Percentage of Completion Example Paterno Construction receives a contract for $1.5 million...
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Transcript of Percentage of Completion Example Paterno Construction receives a contract for $1.5 million...
Percentage of Completion Example
Paterno Construction receives a contract for $1.5 millionRenovation to Beaver StadiumThrough 1997, 1998, and 1999
1997 Costs Incurred: $350,000
When materials are purchased and costs are incurred, we transfer the balance to a work-in-process inventory account called Construction-in-Progress
Basic Journal Entries for Transactions
The Journal Entry to do this transfer might look like:
1997 Costs Incurred: $350,000
Constr In Progr Inv. 350,000
Transferring costs to CIP account.
Basic Journal Entries for Transactions
Materials Inv. 200,000Wages Payable 80,000Cash 70,000
Constr In Progr Inv. 350,000
The Journal Entry to do this transfer might look like:
1997 Costs Incurred: $350,000
Actual costs incurred in the year.
Basic Journal Entries for Transactions
T-Account Summary
CIP Inv
350,000
Basic Journal Entries for Transactions
When the company bills for work in progress, it records an accounts receivable for the amount of the billing and a corresponding contra-asset account called Billings on Construction.
Billings on Construction is a contra-asset account because it reduces the amount of Construction-in-Progress inventory that the firm can claim is theirs.
In other words, it is as if the firm is transferring the rights to ownership of a portion of Construction-in-Progress inventory in exchange for an increase in accounts receivable.
11/30 Accounts Rec. 300,000Billings on Constr 300,000
Example: On Nov. 30, the company mails a bill for $300,000 .
Basic Journal Entries for Transactions
T-Account Summary
1997 Balance Sheet Representation:
Assets: Constr in Prog Inv 350,000 Less: Billings on Construct (300,000) Net CIP Inventory 50,000
CIP Inv
350,000
Billings on Constr
300,000
Example: On Dec. 10, the company receives cash for the bill:
12/10 Cash 300,000Accounts Rec. 300,000
Basic Journal Entries for Transactions
When the company actually receives payment on the recent billing, it simply records the cash in exchange for the accounts receivable.
Computing Revenue under Percentage of Completion
Start with 1997 data for costs incurred and estimated total completion costs.
Percent Complete = 350,000/1,350,000 = 25.926%
1997 Costs Incurred to-date: $350,000Estimated Total Costs: $1,350,000
Computing Revenue under Percentage of Completion
Revenue = Percent Complete x Total Revenue for Project - Prior Revenue Recognized
Revenue1997 = (0.25926 x $1,500,000) - $0
= $388,890
Computing Revenue under Percentage of Completion
Now, compute for 1998. Assume expected completion costs increase to $1,360,000 due to budget overruns.
Revenue1998 = (0.66176 x $1,500,000) - $388,890
Revenue = Percent Complete x Total Revenue for Project - Prior Revenue Recognized
Percent Complete = 900,000/1,360,000 = 66.176%
1998 Costs Incurred to-date: $900,000Estimated Total Costs: $1,360,000
Computing Revenue under Percentage of Completion
= $603,750
Note that this is cumulative (this includes the $350,000 costs incurred in 1997 and an additional $550,000 incurred in 1998).
Computing Revenue under Percentage of Completion
Now, compute for 1999. Assume actual completion costs increase to $1,365,000 due to budget overruns.
= $507,360
Revenue1999 = (1 x $1,500,000) - $388,890 - $603,750
Revenue = Percent Complete x Total Revenue for Project - Prior Revenue Recognized
Percent Complete = 1,365,000/1,365,000 = 100%
1999 Costs Incurred to-date: $1,365,000Estimated Total Costs: $1,365,000
Computing Revenue under Percentage of Completion
Summary of Project
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997
1998
1999
Totals
Summary of Project
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
1998
1999
Totals
Summary of Project
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
1998 550,000 1,360,000 66.176 $603,750
1999
Totals
Summary of Project
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
1998 550,000 1,360,000 66.176 $603,750
1999 465,000 1,365,000 100 $507,360
Totals
Summary of Project
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
1998 550,000 1,360,000 66.176 $603,750
1999 465,000 1,365,000 100 $507,360
Totals 1,365,000 $1,500,000
Annual Journal Entries to Record Revenue and Gross Profit
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
Annual Journal Entries to Record Revenue and Gross Profit
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
1997 End-of-Year Journal Entry:Construction Expense 350,000
Construction Revenue 388,890
Annual Journal Entries to Record Revenue and Gross Profit
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
1997 End-of-Year Journal Entry:Construction Expense 350,000Constr In Prog Inv 38,890
Construction Revenue 388,890
Gross profit goes to CIP Inventory Account
1997 T-Account Summary
CIP Inv
350,00038,890
Billings on Constr
300,000
Actual Costs
Gross Profit
CIP Inv
350,00038,890
Billings on Constr
300,000
1997 Balance388,890 300,000
1997 T-Account Summary
1998 End-of-Year Journal Entry:Construction Expense 550,000
Construction Revenue 603,750
Annual Journal Entries to Record Revenue and Gross Profit
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1998 550,000 1,360,000 66.176 $603,750
1998 End-of-Year Journal Entry:Construction Expense 550,000Constr In Prog Inv 53,750
Construction Revenue 603,750
Annual Journal Entries to Record Revenue and Gross Profit
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1998 550,000 1,360,000 66.176 $603,750
1999 End-of-Year Journal Entry:Construction Expense 465,000Constr In Prog Inv 42,360
Construction Revenue 507,360
Annual Journal Entries to Record Revenue and Gross Profit
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1999 465,000 1,365,000 100 $507,360
CIP Inv Billings on Constr
End of Project T-Account Summary
$1,500,000 $1,500,000
CIP Inv Billings on Constr
End of Project T-Account Summary
$1,500,000 $1,500,000
This is the amount we will have billed the client through the project life.
This includes all costs incurred through the project plus all gross profit on the project.
CIP Inv Billings on Constr
End of Project T-Account Summary
$1,500,000 $1,500,000
Billings on Constr 1,500,000CIP Inv 1,500,000
Closing Journal Entry (to zero out accounts):
Losses on Long-Term Contracts
There are two situations for losses:
1) Loss only in current periodWhen current year’s expenses > current year’s revenues. But the total project will still be profitable.
2) Unprofitable total contractWhen new estimates of total contract costs > expected total revenues.
Losses on Long-Term Contracts
Loss only in current period
Example: 1998 expected total costs increase to $1,450,000
(Note that the total contract is still profitable since we will collect $1,500,000)
Losses on Long-Term Contracts
Loss only in current period
Example: 1998 expected total costs increase to $1,450,000
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
1998 550,000 1,450,000 62 $542,145
900,000 / 1,450,000 = 62%
0.62 x 1,500,000 = $931,035 – 388,890 = $542,145
Losses on Long-Term Contracts
Loss only in current period
Example: 1998 expected total costs increase to $1,450,000
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
1998 550,000 1,450,000 62 $542,145
Notice costs incurred > Current period revenue550,000 542,145
Losses on Long-Term Contracts
Loss only in current period
Journal entry:
Construction Expenses 550,000CIP Inventory (Loss) 7,855Construction Revenue 542,145
Notice costs incurred > Current period revenue550,000 542,145
Losses on Long-Term Contracts
Unprofitable Total Contract
Example: 1998 expected total costs increase to $1,600,000
Note that the total contract is no longer profitable since we will collect only $1,500,000. So, we anticipate a $100,000 loss.
We must recognize this anticipated loss on the entire project in the year we first discover the expected loss (in this case, 1998).
To do this, we do the following:
1. Compute the revenue for the year using same method as before.2. Reverse any prior recorded profits and record the anticipated loss.
Losses on Long-Term Contracts
Unprofitable Total ContractExample: 1998 expected total costs increase to $1,600,000
Year Costs Incurred
Expected Total Costs
%age completed
Revenue
1997 350,000 1,350,000 25.926 $388,890
1998 550,000 1,600,000 56.25 $454,860
900,000 / 1,600,000 = 56.25%
0.5625 x 1,500,000 = $843,750 – 388,890 = $454,860
Compute Revenue for the Year
Note also that we recorded $388,890 - $350,000 = $38,890 Gross Profit in 1997.
1998 Journal entry:
Losses on Long-Term Contracts
Unprofitable Total Contract
Example: 1998 expected total costs increase to $1,600,000
Construction Revenue 454,860
Record the revenue for the year
CIP Inventory (loss) 138,890
Record the $100,000 loss +reverse the 1997 Gross Profit
Construction Exps 593,750