Question

Ex. 18-123-Long-term construction contracts (essay). 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 Instructions (a) Discuss how earnings on long-term construction contracts are recognized and computed under these two methods. (b) Under what circumstances should one method be used over the other? (c) How are job costs and interim billings reflected on the balance sheet under the percentage-of-completion method and the completed-contract method?

Answer 1

A)

Percentage of completion method:

Under the percentage completion method, revenue and expenses should be recognized based on the percent of work completed in case of long term construction contracts.

Percentage of work completed = Costs incurred to date / Total estimated cost to complete the contract

Revenue to be recognized = Contract value * percentage of work completed

Completed contract method:

For long term contracts under the completed contract method, revenue and expenses should be recognized in the year in which the contract is fully completed.

Revenue to be recognized is the total contract price under completed contract method.

B)

Completed contract method is used over percentage completion method under the following circumstances.

1) When there is no possibility that to derive dependable estimates about the percentage of the completion of the contract,

2) When there are inherent hazards that may interface with the completion of the contract,

3) When contracts are of such a short term nature that the results reported under the percentage completion method and completed contract method would not vary materially.

C)

Under the percentage of completion method, revenue and costs are recognized in the statement of profit and loss based on the percentage of work completed. Estimated profit or loss from the contract should be recognized in the same year.

Expenses incurred should be charged off to statement of profit and loss and progressive billings are credited as a liability by debiting accounts receivables.

Under the completed contract method, job costs should be shown as construction in progress and interim billing should be shown under current liabilities as Progress billings. Upon the completion of the contract, these transferred to contract expenses and revenue and net profit of loss will arrive.