1. Income Measurement (Part 2)
Intermediate Accounting I
Chapter 5
(This presentation is under construction.)

2. LONG-TERM CONTRACTS
When the product/service delivery occurs over a long period of time (longer than one fiscal period).
There are two methods of accounting for revenue and expense recognition under long–term contracts:
Completed Contract Method
Percentage-of-completion Method

3. ACCOUNTING FOR COSTS OF CONSTRUCTION AND ACCOUNTS RECEIVABLE
All costs of construction are recorded in an asset (inventory) account called Construction in Progress.
Period billings are credited to a contra-asset account called Billings on Construction Contract.

4. COMPLETED CONTRACT METHOD
No revenues or expenses are recognized until the project is complete.
The completed contract method does not properly portray a company's performance over the construction period and should only be used in unusual situations when forecasts of costs to complete the project are highly uncertain..

5. COMPLETED CONTRACT METHOD Example
At the beginning of 2013, the Harding Construction Company received a contract to build an office building for $5 million. The project is estimated to take three years to complete. According to the contract, Harding will bill the buyer in installments over the construction period according to a prearranged schedule. Information related to the contract is as follows:
2013
2014
2015
Totals
Construction costs incurred during the year
$1,500,000
$1,000,000
$1,600,000
$4,100,000
Billings made during the year
$1,200,000
$2,000,000
$1,800,000
$5,000,000
Cash collections during year
1,000,000
1,400,000
2,600,000

6. COMPLETED CONTRACT METHOD Journal Entries – Costs, Billings & Collections (2013)
Construction in Progress
1,500,000
Various Accounts
To record construction costs
Accounts Receivable
1,200,000
Billings on Construction Contract
To record progress billings
Cash
1,000,000
To record cash collections
Repeat these entries for 2014 and 2015 using the appropriate data for each year.

7. COMPLETED CONTRACT METHOD Journal Entries – Completed Contract (2015)
Construction in Progress (gross profit)
900,000
Cost of Construction (total cost)
4,100,000
Revenue from Long-term Contracts
5,000,000
To record gross profit
Billings on Construction Contract
Construction in Progress
To record transfer of finished asset

8. PERCENTAGE OF COMPLETION METHOD
Allocates a fair share of a project's revenues and expenses to each reporting period during construction.
The allocation of project profit is accomplished by estimating progress to date.
Progress to date (the percentage of completion) can be estimated as the proportion of the project's cost incurred to date divided by total estimated costs, by project milestones, or by relying on an engineer's or architect's estimate.
To determine periodic gross profit, the percentage of completion is multiplied by estimated gross profit to determine gross profit earned to date, and then the current period's gross profit is determined by subtracting from this amount the gross profit recognized in previous periods.
Periodic revenues are determined by multiplying the percentage of completion by the total contract price and then subtracting revenue recognized in prior periods. In most cases, the cost of construction equals the construction costs incurred during the period.
The percentage of completion method is required by GAAP unless it in not possible to make reliable estimates of revenues, expenses, and progress toward completion.

9. PERCENTAGE OF COMPLETION METHOD
Estimated Gross Profit
Percent Complete
Gross Profit Recognized This Period
Contract Price – (Actual Costs to Date + Est Costs to Complete)
Actual Costs Incurred/ (Total Actual Costs + Estimated Costs to Date)
(Total Est Gross Profit X Percentage Completed to Date) – Gross Profit Recognized in Prior Periods

10. COMPLETED CONTRACT METHOD Example
At the beginning of 2013, the Harding Construction Company received a contract to build an office building for $5 million. The project is estimated to take three years to complete. According to the contract, Harding will bill the buyer in installments over the construction period according to a prearranged schedule. Information related to the contract is as follows:
2013
2014
2015
Construction costs incurred during the year
$1,500,000
$1,000,000
$1,600,000
Construction costs incurred in prior years
- 0 -
1,500,000
2,500,000
Cumulative construction costs
4,100,000
Estimated costs to complete at end of year
2,250,000
Total estimated and actual construction costs
$3,750,000
$4,000,000
$4,100,000
Billings made during the year
$1,200,000
$2,000,000
$1,800,000
Cash collections during year
1,000,000
1,400,000
2,600,000

11. PERCENTAGE OF COMPLETION METHOD Journal Entries – Costs, Billings & Collections (2013)
Construction in Progress
1,500,000
Various Accounts
To record actual construction costs incurred
Accounts Receivable
1,200,000
Billings on Construction Contract
To record progress billings
Cash
1,000,000
To record cash collections
Repeat these entries for 2014 and 2015 using the appropriate data for each year.

12. PERCENTAGE OF COMPLETION METHOD Journal Entries – Gross Profit (2013)
Construction in Progress (gross profit)
500,000
Cost of Construction (actual costs)
1,500,000
Revenue from Long-term Contracts (costs + profit)
2,000,000
To record gross profit
click for gross profit calculation
1) Estimated Gross Profit:
Contract Price – (Actual Costs to Date + Est Costs to Complete)
$5,000,000 – (1,500, ,250,000) =
$1,250,000
2) Percent Complete
Actual Costs Incurred / (Actual Costs + Est Costs to Complete)
$1,500,000 / (1,500, ,250,000) =
40%
3) Gross Profit Recognized:
(Est Gross Profit X Percent Complete) – Gross Profit Recog in Prior Periods
$1,250,000 X 40% =
$500,000

13. PERCENTAGE OF COMPLETION METHOD Journal Entries – Gross Profit (2014)
Construction in Progress (gross profit)
125,000
Cost of Construction (actual costs)
1,000,000
Revenue from Long-term Contracts (costs + profit)
1,125,000
To record gross profit
click for gross profit calculation
1) Estimated Gross Profit:
Contract Price – (Actual Costs to Date + Est Costs to Complete)
$5,000,000 – (2,500, ,500,000) =
$1,000,000
2) Percent Complete
Actual Costs Incurred / (Actual Costs + Est Costs to Complete)
$2,500,000 / (2,500, ,500,000) =
62.5%
3) Gross Profit Recognized:
(Est Gross Profit X Percent Complete) – Gross Profit Recog in Prior Periods
$1,000,000 X 62.5% = $625,000 - $500,000 =
$125,000

14. PERCENTAGE OF COMPLETION METHOD Journal Entries – 2015
Construction in Progress (gross profit)
275,000
Cost of Construction (actual costs)
1,600,000
Revenue from Long-term Contracts (costs + profit)
1,875,000
To record gross profit
Billings on Construction Contract (account balance)
5,000,000
Construction in Progress (account balance)
click for gross profit calculation
1) Estimated Gross Profit:
Contract Price – (Actual Costs to Date + Est Costs to Complete)
$5,000,000 – (4,100, ) =
$900,000
2) Percent Complete
Actual Costs Incurred / (Actual Costs + Est Costs to Complete)
$4,100,000 / (4,100, ) =
100%
3) Gross Profit Recognized:
(Est Gross Profit X Percent Complete) – Gross Profit Recog in Prior Periods
$900,000 X 100% = $900,000 - $625,000
$275,000

15. PERCENTAGE OF COMPLETION METHOD Income Statement Presentation - 2013
Revenue from Long-term Contracts
$2,000,000
Cost of Construction
1,500,000
Gross Profit
$500,000
Note that the gross profit reported on the income statement is the same as that recorded in the journal for each reporting period.

16. PERCENTAGE OF COMPLETION METHOD Balance Sheet Presentation - 2013
Revenue from Long-term Contracts
$2,000,000
Cost of Construction
1,500,000
Gross Profit
$500,000
Note that the gross profit reported on the income statement is the same as that recorded in the journal for each reporting period.

17. PERCENTAGE OF COMPLETION METHOD Balance Sheet Presentation - 2013
Construction in progress is compared to billings on construction contract.
A debit balance indicates costs (plus profits for the percentage-of-completion method) in excess of billings and is reported as an asset.
A credit balance indicates billings in excess of costs (plus profits for the percentage-of-completion method) and is reported as a liability.

18. GROSS PROFIT FOR COMPLETED CONTRACT
AND PERCENTAGE-OF-COMPLETION METHODS
Note that the same total amount of gross profit is recognized under the two methods; the only difference is timing. $

19. Intermediate Accounting I – Chapter 5 End of presentation
Income Measurement (Part 2)
Intermediate Accounting I – Chapter 5
End of presentation
(This presentation is under construction.)