A CCOUNTING FOR

CONS TRU CTION

CONTRACTS
REVENUE RECOGNITION

Recognition refers to the time when transactions are recorded on the books. There are two
criteria for recognizing revenues and gains are when:
• They are realized or realizable.
• They have been earned through substantial completion of the activities involved in the earnings
process.
REVENUE RECOGNITION
Record revenue when:

the earnings there is

process is reasonable
complete or AND certainty as to the
virtually collectibility of the
complete. asset to be
received (usually
cash).
LONG-TERM CONSTRUCTION
CONTRACTS
• ‘Long term’ construction contracts are contracts where
construction work extends beyond one year of income.
• A deferral of the recognition of profits and losses until completion
of the contract remains unacceptable.
LONG-TERM CONSTRUCTION
CONTRACTS
• There continues to be two methods which may apply in recognising the
income derived and expenses incurred under a long term construction
contract for income tax purposes – the basic approach and the estimated
profits basis.
LONG-TERM CONSTRUCTION
CONTRACTS
Completed
Contract Method
Long-term
Contracts
Percentage-of-
Completion
Method
COMPLETED-CONTRACT METHOD
If a Company waits until the production or service period is
complete to recognize revenue, this approach is referred to
as the completed-contract method. All income from the
contract is related to the year of completion.
ILLUSTRATIVE EXAMPLE:

In January 2012, Strong Construction Company was

awarded a contract with a total price of $3,000,000. Strong
expects to earn $400,000 profit on the contract. The
construction was completed over a 3-year period.
IN JANUARY 2012, STRONG CONSTRUCTION COMPANY WAS AWARDED A
CONTRACT WITH A TOTAL PRICE OF $3,000,000. STRONG EXPECTS TO
EARN $400,000 PROFIT ON THE CONTRACT. THE CONSTRUCTION WAS
COMPLETED OVER A 3 -YEAR PERIOD.

2012 2013 2014

Construction costs
incurred during the year 1,040,000 910,000 650,000
Construction costs
incurred in prior years - 1,040,000 1,950,000
Cumulative construction
costs 1,040,000 1,950,000 2,600,000
Billings made during the
year 1,000,000 900,000 1,100,000
Cash collections made
during the year 800,000 850,000 1,350,000
Percentage of completion
to date 40% 75% 100%
 JOURNAL ENTRIES
2012
Construction in Progress 1,040,000
Materials, Cash, etc. 1,040,000
To record costs incurred.

Accounts Receivable 1,000,000

Progress Billings on
Construction Contracts 1,000,000
To record billings.
Cash 800,000
Accounts Receivable 800,000
To record cash collections.
 JOURNAL ENTRIES
2013
Construction in Progress 910,000
Materials, Cash, etc. 910,000
To record costs incurred.

Accounts Receivable 900,000

Progress Billings on
Construction Contracts 900,000
To record billings.

Cash 850,000
Accounts Receivable 850,000
To record cash collections.
 JOURNAL ENTRIES
2014
Construction in Progress 650,000
Materials, Cash, etc. 650,000
To record costs incurred.

Accounts Receivable 1,100,000

Progress Billings on
Construction Contracts 1,100,000
To record billings.

Cash 1,350,000
Accounts Receivable 1,350,000
To record cash collections.
 JOURNAL ENTRIES
2014
Under the completed-contract method, the following entries would be made to
recognize revenue and costs and to close out the inventory and billing accounts.
Progress Billings on
Construction Contracts 3,000,000
Revenue from Long-Term
Construction Contracts 3,000,000

Cost of Long-Term
Construction Contracts 2,600,000
Construction in Progress 2,600,000
 EXERCISES:
• Geller Construction entered into a three-year contract to build a
containment vessel for Southeast Power Company for a contract
price of $1,400,000. Presented below is information about the
contract:

2009 2010 2011

Construction costs incurred during the year $ 250,000 $ 550,000 $ 400,000
Construction costs incurred in prior years - 250,000 800,000
Cumulative construction costs 250,000 800,000 1,200,000
Estimated costs to complete at end of the year 1,000,000 425,000 -
Total estimated and actual construction costs $ 1,250,000 $ 1,225,000 $ 1,200,000

Billings made during the year $ 250,000 $ 525,000 $ 625,000

Cash collections during the year 225,000 470,000 405,000
PERCENTAGE OF COMPLETION
ACCOUNTING METHOD
• Percentage-of-completion accounting was developed to
relate recognition of revenue on long-term construction-
type contracts to the activities of a firm in fulfilling these
contracts.
 PERCENTAGE OF COMPLETION
ACCOUNTING METHOD
• The AICPA identified several elements that should be present if the percentage-of-completion
accounting is to be used.
1. Dependable estimates can be made of contract revenues, contract costs, and the extent of
progress toward completion.
2. The contract clearly specifies the enforceable rights regarding goods or services to be
provided and received by the parties, the consideration to be exchanged, and the manner and
terms of settlement.
3. The buyer can be expected to satisfy obligations under the contract.
4. The contractor can be expected to perform the contractual obligation.
ILLUSTRATIVE EXAMPLE:
In January 2012, Strong Construction Company was awarded a contract
with a total price of $3,000,000. Strong expects to earn $400,000 profit
on the contract. The construction was completed over a 3-year period.
IF THE COMPANY USED THE PERCENTAGE -OF-COMPLETION METHOD OF
ACCOUNTING, THE $400,000 PROFIT WOULD HAVE TO BE SPREAD OVER
ALL THREE YEARS OF CONSTRUCTION ACCORDING TO THE ESTIMATED
PERCENTAGE OF COMPLETION EACH YEAR.

2012 2013 2014

Construction costs
incurred during the year 1,040,000 910,000 650,000
Construction costs
incurred in prior years - 1,040,000 1,950,000
Cumulative construction
costs 1,040,000 1,950,000 2,600,000
Billings made during the
year 1,000,000 900,000 1,100,000
Cash collections made
during the year 800,000 850,000 1,350,000
Percentage of completion
to date 40% 75% 100%
 JOURNAL ENTRIES
2012
Construction in Progress 1,040,000
Materials, Cash, etc. 1,040,000
To record costs incurred.

Accounts Receivable 1,000,000

Progress Billings on
Construction Contracts 1,000,000
To record billings.
Cash 800,000
Accounts Receivable 800,000
To record cash collections.
 JOURNAL ENTRIES
2012
Cost of Long-Term
Construction Contracts 1,040,000
Construction in Progress 160,000
Revenue from Long-Term
Construction Contracts 1,200,000
 JOURNAL ENTRIES
2013
Construction in Progress 910,000
Materials, Cash, etc. 910,000
To record costs incurred.

Accounts Receivable 900,000

Progress Billings on
Construction Contracts 900,000
To record billings.

Cash 850,000
Accounts Receivable 850,000
To record cash collections.
 JOURNAL ENTRIES
2013
Cost of Long-Term Construction
Contracts 910,000
Construction in Progress 140,000
Revenue from Long-Term
Construction Contracts 1,050,000
 JOURNAL ENTRIES
2014
Construction in Progress 650,000
Materials, Cash, etc. 650,000
To record costs incurred.

Accounts Receivable 1,100,000

Progress Billings on
Construction Contracts 1,100,000
To record billings.

Cash 1,350,000
Accounts Receivable 1,350,000
To record cash collections.
 JOURNAL ENTRIES
2014
Cost of Long-Term Construction
Contracts 650,000
Construction in Progress 100,000
Revenue from Long-Term
Construction Contracts 750,000

Progress Billings on
Construction Contracts 3,000,000
Construction in Progress 3,000,000
 EXERCISES:
• Geller Construction entered into a three-year contract to build a
containment vessel for Southeast Power Company for a contract
price of $1,400,000. Presented below is information about the
contract:

2009 2010 2011

Construction costs incurred during the year $ 250,000 $ 550,000 $ 400,000
Construction costs incurred in prior years - 250,000 800,000
Cumulative construction costs 250,000 800,000 1,200,000
Estimated costs to complete at end of the year 1,000,000 425,000 -
Total estimated and actual construction costs $ 1,250,000 $ 1,225,000 $ 1,200,000

Billings made during the year $ 250,000 $ 525,000 $ 625,000

Cash collections during the year 225,000 470,000 405,000
 ANSWERS:
2009 2010 2011
Contract price $ 1,400,000 $ 1,400,000 $ 1,400,000
Actual costs to date $250,000 $800,000 $1,200,000
Estimated costs to complete 1,000,000 425,000 0
Total project cost $1,250,000 $1,225,000 $1,200,000
Total gross profit (Contract price - total costs) $ 150,000 $ 175,000 $ 200,000

Percentage-of-completion (actual costs to date) $ 250,000 $ 800,000 (project is complete)

Divided by the estimated total project cost $ 1,250,000 $ 1,225,000
Equals percentage complete to date 20.00% 65.31% 100.00%

Total project gross profit $ 150,000 $ 175,000 $ 200,000

Multiplied by the estimated % of completion 20.00% 65.31% 100.00%
Gross profit earned to date $ 30,000 $ 114,286 200,000
Less gross profit recognized in previous periods - (30,000) (114,286)
Gross profit recognized currently $ 30,000 $ 84,286 $ 85,714