Reference no: EM131119333

Joan Locker and Bill Dasher organized the Arizona Land Development Company (ALDC) on January 2, Year 1. They contributed land with a market value of $300,000 and $100,000 cash for all of the common stock of the corporation. The land served as the initial inventory of property sold to customers.

Required

a. For each of the four income recognition methods illustrated in Exhibits 8.12-8.23, show the supporting calculations for each of the following items for Year 2:

(1) Sales for Year 2

(2) Cost of goods sold for Year 2

(3) Gross profit for Year 2

(4) Notes Receivable on December 31, Year 2, under the first three income recognition methods and the contracts in process account on December 31, Year 2, under the fourth income recognition method

(5) Estimated development costs liability on December 31, Year 2, under the first three income recognition methods and the progress billings account on December 31, Year 2, under the fourth income recognition method.

b. Evaluate each of the four income recognition methods described in the case relative to the criteria for revenue and expense recognition. Which method best portrays the operating performance and financial position of ALDC?

c. Which income recognition method is ALDC likely to prefer when reporting to shareholders?

d. Why did ALDC choose the installment method for tax reporting?

e. With respect to maximizing cumulative reported earnings, the four income recognition methods rank-order as follows:

1. Income Recognition at Time of Sale-No Discounting of Cash Flows

2. Income Recognition at Time of Sale-With Discounting of Cash Flows

3. Income Recognition Using the Percentage-of-Completion Method

4. Income Recognition Using the Installment Method-With Discounting of Cash Flows What is the reason behind this rank ordering?

f. The difference in cumulative reported earnings between any two income recognition methods equals the difference in notes receivable or contracts in process (net) minus the difference in the estimated development cost liability minus the difference in the deferred income taxes liability. What is the rationale behind this relation?

g. Why is the amount shown on the income statement for "current" income taxes the same in each year for all four income recognition methods but the amount of total income tax expenses (current plus deferred) in each year is different across income recognition methods?

h. Given that net income each year differs across the four income recognition methods, why is the amount of cash provided by operations the same? Under what conditions would a firm report different amounts of cash flow from operations for different income recognition methods?