Chapter 5, Problem 5.21E

Income (loss) recognition; Long-term contract; revenue recognition over time vs. upon project completion

• LO5–9

Brady Construction Company contracted to build an apartment complex for a price of $5,000,000. Construction began in 2018 and was completed in 2020. The following is a series of independent situations, numbered 1 through 6, involving differing costs for the project. All costs are stated in thousands of dollars.

Required:

Copy and complete the following table:

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.

Answer to Problem 5.21E

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

(Figure 1)

Explanation of Solution

Working note:

Situation – 1

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

Here,

Particulars	2018	2019	2020
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 2020) $\text{C=}\left(\text{A}-\text{B}\right)$	$500,000	$500,000	$500,000

Table (1)

In the year 2018:

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

In the year 2019:

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

In the year 2020:

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

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

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

Year	Gross profit recognized
2018	0
2019	0
2020	$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	2018	2019	2020
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 2020) $\text{C=}\left(\text{A}-\text{B}\right)$	$500,000	$200,000	$200,000

Table (3)

In the year 2018:

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

In the year 2019:

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

In the year 2020:

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

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

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

Year	Gross profit recognized
2018	0
2019	0
2020	$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	2018	2019	2020
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 2020) $\text{C=}\left(\text{A}-\text{B}\right)$	$500,000	$(100,000)	$(200,000)

Table (5)

In the year 2018:

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

In the year 2019:

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

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

In the year 2020:

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

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

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

Year	Gross profit recognized
2018	0
2019	$(100,000)
2020	$(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	2018	2019	2020
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 2020) $\text{C=}\left(\text{A}-\text{B}\right)$	$1,000,000	$625,000	$500,000

Table (7)

In the year 2018:

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

In the year 2019:

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

In the year 2020:

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

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

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

Year	Gross profit recognized
2018	0
2019	0
2020	$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	2018	2019	2020
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 2020) $\text{C=}\left(\text{A}-\text{B}\right)$	$1,000,000	$0	$200,000

Table (9)

In the year 2018:

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

In the year 2019:

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

In the year 2020:

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

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

Year	Gross profit recognized
2018	0
2019	0
2020	$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	2018	2019	2020
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 2020) $\text{C=}\left(\text{A}-\text{B}\right)$	$(100,000)	$(200,000)	$(300,000)

Table (11)

In the year 2018:

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

In the year 2019:

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

In the year 2020:

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

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

Year	Gross profit recognized
2018	$(100,000)
2019	(100,000)
2020	(100,000)
Total gross profit	$(300,000)

Table (12)

(24)