Flashcards in FAR 30 - Revenue Recognition 2 - Contract Accounting Deck (8):
Choose the correct statement regarding accounting methods for revenue recognition on long-term contracts, for international and US accounting standards.
A. Only US standards require recognition of an overall loss in the year it becomes known.
B. Both sets of standards allow the completed contract method when the percentage of completion method is not appropriate.
C. International standards require the cost recovery method when the percentage of completion method is not appropriate.
D. The percentage of completion method is allowed only under US standards.
C. Contrary to US GAAP, international standards require a modified version of completed contract—the cost recovery method, when the percentage of completion method is not allowed.
At the end of the third year of a contract, total estimated project cost exceeds the contract price. In both of the first two years, the firm recognized gross profit on the contract under percentage of completion. What is the ending balance in the construction-in-progress account at the beginning of year four on the contract under the percentage-of-completion method (PC), and under the completed-contract method (CC), had that method been used?
Cost to date less overall loss
Cost to date less billings
Cost to date
PC & CC = Cost to Date Less Overall Loss
An overall loss is expected, because total estimated cost exceeds contract price. Under PC, the construction-in-progress account is increased by cost and gross profit. If the gross profit is negative (an overall loss), the loss is subtracted from construction in progress. The loss recognized in the year as overall loss becomes evident includes any previous profit. Therefore, the previously recognized gross profit is removed when the total loss is recognized. Under CC, the same idea applies, except that there is no gross profit from previous years to remove. The ending construction-in-progress balance is the same for both methods.
Frame construction company's contract requires the construction of a bridge in three years. The expected total cost of the bridge is $2mn, and Frame will receive $2.5mn for the project. The actual costs incurred to complete the project were $500,000, $900,000, and $600,000, respectively, during each of the three years. Progress payments received by Frame were $600,000, $1.2mn, and $700,000 in each year, respectively. Assuming that the percentage-of-completion method is used, what amount of gross profit should Frame report during the last year of the project?
The gross profit recognized for the first two years must be computed first. Then, the difference between the $500,000 final total gross profit on the project (= $2.5mn - $2mn), and the gross profit for the first two years, is the amount of gross profit recognized in the last (third) year. The percentage of completion at the end of the first two years is 70% (= $500,000 + $900,000)/$2mn). The gross profit recognized through the end of year two is $350,000 [= .70($2.5mn - $2mn)]. Therefore, gross profit for year three is $150,000 (= $500,000 total gross profit on project - $350,000).
Mill Construction Co. uses the percentage-of-completion method of accounting. During 2005, Mill contracts to build an apartment complex for Drew for $20mn. Mill estimates that total costs would amount to $16mn over the period of construction.
In connection with this contract, Mill incurs $2mn of construction costs during 2005. Mill bills and collects $3mn from Drew in 2005.
What amount should Mill recognize as gross profit for 2005?
The project is 12.5% complete at the end of 2005 ($2mn/$16mn). Total gross profit through the end of 2005 is therefore $500,000 [= .125($20mn - $16mn)].
The $500,000 amount is the proportion of completion applied to the total contract profit of $4mn. 2005 is the first year of construction; therefore no gross profit from previous years is subtracted. The entire $500,000 gross profit is recognized in 2005.
A contractor recognizes $42,000 of gross profit on a contract at the end of year one of the contract under the percentage-of-completion method. At the end of year two, the gross profit to be recognized for both years together is $34,000. The total anticipated gross profit on the project estimated at the end of year two is $78,000. What amount of gross profit is to be recognized for year two alone?
C. This is an example of a single-period loss on a profitable contract. The loss for year two is computed as: $34,000 gross profit through year two - $42,000 gross profit year one = - $8,000 single-period loss. The loss "reverses" $8,000 of the $42,000 gross profit recognized in year one.
T/F: Billings on contract is a liability account.
Billings is contra to construction in progress. On the BS, if the balance in construction in progress exceeds cumulative billings to date, the net difference is a current asset; if cumulative billings exceed the construction in progress balance, the difference is disclosed in the current liability section.
T/F: The computation of the percentage of completion, at the end of any year, considers the cost incurred through the end of that year in both the numerator and denominator.