264 SECTION 1 The Role of Accounting as an Information System PERIODIC LOSS OCCURS FOR PROFITABLE PROJECT. When a project qualifies for revenue recognition over time, a loss sometimes must be recognized in at least one period along the way, even though the project as a whole is expected to be profitable. We determine the loss in precisely the same way we determine the profit in profitable years. For example, assume the same $5 million contract for Harding Construction Company described earlier in Illustration 5–24 but with the following cost information: 2016 2017 2018 Construction costs incurred during the year $1,500,000 $1,260,000 $1,840,000 Construction costs incurred in prior years –0– 1,500,000 2,760,000 Cumulative construction costs 1,500,000 2,760,000 4,600,000 Estimated costs to complete at end of year 2,250,000 1,840,000 –0– Total estimated and actual construction costs $3,750,000 $4,600,000 $4,600,000 At the end of 2016, 40% of the project is complete ($1,500,000 4 3,750,000). Revenue of $2,000,000 – cost of construction of $1,500,000 5 gross profit of $500,000 is recognized in 2016, as previously determined. At the end of 2017, though, the company now forecasts a total profit of $400,000 ($5,000,000 2 4,600,000) on the project and, at that time, the project is estimated to be 60% complete ($2,760,000 4 4,600,000). Applying this percentage to the anticipated revenue of $5,000,000 results in revenue to date of $3,000,000. This implies that gross profit recognized to date should be $240,000 ($3,000,000 2 2,760,000). But remember, gross profit of $500,000 was recognized the previous year. We treat a situation like this as a change in accounting estimate because it results from a change in the estimation of costs to complete at the end of 2016. Total estimated costs to complete the project at the end of 2017—$4,600,000—were much higher than the 2016 year-end estimate of $3,750,000. Recall from our discussion of changes in accounting estimates in Chapter 4 that we don’t go back and restate the prior year’s income statement. Instead, the 2017 income statement reports a loss of $260,000 ($500,000 2 240,000) so that the cumulative amount of gross profit recognized to date is $240,000. The loss consists of 2017 revenue of $1,000,000 (computed as $5,000,000 3 60% 5 $3,000,000 revenue to be recognized by end of 2017 less 2016 revenue of $2,000,000) less cost of construction of $1,260,000 (cost incurred in 2017). The following journal entry records the loss in 2017: Cost of construction ............................................................................ 1,260,000 Revenue from long-term contracts (below) ................................. 1,000,000 Construction in progress (CIP) .................................................... 260,000 In 2018 the company recognizes $2,000,000 in revenue ($5,000,000 less revenue of $3,000,000 recognized in 2016 and 2017) and $1,840,000 in cost of construction (cost incurred in 2018), yielding a gross profit of $160,000: Revenue $2,000,000 Less: Cost of construction (1,840,000) Gross profit $ 160,000 Of course, if revenue is instead recognized upon the completion of the contract, rather than over time, no profit or loss is recorded in 2016 or 2017. Instead, revenue of $5,000,000, cost of construction of $4,600,000, and gross profit of $400,000 are recognized in 2018. LOSS IS PROJECTED ON THE ENTIRE PROJECT. If an overall loss is projected on the entire contract, the total loss must be recognized in the period in which that loss becomes evident, regardless of whether revenue is recognized over the term of the Recognized losses on long-term contracts reduce the CIP account.
Spiceland_Inter_Accounting8e_Ch05
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