Long-term Construction Contracts and Franchising

2nd Flr, GF Partners Bldg, 139 H.V. dela Costa, Salcedo Village, Makati City 3rd Flr. EPCIB Bldg. 2070 Claro M. Recto, Manila

Practical Accounting 2

Prof. Cecilla Mercado

LONG-TERM CONSTRUCTION CONTRACTS and FRANCHISING 1. The percentage-of-completion method of inventory valuation of long-term contract a. recognizes income upon completion of work b. recognizes income based on collection billings c. recognizes income based on the progress of work d. does not recognize income at the balance sheet date 2. In accounting for a long-term construction-type contract using the percentage -ofcompletion method, the gross profit recognized during the first year would be the estimated total gross profit from the contract multiplied by the percentage of the cost incurred during the year to the a. total cost incurred to date b. total estimated cost c. unbilled portion of the contract price d. total contract price 3. The theoretical support for using the percentage-of-completion method of accounting for long- term construction projects is that it a. is conservative b. reports a lower net income c. closely confirms to the cost principle d. produces a realistic matching of expenses with revenues 4. If a company uses the percentage of completion method of accounting for long-term construction contracts, then during the period of construction, financial information related to a long -term contract will a. appear on both the income statement and balance sheet during the construction period b. appear only on the income statement during the period of construction c. appear only on the balance sheet during the period of construction d. not appear on the financial statements 5. What is the basis for determining the gross profit to be recognized in the second year of a three-year contract under the percentage-of-completion method? a. Cumulative actual costs incurred only b. Incremental cost for the second year only c. Cumulative actual costs and estimated costs to complete d. No gross profit would be recognized in year 2 6. When the percentage-of-completion method of accounting for long-term construction projects is used, why is the balance of the Construction in Progress account increased by the annual recognized gross profit on long-term construction contracts? a. The cost of the contract has increased b. The project’s value has increased above cost c. The economy experiences inflation over the construction period d. Construction in Progress is not increased by the annual recognized profit

7. A company uses the percentage-of-completion method to account for a four-year construction contract. Progress billings sent in the second year that were collected in the third year would a. be included in the calculation of the income recognized in the second year b. be included in the calculation of the income recognized in the third year c. be included in the calculation of the income recognized in the fourth year d. not be included in the calculation of the income recognized in any year 8. In accounting for a long-term construction contract for which there is a projected profit, the balance in the Construction in Progress asset account the end of the first year of work using the percentage-of- completion method would be a. Zero b. Equal to the actual cost incurred during the year c. The same as the balance of Progress Billings on Construction Contracts d. Equal to the sum of the actual cost incurred and the recognized gross profit during the year 9. How should the balances of Progress Billings and Construction in Progress be shown at reporting dates prior to the completion of a long-term contract? a. Progress Billings as income, Construction in Progress as inventory b. Net, as income from construction if credit balance, and loss from construction if debit balance c. Progress Billings as deferred income. Construction in Progress as a current asset d. Net, as a current asset if debit balance and current liability if credit balance 10. A construction company uses the percentage-of- completion method of recognizing revenue from construction contracts. Then, revenues that are earned but unbilled at the sheet date should be disclosed a. as a long term receivable in the noncurrent assets section of the balance sheet b. only as a footnote disclosure until the customer is billed for the percentage of work completed c. as a construction in progress in the current assets section of the balance sheet d. as construction in progress in the noncurrent assets section of the balance sheet. AAB Construction company uses the percentage-of-completion method of accounting. In 2003 AAB began work under contract #1348, which provided for a contract price of P20,000,000. Other details follows:

Cost incurred during the year Estimated costs to complete, as of December 31 Billing during the year Collections during the year

2003

2004

P 3,000,000 P12,000,000 3,600,000 2,500,000

P 15, 750,000 -015, 400,000 15, 500,000

11. The portion of the total contract price to be recognized as revenue in 2003 is a. P 3,200,000 c. P2,500,000 b. P3,600,000 d. P4,000,000 BBC Construction Company uses the percentage-of-completion method of accounting for long-term construction contracts. In 2003, BBC started to erect a building for P10,500,000. The construction project was completed in 2004. The following pertinent information were extracted from its accounting records: 2003 Progress billings during the year Cost incurred during the year Collected on billings during the year Estimated cost to complete the project

P3,850,000 3,150,000 2,450,000 6,300,000

2004 P6,650,000 6,300,000 8,050,000 -02

12. How much income should BBC have recognized on this contract for the year ended 2003? a. P350,000 c. P525,000 b. P385,000 d. P700,000 CCD Construction, Inc. has consistently used the percentage-of-completion method of recognizing income. Last year, CCD started work on a P9,000,000 construction contract, which was completed this year. The accounting records disclosed the following data for last year: Progress billings Cost incurred Collections Estimated cost to complete

P3,300,000 2,700,000 2,100,000 5,400,000

13. How much income should CCD have recognized on this contract last year? a. 210,000 c. 600,000 b. 300,000 d. 700,000 DDE Construction, Inc. has consistently used the percentage-of-completion method of recognizing income. During 2003, DDE started work on a P15,000,000 fixed-price construction contract. The accounting records disclosed the following data for the year ended December 31,2003: cost incurred - P4,650,000; estimated cost to complete - P10, 850,000; progress billings - P5,500,000; collections -P3,500,000. 14. How much loss should DDE have recognized in 2003? a. P150,000 c. P500,000 b. P350,000 d.P1,150,000 EEF Construction uses the percentage-of-completion method for long-term construction contracts. A specific job was begun in 2003 and completed in 2005. The contract price was P14,000,000 and cost information as of each year -end is given below: End of year estimated cost to complete Annual cost incurred

2003 P4,000,000 4,000,000

2004 P2,000,000 4,000,000

2005 P1,200,000

15. Assuming EEF correctly recorded gross profit in 2003, how much gross profit should the company record in 2004? a. P -0c. P3,000,000 b. P 200,000 d. P3,200,000 The following data relate to a construction job started by FFG Construction Company during 2003: Total contract price Actual costs incurred during 2003 Estimated remaining costs Billed to customer during 2003 Received from customer during 2004

P3,000,000 600,000 1,200,000 900,000 300,000

16. Under the percentage-of completion method, how much should FFG recognized as gross profit during 2003? a. P -0c. P800,000 b. P400,000 d. P100,000 A building project was awarded to Ready Construction Co. in 2003 based on a fixed price of P12,000,000. It was completed in 2004. Pertinent records show the following; 3

2003 Progress billings during the year Cost incurred during the year Collect ions on billings during the year Estimated cost to complete 17. The gross profit percentage for the project was a. 12% b. 10%

2004

P4,400,000 3,600,000 2,800,000 7,200,000

P7,600,000 7,200,000 9,200,000 -

c. 87% d. 40%

HHI Builders is in business of contracting the construction of apartment buildings. Two buildings were in progress at the beginning of 2003. The status of these buildings at the beginning of the year as follows:

Contract Apartment- Cubao Apartment- Marikina

Contract Price P16,000,000 25,200,000

Estimated Cost complete 1/1/03

Cost incurred to 1/1/03 P 6,000,000 P 15,600,000

P8,400,000 6,900,000

During 2003, the following cost were incurred: • Apartment - Cubao P6,000,000 (estimated cost to complete as of 12/31/03, P2,400,000) • Apartment - Marikina P7,500,000 (job Completed) 18. How much is the gross profit in 2003 if HHI uses the percentage -of - completion method a. P 978,000 c. P2,620,000 b. P2,100,000 d. P3,600,000 The JJK Construction Corporation uses the percentage-of-completion method of recognizing income from long-term construction contracts. In 2001 JJK entered into a fizzed- price contract to construct a bridge for P30,000,000. Estimated cost to complete the construction and contract cost incurred up to 2003 were follows: Cumulative Contract costs Incurred As of December 31, 2001 As of December 31, 2002 As of December 31, 2003

P2,000,000 11,000,000 20,000,000

Estimated cost to complete P16,000,000 11,000,000 4,000,000

19. What is the estimated percentage of completion as of Dec. 31 2003? a. 25% c. 50% b. 33.33% d. 83.33% 20. How much income should JJK Construction Corporation recognize on the above contract for the year ended Dec.31 2003? a. 1,000,000 c. 2,700,000 b. 1,666,667 d. 5,000,000 You were engaged to audit the books of accounts of MMN Contractors which had a 3-year construction contract in 2003 for P9,000,000. MMN uses the percentage-of completion method for financial statement purposes. Income to be recognized each year is based on the ratio of cost incurred to total estimated cost to complete the contract.

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Data on this contract follows: Accounts receivable - construction contracts billings Construction in progress P937,500 Less: Accounts billed 843,750 10% retention Net income recognized in 2003 (before tax)

P300,000 93,750 150,000

MMN contractors maintains a separate bank account for each construction contract. Bank deposits to this contract amounted to P500,000. 21. How much cash collected on the contract was not yet deposited at December 31, 2003? a. P 43,750 c. P193,750 b. P1,137,500 d. P287,500 22. What was the estimated total income before tax on this contract? a. P450,000 c. P1,440,000 b. P840,000 d. P 287,000 On September 14, 2003, NNO Contractors, Inc. won the bid for the construction of a 1,000 room hotel for Hoteliers, Inc. on the reclamation area for P1.2 billion. On the terms of payment, parties agreed on the following: One percent (1%) mobilization fee (deductible from the final bill) payable within fifteen days after the signing of the contract; • Retention of 10% on all billings, payable with the final bill after the acceptance of entire completed project; and • Progress billings on construction within seven days from date of acceptance. •

By the end of 2003 , the company has presented one progress billing for 10% completion which Hoteliers Inc. evaluated and accepted on December 28 for payment in January. The company used the percentage of completion method of accounting. 23. In the year 2003 NNO Contractors Inc. received a fee of a. P9.8 million c. P12.0 million b. P10.8 million d. P1.2 million In 2003, QQR Construction Co. was contracted to do private road network of Housing Corp. for P100 million. The project was estimated to be completed in two years. The contract includes the following provisions: • Five percent (5%) mobilization fee(to be deducted from the last billing) payable within fifteen days after the signing of the contract; • Retention provision of 10% on all billings; • Progress billings on construction are payable within seven days from date of acceptance QQR estimated its gross margin on the project at 25% and used the percentage of completion method of accounting. By the end of the year, QQR presented progress billings corresponding to 50% completion. Housing Corp. accepted the bills presented except the last one for 10% which was accepted on January 10. With the exception of the last billing of 8% accepted in 2003 which was due on January 3, 2004, all accepted billings were settled in 2003. 23. The realized gross profit in 2003 is a. P10.0 million b. P12.5million

c. P25.0 million d. P 7.5 million

Golly-Bee was Inc. enters into an agreement with Donald, giving the latter full authority to operate as its franchisee over a 10- year period. An initial franchise fee of P2,750,000 was stipulated in the contract and was promptly paid by Donald during the year.

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24. Assuming Golly-Bee was able to perform the initial services during the year, what is the franchise revenue to be recognized by Golly-Bee in its year-end income statement? a. P -0b. P2,750,000

c. P137,500 d. P275,000

On January 1, 2003. RRS Nuts Corporation received from Rio Legaspi the sum of P550,000 representing franchise fee Franchise services were immediately rendered by RRS and was completed on March 31, 2003 at a cost of P330,000. 25. The franchise fee revenue to be reported by RRS in its March 31, 2003 income statement is a. P550,000 c. P137,500 b. P220,000 d. P -0SST’s Lechon Inc., franchisors, entered into a franchise agreement with Kris Sison, franchisee, on September 30, 2003. The total franchise fee is P500,000 of which P100,000 is payable upon signing and the balance in four equal annual installments. The down payment is refundable in the event franchisor fails to render services and none thus far had been rendered. 26. When SST prepares its financial statements on September 30, 2003, the franchise revenue to be reported is a. P100,000 c. P400,000 b. P -0d. P500,000 UUV Crabs, Inc., entered into a franchise agreement with Liwayway Ligaya, franchisee, on July 1, 2001. The total franchise fees agreed upon is P1,100,000 of which P100,000 is payable upon signing and the balance payable in four equal annual installments. It was agreed that the down payment is nonrefundable, not withstanding lack of substantial performance of service by franchisor. 26. When UUV prepares its financial statements on July 31, 2001, the unearned franchise fees to be reported is a. P -0c. P1,000,000 b. P100,000 d. P1,100,000 On June 1, 2003, VVW Eggs Corporation, franchisor, received P200,000 from Danny Domimgo representing down payment on the franchise agreement signed that day. Domingo gave VVW a non-interest bearing promissory note for the balance of P1,000,000 payable in four equal semi-annual installments. Franchise services was substantially completed by VVW on November 15 at a cost of P900,000. On December 1, 2001, the first semi- annual installment became due and was accordingly paid by Domingo. VVW appropriately uses the accrual method in recording franchise revenues. 27. In its December 31, 2003 financial statements, how much will VVW report as realized gross profit for the year? a. P112,500 c. P300,000 b. P250,000 d. P187, 500 On January 5, WWX awarded its first outside Metro Manila franchise of Japanese noodle shop to Linlin’s of Cebu. The franchise agreement required a P200,000 franchise fee payable P50,000 upon signing of the franchise and the balance in three annual installments starting the end of the current year. The present value using 12% as discount rate of the three installments would be approximately P82,160. The fees once paid are not refundable. The franchise may be cancelled subject to the provisions of the agreement. Should there be unpaid franchise fee attributed to the balance of main fee (P200,000), same need not be paid. Further, the franchisor is entitled to 3% fee on gross sales payable monthly within the first ten days of the following month. The first year of operations yielded gross sales of P1,000,000. 6

28. WWX earned franchise fees in the first year of the Linlin’s operation of a . P 130,000 c. P100,000 b. P 30,000 d. P230,000 XXY Pizza Shack granted a franchise to Eat N Eat for the Ortigas area. Eat N Eat was to pay franchise fee of P100,000 payable in five equal annual installments starting with the payment upon signing of the agreement . The franchise was to pay monthly 1% of gross sales of the preceding month. Should the operations may be cancelled with whatever obligations owing XXY Pizza Shack in connection with the P100,000 franchise fee waived . The first year generated a gross sales of P500,000. 29. XXY Pizza Shack earned franchise fee for the first year amounted to a. P 5,000 c. P25,000 b. P105,000 d. P20,000 On January 3, 2003, YYZ Services, Inc., signed an agreement authorizing BBA Company to operate as a franchisee over a 20-year period for an initial franchise fee of P1,000,000 received when the agreement was signed. BBA commenced operations on July 1, 2003, at which date all of the initial services required of YYZ had been performed. The agreement also provides that BBA must pay a continuing franchise fee equal to 5% of the revenue from the franchise annually to YYZ. BBA’s franchise revenue for 2003 was P8,000,000. 30. For the year ended December 31, 2003, how much should YYZ record as revenue from the franchise fees in respect of the BBA franchise? a. P 1,400,000 c. P 450,000 b. P 900,000 d. P 425,000 At the beginning of the year, RVM got the franchise of Fredo’s, a known steak house of upscale patronage. The franchise agreement required a P500,000 franchise fee payable P100,000 upon signing of the franchise and the balance in four annual installments starting the end of the current year . At present value using 12% as discount rate, the four installments would approximate P199,650. The fees once paid are not refundable. The franchise may be cancelled subject to the provisions of the agreement. Should there be unpaid franchise fee attributed to the balance of the main fee (P500,000), same would become due and demandable upon cancellation. Further, the franchisor is emitted to a 5% fee on gross sales payable monthly within the first ten days of the following month. The Credit Investigation Bureau rated RVM as AAA credit rating. The balance of the franchise fee was guaranteed by a commercial bank the first year of operations yielded gross sales of P9 million. 31. Fredo’s earned franchise fee from RVM for the first year of operations amounted to a. P550,000 c. P749,650 b. P650,000 d. P950,000

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