Question

Question 2 Assume that Beta Inc. entered into an agreement to build a ship for $1,000 million and a reliable estimate of the project's total cost is $800 million. Project costs incurred by beta Inc. are as follows Project Costs Year 2014 2015 2016 Total Cost incurred $400 million $300 million $100 million $800 million Determine Beta's net income from this project for each year using percentage-of- completion and completed contract methods. Also, show the yearly revenues and expenses. [3+2 5 marks]

Answer 1

Case A: Calculation of Net Income for Each Year Using Percentage of Completion Method:

Net revenue = Revenue - cost

Under this method revenue is recognized based on the percentage of completion of the contract.

Percentage complete = (cost incurred till date / estimated total cost)

Percentage complete for year 1 = ($400 million / $800 million) * 100 = 50%

Percentage complete for year 2 = ( ($400 million + $300 million) / $800 million) * 100 = 87.5%

Percentage complete for year 3 = ( ($400 million + $300 million + $100 million) / $800 million) * 100 = 100%

Revenue = ( Percentage complete * Contract price ) - ( revenue preciously recognized )

Revenue for year 1 = ( 50% * $1,000 million ) - ( 0 ) = $500 million

Revenue for year 2 = ( 87.5% * $1,000 million ) - ( $500 million) = $875 million - $500 million = $375 million

Revenue for year 3 = ( 100% * $1,000 million ) - ( $500 million + $375 million ) = $1,000 million - $875 million = $125 million

Calculation of net income:

Net income for year 1 = Revenue for year 1 - cost incurred in year 1 = $500 million - $400 million = $100 million

Net income for year 2 = Revenue for year 2 - cost incurred in year 2 = $375 million - $300 million = $75 million

Net income for year 3 = Revenue for year 3 - cost incurred in year 3 = $125 million - $100 million = $25 million

Therefore net income for the year 1 is $100 million, for the year 2 is $75 million and for the year 3 is $25 million.

Case B: Calculation of Net Income for Each Year Using Completed Contracts Method:

The completed contract method refers to a method in which all of the revenue and profit associated with the project is recognized only after the completion of the project.

Hence, net income for the year 1 and year 2 will be Nil. And the total net income from the project will be recognized in the year 3 i.e. $200 million (Contract price - total cost = $1,000 million - $800 million).

Therefore, net income for the year 1 = Nil

net income for the year 2 = Nil

net income for the year 3 = $200 million