Question

At the beginning of 2018, a construction company that began operations in 2016 changed from the completed-contract method to the percentage-of-completion method for accounting purposes but not for tax purposes. Gross profit figures under both methods for the past three years appear below: Completed-Contract Percentage-of-Completion 2016 $ 950,000 $ 1,800,000 2017 1,250,000 1,900,000 2018 1,400,000 2,100,000 Assuming an income tax rate of 30% for all years, the effect of this accounting change on prior periods should be reported by f Journal Entry at the beginning of 2018 4. What amount will be debited to “Construction in Process” account, to record the change at beginning of 2018? 5. What amount will be credited to “Deferred Tax Liability” account? 6. What amount will be credited to “Retained Earnings” account?

Answer 1

• From begining of 2018 Construction company has changed to percentage of completion method from completed contract method to record and recognise contruction activity i.e. for accounting puporse.
• That means changes in method willl have retrospective effect from year 2016 and such retrospection will be given effect in books of account at begining of 2018.  
• from 2018 and onwards Percentage completion method will be implemented. hence retrospective effect will be of year 2016 and 2017 only.

Year	Gross Profit under	Tax @ 30%	Net of Tax Increase in earning
Completed Contract	Percentage Completion	Increase in Earning             (i.e. Diff .)
	A	B	C=B-A	D= C*30%	E = C-D
2016	950,000	1,800,000	850,000	255,000	595,000
2017	1,250,000	1,900,000	650,000	195,000	455,000
2018	1,400,000	2,100,000	NA	NA	NA

4. What amt will be debited to "Construction work in process" at begining of 2018 to record change ?

Answer : Amt . $1500,000 (i.e. 3,700,000 - 2,200,000)

Explanation :

• Contruction Work in process A/c would have balance of $ 2,200,000 (i.e. 950,000 + 1,250,000) at begining of 2018 under Completed contract method.
• Had Percentage Completion method been applied Since 2016  Contruction Work in process A/c would have balance of $ 3,700,000 (i.e. 1,800,000 + 1,900,000) at begining of 2018.
• Hence Contruction Work in process A/c will be increased by 1500,000 (i.e. 3,700,000 - 2,200,000) to record change

5. What amt will be credited to "Deffered Tax liabilty"?

Answer : Amt . $450,000 (i.e. [3,700,000 - 2,200,000] * 30%)

Explanation :

• as changes are resulting into increase in profitability of the company income tax liabilty would be incresed by that much computed as under.....
• for 2016 = (1,800,000 - 950,000) x 30% = 255,000
• for 2017 = (1,900,000 - 1,250,000) x 30% = 195,000

6. What amt will be credited to retained earning ?

Answer : Amt . $1,050,000 (i.e. [3,700,000 - 2,200,000] * (1-0.3))

Explanation :

• as changes are resulting into increase in profitability of the company; increased profit ner of proposed increased income tax liabilty would be added to Retained earning A/c computed as under.....
• for 2016 = (1,800,000 - 950,000) x (100%-30%) = 595,000
• for 2017 = (1,900,000 - 1,250,000) x (100%-30%) = 455,000

Journal  to record change at at begining of 2018 would be....

Contruction Work in process A/c Dr 1,500,000

To Retained Earning A/c Cr 1,050,000

To Deffered Tax liability A/c Cr 450,000