Diversified Products, Inc. operates in several lines of business, including the construction and real estate industries. While the majority of its revenues are recognized at point of sale, Diversified appropriately recognizes revenue on long-term construction contracts using the percentage-of-completion method. It recognizes sales of some properties using the installment-sales approach. Income data for 2014 from operations other than construction and real estate are as follows.

Revenues             $9,500,000
Expenses               7,750,000

  1. Diversified started a construction project during 2013. The total contract price is $1,000,000, and $200,000 in costs were incurred in both 2013 and 2014. In 2013, Diversified recognized $50,000 gross profit on the project. Estimated costs to complete the project in 2015 were $400,000.
  2. During 2014, Diversified sold real-estate parcels at a price of $630,000. Gross profit at a 25% rate is recognized when cash is received. Diversified collected $500,000 during the year on these sales.

Accounting
Determine Diversified Products’ 2014 net income. (Ignore taxes.)

Analysis
Determine free cash flow (see Chapter 5) for Diversified Products for 2014. In 2014, Diversified had depreciation expense of $175,000 and a net increase in working capital (changes in accounts receivable and accounts payable) of $250,000. In 2014, capital expenditures were $500,000; Diversified paid dividends of $120,000.

Principles
“Application of the percentage-of-completion and installment-sales method revenue recognition approaches illustrates the trade-off between relevance and faithful representation of accounting information.” Explain.