Long-Term Contracts (Construction) Two methods of accounting for long-term construction contracts: Percentage-of-completion method. Cost-recovery (zero-profit) method.

Long-Term Contracts (Construction) Rationale for using percentage-of-completion accounting is that under most of these contracts, the Buyer and seller have enforceable rights. Buyer has the legal right to require specific performance on the contract. Seller has the right to require progress payments that provide evidence of the buyer’s ownership interest. As a result, a continuous sale occurs as the work progresses and companies should recognize revenue according to that progression.

Long-Term Contracts (Construction) Companies must use the percentage-of-completion method when all of the following conditions exist. Total contract revenue can be measured reliably; It is probable that the economic benefits associated with the contract will flow to the company; Both the contract costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably; and The contract costs attributable to the contract can be clearly identified and measured reliably so the actual contract costs incurred can be compared with prior estimates.

Long-Term Contracts (Construction) Companies should use the cost-recovery method when one of the following conditions applies: When a company cannot meet the conditions for using the percentage-of-completion method, or When there are inherent hazards in the contract beyond the normal, recurring business risks.

Long-Term Contracts (Construction) Percentage-of-Completion Method Calculation for Revenue to Be Recognized Illustration 18-11 Illustration 18-12 Illustration 18-13 LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Illustration: KC Construction Company has a contract to construct a €4,500,000 bridge at an estimated cost of €4,000,000. The contract is to start in July 2010, and the bridge is to be completed in October 2012. The following data pertain to the construction period. LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Illustration: Compute percentage complete. Illustration 18-6 LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Illustration: KC would make the following entries to record (1) the costs of construction, (2) progress billings, and (3) collections. Illustration 18-7 LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Percentage-of-Completion, Revenue and Gross Profit, by Year Illustration 18-16

Long-Term Contracts (Construction) Illustration: KC’s entries to recognize revenue and gross profit each year and to record completion and final approval of the contract. Illustration 18-17 LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Illustration: Content of Construction in Process Account—Percentage-of-Completion Method Illustration 18-18 LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Financial Statement Presentation—Percentage-of-Completion Computation of Unbilled Contract Price at 12/31/10 Illustration 18-19 LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Financial Statement—Percentage-of-Completion Illustration 18-20 LO 3

Cost-Recovery (Zero-Profit) Method Illustration: For the bridge project illustrated on the preceding pages, Hardhat Construction would report the following revenues and costs. Illustration 18-21 LO 4 Apply the cost-recovery method for long-term contracts.

Cost-Recovery (Zero-Profit) Method Illustration: Hardhat’s entries to recognize revenue and gross profit each year and to record completion and final approval of the contract. Illustration 18-22 LO 4 Apply the cost-recovery method for long-term contracts.

Cost-Recovery (Zero-Profit) Method Illustration: Comparison of gross profit recognized under different methods. Illustration 18-23 LO 4 Apply the cost-recovery method for long-term contracts.

Long-Term Contracts (Construction) Financial Statement—Cost-Recovery Method Illustration 18-24 LO 4 Apply the cost-recovery method for long-term contracts.

Long-Term Contracts (Construction) Illustration: Casper Construction Co. A) Prepare the journal entries for 2010, 2011, and 2012. LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Illustration: LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Illustration: LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Illustration: LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Cost-Recovery Method Companies recognize revenue only to the extent of costs incurred that are expected to be recoverable. Only after all costs are incurred is gross profit recognized. LO 4 Apply the cost-recovery method for long-term contracts.

Cost-Recovery Method Illustration: LO 4 Apply the cost-recovery method for long-term contracts.

Cost-Recovery Method Illustration: LO 4 Apply the cost-recovery method for long-term contracts.

Long-Term Contracts (Construction) Long-Term Contract Losses Loss in the Current Period on a Profitable Contract Percentage-of-completion method only, the estimated cost increase requires a current-period adjustment of gross profit recognized in prior periods. Loss on an Unprofitable Contract Under both percentage-of-completion and completed- contract methods, the company must recognize in the current period the entire expected contract loss. LO 5 Identify the proper accounting for losses on long-term contracts.

Long-Term Contract Losses Illustration: Loss in Current Period Casper Construction Co. b) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated cost to complete at the end of 2011 was €215,436 instead of €170,100. LO 5 Identify the proper accounting for losses on long-term contracts.

Long-Term Contract Losses Illustration: Loss in Current Period LO 5 Identify the proper accounting for losses on long-term contracts.

Long-Term Contract Losses Illustration: Loss in Current Period LO 5 Identify the proper accounting for losses on long-term contracts.

Long-Term Contract Losses Illustration: Loss on Unprofitable Contract Casper Construction Co. c) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated cost to complete at the end of 2011 was € 246,038 instead of € 170,100. LO 5 Identify the proper accounting for losses on long-term contracts.

Long-Term Contract Losses Illustration: Loss on Unprofitable Contract $675,000 – 683,438 = (8,438) cumulative loss Plug LO 5

Long-Term Contract Losses Illustration: Loss on Unprofitable Contract LO 5 Identify the proper accounting for losses on long-term contracts.

Long-Term Contract Losses Illustration: Loss on Unprofitable Contract For the Cost-Recovery method, companies would recognize the following loss: LO 5 Identify the proper accounting for losses on long-term contracts.