18-1
Two methods of accounting for long-term construction
contracts:
Percentage-of-completion method.
Cost-recovery (zero-profit) method.
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-2
Rationale for using percentage-of-completion accounting
is that under most of these contracts, the
Buyer and seller have enforceable rights.
Buyer has the legal right to require specific performance on
the contract.
Seller has the right to require progress payments that
provide evidence of the buyer’s ownership interest.
As a result, a continuous sale occurs as the work
progresses and companies should recognize revenue
according to that progression.
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-3
Companies must use the percentage-of-completion method
when all of the following conditions exist.
1. Total contract revenue can be measured reliably;
2. It is probable that the economic benefits associated with the
contract will flow to the company;
3. Both the contract costs to complete the contract and the stage
of contract completion at the end of the reporting period can
be measured reliably; and
4. The contract costs attributable to the contract can be clearly
identified and measured reliably so the actual contract costs
incurred can be compared with prior estimates.
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-4
Companies should use the cost-recovery method when one
of the following conditions applies:
1. When a company cannot meet the conditions for using the
percentage-of-completion method, or
2. When there are inherent hazards in the contract beyond the
normal, recurring business risks.
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-5
Calculation for Revenue to Be Recognized
LO 3 Apply the percentage-of-completion method for long-term contracts.
Illustration 18-11
Illustration 18-12
Illustration 18-13
Percentage-of-Completion Method
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-6 LO 3 Apply the percentage-of-completion method for long-term contracts.
Illustration: KC Construction Company has a contract to
construct a €4,500,000 bridge at an estimated cost of
€4,000,000. The contract is to start in July 2010, and the
bridge is to be completed in October 2012. The following data
pertain to the construction period.
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-7 LO 3 Apply the percentage-of-completion method for long-term contracts.
Illustration: Compute percentage complete.Illustration 18-6
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-8 LO 3 Apply the percentage-of-completion method for long-term contracts.
Illustration: KC would make the following entries to record
(1) the costs of construction, (2) progress billings, and (3)
collections.Illustration 18-7
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-9
Percentage-of-Completion, Revenue and Gross Profit, by YearIllustration 18-16
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-10 LO 3 Apply the percentage-of-completion method for long-term contracts.
Illustration: KC’s entries to recognize revenue and gross
profit each year and to record completion and final approval
of the contract.Illustration 18-17
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-11 LO 3 Apply the percentage-of-completion method for long-term contracts.
Illustration: Content of Construction in Process Account—
Percentage-of-Completion Method
Illustration 18-18
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-12 LO 3 Apply the percentage-of-completion method for long-term contracts.
Financial Statement Presentation—Percentage-of-
Completion
Illustration 18-19
Computation of Unbilled Contract Price at 12/31/10
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-13
Financial Statement—Percentage-of-Completion
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
Illustration 18-20
LO 3
18-14
Illustration: For the bridge project illustrated on the preceding
pages, Hardhat Construction would report the following revenues and
costs.
Cost-Recovery (Zero-Profit) MethodCost-Recovery (Zero-Profit) Method
LO 4 Apply the cost-recovery method for long-term contracts.
Illustration 18-21
18-15
Illustration: Hardhat’s entries to recognize revenue and gross profit
each year and to record completion and final approval of the contract.
Cost-Recovery (Zero-Profit) MethodCost-Recovery (Zero-Profit) Method
LO 4 Apply the cost-recovery method for long-term contracts.
Illustration 18-22
18-16
Illustration: Comparison of gross profit recognized under different
methods.
Cost-Recovery (Zero-Profit) MethodCost-Recovery (Zero-Profit) Method
LO 4 Apply the cost-recovery method for long-term contracts.
Illustration 18-23
18-17
Financial Statement—Cost-Recovery Method
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
Illustration 18-24
LO 4 Apply the cost-recovery method for long-term contracts.
18-18
2010 2011 2012 Contract price €675,000 €675,000 €675,000 Cost incurred current year 150,000 287,400 170,100 Estimated cost to complete in future years 450,000 170,100 0 Billings to customer current year 135,000 360,000 180,000 Cash receipts f rom customer Current year 112,500 262,500 300,000
A) Prepare the journal entries for 2010, 2011, and 2012. A) Prepare the journal entries for 2010, 2011, and 2012.
LO 3 Apply the percentage-of-completion method for long-term contracts.
Illustration:
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
Casper Construction Co.
18-19 LO 3 Apply the percentage-of-completion method for long-term contracts.
2010 2011 2012
Costs incurred to date € 150,000 € 437,400 € 607,500
Estimated cost to complete 450,000 170,100
Est. total contract costs 600,000 607,500 607,500
Est. percentage complete 25.0% 72.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 486,000 675,000
Rev. recognized prior year (168,750) (486,000)
Rev. recognized currently 168,750 317,250 189,000
Costs incurred currently (150,000) (287,400) (170,100)
Gross profi t recognized € 18,750 € 29,850 € 18,900
Illustration:
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-20 LO 3 Apply the percentage-of-completion method for long-term contracts.
Construction in progress 150,000 287,400 170,100 Cash 150,000 287,400 170,100
Accounts receivable 135,000 360,000 180,000 Billings on contract 135,000 360,000 180,000
Cash 112,500 262,500 300,000 Accounts receivable 112,500 262,500 300,000
Construction in progress 18,750 29,850 18,900 Construction expense 150,000 287,400 170,100
Construction revenue 168,750 317,250 189,000
Billings on contract 675,000 Construction in progress 675,000
20122010 2011
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
Illustration:
18-21 LO 3 Apply the percentage-of-completion method for long-term contracts.
Income Statement 2010 2011 2012
Revenue on contracts 168,750$ 317,250$ 189,000$
Cost of construction 150,000 287,400 170,100 Gross profit 18,750 29,850 18,900
Balance Sheet (12/31)Current assets:
Accounts receivable 22,500 120,000 - Cost & profits > billings 33,750
Current liabilities:Billings > cost & profits 9,000
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
Illustration:
18-22
Companies recognize revenue only to the extent of costs
incurred that are expected to be recoverable.
Only after all costs are incurred is gross profit recognized.
LO 4 Apply the cost-recovery method for long-term contracts.
Cost-Recovery Method
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-23
Cost-Recovery MethodCost-Recovery Method
Illustration:
Construction in progress 150,000 287,400 170,100 Cash 150,000 287,400 170,100
Accounts receivable 135,000 360,000 180,000 Billings on contract 135,000 360,000 180,000
Cash 112,500 262,500 300,000 Accounts receivable 112,500 262,500 300,000
Construction in progress 67,500 Construction expense 150,000 287,400 170,100
Construction revenue 150,000 287,400 237,600
Billings on contract 675,000 Construction in progress 675,000
20122010 2011
LO 4 Apply the cost-recovery method for long-term contracts.
18-24
Illustration:
Income Statement 2010 2011 2012
Revenue on contracts € 0 € 0 € 675,000
Cost of construction - - 607,500 Gross profit - - 67,500
Balance Sheet (12/31)Current assets:
Accounts receivable 22,500 120,000 - Cost & profits > billings 15,000
Current liabilities:Billings > cost & profits 57,600
Cost-Recovery MethodCost-Recovery Method
LO 4 Apply the cost-recovery method for long-term contracts.
18-25 LO 5 Identify the proper accounting for losses on long-term contracts.
Loss in the Current Period on a Profitable Contract
► Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustment of
gross profit recognized in prior periods.
Loss on an Unprofitable Contract
► Under both percentage-of-completion and completed-
contract methods, the company must recognize in the
current period the entire expected contract loss.
Long-Term Contract Losses
Long-Term Contracts (Construction)Long-Term Contracts (Construction)
18-26
Illustration: Loss in Current Period
Long-Term Contract LossesLong-Term Contract Losses
LO 5 Identify the proper accounting for losses on long-term contracts.
2010 2011 2012 Contract price €675,000 €675,000 €675,000 Cost incurred current year 150,000 287,400 215,436 Estimated cost to complete in future years 450,000 215,436 0 Billings to customer current year 135,000 360,000 180,000 Cash receipts f rom customer Current year 112,500 262,500 300,000
b) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated cost to complete at the end of 2011 was €215,436 instead of €170,100.
b) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated cost to complete at the end of 2011 was €215,436 instead of €170,100.
Casper Construction Co.
18-27
2010 2011 2012
Costs incurred to date € 150,000 € 437,400 € 652,836
Estimated cost to complete 450,000 215,436
Est. total contract costs 600,000 652,836 652,836
Est. percentage complete 25.0% 67.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 452,250 675,000
Rev. recognized prior year (168,750) (452,250)
Rev. recognized currently 168,750 283,500 222,750
Costs incurred currently (150,000) (287,400) (215,436)
Gross profi t recognized € 18,750 (€ 3,900) € 7,314
Long-Term Contract LossesLong-Term Contract Losses
LO 5 Identify the proper accounting for losses on long-term contracts.
Illustration: Loss in Current Period
18-28
Construction in progress 18,750 7,314 Construction expense 150,000 215,436
Construction revenue 168,750 222,750
Construction in progress 3,900 Construction expense 287,400
Construction revenue 283,500
20122010 2011
Long-Term Contract LossesLong-Term Contract Losses
LO 5 Identify the proper accounting for losses on long-term contracts.
Illustration: Loss in Current Period
18-29
Illustration: Loss on Unprofitable Contract
Long-Term Contract LossesLong-Term Contract Losses
LO 5 Identify the proper accounting for losses on long-term contracts.
2010 2011 2012 Contract price €675,000 €675,000 €675,000 Cost incurred current year 150,000 287,400 246,038 Estimated cost to complete in future years 450,000 246,038 0 Billings to customer current year 135,000 360,000 180,000 Cash receipts f rom customer Current year 112,500 262,500 300,000
c) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated cost to complete at the end of 2011 was € 246,038 instead of € 170,100.
c) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated cost to complete at the end of 2011 was € 246,038 instead of € 170,100.
Casper Construction Co.
18-30
2010 2011 2012
Costs incurred to date € 150,000 € 437,400 € 683,438
Estimated cost to complete 450,000 246,038
Est. total contract costs 600,000 683,438 683,438
Est. percentage complete 25.0% 64.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 432,000 675,000
Rev. recognized prior year (168,750) (432,000)
Rev. recognized currently 168,750 263,250 243,000
Costs incurred currently (150,000) (290,438) (243,000)
Gross profi t recognized € 18,750 (€ 27,188) € 0
Long-Term Contract LossesLong-Term Contract Losses
LO 5
$675,000 – 683,438 = (8,438) cumulative loss Plug
Illustration: Loss on Unprofitable Contract
18-31
Construction in progress 18,750 - Construction expense 150,000 243,000
Construction revenue 168,750 243,000
Construction in progress 27,188 Construction expense 290,438
Construction revenue 263,250
20122010 2011
Long-Term Contract LossesLong-Term Contract Losses
LO 5 Identify the proper accounting for losses on long-term contracts.
Illustration: Loss on Unprofitable Contract
18-32
Loss on construction contract 8,438
Construction in progress 8,438
Construction expense 287,400
Construction revenue 287,400
2010 2011
Long-Term Contract LossesLong-Term Contract Losses
LO 5 Identify the proper accounting for losses on long-term contracts.
For the Cost-Recovery method, companies would recognize the
following loss:
Illustration: Loss on Unprofitable Contract