23. Long-term construction-type contracts

Question 1

What’s the difference between the percentage-of-completion method and the completed-contract method of revenue recognition?

Answer 1

The main difference is the timing of revenue recognition. The percentage-of-completion method recognizes revenues and associated costs while a performance obligation is still being satisfied. The completed-contract method recognizes revenue and associated costs once the entire performance obligation is satisfied.

Question 2

How do you calculate the amount of profit to be recognized during a year under the percentage-of-completion method?

Answer 2

1. Total contract - estimated total cost = estimated total profit
2. Costs to date / estimated total cost = % of completion
3. Estimated total profit x % of completion = gross profit to date
4. Gross profit to date - gross profit in last period = gross profit in current period
5. Add gross profit in current period to construction in progress account

Construction in progress consists of expenses incurred to date (including prior years) plus profits recognized to date. Therefore, profits recognized to date equals construction in progress less expenses incurred to date. Therefore, profits during the year equals profits recognized to date less profits recognized in prior years.

Question 3

Under the percentage of completion method, billings and CIP are netted on the balance sheet at year-end to report what?

Answer 3

Either

1) costs + profit in excess of billings (a current asset)

or

2) billings in excess of costs + profits (a current liability)

Question 4

Under the percentage of completion method, what is reported on the income statement at year-end?

Answer 4

1. Revenues: total contract price (i.e. total project revenues) multiplied by percentage of completion to date minus revenues recognized in prior periods
2. Cost of sales: total costs (not profit) added to construction in process during the current period

Question 5

How do you calculate the percentage of completion under the percentage-of-completion method?

Answer 5

Use the cost-to-cost method:

Costs incurred to date ÷ Total construction costs (actual + estimated to complete) = Percentage of completion