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Chapter 6 Long Term Construction Contracts 205
6. The percentage of completion of a contract at any statement of financial
position date is estimated on a cumulative basis. Therefore, changes in
estimates are automatically accounted for in the period in which the
change occurs and in future periods, which is in accordance with PAS 8,
Accounting Policies, Changes in Accounting Estimates and Errors.
CONDITIONS NECESSARY TO USE PERCENTAGE OF
COMPLETION ACCOUNTING
Several elements that should be present if percentage-of-completion accounting is
to be used.
1, Dependable estimates can be made of contract revenues, contract costs,
and the extent of progress toward completion.
2. The contract clearly specifies the enforceable rights regarding goods to be
provided and received by the parties, the consideration to be exchanged,
and the manner and terms of settlement.
3. The buyer can be expected to satisfy obligations under the contract.
4. The contractor can be expected to perform the contractual obligation.
; Re EOF
COMPLETION
1. Percentage of completion=
Actual costs incurred to date
‘Actual costs incurred to date + Est. cost to complete
2. Percentage of completion=
Actual costs incurred to date
Total costs at completion
3. Percentage of completion=
Revenue recognized
‘Contract price 206 AFAR
Percentage of Completion method. PAS 11 RECOGNIZES ONLY the percentage
of completion method of recognition of revenues and costs. The completed
contract method whereby no contract revenue or profits are recognized until the
contracts are completed or are substantially complete is not permitted under Pas 11
The stage of completion of a contract can be estimated by a variety of means,
depending on the nature of the contract and as to how it can be best measured: The
third method suggested is the zero profit method (sometimes referred to a cost
recovery method) wherein cost are recorded just like the first two method. The
revenue recorded is jest equal to the cost, so no profit is recorded during years of
construction, The toal profit is recognized upon completion just like completed
‘contract method.
PAS 11 provides that the stage of completion of a contract may be determined
using any of the following methods
‘A. The proportion that costs incurred at the statement of financial position
date bear to expected total costs required to complete the contract This is
the most commonly used (COST TO COST METHOD)
B. Certification of surveys of work performed; (ARCHITEST’S OR
ENGINEER'S ESTO,ATES)
C. Completion of physical proportion of the contract work. Example of this is
comparing the number of floors completed to the total floors required of a
condo,
ILLUSTRATIVE PROBLEM 1
Basic computations for revenues, costs, and profit illustrated. Assume San
Construction Company is constructing a multi-storey building at a fixed price of
20,000,000. Details of costs incurred during the first year of construction
activities are:
Labor cost 1,600,000
Cost of construction materials 3,400,000
Depreciation of equipment used in
construction 500,000
Marketing and selling expenses sale of
some sections of the building 2,600,000
Total 8,100,000
Additional estimated cost to complete ‘P4,500,000 Chapter 6 Long Term Construction Contract 207
Required: (Based on PAS 11)
1. Cost incurred to date
2. Percentage of completion
3. Revenue realized
4, Profit to be recognized for the year
5. Journal entries for the year
PERCENTAGE OF COMPLETION METHOD
1. Labor cost P1,600,000.
Cost of materials 2,400,000
Dépreciation — Equipment 500,000
Cost incurred to date ‘4,500,000
2. Percentage of completion = Cost incurred to date
‘Actual cost + Est. cost tol complete
= 4,500,000
4,500,000 + 7,500,000
= 315%
. 3. Revenue realized = Contract Price x Percentage of completion
= 20,000,000 x 37.5%
= 1,500,000
4. Revenue (20,000,000 x 37, 5%) 7,500,000
Cost (12,000,000 x 37.5%) 4500,
Gross Profit (_ 8,000,000 x 37.5%) 3,000,000
5, Journal entries
a. Construction in progress 4,500,000
‘Acorued payroll 1,600,000,
Materials, 2,400,000
Accumulated depreciation '300,000
To record cost incurred 208
b. Construction cost 4,500,000
‘Construction in progress 3,000,000
Construction revenue 7,500,000
Torecord profit for the year
‘Take note that the balance of the construction in progress account is equal to cost
of 4,500,000 plus gross profit realized P 3,000,000. Revenue realized is also
7,500,000 So if construction in progress is equal to cost incurred plus gross profit
realized and reverue recognized is also equal to cost incurred plus cost incurred
plus gross profit realized. then CIP = Revenue Recognized. To compute revenue
recognized simply multiply Contract Price by the percentage of completion (20,000,000
x37.5%)
COMPLETED CONTRACT METHOD ;
No profit is recognized during the year. The total profit will be recorded on
the year of completion. The entry for the year is only the recording of the
cost.
a. Construction in progress 4,500,000
Accrued payroll 1,600,000
Materials 2,400,000
Accumulated depreciation 500,000
To record cost incurred
ZERO PROFIT METHOD OR COST RECOVERY METHOD.
This is a combination of completed contract method and percentage of
completion method.
‘a. Construction in progress 4,500,000
Acerued payroll 1,600,000
Materials 2,400,000
Accumulated depreciation 500,000
To record cost incurred
b. Construction cost 4,500,000
Construction revenue 4,500,000
To record revenue realized Chapter 6 Long Term Construction Contract 209
Under this method (ZERO-PROFIT) the revenue realized is equal to cost so no
profit is realized during years of construction..The total profit is reported on the
year of completion.
Iustrative Problem 2
‘At the beginning of 2015, Smart Construction Company received a contract to
build a building for PSO million. The project is to take three years to complete.
‘According to the contract, Smart Construction Company wili bill the buyer in
installments over the construction period according to a prearranged schedule.
Information related to the contract isa follows
2018 2016 2017
Actual costs incurred during the year 15,000,000 10,000,000 16,000,000
Estimated cost to complete at year-end 22,500,000 15,000,000 -0-
Billings during the year 12,000,000 20,000,000 18,000,000
‘Collections during the year 10,000,000 14,000,000 26,000,000
Required:
1. Summary journal entries for the completed contract method.
2. Summary journal entries for the percentage of completion method.
3. Summary journal entries for the zero profit method
‘Completed contract method
2015 2016 2017
‘Construction in progress 15,000,000 10,000,000 16,000,000
Various-accounts 15,000,000 10,000,000 16,000,000
To record construction cost
‘Accounts Receivable 12,000,000. 20,000,000 18,000,000
Progress Billings 12,000,000. 20,000,000 18,000,000
To record billings
Cash 10,000,000 14,000,000 26,000,000
‘Accounts Receivable 10,000,000 14,000,000 26,000,000
To record collections
Entry to record profit recognized
‘Construction Cost 0 41,000,000,
Construction in progress 0- o 9,000,000
Construction Revenue 0 0 0,000,000 210
Progress Billings
Construction in pregress
PERCENTAGE OF COMPLETION METHOD
Construction in progress
‘Various accounts
To record constructon cost
Accounts Receivable
Progress Billings
To record billings
Cash
‘Accounts Receivable
To record collectiors
Entry to record profit recognized
Construction Cost
Construction in progress
Construction Revenue
Progress Billings
Construction in progress
Computations
Contract Price
‘Actual cost incurred curing the year
‘Actual cost ineurred prior years
‘Cumulative actual cos to date
Estimated cost to complete
Total costs
Total gross profit
“Multiplied by of % cf completion
Gross profit earned to date
Gross profit earned prior years
Gross profit recognized this year
Percentage of completion
2015
15,000,000
15,000,000
12,000,000
12,000,000
10,000,000
10,000,000
15,000,000
5,000,000
20,000,000
2016
10,000,000
10,000,000
20,000,000
20,000,000
14,000,000.
14,000,000
10,000,000
1,250,000
11,250,000
0,000,000
50,000,000
2017
16,000,000
16,000,000
18,000,000,
18,000,000
26,000,000
26,000,000,
16,000,000
2,750,000
18,750,000
50,000,000
50,000,000
2017
$0,000,000
16,000,000.
25,000,000
41,000,000
41,000,000
9,000,000
100%
9,000,000
£250,000
2,250,000
41,000,000
41,000,000
AFAR Chapter 6 Long Term Construction Contracts 211
ENTRIES UNDER ZERO PROFIT METNOD ~ THIS IS A COMBINATION OF
THE PERCENTAGE OF COMPLETION METHOD AND COMPLETED
CONTRACT METHOD (for each of construction year no profit is recognized ~
revenue recorded is equal to cost. Total profit is recorded on the year the contract
is completed just like the completed contract method
2015 2016 2017
‘Construction in progress 15,000,000 10,000,000. 16,000,000
Various accounts 15,000,000 10,000,000 16,000,000
To record construction cost
Accounts Receivable 12,000,000 20,000,000 18,000,000
+ Progress Billings 12,000,000 20,000,000 18,000,000
To record billings
Cash 10,000,000 14,000,000 26,000,000
‘Accounts Receivable 10,000,000 14,000,000 26,000,000
To record collections
Entry to record profit recognized
Construction Cost 15,000,000 41,000,000
Construction in progress 0 - 9,000,000
Construction Revenue 15,000,000 10,000,000 50,000,000
Progress Billings 30,000,000
Construction in progress 0,000,000
COMPARISON OF THE THREE METHODS :
Completed Percentage Zero-profit
Gross profit recognized
2015 None 5,000,000 None
2016 None 1,250,000 None
2017 9,000,000 2,750,000 9,000,000
Total 2,000,000 2,000,000 92,000,000
The total gross profit reported is the same for the three methods. The only
difference is that under the percentage of completion method, the gross profit is
shared by the 3 years of construction while under the completed contract and zero
profit, the total profit was reported on the third year, the year of completion. 212
AFAR
With both the completed contract, percentage of completion methods and zero
profit, all costs cf construction are recorded in an asset account called construction
in progress. This account is similar to the asset
in a manufacturing company. This is logical
essentially an inventory item in process for the
‘Take note that the periodic billings are credited to Progress Bi
is a contra account to the construction
the balances in these two accounts are
compared.
IS GREATER THAN PROGRESS BILLINGS)
financial position as an asset. However, if the
THAN PROGRESS) itis reported as a liability.
ILLUSTRATIVE PROBLEM 3
account work in process inventory
because the construction project is
contractor.
igs. This account
Progress asset. At the end of each period,
Ifthe net amount is a debit(CIP
it is reported in the statement of
net amount is a eredit,(CIP IS LESS.
On January 2, 2017, QUICKBUILD ERECTORS entered into contract to construct
two projects, The following data relate to the construction activities,
Contract price
Cost incurred during 2017
Estimated costs to complete
1. Percentage of completion = a
8,437,500
7,875,000
1,968,750
Actual cost incurred + Est. cost to complete
7,875,000 + 1,968,750
= 20%
3. Contract price
Total cost
Estimated net loss
437,500 x 80%
8,437,500
9,843,750
1,406,250) Chapter 6 Long Term Construction Contracts 213
7,875,000.
Various Accounts 7,787,000
b. Accounts receivable 5,593,750.
5,593,750
c. Cash 5,000,000
Accounts receivable 5,000,000
d. Construction Cost 7,875,000
Construction in Progress 1,406,250
Construction revenue 6,468,750
The estimated net loss is reported in full (100%) even if the percentage of
‘completion is 80% only. Construction revenue should be (8,437500 x 80%)
6,750,000, but the amount credited was 6,458,750 representing the difference
between cost of 7,875,000 and loss of 1,406,250. AGAIN , WHEN IT IS LIKELY
THAT CONTRACT COSTS WILL EXCEED CONTRACT REVENUE, THEN
THE ENTIRE LOSS MUST BE RECOGNIZED IN THE STATEMENT OF
COMPREHENSIVE INCOME IMMEDIATELY, REGARDLESS OF THE
STAGE OF COMPLETION.
Under Zero-profit method the rule states that no profit should be recognized
during the construction period, however if it is a net loss then THE LOSS IS
REPORTED IN FULL (100%) just like under completed contract and percentage
of completion.
PRESENTATION OF THE CONSTRUCTION IN PROGRESS AND
PROGRESS BILLINGS
‘Construction in Progress = 7.875,000 — 1,406,250) P 6,468,750
Progress Billings 5,593,750
Cost of uncompleted contract in excess of progress billings
or due from customer P__875,000
Construction in Progress exceeds Progress Billings, so the whole package will be
presented among the assets. 214 AFAR
FINANCIAL STATEMENT PRESENTATION OF ACCOUNTS PECULIAR TO.
LONG TERM CONSTRUCTION CONTRACT.
1, Construction in progress - similar to work in process — presented among
the assets if the amount is greater than progress billings.
2. Accounts receivable — presented among the assets just like the trade
‘accounts receivable
3. Progress billings — presented among the liabilities if the amount is greater
than construction in progress.
4. Construction revenue — part of contract price considered as camed.
resented on statement of comprehensive income
$. Construction cost ~ actual cost incurred during the year. Presented on the
statement of comprehensive income.
Disclosures.
‘A. Anentity siall disclose
1. The amount of contract revenue recognized as revenue in the period
2. The methods used to determine the contract revenue recognized in the
period.
3. The methods used to defermine the stage of completion of contracts in
progress at the statement of financial position date
4. For contracts in progress at the statement of financial position date:
(a) The aggregate amount of cost incurred and recognized profits,
less recognized losses, to date
(b) Advances received
(©) Retentions
5. The gross amount due from customers for contract work as an asset
6. The gross amount due to customers for contract work as a liability
B. The gross amount due from customers for contract work is the net amount
of costs incurred plus recognized profits, less the sum of recognized losses
and progress billings for contract in progress for which cost incurred plus
recognized profits, less recognized losses exceeds progress billings.
|
| CHAPTER 6
LONG TERM CONSTRUCTION
CONTRACTS
LEARNING OBJECTIVES
Upon completion of this chapter, you should be able to
© Know the similarities and differences of completed contract _method,
percentage of completion method and zero profit method of accounting for
Jong —term construction contracts
‘* Know how to compute for the percentage of completion using the different
methods.
* Record transactions for long-term construction contracts using the different
methods.
‘+ Know the financial statement presentation of accounts under the three different
‘methods of recording long-term construction contracts.
In general, revenue is recognized when an earnings process is virtually completed. The
‘general revenue recognition criteria described in the realization principle suggest that
revenue should be recognized when a long term project is finished (that is, when the
‘earings process is virtually complete. This is known as the completed contract method
of revenue recognition. The problem with this methods is that all revenues, expenses,
and resulting income from the project are recognized in the period in which the project
is completed; no revenues or expenses are reported in the income statements of earlier
reporting periods in which much of the work may have been performed. Net income
should provide a measure of périodic accomplishment to help predict future
accomplishments. Clearly, income statements prepared using the completed contract
‘method do not fairly report each period’s accomplishment when a project spans more
than one reporting period. Much of the earings process is far removed the from the
point of delivery.
‘The percentage of completion method of revenue recognition for long term construction
and other projects is designed to help address this problem. By this approach, we
recognize revenues and expenses over time by allocating a share of the project’s
expected revenues and expenses to each period in which the earings process occurs;
that is the contract period. Although the contract usually sj total revenues, the
project’s expenses are not known until completion. Consequently, it is necessary for a
‘company to estimate the project's future costs at the end of each reporting period in
order to estimate total gross profit to be earned on the project. "NOLLATAWOD
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