Question

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Question 1

On October 1, 2018, the Marshall Company sold a large piece of machinery to the Hammond Construction Company for $80,000. The cost of the machine was $40,000. Hammond made a down payment of $10,000 and agreed to pay the remaining balance in seven equal monthly installments of $10,000, plus interest at 12% on the unpaid balance, beginning November 1.

Required:

1. Identify three alternative methods for recognizing revenue and costs for the situation described and compute the amount of gross profit that would be recognized in 2018 using each method.
2. Discuss the circumstances under which each of the three methods would be used.

Question 2

Harvey Alexander, an all-league professional football player, has just declared free agency. Two teams, the San Francisco 49ers and the Dallas Cowboys, have made Harvey the following offers to obtain his services:

49ers:	$1 million signing bonus payable immediately and an annual salary of $1.5 million for the five-year term of the contract.
Cowboys:	$2.5 million signing bonus payable immediately and an annual salary of $1 million for the five-year term of the contract.

With both contracts, the annual salary will be paid in one lump sum at the end of the football season.

Required:

You have been hired as a consultant to Harvey’s agent, Phil Marks, to evaluate the two contracts. Write a short letter to Phil with your recommendation including the method you used to reach your conclusion. Assume that Harvey has no preference between the two teams and that the decision will be based entirely on monetary considerations. Also assume that Harvey can invest his money and earn an 8% annual return.

Answer 1

Question 1:

1:-

The three methods that could be used to recognize revenue and costs for this situation are (1) point of delivery, (2) the installment sales method, and (3) the cost recovery method.

2018 gross profit under the three methods:

(1) Point of delivery:

  $80,000 – 40,000 = $40,000

(2) Installment sales method:

  $40,000

      = 50% = gross profit %

  $80,000

  50% x $30,000 (cash collected) = $15,000

(3) Cost recovery method:

No gross profit recognized since cost ($40,000) exceeds cash collected ($30,000).

2:-

Customers sometimes are allowed to pay for purchases in installments over long periods of time. Uncertainty about collection of a receivable normally increases with the length of time allowed for payment. In most situations, the increased uncertainty concerning the collection of cash from installment sales can be accommodated satisfactorily by estimating uncollectible amounts. In these situations, point of delivery revenue recognition should be used.

If, however, the installment sale creates a situation where there is significant uncertainty concerning cash collection making it impossible to make an accurate assessment of future bad debts, revenue and cost recognition should be delayed. The installment sales method and the cost recovery method are available to handle such situations. These methods should be used only in situations involving exceptional uncertainty. The cost recovery method is the more conservative of the two.

Question 2:

Suggested Grading Concepts and Grading Scheme:

Content (65%)

_______     25     Explanation of the method used (present value) to compare the two contracts.

_______     30     Presentation of the calculations.

                            49ers PV = $6,989,065

                            Cowboys PV = $6,492,710

_______     10     Correct conclusion.

               ______

_______     65 points    

Writing (35%)

_______     5       Proper letter format.

_______     6      Terminology and tone appropriate to the audience of a player's agent.

_______     12     Organization permits ease of understanding.

                                         Introduction that states purpose.

                                         Paragraphs that separate main points.

_______     12     English

                                         Sentences grammatically clear and well organized, concise.

                                         Word selection.

                                         Spelling.

                                         Grammar and punctuation.

                _____

_______     35 points