(Observing the effects of different revenue-recognition methods on financial ratios, LO 2, 3, 5,6) Kinkora Manufacturing Ltd. (Kinkora) is a newly formed company specializing in the production of a new type of pizza oven. Lisa Volente organized Kinkora on the understanding that it would receive a large contract for pizza ovens from her previous employer, Cascumpec Inc. (Cascumpec), which was planning to renovate its chain of pizza restaurants. Cascumpec is one of the largest pizza restaurant chains in central Canada. Kinkora has rented the space and equipment it needs to operate its business. During Kinkora’s first year of operations, the following transactions and economic events took place:

1. July 3, 2006: Lisa Volente contributes $100,000 cash in exchange for 100,000 common shares in Kinkora.

ii. July 5, 2006: Kinkora borrows $200,000 from Cascumpec. The loan carries an interest rate of 10% per year. No interest or principal must be paid until 2009.
iii. July 8, 2006: Kinkora rents space and equipment to operate the business. Rent of $100,000 for two years is paid.
iv. July 10, 2006: Kinkora signs the contract with Cascumpec. The contract requires that Kinkora manufacture and deliver $2,000,000 in pizza ovens over the period August 1, 2006 to June 30, 2008. The contract requires that Cascumpec pay within 90 days of delivery by Kinkora. The selling price of the pizza ovens is specified in the contract. Kinkora begins production of the pizza ovens immediately.
v. During fiscal 2007 Kinkora produced and delivered pizza ovens, and collected cash in the following amounts:

vi. All costs incurred to produce the ovens were purchased on credit. Of the $325,000 incurred to produce ovens in fiscal 2007, $290,000 had been paid by June 30, 2007.
vii. During fiscal 2007 Kinkora incurred additional costs of $95,000, all on credit.
As of June 30, 2007, $80,000 of these costs had been paid. Because these costs were not directly used in the production of ovens, Kinkora plans to expense them in full in fiscal 2007. This amount excludes the amount paid for rent and the interest expense.
viii. Kinkora has a June 30 year end.
Required:

a. Use an accounting equation spreadsheet to record the transactions and economic events that occurred in fiscal 2007 for Kinkora. Prepare a separate spreadsheet using the following critical events for recognizing revenue:
i. Production.
ii. Delivery.
iii. Collection of cash.

b. Prepare Kinkora’s income statement for the year ended June 30, 2007 and its balance sheet as of June 30, 2007, using each of the three critical events (production, delivery, and collection of cash). Your income statements should show revenue, cost of goods sold, gross margin, other expenses, and net income.

c. Calculate the gross margin percentage, profit margin percentage, current ratio, and the debt-to-equity ratio for fiscal 2007 for each critical event.

d. Which method of calculating the ratios in

(c) gives the best indication of Kinkora’s performance and liquidity? Explain.

e. Does it matter how Kinkora recognizes revenue? To whom does it matter and why?

f. Is the actual economic performance of Kinkora affected by how it recognizes revenue? Explain.

Transcribed Image Text:

Selling price of ovens produced during 2007 Cost of ovens produced during 2007 $650,000 325,000 Selling price of ovens delivered to Cascumpec during 2007 400,000 Cost of ovens delivered to Cascumpec during 2007 Cash collected from Cascumpec during 2007 Cost of ovens that were paid for by Cascumpec during 2007 200,000 230,000 115,000