256 SECTION 1 The Role of Accounting as an Information System Accounting for Long-Term Contracts A recent survey of reporting practices of 500 large public companies indicates that approximately one i n every eight companies participates in long-term contracts. 23 These are not only construction companies. Illustration 5–23 lists just a sampling of companies that use long-term contracts, many of which you might recognize. PART C ● LO5–9 Company Type of Industry or Product Oracle Corp. Computer software, license and consulting fees Lockheed Martin Corporation Aircraft, missiles, and spacecraft Hewlett-Packard Information technology Northrop Grumman Newport News Shipbuilding Nortel Networks Corp. Networking solutions and services to support the Internet SBA Communications Corp. Telecommunications Layne Christensen Company Water supply services and geotechnical construction Kaufman & Broad Home Corp. Commercial and residential construction Raytheon Company Defense electronics Foster Wheeler Corp. Construction, petroleum and chemical facilities Halliburton Construction, energy services Allied Construction Products Corp. Large metal stamping presses 23U.S. GAAP Financial Statements—Best Practices in Presentation and Disclosure–2013 (New York: AICPA, 2013). Illustration 5–23 Companies Engaged in Long-Term Contracts The five-step process for recognizing revenue described in Parts A and B of this chapter also applies to long-term contracts. However, steps 2 and 5 merit special attention. Step 2, “Identify the performance obligation(s) in the contract,” is important because long-term contracts typically include many products and services that could be viewed as separate performance obligations. For example, constructing a building requires the builder to deliver many different materials and other products (concrete, lumber, furnace, bathroom fixtures, carpeting) and to provide many different services (surveying, excavating, construction, fixture installation, painting, landscaping). These products and services are capable of being distinct, but they are not separately identifiable, because the seller’s role is to combine those products and services for purposes of delivering a completed building to the customer. Therefore, it’s the bundle of products and services that comprise a single performance obligation. Most long-term contracts should be viewed as including a single performance obligation. Step 5, “Recognize revenue when (or as) each performance obligation is satisfied,” is important because there can be a considerable difference for long-term contracts between recognizing revenue over time and recognizing revenue only when the contract has been completed. Imagine a builder who spends years constructing a skyscraper but only gets to recognize revenue at the end of the contract. Such delayed revenue recognition would do a poor job of informing financial statement users about the builder’s economic activity. Fortunately, most long-term contracts qualify for revenue recognition over time. Often the customer owns the seller’s work in process, such that the seller is creating an asset that the customer controls as it is completed. Also, often the seller is creating an asset that is customized for the customer, so the seller has no other use for the asset and has the right to be paid for progress even if the customer cancels the contract. In either of those cases, the seller recognizes revenue over time. Long-term contracts are complex, and specialized accounting approaches have been developed to handle that complexity. For many years, long-term contracts that qualified for revenue recognition over time were accounted for using an approach called the p ercentageof completion method , which recognized revenue in each year of the contract according to
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