CHAPTER 5 Revenue Recognition and Profitability Analysis 263 until the completion of the contract only if the seller doesn’t qualify for revenue recognition over time according to the criteria listed in Illustration 5–5 . BALANCE SHEET RECOGNITION. The balance sheet presentation for the construction-related accounts for both methods is shown in Illustration 5–24F . Balance Sheet (End of Year) 2016 2017 Projects for which Revenue Recognized Upon Completion: Current assets: Accounts receivable $200,000 $800,000 Costs ($1,500,000) in excess of billings ($1,200,000) 300,000 Current liabilities: Billings ($3,200,000) in excess of costs ($2,500,000) $700,000 Projects for which Revenue Recognized Over Time: Current assets: Accounts receivable $200,000 $800,000 Costs and profit ($2,000,000) in excess of billings ($1,200,000) 800,000 Current liabilities: Billings ($3,200,000) in excess of costs and profit ($3,125,000) $ 75,000 Illustration 5–24F Balance Sheet Presentation In the balance sheet, the construction in progress (CIP) account is offset against the billings on construction contract account, with CIP > Billings shown as a contract asset and Billings > CIP shown as a contract liability. Rather than referring to CIP, companies sometimes refer to what the CIP account contains, as is done in Illustration 5–24F . When revenue is recognized over the term of the contract, CIP contains cost and gross profit; if revenue is recognized upon the completion of the contract, CIP typically contains only costs. Because a company may have some contracts that have a net asset position and others that have a net liability position, it is not unusual to see both contract assets and contract liabilities shown in a balance sheet at the same time. CIP in excess of billings is treated as a contract asset rather than an accounts receivable because something other than the passage of time must occur for the company to be paid for that amount. Although Harding has incurred construction costs (and is recognizing gross profit over the term of the contract) for which it will be paid by the buyer, those amounts are not yet billable according to the construction contract. Once Harding has made progress sufficient to bill the customer, it will debit accounts receivable and credit billings, which will increase the accounts receivable asset and reduce CIP in excess of billings (by increasing billings). On the other hand, Billings in excess of CIP is treated as a contract liability. It reflects that Harding has billed its customer for more work than it actually has done. This is similar to the deferred revenue liability that is recorded when a customer pays for a product or service in advance. The advance is properly shown as a liability that represents the obligation to provide the good or service in the future. Long-Term Contract Losses The Harding Construction Company example above involves a situation in which an overall profit was anticipated at each stage of the contract. Unfortunately, losses sometimes occur on long-term contracts. As facts change, sellers must update their estimates and recognize losses if necessary to properly account for the amount of revenue that should have been recognized to date. How we treat losses in any one period depends on whether the contract is profitable overall. Billings on construction contracts are subtracted from CIP to determine balance sheet presentation.
Spiceland_Inter_Accounting8e_Ch05
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