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    1. Identify the primary criteria for revenuerecognition.

    2. Apply the revenue recognition concepts

    underlying the examples used in SAB 101.3. Record journal entries for long-term

    construction-type contracts using

    percentage-of-completion and completed-contract methods.

    Learning Objectives

    Continued

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    3

    4.Record journal entries for long-term service

    contracts using the proportional

    performance method.

    5.Explain when revenue is recognized after

    delivery of goods or services through

    installment sales, cost recovery, and cash

    methods.

    Learning Objectives

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    5

    Both of these criteria

    generally are met at the

    point of sale.

    Revenue recognition mostoften occurs when goods

    are delivered or when

    services are rendered.

    Revenue Recognition

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    6

    Revenue Recognition

    Criterion Associated With Revenue

    Recognition

    Criterion 1: The customer has providedpayment or a valid promise

    of payment.

    Criterion 2: The company has provideda product or service.

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    Revenue Recognition

    Before the point of Sale

    EXCEPTION:

    Revenue can be recognized

    prior to the point of sale i f:Customer provides a valid

    promise of payment ANDCriterion 1

    Criterion 2 conditions exist thatcontractually guarantee

    subsequent sale.

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    Revenue Recognition

    Point of Sale

    NORMALLY:

    Revenue is generally

    recognized at this point oftime.

    Criterion 1 is typically

    satisfied at this point.Criterion 1

    Criterion 2 Critical 2 is typically

    satisfied at this point.

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    Revenue Recognition

    After the Point of Sale

    EXCEPTION:

    The recognition of revenue

    must be deferred i f:

    Customer does not provide

    a valid promise at time of

    receipt of product or service

    OR

    Criterion 1

    Criterion 2 significant effort remains on

    the contract.

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    A product or service was provided withoutreceiving a valid promise of payment from

    customer. The company has not provided the product

    or service.

    Revenue Recognition

    Generally, revenue is not recognized prior tothe point of sale because either:

    An exception occurs when the customer provides

    a valid promise of payment and conditions exist

    that contractually guarantee the sale.

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    11

    Revenue Recognition

    AICPA Statement of Position 97-2givescompanies more guidance through a checklist

    of four factors that amplify the two criteria:

    a. Persuasive evidence of an arrangementexists.

    b. Delivery has occurred.

    c. The vendors fee is fixed or determinable.

    d. Collectibility is probable.

    Earned

    Realised

    P i E id f

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    12Persuasive Evidence of anArrangement

    The SEC issued SAB 101

    in response to specific

    abuses involving revenuerecognition.

    P i E id f

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    SAB 101is in a question-

    and-answer format. The

    answers given areinvariably No.

    Persuasive Evidence of anArrangement

    P i E id f

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    14Persuasive Evidence of anArrangement

    Typical questions from SAB 101

    Question 1: Company A requires each sale to

    be supported by a written salesagreement signed by an

    authorized representative of

    both Company A and the

    customer.

    Addresses internal controls.

    Question 1: May Company A recognize

    revenue in the current quarter ifthe product is delivered by the

    end of the quarter but the sales

    agreement is not signed by the

    customer until a few days after

    the end of the quarter?

    ENTER

    P i E id f

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    15Persuasive Evidence of anArrangement

    Typical questions from SAB 101

    Question 2: Company Z delivers product to

    a customer on a consignmentbasis. May Company Z

    recognize revenue upon delivery

    of the product to the customer?

    Addresses the issue of circumventing

    internal controls by side agreements.

    16

    D li h d i

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    16Delivery has occurred or servicehas been rendered

    Typical questions from SAB 101

    Question 3: May Company A recognize

    revenue when it completesproduction of inventory for a

    customer if it segregates that

    inventory from other products in

    its warehouse?

    17

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    17Delivery has occurred or servicehas been rendered

    Typical questions from SAB 101

    Question 4: Company R is a retailer that

    offers layaway sales tocustomers. A customer pays a

    portion of the sales price, and

    Company R sets the

    Focuses on issues centered on the

    bill-and-hold arrangements.

    Question 4: merchandise aside until the

    customer pays the remainder ofthe sales price, and takes

    possession of the merchandise.

    When should Company R

    recognize revenue?

    ENTER

    18

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    18Delivery has occurred or servicehas been rendered

    bill-and-hold arrangements.

    In general, revenue should not be recognised

    in a bill-and-hold arrangement until the sellerhas transferred both legal ownership,

    evidence by the buyer taking title to the

    goods, and economic ownership, meaning

    that the buyer accepts responsibility for thesafeguarding and preservation of the goods.

    19

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    19Delivery has occurred or servicehas been rendered

    Receipt of $100 cash as initial layaway payment:

    Cash 100

    Deposit Received from Customers 100Receipt of f inal $1,400 cash payment and delivery

    of goods to customer:

    Cash 1,400

    Deposit Received from Customers 100

    Sales 1,500

    Cost of Goods Sold 1,000

    Inventory 1,000

    Appropriate Layaway Accounting

    20

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    20Delivery has occurred or servicehas been rendered

    21

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    21Delivery has occurred or servicehas been rendered

    E.g. Seller Company receives $1,000 cash from

    a customer as the initial sign-up fee for a

    service. In addition to the sign-up fee, the

    customer is required to pay $50 per month for

    100 monthswhich is the economic life of this

    service agreement.

    Questions 5 & 6Deal with the seller

    receiving some up-front fee as well as

    subsequent periodic payments

    22

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    22Delivery has occurred or servicehas been rendered

    Receipt of $1,000 cash as initial sign-up fee:Cash 1,000

    Unearned Initial Sign-Up Fees 1,000

    Receipt of f irst monthly payment of $50:

    Cash 50

    Monthly Service Revenue 50

    Partial recogni tion of the ini tial signup fee as

    revenue ($1,000/100 months):Unearned Initial Sign-Up Fees 10

    Initial Sign-Up Fee Revenue 10

    23

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    23Delivery has occurred or servicehas been rendered

    Questions 7 & 9Deal with refundable

    fees. In summary, the non-refundable

    portion of the fees can be recognized on

    a monthly basis if the number ofrefunds can be reliably estimated.

    24

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    Price is fixed or determinable

    Typical questions from SAB 101

    Addresses the difference between estimating

    the future impact of past events and

    estimating the future impact of future events.

    Question 8: Company A owns a building and

    leases it to a retailer. The annuallease payment is $1.2 million plus

    1% of all the retailers sales in

    excess of $25 million.

    Question 8: Should Company A estimate and

    recognize revenue associatedwith the 1% of sales over $25

    million on a straight-line basis

    throughout the year? ENTER

    25

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    Reporting Revenue: Gross vs. Net

    Gross = Sales + commission

    Net = Commission only

    SAB 101 Gross is inapp rop r iate

    un less the seller actual ly took

    legal and econom ic ownersh ip of

    the goods being so ld.

    26Revenue Recognition Prior to

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    26Revenue Recognition PriortoProviding Goods or Services

    Completed-contract methodrecognizes all

    income when project is completed.

    Percentage-of-completion method

    recognizes revenue throughout the term ofthe contract. (construction)

    Proportional performance method

    reflects revenue earned on service contractsunder which many acts of service are to be

    performed before the contract is complete.

    27Revenue Recognition Prior to

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    GAAP requires percentage-of-

    completion method unless

    certain criteria are notmet.

    Revenue Recognition Prior toProviding Goods or Services

    28Percentage of

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    28Percentage-of-Completion Accounting

    Dependable estimates of: contract revenues

    contract costs

    progress toward completion Contract clearly specifies:

    enforceable rights of the parties

    consideration to be exchanged manner and terms of settlement

    Continued

    29Percentage of

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    29Percentage-of-Completion Accounting

    The buyer can be expected to satisfy

    obligations under the contract.

    Contractor can be expected to performthe contractual obligation.

    30Percentage of

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    Recognize revenue throughout life of thecontract.

    Revenue recognized is a function of how

    complete the project is to date. Costs are charged to an inventory account:

    Construction in Process(CI P).

    Profits are charged to CI P.

    CI Pis valued at net realizable value.

    Any anticipated loss is booked for the full

    amount of the loss when it becomes measurable.

    Percentage-of-Completion Accounting

    31Percentage of

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    Input measures: Cost-to-cost methodwhere

    the degree of completion is determined by

    comparing costs already incurred with the

    most recent estimates of total expected coststo complete the project.

    Engineers are often called

    in to help provide estimates.

    Percentage-of-Completion Accounting

    32Accounting for Long Term

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    32Accounting for Long-TermConstruction-Type Contracts

    Strong Construction Company wasawarded a contract with a total price of

    $3,000,000. Strong expected to earn

    $400,000 profit on the contract.

    33Accounting for Long Term

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    33Accounting for Long-TermConstruction-Type Contracts

    ActualCost

    Incurred

    EstimatedCost to

    CompleteYear

    Cost

    Percentage

    Total

    Cost

    2004 $1,040,000 $1,560,000 $2,600,000 40

    2005 910,000

    Total $1,950,000 650,000 2,600,000 75

    2006 650,000 0 2,600,000 100

    Total $2,600,000

    34Percentage of

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    Construction in Progress 1,040,000

    Materials, Cash, etc. 1,040,000

    To record costs incurred.

    Accounts Receivable 1,000,000

    Progress Billings on

    Construction Contracts 1,000,000

    To record billings.Cash 800,000

    Accounts Receivable 800,000

    To record cash collections.

    2004

    Percentage-of-Completion Accounting

    35

    Percentage of

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    Cost of Long-Term Construction

    Contracts 1,040,000

    Construction in Progress 160,000

    Revenue from Construction Contracts 1,200,000

    2004

    Percentage-of-Completion Accounting

    Actual Cost

    $3,000,000 x .40

    36Percentage of

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    Construction in Progress 910,000

    Materials, Cash, etc. 910,000

    To record costs incurred.

    Accounts Receivable 900,000

    Progress Billings on

    Construction Contracts 900,000

    To record billings.Cash 850,000

    Accounts Receivable 850,000

    To record cash collections.

    2005

    Percentage-of-Completion Accounting

    37

    Percentage of

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    Cost of Long-Term Construction

    Contracts 910,000

    Construction in Progress 140,000

    Revenue from Long-Term

    Construction Contracts 1,050,000

    2005

    Percentage-of-Completion Accounting

    ($3,000,000 x .75)

    $1,200,000

    38Percentage of

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    Construction in Progress 650,000

    Materials, Cash, etc. 650,000

    To record costs incurred.

    Accounts Receivable 1,100,000

    Progress Billings on

    Construction Contracts 1,100,000

    To record billings.Cash 1,350,000

    Accounts Receivable 1,350,000

    To record cash collections.

    2006

    Percentage-of-Completion Accounting

    39

    Percentage of

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    Cost of Long-Term Construction

    Contracts 650,000

    Construction in Progress 100,000

    Revenue from Long-Term

    Construction Contracts 750,000

    2006

    $ 3,000,000

    (1,200,000)

    (1,050,000)

    $ 750,000

    Percentage-of-Completion Accounting

    40Percentage of

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    Progress Billings on Construction

    Contracts 3,000,000

    Construction in Progress 3,000,000

    2006

    Percentage-of-Completion Accounting

    Construction in Progress

    1,040,000

    160,000

    910,000140,000

    650,000

    100,000

    3,000,000

    Progress Billings on

    Construction Contracts

    1,000,000

    900,0001,100,000

    3,000,000

    41

    i i f i

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    Revision of Estimates

    Instead of the previous illustration, assumethat at the end of 2005, it was estimated that

    the remaining cost to complete construction

    was $720,000 rather than $650,000.

    42

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    Items in bluechanged from

    the previous illustration.

    Revision of Estimates

    ActualCost

    Incurred

    EstimatedCost to

    CompleteYear

    Cost

    Percentage

    Total

    Cost

    2004 $1,040,000 $1,560,000 $2,600,000 40

    2005 910,000

    Total $1,950,000 720,000 2,670,000 73

    2006 700,000 0 2,650,000 100

    Total $2,650,000

    Note that expected gross profit was $400,000 in 2004,

    $330,000 in 2005, and the actual was $350,000 in 2006.

    43

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    Revision of Estimates

    2004

    The entries for 2004 would

    be the same as those shown

    in the previous example.

    44

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    Revision of Estimates

    2005

    All entries for 2005 would

    be the same except for the

    entry to record revenueand cost.

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    Revision of Estimates

    Construction in Progress 700,000

    Materials, Cash, etc. 700,000

    To record costs incurred.

    Accounts Receivable 1,100,000

    Progress Billings on

    Construction Contracts 1,100,000

    To record billings.Cash 1,350,000

    Accounts Receivable 1,350,000

    To record cash collections.

    2006

    Same

    Same

    47

    R i i f E ti t

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    Revision of Estimates

    Cost of Long-Term Construction

    Contracts 700,000

    Construction in Progress 110,000

    Revenue from Long-Term

    Construction Contracts 810,000

    2006

    $3,000,000(1,200,000)

    (990,000)

    $ 810,000

    48

    R i i f E ti t

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    2006Construction in Progress

    1,040,000

    160,000

    910,00080,000

    700,000

    110,000

    3,000,000

    Progress Billings on

    Construction Contracts

    1,000,000

    900,0001,100,000

    3,000,000

    Revision of Estimates

    Items in redare different for

    this illustration.

    Progress Billings on Construction

    Contracts 3,000,000

    Construction in Progress 3,000,000

    49Anticipated Loss: Percentage-of-

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    Anticipated Loss: Percentage ofCompletion Method

    Assume the same facts for Strong

    Construction Company, except that after

    2004 entries have been made, the firm

    determines that the total cost will be$3,250,000. The entries for 2004 would be

    the same, but the loss must be dealt with in

    2005in addition, the $160,000 gross profitrecognized in 2004 must be eliminated.

    50Anticipated Loss: Percentage-of-

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    Anticipated Loss: Percentage ofCompletion Method

    Cost of Long-Term Construction

    Contracts 910,000

    Revenue from Long-Term

    Construction Contracts 600,000

    Construction in Progress 410,000

    2005

    To go from a $160,000 gross profit to an

    anticipated $250,000 loss ($3,000,000

    $3,250,000), the Construction in Progess

    account needs to be credited $410,000.

    51Accounting for Long-Term

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    Accounting for Long TermService Contracts

    Most service contracts involve threetypes of costs:

    (1) Initial direct costs related to obtaining

    and performing initial services on the

    contract.

    (2) Direct costs related to performing the

    various acts of service.

    (3) Indirect costs related to maintaining

    the organization to service the

    contract.

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    53Accounting for Long-Term

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    Accounting for Long TermService Contracts

    Receipt of fees:Cash 50,000

    Deferred Course Revenue 50,000

    Liability account

    I ni tial direct costs:

    Deferred Initial Costs 5,000Cash 5,000

    Direct costs for lesson actually completed:

    Contract Costs 12,000Cash 12,000

    Expense account

    Asset account

    Continued

    54Accounting for Long-Term

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    Accounting for Long TermService Contracts

    Course revenue recognized:Deferred Course Revenue 20,000

    Recognized Course Revenue 20,000

    Recognize contract costs from initial direct costs:

    Contract Costs 2,000Deferred Initial costs 2,000

    $24,000$60,000 x $50,000

    $24,000

    $60,000x $5,000

    55Revenue Recognition After Delivery

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    Revenue Recognition After Deliveryof Goods or Providing Service

    I nstallment Sales Method:Recognizesrevenues and related expenses as cash isreceived (used when collection issomewhat uncertain). (Not to be confused with

    installment sales, which uti l ize accrual accounting)Cost Recovery Method: No income isrecognized on sale until the cost of theitem sold is recovered through cash

    receipts (used when collection is veryuncertain).Cash Method: Recognizes all expenses

    immediately as incurred and all revenues

    only when cash is collected.

    56Revenue Recognition After Delivery

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    Full Accrual At point of saleRecognized at

    point of sale

    Installment

    Sales

    At collection of cash

    (portion of receipt)

    Defer and matchagainst revenue ascash is collected

    Cost

    Recovery

    At collection of cash

    (after all costs havebeen recovered)

    Defer and match

    against cashreceipts

    Cash At collection of cash Charge to expense

    as incurred

    Method Timing of RevenueRecognition Treatmentof Costs

    Revenue Recognition Deliveryof Goods or Providing Service

    57

    Installment Sales Method

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    Installment Sales Method

    The installment salesmethod is used most

    commonly in cases of

    real estate sales.

    58

    Installment Sales Method

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    Installment Sales Method

    George sells merchandise on

    the installment basis.

    Uncertainty of collectionmakes use of the installment

    method necessary. Use the

    accompanying data to prepareGeorges journal entries.

    59

    Installment Sales Method

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    Sales

    Cost of Sales

    Gross Profit

    Gross ProfitPercentage

    2004 2005

    $150,000 $200,000

    100,000 140,000

    $ 50,000 $ 60,000

    33.33% 30%

    Cash Collection2004 Sales $ 30,000 $ 75,000

    2005 Sales $ 70,000

    Installment Sales Method

    60

    Installment Sales Method

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    Installment Accounts Receivable

    2004 150,000

    Installment Sales 150,000

    Cost of Installment Sales 100,000

    Inventory 100,000

    Cash 30,000

    Installment Accounts

    Receivable2004 30,000

    Installment Sales Method

    2004

    Continued

    61

    Installment Sales Method

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    Installment Sales 150,000

    Cost of Installment Sales 100,000

    Deferred Gross Profit2004 50,000

    Deferred Gross Profit2004 10,000

    Realized Gross Profit on

    Installment Sales 10,000

    Installment Sales Method

    2004

    $30,000 x 33.33%

    Continued

    62

    Installment Sales Method

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    Installment Sales Method

    Installment Accounts Receivable

    2005 200,000

    Installment Sales 200,000

    Cost of Installment Sales 140,000

    Inventory 140,000

    Cash 145,000

    Installment A/R2004 75,000

    Installment A/R2005 70,000

    2005

    Continued

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    64

    Cost Recovery Method

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    Cost Recovery Method

    Assume George has touse the cost recovery

    method, but all sales

    and collections remain

    the same.

    CostRecoveredCost

    Revenue

    65

    Cost Recovery Method

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    2005

    All entries are the same except do not

    book the entry to gross profit.

    Deferred Gross Profit2004 5,000

    Realized Gross Profit on

    Installment Sales 5,000

    Cost Recovery Method

    66

    Cost Recovery Method

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    2006

    Deferred Gross Profit2004 30,000

    Deferred Gross Profit2005 10,000Realized Gross Profit on

    Installment Sales 40,000

    Cost Recovery Method

    67

    Cash Method

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    If the probability ofrecovering product or

    service costs is remote the

    cost recovery methodof

    accounting can be used.

    There has to be

    considerable uncertainty as

    to ultimate collection of thecontract price.

    Cash Method

    68

    chapter 8

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    The End

    chapter8

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