Long-Term Construction Contract Flashcards
(23 cards)
True or False:
Under long-term construction contracts, when the customer receives and consumes the benefits of the selling company, at the same time as the latter is performing its obligation, the performance obligation is deemed to be satisfied over time. In that case, the associated revenue should be recognized using the completed-contract method.
False
Under long-term construction contracts, whenever a company satisfies its obligations over time, it recognizes revenue using the percentage of completion method. The performance is satisfied over time if at least one of the following criteria is met:
1) the customer receives and consumes the benefits of the selling company at the same time as the latter is performing its obligations.
2) the asset created or enhanced by the selling company is controlled by the customer as the company is performing its obligations.
3) the asset has no alternative uses.
True or False:
When using the percentage-of-completion method to account for long-term contracts, the progress toward completion may be measured using input measures or output measures. If the units used in the output measures were not comparable in time or effort, the results produced may be inaccurate.
True
If output units are not comparable, progress may be overstated or understated, leading to incorrect revenue recognition.
True or False:
The most commonly used measure to determine the progress toward completion is referred to as the cost-to-cost basis. Under this basis, the percentage of completion is computed as the ratio of the costs incurred to date over the total proceeds collected to date.
False
Cost to cost basis (ratio) is computed as the costs incurred to date over the most recent estimate of the total costs to complete the contract.
True or False:
When using the percentage of completion method, the balance sheet accounts used to report the differences between the construction in progress and the associated billings consist of a current asset account and a contra asset account.
False
When using the percentage of completion method, the balance sheet accounts used to report the differences between the construction in progress and the associated billings consists of a current asset account in case of a net debit balance and a currently liability account in case of a net credit balance.
True or False:
The percentage of completion method is favored over the completed contract method because it relies on actual figures instead of estimated figures to account for revenues and gross profit.
False
The completed contract method uses actual figures to account for the projects revenues and gross profit. However, the percentage of completion method relies on the estimation of unperformed work.
True or False:
When using the percentage of completion method, the total net income recognized over the contract’s lifetime would be higher than the total net income recognized under the completed contract method.
False
They are the same, the only difference is the timing.
True or False:
Under the completed contract and the percentage of completion methods, the annual journal entries prepared to account for the progress billings and collections from customers are the same. In contrast, the revenue and gross profit are reported differently.
True
Under both the completed-contract method and the percentage-of-completion method, the journal entries for progress billings and the collection of payments from customers look the same because in both methods you record:
Billings on Construction in Progress (CIP): Credit “Billings on CIP” and debit “Accounts Receivable” when you send out invoices (progress billings).
Cash Collection: Debit “Cash” and credit “Accounts Receivable” upon receipt.
Where these methods differ is in how and when revenue and gross profit are recognized:
Percentage-of-completion method: Revenue and gross profit are recognized periodically based on the stage of completion.
Completed-contract method: Revenue and gross profit are deferred and recognized only when the contract is substantially complete.
Thus, although the handling of billings and collections is similar under both methods, the timing and presentation of revenue and gross profit differ.
True or False:
When a profitable contract results in a current loss under the percentage of completion and the completed contract methods, the excess gross profit previously recognized should be adjusted.
False:
Under the percentage of completion method, when a profitable contract results in a current loss, the excess gross profit previously recognized should be adjusted. This is not true under the completed contract method where the profit is not recognized until the project is complete.
The Gulf construction company signed a 3-year contract with AlHallal company to construct an opulence building. The contract’s price is $6,000,000, and the estimated costs to complete the construction amounts to $4,750,000.
At the end of the first year of the project, the costs incurred by the Gulf company amounted to $1,187,500. In addition, the company reconfirmed its estimation for the total project costs.
What would be the gross profit that the Gulf company would recognize at the end of the first year under the percentage-of-completion method?
a. $1,250,000
b. $0
c. $312,500
d. $416,667
c. $312,500
The Gulf construction company signed a 3-year contract with AlHallal company to construct an opulence building. The contract’s price is $6,000,000, and the estimated costs to complete the construction amounts to $4,750,000. At the end of the first year of the project, the costs incurred by the Gulf company amounted to $1,187,500. In addition, the company reconfirmed its estimation for the total project costs. What would be the journal entry reported by the Gulf company at the end of year 1 to recognize the gross profit on the project?
a. DR Construction in progress $312,500 CR Gross Profit $312,500
b. DR Construction Expenses $312,500 CR Construction Revenues $312,500
c, DR Construction Expenses $1,500,000 CR Construction Revenues $1,500,000
d. DR Construction in progress $312,500 DR Construction Expenses $1,187,500 CR Construction Revenues $1,500,000
d. DR Construction in progress $312,500 DR Construction Expenses $1,187,500 CR Construction Revenues $1,500,000
Pro-Co Construction Company is engaged in constructing a $3,000,000 building under a 1-year construction contract.
The construction started on March 1, year 1, when Pro-co estimated that the total costs to complete the project would be $1,950,000.
During the period extending from March 1, year 1, till December 31, year 1, the company incurred total costs of $980,000. It also collected $700,000, in cash, out of its progress billing for that period of $1,050,000.
On December 31, year 1, the company’s estimated total costs to complete the project were still the same. Using the percentage-of-completion method, what would be the gross profit that Pro-co company would recognize on December 31, year 1?
a. $0
b. $1,050,000
c. $527,730
d. $875,000
c. $527,730
Pro-Co Construction Company is engaged in constructing a $3,000,000 building under a 1-year construction contract.
The construction started on March 1, year 1, when Pro-co estimated that the total costs to complete the project would be $1,950,000.
During the period extending from March 1, year 1, till December 31, year 1, the company incurred total costs of $980,000. It also collected $700,000, in cash, out of its progress billing for that period of $1,050,000.
On December 31, year 1, the company’s estimated total costs to complete the project were still the same. Using the percentage-of-completion method, what would be the amount of construction-in-progress that the company would report in its year 1 balance sheet?
a. $980,000
b. $1,507,730
c. $1,855,000
d. $2,030,000
b. $1,507,730
Under the percentage-of-completion method, the construction in progress account reported on the balance sheet, at the end of the year, would include the sum of actual costs incurred and gross profit recognized till the balance sheet date. Therefore, the amount of construction-in-progress that Pro-co would report in its year 1 balance sheet is equal to $980,000 + $527,730 = $1,507,730.
Thus, the correct answer choice is (B).
When applying the completed contract method to account for long-term construction contracts, which of the following elements is (are) affected during the lifetime of the contract?
a. revenues and costs only
b. revenues, costs, and gross profit
c. revenues and gross profit only
d. none of the listed answer choices are correct
d. none of the listed answer choices are correct
When the completed-contract method is used to account for long-term construction contracts, the construction costs are accumulated in the construction in progress account over the lifetime of the project. In addition, the customer billings are accumulated in a progress billing account until the project is completed. Therefore, before the project is completed, the company does not report revenues or costs. Accordingly, the gross profit is not affected as well.
Thus, the correct answer choice is (D). None of the listed answer choices is correct.
Prime Construction Co is executing a five year construction contract. At the end of the second year of the project, the prices of the raw materials increased, and the company estimated that the project would results in an overall loss. Under which of the following methods will the company recognize a loss on the project in the second year?
a. under the percentage of completion method
b. under the percentage of completion method and the completed contract method
c. under the completed contract method
d. the company should not recognize the loss until it materializes
b. under the percentage of completion method and the completed contract method
In accordance with the rule of conservatism, any loss should be recognized in its entirety, in the year in which it is discovered.
Therefore, regardless of whether the company is using the percentage-of-completion method or the completed-contract method, the estimated losses should be recognized on the company’s year 2 income statement.
Thus, the correct answer choice is (B).
Why is recognizing revenues over the life of a contract better than recognizing it at a single point in time?
a. it is a better match for the legal property
b. it provides a better measure of periodic accomplishment
c. it provides more conservative results
d. lower income tax results
b. it provides a better measure of periodic accomplishment
Regarding the delay in recognizing the revenue of the long term contract until completion, it is the case that:
a. if there is an estimated loss on the whole contract, these losses are recognized before the project ends.
c. expense recognition happens every period, while revenue recognition happens when the contract is completed.
c. GAAP does not allow using this approach.
d. no gains or losses are recognized if the contract is not completed.
a. if there is an estimated loss on the whole contract, these losses are recognized before the project ends.
the correct answer is A, because if there are estimated losses on the overall contract, they should be recognized in the period where the company realizes them, whereas revenue recognition is delayed until the completion of a contract.
When using the percentage-of-completion method to recognize revenue for a long-term contract, a company calculates the percentage of completion in the first year by dividing:
a. The costs incurred in the first year by the estimated total costs to be incurred in the remaining years of the contract.
b. The costs incurred in the first year by the estimated total costs for the completed contract.
c. The costs incurred in the first year by the estimated remaining costs to complete the work.
d. The costs incurred in the first year by the estimated gross profit.
b. The costs incurred in the first year by the estimated total costs for the completed contract.
Billy’s Contracting constructed a new building lot during 2019 and 2020 under a contract with John’s Real Estate Co. The related contract information and work progress at the end of 2019 and 2020 are as follows:
Contract Amount: $5,000,000
Cost:
2019 = 1,200,000
2020 = 1,800,000
Gross Profit:
2019 = 800,000
2020 = 1,200,000
Contract Billings:
2019 = 2,500,000
2020 = 2,500,000
What would be the journal entry to record revenue in 2019, if Billy’s Contracting recognizes revenue over time with respect to these contracts?
DR) CIP 800,000
DR) Cost of construction 1,200,000
CR) Revenue from LT contracts 2,000,000
Billy’s Contracting constructed a new building lot during 2019 and 2020 under a contract with John’s Real Estate Co. The related contract information and work progress at the end of 2019 and 2020 are as follows:
Contract Amount: $5,000,000
Cost:
2019 = 1,200,000
2020 = 1,800,000
Gross Profit:
2019 = 800,000
2020 = 1,200,000
Contract Billings:
2019 = 2,500,000
2020 = 2,500,000
What would be the journal entry to record revenue in 2020, if Billy’s Contracting recognizes revenue over time with respect to these contracts?
DR) CIP 1,200,000
DR) Cost of construction 1,800,000
CR) Revenue from LT contracts 3,000,000
Billy’s Contracting constructed a new building lot during 2019 and 2020 under a contract with John’s Real Estate Co. The related contract information and work progress at the end of 2019 and 2020 are as follows:
Contract Amount: $5,000,000
Cost:
2019 = 1,200,000
2020 = 1,800,000
Gross Profit:
2019 = 800,000
2020 = 1,200,000
Contract Billings:
2019 = 2,500,000
2020 = 2,500,000
What would Billy’s Contracting report in its December 31, 2019 balance sheet, if it recognizes revenue when the contract is completed?
a. the contract liability, billings in excess of cost, of $1,300,000.
b. the contract liability, billings in excess of cost and profits, of $500,000.
c. the contract asset, contract amount in excess of billings, of $2,500,000.
d. the contract asset, deferred profit, or $1,200,000.
a. the contract liability, billings in excess of cost, of $1,300,000.
Under the completed contract method, construction costs are accumulated in the “Construction in progress” account (an inventory account) and contract billings are accumulated in the “Progress billings” account (a contra-inventory account). The two accounts are netted against each other for balance sheet reporting.
Construction costs for the year 2019 = $1,200,000
Contract billings for the year 2019 = $2,500,000
Because the contra-inventory account (Progress billings) is in excess of the inventory account (Construction in progress), the difference would be classified as a current liability and reported in the “Billings in excess of cost” account.
Billings in excess of cost = $2,500,000 – $1,200,000 = $1,300,000
The gross profit is a distractor information because the gross profit is calculated under the completed contract method when the contract is complete, and it is not considered when reporting balance sheet accounts.
Billy’s Contracting installed a pipeline for a fixed price of $4,500,000 under a contract with Brad co. The related contract costs incurred and estimated costs to complete during the period of the contract are as follows:
2018:
Costs incurred: $500,000
Estimated Costs to Complete: $2,700,000
2019:
Costs incurred: $1,500,000
Estimated Costs to Complete: $1,400,000
2020:
Costs incurred: $1,500,000
Estimated Costs to Complete: $0
What would Billy’s Contracting report as gross profit (loss) in 2018, if it recognizes revenue when the contract in completed?
a. 1,300,000
b. 0
c. 703,125
d. 1,500,000
b. 0
Under the completed contract method, no gross profit is recognized until the contract is completed. Only losses should be recognized in full in the year they are discovered. Billy’s Contracting estimated gross profit (GP) for the year 2018 is:
Estimated GP = Fixed contract revenue – (cost incurred + estimated cost to complete)
= $4,500,000 – ($500,000 + $2,700,000)
= $1,300,000
Under the completed contract method, the gross profit will not be recognized until the contract is completed, and therefore 0 is the right answer.
Billy’s Contracting installed a pipeline for a fixed price of $4,500,000 under a contract with Brad co. The related contract costs incurred and estimated costs to complete during the period of the contract are as follows:
2018:
Costs incurred: $500,000
Estimated Costs to Complete: $2,700,000
2019:
Costs incurred: $1,500,000
Estimated Costs to Complete: $1,400,000
2020:
Costs incurred: $1,500,000
Estimated Costs to Complete: $0
What would Billy’s Contracting report as gross profit (loss) in 2020, if it recognizes revenue when the contract is completed?
a. (50,000)
b. (850,000)
c. (150,000)
d. 100,000
d. 100,000
Under the completed contract method, no gross profit is recognized until the contract is completed. Only losses should be recognized in full in the year they are discovered. The computations for the estimated gross profit (loss) during the period of the contract are as follows:
Because a loss is expected in 2019, it is recognized in full in the same year. Although the contract net loss is $50,000 ($3,350,000 – 3,400,000), the profit recognized in the year 2020 is the difference between the loss already recognized in 2019 and the net contract’s result:
GP = (50,000) – (150,000) = $100,000.
Billy’s Contracting constructed a new building lot during the years 2019, 2020, and 2021 under a contract with John’s Real Estate Co. with a fixed revenue of $50 million. During 2019, Billy’s Contracting incurred $8 million of costs and estimated an additional $24 million of costs to complete the project. What would Billy’s Contracting report as gross profit (loss) in 2019, if it recognizes revenue over time according to the percentage of completion method?
a. 0
b. 4,500,000
c. 18,000,000
d. (8,000,000)
b. 4,500,000
Under the percentage of completion method, Gross profit or loss is calculated as follows:
Step 1: Compute the total expected GP of the project:
Estimated GP = Contract price – Estimated total cost
Estimated GP = $50,000,000 – ($8,000,000 + $24,000,000) = $18,000,000
Step 2: Compute the percentage of completion:
% of completion = Total cost to date / Total estimated contract cost
% of completion = 8$ million / $32 million = 25%
Step 3: Compute GP earned to date:
GP earned to date = Step 1 * Step 2
GP earned to date = $18,000,000 * 25% = $4,500,000
Since 2019 is the first year of the contract, the GP earned in 2019 is the same as the GP earned to date. Therefore, $4,500,000 is the right answer.
