Revenue on Long-Term Contracts

Easy Test

Easy Test

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

1. When is the percent of work completed used to recognize revenue?

a. as cash is collected
b. as billings occur
c. when revenue is recorded over time
d. when revenue is recorded upon delivery

Answer
C. Revenue is recognized over time based on how much of the total work to be done is completed during the period.

2. The term “estimated cost to complete” means

a. the total cost of the contract
b. total costs that have been incurred to date
c. total costs yet to be incurred
d. total expenses yet to be incurred

Answer
C. “Estimated cost to complete” means the total costs estimated to be incurred from now through the end of the contract.
3. How many journal entries will an accountant typically make each period when revenue is recognized upon delivery?

a. 2
b. 3
c. 4
d. 1

Answer
B. The journal entries typically made are recording construction in process for costs incurred, billing the customer, and collecting from the customer. Construction expense and construction revenue are only recorded in the period the contract is complete. They are recorded for the total amount upon completion of the contract.
4. Which of the following accounts are reported on the balance sheet?

a. billings
b. construction expense
c. construction in profit
d. both a. and c.

Answer
A. Billings is a liability account that represents what the contractor owes the customer. Construction in profit is not an account that is used (construction in process is used and is an asset account.) Construction expense and construction revenue are reported on the income statement.
5. Construction expense is equal to the amount

a. incurred during the period
b. paid for expenses during the period
c. billed to the customer during the period
d. the customer owes the contractor

Answer
A. Construction expense is recorded for the amount of costs incurred during the period. It is recorded for the same amount that construction in process is recorded for as costs are incurred.
6. Which account is recorded for the amount that balances the journal entry when revenue is recognized over time and the company expects a loss?

a. construction revenue
b. construction in process
c. construction expense
d. construction profits

Answer
A. Construction expense is recorded for the amount incurred during the period. Construction in process is recorded for the amount that is computed in the table based on work completed and represents the profit. Construction revenue is the amount that will balance the journal entry.
7. The construction in process account is an asset account that represents

a. total billings to the customer
b. total costs incurred to date plus profit or loss earned to date
c. total work performed
d. total work performed that has been billed to the customer

Answer
B. Costs that are incurred are recorded to the construction in process account. These costs are stored in the asset account until the project is turned over to the customer. Construction in process is also recorded for the difference in construction revenue and construction expense as a representation of the profit on the contract.
8. Profit on a contract is not recorded until the asset is delivered when

a. the amount of profit can not be reliably estimated
b. the amount of profit is not certain until the contract is complete
c. the customer is not billed and does not pay until the contract is complete
d. all of the above

Answer
A. Revenue is recognized when the asset is delivered when costs incurred in future periods and total profit cannot be reasonably estimated. The amount of profit is not certain for any long term contract; however, if it can be reasonably estimated it is considered reliable enough to be recorded over the time costs are incurred.
9. Which of the following will always be equal when the contract is completed?

a. construction in process and billings and total contract revenue
b. construction expense, costs incurred, and billings
c. billings and accounts receivable
d. construction expense and construction revenue

Answer

A. All of the items stated in a. will be equal to the total contract price for the project. Accounts receivable will not be equal to billings when the customer makes payments. Construction expense and construction revenue will not be equal when there is profit or loss.

10. Which account is accounts receivable is netted against when preparing the balance sheet?

a. cash
b. construction expense
c. billings
d. construction in process

Answer
C. Accounts receivable (asset) is netted against billings (liability). The net amount of the account with the largest amount is reported on the balance sheet instead of the two gross amounts related to the same customer.
11. A Construction began work on a new county bridge with a negotiated contract price of $2,000,000. Additional data is as follows:

  Year 1 Year 2
Costs incurred during the year $ 1,350,000 $ 500,000
Estimated costs to complete on 12/31 $ 600,000 $              0
Billings during the year $ 1,250,000 $ 750,000
Collections during the year $ 1,200,000 $ 800,000

A. Prepare a table that calculates the amount of income or loss to be recognized for the first and second years of the contract.
B. Prepare all journal entries required for the first and second years of the contract.

Answer
11. A. Table that computes income:

Contract Price $2,000,000 $2,000,000
     
Cost to Date (cumulative) $1,350,000 $1,850,000
+ Estimated Cost to Complete (from this point to the end) $ 600,000 $               0
= Total Cost $1,950,000 $1,850,000
     
= Estimated Income (Price – Total Cost) $       50,000 $    150,000
x Estimated % Complete (cost to date divided by total cost)     .6923      .100  
     
= Estimated income to record to date
(Estimated income x % complete)
$      34,615 $    150,000
     
– Less cumulative income recorded in all previous years $              0 $      (34,615)
= Income to record this period $      34,615 $      115,385
     

11. B. Journal Entries – 1st Year:

As costs are incurred:

Construction in Process (CIP)   1,350,000
           A/P, cash, etc.                           1,350,000

As the customer is billed:

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

As payment is collected from the customer:

Cash                                        1,200,000
         Accounts Receivable                1,200,000

At the end of the period to record revenue earned:

Construction Expense         1,350,000
Construction in Process           34,615
            Construction Revenue               1,384,615

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 a profit and a credit is a loss
Construction Revenue is a plug to balance the journal entry.

 

11. B. Journal Entries – 2nd Year:

As costs are incurred:

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                                        800,000
         Accounts Receivable              800,000

At the end of the period to record revenue earned:

Construction Expense                 500,000
CIP                                                   115,385
            Construction Revenue                           615,385

Construction Expense is equal to the amount incurred during this period
CIP is the amount computed as income this period (from the table)
Construction Revenue is a plug to balance the journal entry

At the end of the period the contract is completed:

Billings                                         2,000,000
            Construction in Process          2,000,000

This will make billings and construction in process equal 0.
The amount it takes to 0 them out is always equal to the total contract price.

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
Costs incurred during the year $ 3,300,000 $3,100,000
Estimated costs to complete on 12/31 $ 2,100,000 $                0
Billings during the year $ 2,250,000 $3,750,000
Collections during the year $ 2,000,000 $4,000,000

A. Prepare a table that calculates the amount of income or loss to be recognized for the first and second.
B. Prepare all journal entries required for the first and second year.
C. Record the journal entry(ies) that would be different given the company cannot estimate costs to be incurred.

Answer
12. A. Table that computes income:

Contract Price $6,000,000 $6,000,000
     
Cost to Date (cumulative) $3,300,000 $6,400,000
+ Estimated Cost to Complete (from this point to the end) $2,100,000 $                 0
= Total Cost $5,400,000 $6,400,000
= Estimated Income (Price – Total Cost) $  600,000 $ (400,000)
x Estimated % Complete (cost to date divided by total cost) .6111 .100
= Estimated income to record to date
(Estimated income x % complete)
$ 366,660 $ (400,000)
– Less cumulative income recorded in all previous years $             0 $ (366,660)
= Income to record this period $   366,660 $ (766,660)

12. B. Journal Entries – 1st Year:

As costs are incurred:

Construction in Process (CIP)           3,300,000
              A/P, cash, etc.                                   3,300,000

As the customer is billed:

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

As payment is collected from the customer:

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

At the end of the period to record revenue earned:

Construction Expense            3,300,000
CIP                                            366,660
           Construction Revenue                      3,666,660

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

12. B. Journal Entries – 2nd Year:

As costs are incurred:

Construction in Process (CIP)        3,100,000
                A/P, cash, etc.                             3,100,000

As the customer is billed:

Accounts Receivable           3,750,000
            Billings (liability)             3,750,000

As payment is collected from the customer:

Cash                                          4,000,000
         Accounts Receivable             4,000,000

At the end of the period to record revenue earned:

Construction Expense                         3,100,000
                  Construction In Process               766,660
                  Construction Revenue               2,333,340

Construction Expense is equal to the amount incurred during this period
CIP is the amount computed as income this period (from the table)
Construction Revenue is a plug to balance the journal entry

At the end of the period the contract is completed:

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

This will make billings and construction in process equal 0.
The amount it takes to 0 them out is always the total contract price.

 

12. C. Entries when recognizing revenue upon delivery:

The first 3 entries for both years are the same.
The entry to close out billings and construction in process is the same.

Construction revenue and construction expense is only recorded at the end of the second year when the contract is completed for the total amount.

Construction Expense             6,400,000
                 Construction In Process       400,000
                 Construction Revenue          6,000,000

13. A construction company began work on a new town square and refurbishing of several buildings along the square with a negotiated contract price of $5,000,000. The customer does not control the asset while it is in construction. Additional data is as follows:

  Year 1 Year 2
Costs incurred during the year $ 2,350,000 $3,100,000
Estimated costs to complete on 12/31 $               ? $              0
Billings during the year $ 2,000,000 $3,000,000
Collections during the year $ 1,500,000 $3,500,000

Record all journal entries required for year 1 and year 2.

Answer
The costs to complete can not be estimated and therefore revenue is recognized upon delivery. No table is used.

13. Journal Entries – 1st Year:

As costs are incurred:

Construction in Process (CIP)           2,350,000
              A/P, cash, etc.                                   2,350,000

As the customer is billed:

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

As payment is collected from the customer:

Cash                                      1,500,000
        Accounts Receivable          1,500,000

Do not record construction revenue or construction expense.

 

13. Journal Entries – 2nd Year:

As costs are incurred:

Construction in Process (CIP)       3,100,000
            A/P, cash, etc.                                  3,100,000

As the customer is billed:

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

As payment is collected from the customer:

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

At the end of the 2nd year record total revenue earned and total expenses incurred for the entire contract:

Construction Expense          5,450,000
           CIP                                           450,000
           Construction Revenue         5,000,000

Construction Expense is equal to total expenses incurred for the contract
CIP is the total amount of profit on the contract
Construction Revenue is the total contract price

At the end of the 2nd year after the asset is delivered:

Billings                                      5,000,000
            Construction in Process          5,000,000

Makes billings and construction in process equal 0.
The amount is always the total contract price.