construction contracts Flashcards
percentage of completion method
first calculate the estimated gross profit of the completed contract and then multiply that amount by the % of completion to date. An estimated loss is recognized immediately in the year it is discovered.
completed contract method
revenue is recognized when the contract is complete, however expected losses are recognized immediately in their entirety.
a current asset
The excess of accumulated costs ($2,000,000) plus estimated earnings ($250,000) over related billings ($1,800,000) will represent a current asset. A liability only exists when progress billings exceed costs and estimated earnings. Estimated earnings under the completed contract method are calculated as follows:
Calculate estimate profit = $9,000,000 − ($2,000,000 + $6,000,000) = $1,000,000
Percent complete = $2,000,000 / ($2,000,000 + $6,000,000) = 25%
Calculate gross profit earned to date = $1,000,000 × 25% = $250,000
Installment method of revenue recognition
Deferred gross profit = GP rate x AR
Under the installment method, total gross profit is deferred until cash payments are received.
Realized gross profit equals the gross profit percentage on the sale times the cash received.
The cost recovery method
Under the cost recovery method, revenue is recognized after cash equaling the cost of the item is collected.
Method is appropriate when there is no reasonable basis for estimating collectibility.
Accounting treatments are not necessarily determined by the timing of title transfer.
Since there is a presumption of cash collection, the cost recovery method would not be applicable.
If sales are subject to a high rate of return, then no sale will be recognized until returns can be determined.
The installment sales method
The installment sales method is permitted to be used only when installment sales are material and there is no reasonable basis for estimating collectability.
When collectability of installment accounts receivable is reasonably predictable, revenue must be recognized under the revenue recognition rule (when the revenue is realized or realizable and earned).
Future gains or losses to be recognized on merchandise repossessions have no bearing on the method used to recognize revenue when the merchandise is originally sold.
If collection expenses and bad debts on installment accounts receivable are deemed to be immaterial, then the company must have a reasonable basis of estimating collectability, in which case it is inappropriate to use the installment sales method of revenue recognition. The installment sales method can only be used when there is no reasonable basis for estimating collectability.
a nonmonetary exchange that lacks commercial substance
If cash (boot) received is less than 10% of the total consideration, a proportional amount of the gain is recognized.
commercial substance
In order to have commercial substance, either (1) the risk, timing, and amount of the expected future cash flows from the asset transferred differs significantly from the risk, timing, and amount of the expected future cash flows from the asset received, or (2) the entity-specific value (based on the company’s expectations of value of the asset and not that of the marketplace) of the asset received differs significantly (in relation to the fair values of the assets exchanged) from the asset transferred.
three exceptions to the general rule of valuing a transaction at fair value
- if the exchange was made solely to facilitate a sale to a third party that is not a party to the exchange (such as a customer).
- lack of commercial substance
commercial substance
the transaction is accounted for using the FAIR VALUE of the asset surrendered or received, whichever is more evident. In this question, it appears that the exchange has commercial substance, as it appears to culminate the earnings process (i.e., a truck is exchanged for stock, which would appear in a business sense to have affected the expected configuration of cash). Therefore, the accounting uses the fair value of the asset surrendered or the fair value of the asset received, whichever is more evident, as the value for the exchange.
When a loss is recorded, the asset received
is recorded at the book value of the asset given up plus any cash paid minus any cash received minus the loss recognized.
Under IFRS, non-monetary exchanges
exchanges of dissimilar assets are regarded as exchanges that generate revenue and all gains and losses are recognized.
Exchanges of similar assets are not regarded as exchanges that generate revenue and no gains are recorded.
a nonmonetary exchange lacks commercial substance
the reported amount of the nonmonetary asset surrendered is used to record the newly acquired asset. If the transaction has commercial substance, the fair value approach is used.
