provision of related services. Changes in the business environment have increased significantlythe variety and uses of those types of contracts and the types of business enterprises that usethem. In the present business environment, diverse types of contracts, ranging from relativelysimple to highly complex and from relatively short-to long-term, are widely used in manyindustries for construction, production, or provision of a broad range of goods and services.However, existing principles related to accounting for contracts were written in terms of long-termconstruction-type contracts, and they are not stated in sufficient detail for the scope of activities towhich they presently are applied. Those activities range far beyond the traditional construction-type activity (the design and physical construction of facilities such as buildings, roads, dams, andbridges) to include, for example, the development and production of military and commercialaircraft, weapons delivery systems, space exploration hardware, and computer software. Theaccounting standards division believes that guidance is now needed in this area of accounting.
The Basic Accounting Issue
The determination of the point or points at which revenue should be recognized as earnedand costs should be recognized as expenses is a major accounting issue common to all businessenterprises engaged in the performance of contracts of the types covered by this statement.Accounting for such contracts is essentially a process of measuring the results of relatively long-term events and allocating those results to relatively short-term accounting periods. This involvesconsiderable use of estimates in determining revenues, costs, and profits and in assigning theamounts to accounting periods. The process is complicated by the need to evaluate continuallythe uncertainties inherent in the performance of contracts and by the need to rely on estimates of revenues, costs, and the extent of progress toward completion.
Present Accounting Requirements and Practices
The pervasive principle of realization and its exceptions and modifications are central factorsunderlying accounting for contracts. APB Statement No. 4
states:Revenue is generally recognized when both of the following conditions are met: (1) the earningsprocess is complete or virtually complete, and (2) an exchange has taken place. [paragraph 150]Revenue is sometimes recognized on bases other than the realization rule. For example, on long-term construction contracts revenue may be recognized as construction progresses. Thisexception to the realization principle is based on the availability of evidence of the ultimateproceeds and the consensus that a better measure of periodic income results. [paragraph 152]The exception to the usual revenue realization rule for long-term construction-type contracts, for example, is justified in part because strict adherence to realization at the time of sale wouldproduce results that are considered to be unreasonable. The judgment of the profession is thatrevenue should be recognized in this situation as construction progresses. [paragraph 174]
Long-Term Construction-Type Contracts
,issued by the AICPA Committee on Accounting Procedure in 1955, describes the two generallyaccepted methods of accounting for long-term construction-type contracts for financial reportingpurposes:
The percentage-of-completion method
recognizes income as work on a contractprogresses; recognition of revenues and profits generally is related to costs incurred inproviding the services required under the contract.