Chapter 5, Problem 5.10P

Requirement – 1

To determine

Contract:

Contract is a written document that creates legal agreement between the parties for buying and selling the property. It is committed by the parties to perform their obligation and to enforce their rights.

Revenue recognized point of long term contract:

A long-term contract qualifies for revenue recognition over time. The seller can recognize the revenue as per percentage of the completion of the project, which is recognized as revenue minus cost of completion until date.

If a contract does not meet the performance obligation norm, then the seller cannot recognize the revenue till the project is complete.

The revenue recognition principle:

The revenue recognition principle refers to the revenue that should be recognized in the time period, when the performance obligation (sales or services) of the company is completed.

To describe: The amount of revenue and gross profit or loss to be recognized in 2016, 2017, and 2018.

Explanation of Solution

The amount of revenue and gross profit or loss to be recognized in 2016, 2017, and 2018 are as follows:

Recognized revenue

In the year 2016:

Given,

The contract price is $10,000,000

Actual cost to date is $2,400,000

Calculated total estimated cost is $8,000,000 (1)  

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ \text{=}\$1\text{0},000,000\times \frac{\$2,400,000}{\$8,000,000}\\ =\$10,000,000\times 30\%\\ =\$3,000,000\end{array}$

Hence, the calculated revenue recognition is $3,000,000.

In the year 2017:

Given,

The contract price is $10,000,000

Actual cost to date is $6,000,000

Calculated total estimated cost is $8,000,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =}\left[\begin{array}{l}\left[\text{Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\right]-\\ \text{Previous year revenue}\end{array}\right]\\ \text{=}\left(\$1\text{0},000,000\times \frac{\$6,000,000}{\$8,000,000}\right)-\$3,000,000\\ =\left(\$10,000,000\times 75\%\right)-\$3,000,000\\ =\$4,500,000\end{array}$

Hence, the calculated revenue recognition is $4,500,000.

In the year 2018:

Given,

Contract price is $10,000,000

Calculated revenue recognition in 2016 is $3,000,000

Calculated revenue recognition in 2017 is $4,500,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contractprice}-\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{18+}\\ \text{Revenue recognition in 2}0\text{19}\end{array}\right)\\ =\$1\text{0},000,000-\left(\$3,000,000+\$4,500,000\right)\\ =\$2,500,000\end{array}$

Hence, the calculated revenue recognition is $2,500,000.

Recognized gross profit

In the year 2016

Here,

Estimated gross profit in 2016 is $2,000,000 (1)

Total estimated cost is $8,000,000,

Actual cost to date is $2,400,000.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{18}\end{array}\right)\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ =\$2,000,000\times \frac{\$2,400,000}{\$8,000,000}\\ =\$2,000,000\times 30\%\\ =\$6,000,000\end{array}$

Hence, the calculated gross profit recognition is $6,000,000.

In the year 2017

Here,

Estimated gross profit in 2017 is $2,000,000 (1)

Total estimated cost is $8,000,000,

Gross profit recognition in 2016 is $6,000,000

Actual cost to date is $6,000,000.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{19}\end{array}\right)\\ \times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ -\left(\begin{array}{l}\text{Gross profit }\\ \text{recognition in 2}0\text{18}\end{array}\right)\end{array}\right)\\ \text{=}\left(\left(\$2,000,000\right)\times \left(\frac{\$6,000,000}{\$8,000,000}\right)-\$6,000,000\right)\\ =\left(\left(\$2,000,000\times 75\%\right)-\$6,000,000\right)\\ =\$15,000,000-\$6,000,000\\ =\$9,000,000\end{array}$

Hence, the calculated gross profit recognition is $9,000,000.

In the year 2018

Here,

Estimated gross profit in 2018 is $1,800,000 (1)

Gross profit recognition in 2016 is $6,000,000,

Gross profit recognition in 2017 is $9,000,000.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross profit in 2}0\text{18}\\ -\left(\begin{array}{l}\text{Gross profitrecognition in 2}0\text{16 }\\ +\text{ Gross profit recognition in 2}0\text{17}\end{array}\right)\end{array}\right)\\ \text{=}\left(\$18,000,000-\left(\begin{array}{l}\$6,000,000\\ +\$9,000,000\end{array}\right)\right)\\ =\left(\$18,000,000-\$15,000,000\right)\\ =\$3,000,000\end{array}$

Hence, the calculated gross profit recognition is $3,000,000.

Working note:

Calculate the value of gross profit (in millions)

Particulars	2016		2017		2018
Contract price		$1,000		$1,000		$1,000
Actual costs to date	$240		$600		$820
Estimated costs to complete	$560		$200		$0
Less: Total estimated cost		$800		$800		$820
Estimated gross profit		$200		$200		$180

Table (1)

(1)

Requirement – 2

To determine

To prepare: The journal entries for the year 2016, 2017 and 2018.

Explanation of Solution

The journal entries for the year 2016, 2017 and 2018 are as follows:

In the year 2016:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Construction in progress		$2,400,000
	Various accounts			$2,400,000
	(To record construction cost)

Table (2)

• Construction in progress is an asset. There is an increase in asset value. Therefore, it is debited.
• Various accounts are revenue. There is an increase in stockholders’ equity value. Therefore, it is credited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Account receivable		$2,000,000
	Billings on construction contract			$2,000,000
	(To record progress billings)

Table (3)

• Account receivable is an asset. There is an increase in asset value. Therefore, it is debited.
• Billings on construction contract is revenue. There is a decrease in stockholders’ equity value. Therefore, it is debited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$1,800,000
	Account receivable			$1,800,000
	(To record cash collection)

Table (4)

• Cash is an asset. There is an increase in asset value. Therefore, it is debited.
• Account receivable is an asset. There is a decrease in asset value. Therefore, it is credited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of construction		$600,000
	Construction in progress		$2,400,000
	Revenue from long-term contracts			$3,000,000
	(To record gross profit)

Table (5)

• Cost of construction is an expense. There is a decrease in liability value. Therefore, it is debited.
• Construction in progress is an asset. There is an increase in asset value. Therefore, it is debited.
• Revenue from long-term contracts is revenue. There is an increase in value of stockholder’s equity. Therefore, it is credited.

In the year 2017:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Construction in progress		$3,600,000
	Various accounts			$3,600,000
	(To record construction cost)

Table (6)

• Construction in progress is an asset. There is an increase in asset value. Therefore, it is debited.
• Various accounts are revenue. There is an increase in value of stockholder’s equity. Therefore, it is credited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Account receivable		$4,000,000
	Billings on construction contract			$4,000,000
	(To record progress billings)

Table (7)

• Account receivable is an asset. There is an increase in asset value. Therefore, it is debited.
• Billings on construction contract is revenue. There is a decrease in value of stockholder’s equity. Therefore, it is debited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$3,600,000
	Account receivable			$3,600,000
	(To record cash collection)

Table (8)

• Cash is an asset. There is an increase in asset value. Therefore, it is debited.
• Account receivable is an asset. There is a decrease in asset value. Therefore, it is credited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of construction		$900,000
	Construction in progress		$3,600,000
	Revenue from long-term contracts			$4,500,000
	(To record gross profit)

Table (9)

• Cost of construction is an expense. There is a decrease in liability value. Therefore, it is debited.
• Construction in progress is an asset. There is an increase in asset value. Therefore, it is debited.
• Revenue from long-term contracts is revenue. There is an increase in value of stockholder’s equity. Therefore, it is credited.

In the year 2018:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Construction in progress		$2,200,000
	Various accounts			$2,200,000
	(To record construction cost)

Table (10)

• Construction in progress is an asset. There is an increase in asset value. Therefore, it is debited.
• Various accounts are revenue. There is an increase in value of stockholder’s equity. Therefore, it is credited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Account receivable		$4,000,000
	Billings on construction contract			$4,000,000
	(To record progress billings)

Table (11)

• Account receivable is an asset. There is an increase in asset value. Therefore, it is debited.
• Billings on construction contract is revenue. There is a decrease in value of stockholder’s equity. Therefore, it is debited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$4,600,000
	Account receivable			$4,600,000
	(To record cash collection)

Table (12)

• Cash is an asset. There is an increase in asset value. Therefore, it is debited.
• Account receivable is an asset. There is a decrease in asset value. Therefore, it is credited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Construction in progress		$300,000
	Cost of construction		$2,200,000
	Revenue from long-term contracts			$2,500,000
	(To record gross profit)

Table (13)

• Construction in progress is an asset. There is an increase in asset value. Therefore, it is debited.
• Cost of construction is an expense. There is a decrease in value of stockholder’s equity. Therefore, it is debited.
• Revenue from long-term contracts is revenue. There is an increase in value of stockholder’s equity. Therefore, it is credited.

Conclusion

The journal entries for the year 2016, 2017 and 2018 are recorded.

Requirement – 3

To determine

To prepare: The partial balance sheet for 2016 and 2017.

Explanation of Solution

Partial balance sheet of W Construction Company is as follows:

In the year 2016:

Assets	2016
Account receivables		$200,000
Construction in progress	$3,000,000
Less: Billings	($2,000,000)
Costs in excess of billings		$1,000,000

Table (14)

In the year 2017:

Assets	2017
Account receivables		$600,000
Construction in progress	$7,500,000
Less: Billings	($6,000,000)
Costs in excess of billings		$1,500,000

Table (15)

Requirement – 4

To determine

The amount of revenue and gross profit or loss to be recognized in 2016, 2017, and 2018.

Explanation of Solution

The amount of revenue and gross profit or loss to be recognized in 2016, 2017, and 2018 are as follows:

Recognized revenue

In the year 2016:

Given,

The contract price is $10,000,000

Actual cost to date is $2,400,000

Calculated total estimated cost is $8,000,000 (1)  

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ \text{=}\$1\text{0},000,000\times \frac{\$2,400,000}{\$8,000,000}\\ =\$10,000,000\times 30\%\\ =\$3,000,000\end{array}$

Hence, the calculated revenue recognition is $3,000,000.

In the year 2017:

Given,

The contract price is $10,000,000

Actual cost to date is $6,200,000

Calculated total estimated cost is $9,300,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =}\left[\begin{array}{l}\left[\text{Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\right]-\\ \text{Previous year revenue}\end{array}\right]\\ \text{=}\left(\$1\text{0},000,000\times \frac{\$6,200,000}{\$9,300,000}\right)-\$3,000,000\\ =\left(\$10,000,000\times 60.6667\%\right)-\$3,000,000\\ =\$3,666,667\end{array}$

Hence, the calculated revenue recognition is $3,666,667.

In the year 2018:

Given,

Contract price is $10,000,000

Calculated revenue recognition in 2016 is $3,000,000

Calculated revenue recognition in 2017 is $3,666,667

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contractprice}-\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{18+}\\ \text{Revenue recognition in 2}0\text{19}\end{array}\right)\\ =\$1\text{0},000,000-\left(\$3,000,000-\$3,666,667\right)\\ =\$3,333,333\end{array}$

Hence, the calculated revenue recognition is $3,333,333.

Recognized gross profit

In the year 2016

Here,

Estimated gross profit in 2016 is $2,000,000, (2)  

Total estimated cost is $8,000,000,

Actual cost to date is $2,400,000.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{16}\end{array}\right)\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ =\$2,000,000\times \frac{\$2,400,000}{\$8,000,000}\\ =\$2,000,000\times 30\%\\ =\$6,000,000\end{array}$

Hence, the calculated gross profit recognition is $6,000,000.

In the year 2017

Here,

Estimated gross profit in 2017 is $700,000 (2)  

Total estimated cost is $9,300,000,

Gross profit recognition in 2016 is $6,000,000

Actual cost to date is $6,200,000.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{17}\end{array}\right)\\ \times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ -\left(\begin{array}{l}\text{Gross profit }\\ \text{recognition in 2}0\text{16}\end{array}\right)\end{array}\right)\\ \text{=}\left(\left(\$700,000\right)\times \left(\frac{\$6,200,000}{\$9,300,000}\right)-\$6,000,000\right)\\ =\left(\left(\$700,000\times 66.6667\%\right)-\$6,000,000\right)\\ =\$466,667-\$6,000,000\\ =\left(\$133,333\right)\end{array}$

Hence, the calculated gross loss recognition is $133,333.

In the year 2018

Here,

Estimated gross profit in 2018 is $600,000 (2)

Gross profit recognition in 2016 is $600,000,

Gross profit recognition in 2017 is -$133,333.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross profit in 2}0\text{18}\\ -\left(\begin{array}{l}\text{Gross profitrecognition in 2}0\text{16 }\\ +\text{ Gross profit recognition in 2}0\text{17}\end{array}\right)\end{array}\right)\\ \text{=}\left(\$600,000-\left(\begin{array}{l}\$600,000\\ +\$133,333\end{array}\right)\right)\\ =\left(\$600,000-\$466,667\right)\\ =\$133,333\end{array}$

Hence, the calculated gross profit recognition is $133,333.

Working note

Here,

Particulars	2016	2017	2018
Costs incurred during the year	$2,400,000	$3,800,000	$3,200,000
Estimated costs to complete as of year-end	$5,600,000	$3,100,000

Table (16)

Calculate the estimated gross profit ($ in millions):

Particulars	2016		2017		2018
Contract price		$1,000		$1,000		$1,000
Actual costs to date	$240		$620		$940
Estimated costs to complete	$560		$310		$0
Total estimated cost		$800		$930		$940
Estimated gross profit		$200		$70		$60

Table (17) (2)

Requirement – 5

To determine

The amount of revenue and gross profit or loss to be recognized in 2016, 2017, and 2018.

Explanation of Solution

Recognized revenue

In the year 2016:

Given,

The contract price is $10,000,000

Actual cost to date is $2,400,000

Calculated total estimated cost is $8,000,000 (1)  

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ \text{=}\$1\text{0},000,000\times \frac{\$2,400,000}{\$8,000,000}\\ =\$10,000,000\times 30\%\\ =\$3,000,000\end{array}$

Hence, the calculated revenue recognition is $3,000,000.

In the year 2017:

Given,

The contract price is $10,000,000

Actual cost to date is $6,200,000

Calculated total estimated cost is $10,300,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =}\left[\begin{array}{l}\left[\text{Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\right]-\\ \text{Previous year revenue}\end{array}\right]\\ \text{=}\left(\$1\text{0},000,000\times \frac{\$6,200,000}{\$10,300,000}\right)-\$3,000,000\\ =\left(\$10,000,000\times 60.19417\%\right)-\$3,000,000\\ =\$3,019,417\end{array}$

Hence, the calculated revenue recognition is $3,019,417.

In the year 2018:

Given,

Contract price is $10,000,000

Calculated revenue recognition in 2016 is $3,000,000

Calculated revenue recognition in 2017 is $3,019,417

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contractprice}-\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{18+}\\ \text{Revenue recognition in 2}0\text{19}\end{array}\right)\\ =\$1\text{0},000,000-\left(\$3,000,000-\$3,019,417\right)\\ =\$3,980,583\end{array}$

Hence, the calculated revenue recognition is $3,980,583.

Recognized gross profit

In the year 2016

Here,

Estimated gross profit in 2016 is $2,000,000 (3)

Total estimated cost is 8,000,000

Actual cost to date is $2,400,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{16}\end{array}\right)\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ =\$2,000,000\times \frac{\$2,400,000}{\$8,000,000}\\ =\$2,000,000\times 30\%\\ =\$6,000,000\end{array}$

Hence, the calculated gross profit recognition is $6,000,000.

In the year 2017

Here,

Estimated gross profit in 2017 is -$300,000 (3)

Gross profit recognition in 2016 is $6,000,000.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{17}\end{array}\right)\\ -\left(\begin{array}{l}\text{Gross profit }\\ \text{recognition in 2}0\text{16}\end{array}\right)\end{array}\right)\\ \text{=}\left(\left(-\$300,000\right)-\$6,000,000\right)\\ =-\$900,000\end{array}$

Hence, the calculated gross profit recognition is ($900,000).

In the year 2018

Here,

Estimated gross profit in 2018 is -$100,000 (3)  

Gross profit recognition in 2016 is $600,000,

Gross profit recognition in 2017 is -$900,000.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross profit in 2}0\text{18}\\ -\left(\begin{array}{l}\text{Gross profitrecognition in 2}0\text{16 }\\ +\text{ Gross profit recognition in 2}0\text{17}\end{array}\right)\end{array}\right)\\ \text{=}\left(-\$100,000-\left(\begin{array}{l}\left(\$600,000\right)\\ +\left(-\$900,000\right)\end{array}\right)\right)\\ =\left(\left(-\$100,000\right)-\left(-\$300,000\right)\right)\\ =\$200,000\end{array}$

Hence, the calculated gross profit recognition is $200,000.

Working note

Here,

Particulars	2016	2017	2018
Costs incurred during the year	$2,400,000	$3,800,000	$3,900,000
Estimated costs to complete as of year-end	$5,600,000	$4,100,000

Table (18)

Calculate the value of estimated gross profit ($ in millions):

Particulars	2016		2017		2018
Contract price		$1,000		$1,000		$1,000
Actual costs to date	$240		$620		$1,100
Estimated costs to complete	$560		$410		$0
Less: Total estimated cost		$800		$1,030		$1,010
Estimated gross profit		$200		-$30		-$10

Table (19)

(3)