ACCOUNTING FOR LONG-TERM CONSTRUCTION PROJECT 8.

In selecting an accounting method for a newly contracted long-term construction project, the principal factor to be considered should be a. the terms of payment in the contract. b. the degree to which a reliable estimate of the costs to complete and extent of progress toward completion is practicable. c. the method commonly used by the contractor to account for other long-term construction contracts. d. the inherent nature of the contractor's technical facilities used in construction. K, W W PERCENTAGE OF COMPLETION METHOD Basic Concepts !. "he use of the percentage of completion method of accounting for long term construction contracts is a measurement of re#enue under the a. $ost principle. c. %bjecti#ity principle. b. &eali'ation principle. d. (onetary principle. &)$)* +,-. Criteria +,. When wor/ to be done and costs to be incurred on a long-term contract can be estimated dependably, which of the following methods of re#enue recognition is preferable0 a. Installment method c. $ompleted-contract method b. )ercentage-of-completion method d. 1one of these K, W W +2. Which of the following is not an element identified by the *I$)* as being necessary in order to use percentage-of-completion accounting0 a. "he construction period can be reasonably estimated. b. "he buyer can be expected to satisfy obligations under the contract. c. 3ependable estimates can be made of the extent of progress toward completion. d. 3ependable estimates can be made of contract costs. 4, 4 4 .. "he profession re5uires that the percentage-of-completion method be used when certain conditions exist. Which of the following is not one of those necessary conditions0 a. 6stimates of progress toward completion, re#enues, and costs are reasonably dependable. b. "he contractor can be expected to perform the contractual obligation. c. "he buyer can be expected to satisfy some of the obligations under the contract. d. "he contract clearly specifies the enforceable rights of the parties, the consideration to be exchanged, and the manner and terms of settlement. K, W W

C aracteristics 72. "he rationale for adoption of the percentage-of-completion method is that8 *. &esults are more conser#ati#e. 9. It pro#ides a measure of periodic accomplishment. $. It is a better match with legal ownership. 3. It results in a lower income tax. !.

4, 4 "

"he percentage-of-completion method of in#entory #aluation of long-term contracts a. &ecogni'es income upon completion of wor/. b. &ecogni'es income based on collected billings. c. &ecogni'es income based on the progress of wor/. d. 3oes not recogni'e income at the balance sheet date. &)$)* +,-7

7:. "he accounting method that recogni'es re#enue prior to the point of sale based on either an input or an output measure of the earning process is /nown as the a. 3eposit method. c. Installment sales method. b. $ost reco#ery method. d. )ercentage-of-completion method &)$)* ,2.:
+

"he percentage-of-completion method of accounting for long-term construction contracts is an exception to the $(* +;.: ;-+, *. (atching principle. $. 6conomic-entity assumption. 9. <oing-concern assumption. 3. &e#enue recognition principle. "he percentage-of-completion method of accounting for long-term construction contracts is an exception to the *. (atching principle. $. =istorical cost principle. $(* ,:.+ ;-+2 9. <oing concern assumption. 3. &e#enue recognition principle.

77. "he percentage-of-completion method #iolates the general rule on re#enue recognition that8 *. $ollection is reasonably assured. 9. $osts are /nown or reasonably estimated. $. "he earnings process is complete. 3. $ollections ha#e been recei#ed. 4, 4 "
>

*lthough a transfer of ownership has not occurred, the percentage-of-completion method is acceptable under the re#enue recognition principle because *. "he assets are readily con#ertible into cash. 9. "he production process can be readily di#ided into definite stages. $. $ash has been recei#ed from the customer.

3. "he earning process is completed at #arious stages.

$(* +;.; ;-+-

*d#antage of using )ercentage-of-$ompletion (ethod +-. "he theoretical support for using the percentage-of-completion method of accounting for longterm construction projects is that it a. is more conser#ati#e than the completed-contract method. b. reports a lower 1et Income figure than the completed-contract method. c. more closely conforms to the cost principle. d. produces a realistic matching of expenses with re#enues. 4, 4 4 3isad#antage of using percentage-of-completion +2. "he principal disad#antage of using the percentage-of-completion method of recogni'ing re#enue from long-term contracts is that it a. is unacceptable for income tax purposes. b. gi#es results based upon estimates which may be subject to considerable uncertainty. c. is li/ely to assign a small amount of re#enue to a period during which much re#enue was actually earned. d. none of these. K, W W App!ications 7 . 4as/ia $o.?s construction projects extend o#er se#eral years, and collection of recei#ables is reasonably certain. 6ach project has a firm contract price, reliable estimated of the extent of progress and cost to finish, and a contract that is specific as to the rights and obligations of all parties. "he contractor and the buyer are expected to fulfill their contractual obligations on each project. "he method that the company should use to account for construction re#enue is a. Installment sales. c. $ompleted-contract. b. )ercentage-of-completion method. d. )oint-of-sale. $I* ++82 I@-+> :. 3illa $onstruction $ompany's projects extend o#er se#eral years and collection of recei#ables is reasonably certain. 6ach project has a contract that specifies a price and the rights and obligations of all parties. 9oth the contractor and the customer are expected to fulfill their contractual obligations on each project. &eliable estimates can be made of the extent of progress and cost to complete each project. "he method that the company should use to account for construction re#enue is a. installment sales. c. completed-contract. b. percentage-of-completion. d. cost reco#ery. 4, 4 4
2

5uarterly inter#als. Which of the following describes the preferable point for re#enue recognition for this contract if the outcome of the contract can be estimated reliably0 *. *fter the contract is signed. 9. *s progress is made toward completion of the contract. $. *s cash is recei#ed. 3. When the contract is completed. $I* ++.> I@-;8 C"rrent Asset#Lia$i!it% Anbilled &e#enues !. =ow should earned but unbilled re#enues at the balance sheet date on a long-term construction contract be disclosed if the percentage-of-completion method of re#enue recognition is used0 a. In a footnote to the financial statements until the customer is formally billed for the portion of the wor/ completed. b. *s a recei#able in the noncurrent asset section of the balance sheet. &)$)* +,.: c. *s a construction in progress in the noncurrent asset section of the balance sheet. d. *s construction in progress in the current asset section of the balance sheet. $osts %f Ancompleted $ontracts In 6xcess %f &elated 9illings !. B$osts of uncompleted contracts in excess of related billingsC in most cases is shown as a a. $urrent liability, i.e., *ccounts )ayable. b. Dong-term debt, i.e, 1otes )ayable. c. $urrent assets, i.e., &ecei#ables. d. In#estments, i.e., $onstruction in )rogress. &)$)* +,-. $osts %f Ancompleted $ontracts In 6xcess %f &elated $osts !. B9illings on uncompleted contracts in excess of related costsC in most cases is shown as a a. $urrent liability, i.e., *ccounts )ayable. b. Dong-term debt, i.e., 1otes )ayable. c. $urrent assets, i.e., &ecei#ables. d. In#estments, i.e., $onstruction in )rogress. &)$)* +,-. $onstruction in )rocess !. "he $onstruction-in-)rocess account accumulates the following when the percentage-ofcompletion method is used a. $onstruction costs to date. b. $onstruction costs to date less payments recei#ed. c. $onstruction costs to date less billings to date. d. $onstruction costs plus gross profit earned to date. &)$)* ,2.;

* building contractor has a fixed-price contract to construct a large building. It is estimated that the building will ta/e ; years to complete. )rogress billings will be sent to the customer at

+.. When the percentage-of-completion method of accounting for long-term construction projects is used, why is $onstruction in )rogress increased by the annual recogni'ed gross profit on long-term construction contracts0 a. "he cost of the contract has increased. b. "he project's #alue has increased abo#e cost. c. "he economy experiences inflation o#er the construction period. d. $onstruction in )rogress is not increased by the annual recogni'ed profit. 4, 4 4 -,. In accounting for a long-term construction contract using the percentage of completion method, the amount of income recogni'ed in any year would be added to E6F *. 3eferred re#enue $. $onstruction in progress 9. )rogress billings on contracts 3. )roperty, plant, and e5uipment $)*& )rogress 9illings >:. GA(9% $orp. uses the percentage-of-completion method of re#enue recognition in accounting for its long-term construction contracts. GA(9% $orp.?s progress billings account is a a. &e#enue account. c. 1on-current liability account. b. $ontra current asset account. d. $ontra non-current asset account. &)$)* ,2.!. "ay $o. uses the percentage-of-completion method to account for a fi#e-year construction contract. "hird year progress billings collected in the fourth year would a. 9e included in the calculation of third year income. b. 9e included in the calculation of third year income insofar as they exceeded second year billings collected in the third year. c. 9e included in the calculation of fourth year income. d. 1ot be included in the calculation of third, fourth, or fifth year incomes. *I$)* ,2.+ "-;8

a. )rogress billings as deferred income, construction in progress as a deferred income. b. )rogress billings as income, construction in progress as in#entory. c. 1et, as an income from construction if credit balance, and loss from construction if debit balance. d. 1et as a current asset if debit balance, and current liability if credit balance. &)$)* +,88. If the $onstruction in )rogress account has a balance of )+,,,,,,,, while the )rogress 9illings on $ontracts account?s balance is )8,,,,,,, how should these accounts be reflected on the balance sheet0 a. $onstruction in )rogress will be shown as a current asset. b. )rogress 9illings on $ontracts will be shown as a current liability. &)$)* ,2.8 c. "he difference between the two accounts will be reflected as a current asset. d. "he difference between the two accounts will be reflected as a current liability.
:

)%$ $ompany accounts for a long-term construction contract using the percentage-ofcompletion method. *s of the end of the current fiscal year, the following information was a#ailable regarding a project expected to be completed in the following year8 $umulati#e progress billings H7,,,,,, $umulati#e costs incurred >,,,,,, $umulati#e re#enues recogni'ed 8,,,,, "he difference between construction in progress and progress billings should be reported in the statement of financial position for the current year as a. * current asset of H;,,,,,. b. * current liability of H;,,,,,. c. Anearned re#enue of H+,,,,,,. d. * separate component of shareholders? e5uity of H+,,,,,,. <leim

;2. * company uses the percentage-of-completion method to account for a four year construction contract. )rogress billings sent in the second year that were collected in the third year would a. be included in the calculation of the income recogni'ed in the second year. b. be included in the calculation of the income recogni'ed in the third year. c. be included in the calculation of the income recogni'ed in the fourth year. d. not be included in the calculation of the income recogni'ed in any year. 4, 4 4 $onstruction in )rogress )rogress 9illings !. In accounting for a long-term construction type contract, the two peculiar accounts used are the Bprogress billingsC and Bconstruction in progressC accounts. *s of year-end, but prior to the completion of a long-term contract, how should the balance of these two accounts be shown0

Gross Pro&it +;. In accounting for a long-term construction-type contract using the percentage-of-completion method, the gross profit recogni'ed during the first year would be the estimated total gross profit from the contract, multiplied by the percentage of the costs incurred during the year to the a. total costs incurred to date. c. unbilled portion of the contract price. b. total estimated cost. d. total contract price. K, W W Reco'ni(e) Pro&it Iirst Jear

* company uses the percentage-of-completion method of accounting for a 7-year construction contract. Which of the following items should be used in the calculation of the income recogni'ed in the first year0 *I$)*, adapted a. b. c. d. )rogress 9illings Jes Jes 1o 1o $ollections on )rogress 9illings Jes 1o 1o Jes Ander the percentage of completion method, the net income to be recogni'ed for the first year of a three-year construction contract is to be determined on the basis of the ratio of a. 6stimated cost to complete to total estimated costs. b. $osts incurred to date to total estimated costs. c. *ctual costs incurred to total estimated costs. d. "otal estimated costs to estimated costs to complete. &)$)* +,8:

"he calculation of the income recogni'ed in the third year of a 2-year construction contract accounted for using the percentage-of-completion method includes the ratio of a. "otal costs incurred to date to total estimated costs. b. "otal costs incurred to date to total billings to date. c. $osts incurred in year > to total estimated costs. d. $osts incurred in year > to total billings to date. *I$)* ++.> "->8 * company used the percentage-of-completion method of accounting for a 2-year construction contract. Which of the following items will the company use to calculate the income recogni'ed in the third year0 *I$)* ++.; "-8 a. b. c. d. )rogress billings to date Jes 1o 1o Jes Income pre#iously recogni'ed 1o Jes 1o Jes

!.

!.

-;. In arri#ing at the gross profit during the first year using the percentage of completion method of accounting for a long-term construction contract, the estimated total gross profit from the contract is multiplied by E6F *. "he percentage of the costs incurred during the year to the total contract price. 9. "he percentage of the costs incurred during the year to the total estimated cost $. "he percentage of the costs incurred during the year to the total costs incurred to date. 3. "he percentage of the costs incurred during the year to the unbilled portion of the total contract price. $)*& 4econd Jear 8 . * company used the percentage-of-completion method of accounting for a 7-year construction contract. Which of the following items should be used to calculate the income recogni'ed in the second year0 *I$)* ++.; "-8, &)$)* ,2.> a. b. c. d. Income )re#iously &ecogni'ed Jes 1o Jes 1o )rogress 9illings to 3ate Jes Jes 1o 1o 8. If the percentage-of-completion method is used, what is the basis for determining the gross profit to be recogni'ed in the second year of a three-year contract0 a. $umulati#e actual costs incurred only. b. Incremental cost for the second year only. c. $umulati#e actual costs and estimated costs to complete. d. 1o gross profit would be recogni'ed in year ;. 4, 4 4 "hird Jear

+,

. "he calculation of the income recogni'ed in the third year of a fi#e-year construction contract accounted for using the percentage-of-completion method includes the ratio of a. "otal costs incurred to date to total estimated costs. b. "otal costs incurred to date to total billings to date. c. $osts incurred in year > to total estimated costs. d. $osts incurred in year > to total billings to date. *I$)* ++.> "->8

Iinal Jear ++ . Which of the following is used in calculating the income recogni'ed in the fourth and final year of a contract accounted for by the percentage-of-completion method0 *I$)* ,2.2 I-;: a. b. c. d. *ctual total costs Jes Jes 1o 1o Income pre#iously recogni'ed Jes 1o Jes 1o +,. Which of the following would be used in the calculation of the gross profit recogni'ed in the third and final year of a construction contract that is accounted for using the percentage-ofcompletion method0 4, 4 4 *. 9. $. 3. *ctual $ontract )rice Jes Jes Jes 1o "otal $osts Jes Jes 1o Jes Income )re#iously &ecogni'ed 1o Jes Jes Jes Anticipate) Loss 7,. 1*"I%1*D $orp. is faced with an impending loss on a long-term construction project and has as/ed for ad#ice on how to boo/ the impending loss. *ssuming that 1*"I%1*D $orp.

employs the percentage-of-completion method, when should the loss be ta/en up in 1*"I%1*D $orp.?s boo/s0 a. Immediately. b. %#er the period of the project. c. Apon completion of the project. d. When progress billings exceed contract costs incurred. &)$)* ,2.Jo"rna! Entries Ase the following to answer 5uestions 28-:,8 4, 4 " (oon @iew 3esert =omes constructed a subdi#ision of upscale homes north of $a#e $ree/, *ri'ona, during ;,,> and ;,,7 under contract with 6mpire 3e#elopment. &ele#ant data are summari'ed below8 $ontract *mount H;,,,,,,,, ;,,> ;,,7 $ost 8,,,,,, :,,,,,, <ross )rofit >2,,,,, ;2,,,,, $ontract 9illings +,,,,,,,, +,,,,,,,, (oon @iew uses the percentage-of-completion method to recogni'e re#enue. 28. What would be the journal entry made in ;,,> to record re#enue0 *. *ccounts recei#able +,,,,,,,, &e#enue from long-term contracts 9. *ccounts recei#able +,>2,,,,, <ross profit &e#enue from long-term contracts $. $onstruction in progress >2,,,,, $ost of construction 8,,,,,, &e#enue from long-term contracts 3. *ccounts recei#able +,,,,,,,, 9illings in excess of cost >2,,,,, &e#enue from long-term contracts
+;

9. $. 3.

&e#enue for long-term contracts $onstruction in progress $ost of construction &e#enue for long-term contracts $ost of construction <ross profit &e#enue for long-term contracts *ccounts recei#able $ost of construction <ross profit 3eferred re#enue

+,,,,,,,, ;2,,,,, :,,,,,, 82,,,,, +,7,,,,,, :,,,,,, ;,,,,,,,, +,,,,,,,, :,,,,,, ;2,,,,, +2,,,,,

COMPLETED-CONTRACT METHOD Criteria +7. "he completed-contract method of accounting for long-term construction-type contracts is preferable when a. a contractor is in#ol#ed in numerous projects. b. the contracts are of a relati#ely long duration. c. estimates of costs to complete and extent of progress toward completion are reasonably dependable. d. there are inherent uncertainties in the contract beyond normal business ris/s. 4, 4 4 Reco'ni(e) Re*en"e +> . "he accounting method most clearly consistent with basic re#enue recognition principles is the *. )ercentage-of-completion method. $. $ompletion-of-production method. 9. Installment sales method. 3. $ompleted-contract method. <leim
+7

+,,,,,,,, >2,,,,, +,,,,,,,, +,+2,,,,, +,>2,,,,,

. In its 3ecember >+, ;,,> balance sheet, (oon @iew would report8 *. "he asset, cost and profits in excess of billings of H+2,,,,,. 9. "he liability, billings in excess of cost of H;,,,,,,. $. "he asset, contract amount in excess of billings of H+,,,,,,,,. 3. "he asset, deferred profit of H 7,,,,,,.

. * company uses the completed-contract method to account for contract. &e#enue is recogni'ed when recorded progress billings *I$)* ,2.; "-77 a. b. *re collected Jes 1o 6xceed recorded costs Jes 1o

a long-term construction c. Jes 1o d. 1o Jes

+2

:,. What would be the journal entry to record re#enue in ;,,70 *. *ccounts recei#able +,,,,,,,,

. * company uses the completed-contract method to account for a long-term construction contract. &e#enue is recogni'ed when progress billings are *I$)*, *dapted a. b. c. d. &ecorded 1o Jes Jes 1o $ollected Jes Jes 1o 1o

+7. Ander the completed-contract method a. re#enue, cost, and gross profit are recogni'ed during the production cycle. b. re#enue and cost are recogni'ed during the production cycle, but gross profit recognition is deferred until the contract is completed. c. re#enue, cost, and gross profit are recogni'ed at the time the contract is completed. d. none of these. K, W W .. If the completed-contract method is used, what is the basis for determining the income to be recogni'ed in the second year of a three-year contract0 a. $umulati#e actual costs incurred only. b. Incremental cost for the second year only. c. Datest a#ailable estimated costs. d. 1o income would be recogni'ed in year ;. 4, 4 4 Anticipate) Loss +: . Ielidae $o. uses the completed-contract method to account for a 7-year construction contract that is currently in its third year. )rogress billings were recorded and collected in the third year. 9ased on e#ents occurring in the third year, a loss is now anticipated on the contract. When will the effect of each of the following be reported in the company?s income statement0 *I$)* ,28. "-+> a. b. c. d. "hird-year )rogress 9illings 1ot third year 1ot third year "hird year "hird year *nticipated Doss "hird year Iourth year "hird year Iourth year +-. $ost estimates at the end of the second year indicate a loss will result on completion of the entire contract. Which of the following statements is correct0 a. Ander the completed-contract method, the loss is not recogni'ed until the year the construction is completed. b. Ander the percentage-of-completion method, the gross profit recogni'ed in the first year must not be changed. c. Ander the completed-contract method, when the billings exceed the accumulated costs, the amount of the estimated loss is reported as a current liability. d. Ander the completed-contract method, when the $onstruction in )rocess balance exceeds the billings, the estimated loss is added to the accumulated costs. K, W W PERCENTAGE-OF-COMPLETION +S, THE COMPLETED CONTRACT METHOD A)*anta'e o& Percenta'e-o&-Co-p!etion Met o) 2;. "he percentage-of-completion method is preferable to the completed contract method because it is a better measure of8 *. $osts and completion rates. $. *ssets and e5uities.

9. &ecei#ables and in#entory.

3. 6ffort and accomplishment.

4, 4 "

Si-i!arities ;,. When comparing the percentage-of-completion and completed-contract methods of accounting for long-term construction contracts, both methods will report a. the same balances each period in the )rogress 9illings account. b. the same expense for cost of construction each year. c. the same amount of income in the year of completion. d. the same in#entory carrying #alue each year during the construction period. 4, 4 4 Di&&erence ;:. In accounting for a long-term construction contract for which there is a projected profit, the balance in the $onstruction in )rogress account at the end of the first year of wor/ using the percentage-of-completion method would be a. 'ero. b. the same as the completed-contract method. c. higher than the completed-contract method. d. lower than the completed-contract method. 4, 4 4
+-

. "he percentage-of-completion and the completed-contract methods of accounting for longterm construction projects in progress differ in that *. It is only under the percentage-of-completion method that progress billings are accumulated in a contra-in#entory account called billings on construction in progress. 9. It is only under the completed-contract method that accumulated construction costs are included in a construction in progress in#entory account. $. %nly the percentage-of-completion method recogni'es all re#enues and gross profit on the contract when the contract is completed. 3. It is only under the percentage-of-completion method that gross profit earned to date is accumulated in the construction in progress in#entory account. $I* ,2.7 I@-;:

+:. Which of the following is not a difference between the percentage-of completion and completed-contract methods of accounting for long-term construction contracts0 a. "hey report different amounts for in#entory during the construction period. b. "hey report different amounts for progress billings during the construction period. c. "hey cause a different cash inflow during the construction period. 4, 4 4 d. "hey report different amounts for accounts recei#able during the construction period. Anticipate) Loss

+:. $ost estimates on a long-term contract may indicate that a loss will result on completion of the entire contract. In this case, the entire expected loss should be a. recogni'ed in the current period, regardless of whether the percentage-of-completion or completed-contract method is employed. b. recogni'ed in the current period under the percentage-of-completion method, but the completed-contract method should defer recognition of the loss to the time when the contract is completed. c. recogni'ed in the current period under the completed-contract method, but the percentage-of-completion method should defer the loss until the contract is completed. d. deferred and recogni'ed when the contract is completed, regardless of whether the percentage-of-completion or completed-contract method is employed. K, W W >:. When should an anticipated loss on a long-term contract be recogni'ed under the percentageof-completion method and the completed contract method, respecti#ely0 &)$)* +,8;, ,2.> )ercentage-of-completion $ompleted $ontract a. %#er life of the project $ompletion of contract b. Immediately $ompletion of contract c. %#er life of the project Immediately d. Immediately Immediately
+8

JOURNAL ENTRIES FINANCIAL STATEMENT PRESENTATION . RE/UIRED DISCLOSURES Financia! State-ent Presentation )rogress billings and construction in process ;, . =ow should the balances of progress billings and construction in progress be shown at reporting dates prior to the completion of a long-term contract0 a. )rogress billings as deferred income, construction in progress as a deferred expense. b. )rogress billings as income, construction in progress as in#entory. c. 1et, as a current asset if debit balance and current liability if credit balance. d. 1et, as income from construction if credit balance, and loss from construction if debit balance. *I$)* ++-8 "-7, $onstruction in )rogress +>. =ow should earned but unbilled re#enues at the balance sheet date on a long-term construction contract be disclosed if the percentage-of-completion method of re#enue recognition is used0 a. *s construction in progress in the current asset section of the balance sheet. b. *s construction in progress in the noncurrent asset section of the balance sheet. c. *s a recei#able in the noncurrent asset section of the balance sheet. d. In a note to the financial statements until the customer is formally billed for the portion of wor/ completed. K, W W Re0"ire) Disc!os"re $ompleted $ontract (ethod +8. If a company uses the completed-contract method of accounting for long-term construction contracts, then during the period of construction, financial information related to a long-term contract will a. appear on both the income statement and balance sheet during the construction period. b. appear only on the income statement during the period of construction. c. appear only on the balance sheet during the period of construction. d. not appear on the financial statements. 4, 4 4

. *n organi'ation has a long-term construction contract in process. 3uring the current period, the estimated total contract cost has increased sufficiently so that there is a current-period loss, e#en though the contract is still estimated to be profitable o#erall. Ander these circumstances, the KDist *L method of re#enue recognition would re5uire a KDist 9L period adjustment of expected gross profit recogni'ed on the contract. $I* ++.2 I@-+: Dist * Dist 9 *. )ercentage-of-completion )rior 9. )ercentage-of-completion $urrent $. $ompleted-contract )rior 3. $ompleted-contract $urrent . 3uring +..,, "idal $o. began construction on a project scheduled for completion in +..;. *t 3ecember >+, +..,, an o#erall loss was anticipated at contract completion. What would be the effect of the project on +.., operating income under the percentage-of-completion method and the completed-contract method0 *I$)* ++.+ "-2 a. b. c. d. )ercentage-of-completion 1o effect 1o effect 3ecrease 3ecrease $ompleted-contract 1o effect 3ecrease 1o effect 3ecrease

+.

. *nswer E3F is correct. "he re#enue recognition principle states that re#enue should be recogni'ed ErecordedF when reali'ed or reali'able and earned. &e#enue is earned when the earning process is essentially complete. In effect, re#enue is recorded when the most important e#ent in the earning of that re#enue has occurred. "hus, re#enue is normally recorded at the time of the sale or, occasionally, at the time cash is collected. =owe#er, sometimes neither the sales basis nor the cash basis is appropriate, such as when a construction contract extends o#er se#eral accounting periods. *s a result, contractors ordinarily recogni'e re#enue using the percentage-of-completion method so that some re#enue is recogni'ed each year o#er the life of the contract. =ence, this method is an exception to the general principle of re#enue recognition, primarily because it better matches re#enues and expenses. *nswer E*F is incorrect because the percentage-of-completion method attempts to match re#enues and expenses with the appropriate periods. *nswer E9F is incorrect because the going-concern assumption is appropriate for a contractor using the percentage-of-completion method, as for any other type of company. *nswer E$F is incorrect because the economic-entity assumption is appropriate for a contractor using the percentage-of-completion method, as for any other type of company. . *nswer E3F is correct. &e#enue is recogni'ed when reali'ed or reali'able and the earning process is substantially complete. "his ordinarily occurs at the time of sale and deli#ery of goods or ser#ices. "hus, the percentage-ofcompletion method is essentially an exception to the re#enue recognition principle. )roduction rather than sale and deli#ery is considered to be the culmination of the earning process. *nswer E*F is incorrect because the percentage-of-completion method attempts a more accurate association of cost incurrence and re#enue recognition. *nswer E9F is incorrect because the percentage-of-completion method is completely consistent with the going concern assumption. *nswer E$F is incorrect because the percentage-of-completion method is completely consistent with the historical cost principle. . *nswer E3F is correct. 4I*$ 2 states that re#enue should be recogni'ed when it is both reali'ed or reali'able and earned. If a project is contracted for before production and co#ers a long time period in relation to reporting periods, re#enues may be recogni'ed by a percentage-of-completion method as they are earned Eas production occursF, pro#ided reasonable estimates of results at completion and reliable measures of progress are a#ailable. "hus, contractors traditionally use the percentage-of-completion method because some re#enue can be recogni'ed during each period of the production process. In a sense, the earning process is completed in #arious stagesM thus, re#enues should be recorded in each stage. *nswer E*F is incorrect because, depending upon the terms of the contract, the assets may not be readily con#ertible into cash. *nswer E9F is incorrect because, on a large construction project, the production process often cannot be easily di#ided into definite stages. *nswer E$F is incorrect because cash is sometimes not recei#ed until the project is completed. . &6NAI&638 "he method appropriate to account for construction re#enue. 3I4$A44I%18 E9F 4I*$ 2, &ecognition and (easurement in Iinancial 4tatements of 9usiness 6nterprises, states that re#enue should be recogni'ed when it is both reali'ed or reali'able and earned. If a project is contracted for before production and is long in relation to reporting periods, re#enues may be recogni'ed by a percentage-of-completion method as they are earned Eas production occursF, pro#ided reasonable estimates of results at completion and reliable measures of progress are a#ailable. "his method results in information that is more rele#ant and representationally faithful than that based on waiting for deli#ery, completion of the project, or payment. *nswer E*F is incorrect because the installment method is appropriate if collectibility is doubtful. *nswer E$F is incorrect because the completed-contract method is appropriate if reasonable estimates of results at completion and reliable measures of progress are not a#ailable. *nswer E3F is incorrect because the point-of-sale method is appropriate when the product or merchandise is deli#ered or ser#ices are rendered directly to customers. . *nswer E9F is correct. Ander the percentage-of-completion method, re#enues and expenses are recogni'ed based on the stage of completion at the balance sheet date if the outcome of the contract can be estimated reliably. Ior a fixed-price contract, the outcome can be estimated reliably if E+F total re#enue can be measured reliably, E;F it is probable that the economic benefits of the contract will flow to the enterprise, E>F contract costs to complete and stage of completion can be measured reliably, and E7F contract costs can be clearly identified and measured reliably so that actual and estimated costs can be compared.

*nswer E*F is incorrect because re#enue is not recogni'ed until progress has been made toward completion. *nswer E$F is incorrect because the cash basis is inappropriate. *n accrual method, that is, the percentage-of-completion method, should be used. *nswer E3F is incorrect because the completed-contract method is not a permissible method.
6

. &6NAI&638 "he reporting of the difference between construction in progress and progress billings. 3I4$A44I%18 E9F )rogress billings is an offset to construction in progress Eor #ice #ersaF on the balance sheet. "he difference between construction in progress Ecosts and recogni'ed incomeF and progress billings to date is shown as a current asset if construction in progress exceeds total billings, and as a current liability if billings exceed construction in progress. 9ecause progress billings exceed construction in progress, the difference should be reported as a current liability of H;,,,,, KH7,,,,,, O EH>,,,,,, P H8,,,,,FL. *nswer E*F is incorrect because progress billings exceed construction in progress. *nswers E$F and E3F are incorrect because H+,,,,,, ignores the re#enue already recogni'ed. . &6NAI&638 "he effect that progress billings and collections ha#e on the determination of earnings. 3I4$A44I%18 Ander <**), re#enue should be recogni'ed when it is reali'ed or reali'able and earned. Ior long-term construction contracts, these criteria are met in accordance with either the percentage-of-completion method or the completed-contract method. 1either the issuance of a progress billing Edebit accounts recei#able, credit progress billingsF nor the collection of cash Edebit cash, credit accounts recei#ableF results in recognition of income. *nswers E*F, E9F, and E3F are incorrect because neither progress billings nor collections on progress billings should be used to calculate income. . &6NAI&638 "he itemEsF used in computing income in the second year using the percentage-of-completion method. 3I4$A44I%18 E$F "he percentage-of-completion method pro#ides for the recognition of income based on the relationship between the costs incurred to date and estimated total costs for the completion of the contract. "he amount of income Ebased on the latest a#ailable estimated costsF recogni'ed in the second year of a 7-year contract is calculated as follows8 "he total anticipated income is multiplied by the ratio of the costs incurred to date to the total estimated costs, and the product is reduced by pre#iously recogni'ed income. Income pre#iously recogni'ed is therefore used to calculated income to be recogni'ed in the second year. =owe#er, progress billings to date ha#e no effect on the amount of income to be recogni'ed in the second year. *nswers E*F, E9F, and E3F are incorrect because income pre#iously recogni'ed is used to calculate the income recogni'ed. )rogress billings to date are not. . &6NAI&638 "he ratio used in the calculation of income recogni'ed for a construction contract using the percentage-of-completion method. 3I4$A44I%18 E*F *ccording to *&9 72, the percentage-of-completion method pro#ides for the recognition of income based on the relationship between costs incurred to date and estimated total costs for completion of the contract. E9ut *&9 72 permits any other measure of progress Bas may be appropriate ha#ing due regard to wor/ performed.CF "he amount of income recogni'ed in the >rd period of a 2-year contract is calculated as follows8 "he total anticipated income Ebased on the latest a#ailable estimated costsF is multiplied by the ratio of costs incurred to date to the latest a#ailable total estimated costs, and the product is reduced by the pre#iously recogni'ed income. *nswer E9F is incorrect because the ratio of total costs incurred to date to total billings to date is not rele#ant. *nswer E$F is incorrect because total costs incurred must be used. *nswer E3F is incorrect because neither the issuance nor the collection of billings results in income recognition. . &6NAI&638 "he ratio used in the calculation of income recogni'ed for a construction contract using the percentage-of-completion method. 3I4$A44I%18 E*F *ccording to *&9 72, the percentage-of-completion method pro#ides for the recognition of income based on the relationship between costs incurred to date and estimated total costs for completion of the contract. E9ut *&9 72 permits any other measure of progress Bas may be appropriate ha#ing due regard to wor/ performed.CF "he amount of income recogni'ed in the third year of a 2-year contract is calculated as follows8 "he total anticipated income Ebased on the latest a#ailable estimated costF is multiplied by the ratio of costs incurred to date to the latest a#ailable total estimated costs, and the product is reduced by pre#iously recogni'e income.

10

*nswer E9F is incorrect because the ratio of total costs incurred to date to total billings to date is not rele#ant. *nswer E$F is incorrect because total costs incurred must be used. *nswer E3F is incorrect because neither the issuance nor the collection of billings results in income recognition.
11

. &6NAI&638 "he items used to calculate income in the last year of a contract using the percentage-of-completion method. 3I4$A44I%18 E*F "he percentage-of-completion method recogni'es re#enues, costs, and income depending on the progress made on the contract. Income recogni'ed in the last year of the contract e5uals the contract price, minus actual total costs, minus income pre#iously recogni'ed. *nswers E9F, E$F, and E3F are incorrect because income pre#iously recogni'ed and actual total costs are used. . 9illings8 6xcess8 E*F H+,+2,,,,, $osts P profits8 +,,,,,,,, H+2,,,,, H8,,,,,, P >2,,,,, Q

12

13

. *nswer E3F is correct. *ccording to the re#enue recognition principle, re#enue should be recogni'ed when E+F reali'ed or reali'able and E;F earned. Ander the completed-contract method, re#enue is not recogni'ed until a long-term construction contract is complete. *t this stage, the entity is most clearly entitled to the resulting re#enues and is most li/ely to ha#e been in#ol#ed in an exchange. *nswer E*F is incorrect because the percentage-of-completion method allows for re#enue to be recogni'ed at #arious stages of the contract although the entire job is not complete. *nswer E9F is incorrect because, if the collectibility of assets is relati#ely uncertain, re#enues and gains may be recogni'ed as cash is recei#ed using the installment sales method. *nswer E$F is incorrect because the completion-of-production method is an appropriate basis for recognition if products or other assets are readily reali'able, e.g., precious metals and some agricultural products. . &6NAI&638 "he effect of the completed-contract method on re#enue recognition. 3I4$A44I%18 E9F Ander the completed-contract method of accounting for long-term construction contracts, recorded progress billings ha#e no effect on the recognition of income. *nswers E*F, E$F, and E3F are incorrect because under the completed-contract method, progress billings are recorded when issued and remo#ed at the completion of the contract. . &6NAI&638 "he effect of progress billings on the recognition of re#enue. 3I4$A44I%18 E3F <**) re5uires that re#enue be recogni'ed when it is reali'ed or reali'able and earned. Ander the completed-contract method, re#enue recognition is appropriate only at the completion of the contract. 1either the recording nor the collection of progress billings affects this recognition. *nswers E*F, E9F, and E$F are incorrect because neither the issuance of a progress billing Edebit accounts recei#able, credit progress billingsF nor the collection of cash Edebit cash, credit accounts recei#ableF results in recognition of income. . &6NAI&638 "he effect of progress billings and an anticipated loss on the company?s income statement. 3I4$A44I%18 E*F Ander the completed-contract method, the gross profit on the contract should be recogni'ed upon the completion of the contract. If a loss is anticipated, howe#er, the loss should be recogni'ed immediately. Ander <**), the entries to record progress billings and their collection do not affect the recognition of profit or loss. "hus, the >rd year progress billings ha#e not effect on the income statement, but the loss anticipated in the >rd year should be recogni'ed in full in that year. *nswers E9F, E$F, and E3F are incorrect because, under the completed-contract method, progress billings ha#e not effect on the recognition of income, and an anticipated loss should be recogni'ed in the year it occurs. . *nswer E3F is correct. "he completed-contract method does not recogni'e any gross profit until the contract is completed. "he percentage-of-completion method recogni'es a portion of re#enues and gross profit each period, based upon the ratio of costs incurred to date to total estimated costs of completion. *ccumulated gross profit and accumulated

14

15

16

17

construction costs are included in the construction in progress in#entory account under the percentage-of-completion method. *nswer E*F is incorrect because progress billings are accumulated in the billings on construction in progress account under both methods. *nswer E9F is incorrect because accumulated construction costs are included in the construction in progress in#entory account under both methods. *nswer E$F is incorrect because the percentage-of-completion method recogni'es a percentage of re#enues and gross profit each period.
18

. *nswer E9F is correct. Ander the percentage-of-completion method, a current-period loss on a profitable contract is treated as a change in accounting estimate. "hus, a current-period adjustment is re5uired. )rior-period adjustments are made to correct errors, not to reflect changes in estimates. *nswer E*F is incorrect because, under the percentage-of-completion method, a current-period loss on a profitable contract re5uires a current-period adjustment. *nswer E$F is incorrect because, under the completed-contract method, no profit is recogni'ed until the contract is completed. $ost estimate adjustments while construction is in progress do not result in profit or loss recognition prior to completion unless an o#erall loss is expected on the contract. *nswer E3F is incorrect because, under the completed-contract method, no profit is recogni'ed until the contract is completed. $ost estimate adjustments while construction is in progress do not result in profit or loss recognition prior to completion unless an o#erall loss is expected on the contract. . &6NAI&638 "he effect of the project on +.., operating income under the percentage-of-completion method and the completed-contract method. 3I4$A44I%18 E3F When the current estimate of total contract costs indicates a loss, an immediate pro#ision for the entire loss should be made regardless of method. "hus, under either method, +.., operating income is decreased by the projected loss. *nswers E*F, E9F, and E$F are incorrect because, under either method, +.., operating income is decreased by the projected loss. . &6NAI&638 "he proper balance sheet presentation of progress billings and construction in progress. 3I4$A44I%18 E$F *&9 72, Dong-"erm $onstruction-"ype $ontracts, re5uires that the difference between construction in progress Ecosts and recogni'ed incomeF and progress billings to date be shown as a current asset if construction in progress exceeds total billings, and as a current liability if billings exceed construction in progress. 4eparate recognition is re5uired for each project. *nswers E*F and E9F are incorrect because progress billings and construction in progress should be netted for balance sheet presentation as a current asset or liability. *nswer E3F is incorrect because neither income nor loss results from progress billings.

19

20