An 

accrual is an accounting adjustment used to track and record revenues that have been
earned but not received, or expenses that have been incurred but not paid.

EXERCISES

Ex. 18-121— Revenue recognition (essay).

The revenue recognition principle provides that revenue is recognized when (1) it is realized or
realizable and (2) it is earned.

Instructions

Explain when revenues are (a) realized, (b) realizable, and (c) earned.

Solution 18-121

(a) Revenues are realized when goods or services are exchanged for cash or claims to cash
(receivables).

(b) Revenues are realizable when assets received in exchange are readily convertible to
known amounts of cash or claims to cash.
(c) Revenues are earned when the earnings process is complete or virtually complete.

Ex. 18-122—Revenue recognition (essay).

The earning of revenue by a business is recognized for accounting purposes when the
transaction is recorded. Revenue is often recognized at time of sale.

Instructions

At what times, other than at time of sale, may it be appropriate to recognize revenue? Explain and
justify each of these times.
Solution 18-122
Revenue is also recognized (1) during production, (2) at completion, and (3) at collection.

(1) During production. The most common situation is the use of the percentage-of-completion method
for long-term construction contracts. The point of sale is much less significant than production
activity. If the contractor can expect to perform the contractual obligation, the revenue is assured
by the contract. To defer recognition until completion of the entire contract misrepresents the
efforts (costs) and accomplishments (revenues) of the interim periods. If progress toward
completion can be estimated with reasonable accuracy, the percentage-of-completion method
should be used.

(2) At completion. Examples of revenue recognition at completion of production involve precious

metals and agricultural products with quoted prices. These sales prices are reasonably assured,
there are low additional costs of distribution, and unit costs cannot be determined because of joint
costs.

(3) At collection. When collection is highly uncertain and there is no reasonably objective basis for
estimating the degree of collectibility, revenue should not be recognized until cash is received. In
addition, if collection costs and bad debts are expected to be high and their amount cannot be
reasonably estimated, revenue recognition should be deferred.

Ex. 18-123—Long-term construction contracts (essay).

In accounting for long-term construction contracts (those taking longer than one year to complete), the
two methods commonly followed are percentage-of-completion and completed-contract.

Instructions

(a) Discuss how earnings on long-term construction contracts are recognized and computed under
these two methods.

(b) Under what circumstances should one method be used over the other?

(c) How are job costs and interim billings reflected on the balance sheet under the percentage-of-
completion method and the completed-contract method?

Solution 18-123
(a) The revenue recognized on a long-term construction contract under the percentage-of-completion
method is determined by applying a percentage representing the degree of completion to the
total contract price at the end of the accounting period. The percentage may be derived by
dividing the costs incurred to date by the total estimated costs of the entire contract based on the
most recent information. The revenue so derived is then reduced by the direct contract costs to
determine the gross profit recognized in the initial period.

In subsequent periods, since the percentage-of-completion method described produces

cumulative results, revenue and gross profit recognized in prior periods must be subtracted to
obtain current revenue and gross profit to be recognized.
Solution 18-123 (cont.)
Under the completed-contract method, no earnings are recognized until the contract is
substantially completed. For the period in which completion occurs, gross revenues include the
total contract price. Total job costs incurred are deducted from gross revenues, resulting in
recognition of the entire amount of gross profit in the completion period. If it is expected that a
loss will occur on the contract, a provision for loss should be recognized immediately under both
the completed-contract method and the percentage-of-completion method.

(b) The percentage-of-completion method should be used when estimates of the bases upon which
progress is measured are reasonably dependable and all the following conditions exist:

1. The contract clearly specifies the enforceable rights regarding goods or services to be
provided and received by the parties, the consideration to be exchanged, and the manner and
terms of settlement.

2. The buyer can be expected to satisfy all obligations under the contract.

3. The contractor can be expected to perform the contractual obligation.

The completed-contract method should be used when inherent hazards or lack of depend-able
estimates cause the forecasts to be of doubtful value.

(c) Under the percentage-of-completion method, a schedule is made of the contracts in process,
showing the total costs incurred as of the end of a given period, the estimated gross profit
recognized based on the degree of completion, and the total billings rendered on each individual
contract. If costs incurred plus recognized profits exceed the related billings on a contract, this net
figure is shown as a current asset. This treatment shows that the contractor has not fully billed the
customer for work performed to date and has a claim against the customer for that portion of
work completed but not yet billed. If billings on a contract exceed costs incurred plus estimated
profits, this net figure is shown as a current liability, which means that the contractor has
overbilled the customer for work done to date and must complete the work represented by the
excess billings.

Under the completed-contract method, the treatment of excess costs and billings is the same as
under the percentage-of-completion method except that estimated profits are not computed
because profit recognition is deferred until a contract is completed. The excess of costs over
related billings on a contract is a current asset while the excess of billings over related costs on a
contract is a current liability.

Ex. 18-124—Journal entries—percentage-of-completion.

Dixon Construction Company was awarded a contract to construct an interchange at the junction of U.S.
94 and Highway 30 at a total contract price of $10,000,000. The estimated total costs to complete the
project were $7,500,000.

Instructions

(a) Make the entry to record construction costs of $4,500,000, on construction in process to date.

(b) Make the entry to record progress billings of $2,500,000.

(c) Make the entry to recognize the profit that can be recognized to date, on a percentage-of-
completion basis.

Solution 18-124
(a) Construction in Process........................................................................... 4,500,000

Materials, Cash, Payables........................................................... 4,500,000

(b) Accounts Receivable............................................................................... 2,500,000

Billings on Construction in Process............................................. 2,500,000

(c) Construction Expenses............................................................................ 4,500,000

Construction in Process (60% complete)................................................. 1,500,000

Revenue from Long-Term Contracts.......................................... 6,000,000

Ex. 18-125—Percentage-of-completion method.

Dalton Construction Co. contracted to build a bridge for $10,000,000. Construction began in 2012 and
was completed in 2013. Data relating to the construction are:

2012 2013
Costs incurred $3,300,000 $2,750

Estimated costs to complete 2,700,000 —

Dalton uses the percentage-of-completion method.

Instructions

(a) How much revenue should be reported for 2012? Show your computation.

(b) Make the entry to record progress billings of $3,300,000 during 2012.

(c) Make the entry to record the revenue and gross profit for 2012.

(d) How much gross profit should be reported for 2013? Show your computation.

Solution 18-125
(a) $3,300,000

————— × $10,000,000 = $5,500,000

$6,000,000

(b) Accounts Receivable............................................................................... 3,300,000

Billings on Construction in Process ............................................ 3,300,000

(c) Construction Expenses............................................................................ 3,300,000

Construction in Process........................................................................... 2,200,000

Revenue from Long-Term Contracts.......................................... 5,500,000

Solution 18-125 (cont.)
(d) Revenue $10,000,000

Costs 6,050,000

Total gross profit 3,950,000

Recognized in 2012 (2,200,000)

Recognized in 2013 $ 1,750,000

Or

Total revenue $10,000,000

Recognized in 2012 (5,500,000)

Recognized in 2013 4,500,000

Costs in 2013 (2,750,000)

Gross profit in 2013 $ 1,750,000

Ex. 18-126—Percentage-of-completion method.

Penner Builders contracted to build a high-rise for $21,000,000. Construction began in 2012 and is
expected to be completed in 2015. Data for 2012 and 2013 are:

2012 2013
Costs incurred to date $2,700,000 $7,800,000

Estimated costs to complete 10,800,000 7,200,000

Penner uses the percentage-of-completion method.

Instructions
(a) How much gross profit should be reported for 2012? Show your computation.

(b) How much gross profit should be reported for 2013?

(c) Make the journal entry to record the revenue and gross profit for 2013.

Solution 18-126
(a) $2,700,000
 ————— × $7,500,000 = $1,500,000

$13,500,000

(b) $7,800,000

—————— × $6,000,000 = $3,120,000

$15,000,000

Less 2012 gross profit 1,500,000

Gross profit in 2013 $1,620,000

(c) Construction in Process........................................................................... 1,620,000

Construction Expenses............................................................................ 5,100,000

Revenue from Long-Term Contracts.......................................... 6,720,000

Ex. 18-127—Percentage-of-completion and completed-contract methods.
On February 1, 2012, Marsh Contractors agreed to construct a building at a contract price of $5,400,000.
Marsh estimated total construction costs would be $4,000,000 and the project would be finished in
2014. Information relating to the costs and billings for this contract is as follows:

2012 2013 2014

Total costs incurred to date $1,500,000 $2,640,000 $4,600,000

Estimated costs to complete 2,500,000 1,760,000 -0-

Customer billings to date 2,200,000 4,000,000 5,600,000

Collections to date 2,000,000 3,500,000 5,500,000

Instructions

Fill in the correct amounts on the following schedule. For percentage-of-completion accounting and for
completed-contract accounting, show the gross profit that should be recorded for 2012, 2013, and 2014.

Percentage-of-Completion Completed-Contract

Gross Profit Gross Profit

2012 _____________ 2012 _____________

2013 _____________ 2013 _____________

2014 _____________ 2014 _____________

Solution 18-127
Percentage-of-Completion Completed-Contract

Gross Profit Gross Profit

2012 $525,000a 2012 —

2013 $ 75,000b 2013 —

2014 $440,000c 2014 $800,000d

a
$1,500,000

————— × $1,400,000 = $525,000

$4,000,000

b
$2,640,000

————— × $1,000,000 = $600,000

$4,400,000

Less 2012 gross profit (525,000)

2013 gross profit $75,000

c
Total revenue $5,400,000

Total costs 4,600,000

Total gross profit 800,000

Recognized to date (600,000)

2014 gross profit $ 200,000

d
Total revenue $5,400,000

Total costs 4,600,000

Total gross profit $800,000

Ex. 18-128—Installment sales.

Newton Co. had installment sales of $1,000,000 and cost of installment sales of $650,000 in 2012. A
2012 sale resulted in a default in 2014, at which time the balance of the installment receivable was
$40,000. The repossessed merchandise had a fair value of $21,000.

Instructions

(a) Calculate the rate of gross profit on 2012 installment sales.

(b) Make the entry to record the repossession.

Solution 18-128
(a) $350,000 ÷ $1,000,000 = 35%
(b) Repossessed Merchandise........................................................................ 21,000

Deferred Gross Profit, 2012 (.35 × $40,000)............................................. 14,000

Loss on Repossession................................................................................ 5,000

Installment Accounts Receivable, 2012 ........................................... 40,000

Ex. 18-129—Installment sales.

Sawyer Furniture Company concluded its first year of operations in which it made sales of $900,000, all
on installment. Collections during the year from down payments and installments totaled $300,000.
Purchases for the year totaled $620,000; the cost of merchandise on hand at the end of the year was
$80,000.

Instructions

Using the installment-sales method, make summary entries to record:

(a) the installment sales and cash collections;

(b) the cost of installment sales;

(c) the unrealized gross profit;

(d) the realized gross profit.

Solution 18-129
(a) Installment Accounts Receivable............................................................ 900,000

Installment Sales........................................................................ 900,000

Cash........................................................................................................ 300,000

Installment Accounts Receivable............................................... 300,000

(b) Cost of Installment Sales ($620,000 – $80,000)...................................... 540,000

Inventory.................................................................................... 540,000
(c) Installment Sales..................................................................................... 900,000

Cost of Installment Sales............................................................ 540,000

Deferred Gross Profit (40%)....................................................... 360,000

(d) Deferred Gross Profit (40% × $300,000)................................................. 120,000

Realized Gross Profit ................................................................. 120,000

Ex. 18-130—Installment sales.
Finley Company sells office equipment. On January 1, 2013, Finley entered into an installment sale
contract with Miller Company for a six-year period expiring January 1, 2019. Equal annual payments
under the installment sale are $894,000 and are due on January 1. The first payment was made on
January 1, 2013.

Additional information is as follows:

The cash selling price of the equipment, i.e., the amount that would be realized on an outright
sale, is $4,584,000.

The cost of sales relating to the equipment is $3,438,000.

The finance charges relating to the installment period are $780,000 based on a stated interest
rate of 7% which is appropriate. For tax purposes, Finley appropriately uses the accrual basis for
recording finance charges.

Circumstances are such that the collection of the installment sale is reasonably assured.

The installment sale qualified for the installment method of reporting for tax purposes.

Assume that the income tax rate is 30%.

Instructions

What income (loss) before income taxes should Finley appropriately record as a result of this transaction
for the year ended December 31, 2013? Show supporting computations in good form.

Solution 18-130
(Note: For financial accounting purposes, the installment-sales method is not used, and the full gross
profit is recognized in the year of sale, because collection of the receivable is reasonably assured.)

Finley Company

Computation of Income Before Income Taxes

On Installment Sale Contract

For the Year Ended December 31, 2013

Sales $4,584,000

Cost of Sales 3,438,000

Gross Profit 1,146,000

Interest Revenue (Schedule I) 343,800

Income before Income Taxes $802,200

Schedule I

Computation of Interest Revenue on

Installment Sale Contract

Cash selling price (sales) $4,584,000

Payment made on January 1, 2013 894,000

Balance outstanding at 12/31/13 3,690,000

Interest rate 7%

Interest Revenue $ 258,300

*Ex. 18-131—Franchises.
Pasta Inn charges an initial fee of $900,000 for a franchise, with $180,000 paid when the agreement is
signed and the balance in four annual payments. The present value of the annual payments, discounted
at 10%, is $570,600. The franchisee has the right to purchase $60,000 of kitchen equipment and supplies
for $50,000. An additional part of the initial fee is for advertising to be provided by Pasta Inn during the
next five years. The value of the advertising is $1,000 a month. Collectibility of the payments is
reasonably assured and Pasta Inn has performed all the initial services required by the contract.

Instructions

Prepare the entry to record the initial franchise fee. Show supporting computations in good form.

*Solution 18-131
Total fee $900,000

Discount $ 720,000

(570,600) (149,400)

Bargain purchase (10,000)

Advertising ($1,000 × 60) (60,000)

$680,600

Cash..................................................................................................... 180,000

Notes Receivable................................................................................. 720,000

Discount on Notes Receivable ................................................ 149,400

Revenue from Franchise Fees ................................................ 680,600

Unearned Franchise Fees ....................................................... 70,000