Explain the reporting for (a) costs to fulfill a contract and (b) collectibility.
(a) Companies divide fulfillment costs (contract acquisition costs) into two categories: (1) those that result in an asset (2) those that are expensed as they are incurred.
(b) Collectibility: The risk that a customer will be unable to pay the agreed-upon amount of consideration is referred to as collectibility.
Collectibility relates to a client's credit risk or the possibility that the customer may be unable to pay the agreed-upon amount of consideration. The revenue amount is not adjusted for customer credit risk under the revenue guideline as long as a contract exists (it is likely that the customer will pay).
Companies categorize fulfillment expenses (contract acquisition costs) into two groups: those that result in an asset and those that are expensed as they are spent.
If the extra expenditures are incurred to acquire a contract with a client, the charges are recognized as an asset. In other words, incremental costs are expenses that a firm would not have incurred if the contract had not been awarded (for example, selling commissions).
Other examples include:
(a) direct labor, direct materials, and cost allocation for contract-related expenditures (such as contract management and supervision costs, insurance, and depreciation of tools and equipment).
(b) Costs that produce or increase the company's resources that will be used to meet future performance requirements. Intangible design and engineering costs that will continue to benefit the company in the future are included in the costs. Businesses capitalize direct, incremental, and recoverable expenses (assuming that the contract period is for more than a year).
A collectibility problem arises whenever a business sells a product or provides a service on credit. Collectibility refers to the risk that a client will be unable to pay the agreed-upon amount of consideration. The amount recorded as revenue is not adjusted for client credit risk under revenue guidance as long as a contract exists (it is likely that the customer will pay). As a result, organizations report gross revenue(without taking into account credit risk) and then show an allowance for any impairment due to bad debts recognized initially and later in line with the specific bad debt advice). An impairment attributable to bad loans is presented as an operating expenditure in the income statement. A corporation will be compensated for fulfilling a performance obligation that has no impact on revenue recognition.
(Existence of a Contract) On May 1, 2017, Richardson Inc. entered into a contract to deliver one of its specialty mowers to Kickapoo Landscaping Co. The contract requires Kickapoo to pay the contract price of $900 in advance on May 15, 2017. Kickapoo pays Richardson on May 15, 2017, and Richardson delivers the mower (with cost of $575) on May 31, 2017.
(a) Prepare the journal entry on May 1, 2017, for Richardson.
(b) Prepare the journal entry on May 15, 2017, for Richardson.
(c) Prepare the journal entry on May 31, 2017, for Richardson.
(Recognition of Profit on Long-Term Contracts) During 2017, Nilsen Company started a construction job with a contract price of $1,600,000. The job was completed in 2019. The following information is available.
2017 2018 2019
Costs incurred to date $400,000 $825,000 $1,070,000
Estimated costs to complete 600,000 275,000 –0–
Billings to date 300,000 900,000 1,600,000
Collections to date 270,000 810,000 1,425,000
(a) Compute the amount of gross profit to be recognized each year, assuming the percentage-of-completion method is used.
(b) Prepare all necessary journal entries for 2018.
(c) Compute the amount of gross profit to be recognized each year, assuming the completed-contract method is used.
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