Intermediate Accounting
9th Edition
ISBN: 9781259722660
Author: J. David Spiceland, Mark W. Nelson, Wayne M Thomas
Publisher: McGraw-Hill Education
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Chapter 5, Problem 5.17P
Installment sales and cost recovery methods
Mulcahey Builders (MB) remodels office buildings in low-income urban areas that are undergoing economic revitalization. MB typically accepts a 25% down payment when they complete a job and a note that requires that the remainder be paid in three equal installments over the next three years, plus interest. Because of the inherent uncertainty associated with receiving these payments, MB has historically used the cost recovery method to recognize revenue.
As of January 1, 2018, MB’s outstanding gross installment
1. $400,000 due from the Bluebird Motel. MB completed the Bluebird job in 2016, and estimated gross profit on that job is 25%.
2. $150,000 due from the PitStop Gas and MiniMart. MB completed the PitStop job in 2015, and estimated gross profit on that job is 35%.
Dan Mulcahey has been considering switching from the cost recovery method to the installment sales method, because he wants to show the highest possible gross profit in 2018 and he understands that the installment sales method recognizes gross profit sooner than does the cost recovery method.
Required:
1. Calculate how much gross profit is expected to be earned on these jobs in 2018 under the cost recovery method, and how much would be earned if MB instead used the installment sales method. Ignore interest.
2. If Dan is primarily concerned about 2018, do you think he would be happy with a switch to the installment sales method? Explain.
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Differential Analysis Involving Opportunity Costs
On July 1, Campus Stores Inc. is considering leasing a building and purchasing the necessary equipment to operate a retail store. Alternatively, the company could use the funds to invest in $1,500,000 of 2% U.S. Treasury bonds that mature in 15 years. The bonds could be purchased at face value. The following data have been assembled:
Line Item Description
Amount
Cost of store equipment
$1,500,000
Life of store equipment
15 years
Estimated residual value of store equipment
$75,000
Yearly costs to operate the store, excludingdepreciation of store equipment
$320,000
Yearly expected revenues—years 1-6
$400,000
Yearly expected revenues—years 7-15
$600,000
Required:
Question Content Area
1. Prepare a differential analysis as of July 1 presenting the proposed operation of the store for the 15 years (Alternative 1) as compared with investing in U.S. Treasury bonds (Alternative 2). If an amount is zero, enter "0". If…
Chapter 5 Solutions
Intermediate Accounting
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