Practice Exam Chapters 18-20 Part II P185B (Completed-Contract and Percentage-of

Question

Practice Exam Chapters 18-20 Part II P185B (Completed-Contract and Percentage-of-Completion with Interim Loss) Limerack Custom Builders was established in 1971 by Jon Rock and initially built high-quality customized homes under contract with specific buyers. In the 1990s, Rock's son joined the company and expanded Limerock's activities into industrial and commercial retail markets. Upon the retirement of Limerock's long-time financial manager, Rock's son recently hired Flint, a former college friend, as the new controller for Limerock. Flint, has been associated with a public accounting firm for the last 6 years. Upon reviewing Limerock's accounting practices, Flint observed that Limerock followed the completed-contract method of revenue recognition, a carryover from the years when individual home building was the majority of Limerock's operations. Several years ago, the predominant portion of Limeorck's activities shifted to the commerical retail and industrial building areas. From land acquisi- tion to the completion of construction, most building contracts cover several years. Under the circum- stances, Flint believes that Limec nces, Flint believes that Limeorck should follow the percentage-of-completion method of accounting rom a typical building contract, Flint developed the following data SUNSHINE MALL Contract price: $12,000,000 2015 $3,000,000 $4,200,000 $2,800,000 2.000,000 4,000,000 6,000,000 ,600,000 3,800,000 6,600,000 2014 Estimated costs Progress billings a) Explain the differnence betwen completed-contract revenue recognition and percentage-of-completion (b) Using the data provided for the Sunshine Mall and assuming the percentage-of-completion method of revenue recognition is used, calculate Limerock's revenue and gross profit for 2014, 2015, and 2016, under each of the following circumstances. (1) Assume that all costs are incurred, all billings to customers are made, and all collections from customers are received within 30 davs of billing, as planned. (2) Further assume that, as a result of unforeseen local ordinances and the fact that the building site was in a wetlands area, Limerock experienced cost overruns of $800,000 in 2014 to bring the site into compliance with the ordinances and to overcome wetlands barriers to construction (3) Further assume that, in addition to the cost overruns of $S00,000 for this contract incurred under part (bx2), inflationary factors over and above tho the original contract cost have caused an additic anticipated that any cost overruns will occur in 2016

Explanation / Answer

a. The completed contract revenue recognition is the method of revenue recognition in which the revenue is recognized at the end of the contract/project. Wheras under the percentage of completion method revenue is recognized on the basis of percentage of completion of project. b The recognition of revenue and gross profit under percentage of completion method is as under: 1 The difference between total contract value less total estimated cost is the total profit to be recognized. The revenue to be recognized on the basis of percentage of completion of contract. Percentage of completion =Cost incurred to date/Total estimated cost to be incurred 2014 2015 2016 Cost to date $3,000,000 $7,200,000 $10,000,000 Total Estimated cost $10,000,000 $10,000,000 $10,000,000 Percentage of completion 30% 72% 100% Revenue recognition for the contract price of $12,000,000 Revenue recognition $     3,600,000 $       8,640,000 $       12,000,000 Revenue recognized during the year $     3,600,000 $       5,040,000 $         6,960,000 2014 2015 2016 Revenue recognized $     3,600,000 $       5,040,000 $         6,960,000 Less: Cost incurred $3,000,000 $4,200,000 $5,800,000 Profit to be recognized during the year $        600,000 $          840,000 $         1,160,000 2 The calculation of percentage of completion is as under: 2014 2015 2016 Cost to date $3,800,000 $8,000,000 $10,800,000 Total Estimated cost $10,800,000 $10,800,000 $10,800,000 Percentage of completion 35% 74% 100% 2014 2015 2016 Revenue recognized (Contract price*percentage of completion) $     4,200,000 $       4,680,000 $         3,120,000 Less: Cost incurred $3,800,000 $4,200,000 $2,800,000 Profit to be recognized during the year $        400,000 $          480,000 $            320,000 3 If cost overrun in 2014 and 2015 of $800,000 and $900,000 then the revenue and profit recognized during the year would be as under: 2014 2015 2016 Cost to date $3,800,000 $8,900,000 $11,700,000 Total Estimated cost $11,700,000 $11,700,000 $11,700,000 Percentage of completion 32% 76% 100% 2014 2015 2016 Revenue recognized (Contract price*percentage of completion) $     3,840,000 $       5,280,000 $         2,880,000 Less: Cost incurred $3,800,000 $5,100,000 $2,800,000 Profit to be recognized during the year $          40,000 $          180,000 $              80,000

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