Revenue Recognition

LT Contracts- Percentage-of-Completion Method

Current income = (Actual cost to date / Estimated total cost x Total estimated income) - Income previously
recognized
Example Problem: Company signs $1.8m, 3 year, fixed price contract
• Year 1- Costs of $250K
• EOY 1- Still $1,250,000 estimated costs to complete project
• During yr1- Billed client $220K and collected $180K
• Yr2 costs = $990K
• EOY 2 = $310K estimated to complete project
• During yr2 – Billed $1,130,000; Collected $1,040,000
• EOY 2 total est profit = (1.8m – 250K – 990K – 310K) = 250K
• EOY 2 profit earned % = (1240K / 1550K) = 80%
• Yr 2 profit earned = (80% * 250K) – (50K profit, earned in year 1) = 150K
• Year 3 – incurred final $290K of construction costs
• Yr 3 – billed client the final 450K; collected 530K cash from client
• Total actual construction costs = $1,530,000
• Total actual profit on project = $1.8m - $1.53m = $270K total profit
• Year 3 profit = 270K total profit – (200K profit previously recognized) = $70K

Year 1 JE’s:
CIP 250K [costs are debited to CIP]
Cash/payables 250K

A/R 220K [client billings]

Progress Billings 220K [B/S account]

Cash 180K [cash collected in year 1]

A/R 180K

Steps to arrive at 4 JE:

th

Total estimated profit = (1.8m contract price) – (costs incurred to date + est costs to complete)
Profit earned formula = (Cumulative costs to date) / (Total est costs at completion) * (Total est profit)

CIP 50K [note: profits also go to CIP]

Income 50K

Year 2 JE’s:
CIP 990K [construction costs]
Cash/payables 990K
A/R 1130K [to record billings during yr2]
Progress billings 1130K
Cash 1040K [to record cash collections]
A/R 1040K
CIP 150K [see yr 2 calculations, above]
Income 150K
Yr 3: End of project additional entry
Progress Billings 1.8m [to close project, CIP should = progress billings]
CIP 1.8m

Balance Sheet Treatment

• At year-end, net CIP and Progress Billings
• If Dr. Bal (CIP > billings) à current asset
• If Cr. Bal (billings > CIP) à current liability
• If multiple projects ongoing for same company…
• Can NOT offset/net CA’s/CL’s for multiple projects

Total Estimated Losses à Expense fully in year loss is expected

Completed-Contract Method
• Construction costs, collections and billings are same as % of completion method
• Don’t recognize any profit from the contract until it’s completed
• B/S rules are the same (net CIP and progress billings for each contract) for CA/CL position

Year 3 JE differing from %-of-completion:

Total actual costs = $1,530,000
Total actual profit = 1.8m contract – 1.53m costs = $270K

CIP 270K [all profit is recognized in final year of

contract]
Income 270K

Progress billings 1.8m [to close the project]

CIP 1.8m

If estimated total costs exceed total contract price…

• Recognize total loss in current year I/S under either method for LT contracts

Loss xx
Est Liability xx

Installment Sales Method – Non-GAAP

• Defer recognition of profit until payments come in
• Required: Receivables (by year) and Gross Profit % (by year)
Illustrative Problem: Installment Sales
• In 2011, a company makes a $10,000 sale. The customer agrees to pay $1,000 a year for 10
years, with the first payment due in 2012. The merchandise cost the seller $7,000.
• In 2012, the company makes a $15,000 sale. The customer agrees to pay $1,500 a year for 10
years,
with the first payment due in 2013. The merchandise cost the seller $10,000. Also in 2012, the
company gets the first $1,000 installment from the 2011 customer.
• In 2013, the company receives the second $1,000 installment from the 2011 customer. Also in
2013,
the company receives the first $1,500 installment from the 2012 customer.
To record the sale
2011 A/R 10K [must keep track of receivables by year]
Sales 10K
COGS 7K [assuming perpetual inventory system]
Inventory 7K

EOY 11- closing entry

Sales 10K
COGS 7K
Deferred G.P. 3K [B/S account]
Note: G.P. % for year 11 is 30% (3K G.P. on a 10K sale)
Deferred G.P. formula = (G.P. % by year) * (outstanding receivables by year)

2012 JE’s:
2012 A/R 15K [to record sales made in 2012]
Sales 15K
COGS 10K
INV 10K

Cash 1000 [to record first collection of 2011 sale]

2011 A/R 1000
Deferred G.P. 300 [to realize profit = 30% G.P. % * 1000]
Realized G.P. 300

Sales 15K
COGS 10K
Deferred G.P. 5K [B/S acct, to defer profit until pmt is received]
*G.P. % for year 12 = 5K/15K = 33.33%

2013 JE’s:
Cash 1000
2011 A/R 1000
Deferred G.P. 300
Realized G.P. 300 [goes to I/S]
Cash 1500
2012 A/R 1500
Deferred G.P. 500 [33.3% * 1500 cash collected]
Realized G.P. 500

Realized G.P. for year = (G.P. % for year * collection of that year’s A/R)
Deferred G.P. = (G.P. % by year * outstanding A/R balance for year]

Price-Level Accounting
• Voluntary basisà firms may present price-level adjusted information to supplement the F/S

Holding gains/losses: If company uses current cost method (replacement cost)

Monetary Items: Cash, A/R, bonds, A/P, N/P, anything else tied to a currency
 Def: Monetary assets represent a claim to receive a fixed sum of money or an amount determinable
without reference to future prices of specific goods and services
Nonmonetary Items: fixed assets, depreciation, intangibles, goodwill, inventory