M4 - Revenue Recognition: Part 2

Question 1

3 year contract. After year 1 an overall loss was anticipated. What would be the effect on Year 1 operating income under the GAAP percentage-of-completion and completed contract methods?

Answer 1

Both decrease. The estimated loss is recorded for a loss contract in progress (not only the loss incurred to date).

Question 2

True or false: Under the completed contract method, revenue is recognized when the contract is complete, however expected losses are recognized immediately in their entirety.

Answer 2

True (expected losses on contracts are recognized prior to job completion (conservatism))

Question 3

Project 1 Project 2
Contract Price 420,000 300,000
Cost incurred during Y2 240,000 280,000
Estimated costs to complete 120,000 40,000
Billed to customers during Y2 150,000 270,000
Received from customers during Y2 90,000 250,000

If Pell used the percentage-of-completion method, what amount of gross profit (loss) would Pell report in its Year 2 income statement?

Answer 3

For Project 1, 240,000 of the total costs of 360,000 have been incurred, or 2/3 of the total costs. The contract price of 420,000 less estimated costs of 360,000 gives an estimated profit of 60,000. Current profit is then 2/3 times 60,000 which is 40,000. Project 2 estimates a 20,000 loss (300,000 - 280,000 - 40,000) which is recognized immediately so the total profit would be 40,000 profit - 20,000 loss = 20,000 profit.

Question 4

A-company uses the completed contract method to account for a long term construction contract under US GAAP. Revenue is recognized when recorded progress billings: 
Are Collected (yes or no) 
Exceed recorded costs (yes or no)

Answer 4

No-no
When a company uses the US GAAP completed contract method to account for a long term construction contract revenue is recognized when the job is completed not win progress billings are collected or when they exceed record it cost.
When the percentage of completion contract method of recording revenue is used, engineering estimates of completion or cost incurred to date versus total estimated cost is the basis for recognizing revenue not progress Billings.

Question 5

What is the formula to find the annual gross profit under the percentage-of-completion method?

Answer 5

(total cost incurred/total expected cost) x (total expected gross profit) - total gross profit previously recognized.

In the final year of the contract, actual rather than expected amounts are used.

Question 6

When does a liability exist under the percentage of completion contract method?

Answer 6

A liability only exist when progress billings exceed cost an estimated earnings.