Question

A manufacturer of large equipment sells on an installment basis to customers with questionable credit ratings. Which of the following methods of revenue recognition is least likely to overstate the amount of gross profit reported?

Select one:
A. at the time of completion of the equipment (completion of the production method)
B. at the date of delivery (sales method)
C. the installment-sales method
D. the cost-recovery method

Answer 1

The cost-recovery method is the least likely to overstate gross profit when selling to customers with questionable credit ratings, as it defers profit recognition until cash payments exceed the costs of goods sold.

Step-by-step explanation:

In determining which method of revenue recognition is least likely to overstate the amount of gross profit reported, we evaluate four different methods. Among these, the cost-recovery method is least likely to overstate gross profit when selling to customers with questionable credit ratings. This method defers all profit recognition until the cash payments received from the customer exceed the costs of the goods sold, which means it recognizes profits conservatively and only after the recovery of the cost is reasonably assured. On the contrary, the completion of the production method would recognize revenue when the production is complete, and the sales method would recognize revenue at the date of delivery, both of which may lead to the potential for overstating profits if the collectibility of sales is uncertain. The installment-sales method recognizes profit in proportion to cash collected, which is more conservative than the first two methods but less conservative than the cost-recovery method.