Question

On February 1, 2016, Arrow Construction Company entered into a three-year construction contract to build a bridge for a price of $8,000,000. During 2016, costs of $2,000,000 were incurred with estimated costs of $4,000,000 yet to be incurred. Billings of $2,500,000 were sent, and cash collected was $2,250,000.

In 2017, costs incurred were $2,500,000 with remaining costs estimated to be $3,600,000. 2017 billings were $2,750,000, and $2,475,000 cash was collected. The project was completed in 2018 after additional costs of $3,800,000 were incurred. The company’s fiscal year-end is December 31. Arrow recognizes revenue over time according to percentage of completion.

Required:

1. Calculate the amount of revenue and gross profit or loss to be recognized in each of the three years.

2. Prepare journal entries for 2016 and 2017 to record the transactions described (credit “various accounts” for construction costs incurred).

3. Prepare a partial balance sheet to show the presentation of the project as of December 31, 2016 and 2017.

Answer 1

Long-term contract; revenue recognition overtime; loss projected on entire project;

Requirement: 1

Calculation of estimated gross profit ($ in millions):

Hence, the calculated estimated gross profit in 2016 is , loss in 2017 is and loss in 2018 is .

Calculation of revenue recognition (2016):

It is given that the contract price is $8,000,000, actual cost to date is $2,000,000, and calculated total estimated cost is $6,000,000.

Now, calculate the revenue recognition:

Hence, the calculated revenue recognition is .

Calculation of revenue recognition (2017):

It is given that the contract price is $8,000,000, actual cost to date is $4,500,000, calculated total estimated cost is $8,100,000, and revenue recognition in 2016 is $2,666,667.

Now, calculate the revenue recognition:

Hence, the calculated revenue recognition is .

Calculation of revenue recognition (2017):

It is given that the contract price is $8,000,000, calculated revenue recognition in 2016 is $2,666,667, and revenue recognition in 2017 is $1,777,778.

Now, calculate the revenue recognition:

Hence, the calculated revenue recognition is .

Calculation of gross profit recognition (2016):

Calculated revenue recognition in 2016 is $2,666,667 and given actual cost to date is $2,000,000.

Now, calculate the gross profit recognition:

Hence, the calculated gross profit recognition is .

Calculation of gross profit recognition (2017):

Calculated revenue recognition in 2017 is ($100,000) and calculated gross profit recognition in 2016 is $666,667.

Now, calculate the gross profit recognition:

Hence, the calculated gross loss recognition is .

Calculation of gross profit recognition (2018):

Calculated revenue recognition in 2018 is ($300,000), revenue recognition in 2017 is ($100,000).

Now, calculate the gross profit recognition:

Hence, the calculated gross loss recognition is .

Requirement: 2

Preparation of journal entry for 2016:

• Construction in progress is an asset. There is an increase in asset value. Therefore, it is debited.

• Various accounts are revenue. There is an increase in liability value. Therefore, it is credited.

• Account receivable is an asset. There is an increase in asset value. Therefore, it is debited.

• Billings on construction contract is revenue. There is a decrease in liability value. Therefore, it is debited.

• Cash is an asset. There is an increase in asset value. Therefore, it is debited.

• Account receivable is an asset. There is a decrease in asset value. Therefore, it is credited.

• Construction in progress is an asset. There is an increase in asset value. Therefore, it is debited.

• Cost of construction is an expense. There is a decrease in liability value. Therefore, it is debited.

• Revenue from long-term contracts is revenue. There is an increase in liability value. Therefore, it is credited.

Preparation of journal entry for 2017:

• Construction in progress is an asset. There is an increase in asset value. Therefore, it is debited.

• Various accounts are revenue. There is an increase in liability value. Therefore, it is credited.

• Account receivable is an asset. There is an increase in asset value. Therefore, it is debited.

• Billings on construction contract is revenue. There is a decrease in liability value. Therefore, it is debited.

• Cash is an asset. There is an increase in asset value. Therefore, it is debited.

• Account receivable is an asset. There is a decrease in asset value. Therefore, it is credited.

• Cost of construction is an expense. There is a decrease in liability value. Therefore, it is debited.

• Revenue from long-term contracts is revenue. There is an increase in liability value. Therefore, it is credited.

• Construction in progress is an asset. There is a decrease in asset value. Therefore, it is credited.

Calculation of cost of construction (2017):

Calculated revenue recognition in 2017 is $1,777,778 and loss recognition in 2017 is $766,667.

Now, calculate the gross profit recognition:

Hence, the calculated gross loss recognition is .

Requirement: 3

Prepare balance sheet:

To prepare balance sheet it is required to calculate costs and profit in excess of billings for 2016 and billings in excess of cost less loss for 2017.

Calculation of costs and profit in excess of billings:

It is given that the profit is $2,666,667 ($2,000,000 + $666,667) and billing profit is $2,500,000.

Now, calculate the costs and profit in excess of billings:

…… (1)

Hence, the calculated costs and profit in excess of billings is .

Calculation billings in excess of cost less loss for 2017:

It is given that the profit is $5,250,000 and it is required to calculate excess of costs less loss using the below formula:

Hence, excess of costs less loss is .

Now, calculate the costs and profit in excess of billings:

…… (2)

Hence, the calculated costs and profit in excess of billings is .

Now, prepare balance sheet: