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CHAPTER 5 Revenue Recognition and Profitability Analysis 319 b. Installment sales method. c. Cost recovery method. 2. Prepare journal entries for each of the five years applying the three revenue recognition methods listed in requirement 1. Ignore interest charges. 3. Prepare a partial balance sheet as of the end of 2016 and 2017 listing the items related to the installment sale applying each of the three methods listed in requirement 1. 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: 1. $400,000 due from the Bluebird Motel. MB completed the Bluebird job in 2014, and estimated gross profit on that job is 25%. 2. $150,000 due from the PitStop Gas and MiniMart. MB completed the PitStop job in 2013, and estimated gross profit on that job is 35%. 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: 1. 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. 2. If Dan is primarily concerned about 2016, do you think he would be happy with a switch to the installment sales method? Explain. This is a variation of Problem 5–10 modified to focus on IFRS. Required: Complete the requirements of Problem 5–10 assuming that Westgate Construction reports under IFRS and concludes that the percentage-of-completion method is not appropriate. Olive Branch Restaurant Corporation sells franchises throughout the western states. On January 30, 2016, the company entered into the following franchise agreement with Jim and Tammy Masters: 1. The initial franchise fee is $1.2 million. $200,000 is payable immediately and the remainder is due in ten, $100,000 installments plus 10% interest on the unpaid balance each January 30, beginning January 30, 2017. The 10% interest rate is an appropriate market rate. 2. In addition to allowing the franchisee to use the franchise name for the 10-year term of the agreement, in exchange for the initial fee Olive Branch agrees to assist the franchisee in selecting a location, obtaining financing, designing and constructing the restaurant building, and training employees. 3. All of the initial down payment of $200,000 is to be refunded by Olive Branch and the remaining obligation canceled if, for any reason, the franchisee fails to open the franchise. 4. In addition to the initial franchise fee, the franchisee is required to pay a monthly fee of 3% of franchise sales for advertising, promotion, menu planning, and other continuing services to be provided by Olive Branch over the life of the agreement. This fee is payable on the 10th of the following month. Substantial performance of the initial services provided by Olive Branch, which are significant, is deemed to have occurred when the franchise opened on September 1, 2016. Franchise sales for the month of September 2016 were $40,000. Required: 1. Assuming that collectibility of the installment receivable is reasonably certain, prepare the necessary journal entries for Olive Branch on the following dates (ignore interest charges on the installment receivable and the costs of providing franchise services): a. January 30, 2016 b. September 1, 2016 c. September 30, 2016 d. January 30, 2017 P 5–21 Installment sales and cost recovery methods ✮ P 5–22 Construction accounting under IFRS IFRS P 5–23 Franchise sales; installment sales method ✮


Spiceland_Inter_Accounting8e_Ch05
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