Revenue on Long-Term Contracts

Practice as You Learn

Practice as You Learn

 

Practice Problem 1. Record revenue over time (% of completion method):

A Construction company began work on a new elementary school with a negotiated contract price of $10,000,000. The school was completed by the end of the second year. Additional data is as follows:

  Year 1 Year 2
Costs incurred during the year $ 4,500,000 $4,800,000
Estimated costs to complete on 12/31 $ 4,600,000 $              0
Billings during the year $ 4,250,000 $5,750,000
Collections during the year $ 4,000,000 $6,000,000

A. Prepare a table that calculates the amount of income or loss to be recognized for the life of the contract.
B. Prepare all journal entries required for the life of the contract using the percentage of completion method.

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

Year 1 Year 2
Contract Price $10,000,000 $10,000,000
Cost to Date (cumulative) $4,500,000 $9,300,000
+ Estimated Cost to Complete (from this point to the end) $4,600,000 $                   0
= Total Estimated Cost $9,100,000 $9,300,000
= Estimated Income (Contract Price – Total Cost) $ 900,000 $    700,000
x Estimated % Complete (cost to date / total cost) 0.4945 100%
= Estimated income to record to date
(Estimated income x % complete)
$     445,050 $     700,000
– Cumulative income recorded in all previous years $                 0 $   (445,050)
= Income to record this period $     445,050 $      254,950

The cost to date amount is cumulative; in the first year it is first year costs and in the second year it is first plus second year costs.

The estimated % complete is computed as costs to date divided by total estimated costs 4,500,000 / 9,100,000 = 0.4945

For the second year, it is all finished and is 100% complete.

Estimated income to record to date is a cumulative amount: current year plus all prior years

 

1. B. Journal Entries – 1st Year:

Very Important:
The amount in the journal entry is for the current year only.
Do not put cumulative amounts in the journal entries.

Costs are incurred, current Year only:

Construction in Process (CIP)  4,500,000
                A/P, cash, etc.                           4,500,000

The customer is billed, current year only

Accounts Receivable             4,250,000
               Billings (liability)               4,250,000

Collected from the customer, current year only

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

At the end of the period to record revenue earned, current year only

Construction expense is the amount of costs incurred this year.
CIP represents the profit recorded this year and is the final amount in the 1st year in the table above.
Construction revenue is a plug to make the journal entry balance.

Construction Expense          4,500,000
Construction in Process          445,050
          Construction Revenue                    4,945,050

 

Journal Entries – 2nd Year:

Very Important:
The amount in the journal entry is for the current year only.
Do not put cumulative amounts in the journal entries.

Costs are incurred, current Year only:

Construction in Process (CIP)      4,800,000
                A/P, cash, etc.                           4,800,000

The customer is billed, current year only

Accounts Receivable            5,750,000
           Billings (liability)                  5,750,000

Collected from the customer, current year only

Cash                                          6,000,000
        Accounts Receivable                  6,000,000

At the end of the period to record revenue earned, current year only

Construction expense is the amount of costs incurred this year.
CIP represents the profit recorded this year and is the final amount in the 2nd year in the table.

Construction revenue is a plug to make the journal entry balance.

Construction Expense           4,800,000
Construction in Process           254,950
            Construction Revenue                  5,054,950

 

At the end of the period the contract is completed:

Billings                               10,000,000
               Construction in Process           10,000,000

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

 

 

Things to Notice:

Total recorded to “Construction in Process” must be equal to the total contract price

Year 1 costs 4,500,000
Year 2 costs 4,800,000
Year 1 profit 445,050
Year 2 profit 254,950
Total 10,000,000

Total Billings must be equal to the total contract price
(4,250,000 + 5,750,000 = 10,000,000)

Total profit/loss for all cumulative years must be equal to the total profit/loss on the entire contract. (445,050 + 254,950 = 700,000 total profit)

Practice Problem 2. Record revenue upon delivery of the asset

A Construction company began work on a new elementary school with an initial negotiated contract price of $10,000,000 that is subject to change. The construction company cannot reliably estimate the total cost of the contract. The customer does not control the asset while it is in construction. The school was completed by the end of the second year. Additional data is as follows:

Year 1 Year 2
Costs incurred during the year $ 4,500,000 $4,800,000
Billings during the year $ 4,250,000 $5,750,000
Collections during the year $ 4,000,000 $6,000,000

Prepare all journal entries required for the life of the contract.

Answer
No table can be prepared because cost to complete can not be reasonably estimated and therefore income to date can not be reasonably estimated.

Journal Entries – 1st Year:

Very Important:
The amount in the journal entry is for the current year only.
Do not put cumulative amounts in the journal entries.

Costs are incurred, current Year only:

Construction in Process (CIP)    4,500,000
          A/P, cash, etc.                             4,500,000

The customer is billed, current year only

Accounts Receivable         4,250,000
            Billings (liability)              4,250,000

Collected from the customer, current year only

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

Construction Revenue and Construction Expense is not recorded until the contract is
completed.

 

2. Journal Entries – 2nd Year:

Very Important:
The amount in the journal entry is for the current year only.

Costs are incurred, current Year only:

Construction in Process (CIP)     4,800,000
                A/P, cash, etc.                           4,800,000

The customer is billed, current year only

Accounts Receivable         5,750,000
           Billings (liability)            5,750,000

Collected from the customer, current year only

Cash                                      6,000,000
        Accounts Receivable       6,000,000

 

This is the only part that it different from the Percentage of Completion Method:

Construction is complete and total construction revenue and total construction expense is
recorded in the period it is completed.

Construction expense is the amount of total costs incurred. Construction in Process
represents the total profit on the contract. Construction revenue is a plug to make the
journal entry balance.

Construction Expense           9,300,000
Construction in Process            700,000
          Construction Revenue                  10,000,000

 

At the end of the period the contract is completed:

Billings                                    10,000,000
          Construction in Process         10,000,000

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.