Chapter 5, Problem 5.19E

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

Explanation of Solution

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

Recognized revenue

In the year 2016:

Here,

Contract price is $8,000,000,

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

Total estimated cost is $6,000,000.

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ =\$8,000,000\times \frac{\$2,000,000}{\$6,000,000}\\ =\$8,000,000\times 33.33\%\\ =\$2,666,667\end{array}$

Hence, the calculated revenue recognition is $2,666,667.

In the year 2017:

Here,

Contract price is $8,000,000,

Actual cost to date is $4,500,000,

Total estimated cost is $8,100,000,

Revenue recognition in 2016 is $2,666,667.

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =}\left(\begin{array}{l}\left(\begin{array}{l}\text{Contract price}\\ \times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\end{array}\right)\\ -\text{Revenue recognition in 2}0\text{18}\end{array}\right)\\ \text{=}\left(\left(\$8,000,000\times \frac{\$4,500,000}{\$8,100,000}\right)-\$2,666,667\right)\\ =\left(\left(\$8,000,000\times 55.5556\%\right)-\$2,666,667\right)\\ =\$4,444,448-\$2,666,667\\ =\$1,777,778\end{array}$

Hence, the calculated revenue recognition is $1,777,778.

In the year 2018:

Here,

Contract price is $8,000,000,

Revenue recognition in 2016 is $2,666,667,

Revenue recognition in 2017 is $1,777,778.

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contractprice}-\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{16}\\ \text{+ Revenue recognition in 2}0\text{17}\end{array}\right)\\ =\$8,000,000-\left(\$\text{2},\text{666},\text{667}+\$\text{1},\text{777},\text{778}\right)\\ =\$8,000,000-\$4,444,445\\ =\$3,555,555\end{array}$

Hence, the calculated revenue recognition is $3,555,555.

Recognized gross profit

In the year 2016:

Here,

Revenue recognition in 2016 is $2,666,667

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

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{16}\\ -\text{ Actual cost to date}\end{array}\right)\\ \text{=}\$\text{2},\text{666},\text{667}-\$2,000,000\\ =\$666,667\end{array}$

Hence, the calculated gross profit recognition is $666,667.

In the year 2017:

Here,

Revenue recognition in 2017 is ($100,000)

Gross profit recognition in 2016 is $666,667.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{17}\\ -\text{ Gross profit recognition in 2}0\text{16}\end{array}\right)\\ \text{=}\left(\$100,000\right)-\$666,667\\ =\left(\$766,667\right)\end{array}$

Hence, the calculated gross loss recognition is ($766,667).

In the year 2018:

Here,

Revenue recognition in 2018 is ($300,000)

Revenue recognition in 2017 is ($100,000).

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{18}\\ -\text{ Revenue recognition in 2}0\text{17}\end{array}\right)\\ \text{=}\left(\$\text{3}00,000\right)-\left(\$\text{1}00,000\right)\\ =\left(\$200,000\right)\end{array}$

Hence, the calculated gross loss recognition is ($200,000).

Working note:

Calculate the value of gross profit (in millions)

Particulars	2016		2017		2018
Contract price		$8		$8		$8
Actual costs to date	$2		$4.5		$8.3
Estimated costs to complete	$4		$3.6		$0
Total estimated cost		$6		$8.1		$8.3
Estimated gross profit		$2		($0.1)		($0.3)

Table (1)

(1)

Requirement – 2

To determine

To record: The journal entry for the year 2016 and 2017.

Explanation of Solution

The journal entry for the year 2016 and 2017 are as follows:

In the year 2016:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Construction in progress		$2,000,000
	Various accounts			$2,000,000
	(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		$2,500,000
	Billings on construction contract			$2,500,000
	(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 value of liability. Therefore, it is debited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$2,250,000
	Account receivable			$2,250,000
	(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
	Construction in progress		$666,667
	Cost of construction		$2,000,000
	Revenue from long-term contracts			$2,666,667
	(To record gross profit)

Table (5)

• 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.

In the year 2017:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Construction in progress		$2,500,000
	Various accounts			$2,500,000
	(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		$2,750,000
	Billings on construction contract			$2,750,000
	(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		$2,475,000
	Account receivable			$2,475,000
	(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 (2)		$2,544,445
	Revenue from long-term contracts			$1,777,778
	Construction in progress			$766,667
	(To record expected loss)

Table (9)

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

Working note:

Calculate the cost of construction

Given,

Revenue recognition in 2017 is $1,777,778

Loss recognition in 2017 is $766,667.

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{17}\\ \text{+ Loss recognition in 2}0\text{17}\end{array}\right)\\ =\$1,777,778+\$766,667\\ =\$2,544,445\end{array}$

(2)

Conclusion

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

Requirement – 3

To determine

To prepare: A partial balance sheet to show the presentation of the project as of December 31, 2016 and 2017.

Explanation of Solution

In the year ended 2016:

Balance sheet At December 31,2016
Current assets	Amount
Account receivable	$250,000
Cost and profit in excess of billings (3)	$166,667

Table (10)

Working note:

Calculate the costs and profit in excess of billings:

Given,

Profit is $2,666,667 $\left(\$2,000,000+\$666,667\right)$

Billing profit is $2,500,000.

Now, calculate the costs and profit in excess of billings:

$\begin{array}{c}\text{Costs and profit in excess of billings =}\left(\begin{array}{l}\text{Profit }\\ -\text{ Billing profit}\end{array}\right)\\ =\$2,666,667-\$2,500,000\\ =\$166,667\end{array}$

(3)

In the year ended 2017:

Balance sheet At December 31,2017
Current assets	Amount
Account receivable	$525,000
Current liability	Amount
Cost and profit in excess of billings (4)	$850,000

Table (11)

Working note:

Calculate the costs and profit in excess of billings:

Given,

Profit is $5,250,000

Billing profit is $4,400,000.

Now, calculate the costs and profit in excess of billings:

$\begin{array}{c}\text{Costs and profit in excess of billings =}\left(\begin{array}{l}\text{Profit }\\ -\text{ Billing profit}\end{array}\right)\\ =\$5,250,000-\$4,400,000\\ =\$850,000\end{array}$ (4)

Conclusion

Therefore, the partial balance sheet of the project for the year ended December 31, 2016 and 2017 are recorded.