Revenue on Long-Term Contracts

Key Things To Know

 

Recognize Revenue over a Period of Time (% of completion) if:

1) The customer controls the asset as it is created (the seller’s work in process).

or

2) The seller is creating an asset that has no alternative use to the seller and the seller has the legal right to receive payment for progress to date.

Recognize Revenue at a Point in Time (delivery of asset) if neither of the above two requirements are not met.

Report all revenue when the asset is delivered to the buyer.

Accounting for Long-term Contracts Over a Period of Time (% of Completion)

Use four journal entries to record the exchanges that occur under the long-term contract that qualifies to report revenue over the time the seller performs the contract work:

1) Record the costs incurred during the period:

Construction in Process (CIP)     $XXX
               A/P, cash, etc.                         $XXX

Construction in process functions like a long-term inventory account.

Record all costs and profits to CIP inventory. Record the expense in entry 4.

Do not expense the CIP balance upon delivery. Remove construction in process along with the billings account at the end of the contract when the asset is delivered to the customer. (As such, it is okay to record the cost twice.)

2) Record amounts billed to the customer during the period:

Accounts Receivable     $XXX
           Billings (liability)            $XXX

Billings represents the portion of the contract that is owed to the customer.

3) Record collections from the customer during the period:

Cash                                  $XXX
         Accounts Receivable         $XXX

4) Record revenue earned and expenses incurred during the period:

Construction Expense                       $XXX
    Construction in Process (CIP)*                $XXX
         Construction Revenue                                 $XXX

* CIP can be a debit (profit) or a credit (loss)

Make this entry at the end of the period using computed amounts.

Reported on the Financial Statements:

• Report CIP and Billings net on the balance sheet as follows:

Construction in Process (CIP):       Recorded as long-term inventory; an asset account
Billings (to Customer):                    Recorded as a liability account called “billings”
Net, CIP or Billings                         Recorded NET on the balance sheet for the account with the largest amount at the end of the period

Amounts recorded to the CIP account do not become an expense; CIP is removed with the billings account when delivery of the asset occurs.

Report revenue at the estimated amount earned during the period.
Do not record revenue for the amount billed.

Report expenses at the amount of cost incurred during the same period.

Report income earned to date as part of the asset construction in process.

Table to determine the income to record for each period:

       Total Contract Price

       Costs Incurred in Prior Years
+     Costs Incurred in the Current Year
=     Cost to Date (Cumulative Actual)
+     Estimated Cost to Complete (in future periods)
=  –  Estimated Total Cost
=     Estimated Income (Total Contract Price – Estimated Total Cost)
x     Estimated % Complete (Cost to Date Divided by Estimated Total Cost
=     Estimated Income to Date (Estimated Income x % Complete)
–      Cumulative Income Recorded in all Previous Periods
=     Revenue less Expense (Earnings) to Record in the Current Period

The table computes the estimated income earned during the current period.

Record construction expense for the costs incurred during the period.
Record the income computed on the table for the current period to the CIP account:

Record income with a debit to CIP (increases the value of the asset)
Record loss with a credit to CIP (decreases the value of the asset)

Revenue recorded for the current period will equal:

   The % complete to date
x Total contract revenue
= Total revenue to record to date
– Total revenue recorded in all prior periods
= Revenue to record in the current period

Important:

When expecting a loss on the total contract:
  The % complete is always 100% in the period the company first expects the loss
  Revenue will differ from the above calculation
  You must use the table above to compute income and plug the revenue amount

Recognize Revenue when the Contract is Complete and the Asset is Delivered

Use this method when:
  the total cost cannot be reliably estimated
  the customer does not control the asset as it is created

The only difference in entries and reporting is:

The entry to record construction revenue, construction expense, and profit to CIP is made for the total amount at the end of the contract

The first three entries are made in the period the work is done:

1) Record the costs incurred during the period:

Construction in Process (CIP)     $XXX
              A/P, cash, etc.                          $XXX

2) Record amounts billed to the customer during the period:

Accounts Receivable       $XXX
          Billings (liability)                       $XXX

Billings represents the portion of the contract that is owed to the customer.

3) Record collections from the customer during the period:

Cash                                     $XXX
         Accounts Receivable            $XXX

Make this entry ONLY at the end of the contract for the total amount.

4) Record revenue earned and expenses incurred during the period:

Construction Expense                    $XXX                 
           Construction in Process (CIP)        $ XX
                      Construction Revenue                $XXX