NAMA : ESTER SABATINI

NRP : 8312419007

A real estate developer sells land parcels to its customers and provides them with financing. In
2000, the first year of operation, the firm signed new land sale contracts for $25,000,000. This land
had originally been acquired for $20,000,000, implying a gross margin of 20 percent. Customer
receipts for the year were $8,000,000 for deposits on property sold and $1,000,000 in principal
repayments under financing agreements with customers. What are the financial statement effects
of this transaction if (a) revenue is recognized at sale, and (b) revenue is recognized when cash is
received? What forecasts, if any, do you have to make to complete the recording of this
transaction? What factors would determine which of these two approaches is appropriate? As a
financial analyst, what questions would you raise with the firm’s

ANSWER :

A. Under sales type lease, a sales is recognized as the present value of the minimum lease payments
or the fair value. The Cost of Goods Sold equal to the book value of the leased asset would be
recognized. Since revenue, lease receivable which is an asset will also be recognized. The
inventory as well would decrease.

B. Under Operating lease, you would only record the depreciation of the asset and recognize the
income as earned. If not yet received, then a receivable would be recognized.

C. The classification would be important to forecast with since the treatment of operating and
finance would be different. It is important to analyse the nature of the contract so that proper
accounting treatment can be done.

D. It depends. If risks and rewards of the asset has been passed to the lessee then the lessor would
consider it as a finance lease. Indicators were 1. Bargain purchase option 2. Ownership will be
passed at the end of the period, 3. Lease term is more than 75% of the useful life 4. Minimum lease
payments is more than 90% of Fair Value. If it doesn't meet any, then the lessor would consider it
an operating lease.

E. The CFO must know the effects of both to the financial statements. It is important to know these
so that they can see whose more advantageous than the other.
A real estate developer sells land parcels to its customers and provides them with financing. In
2000, the first year of operation, the firm signed new land sale contracts for $25,000,000. This land
had originally been acquired for $20,000,000, implying a gross margin of 20 percent. Customer
receipts for the year were $8,000,000 for deposits on property sold and $1,000,000 in principal
repayments under financing agreements with customers. What are the financial statement effects
of this transaction if (a) revenue is recognized at sale, and (b) revenue is recognized when cash is
received? What forecasts, if any, do you have to make to complete the recording of this
transaction? What factors would determine which of these two approaches is appropriate? As a
financial analyst, what questions would you raise with the firm's CFO?

Answer :

Consequently, the point of sale is the point of income recognition. At this point, the significant
risks and rewards of ownership of the goods are transferred to the buyer. The whole $25,000,000
is recognized in the year of sale, the sale account in the income statement will obviously grow big
and will generate a huge amount of net income. The customer gave an $8,000,000 deposit which
shall be recognized as an income in that particular year and the remaining balance shall be paid
with the amount of $1,000,000 each year or when the cash from the customer is received. For me,
the best option in recording this transaction is to recognize income in installment or when the cash
is received. Because when the company prepares the financial statement and computed their tax,
the company will pay smaller amount of tax and the reason is the income that they are receiving
is small due to the installment method used. Unlike in recognizing it in point of sale where the
company will pay higher tax because of a large tax base. With the use of installment method, the
company will have a big tax savings.