Revenue on Long-Term Contracts

Medium Test

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Medium Test

Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.

1. “Billings” is considered a liability account because

a. the customer owes for work performed
b. the contractor owes the work that has been completed
c. cash was collected and it is an unearned revenue
d. both b. and c.

Answer
B. The billings account is recorded as a liability when the customer is billed for work performed. An accounts receivable is also recorded for the work performed. The contractor owes the customer the asset in construction (billings) and the customer owes the contractor payment for work performed (accounts receivable).
2. What is reported on the financial statements at the end of the first year of a three-year contract when revenue is not recorded over time?

a. construction revenue
b. construction in process
c. construction expense
d. all of the above

Answer
B. Construction in process (an asset) is reported on the balance sheet as a representation of costs that have been incurred. Construction revenue and construction expense is not reported until the contract is completed and the asset is delivered.
3. The construction in process account represents

a. expenses incurred to date on the contract
b. profit or loss earned to date on the contract
c. both a. and b.
d. neither a. or b.

Answer
C. Construction in process increases when costs are incurred. The difference in construction expense and construction revenue is recorded to construction in process as a representation of profit on the asset under contract. Total construction in process is equal to the total costs incurred and profit or loss earned to date.
4. The income that is recorded for the current period is equal to

a. the total construction in process
b. the percentage completed multiplied by total income earned to date
c. the percentage completed multiplied by total estimated income earned to date less income reported in previous periods
d. total billings during the current period

Answer
C. The current period income is equal to the cumulative estimated income to date less the income recorded in prior periods.
5. Which of the following is not true?

a. Revenue is recorded over time when the price of the contract is determined and costs can be reasonably estimated
b. Construction in process is equal to the total contract price when the contract is complete
c. Revenue is recorded when the asset is delivered when the total cost of the contract can be reasonably estimated
d. Record revenue when the customer is billed according to the contract

Answer
C. Revenue is all recorded at the end of the contract when the total cost and future costs of the contract can not be reliably estimated. When the company cannot estimate future costs, they cannot estimate the percentage of completion on the contract. All other statements are true.
6. When the contracted is completed the amount in the

a. billings account will equal the amount in construction in process
b. billings account will equal the contract price
c. construction in process account will equal the total costs incurred to date plus total profit or loss earned on the contract
d. all of the above

Answer
D. All of the above are true when the contract is completed.
7. When the contractor expects to incur a loss on the total contract the amount of income recorded in the current period must be equal to

a. the loss incurred for the current year only
b. the total loss expected to be incurred less any income previously recorded
c. the total amount of the expected loss
d. none of the above

Answer
B. When a loss is expected on the contact all prior income recorded must be taken back and the total loss must be reported in the current period. The amount of loss reported in the current period must be the amount that when added with all previously reported income or loss will net to the total expected loss on the contract.
8. Which general rule of revenue recognition does recording revenue over time violate?

a. matching principle
b. collection of cash is reasonably assured
c. the earnings process is complete
d. the contract price is fixed and determinable

Answer
C. Recording revenue over periods before the customer receives the goods is before the earnings process is completed. Revenue is recognized as the goods are being constructed. This method complies with the matching principles and recognizes revenue as the company incurs expenses and work is performed in support of the revenue process.
9. When revenue is recognized at the end of the contract, the profit reported is equal to

a. the balance in the construction in process account
b. cash collected in the current period
c. cumulative profit earned less prior year profits
d. cumulative profit earned less profits earned to date

Answer
C. No profit is recognized until the contract is completed and the profit is known. No prior year profit is recognized. All profit is recognized when the work is complete.
10. Which method is used when the contract price is fixed and also subject to change; however, costs can be reasonably estimated?

a. recognize revenue when the asset is delivered
b. recognize revenue over time
c. either method is acceptable
d. neither method can be used

Answer
B. Revenue is recognized over time when the contract price is fixed and costs can be reasonably estimated. A contract price change is common when additional work was not planned for. When the contract price changes the estimated profit also will change for the current and future periods.
11. A Construction company uses the percentage-of-completion method to account for work performed under long-term construction contracts. The company began work on a new county road with a negotiated contract price of $3,000,000. Additional data is as follows

Year 1 Year 2 Year 3
Costs incurred during the year $1,300,000 $ 500,000 $1,400,000
Estimated costs to complete on 12/31 $1,200,000 $ 900,000  $               0
Billings during the year $1,250,000 $ 750,000 $1,000,000
Collections during the year $1,200,000 $ 700,000 $1,100,000

A. Prepare a table that calculates the amount of income or loss to be recognized for all years of the contract.
B. Prepare all journal entries required for the second year of the contract.
C. Determine what will be reported on the balance sheet and the income statement for the second year.

Answer
A. Table that computes income to be recorded:

							                         Year 1         Year 2              Year 3

Contract Price						                   $3,000,000	  $3,000,000	  $3,000,000

    Cost to Date (cumulative)                                                    $1,300,000     $1,800,000	  $3,200,000
+  Estimated Cost to Complete (from this point to the end)    $1,200,000           $   900,000   $             0
=  Total Cost						                   $2,500,000          $2,700,000   $3,200,000

=  Estimated Income     (Price – Total Cost)              $   500,000     $   300,000   $ (200,000)
x  Estimated % Complete  (cost to date divided by total cost)       .52	                 .6667              100%    
		
=  Estimated income to record to date                   $   260,000     $    200,010   (200,000)
       (Estimated income x % complete)

-   Less cumulative income recorded in all previous years   $	    0       $   (260,000)   $ 200,010

=  Income to record this period                                                $   260,000         $   (  59,990)      $(400,010)

11. B. Journal Entries – 2nd Year:

As costs are incurred – current year cost only:

Construction in Process (CIP)     500,000
            A/P, cash, etc.                         500,000

As the customer is billed:

Accounts Receivable       750,000
        Billings (liability)            750,000

As payment is collected from the customer:

Cash                                      700,000
        Accounts Receivable            700,000

At the end of the period to record revenue earned:

Construction Expense         500,000
             CIP                                        59,990
             Construction Revenue        440,010

Construction Expense is equal to the amount incurred during this period
CIP is the amount computed as income this period (from the table).
A debit is profit and a credit is a loss
Construction Revenue is a plug to balance the journal entry

11. C. Reported on the financial statements for the 2nd year:

On the Balance Sheet as of the end of the year:

Construction in Process:                $2,000,010

1,800,000 + 200,010
Total costs to date + – profit to date

Billings:                                          $2,000,000
year 1 plus year 2

Net Construction in Process $10

Accounts Receivable:                  $100,000

1,250,000 + 750,000 – 1,200,000 – 700,000
Cumulative Billings – Cumulative cash collected

On the Income Statement for the second year ended:

Construction Revenue        500,000
Construction Expense        (440,010)
Gross Profit                         59,990

12. A construction company began work on a new county courthouse with a negotiated contract price of $6,000,000. Additional data is as follows:

Year 1 Year 2 Year 3
Cumulative costs incurred to date $1,200,000 $3,900,000 $5,900,000
Estimated costs to complete on 12/31 $4,200,000 $1,100,000 $               0
Cumulative billings $1,250,000 $3,750,000 $6,000,000
Cumulative collections $1,000,000 $4,000,000 $6,000,000

A. Prepare a table that calculates the amount of income or loss to be recognized for the all years when revenue is recognized over time.
B. Prepare all journal entries required for the third year of the contract when revenue is recognized over time.
C. Prepare all journal entries required for the first and the third year of the contract
when revenue is recognized upon delivery.

Answer
12. A. Table that computes income to be recorded:

							                                    Year 1	        Year 2                  Year 3

Contract Price                                                $6,000,000           $6,000,000           $6,000,000

    Cost to Date (cumulative)                                     $1,200,000      $3,900,000     $5,900,000
+  Estimated Cost to Complete (from this point to the end)            $4,200,000	    $1,100,000         $	          0
=  Total Cost                                                                                               $5,400,000      $5,000,000	  $5,900,000

=  Estimated Income     (Price – Total Cost)                         $   600,000      $1,000,000          $   100,000
x  Estimated % Complete  (cost to date divided by total cost)                0.2222            .78           100%    
		
=  Estimated income to record to date                              $   133,320      $   780,000      100,000
       (Estimated income x % complete)

-   Less cumulative income recorded in all previous years              $	      0         $  (133,320)    $(780,000)

=  Income to record this period                                    $    133,320           $   646,680          $(680,000)

12. B. Journal Entries – 3rd Year: revenue recognized over time:

As costs are incurred – current year cost only:
5,900,000 less 3,900,000 prior cumulative

Construction in Process (CIP)    2,000,000
             A/P, cash, etc.                     2,000,000

As the customer is billed – this year only:
6,000,000 – 3,750,000

Accounts Receivable         2,250,000
           Billings (liability)             2,250,000

Payment collected from the customer –
current year only: 6,000,000 – 4,000,000

Cash                        2,000,000
          Accounts Receivable      2,000,000

At the end of the period to record revenue earned:

Construction Expense         2,000,000
          CIP                                      680,000
          Construction Revenue    1,320,000

Construction Expense is equal to the amount incurred during this period
CIP is the amount computed as income this period (from the table).
A debit is profit and a credit is a loss
Construction Revenue is a plug to balance the journal entry

Close out construction in process and billings at the end of the 3rd year when the contract is completed:

Billings                             6,000,000
        Construction in Process       6,000,000

12. C. 1st and 3rd year: revenue is recognized upon delivery

1st year journal entries:

As costs are incurred – current year cost only:

Construction in Process (CIP) 1,200,000
                   A/P, cash, etc.              1,200,000

As the customer is billed – current year only:

Accounts Receivable           1,250,000
           Billings (liability)               1,250,000

Payment collected from the customer – this year only:

Cash                                 1,000,000
        Accounts Receivable        1,000,000

Revenue and expense are not recorded until the contract is complete.

12. 3rd Year journal entries for revenue recorded only upon delivery are the same entries made for % of completion except amounts for construction revenue
and construction expense.

As costs are incurred – current year cost only:
5,900,000 less 3,900,000 prior year cumulative

Construction in Process (CIP)     2,000,000
          A/P, cash, etc.                           2,000,000

As the customer is billed – current year only:
6,000,000 – 3,750,000

Accounts Receivable                      2,250,000
             Billings (liability)                       2,250,000

Payment collected from the customer –
current year only: 6,000,000 – 4,000,000

Cash                                       2,000,000
         Accounts Receivable            2,000,000

At the end of the period and the contract has been completed total construction revenue and total construction expense is recorded for the entire contract.

Construction Expense                 5,900,000
CIP                                                 100,000
          Construction Revenue                  6,000,000

Close out construction in process and billings at the end of the 3rd year when the contract is completed:

Billings                                             6,000,000
              Construction in Process             6,000,000

13. A construction company began work on a medical building with a negotiated contract price of $8,000,000. Additional data is as follows:

Year 1 Year 2 Year 3
Costs incurred this period $2,200,000 $2,600,000 $2,200,000
Estimated costs to complete on 12/31 $5,100,000 $4,100,000 $               0
Billings to date $ 1,250,000 $4,750,000 $8,000,000
Collections to date $    800,000 $4,500,000 $8,000,000

A. Prepare a table that calculates the amount of income or loss to be recognized for all years when revenue is recognized over time.
B. Prepare all journal entries required for the second and third years for the contract when revenue is recognized over time.
C. Prepare all journal entries required for the second and third years for the contract given the company cannot estimate future costs.

Answer
      13. A. Table that computes income to be recorded:

							                               Year 1	       Year 2                 Year 3

Contract Price						                         $8,000,000	    $8,000,000	     $8,000,000

    Cost to Date (cumulative)                                                              $2,200,000           $4,800,000        $7,000,000
+  Estimated Cost to Complete (from this point to the end)         $5,100,000      $4,100,000            $         0
=  Total Cost                                                                                      $7,300,000      $8,900,000        $7,000,000

=  Estimated Income     (Price – Total Cost)                    $   700,000      $ (900,000)               $1,000,000
x  Estimated % Complete  (cost to date divided by total cost)          .3014	               100%                       100%    
		
=  Estimated income to record to date                         $   210,980      $ (900,000)	     $1,000,000
       (Estimated income x % complete)

-   Less cumulative income recorded in all previous years         $	         0	     $  (210,980)       $(1,110,980)

=  Income to record this period                               $     210,980      $(1,110,980)   	 $2,110,980        
									                                  Record all losses	 Take back loss

13. B. Journal Entries – 2nd Year recognize revenue over time:

As costs are incurred – current year cost only:

Construction in Process (CIP) 2,600,000 
             A/P, cash, etc.                    2,600,000

As the customer is billed – current year only:
4,750,000 – 1,250,000

Accounts Receivable        3,500,000 
          Billings (liability)            3,500,000

Payment collected from the customer –
current year only: 4,500,000 – 800,000

Cash                                    3,700,000
         Accounts Receivable           3,700,000

At the end of the period to record revenue earned:

Construction Expense      2,600,000
        CIP                                          1,110,980
        Construction Revenue            1,489,020

Construction Expense is equal to the amount incurred during this period
CIP is the amount computed as income this period (from the table).
A debit is profit and a credit is a loss
Construction Revenue is a plug to balance the journal entry

13. B. Journal Entries – 3rd Year recognize revenue over time:

As costs are incurred – current year cost only:

Construction in Process (CIP)   2,200,000
           A/P, cash, etc.                          2,200,000

As the customer is billed – current year only:
8,000,000 – 4,750,000

Accounts Receivable          3,250,000
         Billings (liability)               3,250,000

Payment collected from the customer –
current year only: 8,000,000 – 4,500,000

Cash                                     3,500,000
        Accounts Receivable       3,500,000

At the end of the period to record revenue earned:

Construction Expense    2,200,000
CIP                                 2,110,980
       Construction Revenue       4,310,980

Construction Expense is equal to the amount incurred during this period
CIP is the amount computed as income this period (from the table).
A debit is profit and a credit is a loss
Construction Revenue is a plug to balance the journal entry

At the end of the contract, billings and construction in process must be closed out:

Billings                           8,000,000
          Construction in Process       8,000,000

The amount will be the total of the contract

13. C. 2nd year: Recognize revenue at delivery

These entries are the same as % of completion except
construction revenue and construction expense is not recorded:

As costs are incurred – current year cost only:

Construction in Process (CIP)     2,600,000
          A/P, cash, etc.                         2,600,000

As the customer is billed –
current year only: 4,750,000 – 1,250,000

Accounts Receivable      3,500,000
          Billings (liability)            3,500,000

Payment collected from the customer –
current year only: 4,500,000 – 800,000

Cash                                3,700,000
         Accounts Receivable      3,700,000

Construction revenue and construction expense is not recorded until the contract is completed.

13. C. Journal Entries – 3rd Year record revenue at delivery:

As costs are incurred – current year cost only:

Construction in Process (CIP)          2,200,000
         A/P, cash, etc.                               2,200,000

As the customer is billed –
current year only: 8,000,000 – 4,750,000

Accounts Receivable                 3,250,000
            Billings (liability)                     3,250,000

Payment collected from the customer –
current year only: 8,000,000 – 4,500,000

Cash                                    3,500,000
         Accounts Receivable       3,500,000

At the end of the period total construction revenue and total construction expense is recorded:

Construction Expense        7,000,000
CIP                                     1,000,000
           Construction Revenue          8,000,000

At the end of the contract, close out billings and construction in process:

Billings                                 8,000,000
         Construction in Process        8,000,000

The amount will be the total price of the contract