Percentage of Completion Example Paterno Construction receives a contract for $1.5 million...

Percentage of Completion Example

Paterno Construction receives a contract for $1.5 millionRenovation to Beaver StadiumThrough 1997, 1998, and 1999

1997 Costs Incurred: $350,000

When materials are purchased and costs are incurred, we transfer the balance to a work-in-process inventory account called Construction-in-Progress

Basic Journal Entries for Transactions

The Journal Entry to do this transfer might look like:


Constr In Progr Inv. 350,000

Transferring costs to CIP account.


Materials Inv. 200,000Wages Payable 80,000Cash 70,000

Constr In Progr Inv. 350,000

The Journal Entry to do this transfer might look like:


Actual costs incurred in the year.


T-Account Summary

CIP Inv

350,000


When the company bills for work in progress, it records an accounts receivable for the amount of the billing and a corresponding contra-asset account called Billings on Construction.

Billings on Construction is a contra-asset account because it reduces the amount of Construction-in-Progress inventory that the firm can claim is theirs.

In other words, it is as if the firm is transferring the rights to ownership of a portion of Construction-in-Progress inventory in exchange for an increase in accounts receivable.

11/30 Accounts Rec. 300,000Billings on Constr 300,000

Example: On Nov. 30, the company mails a bill for $300,000 .


T-Account Summary

1997 Balance Sheet Representation:

Assets: Constr in Prog Inv 350,000 Less: Billings on Construct (300,000) Net CIP Inventory 50,000

CIP Inv

350,000

Billings on Constr

300,000

Example: On Dec. 10, the company receives cash for the bill:

12/10 Cash 300,000Accounts Rec. 300,000


When the company actually receives payment on the recent billing, it simply records the cash in exchange for the accounts receivable.

Computing Revenue under Percentage of Completion

Start with 1997 data for costs incurred and estimated total completion costs.

Percent Complete = 350,000/1,350,000 = 25.926%

1997 Costs Incurred to-date: $350,000Estimated Total Costs: $1,350,000


Revenue = Percent Complete x Total Revenue for Project - Prior Revenue Recognized

Revenue1997 = (0.25926 x $1,500,000) - $0

= $388,890


Now, compute for 1998. Assume expected completion costs increase to $1,360,000 due to budget overruns.

Revenue1998 = (0.66176 x $1,500,000) - $388,890


Percent Complete = 900,000/1,360,000 = 66.176%

1998 Costs Incurred to-date: $900,000Estimated Total Costs: $1,360,000


= $603,750

Note that this is cumulative (this includes the $350,000 costs incurred in 1997 and an additional $550,000 incurred in 1998).


Now, compute for 1999. Assume actual completion costs increase to $1,365,000 due to budget overruns.

= $507,360

Revenue1999 = (1 x $1,500,000) - $388,890 - $603,750


Percent Complete = 1,365,000/1,365,000 = 100%

1999 Costs Incurred to-date: $1,365,000Estimated Total Costs: $1,365,000


Summary of Project

Year Costs Incurred

Expected Total Costs

%age completed

Revenue

1997

1998

1999

Totals

Summary of Project

Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890

1998

1999

Totals

Summary of Project

Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890

1998 550,000 1,360,000 66.176 $603,750

1999

Totals

Summary of Project

Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890

1998 550,000 1,360,000 66.176 $603,750

1999 465,000 1,365,000 100 $507,360

Totals

Summary of Project

Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890

1998 550,000 1,360,000 66.176 $603,750

1999 465,000 1,365,000 100 $507,360

Totals 1,365,000 $1,500,000

Annual Journal Entries to Record Revenue and Gross Profit

Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890


Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890

1997 End-of-Year Journal Entry:Construction Expense 350,000

Construction Revenue 388,890


Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890

1997 End-of-Year Journal Entry:Construction Expense 350,000Constr In Prog Inv 38,890


Gross profit goes to CIP Inventory Account

1997 T-Account Summary

CIP Inv

350,00038,890

Billings on Constr

300,000

Actual Costs

Gross Profit

CIP Inv

350,00038,890

Billings on Constr

300,000

1997 Balance388,890 300,000

1997 T-Account Summary

1998 End-of-Year Journal Entry:Construction Expense 550,000



Year Costs Incurred


%age completed

Revenue

1998 550,000 1,360,000 66.176 $603,750




Year Costs Incurred


%age completed

Revenue

1998 550,000 1,360,000 66.176 $603,750




Year Costs Incurred


%age completed

Revenue

1999 465,000 1,365,000 100 $507,360

CIP Inv Billings on Constr

End of Project T-Account Summary

$1,500,000 $1,500,000



$1,500,000 $1,500,000

This is the amount we will have billed the client through the project life.

This includes all costs incurred through the project plus all gross profit on the project.



$1,500,000 $1,500,000

Billings on Constr 1,500,000CIP Inv 1,500,000

Closing Journal Entry (to zero out accounts):

Losses on Long-Term Contracts

There are two situations for losses:

1) Loss only in current periodWhen current year’s expenses > current year’s revenues. But the total project will still be profitable.

2) Unprofitable total contractWhen new estimates of total contract costs > expected total revenues.


Loss only in current period

Example: 1998 expected total costs increase to $1,450,000

(Note that the total contract is still profitable since we will collect $1,500,000)




Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890

1998 550,000 1,450,000 62 $542,145

900,000 / 1,450,000 = 62%

0.62 x 1,500,000 = $931,035 – 388,890 = $542,145




Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890

1998 550,000 1,450,000 62 $542,145

Notice costs incurred > Current period revenue550,000 542,145



Journal entry:

Construction Expenses 550,000CIP Inventory (Loss) 7,855Construction Revenue 542,145

Notice costs incurred > Current period revenue550,000 542,145


Unprofitable Total Contract


Note that the total contract is no longer profitable since we will collect only $1,500,000. So, we anticipate a $100,000 loss.

We must recognize this anticipated loss on the entire project in the year we first discover the expected loss (in this case, 1998).

To do this, we do the following:

1. Compute the revenue for the year using same method as before.2. Reverse any prior recorded profits and record the anticipated loss.


Unprofitable Total ContractExample: 1998 expected total costs increase to $1,600,000

Year Costs Incurred


%age completed

Revenue

1997 350,000 1,350,000 25.926 $388,890

1998 550,000 1,600,000 56.25 $454,860

900,000 / 1,600,000 = 56.25%

0.5625 x 1,500,000 = $843,750 – 388,890 = $454,860

Compute Revenue for the Year

Note also that we recorded $388,890 - $350,000 = $38,890 Gross Profit in 1997.

1998 Journal entry:


Unprofitable Total Contract



Record the revenue for the year

CIP Inventory (loss) 138,890

Record the $100,000 loss +reverse the 1997 Gross Profit

Construction Exps 593,750

Percentage of Completion Example Paterno Construction receives a contract for $1.5 million...

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