262 SECTION 1 The Role of Accounting as an Information System 2016 Revenue recognized ($5,000,000 3 40%) $2,000,000 Cost of construction (1,500,000) Gross profit $ 500,000 2017 Revenue recognized to date ($5,000,000 3 62.5%) $3,125,000 Less: Revenue recognized in 2016 2,000,000 Revenue recognized $1,125,000 Cost of construction (1,000,000) Gross profit $ 125,000 2018 Revenue recognized to date ($5,000,000 3 100%) $5,000,000 Less: Revenue recognized in 2016 and 2017 3,125,000 Revenue recognized $1,875,000 Cost of construction (1,600,000) Gross profit $ 275,000 A Comparison of Revenue Recognized Over the Term of the Contract and at the Completion of Contract INCOME RECOGNITION. Illustration 5–24B (page 261) shows the journal entries that would determine the amount of revenue, cost, and therefore gross profit that would appear in the income statement when we recognize revenue over the term of the contract and at the completion of contract. Comparing the gross profit patterns produced by each method of revenue recognition demonstrates the essential difference between them: Revenue Recognition Over Time Upon Completion Gross profit recognized: 2016 $500,000 –0– 2017 125,000 –0– 2018 275,000 $900,000 Total gross profit $ 900,000 $900,000 28 For income tax purposes, revenue can be recognized at completion for home construction contracts and certain other real estate construction contracts. All other contracts must recognize revenue over time according to percentage of completion. Illustration 5–24D Recognition of Revenue and Cost of Construction in Each Period Illustration 5–24E Journal Entry to Close Billings and CIP Accounts Upon Contract Completion 2016 2017 2018 Billings on construction contract ........ 5,000,000 Construction in progress (CIP) ........ 5,000,000 To close accounts. Whether revenue is recognized over time or upon completion does not affect the total gross profit of $900,000 recognized over the three-year contract, but the timing of gross profit recognition is affected. When the contract does not qualify for recognizing revenue over time, we defer all gross profit to 2018, when the project is completed. Obviously, recognizing revenue over the term of the contract provides a better measure of the company’s economic activity and progress over the three-year term. As indicated previously, most long-term contracts qualify for revenue recognition over time. 28 Revenue is deferred Timing of revenue recognition does not affect the total amount of profit or loss recognized.
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