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    Contracts: Percentage of completion, completed contract

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    1. Long term construction contract

    In accounting for long term construction contracts (those taking longer than one year to complete), the two methods commonly followed are percentage of completion and completed contract.
    a. Discuss how earnings on long term construction contracts are recognized and computed under these two methods.
    b. Under what circumstances should one method be used over the other?
    c. How are job costs and interim billings reflected on the balance sheet under the percentage of completion method and the completed contract method?

    2. Percentage of completion method and completed contract methods.

    On February 1, 2007, Nance Contractors agreed to construct a building at a contract price of $6,000,000. Nance estimated total construction costs would be $4,000,000 and the project would be finished in 2009. Information relating to the costs and billings for the contract is as follows:

    2007 2008 2009
    Total costs incurred to date $1,500,000 $2,640,000 $4,600,000
    Estimated costs to complete $2,500,000 $1,760,000 0
    Customer billings to date $2,200,000 $4,000,000 $5,600,000
    Collections to date $2,000,000 $3,500,000 $5,500,000

    a. Complete the revenue and gross profit to be recognized in each year.
    b. Prepare the 2009 journal entries to record the construction costs, billings, collections, and revenue recognition
    c. Prepare the 2009 journal entries for revenue recognition if the completed contract method was used.

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    Solution Preview

    Long term construction contracts can be accounted for and reported under one of two methods: percentage of completion or completed contract. The purpose for the two methods is to determine the proper amount of revenue and expense which will be recognized in each of the accounting periods involved. Under the definition, a contract will not be considered for this treatment unless it involves the manufacture of unique items normally requiring more than 12 months to complete. A more descriptive term for the percent complete method is percentage-of-completion capitalized-cost method.

    For the percentage method, the end result is that the percentage of the contract that is completed within each accounting period will determine the amount of revenue and expense that will be reported. The logistics of this process involve a good estimate of the expected profit on the job times the percentage complete. These types of contracts are normally bid and in order to bid, the construction company usually prepares a detail cost estimate for the job. When the bid is accepted, the company then knows the revenue and they already have the cost estimate.

    The expected profit on the job is known, but the problem arises when costs change during the contract. As the contract progresses, the profit estimate is constantly revised which then changes the amount of ...

    Solution Summary

    The 870 word solution presents a comprehensive discussion of the two methods of reporting long-term contracts. Following the narrative explanation of the two methods, there is a cited section showing exactly how revenue is reported for both methods. The attached Excel spreadsheet analyzes Nance's contract for three years including journal entries to be made in 2009 for both methods.