T04 - Long-Term Construction-Type Contracts

ACCOUNTING FOR LONG-TERM CONSTRUCTION PROJECT 8. In selecting an accounting method for a newly contracted long-term construction project, the principal factor to be considered should be a. the terms of payment in the contract. b. the degree to which a reliable estimate of the costs to complete and extent of progress toward completion is practicable. c. the method commonly used by the contractor to account for other long-term construction contracts. d. the inherent nature of the contractor's technical facilities used in construction. K, W & W PERCENTAGE OF COMPLETION METHOD Basic Concepts *. The use of the percentage of completion method of accounting for long term construction contracts is a measurement of revenue under the a. Cost principle. c. Objectivity principle. b. Realization principle. d. Monetary principle. RPCPA 1079 Criteria 10. When work to be done and costs to be incurred on a long-term contract can be estimated dependably, which of the following methods of revenue recognition is preferable? a. Installment method c. Completed-contract method b. Percentage-of-completion method d. None of these K, W & W 15. Which of the following is not an element identified by the AICPA as being necessary in order to use percentage-of-completion accounting? a. The construction period can be reasonably estimated. b. The buyer can be expected to satisfy obligations under the contract. c. Dependable estimates can be made of the extent of progress toward completion. d. Dependable estimates can be made of contract costs. S, S & S 9. The profession requires that the percentage-of-completion method be used when certain conditions exist. Which of the following is not one of those necessary conditions? a. Estimates of progress toward completion, revenues, and costs are reasonably dependable. b. The contractor can be expected to perform the contractual obligation. c. The buyer can be expected to satisfy some of the obligations under the contract. d. The contract clearly specifies the enforceable rights of the parties, the consideration to be exchanged, and the manner and terms of settlement. K, W & W

Characteristics 45. The rationale for adoption of the percentage-of-completion method is that: A. Results are more conservative. B. It provides a measure of periodic accomplishment. C. It is a better match with legal ownership. D. It results in a lower income tax. *.

S, S & T

The percentage-of-completion method of inventory valuation of long-term contracts a. Recognizes income upon completion of work. b. Recognizes income based on collected billings. c. Recognizes income based on the progress of work. d. Does not recognize income at the balance sheet date. RPCPA 1074

46. The accounting method that recognizes revenue prior to the point of sale based on either an input or an output measure of the earning process is known as the a. Deposit method. c. Installment sales method. b. Cost recovery method. d. Percentage-of-completion method RPCPA 0596 1. The percentage-of-completion method of accounting for long-term construction contracts is an exception to the CMA 1296 2-10 A. Matching principle. C. Economic-entity assumption. B. Going-concern assumption. D. Revenue recognition principle. 2. The percentage-of-completion method of accounting for long-term construction contracts is an exception to the A. Matching principle. C. Historical cost principle. CMA 0691 2-15 B. Going concern assumption. D. Revenue recognition principle. 44. The percentage-of-completion method violates the general rule on revenue recognition that: A. Collection is reasonably assured. B. Costs are known or reasonably estimated. C. The earnings process is complete. D. Collections have been received. S, S & T 3. Although a transfer of ownership has not occurred, the percentage-of-completion method is acceptable under the revenue recognition principle because A. The assets are readily convertible into cash. B. The production process can be readily divided into definite stages.

C. Cash has been received from the customer. D. The earning process is completed at various stages.

CMA 1292 2-17

Advantage of using Percentage-of-Completion Method 17. The theoretical support for using the percentage-of-completion method of accounting for longterm construction projects is that it a. is more conservative than the completed-contract method. b. reports a lower Net Income figure than the completed-contract method. c. more closely conforms to the cost principle. d. produces a realistic matching of expenses with revenues. S, S & S Disadvantage of using percentage-of-completion 15. The principal disadvantage of using the percentage-of-completion method of recognizing revenue from long-term contracts is that it a. is unacceptable for income tax purposes. b. gives results based upon estimates which may be subject to considerable uncertainty. c. is likely to assign a small amount of revenue to a period during which much revenue was actually earned. d. none of these. K, W & W Applications 4. Saskia Co.’s construction projects extend over several years, and collection of receivables is reasonably certain. Each project has a firm contract price, reliable estimated of the extent of progress and cost to finish, and a contract that is specific as to the rights and obligations of all parties. The contractor and the buyer are expected to fulfill their contractual obligations on each project. The method that the company should use to account for construction revenue is a. Installment sales. c. Completed-contract. b. Percentage-of-completion method. d. Point-of-sale. CIA 1185 IV-13 6. Dilla Construction Company's projects extend over several years and collection of receivables is reasonably certain. Each project has a contract that specifies a price and the rights and obligations of all parties. Both the contractor and the customer are expected to fulfill their contractual obligations on each project. Reliable estimates can be made of the extent of progress and cost to complete each project. The method that the company should use to account for construction revenue is a. installment sales. c. completed-contract. b. percentage-of-completion. d. cost recovery. S, S & S

5. A building contractor has a fixed-price contract to construct a large building. It is estimated that the building will take 2 years to complete. Progress billings will be sent to the customer at quarterly intervals. Which of the following describes the preferable point for revenue recognition for this contract if the outcome of the contract can be estimated reliably? A. After the contract is signed. B. As progress is made toward completion of the contract. C. As cash is received. D. When the contract is completed. CIA 1193 IV-28 Current Asset/Liability Unbilled Revenues *. How should earned but unbilled revenues at the balance sheet date on a long-term construction contract be disclosed if the percentage-of-completion method of revenue recognition is used? a. In a footnote to the financial statements until the customer is formally billed for the portion of the work completed. b. As a receivable in the noncurrent asset section of the balance sheet. RPCPA 1096 c. As a construction in progress in the noncurrent asset section of the balance sheet. d. As construction in progress in the current asset section of the balance sheet. Costs Of Uncompleted Contracts In Excess Of Related Billings *. “Costs of uncompleted contracts in excess of related billings” in most cases is shown as a a. Current liability, i.e., Accounts Payable. b. Long-term debt, i.e, Notes Payable. c. Current assets, i.e., Receivables. d. Investments, i.e., Construction in Progress. RPCPA 1079 Costs Of Uncompleted Contracts In Excess Of Related Costs *. “Billings on uncompleted contracts in excess of related costs” in most cases is shown as a a. Current liability, i.e., Accounts Payable. b. Long-term debt, i.e., Notes Payable. c. Current assets, i.e., Receivables. d. Investments, i.e., Construction in Progress. RPCPA 1079 Construction in Process *. The Construction-in-Process account accumulates the following when the percentage-ofcompletion method is used a. Construction costs to date. b. Construction costs to date less payments received.

c. Construction costs to date less billings to date. d. Construction costs plus gross profit earned to date.

RPCPA 0592

19. When the percentage-of-completion method of accounting for long-term construction projects is used, why is Construction in Progress increased by the annual recognized gross profit on long-term construction contracts? a. The cost of the contract has increased. b. The project's value has increased above cost. c. The economy experiences inflation over the construction period. d. Construction in Progress is not increased by the annual recognized profit. S, S & S 70. In accounting for a long-term construction contract using the percentage of completion method, the amount of income recognized in any year would be added to (E) A. Deferred revenue C. Construction in progress B. Progress billings on contracts D. Property, plant, and equipment CPAR Progress Billings 36. JUMBO Corp. uses the percentage-of-completion method of revenue recognition in accounting for its long-term construction contracts. JUMBO Corp.’s progress billings account is a a. Revenue account. c. Non-current liability account. b. Contra current asset account. d. Contra non-current asset account. RPCPA 0597 *.

Tay Co. uses the percentage-of-completion method to account for a five-year construction contract. Third year progress billings collected in the fourth year would a. Be included in the calculation of third year income. b. Be included in the calculation of third year income insofar as they exceeded second year billings collected in the third year. c. Be included in the calculation of fourth year income. d. Not be included in the calculation of third, fourth, or fifth year incomes. AICPA 0591 T-28

25. A company uses the percentage-of-completion method to account for a four year construction contract. Progress billings sent in the second year that were collected in the third year would a. be included in the calculation of the income recognized in the second year. b. be included in the calculation of the income recognized in the third year. c. be included in the calculation of the income recognized in the fourth year. d. not be included in the calculation of the income recognized in any year. S, S & S

Construction in Progress & Progress Billings *. In accounting for a long-term construction type contract, the two peculiar accounts used are the “progress billings” and “construction in progress” accounts. As of year-end, but prior to the completion of a long-term contract, how should the balance of these two accounts be shown? a. Progress billings as deferred income, construction in progress as a deferred income. b. Progress billings as income, construction in progress as inventory. c. Net, as an income from construction if credit balance, and loss from construction if debit balance. d. Net as a current asset if debit balance, and current liability if credit balance. RPCPA 1087 8. If the Construction in Progress account has a balance of P1,000,000 while the Progress Billings on Contracts account’s balance is P800,000, how should these accounts be reflected on the balance sheet? a. Construction in Progress will be shown as a current asset. b. Progress Billings on Contracts will be shown as a current liability. RPCPA 0598 c. The difference between the two accounts will be reflected as a current asset. d. The difference between the two accounts will be reflected as a current liability. 6.

POC Company accounts for a long-term construction contract using the percentage-ofcompletion method. As of the end of the current fiscal year, the following information was available regarding a project expected to be completed in the following year: Cumulative progress billings $400,000 Cumulative costs incurred 300,000 Cumulative revenues recognized 80,000 The difference between construction in progress and progress billings should be reported in the statement of financial position for the current year as a. A current asset of $20,000. b. A current liability of $20,000. c. Unearned revenue of $100,000. d. A separate component of shareholders’ equity of $100,000. Gleim

Gross Profit 12. In accounting for a long-term construction-type contract using the percentage-of-completion method, the gross profit recognized during the first year would be the estimated total gross profit from the contract, multiplied by the percentage of the costs incurred during the year to the a. total costs incurred to date. c. unbilled portion of the contract price. b. total estimated cost. d. total contract price. K, W & W

Recognized Profit First Year 7. A company uses the percentage-of-completion method of accounting for a 4-year construction contract. Which of the following items should be used in the calculation of the income recognized in the first year? AICPA, adapted a. b. c. d. Progress Billings Yes Yes No No Collections on Progress Billings Yes No No Yes

Third Year 9. The calculation of the income recognized in the third year of a 5-year construction contract accounted for using the percentage-of-completion method includes the ratio of a. Total costs incurred to date to total estimated costs. b. Total costs incurred to date to total billings to date. c. Costs incurred in year 3 to total estimated costs. d. Costs incurred in year 3 to total billings to date. AICPA 1193 T-38

*.

*.

Under the percentage of completion method, the net income to be recognized for the first year of a three-year construction contract is to be determined on the basis of the ratio of a. Estimated cost to complete to total estimated costs. b. Costs incurred to date to total estimated costs. c. Actual costs incurred to total estimated costs. d. Total estimated costs to estimated costs to complete. RPCPA 1086

72. In arriving at the gross profit during the first year using the percentage of completion method of accounting for a long-term construction contract, the estimated total gross profit from the contract is multiplied by (E) A. The percentage of the costs incurred during the year to the total contract price. B. The percentage of the costs incurred during the year to the total estimated cost C. The percentage of the costs incurred during the year to the total costs incurred to date. D. The percentage of the costs incurred during the year to the unbilled portion of the total contract price. CPAR Second Year 8. A company used the percentage-of-completion method of accounting for a 4-year construction contract. Which of the following items should be used to calculate the income recognized in the second year? AICPA 1192 T-8, RPCPA 0593 a. b. c. d. Income Previously Recognized Yes No Yes No Progress Billings to Date Yes Yes No No 8. If the percentage-of-completion method is used, what is the basis for determining the gross profit to be recognized in the second year of a three-year contract? a. Cumulative actual costs incurred only. b. Incremental cost for the second year only. c. Cumulative actual costs and estimated costs to complete. d. No gross profit would be recognized in year 2. S, S & S

A company used the percentage-of-completion method of accounting for a 5-year construction contract. Which of the following items will the company use to calculate the income recognized in the third year? AICPA 1192 T-8 a. b. c. d. Progress billings to date Yes No No Yes Income previously recognized No Yes No Yes

10. The calculation of the income recognized in the third year of a five-year construction contract accounted for using the percentage-of-completion method includes the ratio of a. Total costs incurred to date to total estimated costs. b. Total costs incurred to date to total billings to date. c. Costs incurred in year 3 to total estimated costs. d. Costs incurred in year 3 to total billings to date. AICPA 1193 T-38 Final Year 11. Which of the following is used in calculating the income recognized in the fourth and final year of a contract accounted for by the percentage-of-completion method? AICPA 0595 F-26 a. b. c. d. Actual total costs Yes Yes No No Income previously recognized Yes No Yes No 10. Which of the following would be used in the calculation of the gross profit recognized in the third and final year of a construction contract that is accounted for using the percentage-ofcompletion method? S, S & S A. B. C. D. Actual Contract Price Yes Yes Yes No Total Costs Yes Yes No Yes Income Previously Recognized No Yes Yes Yes Anticipated Loss

40. NATIONAL Corp. is faced with an impending loss on a long-term construction project and has asked for advice on how to book the impending loss. Assuming that NATIONAL Corp. employs the percentage-of-completion method, when should the loss be taken up in NATIONAL Corp.’s books? a. Immediately. b. Over the period of the project. c. Upon completion of the project. d. When progress billings exceed contract costs incurred. RPCPA 0597 Journal Entries Use the following to answer questions 58-60: S, S & T Moon View Desert Homes constructed a subdivision of upscale homes north of Cave Creek, Arizona, during 2003 and 2004 under contract with Empire Development. Relevant data are summarized below: Contract Amount $2,000,000 2003 2004 Cost 800,000 600,000 Gross Profit 350,000 250,000 Contract Billings 1,000,000 1,000,000 Moon View uses the percentage-of-completion method to recognize revenue. 58. What would be the journal entry made in 2003 to record revenue? A. Accounts receivable 1,000,000 Revenue from long-term contracts B. Accounts receivable 1,350,000 Gross profit Revenue from long-term contracts C. Construction in progress 350,000 Cost of construction 800,000 Revenue from long-term contracts D. Accounts receivable 1,000,000 Billings in excess of cost 350,000 Revenue from long-term contracts 12.

In its December 31, 2003 balance sheet, Moon View would report: A. The asset, cost and profits in excess of billings of $150,000. B. The liability, billings in excess of cost of $200,000. C. The asset, contract amount in excess of billings of $1,000,000. D. The asset, deferred profit of $ 400,000.

1,000,000 350,000 1,000,000 1,150,000 1,350,000

60. What would be the journal entry to record revenue in 2004? A. Accounts receivable 1,000,000 Revenue for long-term contracts B. Construction in progress 250,000 Cost of construction 600,000 Revenue for long-term contracts C. Cost of construction 1,400,000 Gross profit 600,000 Revenue for long-term contracts D. Accounts receivable 1,000,000 Cost of construction Gross profit Deferred revenue

1,000,000 850,000 2,000,000 600,000 250,000 150,000

COMPLETED-CONTRACT METHOD Criteria 14. The completed-contract method of accounting for long-term construction-type contracts is preferable when a. a contractor is involved in numerous projects. b. the contracts are of a relatively long duration. c. estimates of costs to complete and extent of progress toward completion are reasonably dependable. d. there are inherent uncertainties in the contract beyond normal business risks. S, S & S Recognized Revenue 13. The accounting method most clearly consistent with basic revenue recognition principles is the A. Percentage-of-completion method. C. Completion-of-production method. B. Installment sales method. D. Completed-contract method. Gleim 14. A company uses the completed-contract method to account for contract. Revenue is recognized when recorded progress billings AICPA 0592 T-44 a. b. Are collected Yes No Exceed recorded costs Yes No

a long-term construction c. Yes No

d. No Yes

15. A company uses the completed-contract method to account for a long-term construction contract. Revenue is recognized when progress billings are AICPA, Adapted a. b. c. d.

Recorded Collected

No Yes

Yes Yes

Yes No

No No

14. Under the completed-contract method a. revenue, cost, and gross profit are recognized during the production cycle. b. revenue and cost are recognized during the production cycle, but gross profit recognition is deferred until the contract is completed. c. revenue, cost, and gross profit are recognized at the time the contract is completed. d. none of these. K, W & W 9. If the completed-contract method is used, what is the basis for determining the income to be recognized in the second year of a three-year contract? a. Cumulative actual costs incurred only. b. Incremental cost for the second year only. c. Latest available estimated costs. d. No income would be recognized in year 2. S, S & S Anticipated Loss 16. Felidae Co. uses the completed-contract method to account for a 4-year construction contract that is currently in its third year. Progress billings were recorded and collected in the third year. Based on events occurring in the third year, a loss is now anticipated on the contract. When will the effect of each of the following be reported in the company’s income statement? AICPA 0589 T-13 a. b. c. d. Third-year Progress Billings Not third year Not third year Third year Third year Anticipated Loss Third year Fourth year Third year Fourth year 17. Cost estimates at the end of the second year indicate a loss will result on completion of the entire contract. Which of the following statements is correct? a. Under the completed-contract method, the loss is not recognized until the year the construction is completed. b. Under the percentage-of-completion method, the gross profit recognized in the first year must not be changed. c. Under the completed-contract method, when the billings exceed the accumulated costs, the amount of the estimated loss is reported as a current liability. d. Under the completed-contract method, when the Construction in Process balance exceeds the billings, the estimated loss is added to the accumulated costs. K, W & W PERCENTAGE-OF-COMPLETION VS. THE COMPLETED CONTRACT METHOD Advantage of Percentage-of-Completion Method

52. The percentage-of-completion method is preferable to the completed contract method because it is a better measure of: A. Costs and completion rates. C. Assets and equities. B. Receivables and inventory. D. Effort and accomplishment. S, S & T Similarities 20. When comparing the percentage-of-completion and completed-contract methods of accounting for long-term construction contracts, both methods will report a. the same balances each period in the Progress Billings account. b. the same expense for cost of construction each year. c. the same amount of income in the year of completion. d. the same inventory carrying value each year during the construction period. S, S & S Difference 26. In accounting for a long-term construction contract for which there is a projected profit, the balance in the Construction in Progress account at the end of the first year of work using the percentage-of-completion method would be a. zero. b. the same as the completed-contract method. c. higher than the completed-contract method. d. lower than the completed-contract method. S, S & S 17. The percentage-of-completion and the completed-contract methods of accounting for longterm construction projects in progress differ in that A. It is only under the percentage-of-completion method that progress billings are accumulated in a contra-inventory account called billings on construction in progress. B. It is only under the completed-contract method that accumulated construction costs are included in a construction in progress inventory account. C. Only the percentage-of-completion method recognizes all revenues and gross profit on the contract when the contract is completed. D. It is only under the percentage-of-completion method that gross profit earned to date is accumulated in the construction in progress inventory account. CIA 0594 IV-26 16. Which of the following is not a difference between the percentage-of completion and completed-contract methods of accounting for long-term construction contracts? a. They report different amounts for inventory during the construction period. b. They report different amounts for progress billings during the construction period. c. They cause a different cash inflow during the construction period. S, S & S d. They report different amounts for accounts receivable during the construction period.

Anticipated Loss 16. Cost estimates on a long-term contract may indicate that a loss will result on completion of the entire contract. In this case, the entire expected loss should be a. recognized in the current period, regardless of whether the percentage-of-completion or completed-contract method is employed. b. recognized in the current period under the percentage-of-completion method, but the completed-contract method should defer recognition of the loss to the time when the contract is completed. c. recognized in the current period under the completed-contract method, but the percentage-of-completion method should defer the loss until the contract is completed. d. deferred and recognized when the contract is completed, regardless of whether the percentage-of-completion or completed-contract method is employed. K, W & W 36. When should an anticipated loss on a long-term contract be recognized under the percentageof-completion method and the completed contract method, respectively? RPCPA 1082, 0593 Percentage-of-completion Completed Contract a. Over life of the project Completion of contract b. Immediately Completion of contract c. Over life of the project Immediately d. Immediately Immediately 18. An organization has a long-term construction contract in process. During the current period, the estimated total contract cost has increased sufficiently so that there is a current-period loss, even though the contract is still estimated to be profitable overall. Under these circumstances, the [List A] method of revenue recognition would require a [List B] period adjustment of expected gross profit recognized on the contract. CIA 1195 IV-16 List A List B A. Percentage-of-completion Prior B. Percentage-of-completion Current C. Completed-contract Prior D. Completed-contract Current 19. During 1990, Tidal Co. began construction on a project scheduled for completion in 1992. At December 31, 1990, an overall loss was anticipated at contract completion. What would be the effect of the project on 1990 operating income under the percentage-of-completion method and the completed-contract method? AICPA 1191 T-5 a. b. c. d. Percentage-of-completion No effect No effect Decrease Decrease

Completed-contract

No effect

Decrease

No effect

Decrease

JOURNAL ENTRIES FINANCIAL STATEMENT PRESENTATION & REQUIRED DISCLOSURES Financial Statement Presentation Progress billings and construction in process 20. How should the balances of progress billings and construction in progress be shown at reporting dates prior to the completion of a long-term contract? a. Progress billings as deferred income, construction in progress as a deferred expense. b. Progress billings as income, construction in progress as inventory. c. Net, as a current asset if debit balance and current liability if credit balance. d. Net, as income from construction if credit balance, and loss from construction if debit balance. AICPA 1178 T-40 Construction in Progress 13. How should earned but unbilled revenues at the balance sheet date on a long-term construction contract be disclosed if the percentage-of-completion method of revenue recognition is used? a. As construction in progress in the current asset section of the balance sheet. b. As construction in progress in the noncurrent asset section of the balance sheet. c. As a receivable in the noncurrent asset section of the balance sheet. d. In a note to the financial statements until the customer is formally billed for the portion of work completed. K, W & W Required Disclosure Completed Contract Method 18. If a company uses the completed-contract method of accounting for long-term construction contracts, then during the period of construction, financial information related to a long-term contract will a. appear on both the income statement and balance sheet during the construction period. b. appear only on the income statement during the period of construction. c. appear only on the balance sheet during the period of construction. d. not appear on the financial statements. S, S & S

1. Answer (D) is correct. The revenue recognition principle states that revenue should be recognized (recorded) when realized or realizable and earned. Revenue is earned when the earning process is essentially complete. In effect, revenue is recorded when the most

important event in the earning of that revenue has occurred. Thus, revenue is normally recorded at the time of the sale or, occasionally, at the time cash is collected. However, sometimes neither the sales basis nor the cash basis is appropriate, such as when a construction contract extends over several accounting periods. As a result, contractors ordinarily recognize revenue using the percentage-of-completion method so that some revenue is recognized each year over the life of the contract. Hence, this method is an exception to the general principle of revenue recognition, primarily because it better matches revenues and expenses. Answer (A) is incorrect because the percentage-of-completion method attempts to match revenues and expenses with the appropriate periods. Answer (B) is incorrect because the going-concern assumption is appropriate for a contractor using the percentage-of-completion method, as for any other type of company. Answer (C) is incorrect because the economicentity assumption is appropriate for a contractor using the percentage-of-completion method, as for any other type of company. 2. Answer (D) is correct. Revenue is recognized when realized or realizable and the earning process is substantially complete. This ordinarily occurs at the time of sale and delivery of goods or services. Thus, the percentage-of-completion method is essentially an exception to the revenue recognition principle. Production rather than sale and delivery is considered to be the culmination of the earning process. Answer (A) is incorrect because the percentage-of-completion method attempts a more accurate association of cost incurrence and revenue recognition. Answer (B) is incorrect because the percentage-of-completion method is completely consistent with the going concern assumption. Answer (C) is incorrect because the percentage-of-completion method is completely consistent with the historical cost principle. 3. Answer (D) is correct. SFAC 5 states that revenue should be recognized when it is both realized or realizable and earned. If a project is contracted for before production and covers a long time period in relation to reporting periods, revenues may be recognized by a percentageof-completion method as they are earned (as production occurs), provided reasonable estimates of results at completion and reliable measures of progress are available. Thus, contractors traditionally use the percentage-of-completion method because some revenue can be recognized during each period of the production process. In a sense, the earning process is completed in various stages; thus, revenues should be recorded in each stage. Answer (A) is incorrect because, depending upon the terms of the contract, the assets may not be readily convertible into cash. Answer (B) is incorrect because, on a large construction project, the production process often cannot be easily divided into definite stages. Answer (C) is incorrect because cash is sometimes not received until the project is completed.

4. REQUIRED: The method appropriate to account for construction revenue. DISCUSSION: (B) SFAC 5, Recognition and Measurement in Financial Statements of Business Enterprises, states that revenue should be recognized when it is both realized or realizable and earned. If a project is contracted for before production and is long in relation to reporting periods, revenues may be recognized by a percentage-of-completion method as they are earned (as production occurs), provided reasonable estimates of results at completion and reliable measures of progress are available. This method results in information that is more relevant and representationally faithful than that based on waiting for delivery, completion of the project, or payment. Answer (A) is incorrect because the installment method is appropriate if collectibility is doubtful. Answer (C) is incorrect because the completed-contract method is appropriate if reasonable estimates of results at completion and reliable measures of progress are not available. Answer (D) is incorrect because the point-of-sale method is appropriate when the product or merchandise is delivered or services are rendered directly to customers. 5. Answer (B) is correct. Under the percentage-of-completion method, revenues and expenses are recognized based on the stage of completion at the balance sheet date if the outcome of the contract can be estimated reliably. For a fixed-price contract, the outcome can be estimated reliably if (1) total revenue can be measured reliably, (2) it is probable that the economic benefits of the contract will flow to the enterprise, (3) contract costs to complete and stage of completion can be measured reliably, and (4) contract costs can be clearly identified and measured reliably so that actual and estimated costs can be compared. Answer (A) is incorrect because revenue is not recognized until progress has been made toward completion. Answer (C) is incorrect because the cash basis is inappropriate. An accrual method, that is, the percentage-of-completion method, should be used. Answer (D) is incorrect because the completed-contract method is not a permissible method. 6.

REQUIRED: The reporting of the difference between construction in progress and progress billings. DISCUSSION: (B) Progress billings is an offset to construction in progress (or vice versa) on the balance sheet. The difference between construction in progress (costs and recognized income) and progress billings to date is shown as a current asset if construction in progress exceeds total billings, and as a current liability if billings exceed construction in progress. Because progress billings exceed construction in progress, the difference should be reported as a current liability of $20,000 [$400,000 – ($300,000 + $80,000)]. Answer (A) is incorrect because progress billings exceed construction in progress. Answers (C) and (D) are incorrect because $100,000 ignores the revenue already recognized.

7. REQUIRED: The effect that progress billings and collections have on the determination of earnings. DISCUSSION: Under GAAP, revenue should be recognized when it is realized or realizable and earned. For long-term construction contracts, these criteria are met in accordance with either the percentage-of-completion method or the completed-contract method. Neither the issuance of a progress billing (debit accounts receivable, credit progress billings) nor the collection of cash (debit cash, credit accounts receivable) results in recognition of income. Answers (A), (B), and (D) are incorrect because neither progress billings nor collections on progress billings should be used to calculate income. 8. REQUIRED: The item(s) used in computing income in the second year using the percentageof-completion method. DISCUSSION: (C) The percentage-of-completion method provides for the recognition of income based on the relationship between the costs incurred to date and estimated total costs for the completion of the contract. The amount of income (based on the latest available estimated costs) recognized in the second year of a 4-year contract is calculated as follows: The total anticipated income is multiplied by the ratio of the costs incurred to date to the total estimated costs, and the product is reduced by previously recognized income. Income previously recognized is therefore used to calculated income to be recognized in the second year. However, progress billings to date have no effect on the amount of income to be recognized in the second year. Answers (A), (B), and (D) are incorrect because income previously recognized is used to calculate the income recognized. Progress billings to date are not. 9. REQUIRED: The ratio used in the calculation of income recognized for a construction contract using the percentage-of-completion method. DISCUSSION: (A) According to ARB 45, the percentage-of-completion method provides for the recognition of income based on the relationship between costs incurred to date and estimated total costs for completion of the contract. (But ARB 45 permits any other measure of progress “as may be appropriate having due regard to work performed.”) The amount of income recognized in the 3rd period of a 5-year contract is calculated as follows: The total anticipated income (based on the latest available estimated costs) is multiplied by the ratio of costs incurred to date to the latest available total estimated costs, and the product is reduced by the previously recognized income. Answer (B) is incorrect because the ratio of total costs incurred to date to total billings to date is not relevant. Answer (C) is incorrect because total costs incurred must be used. Answer

(D) is incorrect because neither the issuance nor the collection of billings results in income recognition. 10. REQUIRED: The ratio used in the calculation of income recognized for a construction contract using the percentage-of-completion method. DISCUSSION: (A) According to ARB 45, the percentage-of-completion method provides for the recognition of income based on the relationship between costs incurred to date and estimated total costs for completion of the contract. (But ARB 45 permits any other measure of progress “as may be appropriate having due regard to work performed.”) The amount of income recognized in the third year of a 5-year contract is calculated as follows: The total anticipated income (based on the latest available estimated cost) is multiplied by the ratio of costs incurred to date to the latest available total estimated costs, and the product is reduced by previously recognize income. Answer (B) is incorrect because the ratio of total costs incurred to date to total billings to date is not relevant. Answer (C) is incorrect because total costs incurred must be used. Answer (D) is incorrect because neither the issuance nor the collection of billings results in income recognition. 11. REQUIRED: The items used to calculate income in the last year of a contract using the percentage-of-completion method. DISCUSSION: (A) The percentage-of-completion method recognizes revenues, costs, and income depending on the progress made on the contract. Income recognized in the last year of the contract equals the contract price, minus actual total costs, minus income previously recognized. Answers (B), (C), and (D) are incorrect because income previously recognized and actual total costs are used. . (A) Costs + profits: Billings: Excess:

12

$800,000 + 350,000 =

$1,150,000 1,000,000 $150,000

13. Answer (D) is correct. According to the revenue recognition principle, revenue should be recognized when (1) realized or realizable and (2) earned. Under the completed-contract method, revenue is not recognized until a long-term construction contract is complete. At this stage, the entity is most clearly entitled to the resulting revenues and is most likely to have been involved in an exchange. Answer (A) is incorrect because the percentage-of-completion method allows for revenue to be recognized at various stages of the contract although the entire job is not complete. Answer

(B) is incorrect because, if the collectibility of assets is relatively uncertain, revenues and gains may be recognized as cash is received using the installment sales method. Answer (C) is incorrect because the completion-of-production method is an appropriate basis for recognition if products or other assets are readily realizable, e.g., precious metals and some agricultural products. 14. REQUIRED: The effect of the completed-contract method on revenue recognition. DISCUSSION: (B) Under the completed-contract method of accounting for long-term construction contracts, recorded progress billings have no effect on the recognition of income. Answers (A), (C), and (D) are incorrect because under the completed-contract method, progress billings are recorded when issued and removed at the completion of the contract. 15. REQUIRED: The effect of progress billings on the recognition of revenue. DISCUSSION: (D) GAAP requires that revenue be recognized when it is realized or realizable and earned. Under the completed-contract method, revenue recognition is appropriate only at the completion of the contract. Neither the recording nor the collection of progress billings affects this recognition. Answers (A), (B), and (C) are incorrect because neither the issuance of a progress billing (debit accounts receivable, credit progress billings) nor the collection of cash (debit cash, credit accounts receivable) results in recognition of income. 16. REQUIRED: The effect of progress billings and an anticipated loss on the company’s income statement. DISCUSSION: (A) Under the completed-contract method, the gross profit on the contract should be recognized upon the completion of the contract. If a loss is anticipated, however, the loss should be recognized immediately. Under GAAP, the entries to record progress billings and their collection do not affect the recognition of profit or loss. Thus, the 3rd year progress billings have not effect on the income statement, but the loss anticipated in the 3rd year should be recognized in full in that year. Answers (B), (C), and (D) are incorrect because, under the completed-contract method, progress billings have not effect on the recognition of income, and an anticipated loss should be recognized in the year it occurs. 17. Answer (D) is correct. The completed-contract method does not recognize any gross profit until the contract is completed. The percentage-of-completion method recognizes a portion of revenues and gross profit each period, based upon the ratio of costs incurred to date to total estimated costs of completion. Accumulated gross profit and accumulated construction costs

are included in the construction in progress inventory account under the percentage-ofcompletion method. Answer (A) is incorrect because progress billings are accumulated in the billings on construction in progress account under both methods. Answer (B) is incorrect because accumulated construction costs are included in the construction in progress inventory account under both methods. Answer (C) is incorrect because the percentage-of-completion method recognizes a percentage of revenues and gross profit each period. 18. Answer (B) is correct. Under the percentage-of-completion method, a current-period loss on a profitable contract is treated as a change in accounting estimate. Thus, a current-period adjustment is required. Prior-period adjustments are made to correct errors, not to reflect changes in estimates. Answer (A) is incorrect because, under the percentage-of-completion method, a current-period loss on a profitable contract requires a current-period adjustment. Answer (C) is incorrect because, under the completed-contract method, no profit is recognized until the contract is completed. Cost estimate adjustments while construction is in progress do not result in profit or loss recognition prior to completion unless an overall loss is expected on the contract. Answer (D) is incorrect because, under the completed-contract method, no profit is recognized until the contract is completed. Cost estimate adjustments while construction is in progress do not result in profit or loss recognition prior to completion unless an overall loss is expected on the contract. 19. REQUIRED: The effect of the project on 1990 operating income under the percentage-ofcompletion method and the completed-contract method. DISCUSSION: (D) When the current estimate of total contract costs indicates a loss, an immediate provision for the entire loss should be made regardless of method. Thus, under either method, 1990 operating income is decreased by the projected loss. Answers (A), (B), and (C) are incorrect because, under either method, 1990 operating income is decreased by the projected loss. 20. REQUIRED: The proper balance sheet presentation of progress billings and construction in progress. DISCUSSION: (C) ARB 45, Long-Term Construction-Type Contracts, requires that the difference between construction in progress (costs and recognized income) and progress billings to date be shown as a current asset if construction in progress exceeds total billings, and as a current liability if billings exceed construction in progress. Separate recognition is required for each project.

Answers (A) and (B) are incorrect because progress billings and construction in progress should be netted for balance sheet presentation as a current asset or liability. Answer (D) is incorrect because neither income nor loss results from progress billings.