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Chapter 18: Q.18-10_2 (page 1045)

Question: P18-10 (LO5,6,7) (Long-Term Contract with Interim Loss) On March 1, 2017, Pechstein Construction Company contracted to construct a factory building for Fabrik Manufacturing Inc. for a total contract price of \(8,400,000. The building was completed by October 31, 2019. The annual contract costs incurred, estimated costs to complete the contract, and accumulated billings to Fabrik for 2017, 2018, and 2019 are given below.

2017

2018

2019

Contract cost incurred during the year

\)2,880,000

\(2,230,000

\)2,190,000

Estimated cost to complete the contract at 12/31

3,520,000

2,190,000

0

Billings to Fabrik during the year

3,200,000

3,500,000

1,700,000


Instructions

Using the completed-contract method, prepare schedules to compute the profit or loss to be recognized as a result of this contract for the years ended December 31, 2017, 2018, and 2019. (Ignore incomes taxes.)

Short Answer

Expert verified

Answer

The business entity will recognize$1,100,000 in gross profit in 2019.

Step by step solution

01

Definition of Contract Price

Contract price can be defined as the sum agreed upon a contract payable on completion or execution of the contract. In other words, it can be said as the consideration paid against the contract.

02

Gross profit under the complete contract method

Particular

Amount $

Contract price

$8,400,000

Less: Cost incurred

(7,300,000)

Gross profit

$1,100,000

No gross profit will be recognized for 2017 and 2018 because the contract gets completed in 2019.

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Most popular questions from this chapter

Archer Construction Company began work on a \(420,000 construction contract in 2017. During 2017, Archer incurred costs of \)278,000, billed its customer for \(215,000, and collected \)175,000. At December 31, 2017, the estimated additional costs to complete the project total $162,000. Prepare Archer鈥檚 journal entry to record profit or loss, if any, using (a) the percentage-of-completion method and (b) the completed-contract method.

Ismail Construction enters into a contract to design and build a hospital. Ismail is responsible for the overall management of the project and identifies various goods and services to be provided, including engineering, site clearance, foundation, procurement, construction of the structure, piping and wiring, installation of equipment, and finishing. Does Ismail have a single performance obligation to the customer in this revenue arrangement? Explain.

What are the two types of losses that can become evident in accounting for long-term contracts? What is the nature of each type of loss? How is each type accounted for?

(Allocate Transaction Price, Modification of Contract) Refer to the Tablet Bundle A revenue arrangement in P18-1. In response to competitive pressure for Internet access for Tablet Bundle A, after 2 years of the 3-year contract, Tablet Tailors offers a modified contract and extension incentive. The extended contract services are similar to those provided in the first 2 years of the contract. Signing the extension and paying $90 (which equals the standalone selling of the revised Internet service package) extends access for 2 more years of Internet connection. Forty Tablet Bundle A customers sign up for this offer.

Instructions

(a) Prepare the journal entries when the contract is signed on January 2, 2019, for the 40 extended contracts. Assume the modification does not result in a separate performance obligation.

Question: P18-12 (LO8) (Franchise Revenue) Amigos Burrito Inc. sells franchises to independent operators throughout the northwestern part of the United States. The contract with the franchisee includes the following provisions.

1. The franchisee is charged an initial fee of \(120,000. Of this amount, \)20,000 is payable when the agreement is signed, and a \(100,000 zero-interest-bearing note is payable with a \)20,000 payment at the end of each of the 5 subsequent years. The present value of an ordinary annuity of five annual receipts of \(20,000, each discounted at 10%, is \)75,816.

2. All of the initial franchise fee collected by Amigos is to be refunded and the remaining obligation cancelled if, for any reason, the franchisee fails to open his or her franchise.

3. In return for the initial franchise fee, Amigos agrees to (a) assist the franchisee in selecting the location for the business, (b) negotiate the lease for the land, (c) obtain financing and assist with building design, (d) supervise construction, (e) establish accounting and tax records, and (f) provide expert advice over a 5-year period relating to such matters as employee and management training, quality control, and promotion. This continuing involvement by Amigos helps maintain the brand value of the franchise.

4. In addition to the initial franchise fee, the franchisee is required to pay to Amigos a monthly fee of 2% of sales for menu planning, recipe innovations, and the privilege of purchasing ingredients from Amigos at or below prevailing market prices. Management of Amigos Burrito estimates that the value of the services rendered to the franchisee at the time the contract is signed amounts to at least \(20,000. All franchisees to date have opened their locations at the scheduled time, and none have defaulted on any of the notes receivable. The credit ratings of all franchisees would entitle them to borrow at the current interest rate of 10%.

Instructions

(b) Prepare the journal entries for the initial and continuing franchise fees, assuming:

(1) Franchise agreement is signed on January 5, 2017.

(2) Amigos completes franchise startup tasks and the franchise opens on July 1, 2017.

(3) The franchisee records \)260,000 in sales in the first 6 months of operations and remits the monthly franchise fee on December 31, 2017.

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