Long-term construction contracts/Accounting for Installment Sales

Question 1

Completed Contract Method

Answer 1

• US GAAP only
• recognizes income only on completion of the contract
  Used when:
• difficult to estimate costs of a contract in progress
• many contract in progress at same time
• projects are short duration and collections not assured
• Not permitted under IFRS

Question 2

Balance Sheet Presentation - Completed Contract Method

Answer 2

The excess of accumulated costs over related billings should be reflected in the balance sheet as a current asset, and the excess of accumulated billings over related costs should be reflected as a current liability.
“Costs (billings) of uncompleted contracts in excess of related billings (costs)”

Question 3

Accounting for the Completed Contract Method

Answer 3

• Applicable OH and direct costs should be charged to a construction in progress account (asset)
• Billings and/or cash received should be credited to advances on construction in progress account (liability)
• Gross profit/loss = contract price - total costs
• losses should be recognized in full in the year they are discovered. rule of conservatism

Question 4

Advantages and Disadvantages of Completed Contract Method

Answer 4

• Advantage: it is based on final results rather than on estimates
• Disadvantage: it does not properly reflect the matching principle when the period of the contract extends over more than one accounting period.

Question 5

Percentage-of-Completion Method

Answer 5

• US GAAP and IFRS
• used when collection is assured, profitability is reasonably estimated, and provide a reliable measure of progress toward completion.
• recognizes income as work progresses on the contract…exception to the basic realization principle
• accrual method

Question 6

Determination of Revenues Recognized

Answer 6

Cost incurred/total expected cost
= work done/total expected work
= % of job “earned”

Question 7

Losses for % of Completion Method

Answer 7

A provision for the loss on the entire contract should be made when current estimates of the total contract costs indicate a loss. (rule of conservatism)

Question 8

Advantages and Disadvantages of % of Completion Method

Answer 8

• Advantage: the accurate reporting of the status of the uncompleted contracts and the periodic recognition of income currently as contracts are completed.
• Disadvantage: The necessity of relying on estimates of the ultimate cots.

Question 9

Accounting for % of Completion Method

Answer 9

An estimated loss on the total contract is recognized immediately in the year it is discovered. However, any previous gross profit or loss reported in prior years must be adjusted for when calculating the total estimated loss.

Question 10

Installment Method

Answer 10

• used only when there is no reasonable basis for estimating the degree of collectibility. Revenue is not recognized at the time a sale is made but rather when cash is actually collected. (cash basis)

Question 11

Gross Profit

Answer 11

= Sales - COGS

Question 12

Gross Profit Percentage

Answer 12

= Gross Profit/Sales Price

Question 13

Earned Gross Profit

Answer 13

= Cash collections * Gross Profit %

Question 14

Deferred Gross Profit

Answer 14

= Installment receivables * Gross Profit %

contra asset

Question 15

Cost Recovery Method

Answer 15

No profit is recognized on a sale until all costs have been recovered. At the time of sale, the expected profit on the sale is recorded as deferred gross profit. Cash collections are first applied to the recovery of product costs. Collections after all costs have been recovered are recognized as profit. (most conservative method)