Practical Accounting 2 LONG-TERM Construction Contracts PDF

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PRACTICAL ACCOUNTING 2PRACTICAL ACCOUNTING 2Monday, July 20, 2015LONG-TERM CONSTRUCTION CONTRACTSLONG-TERM CONSTRUCTION CONTRACTS========================================================================In accounting for long-term construction contracts (those taking longer than one year to complete),...

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PRACTICAL ACCOUNTING 2 Monday, July 20, 2015

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LONG-TERM CONSTRUCTION CONTRACTS

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LONG-TERM CONSTRUCTION CONTRACTS ======================================================================== In accounting for long-term construction contracts (those taking longer than one year to complete), the two methods commonly followed are percentage-of-completion and completed-contract. (a) The revenue recognized on a long-term construction contract under the percentage-of-completion method is determined by applying a percentage representing the degree of completion to the total contract price at the end of the accounting period. The percentage may be derived by dividing the costs incurred to date by the total estimated costs of the entire contract based on the most recent information. The revenue so derived is then reduced by the direct contract costs to determine the gross profit recognized in the initial period. In subsequent periods, since the percentage-of-completion method described produces cumulative results, revenue and gross profit recognized in prior periods must be subtracted to obtain current revenue and gross profit to be recognized. Under the completed-contract method, no earnings are recognized until the contract is substantially completed. For the period in which completion occurs, gross revenues include the total contract price. Total job costs incurred are deducted from gross revenues, resulting in recognition of the entire amount of gross profit in the completion period. If it is expected that a loss will occur on the contract, a provision for loss should be recognized immediately under both the completed-contract method and the percentage-ofcompletion method. (b) The percentage-of-completion method should be used when estimates of the bases upon which progress is measured are reasonably dependable and all the following conditions exist: 1. The contract clearly specifies the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement. 2. The buyer can be expected to satisfy all obligations under the contract. 3. The contractor can be expected to perform the contractual obligation. The completed-contract method should be used when inherent hazards or lack of dependable estimates cause the forecasts to be of doubtful value. (c) Under the percentage-of-completion method, a schedule is made of the contracts in process, showing the total costs incurred as of the end of a given period, the estimated gross profit recognized based on the degree of completion, and the total billings rendered on each individual contract. If costs incurred plus recognized profits exceed the related billings on a contract, this net figure is shown as a current asset. This treatment shows that the contractor has not fully billed the customer for work performed to date and has a claim against the customer for that portion of work completed but not yet billed. If billings on a contract exceed costs incurred plus estimated profits, this net figure is shown as a current liability, which means that the contractor has overbilled the customer for work done to date and must complete the work represented by the excess billings. Under the completed-contract method, the treatment of excess costs and billings is the same as under the percentage-of-completion method except that estimated profits are not computed because profit recognition is deferred until a contract is completed. The excess of costs over related billings on a contract is a current asset while the excess of billings over related costs on a contract is a current liability.

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▼ 2015 (16) ► September (2) ▼ July (10) INSTALLMENT SALES LONG-TERM CONSTRUCTION CONTRACTS TOA3 TOA2 TOA1 STANDARD COSTING - Variance Analysis ABC and STANDARD COSTING LINK: PROCESS COSTING, FOREX AND HEDGING, and MAS ... Joint Products Cost Just In Time ► June (4)

PROBLEM 1 Waya Construction Co. has used the cost to cost percentage of completion method of recognizing profits. Lia Ortega assumes leadership of the business after the retirement of her mother Lyca. In reviewing the records, Lia finds the following information regarding a recently completed building project for which the total contract was P500,000. 2009 2010 2011 Gross Profit (loss) P10,000 P35,000 P(5,000) Cost incurred/year 90,000 ? P205,000 Lia wants to know how effectively the company operated during the last three years on this project and, since the information is not complete, has asked you to help by answering the following questions a. How much cost was incurred in 2010? b. What percentage of the project was completed by the end of 2010? c. What was the total estimated gross profit on the project by the end of 2010? d. What was the estimated cost to complete the project at the end of 2010? e. What percentage of the project was completed by the end of 2009? PROBLEM 2

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PRACTICAL ACCOUNTING 2: LONG-TERM CONSTRUCTION CONTRACTS In 2009, Golden Engineering entered into an agreement to construct an office building at a contract price of P5,100,000. Construction data were as follows: 2009 P 750,000

Construction costs incurred Estimated costs to complete Progress billings Collections from client

2010 P2,700,000

3,000,000

862,500

570,000 450,000

3,600,000 3,300,000

2011 P 630,000 -930,000 1,350,000

Prepare the necessary entries for each year, assuming the firm uses the: (1) (2)

completed-contract method percentage-of-completion method.

PROBLEM 3 Solidrock Construction contracted to build a ship over a two year period. The contract price was P21,000,000 with an estimate total cost of P18,400,000. The following cost data relate to the construction period.

Year 2009 2010 2011

Costs Incurred in Year P9,000,000 9,500,000 0

Estimated Cost to Complete P10,000,000 0 0

Billings P11,000,000 8,000,000 2,000,000

Cash Collected P7,500,000 9,000,000 4,500,000

Prepare the necessary journal entries for 2009, 2010, and 2011 assuming Solidrock uses the percentage-ofcompletion method. PROBLEM 4 Sealand Construction entered into a contract to construct a floating bridge across a lake. The contract price for the bridge is P7,500,000. During 2009, costs of P1,800,000 were incurred representing 30% of total expected costs. Prepare the necessary entries for 2009 to recognize gross profit for the year assuming the firm uses the (1) (2)

completed-contract method. percentage-of-completion method.

PROBLEM 5 .

In 2009, Mandaluyong Builders began construction work under a three-year contract at a price of P7,525,000. The firm uses the percentage-of-completion method for financial accounting purposes. The income to be recognized each year is based on the proportion of cost incurred to the total estimated costs for completing the contract. The financial statement presentations relating to this contract on December 31, 2009, are: Balance Sheet Accounts receivable ........................ Construction in progress ................... Less progress billings .....................

P150,500 P602,000 562,000

Income Statement Gross profit on construction contracts .....

40,000

P301,000

Determine the (1) cash collected in 2009. (2) estimated income on the construction contract.

PROBLEM 6 On January 1, 2009, Jaguar Enterprises obtained a contract to construct a building. It was estimated at the beginning of the contract that it would take three years to complete the project at an expected cost of P200,000. The contract price was P250,000. The following information describes the status of the job at the close of production each year:

Actual costs incurred ........... Estimated costs to complete ..... Billings on contract ............ Collections on contract .........

2009 P110,000 100,000 125,000 120,000

2010 P120,000 20,000 125,000 120,000

2011 P15,000 0 0 10,000

Compute the items listed below for each year assuming the use of the percentage-of-completion cost-tocost method. (Round all percentages to two decimals). 2009

2010

2011

1. Revenue recognized during the year ..........................

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PRACTICAL ACCOUNTING 2: LONG-TERM CONSTRUCTION CONTRACTS 2. Gross profit recognized during the year ...................... 3. Balance in the construction in progress account at December 31 (after closing entries) ....... 4. Balance in the progress billings account at December 31 (after closing entries) ..............

PROBLEM 7 On January 1, 2009, Boston Inc. obtained a contract to construct a building. It was estimated at the beginning of the contract that it would take 3 years to complete the project at an expected cost of P200,000. The contract price was P250,000. The following information describes the status of the job at the close of production each year:

Actual costs incurred ............ Estimated costs to complete ...... Billings on contract ............. Collections on contract ..........

2009 P150,000 90,000 110,000 100,000

2010 P100,000 20,000 120,000 120,000

2011 P15,000 0 20,000 30,000

Compute the items listed below for each year assuming the use of the percentage-of- completion cost-tocost method. (Round all percentages to two decimals.) 2009

2010

2011

1. Construction costs (expense) recognized during the year .... 2. Gross profit recognized during the year ...................... 3. Balance in the construction in progress account at Dec. 31 (after closing entries) ....... 4. Balance in accounts receivable at Dec. 31 (after closing entries) ......................

LONG-TERM CONSTRUCTION CONTRACTS Multiple Choice

Identify the choice that best completes the statement or answers the question.

____ 1. How should the balances of Progress Billings and Construction in Progress be shown at reporting dates prior to the completion of a long-term contract? a. Progress Billings as income, Construction in Progress as inventory. b. Net, as income from construction if credit balance, and loss from construction if debit balance. c. Progress Billings as deferred income, Construction in Progress as a current asset. d. Net, as a current asset if debit balance and current liability if credit balance. ____ 2. If the percentage-of-completion method is used, what is the basis for determining the gross profit to be recognized in the second year of a three-year contract? a. Cumulative actual costs incurred only. b. Incremental cost for the second year only. c. Cumulative actual costs and estimated costs to complete. d. No gross profit would be recognized in year 2. ____ 3.. If the completed-contract method is used, what is the basis for determining the income to be recognized in the second year of a three-year contract?

a. b. c. d.

Cumulative actual costs incurred only. Incremental cost for the second year only. Latest available estimated costs. No income would be recognized in year 2.

____ 4. Which of the following would be used in the calculation of the gross profit recognized in the third and final year of a construction contract that is accounted for using the percentage-of-completion method? Actual Income Contract Total Previously

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PRACTICAL ACCOUNTING 2: LONG-TERM CONSTRUCTION CONTRACTS a. b. c. d.

Price Yes Yes Yes No

Yes Yes No Yes

Costs No Yes Yes Yes

Recognized

____ 5. Assume the percentage-of-completion method of revenue recognition is used on a long-term construction contract. Under this method, revenues that are earned but unbilled at the balance sheet date should be disclosed a. as a long-term receivable in the noncurrent assets section of the balance sheet. b. only as a footnote disclosure until the customer is billed for the percentage of work completed. c. as construction in progress in the current assets section of the balance sheet. d. as construction in progress in the noncurrent assets section of the balance sheet.

____ 6. The completed-contract method of accounting for long-term construction-type contracts is preferable when a. a contractor is involved in numerous projects. b. the contracts are of a relatively long duration. c. estimates of costs to complete and extent of progress toward completion are reasonably dependable. d. there are inherent uncertainties in the contract beyond normal business risks.

____ 7. Which of the following is not a difference between the percentage-of completion and completed-contract methods of accounting for long-term construction contracts? a. They report different amounts for inventory during the construction period. b. They report different amounts for progress billings during the construction period. c. They cause a different cash inflow during the construction period. d. They report different amounts for accounts receivable during the construction period.

____ 8. The theoretical support for using the percentage-of-completion method of accounting for long-term construction projects is that it a. is more conservative than the completed-contract method. b. reports a lower Net Income figure than the completed-contract method. c. more closely conforms to the cost principle. d. produces a realistic matching of expenses with revenues. ____ 9. If a company uses the completed-contract method of accounting for long-term construction contracts, then during the period of construction, financial information related to a long-term contract will a. appear on both the income statement and balance sheet during the construction period. b. appear only on the income statement during the period of construction. c. appear only on the balance sheet during the period of construction. d. not appear on the financial statements. ____ 10. When the percentage-of-completion method of accounting for long-term construction projects is used, why is Construction in Progress increased by the annual recognized gross profit on long-term construction contracts? a. The cost of the contract has increased. b. The project's value has increased above cost. c. The economy experiences inflation over the construction period. d. Construction in Progress is not increased by the annual recognized profit. ____ 11. When comparing the percentage-of-completion and completed-contract methods of accounting for long-term construction contracts, both methods will report a. the same balances each period in the Progress Billings account. b. the same expense for cost of construction each year. c. the same amount of income in the year of completion. d. the same inventory carrying value each year during the construction period.

____ 12. A company uses the percentage-of-completion method to account for a four year construction contract. Progress billings sent in the second year that were collected in the third year would a. be included in the calculation of the income recognized in the second year. b. be included in the calculation of the income recognized in the third year. c. be included in the calculation of the income recognized in the fourth year. d. not be included in the calculation of the income recognized in any year.

____ 13. In accounting for a long-term construction contract for which there is a projected profit, the balance in the Construction in Progress account at the end of the first year of work using the percentage-of-completion method would be

a. b.

zero. the same as the completed-contract method.

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PRACTICAL ACCOUNTING 2: LONG-TERM CONSTRUCTION CONTRACTS c. d.

higher than the completed-contract method. lower than the completed-contract method.

____ 14. On May 1, 2009, Pateros Construction Company entered into a fixed-price contract to construct an apartment building for P3,000,000. Pateros appropriately accounts for this contract under the percentage-ofcompletion method. Information relating to the contract is as follows: 2009 2010 At December 31: Percentage of completion ........ 20% 60% Estimated costs at completion ... P2,250,000 P2,400,000 Income recognized (cumulative) .. P 150,000 P 360,000 What is the amount of contract costs incurred during the year ended December 31, 2010?

a. b. c. d.

P600,000 P960,000 P990,000 P1,440,000

____ 15. Navotas Construction, Inc. has consistently used the percentage-of-completion method of recognizing income. Last year Navotas started work on a P4,500,000 construction contract, which was completed this year. The accounting records disclosed the following data for last year: Progress billings ..................................... Costs incurred ........................................ Collections ........................................... Estimated cost to complete ............................

P1,650,000 1,350,000 1,050,000 2,700,000

How much income should avotas have recognized on this contract last year?

a. b. c. d.

P105,000 P150,000 P300,000 P350,000

____ 16. Caloocan Construction, Inc. has consistently used the percentage-of-completion method of recognizing income. During 2009, Caloocan started work on a P1,500,000 fixed-price construction contract. The accounting records disclosed the following data for the year ended December 31, 2009: Costs incurred ........................................ Estimated cost to complete ............................ Progress billings ..................................... Collections ...........................................

P 465,000 1,085,000 550,000 350,000

How much loss should Caloocan have recognized in 2009?

a. b. c. d.

P15,000 P35,000 P50,000 P115,000

____ 17. Pasay Construction Company has consistently used the percentage-of- completion method. On January 10, 2009, Pasay began work on a P3,000,000 construction contract. At the inception date, the estimated cost of construction was P2,250,000. The following data relate to the progress of the contract: Gross profit recognized at December 31, 2009 .......... Costs incurred Jan. 10, 2009, through Dec. 31, 2010 ... Estimated cost to complete at December 31, 2010 .......

P 300,000 1,800,000 600,000

How much gross profit should Pasay recognize for the year ended December 31, 2010?

a. b. c. d.

P150,000 P262,500 P300,000 P450,000

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PRACTICAL ACCOUNTING 2: LONG-TERM CONSTRUCTION CONTRACTS

____ 18. For a construction firm using the completed-contract method, if costs exceed billings on some contracts by P1,000,000 and billings exceed costs by P800,000 on others, the contracts should ordinarily be reported as a a. current asset of P200,000. b. current liability of P200,000. c. current asset of P1,000,000 less a contra-current asset of P800,000. d. current asset of P1,000,000 and a current liability of P800,000. ____ 19. Makati Construction Company uses the per...