000
Actual costs to date 500,000 3,500,000 4,500,000
Estimated costs to complete 3,500,000 875,000 -0-
(actual in 2013) $1,000,000 $ 625,000 $ 500,000
2011: $ 500,000
= 12.5% x $1,000,000 = $125,000
$4,000,000
2012: $3,500,000
= 80.0% x $625,000 = $500,000 – 125,000 = $375,000
$4,375,000
2013: $500,000 – 500,000 = $ - 0 -

2011 -0-
2012 -0-
2013 $500,000
5-25
2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000
(actual in 2013) $1,000,000 $ -0- $ 200,000
2011: $ 500,000
= 12.5% x $1,000,000 = $125,000
$4,000,000
2012: $ 0 – 125,000 = $(125,000)
2013: $200,000 – 0 = $200,000

2011 -0-
2012 -0-
2013 $200,000
5-26
2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000
(actual in 2013) $ (100,000) $ (200,000) $ (300,000)
2011: $(100,000)
2012: $(200,000) – (100,000) = $(100,000)
2013: $(300,000) – (200,000) = $(100,000)

2011 $(100,000)
2012 (100,000)
2013 (100,000)
5-27
Exercise 5-14
Requirement 1
Construction in progress = Costs incurred + Profit recognized
$100,000 = ? + $20,000
Actual costs incurred in 2011 = $80,000

Requirement 2
Billings = Cash collections + Accounts Receivable
$94,000 = ? + $30,000
Cash collections in 2011 = $64,000

Requirement 3
Let A = Actual cost incurred + Estimated cost to complete
Actual cost incurred

x (Contract price – A) = Profit recognized
A
$80,000
($1,600,000 – A) = $20,000
A
$128,000,000,000 – 80,000A = $20,000A
$100,000A = $128,000,000,000
A = $1,280,000
Estimated cost to complete = $1,280,000 – 80,000 = $1,200,000

Requirement 4
$80,000
= 6.25%
$1,280,000
5-28
Exercise 5-15
Requirement 1
Revenue should be recognized as follows:
Software - date of shipment, July 1, 2011
Technical support - evenly over the 12 months of the agreement
Upgrade - date of shipment, January 1, 2012
The amounts are determined by an allocation of total contract price in

proportion to the individual fair values of the components if sold separately:
Software $210,000 ÷ $270,000 x $243,000 = $189,000

Technical support $30,000 ÷ $270,000 x $243,000 = 27,000
Upgrade $30,000 ÷ $270,000 x $243,000 = 27,000
Total $243,000
Requirement 2
July 1, 2011 To record sale of software

Cash ................................................................................ 243,000
Revenue ...................................................................... 189,000
Unearned revenue ($27,000 + 27,000) ........................... 54,000
5-29
Exercise 5-16
Requirement 1
Conveyer ($20,000 ÷ $50,000) x $45,000 = $18,000

Labeler ($10,000 ÷ $50,000) x $45,000 = 9,000
Filler ($15,000 ÷ $50,000) x $45,000 = 13,500
Capper ($5,000 ÷ $50,000) x $45,000 = 4,500
total $45,000
Requirement 2
All $45,000 of revenue is delayed until installation of the conveyer,

because the usefulness of the other elements of the multi-part arrangement
is contingent on its delivery.
5-30
Exercise 5-17
Requirement 1
Conveyer ($20,000 ÷ $50,000) x $45,000 = $18,000

Labeler ($10,000 ÷ $50,000) x $45,000 = 9,000
Filler ($15,000 ÷ $50,000) x $45,000 = 13,500
Capper ($5,000 ÷ $50,000) x $45,000 = 4,500
total $45,000
Requirement 2
Under IFRS, it is likely that Richardson would recognize revenue the same
as in Requirement 1, because (a) revenue for each part can be estimated
reliably and (b) the receipt of economic benefits is probable.
5-31
Exercise 5-18
October 1, 2011 To record franchise agreement and down payment

Cash (10% x $300,000) ...................................................... 30,000
Note receivable ............................................................... 270,000
Unearned franchise fee revenue ................................. 300,000
January 15, 2012 To recognize franchise fee revenue

Unearned franchise fee revenue ..................................... 300,000
Franchise fee revenue ................................................. 300,000
Exercise 5-19
List A List B
h 1. Inventory turnover a. Net income divided by net sales.
d 2. Return on assets b. Defers recognition until cash collected equals
cost.
g 3. Return on shareholders' equity c. Defers recognition until project is complete.
a 4. Profit margin on sales d. Net income divided by assets.
b 5. Cost recovery method e. Risks and rewards of ownership retained
by seller.
i 6. Percentage-of-completion method f. Contra account to construction in progress.
c 7. Completed contract method g. Net income divided by shareholders' equity.
k 8. Asset turnover h. Cost of goods sold divided by inventory.
l 9. Receivables turnover i. Recognition is in proportion to work completed.
m 10. Right of return j. Recognition is in proportion to cash received.
f 11. Billings on construction contract k. Net sales divided by assets.
j 12. Installment sales method l. Net sales divided by accounts receivable.
e 13. Consignment sales m. Could cause the deferral of revenue recognition
beyond delivery point.
5-32
Exercise 5-20
Requirement 1
Inventory turnover ratio = Cost of goods sold
Average inventory
= $1,840,000
[$690,000 + 630,000] ÷ 2
= 2.79 times
Requirement 2
By itself, this one ratio provides very little information. In general, the higher
the inventory turnover, the lower the investment must be for a given level of sales. It
indicates how well inventory levels are managed and the quality of inventory,
including the existence of obsolete or overpriced inventory.
However, to evaluate the adequacy of this ratio it should be compared with some
norm such as the industry average. That indicates whether inventory management
practices are in line with the competition.
It’s just one piece in the puzzle, though. Other points of reference should be
considered. For instance, a high turnover can be achieved by maintaining too low
inventory levels and restocking only when absolutely necessary. This can be costly in
terms of stockout costs.
The ratio also can be useful when assessing the current ratio. The more liquid
inventory is, the lower the norm should be against which the current ratio should be
compared.
5-33
Exercise 5-21
Turnover ratios for Anderson Medical Supply Company for 2011:
Inventory turnover ratio = $4,800,000

[$900,000 + 700,000] ÷ 2
= 6 times
Receivables turnover ratio = $8,000,000

[$700,000 + 500,000] ÷ 2
= 13.33 times
Average collection period = 365

13.33
= 27.4 days
Asset turnover ratio = $8,000,000

[$4,300,000 + 3,700,000] ÷ 2
= 2 times
The company turns its inventory over 6 times per year compared to the industry
average of 5 times per year. The asset turnover ratio also is slightly better than the
industry average (2 times per year versus 1.8 times). These ratios indicate that
Anderson is able to generate more sales per dollar invested in inventory and in total
assets than the industry averages. However, Anderson takes slightly longer to collect
its accounts receivable (27.4 days compared to the industry average of 25 days).
5-34
Exercise 5-22
Requirement 1
a. Profit margin on sales $180 ÷ $5,200 = 3.5%
b. Return on assets $180 ÷ [($1,900 + 1,700) ÷ 2] = 10%
c. Return on shareholders’ equity $180 ÷ [($550 + 500) ÷ 2] = 34.3%
Requirement 2
Retained earnings beginning of period $100,000
Add: Net income 180,000
280,000
Less: Retained earnings end of period 150,000
Dividends paid $130,000
Exercise 5-23
Requirement 1
a. Profit margin on sales $180 ÷ $5,200 = 3.5%
b. Asset turnover $5,200 ÷ [($1,900 + 1,700) ÷ 2] = 2.89
c. Equity multiplier [($1,900 + 1,700) ÷ 2] ÷ [($550 + 500) ÷ 2] = 3.43
d. Return on shareholders’ equity $180 ÷ [($550 + 500) ÷ 2] = 34.3%
Requirement 2
Profit margin x Asset turnover x Equity multiplier = ROE
3.5% x 2.89 x 3.43 = 34.7% ~ 34.3% (difference due
to rounding)
Exercise 5-24
Quarter
First Second Third
Cumulative income before taxes $50,000 $90,000 $190,000
Estimated annual effective tax rate 34% 30% 36%
17,000 27,000 68,400
Less: Income tax reported earlier 0 17,000 27,000
Tax expense to be reported $17,000 $10,000 $ 41,400
5-35
Exercise 5-25
Incentive compensation $300 million ÷ 4 = $ 75 million
Depreciation expense $60 million ÷ 4 = 15 million
Gain on sale 23 million
Exercise 5-26
1st 2nd 3rd 4th
Advertising $200,000 $200,000 $200,000 $200,000
Property tax 87,500 87,500 87,500 87,500
Equipment repairs 65,000 65,000 65,000 65,000
Extraordinary casualty loss 0 185,000 0 0
Research and development 0 32,000 32,000 32,000
5-36

CH 5 Solution

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CH 5 Solution

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Chapter 05 - Income Measurement and Profitability Analysis

Chapter 5 Income Measurement and Profitability

Brief Exercise 5-1

Brief Exercise 5-2

2011 gross profit = 2011 cash collection of $150,000 x 60% = $90,000

Brief Exercise 5-3

Brief Exercise 5-4

Brief Exercise 5-5

Brief Exercise 5-6

Total estimated gross profit ($20 million – 15 million) = $5,000,000

First year revenue = $20,000,000 x 40% = $8,000,000

Brief Exercise 5-7

* Total estimated gross profit ($20 million – 15 million) = $5,000,000

Brief Exercise 5-8

Brief Exercise 5-9

Brief Exercise 5-10

Brief Exercise 5-11

Brief Exercise 5-12

Brief Exercise 5-13

November 6, 2011 To record the cash collection

December 31, 2011 To recognize revenue earned in December (no

2012 Cost recovery %:

2011 gross profit:

2012 gross profit:

2012 deferred gross profit balance:

2012 initial gross profit ($350,000 – 245,000) 105,000

2011 To record installment sales

2011 To record cash collections from installment sales

2011 To recognize gross profit from installment sales

2012 To record installment sales

2012 To record cash collections from installment sales

2012 To recognize gross profit from installment sales

Year Cash Collected Cost Recovery(40%) Gross Profit(60%)

Year Cash Collected Cost Recovery Gross Profit

July 1, 2011 To record installment sale

Cost of goods sold .......................................................... 120,000

To record cash collection from installment sale

July 1, 2012 To record cash collection from installment sale

Exercise 5-5 (continued)

July 1, 2011 To record installment sale

To record cash collection from installment sale

To recognize gross profit from installment sale

July 1, 2012 To record cash collection from installment sale

To recognize gross profit from installment sale

Exercise 5-5 (concluded)

July 1, 2011 To record installment sale

To record cash collection from installment sale

July 1, 2012 To record cash collection from installment sale

To recognize gross profit from installment sale

Cash collected x Gross profit percentage = Gross profit recognized

$500,000 x 60% = $300,000 gross profit

To record the cash down payment from installment sale

To recognize gross profit from installment sale

*$2,200,000  $4,000,000 = 55% gross profit percentage

April 1, 2011 To record installment sale

April 1, 2011 To record cash collection from installment sale

April 1, 2012 To record cash collection from installment sale

April 1, 2011 To record installment sale

Exercise 5-8 (concluded)

When payments are received, gain on sale of land is recognized, calculated by

April 1, 2011 To record cash collection from installment sale

To recognize profit from installment sale