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Percentage-of-completion Method & Completed-contract Method

What are the two basic methods of accounting for long-term construction contracts? What circumstances determine when one or the other of these methods should be used?
For what reasons should the percentage-of-completion method be used over the completed-contract method whenever possible?

Problem

On March 1, 2010, Pechstein Construction Company contracted to construct a factory building for Fabrik Manufacturing Inc. for a total contract price of $8,400,000. The building was completed by October 31, 2012. The annual contract cost incurred, estimated costs to complete the contract, and accumulated billings to Fabrik for 2010, 2011, and 2012 are given below.

2010 2011 2012
Contract costs incurred during the year $2,880,000 $2,230,000 $2,190,000
Estimated costs to complete the contract 3,520,000 2,190,000 -0-
at 12/31
Billings to Fabrik during the year 3,200,000 3,500,000 1,700,000

Instructions
(a) Using the percentage-of-completion method, prepare schedules to compute the profit or loss to be recognized as a result of this contract for the years ended December 31, 2010, 2011, and 2012. (Ignore income taxes.)
(b) Using the completed-contract method, prepare schedules to compute the profit or loss to be recognized as a result of this contract for the years ended December 31, 2010, 2011, and 2012. (Ignore income taxes.)

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Solution
(a)
Computation of Recognizable Profit/Loss
Percentage-of-Completion Method

2010

Costs to date (12/31/10) $2,880,000
Plus: Estimated costs to complete 3,520,000
Estimated total costs $6,400,000

Percent complete ($2,880,000 / $6,400,000) ...

Solution Summary

This solution is comprised of one intermediate accounting problem dealing with the following concepts:
1) What are the two basic methods of accounting for long-term construction contracts? 2) What circumstances determine when one or the other of these methods should be used? 3) For what reasons should the percentage-of-completion method be used over the completed-contract method whenever possible? 4) Using the percentage-of-completion method, prepare schedules to compute the profit or loss to be recognized for a long-term construction contract. 5) Using the completed contract method, prepare schedules to compute the profit or loss to be recognized for a long-term construction contract.
The problem shown here is taken from Intermediate Accounting, 13h ed., Wiley Publishing, however, the detail step-by-step explanation of these topics provides students with a clear understanding of the concepts.

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