Chapter 5, Problem 5.18E

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 by 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 will report in 2016, 2017, and 2018 income statement of S Contraction, assume revenue recognize over time according to percentage of completion.

Explanation of Solution

Recognized revenue

In the year 2016:

Given,

The contract price is $220,000,000

Actual cost to date is $4,000,000

Calculated total estimated cost is $160,000,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ \text{=}\$\text{220},000,000\times \frac{\$40,000,000}{\$160,000,000}\\ =\$220,000,000\times 25\%\\ =\$55,000,000\end{array}$

Hence, the calculated revenue recognition is $55,000,000.

In the year 2017:

Given,

The contract price is $220,000,000

Actual cost to date is $120,000,000

Calculated total estimated cost is $180,000,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =}\left[\begin{array}{l}\left[\text{Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\right]-\\ \text{Previous year revenue}\end{array}\right]\\ \text{=}\left(\$\text{220},000,000\times \frac{\$120,000,000}{\$180,000,000}\right)-\$55,000,000\\ =\left(\$220,000,000\times 25\%\right)-\$55,000,000\\ =\$91,670,000\end{array}$

Hence, the calculated revenue recognition is $91,670,000.

In the year 2018:

Given,

Contract price is $220,000,000

Calculated revenue recognition in 2016 is $55,000,000

Calculated revenue recognition in 2017 is $91,670,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contractprice}-\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{18+}\\ \text{Revenue recognition in 2}0\text{19}\end{array}\right)\\ =\$\text{220},000,000-\left(\$55,000,000-\$91,670,000\right)\\ =\$73,330,000\end{array}$

Hence, the calculated revenue recognition is $73,330,000.

Recognized gross profit

In the year 2016:

Given,

Estimated gross profit in 2016 is $60,000,000 (1)

Total estimated cost is $160,000,000

Actual cost to date is $40,000,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{18}\end{array}\right)\times \left(\frac{\text{Actual costto date}}{\text{Total estimated cost}}\right)\\ =\$60,000,000\times \frac{\$40,000,000}{\$160,000,000}\\ =\$60,000,000\times 25\%\\ =\$15,000,000\end{array}$

Hence, the calculated gross profit recognition is $15,000,000.

In the year 2017:

Here,

Estimated gross profit in 2017 is $40,000,000 (1)

Total estimated cost is $180,000,000

Gross profit recognition in 2016 is $15,000,000

Actual cost to date is $120,000,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{19}\end{array}\right)\\ \times \left(\frac{\text{Actual costto date}}{\text{Total estimated cost}}\right)\\ -\left(\begin{array}{l}\text{Gross profit }\\ \text{recognition in 2}0\text{18}\end{array}\right)\end{array}\right)\\ \text{=}\left(\left(\$4\text{0},000,000\right)\times \left(\frac{\$12\text{0},000,000}{\$\text{180},000,000}\right)-\$15,000,000\right)\\ =\left(\left(\$60,000,000\times 66.67\%\right)-\$15,000,000\right)\\ =\$26,670,000-\$15,000,000\\ =\$11,670,000\end{array}$

Hence, the calculated gross profit recognition is $11,670,000.

In the year 2018:

Here,

Estimated gross profit in 2016 is $50,000,000 (1)

Gross profit recognition in 2016 is $15,000,000

Gross profit recognition in 2017 is $11,670,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross profit in 2}020\\ -\left(\begin{array}{l}\text{Gross profitrecognition in 2}0\text{18 }\\ +\text{ Gross profit recognition in 2}0\text{19}\end{array}\right)\end{array}\right)\\ \text{=}\left(\$\text{5}0,000,000-\left(\begin{array}{l}\$\text{15},000,000\\ +\$\text{11},\text{67}0,000\end{array}\right)\right)\\ =\left(\$50,000,000-\$26,670,000\right)\\ =\$23,330,000\\ =\$11,670,000\end{array}$

Hence, the calculated gross profit recognition is $11,670,000.

Working note:

Calculate the value of gross profit (in millions)

Particulars	2016		2017		2018
Contract price		$220		$220		$220
Actual costs to date	$40		$120		$170
Estimated costs to complete	$120		$60		$0
Less: Total estimated cost		$160		$180		$170
Estimated gross profit		$60		$40		$50

Table (1)

(1)

Requirement – 2

To determine

To calculate: The amount of revenue and gross profit or loss to be recognized in 2016, 2017 and 2018 assuming the project does not qualify for revenue recognition over time.

Explanation of Solution

Revenue recognition:

In this case, there is no revenue recognition because the project does not qualify for revenue recognition overtime.

Recognized gross profit:

In the year 2016 and 2017:

In this case, there is no recognized profit, because the contract is not yet completed. Hence, the gross profit in the year 2016 and 2017 is $0.

In the year 2018:

Here,

The contract price is $220,000,000

Actual cost to date is $170,000,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Contract price}\\ -\text{ Actual cost to date}\end{array}\right)\\ =\$220,000,000-\$170,000,000\\ =\$50,000,000\end{array}$

Hence, the calculated gross profit recognition is $50,000,000.

Requirement – 3

To determine

The amount of revenue and gross profit or loss to be recognized in 2017, and assume S Construction recognizes revenue over time according to percentage of completion.

Explanation of Solution

Revenue recognition in the year 2017:

Here,

Contract price is $220,000,000

Actual cost to date is $120,000,000

Total estimated cost is $200,000,000

Revenue recognition is $55,000,000 $\left(\$15,000,000+\$40,000,000\right)$

Profit recognizes is $15,000,000.

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =}\left(\begin{array}{l}\text{Contract price}\\ \times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\end{array}\right)-\text{Revenue recognition}\\ \text{=}\left(\begin{array}{l}\$\text{220},000,000\\ \times \frac{\$\text{12}0,000,000}{\$\text{2}00,000,000}\end{array}\right)-\$\text{55},000,000\\ =\left(\$220,000,000\times 60\%\right)-\$\text{55},000,000\\ =132,000,000-\$\text{55},000,000\\ =\$77,000,000\end{array}$

Hence, the calculated revenue recognition is $77,000,000.

Recognized gross profit in the year 2017:

Here,

Revenue recognition in 2017 is $77,000,000

Actual cost to date is $80,000,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{17}\\ -\text{ Actual cost to date}\end{array}\right)\\ =\$77,000,000-\$80,000,000\\ =-\$300,000\end{array}$

Hence, the calculated gross loss recognition is $300,000.