Long-Term Contracts Loss Adjustment

Long-Term Contracts (Construction)
Illustration: KC Construction Company has a contract to

construct a €4,500,000 bridge at an estimated cost of
€4,000,000. The contract is to start in July 2010, and the
bridge is to be completed in October 2012. The following data
pertain to the construction period.
18-2
Illustration: Compute percentage complete.

Illustration 18-6
18-3
Illustration: KC would make the following entries to record

(1) the costs of construction, (2) progress billings, and (3)
collections.
Illustration 18-7
18-4
Percentage-of-Completion, Revenue and Gross Profit, by Year

Illustration 18-16
18-5
Illustration: KC’s entries to recognize revenue and gross

profit each year and to record completion and final approval
of the contract.
Illustration 18-17
18-6
Illustration: Content of Construction in Process Account—

Percentage-of-Completion Method
Illustration 18-18
18-7
Financial Statement Presentation—Percentage-of-

Completion
Computation of Unbilled Contract Price at 12/31/10

Illustration 18-19
18-8
Financial Statement—Percentage-of-Completion
Illustration 18-20
18-9
Cost-Recovery (Zero-Profit) Method
Illustration: For the bridge project illustrated on the preceding pages,

Hardhat Construction would report the following revenues and costs.
Illustration 18-21
18-10
Illustration: Hardhat’s entries to recognize revenue and gross profit

each year and to record completion and final approval of the contract.
Illustration 18-22
18-11
Illustration: Comparison of gross profit recognized under different

methods.
Illustration 18-23
18-12
Illustration:
Casper Construction Co.

2010 2011 2012
Contract price €675,000 €675,000 €675,000
Cost incurred current year 150,000 287,400 170,100
Estimated cost to complete
in future years 450,000 170,100 0
Billings to customer current year 135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
A) Prepare the journal entries for 2010, 2011, and 2012.
18-13
Financial Statement—Cost-Recovery Method

Illustration 18-24
18-14
Illustration: 2010 2011 2012

Costs incurred to date € 150,000 € 437,400 € 607,500
Estimated cost to complete 450,000 170,100
Est. total contract costs 600,000 607,500 607,500
Est. percentage complete 25.0% 72.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 486,000 675,000
Rev. recognized prior year (168,750) (486,000)
Rev. recognized currently 168,750 317,250 189,000
Costs incurred currently (150,000) (287,400) (170,100)
Gross profit recognized € 18,750 € 29,850 € 18,900
18-15
Illustration:
2010 2011 2012
Construction in progress 150,000 287,400 170,100
Cash 150,000 287,400 170,100
Accounts receivable 135,000 360,000 180,000

Billings on contract 135,000 360,000 180,000
Cash 112,500 262,500 300,000


Construction expense 150,000 287,400 170,100
Construction revenue 168,750 317,250 189,000
Billings on contract 675,000

Construction in progress 675,000
18-16
Illustration:
Income Statement 2010 2011 2012
Revenue on contracts $ 168,750 $ 317,250 $ 189,000
Cost of construction 150,000 287,400 170,100
Gross profit 18,750 29,850 18,900
Balance Sheet (12/31)

Current assets:
Accounts receivable 22,500 120,000 -
Cost & profits > billings 33,750
Current liabilities:
Billings > cost & profits 9,000
18-17
Cost-Recovery Method
Companies recognize revenue only to the extent of costs

incurred that are expected to be recoverable.
Only after all costs are incurred is gross profit recognized.
18-18
Illustration:
2010 2011 2012
Cash 150,000 287,400 170,100

Billings on contract 135,000 360,000 180,000
Cash 112,500 262,500 300,000


Construction expense 150,000 287,400 170,100
Construction revenue 150,000 287,400 237,600
Billings on contract 675,000

18-19
Illustration:
Income Statement 2010 2011 2012

Revenue on contracts €0 €0 € 675,000
Cost of construction - - 607,500
Gross profit - - 67,500
Balance Sheet (12/31)

Current assets:
Accounts receivable 22,500 120,000 -
Cost & profits > billings 15,000
Current liabilities:
Billings > cost & profits 57,600
18-20
Long-Term Contract Losses

 Loss in the Current Period on a Profitable Contract
► Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustment of
gross profit recognized in prior periods.
 Loss on an Unprofitable Contract

► Under both percentage-of-completion and completed-
contract methods, the company must recognize in the
current period the entire expected contract loss.
18-21
Illustration: Loss in Current Period

2010 2011 2012
Contract price €675,000 €675,000 €675,000
in future years 450,000 215,436 0
Current year 112,500 262,500 300,000
b) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated
cost to complete at the end of 2011 was €215,436 instead of €170,100.
18-22

2010 2011 2012
Contract price 675,000 675,000 675,000
Gross profit recognized € 18,750 (€ 3,900) € 7,314
18-23
2010 2011 2012
Construction in progress 18,750 7,314

Construction expense 150,000 215,436
Construction revenue 168,750 222,750

Construction expense 287,400
Construction revenue 283,500
18-24
Illustration: Loss on Unprofitable Contract

2010 2011 2012
Contract price €675,000 €675,000 €675,000
in future years 450,000 246,038 0
Current year 112,500 262,500 300,000
c) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated
cost to complete at the end of 2011 was € 246,038 instead of € 170,100.
18-25

2010 2011 2012
Contract price 675,000 675,000 675,000
Gross profit recognized € 18,750 (€ 27,188) €0
$675,000 – 683,438 = (8,438) cumulative loss Plug

18-26
2010 2011 2012
Construction in progress 18,750 -

Construction expense 150,000 243,000
Construction revenue 168,750 243,000

18-27
For the Cost-Recovery method, companies would recognize the

following loss:
2010 2011
Loss on construction contract 8,438


18-28
Disclosures in Financial Statements

Construction contractors should disclosure:
 Revenue recognized during the period and the methods used to
determine the contract revenue and stage of completion.
 For contracts in progress,
► aggregate amount of costs incurred and recognized net

income, amount of advances received, and amount of
retentions.
 Any contingent assets or liabilities related to these contracts.
18-29
Other Revenue Recognition Issues
Service Contracts
Follow the same criteria as long-term contracts.
To recognize revenue:
 It must be reliably measurable;
 Economic benefits are probable;
 Stage of completion must be reliably measurable; and
 Costs must be reliably measurable.
18-30
Other Revenue Recognition Issues
Service Contracts
Single Act: Revenue recognized at the time of the act.
More Than One Act: Revenue recognized as various acts

occur.
Three circumstances:
1. Specified number of identical or similar acts.
2. Specified number of defined but not identical acts.
3. Unspecified number of identical acts or similar acts with a

fixed period for performance.
18-31

Long-Term Contracts Loss Adjustment

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Long-Term Contracts (Construction)

Illustration: KC Construction Company has a contract to

Illustration: Compute percentage complete.

Illustration: KC would make the following entries to record

Percentage-of-Completion, Revenue and Gross Profit, by Year

Illustration: KC’s entries to recognize revenue and gross

Illustration: Content of Construction in Process Account—

Financial Statement Presentation—Percentage-of-

Computation of Unbilled Contract Price at 12/31/10

Illustration: For the bridge project illustrated on the preceding pages,

Illustration: Hardhat’s entries to recognize revenue and gross profit

Illustration: Comparison of gross profit recognized under different

Casper Construction Co.

A) Prepare the journal entries for 2010, 2011, and 2012.

Financial Statement—Cost-Recovery Method

Illustration: 2010 2011 2012

Accounts receivable 135,000 360,000 180,000

Cash 112,500 262,500 300,000

Construction in progress 18,750 29,850 18,900

Billings on contract 675,000

Balance Sheet (12/31)

Companies recognize revenue only to the extent of costs

Only after all costs are incurred is gross profit recognized.

Accounts receivable 135,000 360,000 180,000

Cash 112,500 262,500 300,000

Construction in progress 67,500

Billings on contract 675,000

Income Statement 2010 2011 2012

Balance Sheet (12/31)

Long-Term Contract Losses

 Loss on an Unprofitable Contract

Illustration: Loss in Current Period

Casper Construction Co.

Illustration: Loss in Current Period

Illustration: Loss in Current Period

2010 2011 2012

Construction in progress 18,750 7,314

Construction in progress 3,900

Illustration: Loss on Unprofitable Contract

Casper Construction Co.

Illustration: Loss on Unprofitable Contract

$675,000 – 683,438 = (8,438) cumulative loss Plug

Illustration: Loss on Unprofitable Contract

2010 2011 2012

Construction in progress 18,750 -

Construction in progress 27,188

Illustration: Loss on Unprofitable Contract

For the Cost-Recovery method, companies would recognize the

Loss on construction contract 8,438

Construction expense 287,400

Disclosures in Financial Statements

 For contracts in progress,

► aggregate amount of costs incurred and recognized net

 Any contingent assets or liabilities related to these contracts.

 It must be reliably measurable;

 Economic benefits are probable;

 Stage of completion must be reliably measurable; and

 Costs must be reliably measurable.

More Than One Act: Revenue recognized as various acts

2. Specified number of defined but not identical acts.

3. Unspecified number of identical acts or similar acts with a

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