Chapter 18, Problem 60P

Ostrich Company makes gasoline storage tanks. Everything produced is under contract (that is, the company does not produce any tanks until it gets a contract for a product). Ostrich makes three basic models. However, the tanks must be adapted to each individual customer’s location and needs (e.g., the location of the valves and the quality of the materials and insulation). Discuss the following issues relative to Ostrich’s operations.

1. a. An examining IRS agent contends that each of the company’s contracts is to produce a “unique product.” What difference does it make whether the product is unique or a “shelf item”?
2. b. Producing one of the tanks takes over one year from start to completion, and the total cost is in excess of $1 million. What costs must be capitalized for this contract that are not subject to capitalization for a contract with a shorter duration and lower cost?
3. c. What must Ostrich do with the costs of bidding on contracts?
4. d. Ostrich frequently makes several cost estimates for a contract, using various estimates of materials costs. These costs fluctuate almost daily. Assuming that Ostrich must use the percentage of completion method to report the income from the contract, what will be the consequence if the company uses the highest estimate of a contract’s cost and the actual cost is closer to the lowest estimated cost?