LEEDS SCHOOL OF BUSINESS
MBAC 6020: AS&S
Work problem 7-50 in the text, but make the following changes tothe problem:
The text part of the problem (the first paragraph) remains as is, but replace parts a and b with the following:
a. Assume Appliance Sales and Service (AS&S) records the sale in July 2008 normally under the belief that it will receive all future cash payments from the customer; also assume that AS&S prepares monthly financial statements. What will appear in the annual income statement for sales revenue and cost of goods sold expense for the year ended June, 30 2009.
Sales revenue / $2,440 / (244 * 10 payments)Cost of goods sold / ( 2,220) / (must be 91% * 2,440)
Gross profit / $ 220 / (2,440 * 9% - given in the problem)
b. Assume the customer makes all 10 payments and that AS&S issues monthly financial statements. What would appear in the July, 2008 – April, 2009 income statements for sales revenue and cost of goods sold expense if AS&S used each of these methods.
(1) installment method: uses the “cash basis” to determine revenue and then uses the matching principle to “match” cost of goods sold with revenue based on the percents in part a, above:
Month: / July / Aug. / Sept. / Oct. / Nov. / Dec. / Jan. / Feb. / Mar. / Apr.S.Rev / 244 / 244 / 244 / 244 / 244 / 244 / 244 / 244 / 244 / 244
COGS x / (222) / (222) / (222) / (222) / (222) / (222) / (222) / (222) / (222) / (222)
G.P. / 22 / 22 / 22 / 22 / 22 / 22 / 22 / 22 / 22 / 22
(2) cost recovery method: uses the “cash basis” to determine revenue then says the company should not recognize any gross profit until the company has received more cash than the product cost:
Month: / July / Aug. / Sept. / Oct. / Nov. / Dec. / Jan. / Feb. / Mar. / Apr.S.Rev / 244 / 244 / 244 / 244 / 244 / 244 / 244 / 244 / 244 / 244
COGS x / (244) / (244) / (244) / (244) / (244) / (244) / (244) / (244) / (244) / ( 24)
G.P. / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 220
The argument for the installment and cost recovery method is that the normal accrual basis (in part a) recognizes a profit when the product is sold, but if the company really doesn’t collect all the cash from the sale (and is unable to estimate the amount of money it may not collect) the company has recognized profit that really doesn’t exist, so in that case the methods in part b are more appropriate, as we can see in part c, below.
c. Assume the customer stops making payments after making the November 2008 payment and that AS&S issues monthly financial statements. In December 2008, AS&S repossesses all three appliances and estimates that it could sell the repossessed appliances for $980. What would appear in the July, 2008 – December 2008 income statements for sales revenue, cost of goods sold expense, and loss on repossession if AS&S used each of these methods.
(2) cost recovery method (I’m going to show this method first)
Month: / July / Aug. / Sept. / Oct. / Nov. / Dec. / Jan. / Feb. / Mar. / Apr.S.Rev / 244 / 244 / 244 / 244 / 244
COSG x / (244) / (244) / (244) / (244) / (244)
G.P. / 0 / 0 / 0 / 0 / 0
Loss on repossession / $(20)
The version of the modification I emailed the class didn’t ask for “loss on repossession” but in December AS&S repossessed the merchandise that originally cost $2,220; the company has received $1,220 ($244 * 5 months) from the customer, in a sense recovering $1,220 of the cost of the appliances, which means they haven’t recovered the other $1,000 ($2,220 - $1220). Since the repossessed appliances are worth $980, the company would report a loss on repossession of the difference: $20.
Another way of looking at this is to say the customer gave AS&S two assets:
$1,220 in cash
+ 980 in repossessed appliances
Total $2,200, but the company gave the customer appliances costing $2,220, the difference is a loss to AS&S.
As you can see that the cost recovery method says that the company really didn’t have a profit on the transactions – they really had a loss, which is what is reported on the income statement.
(1) installment sales method:
Month: / July / Aug. / Sept. / Oct. / Nov. / Dec. / Jan. / Feb. / Mar. / Apr.S.Rev / 244 / 244 / 244 / 244 / 244
COSG x / (222) / (222) / (222) / (222) / (222)
G.P. / 22 / 22 / 22 / 22 / 22
Loss on repossession / $(130)
Building on the cost recovery method, the company really has a $20 loss on these transactions, BUT, since the installment sales method reported gross profits of $110 ($22 * 5 months) in July - November, AS&S would have to report a repossession loss of $130 ($20 of real loss plus $110 to “negate” the profits it reported that turned out to not exist).