CA2-6 (Revenue and Expense Recognition Principles) On June 5, 2011, Argot Corporation signed a contract with Lopez Associates under which Lopez agreed
(1) to construct an office building on land owned by Argot,
(2) to accept responsibility for procuring financing for the project and finding tenants, and
(3) to manage the property for 35 years. The annual net income from the project, after debt service, was to be divided equally between Argot Corporation and Lopez Associates. Lopez was to accept its share of future net income as full payment for its services in construction, obtaining finances and tenants, and management of the project. By May 31, 2012, the project was nearly completed, and tenants had signed leases to occupy 90% of the available space at annual rentals totaling $4,000,000. It is estimated that, after operating expenses and debt service, the annual net income will amount to $1,500,000. The management of Lopez Associates believed that
(a) the economic benefit derived from the contract with Argot should be reflected on its financial statements for the fiscal year ended May 31, 2012, and directed that revenue be accrued in an amount equal to the commercial value of the services Lopez had rendered during the year,
(b) this amount should be carried in contracts receivable, and
(c) all related expenditures should be charged against the revenue.
(a) Explain the main difference between the economic concept of business income as reflected by Lopez’s management and the measurement of income under generally accepted accounting principles.
(b) Discuss the factors to be considered in determining when revenue should be recognized for the purpose of accounting measurement of periodic income.
(c) Is the belief of Lopez’s management in accordance with generally accepted accounting principles for the measurement of revenue and expense for the year ended May 31, 2012? Support your opinion by discussing the application to this case of the factors to be considered for asset measurement and revenue and expense recognition. (AICPA adapted).