CHAPTER 5 Revenue Recognition and Profitability Analysis 313 Q 5–32 Distinguish between the installment sales method and the cost recovery method of accounting for installment sales. Q 5–33 How does a company report deferred gross profit resulting from the use of the installment sales method in its balance sheet? Q 5–34 When percentage-of-completion accounting is not appropriate, U.S. GAAP requires the use of the completed contract method, while IFRS requires the use of the cost recovery method. Explain how the two methods affect recognition of revenue, cost of construction, and gross profit over the life of a profitable contract. Q 5–35 Briefly describe the guidelines for recognizing revenue from the sale of software and other multiple-deliverable arrangements. Q 5–36 Briefly describe how IFRS guidelines for recognizing revenue from multiple-deliverable arrangements differ from U.S. GAAP guidelines. Q 5–37 Briefly describe the guidelines provided by GAAP for the recognition of revenue by a franchisor for an initial franchise fee. IFRS IFRS Brief Exercises On July 1, 2016, 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 2017. Apache has no significant obligations to perform services after the sale. How much gross profit will Apache recognize in both 2016 and 2017 applying the installment sales method? Refer to the situation described in BE 5–35. What should be the balance in the deferred gross profit account at the end of 2017 applying the installment sales method? Refer to the situation described in BE 5–35. How much gross profit will Apache recognize in both 2016 and 2017 applying the cost recovery method? 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. The building was completed during the second year. Construction costs incurred during the second year were $10 million. 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? 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 online 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? Refer to the situation described in BE 5–39. How would your answer change if Orange reported under IFRS? 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 5–35 Installment sales method BE 5–36 Installment sales method BE 5–37 Cost recovery method BE 5–38 IFRS; long-term contracts; cost recovery method IFRS BE 5–39 Revenue recognition; software contracts BE 5–40 Revenue recognition; software contracts under IFRS IFRS BE 5–41 Revenue recognition; franchise sales
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