Chapter 5, Problem 5.10P

Long-term contract; revenue recognition over time

• LO5–8, LO5–9

In 2018, the Westgate Construction Company entered into a contract to construct a road for Santa Clara County for $10,000,000. The road was completed in 2020. Information related to the contract is as follows: Westgate recognizes revenue over time according to percentage of completion.

Required:

1. Calculate the amount of revenue and gross profit to be recognized in each of the three years.

2. Prepare all necessary journal entries for each of the years (credit “various accounts” for construction costs incurred).

3. Prepare a partial balance sheet for 2018 and 2019 showing any items related to the contract. Indicate whether any of the amounts shown are contract assets or contract liabilities.

4. Calculate the amount of revenue and gross profit to be recognized in each of the three years assuming the following costs incurred and costs to complete information:

5. Calculate the amount of revenue and gross profit to be recognized in each of the three years assuming the following costs incurred and costs to complete information:

To determine

Contract

Contract is a written document that creates legal enforcement for buying and selling the property. It is committed by the parties to perform their obligations and enforcing 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 by revenue minus cost of completion until date.

If a contract does not meet the performance obligation norm, the seller cannot recognize the revenue till the project 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 determine: The amount of revenue and gross profit or loss to be recognized in 2018, 2019, and 2020.

Explanation of Solution

Recognized revenue

In the year 2018:

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 2019:

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 2020:

Given,

Contract price is $10,000,000

Calculated revenue recognition in 2018 is $3,000,000

Calculated revenue recognition in 2019 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 2018

Here,

Estimated gross profit in 2018 is $2,000,000 (1)

Total estimated cost is $8,000,000,

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

Now, calculate the gross profitrecognition:

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

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

In the year 2019

Here,

Estimated gross profit in 2019 is $2,000,000(1)

Total estimated cost is $8,000,000,

Gross profit recognition in 2018 is $6,000,000

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

Now, calculate the gross profitrecognition:

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

$=\$9,000,000$

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

In the year 2020

Here,

Estimated gross profit in 2020 is $1,800,000(1)

Gross profit recognition in 2018 is $6,000,000,

Gross profit recognition in 2019 is $9,000,000.

Now, calculate the gross profitrecognition:

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

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

Working note:

Calculate the value of gross profit (in millions)

Particulars	2018		2019		2020
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)

To determine

To prepare: The journal entries for the year 2018, 2019 and 2020.

Explanation of Solution

In the year 2018:

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 liability 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 liability 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 constructionis anexpense. 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 liability value. Therefore, it is credited.

In the year 2019:

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 liability value. 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 liability value. 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 constructionis anexpense. 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 liability value. Therefore, it is credited.

In the year 2020:

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 liability value. 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 liability value. 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 constructionis anexpense. There is a decrease in liability value. Therefore, it is debited.
• Revenue from long-term contracts is revenue. There is an increase in liability value. Therefore, it is credited.

To determine

To prepare: The partial balance sheet for 2018 and 2019.

Explanation of Solution

Partial balance sheet of W Construction Company is as follows:

In the year 2018:

Assets	2018
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 2019:

Assets	2019
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)

To determine

The amount of revenue and gross profit or loss to be recognized in 2018, 2019, and 2020.

Explanation of Solution

Recognized revenue

In the year 2018:

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 2019:

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 2020:

Given,

Contract price is $10,000,000

Calculated revenue recognition in 2018 is $3,000,000

Calculated revenue recognition in 2019 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 2018

Here,

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

Total estimated cost is $8,000,000,

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

Now, calculate the gross profitrecognition:

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

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

In the year 2019

Here,

Estimated gross profit in 2019 is $700,000 (2)

Total estimated cost is $9,300,000,

Gross profit recognition in 2018 is $6,000,000

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

Now, calculate the gross profitrecognition:

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

$=\left(\$133,333\right)$

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

In the year 2020

Here,

Estimated gross profit in 2020 is $600,000(2)

Gross profit recognition in 2018 is $600,000,

Gross profit recognition in 2019 is -$133,333.

Now, calculate the gross profitrecognition:

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

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

Working note

Particulars	2018	2019	2020
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

Calculate the estimated gross profit ($ in millions):

Particulars	2018		2019		2020
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 (15)

(2)

To determine

The amount of revenue and gross profit or loss to be recognized in 2018, 2019, and 2020.

Explanation of Solution

Recognized revenue

In the year 2018:

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 2019:

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 2020:

Given,

Contract price is $10,000,000

Calculated revenue recognition in 2018 is $3,000,000

Calculated revenue recognition in 2019 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 2018

Here,

Estimated gross profit in 2018 is $2,000,000(3)

Total estimated cost is 8,000,000

Actual cost to date is $2,400,000

Now, calculate the gross profitrecognition:

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

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

In the year 2019

Here,

Estimated gross profit in 2019 is -$300,000(3)

Gross profit recognition in 2018 is $6,000,000.

Now, calculate the gross profitrecognition:

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

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

In the year 2020

Here,

Estimated gross profit in 2020 is -$100,000 (3)

Gross profit recognition in 2018 is $600,000,

Gross profit recognition in 2019 is -$900,000.

Now, calculate the gross profitrecognition:

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

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

Working note

Particulars	2018	2019	2020
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

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

Particulars	2018		2019		2020
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

(3)