Revenue Recognition

[diselsamm]

Hi,

I am struggling with the following question regarding revenue recognition:

An airplane manufacturing company routinely builds fighter jets for the U.S. armed forces. It takes fourteen months to build one jet, and the government pays for them in installments over the fourteen-month period. Which revenue recognition method should be used?

A)

Installment sales method.

B)

Completed contract method.

C)

Percentage-of-completion method.

The answer mentioned as correct is C. The percentage-of-completion method is appropriate in this case because payment is assured when dealing with the U.S. government, and cost and price estimates are assumed reliable due to the ongoing and routine nature of the contract.

But why not A? As indivuals, we are not as reliable?

[pdub]

i would imagine here that the most important clue in this one is not that its the US Government as much as the “routinely builds for X”. i havent looked back on this section for a few weeks, but if you look up what is required for percentage-of-completion then i think that will answer the question. I think because its routine we can assume costs are known…so if we know costs and its someone that we routinely build for, we can probably assume payments are reliable…and if we know those 2 things then we can use POC…i think…

[pdub]

@BlueCollarHero

abomnia, your explanation of installment sales is actually the cost recovery method, where you don’t recognize any profit until the cost of your widget had been recovered. In the installment sales method, if you profit is 1%, for every $100 in installments you receive, you book $1 of profit. Hope that helps. Installment sales is not much different than the percentage of completion method conceptually. In % of completion, you can book the profit once the cost has been incurred even though you have not received payment. In installment sales, you have to have sold the product and must wait for the payments to book profit.

i got that from another post…so percentage of completion = construction project…installment sale = magazine subscription…sold a completed good and collecting payments later

[waiguy]

in installment method usually - the delivery of the good has already taken place and the customer pays the supplier according to a contracted installment schedule. Its a kind of mortgage. In this case delivery happens only at the 14th month, and the customer owes no more money after delivery of the plane. Clearly not an installment sale in normal business parlance as well. I agree with the other comments above as well.

[extreme227]

The installment sales method is used only when collection is uncertain. In this case, since it is the US Government that will pay, there is a high certainty that they can make payment. As such, this method won’t be used.

[diselsamm]

Thank you. It makes sense now.