Chapter 5, Problem 5.21E

To determine

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.

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.

To determine: The amount of gross profit or loss to be recognized under various situations.

Explanation of Solution

The amount of gross profit or loss to be recognized under various situations is as follows:

(Figure 1)

Working note:

Situation – 1

1. Compute the value of gross profit or loss recognized over time

Here,

Particulars	2016	2017	2018
Contract price (A)	$5,000,000	$5,000,000	$5,000,000
Actual costs to date	1,500,000	3,600,000	4,500,000
Estimated costs to complete	3,000,000	900,000	0
Total estimated costs (B)	4,500,000	4,500,000	4,500,000
Estimated gross profit(actual in 2018) $\text{C=}\left(\text{A}-\text{B}\right)$	$500,000	$500,000	$500,000

Table (1)

In the year 2016:

$\begin{array}{c}\text{Gross}\text{profit}\text{=}\frac{\text{\$1,500,000}}{\text{\$4,500,000}}\text{×100}\\ \text{=33}\text{.3333\%×\$500,000}\\ \text{=\$166,667}\end{array}$ (1)

In the year 2017:

$\begin{array}{c}\text{Gross}\text{profit}\text{=}\frac{\$3,600,000}{\$4,500,000}\text{×100}\\ \text{=80\%×\$500,000}\\ \text{=\$400,000}-\text{\$166,667}\\ \text{=\$233,333}\end{array}$ (2)

In the year 2018:

$\begin{array}{c}\text{Revenue = \$5,000,000}-\$4,000,000\\ =\$1,000,000\end{array}$

$\begin{array}{c}\text{Gross profit = \$1,000,000}-\$900,000\\ =\$100,000\end{array}$ (3)

2. Compute the value of gross profit or loss recognized upon completion

Year	Gross profit recognized
2016	0
2017	0
2018	$500,000
Total gross profit	$500,000

Table (2)

(4)

Situation – 2

1. Compute the value of gross profit or loss recognized over time

Here,

Particulars	2016	2017	2018
Contract price (A)	$5,000,000	$5,000,000	$5,000,000
Actual costs to date	1,500,000	2,400,000	4,800,000
Estimated costs to complete	3,000,000	2,400,000	0
Total estimated costs (B)	4,500,000	4,800,000	4,800,000
Estimated gross profit(actual in 2018) $\text{C=}\left(\text{A}-\text{B}\right)$	$500,000	$200,000	$200,000

Table (3)

In the year 2016:

$\begin{array}{c}\text{Gross}\text{profit}\text{=}\frac{\text{\$1,500,000}}{\text{\$4,500,000}}\text{×100}\\ \text{=33}\text{.3333\%×\$500,000}\\ \text{=\$166,667}\end{array}$ (5)

In the year 2017:

$\begin{array}{c}\text{Gross}\text{profit}\text{=}\frac{\$2,400,000}{\$4,800,000}\text{×100}\\ \text{=50}\text{. 0\%×\$200,000}\\ \text{=\$100,000}-\text{\$166,667}\\ \text{=\$(66,667)}\end{array}$ (6)

In the year 2018:

$\begin{array}{c}\text{Revenue = \$5,000,000}-\$2,500,000\\ =\$2,500,000\end{array}$

$\begin{array}{c}\text{Gross profit = \$2,500,000}-\$2,400,000\\ =\$100,000\end{array}$ (7)

2. Compute the value of gross profit or loss recognized upon completion

Year	Gross profit recognized
2016	0
2017	0
2018	$200,000
Total gross profit	$200,000

Table (4)

(8)

Situation – 3

1. Compute the value of gross profit or loss recognized over time

Here,

Particulars	2016	2017	2018
Contract price (A)	$5,000,000	$5,000,000	$5,000,000
Actual costs to date	1,500,000	3,600,000	5,200,000
Estimated costs to complete	3,000,000	1,500,000	0
Total estimated costs (B)	4,500,000	5,100,000	5,200,000
Estimated gross profit(actual in 2018) $\text{C=}\left(\text{A}-\text{B}\right)$	$500,000	$(100,000)	$(200,000)

Table (5)

In the year 2016:

$\begin{array}{c}\text{Gross}\text{profit}\text{=}\frac{\text{\$1,500,000}}{\text{\$4,500,000}}\text{×100}\\ \text{=33}\text{.3333\%×\$500,000}\\ \text{=\$166,667}\end{array}$ (9)

In the year 2017:

$\begin{array}{c}\text{Overall loss = \$5,000,000}-\$5,100,000\\ =\$(100,000)\end{array}$

$\begin{array}{c}\text{Gross}\text{profit}=\$(100,000)-\$166,667\\ =\$(266,667)\end{array}$ (10)

In the year 2018:

$\begin{array}{c}\text{Overall loss = \$5,000,000}-\$5,200,000\\ =\$(200,000)\end{array}$

$\begin{array}{c}\text{Gross profit = \$(200,000)}-\$(100,000)\\ =\$(100,000)\end{array}$ (11)

2. Compute the value of gross profit or loss recognized upon completion

Year	Gross profit recognized
2016	0
2017	$(100,000)
2018	$(100,000)
Total gross profit	$(200,000)

Table (6)

(12)

Situation – 4

1. Compute the value of gross profit or loss recognized over time

Here,

Particulars	2016	2017	2018
Contract price (A)	$5,000,000	$5,000,000	$5,000,000
Actual costs to date	500,000	3,500,000	4,500,000
Estimated costs to complete	3,500,000	875,000	0
Total estimated costs (B)	4,000,000	4,375,000	4,500,000
Estimated gross profit(actual in 2018) $\text{C=}\left(\text{A}-\text{B}\right)$	$1,000,000	$625,000	$500,000

Table (7)

In the year 2016:

$\begin{array}{c}\text{Gross}\text{profit}\text{=}\frac{\text{\$500,000}}{\text{\$4,000,000}}\text{×100}\\ \text{=12}\text{.5\%×\$500,000}\\ \text{=\$625,000}\end{array}$ (13)

In the year 2017:

$\begin{array}{c}\text{Gross}\text{profit}\text{=}\frac{\$3,500,000}{\$4,375,000}\text{×100}\\ \text{=80}\text{. 0\%×\$625,000}\\ \text{=\$500,000}-\text{\$125,000}\\ \text{=\$375,000}\end{array}$ (14)

In the year 2018:

$\begin{array}{c}\text{Revenue = \$5,000,000}-\$4,000,000\\ =\$1,000,000\end{array}$

$\begin{array}{c}\text{Gross profit = \$1,000,000}-\$1,000,000\\ =\$0\end{array}$ (15)

2. Compute the value of gross profit or loss recognized upon completion

Year	Gross profit recognized
2016	0
2017	0
2018	$500,000
Total gross profit	$500,000

Table (8)

(16)

Situation – 5

1. Compute the value of gross profit or loss recognized over time

Here,

Particulars	2016	2017	2018
Contract price (A)	$5,000,000	$5,000,000	$5,000,000
Actual costs to date	500,000	3,500,000	4,800,000
Estimated costs to complete	3,500,000	1,500,000	0
Total estimated costs (B)	4,000,000	5,000,000	4,800,000
Estimated gross profit(actual in 2018) $\text{C=}\left(\text{A}-\text{B}\right)$	$1,000,000	$0	$200,000

Table (9)

In the year 2016:

$\begin{array}{c}\text{Gross}\text{profit}\text{=}\frac{\text{\$500,000}}{\text{\$4,000,000}}\text{×100}\\ \text{=12}\text{.5\%×\$1,000,000}\\ \text{=\$125,000}\end{array}$ (17)

In the year 2017:

$\begin{array}{c}\text{Gross}\text{profit}=\$0-\$125,000\\ =\$(125,000)\end{array}$ (18)

In the year 2018:

$\begin{array}{c}\text{Gross profit = \$200,000}-\$0\\ =\$200,000\end{array}$ (19)

2. Compute the value of gross profit or loss recognized upon completion

Year	Gross profit recognized
2016	0
2017	0
2018	$200,000
Total gross profit	$200,000

Table (10)

(20)

Situation – 6

1. Compute the value of gross profit or loss recognized over time

Here,

Particulars	2016	2017	2018
Contract price (A)	$5,000,000	$5,000,000	$5,000,000
Actual costs to date	500,000	3,500,000	5,300,000
Estimated costs to complete	4,600,000	1,700,000	0
Total estimated costs (B)	5,100,000	5,200,000	5,300,000
Estimated gross profit(actual in 2018) $\text{C=}\left(\text{A}-\text{B}\right)$	$(100,000)	$(200,000)	$(300,000)

Table (11)

In the year 2016:

$\text{Gross}\text{profit=\$(100,000)}$ (21)

In the year 2017:

$\begin{array}{c}\text{Gross}\text{profit}=\$(200,000)-\$(100,000)\\ =\$(100,000)\end{array}$ (22)

In the year 2018:

$\begin{array}{c}\text{Gross profit = \$(300,000)}-\$(200,000)\\ =\$(100,000)\end{array}$ (23)

2. Compute the value of gross profit or loss recognized upon completion

Year	Gross profit recognized
2016	$(100,000)
2017	(100,000)
2018	(100,000)
Total gross profit	$(300,000)

Table (12)

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