Halliburton Company: Accounting for Cost Overruns and Recoveries

1. What types of financial transactions are at issue in this case?

The financial transaction that is at issue is the accounting treatment for claim. Normally, the company
will do the job as agreed in the contract and receive earnings at the price specified in the contract.
Sometimes, there might be some change order which increase the scope of the project and cause the
costs exceeding the estimation in the contract. The change order that has not approved yet in both
scope and price is treated as claims. According to SOP 81-1, the recognition of the additional revenue
arising from the change order is only appropriate when the claim will result in additional contract
revenue and if the amount of that revenue can be measured reliably. Otherwise, the claim should be
deferred until the collection amount is agreed with the customer and the collection is deemed as
probable.
2. How did the company account for cost recoveries prior to 1998? After 1998?
Before 1998: Companys accounting policy was to record cost overrun expenses as soon as they
occurred but not to book the revenues associated with claims until the company agreed the amount to
be received with the clients.
After 1998: Company had changed the accounting treatment when theres cost overrun. The company
started to estimate the amount of claim in that period when cost overruns occurred. It would be
included in revenues even though the company had not negotiated about the price with the customers
yet. When the amount of the claim was finally agreed upon with the client, the estimated amount
might be different from the actual amount. The difference between the two would be credited to the
income statement.

3. Which method is more appropriate from the standpoint of; Realizability; Earned; Conservatism;
Matching?
* Realizability
The method after 1998 is more appropriate from the stand point of realizability. The new method
estimated the amount of revenues to be collected period by period. The costs from change order are
realized and recorded in the period that it occurred. The revenues that occurred and deemed as
collectible should be recognized in the same period.
* Earned
From the standpoint of earned, the method that is considered as more appropriate is the method
before 1998. The amount of revenue to be collected in the future is still uncertain. Thus, the company
should not recognize the revenue associated with claims until the company and the customers agreed
upon the additional amount of work and costs.
* Conservatism
For conservatism standpoint, the pre 1998 Method would be more appropriate. Conservatism concept
in accounting allows us to recognize and record revenues when it can be measured reliably and
record expenses immediately when they occur or when they are reasonably possible. For the pre
1998 method, the company recognized the construction revenues by percentage of completion. If
theres unapproved additional work which had not agreed by customers in terms of price and scope, it
would not recognize that part of income.

* Matching
Method after 1998 is more appropriate from the stand point of matching. The post 1998 method
estimates the revenues of the period even though it has not been negotiated yet. It will begin
estimating the revenues when therere cost overruns. The company will recognize the revenues when
the collection is probable.

4. Does Halliburton's accounting method have a material impact on their financials?

Yes, it does. Halliburton had changed the accounting treatment for revenue recognition associated
with claims. The company estimated the amount of revenues before the claims had been resolved. If
theres any difference between the estimated amount and the actual amount, the company would
adjust it by crediting the income statement. The company changed this method and did not disclose
the change and its effect.
Even though the corporate officials might argue that the revenues increased in each year is
immaterial compared to the total revenues of that year, it still has material impact on their financials.
$534 million is the large amount of income that the investors could view it as manipulating income.

5. Which method is more appropriate for Halliburton to use?

The before 1998 method is more appropriate for Halliburton to use. According to FASB, the revenues
will be recognized when they are realized or realizable and earned. In the case of how the company
dealt with claims after 1998, the company just estimated the amount that it expected to receive when
cost overran.
Moreover, the company violated the GAAP by not disclosing the change in the accounting method for
claims in 1998. The entity should disclose the new method used, the effect on net income and also
why this new method is preferable. The company should not change the accounting method if it
cannot prove why the new method is preferable. As the company changed the revenue recognition
policy in the year that theres economic crisis and also did not specify why the company changed the
policy, this change might have been made because the company want to improve its earnings in the
1998 fiscal year.

6. Comment on the disclosure the company made regarding the accounting change.
Halliburton did not disclose the accounting policy change until a year after it was implemented which
violated APB Opinion No. 20. According to APB Opinion No. 20., changing new accounting policy or
accounting method requires the company to disclose this new implementation to the footnotes in the
year that the company makes change. Moreover, the company is required to disclose the impact on
net income from this new method and justify why the new alternative is preferable.