Chapter 5

Income Measurement and Profitability Analysis

EXERCISES
Requirement 1
Year Income recognized
2011 $250,000 ($400,000 - 150,000)
2012 0
2013 0
2014 0
2015 0
Total
$250,000

Exercise 5-1

Requirement 2
Year
2011
2012
2013
2014
2015
Totals

Cash Collected
$100,000
75,000
75,000
75,000
75,000
$400,000

Cost Recovery(37.5%)
$ 37,500
28,125
28,125
28,125
28,125
$150,000

Gross Profit(62.5%)
$ 62,500
46,875
46,875
46,875
46,875
$250,000

Cost Recovery
$100,000
50,000
-0-0-0$150,000

Gross Profit
-0$ 25,000
75,000
75,000
75,000
$250,000

Requirement 3
Year
2011
2012
2013
2014
2015
Totals

Cash Collected
$100,000
75,000
75,000
75,000
75,000
$400,000
Requirement 1

Exercise 5-2

Contract price
Actual costs to date
Estimated costs to complete
Alternate Exercise and Problem Solutions

$2,600,000
360,000
1,560,000

2011
2012
$2,600,000
2,010,000
-0 The McGraw-Hill Companies, Inc., 2011
5-1

Total estimated costs

Estimated (actual) gross profit

1,920,000
$ 680,000

2,010,000
$ 590,000

Gross profit recognition:

2011: $ 360,000
= 18.75% x $680,000 = $127,500
$1,920,000
2012:

$590,000 - 127,500 = $462,500

Requirement 2
2011
2012

$
-0$590,000

Requirement 3
Balance Sheet
At December 31, 2011
Current assets:
Accounts receivable
Costs and profit ($487,500)* in excess
of billings ($430,000)

$ 110,000
57,500

* Costs ($360,000) + profit ($127,500)

The McGraw-Hill Companies, Inc., 2011

5-2

Intermediate Accounting, 6/e

Exercise 5-2 (concluded)

Requirement 4
Balance Sheet
At December 31, 2011
Current assets:
Accounts receivable

$ 110,000

Current liabilities:
Billings ($430,000) in excess of costs ($360,000)

$ 70,000

Requirement 1

Exercise 5-3

Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)

$12,000,000
3,000,000
6,000,000
9,000,000
$ 3,000,000

2011
$12,000,000
7,000,000
5,600,000
12,600,000
$ (600,000)

2012 2013
$12,000,000
12,800,000
-012,800,000
$ (800,000)

Gross profit (loss) recognition:

2011: $3,000,000
= 33.3333% x $3,000,000 = $1,000,000
$9,000,000
2012: $(600,000) - 1,000,000

= $(1,600,000)

2013: $(800,000) - (600,000) = $(200,000)

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011

5-3

Exercise 5-3 (continued)

Requirement 2
Construction in progress
Various accounts
To record construction costs.

2011
2012
3,000,000
4,000,000
3,000,000
4,000,000

Accounts receivable
Billings on construction contract
To record progress billings.

3,800,000
3,500,000
3,800,000
3,500,000

Cash
Accounts receivable
To record cash collections.

3,250,000
3,600,000
3,250,000
3,600,000

Construction in progress
(gross profit)

Cost of construction
Revenue from long-term contracts

1,000,000
3,000,000
4,000,000

(33.3333% x $12,000,000)

To record gross profit.

Cost of construction (2)
Revenue from long-term contracts
Construction in progress (loss)
To record expected loss.

(1)

4,266,667
2,666,667
1,600,000

(1) and (2):

Percent complete = $7,000,000 $12,600,000 = 55.55%
Revenue recognized to date:
55.55% x $12,000,000 =
$6,666,667
Less: Revenue recognized in 2011 (above)
(4,000,000)
Revenue recognized in 2012
2,666,667 (1)
Plus: Loss recognized in 2012 (above)
1,600,000
Cost of construction, 2012
$4,266,667 (2)

The McGraw-Hill Companies, Inc., 2011

5-4

Intermediate Accounting, 6/e

Exercise 5-3 (concluded)

Requirement 3
Balance Sheet

2011

Current assets:
Accounts receivable
Costs and profit ($4,000,000)* in
excess of billings ($3,800,000)

2012

$550,000 $450,000
200,000

Current liabilities:
Billings ($7,300,000) in excess
of costs less loss ($6,400,000)

$900,000

* Costs ($3,000,000) + profit ($1,000,000)

Exercise 5-4

November 15, 2011 To record franchise agreement

and down payment
Cash (50% x $25,000)....................................................
12,500
Note receivable........................................................... 12,500
Unearned franchise fee revenue.....
25,000

February 15, 2012 To recognize franchise fee revenue

Unearned franchise fee revenue................................. 25,000
.................................................Franchise fee revenue
.........................................................................25,000

Exercise 5-5

Turnover ratios for Garret & Sons Music Company for 2011:

Inventory turnover ratio

Receivables turnover ratio
Average collection period
Asset turnover ratio

2 and Problem Solutions

Alternate Exercise

=
=
=
=
=
=
=

$6,000,000
$10,000,000
[$850,000
+ 700,000] 2
[$800,000 +365
600,000] 2
$10,000,000
7.74
14.29
times
[$4,490,000
14.29+ times
4,100,000]
The McGraw-Hill Companies, Inc., 2011
25.5 days
5-5
2.33 times

The company turns its inventory over 7 times per year compared to the industry
average of 6 times per year. The asset turnover ratio also is slightly better than the
industry average (2.33 times per year versus 2 times). These ratios indicate that
Garret & Sons is able to generate more sales per dollar invested in inventory and in
total assets than the industry averages. The company also is able to collect its
receivables quicker than the industry average (25.5 days compared to the industry
average of 28 days).
Requirement 1
a. Profit margin on sales $360 $7,200 = 5%
b. Return on assets
$360 [($2,900 + 2,700) 2] = 12.86%
c. Return on shareholders equity
$360 [($1,700 + 1,550) 2] = 22.2%

Exercise 5-6

Requirement 2
a. Profit margin on sales
$360 $7,200 = 5%
b. Asset turnover
$7200 [($2,900 + 2,700) 2] = 2.57
c. Equity multiplier
[($2,900 + 2,700) 2] [($1,700 + 1,550) 2] = 1.72
d. Return on shareholders equity
$360 [($1,700 + 1,550) 2] = 22.2%
5% x 2.57 x 1.72 = 22.1%
Requirement 3
Retained earnings beginning of period
Add: Net income
Less: Retained earnings end of period
Dividends paid

The McGraw-Hill Companies, Inc., 2011

5-6

$550,000
360,000
910,000
700,000
$210,000

Intermediate Accounting, 6/e

PROBLEMS
Requirement 1

Problem 5-1Total profit = $800,000 - 400,000 = $400,000

Installment sales method: Gross profit % = $400,000 $800,000 = 50%
10/31/11 10/31/12 10/31/13 10/31/14
Cash collections

$200,000 $200,000 $200,000 $200,000

a. Point of delivery method

$400,000

-0-

-0-

-0-

b. Installment sales method

(50% x cash collected)

c. Cost recovery method

Alternate Exercise and Problem Solutions

$100,000 $100,000 $100,000 $100,000

-0-

- 0 - $200,000 $200,000

The McGraw-Hill Companies, Inc., 2011

5-7

Problem 5-1 (continued)

Requirement 2

Installment receivable
Sales revenue
Cost of goods sold
Inventory
To record sale on 10/31/11.

Point of
Delivery
800,000
800,000
400,000
400,000

Installment receivable
Inventory
Deferred gross profit
To record sale on 10/31/12.
Cash
Installment receivable
Entry made each Oct. 31.
Deferred gross profit
Realized gross profit
To record gross profit.
Entry made each Oct. 31.
Deferred gross profit
Realized gross profit
To record gross profit.
Entry made 10/31/13 &
10/31/14.

The McGraw-Hill Companies, Inc., 2011

5-8

Installment
Sales

800,000

Cost Recovery

800,000
400,000
400,000

200,000

200,000
200,000

400,000
400,000
200,000

200,000

200,000

100,000
100,000

200,000
200,000

Intermediate Accounting, 6/e

Problem 5-1 (concluded)

Requirement 3
Point of
Delivery

Installment
Sales

Cost
Recovery

December 31, 2011

Assets
Installment receivables
Less: Deferred gross profit
Installment receivables, net

600,000

600,000
(300,000)
300,000

600,000
(400,000)
200,000

December 31, 2012

Assets
Installment receivable
Less: Deferred gross profit
Installment receivables, net

400,000

400,000
(200,000)
200,000

400,000
(400,000)
-0-

Problem 5-2Requirement 1
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)

2011
$15,000,000
4,000,000
8,000,000
12,000,000
$ 3,000,000

2012
$15,000,000
8,800,000
4,000,000
12,800,000
$ 2,200,000

2013
$15,000,000
13,000,000
-013,000,000
$ 2,000,000

Gross profit (loss) recognition:

2011: $4,000,000
= 33.33% x $3,000,000 = $1,000,000
$12,000,000
2012: $8,800,000
= 68.75% x $2,200,000 = $1,512,500 - 1,000,000 = $512,500
$12,800,000
2013: $2,000,000 - 1,512,500 = $487,500
Requirement 2
2011
Alternate Exercise and Problem Solutions

2012

2013

The McGraw-Hill Companies, Inc., 2011

5-9

Construction in progress
Various accounts
To record construction costs.

4,000,000
4,800,000
4,200,000
4,000,000
4,800,000
4,200,000

Accounts receivable
Billings on construction contract
To record progress billings.

3,500,000
5,000,000
6,500,000
3,500,000
5,000,000
6,500,000

Cash
Accounts receivable
To record cash collections.

2,800,000
5,600,000
6,600,000
2,800,000
5,600,000
6,600,000

Construction in progress (gross profit) 1,000,000

512,500
487,500
Cost of construction (cost incurred)
4,000,000
4,800,000
4,200,000
Revenue from long-term contracts (1)
5,000,000
5,312,500
4,687,500
To record gross profit.

The McGraw-Hill Companies, Inc., 2011

5-10

Intermediate Accounting, 6/e

Problem 5-2 (continued)

(1) Revenue recognized:
2011: 33.33% x $15,000,000 =
2012: 68.75% x $15,000,000 =
Less: Revenue recognized in 2011
Revenue recognized in 2012
2013: 100% x $15,000,000 =
Less: Revenue recognized in 2011 & 2012
Revenue recognized in 2013

$5,000,000
$10,312,500
(5,000,000)
$5,312,500
$15,000,000
(10,312,500)
$4,687,500

Requirement 3
Balance Sheet
Current assets:
Accounts receivable
Construction in progress
Less: Billings
Costs and profit in excess
of billings

2011

2012

$ 700,000
$5,000,000
(3,500,000)

$100,000
$10,312,500
(8,500,000)

1,500,000

1,812,500

Requirement 4
Costs incurred during the year
Estimated costs to complete
as of year-end
Contract price
Actual costs to date
Estimated costs to complete
Total estimated costs
Estimated gross profit (loss)

Alternate Exercise and Problem Solutions

2011
$4,000,000

2012
$4,200,000

8,000,000

7,100,000

2011
$15,000,000
4,000,000
8,000,000
12,000,000
$ 3,000,000

2012
$15,000,000
8,200,000
7,100,000
15,300,000
$ (300,000)

2013
$7,200,000
2013
$15,000,000
15,400,000
-015,400,000
$ (400,000)

The McGraw-Hill Companies, Inc., 2011

5-11

Problem 5-2 (concluded)

Gross profit (loss) recognition:
2011: $4,000,000
= 33.33% x $3,000,000 = $1,000,000
$12,000,000
2012: 100% x $(300,000) = $(300,000) - 1,000,000 = $(1,300,000)
2013:

$(400,000) (300,000) = $(100,000)

The McGraw-Hill Companies, Inc., 2011

5-12

Intermediate Accounting, 6/e