260 SECTION 1 The Role of Accounting as an Information System Recognizing Revenue upon Completion Construction in Progress (CIP) 2016 construction costs 1,500,000 End balance, 2016 2017 construction costs 1,500,000 1,000,000 End balance, 2017 2018 construction costs Total gross profit 2,500,000 1,600,000 900,000 Balance, before closing 5,000,000 Billings on Construction Contract 1,200,000 2016 billings 1,200,000 2,000,000 End balance, 2016 2017 billings 3,200,000 1,800,000 End balance, 2017 2018 billings 5,000,000 Balance, before closing RECOGNIZING REVENUE OVER TIME ACCORDING TO PERCENTAGE OF COMPLETION. If a contract qualifies for revenue recognition over time, revenue is recognized based on progress towards completion. How should progress to date be estimated? As discussed in Part A of this chapter, one approach to estimating progress towards completion is to use output-based measures, like number of units produced or delivered, achievement of milestones, and surveys or appraisals of performance completed to date. A shortcoming of output measures is that they may provide a distorted view of actual progress to date.25 For example, an output measure for highway construction might be finished miles of road, but that measure could be deceptive if not all miles of road require the same effort. A highway contract for the state of Arizona would likely pay the contractor more for miles of road blasted through the mountains than for miles paved across flat dessert. Another shortcoming of some output measures is that the information they require, such as surveys or appraisals, might be costly to obtain. Another way to estimate progress is to base it on the seller’s input, measured as the proportion of effort expended thus far relative to the total effort expected to satisfy the performance obligation. Measures of effort include costs incurred, labor hours expended, machine hours used, or time lapsed. The most common approach to estimating progress toward completion is to use a “cost-to-cost ratio” that compares total cost incurred to date to the total estimated cost to complete the project. 26 When using that approach, sellers have to make sure to exclude from the ratio costs that don’t reflect progress toward completion. For example, inefficiencies in production could lead to wasted materials, labor, or other resources. Those costs must be expensed as incurred, but not included in the cost-to-cost ratio. Regardless of the specific approach used to estimate progress towards completion, we determine the amount of revenue recognized in each period using the following logic: r ec ogn iz e d t his Revenue period 5 ( Total e st im at ed revenue ) 2 com p let ed to date 3 Percentage Revenue r ec og n i z ed in prior periods If a contract qualifies for revenue recognition over time, revenue is recognized over time as the project is completed. Cumulative revenue to be recognized to date 25 Number of units produced or delivered is not an appropriate basis for measuring progress toward completion if these measures are distorted by the seller having material amounts of work-in-progress or finished-goods inventory at the end of the period. 26 R. K. Larson and K. L. Brown, 2004, “Where Are We with Long-Term Contract Accounting?” Accounting Horizons, September, pp. 207–219. If revenue is recognized upon completion of the contract, CIP is updated to include gross profit at that point in time. Illustration 5–24C shows the calculation of revenue for each of the years for our Harding Construction Company example, with progress to date estimated using the cost-to-cost ratio. Notice that this approach automatically includes changes in estimated cost to complete the job, and therefore in estimated percentage completion, by first calculating the cumulative amount of revenue to be recognized to date and then subtracting revenue recognized in prior periods to determine revenue recognized in the current period. Refer to the T-accounts that follow Illustration 5–24C to see that the gross profit recognized in each period is added to the CIP account.
Spiceland_Inter_Accounting8e_Ch05
To see the actual publication please follow the link above