Revenue on Long-Term Contracts

Self Test

Key Things to Know

j

Practice as You Learn

Self Test

b

Easy Test

h

Medium Test

Self Test

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

1. Recognize revenue over time when a company

a. knows the total price of the contract
b. can reasonably estimate the total cost of the project
c. can estimate the cost incurred as you work on the project
d. all of the above

Answer
D. All the above are required to use the percentage of completion method and estimate and record revenue each period during asset construction.
2. Recognize revenue at the time of delivery when the

a. price of the contract is uncertain and future costs can not be estimated
b. total cost of the contract can be reasonably estimated
c. contract is completed in less than one year
d. all of the above

Answer
A. Revenue is recognized at the time of delivery when future costs can not be reliably estimated. When costs can’t be reliably estimated, income and revenues can not be reliably estimated and is not recorded.
3. Under the percentage of completion method (over time) revenue is recognized based on

a. what percent of the contract price has been collected
b. what percent of the contract price has been billed
c. what percent of the contract has been finished
d. what percent of the total income has been earned

Answer
C. Revenue is recognized over time based on the percentage of the work done on the contract to date.
4. Compute the percentage used to estimate income when recognizing revenue and income over time as

a. contract price divided by total costs
b. costs to date divided by total estimated costs
c. revenues recorded to date divided by the total contract price
d. total estimated costs divided by costs to date

Answer
B. The percentage used to recognize revenue and income is computed as costs incurred to date divided by total estimated costs. The percentage is a measure of how much of the work is complete. Revenue is recorded for the portion of the completed obligation.
5. The account “construction in process” is a(n)

a. asset account
b. liability account
c. revenue account
d. gross profit account

Answer
A. Construction in process is an asset account like a long-term inventory account that accumulates the cost of what will be provided to the customer.
6. The account “billings” is

a. an asset account
b. a liability account
c. a revenue account
d. an expense account

Answer
B. Billings is a liability account. It represents the portion of the project the contractor owes to the customer.
7. Credit the account “billings” when

a. cash is received from the customer
b. the customer is requested to pay
c. the contract is completed
d. both b. and c.

Answer
B. Credit billings when the contractor invoices the customer for the invoice amount. Billings is a liability because the contractor owes the asset in construction to the customer. Debit the billings account when cash is received and the contract is completed.
8. Use the “construction in process” account when

a. expenses are incurred
b. gross profit is recorded
c. only when the project is complete
d. both a. and b.

Answer
D. Use the construction in process account to record costs incurred during the period and to record profit or loss. The total amount in the construction in process account is the total amount invested to construct the asset.
9. When is “construction revenue” recorded when a company does not earn revenue over time?

a. when cash is received
b. when the contract is completed
c. during each period work occurs on the contract
d. all of the above

Answer
B. Record construction revenue and construction expense only at the end of the contract when the revenue can be estimated because costs and revenue are know. Revenue is only recorded prior to completion when a reliable estimate of revenue earned in the period is possible.
10. Which of the following two accounts will the accountant close against each other when the asset is delivered?

a. accounts receivable and billings
b. billings and construction expense
c. billings and construction in process
d. accounts receivable and construction in process

Answer
C. The accounts “billings” and “construction in process” are both closed to 0 when the contract is complete and the asset is delivered. Nothing is owed to the customer once the asset is delivered to the customer. The seller/contractor no longer has the asset after the asset is delivered to the customer (no CIP). The total in each account before they are closed against each other will equal the total price of the contract.
11. The two accounts netted with the largest account reported on the balance sheet are

a. billings and accounts receivable
b. billings and construction in process
c. construction in process and accounts receivable
d. accounts receivable and accounts payable

Answer
B. Net the asset account “construction in process” with the liability account “billings” to show the net asset or liability that represents the work under one contract.
12. The table that computes income for the current year must be used instead of the % of revenue (total revenue x % complete to date) when

a. it is the first year of the contract
b. it is the last year of the contract
c. the company expects incur loss on the contract
d. the company expects to earn income on the contract

Answer
C. A company must recognize 100% of an expected loss in the first year the company expects a total loss on the contract. The percent of the total work complete cannot be used to compute revenue to recognize when a loss on the contract is expected.
13. Record a credit to the construction in process account when

a. costs are incurred during the current year
b. the asset is delivered to the customer
c. the amount of income earned on the contract to date increases
d. the customer pays the contractor

Answer
B. The total amount of construction in process decreases with a credit when the asset is delivered to the customer. Record current period costs incurred and income earned with a debit to CIP. Accounts receivable decreases and cash increases when the customer pays the contractor.
14. The amount recorded during each period changes as the percentage complete changes for which account?

a. billings
b. accounts receivable
c. cash
d. construction in process

Answer
D. Record the amount of income earned (lost) to the construction in process account, which varies based on the percent of work completed to date (see the table that computes income earned). Billings, accounts receivable, and cash vary with contract terms.
15. Report the net of construction expense and construction revenue on the income statement as

a. net income
b. operating income
c. other income
d. gross profit (margin)

Answer
D. Contractors use the multi-step income statement that reports the gross profit earned as a result of revenue earned in exchange for the direct contract costs related to the contract.