Peace Book Distribution Division Our book distribution division sells to nationa

Question

Peace Book Distribution Division Our book distribution division sells to national bookstores. Our division allows for up to 25% of sales in returns. For the past 4 years, returns have averaged 20%. We record revenue based on revenue recognition when the right of return exists. Total Sales for 2012 $ 9,000,000 Sales Still Available for return for six months $ 2,000,000 Actual Returns on Sales not returnable 21% 2011 Sales collected in 2012 $ 2,500,000 2011 Sales returned in 2012 19% Required: (a) We have studied several methods of revenue recognition. Define and describe each of the following methods of revenue recognition, and indicate whether each is in accordance with generally accepted accounting principles. - Point of sale. - Completion-of-production. - Percentage-of-completion. - Installment-sales. (b) Calculate the revenue to be recognized in fiscal year 2012 for each division of Patty Corporation in accordance with generally accepted accounting principles. Show all calculations for full credit.

Explanation / Answer

This exception primarily deals with long-term contracts such as constructions (buildings, stadiums, bridges, highways, etc.), development of aircraft, weapons, and space exploration hardware. Such contracts must allow the builder (seller) to bill the purchaser at various parts of the project (e.g. every 10 miles of road built). The percentage-of-completion method says that if the contract clearly specifies the price and payment options with transfer of ownership, the buyer is expected to pay the whole amount and the seller is expected to complete the project, then revenues, costs, and gross profit can be recognized each period based upon the progress of construction (that is, percentage of completion). For example, if during the year, 25% of the building was completed, the builder can recognize 25% of the expected total profit on the contract. This method is preferred. However, expected loss should be recognized fully and immediately due to conservatism constraint.Apart from accounting requirement, there is a need for calculating the percentage of completion for comparing budgets and actuals to control the cost of long term projects and optimize Material,Man,Machine,Money and time (OPTM4) .The method used for determining revenue of a long term contract can be complex. Usually two methods are employed to calculate the percentage of completion.(i) by calculating the percentage of accumulated cost incurred to the total budgeted cost. (ii) by determining the percentage of deliverable completed as a percentage of total deliverable. Second method is accurate but cumbersome. To achieve this, one needs the help of a software ERP package which integrates Financial, inventory, Human resources and WBS (Work breakdown structure) based planning and scheduling while booking of all cost components should be done with reference to one of the WBS elements.There are only very few contracting ERP software packages which has the complete integrated module to do this. The completed-contract method should be used only if percentage-of-completion is not applicable or the contract involves extremely high risks. Under this method, revenues, costs, and gross profit are recognized only after the project is fully completed. Thus, if a company is working only on one project, its income statement will show $0 revenues and $0 construction-related costs until the final year. However, expected loss should be recognized fully and immediately due to conservatism constraint. [edit]Completion of production basis This method allows recognizing revenues even if no sale was made. This applies to agricultural products and minerals.There is a ready market for these products with reasonably assured prices, the units are interchangeable, and selling and distributing does not involve significant costs. [edit]Revenues recognized after Sale Sometimes, the collection of receivables involves a high level of risk. If there is a high degree of uncertainty regarding collectibility then a company must defer the recognition of revenue. There are three methods which deal with this situation: Installment sales method allows recognizing income after the sale is made, and proportionately to the product of gross profit percentage and cash collected calculated. The unearned income is deferred and then recognized to income when cash is collected.[1] For example, if a company collected 45% of total product price, it can recognize 45% of total profit on that product. Cost recovery method is used when there is an extremely high probability of uncollectable payments. Under this method no profit is recognized until cash collections exceed the seller's cost of the merchandise sold. For example, if a company sold a machine worth $10,000 for $15,000, it can start recording profit only when the buyer pays more than $10,000. In other words, for each dollar collected greater than $10,000 goes towards your anticipated gross profit of $5,000. Deposit method is used when the company receives cash before sufficient transfer of ownership occurs. Revenue is not recognized because the risks and rewards of ownership have not transferred to the buyer

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