Required: For each of the scenarios, determine whether the seller should recogni

Question

Required: For each of the scenarios, determine whether the seller should recognize revenue (a) over time or (b) when the product or service is completed. Explain the your answer using GAAP revenue recognition rules and how each would appear on the income statement and balance sheet.

Consider each of the following scenarios separately:

Scenario 1: Your construction company entered into a contract with Starwood Hotel to build a highly sophisticated, customized conference room to be completed for a fixed price of $400,000. Nonrefundable progress payments are made on a monthly basis for work completed during the month. Legal title to the conference room equipment is held by your company until the end of the construction project, but if the contract is terminated before the conference room is finished, Starwood retains the partially completed job and must pay for any work completed to date.

Scenario 2:Your Company entered into a contract with Starwood Hotel for constructing and installing a standard designed gym for a fixed price of $400,000. Nonrefundable progress payments are made on a monthly basis for work completed during the month. Legal title to the gym passes to Starwood upon completion of the building process. If Starwood cancels the contract before the gym construction is completed, your company removes all the installed equipment and Starwood must compensate your company for any loss of profit on sale of the gym to another customer.

Scenario 3: On January 1, your consulting firm, entered into a three-month contract with Bad Food Restaurant to analyze its cost structure in order to find a way to reduce operating costs and increase profits. Your company promises to share findings with the restaurant every two weeks and to provide the restaurant with a final analytical report at the end of the contract. This service is customized to Bad Food, and your company would need to start from scratch if it provided a similar service to another client. Bad Food promises to pay $5,000 per month. If Bad Food chooses to terminate the contract, it is entitled to receive a report detailing analyses to that stage.

Scenario 4: Your Company is developing luxury residential real estate and begins to market individual apartments during their construction. Your Company entered into a contract with Smith for the sale of a specific apartment. Smith pays a deposit that is refundable only if the your company fails to deliver the completed apartment in accordance with the contract. The remainder of the purchase price is paid on completion of the contract when Smith obtains possession of the apartment.

Explanation / Answer

Scenario Ans Explanation 1 Over time, % completion Method Though the legal title remains with the contractor, terms of the contract are such that the risk is transferred to contractee and also the product under consideration is highly customized. 2 when the product or service is completed, Completed Service Contract Method In this case Contractor deals with a standard product which have a ready market further guaranteed by the contractee for any loss of profit. 3 Over time, % completion Method Product under consideration is highly customized and risk and rewards are transferred over the period of contract as evident from the term stipulating" the contractee entitled to the report completed up to a particular stage. 4 when the product or service is completed, Completed Service Contract Method Risk and Rewards get transferred only on sale of apartments and also the company is in to the business of developing and selling the apartments.

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