Question

Lake Power Sports sells jet skis and other powered recreational equipment. Customers pay one-third of the sales price of a jet ski when they initially purchase the ski, and then pay another one-third each year for the next two years. Because Lake has little information about the ability to collect these receivables, it uses the cost recovery method to recognize revenue on these installment sales. In 2017, Lake began operations and sold jet skis with a total price of $1,200,000 that cost Lake $600,000. Lake collected $400,000 in 2017, $400,000 in 2018, and $400,000 in 2019 associated with those sales. In 2018, Lake sold jet skis with a total price of $1,590,000 that cost Lake $954,000. Lake collected $530,000 in 2018, $375,000 in 2019, and $375,000 in 2020 associated with those sales. In 2020, Lake also repossessed $310,000 of jet skis that were sold in 2018. Those jet skis had a fair value of $116,250 at the time they were repossessed.

In 2017, Lake would recognize realized gross profit of:

Multiple Choice

$400,000.

Incorrect

$200,000.

$0.

$600,000.

Answer 1

Cost Recovery method of Revenue recognition:

Cost recovery method of revenue recognition is opted when the company is uncertain about the receipt of amount from the credit sales. Under this method profit is not recognized unless the company recovers atleast cost of goods sold from the customer.

Answer: In 2017, Lake would recognize realized gross profit of

Cash collected = $ 400000

Sales revenue = $ 1200000

Cost of goods sold = $ 600000

Deffered Gross Profit = $ 600000 (1200000-600000)

Gross Profit to be recognized = $ 0 (since cash collected is less the cost incurred, no profit is recognized)

Lake would recognize realized gross profit of $0.