CHAPTER 5 Revenue Recognition and Profitability Analysis 257 the progress toward completion that occurred during that year. Long-term contracts that didn’t qualify for revenue recognition over time were accounted for using an approach called the completed contract method , because all revenue was recognized at a single point in time—upon completion of the contract. ASU No. 2014–09 removes the terms “percentage-of-completion method” and “completed contract method” from the Accounting Standards Codification, and changes the criteria that determine whether revenue should be recognized over a period of time or at a point in time. However, the journal entries necessary to account for revenue over time are the same as those that were used under the percentage-of-completion method, and those used to account for revenue at a point in time are the same as those used under the completed contract method. We demonstrate those journal entries next. Accounting for a Profitable Long-Term Contract Much of the accounting for long-term contracts is the same regardless of whether we recognize revenue over the contract period or upon completion of the contract. So, we start by discussing the similarities between the two approaches, and then the differences. You’ll see that we recognize the same total amounts of revenue and profit over the life of the contract either way. Only the timing of recognition differs. Illustration 5–24 provides information for a typical long-term construction contract that we’ll use to consider accounting for long-term contracts. FINANCIAL Reporting Case Q3, p. 231 Illustration 5–24 Example of Long-Term Construction Contract At the beginning of 2016, the Harding Construction Company received a contract to build an office building for $5 million. Harding will construct the building according to specifications provided by the buyer, and 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: 2016 2017 2018 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 actual construction costs 1,500,000 2,500,000 4,100,000 Estimated costs to complete at end of year 2,250,000 1,500,000 -0- 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 Construction costs include the labor, materials, and overhead costs directly related to the construction of the building. Notice how the total of estimated and actual construction costs changes from period to period. Cost revisions are typical in long-term contracts because costs are estimated over long periods of time. ACCOUNTING FOR THE COST OF CONSTRUCTION AND ACCOUNTS RECEIVABLE. Summary journal entries are shown in Illustration 5–24A for actual construction costs, billings, and cash receipts. These journal entries are not affected by the timing of revenue recognition. The first journal entry shows Harding incurring various costs during the construction process and recording them in an asset account called construction in progress (or “CIP” for short). This asset account is equivalent to work-in-process inventory in a manufacturing company. This is logical because the construction project is essentially an inventory item in process for the contractor. Construction in progress (CIP) is the contractor’s work-in-process inventory.
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