ACCOUNTING FOR LONG-TERM CONSTRUCTION PROJECT

8. In selecting an accounting method for a newly contracted long-term construction project, the
principal factor to be considered should be
a. the terms of payment in the contract.
b. the degree to which a reliable estimate of the costs to complete and extent of progress
toward completion is practicable.
c. the method commonly used by the contractor to account for other long-term construction
contracts.
d. the inherent nature of the contractor's technical facilities used in construction. K, W & W
PERCENTAGE OF COMPLETION METHOD
Basic Concepts
*. The use of the percentage of completion method of accounting for long term construction
contracts is a measurement of revenue under the
a. Cost principle.
c. Objectivity principle.
b. Realization principle.
d. Monetary principle.
RPCPA 1079
Criteria
10. When work to be done and costs to be incurred on a long-term contract can be estimated
dependably, which of the following methods of revenue recognition is preferable?
a. Installment method
c. Completed-contract method
b. Percentage-of-completion method
d. None of these
K, W & W
15. Which of the following is not an element identified by the AICPA as being necessary in order to
use percentage-of-completion accounting?
a. The construction period can be reasonably estimated.
b. The buyer can be expected to satisfy obligations under the contract.
c. Dependable estimates can be made of the extent of progress toward completion.
d. Dependable estimates can be made of contract costs.
S, S & S
9. The profession requires that the percentage-of-completion method be used when certain
conditions exist. Which of the following is not one of those necessary conditions?
a. Estimates of progress toward completion, revenues, and costs are reasonably
dependable.
b. The contractor can be expected to perform the contractual obligation.
c. The buyer can be expected to satisfy some of the obligations under the contract.
d. The contract clearly specifies the enforceable rights of the parties, the consideration to be
exchanged, and the manner and terms of settlement.
K, W & W

Characteristics
45. The rationale for adoption of the percentage-of-completion method is that:
A. Results are more conservative.
B. It provides a measure of periodic accomplishment.
C. It is a better match with legal ownership.
D. It results in a lower income tax.
*.

S, S & T

The percentage-of-completion method of inventory valuation of long-term contracts

a. Recognizes income upon completion of work.
b. Recognizes income based on collected billings.
c. Recognizes income based on the progress of work.
d. Does not recognize income at the balance sheet date.
RPCPA 1074

46. The accounting method that recognizes revenue prior to the point of sale based on either an
input or an output measure of the earning process is known as the
a. Deposit method.
c. Installment sales method.
b. Cost recovery method.
d. Percentage-of-completion method
RPCPA 0596
1

The percentage-of-completion method of accounting for long-term construction contracts is an

exception to the
CMA 1296 2-10
A. Matching principle.
C. Economic-entity assumption.
B. Going-concern assumption.
D. Revenue recognition principle.

The percentage-of-completion method of accounting for long-term construction contracts is an

exception to the
A. Matching principle.
C. Historical cost principle. CMA 0691 2-15
B. Going concern assumption.
D. Revenue recognition principle.

44. The percentage-of-completion method violates the general rule on revenue recognition that:
A. Collection is reasonably assured.
B. Costs are known or reasonably estimated.
C. The earnings process is complete.
D. Collections have been received.
S, S & T
3

Although a transfer of ownership has not occurred, the percentage-of-completion method is

acceptable under the revenue recognition principle because
A. The assets are readily convertible into cash.
B. The production process can be readily divided into definite stages.

C. Cash has been received from the customer.

D. The earning process is completed at various stages.

CMA 1292 2-17

Advantage of using Percentage-of-Completion Method

17. The theoretical support for using the percentage-of-completion method of accounting for longterm construction projects is that it
a. is more conservative than the completed-contract method.
b. reports a lower Net Income figure than the completed-contract method.
c. more closely conforms to the cost principle.
d. produces a realistic matching of expenses with revenues.
S, S & S
Disadvantage of using percentage-of-completion
15. The principal disadvantage of using the percentage-of-completion method of recognizing
revenue from long-term contracts is that it
a. is unacceptable for income tax purposes.
b. gives results based upon estimates which may be subject to considerable uncertainty.
c. is likely to assign a small amount of revenue to a period during which much revenue was
actually earned.
d. none of these.
K, W & W
Applications
4
. Saskia Co.s construction projects extend over several years, and collection of receivables is
reasonably certain. Each project has a firm contract price, reliable estimated of the extent of
progress and cost to finish, and a contract that is specific as to the rights and obligations of all
parties. The contractor and the buyer are expected to fulfill their contractual obligations on
each project. The method that the company should use to account for construction revenue is
a. Installment sales.
c. Completed-contract.
b. Percentage-of-completion method.
d. Point-of-sale.
CIA 1185 IV-13
6. Dilla Construction Company's projects extend over several years and collection of receivables
is reasonably certain. Each project has a contract that specifies a price and the rights and
obligations of all parties. Both the contractor and the customer are expected to fulfill their
contractual obligations on each project. Reliable estimates can be made of the extent of
progress and cost to complete each project. The method that the company should use to
account for construction revenue is
a. installment sales.
c. completed-contract.
b. percentage-of-completion.
d. cost recovery.
S, S & S

A building contractor has a fixed-price contract to construct a large building. It is estimated that
the building will take 2 years to complete. Progress billings will be sent to the customer at
quarterly intervals. Which of the following describes the preferable point for revenue
recognition for this contract if the outcome of the contract can be estimated reliably?
A. After the contract is signed.
B. As progress is made toward completion of the contract.
C. As cash is received.
D. When the contract is completed.
CIA 1193 IV-28

Current Asset/Liability
Unbilled Revenues
*. How should earned but unbilled revenues at the balance sheet date on a long-term
construction contract be disclosed if the percentage-of-completion method of revenue
recognition is used?
a. In a footnote to the financial statements until the customer is formally billed for the portion
of the work completed.
b. As a receivable in the noncurrent asset section of the balance sheet.
RPCPA 1096
c. As a construction in progress in the noncurrent asset section of the balance sheet.
d. As construction in progress in the current asset section of the balance sheet.
Costs Of Uncompleted Contracts In Excess Of Related Billings
*. Costs of uncompleted contracts in excess of related billings in most cases is shown as a
a. Current liability, i.e., Accounts Payable.
b. Long-term debt, i.e, Notes Payable.
c. Current assets, i.e., Receivables.
d. Investments, i.e., Construction in Progress.
RPCPA 1079
Costs Of Uncompleted Contracts In Excess Of Related Costs
*. Billings on uncompleted contracts in excess of related costs in most cases is shown as a
a. Current liability, i.e., Accounts Payable.
b. Long-term debt, i.e., Notes Payable.
c. Current assets, i.e., Receivables.
d. Investments, i.e., Construction in Progress.
RPCPA 1079
Construction in Process
*. The Construction-in-Process account accumulates the following when the percentage-ofcompletion method is used
a. Construction costs to date.
b. Construction costs to date less payments received.

c. Construction costs to date less billings to date.

d. Construction costs plus gross profit earned to date.

RPCPA 0592

19. When the percentage-of-completion method of accounting for long-term construction projects
is used, why is Construction in Progress increased by the annual recognized gross profit on
long-term construction contracts?
a. The cost of the contract has increased.
b. The project's value has increased above cost.
c. The economy experiences inflation over the construction period.
d. Construction in Progress is not increased by the annual recognized profit.
S, S & S
70. In accounting for a long-term construction contract using the percentage of completion
method, the amount of income recognized in any year would be added to (E)
A. Deferred revenue
C. Construction in progress
B. Progress billings on contracts
D. Property, plant, and equipment
CPAR
Progress Billings
36. JUMBO Corp. uses the percentage-of-completion method of revenue recognition in accounting
for its long-term construction contracts. JUMBO Corp.s progress billings account is a
a. Revenue account.
c. Non-current liability account.
b. Contra current asset account.
d. Contra non-current asset account.
RPCPA 0597
*.

Tay Co. uses the percentage-of-completion method to account for a five-year construction
contract. Third year progress billings collected in the fourth year would
a. Be included in the calculation of third year income.
b. Be included in the calculation of third year income insofar as they exceeded second year
billings collected in the third year.
c. Be included in the calculation of fourth year income.
d. Not be included in the calculation of third, fourth, or fifth year incomes. AICPA 0591 T-28

25. A company uses the percentage-of-completion method to account for a four year construction
contract. Progress billings sent in the second year that were collected in the third year would
a. be included in the calculation of the income recognized in the second year.
b. be included in the calculation of the income recognized in the third year.
c. be included in the calculation of the income recognized in the fourth year.
d. not be included in the calculation of the income recognized in any year.
S, S & S

Construction in Progress & Progress Billings

*. In accounting for a long-term construction type contract, the two peculiar accounts used are
the progress billings and construction in progress accounts. As of year-end, but prior to the
completion of a long-term contract, how should the balance of these two accounts be shown?
a. Progress billings as deferred income, construction in progress as a deferred income.
b. Progress billings as income, construction in progress as inventory.
c. Net, as an income from construction if credit balance, and loss from construction if debit
balance.
d. Net as a current asset if debit balance, and current liability if credit balance. RPCPA 1087
8. If the Construction in Progress account has a balance of P1,000,000 while the Progress
Billings on Contracts accounts balance is P800,000, how should these accounts be reflected
on the balance sheet?
a. Construction in Progress will be shown as a current asset.
b. Progress Billings on Contracts will be shown as a current liability.
RPCPA 0598
c. The difference between the two accounts will be reflected as a current asset.
d. The difference between the two accounts will be reflected as a current liability.
6

POC Company accounts for a long-term construction contract using the percentage-ofcompletion method. As of the end of the current fiscal year, the following information was
available regarding a project expected to be completed in the following year:
Cumulative progress billings
$400,000
Cumulative costs incurred
300,000
Cumulative revenues recognized
80,000
The difference between construction in progress and progress billings should be reported in
the statement of financial position for the current year as
a. A current asset of $20,000.
b. A current liability of $20,000.
c. Unearned revenue of $100,000.
d. A separate component of shareholders equity of $100,000.
Gleim

Gross Profit
12. In accounting for a long-term construction-type contract using the percentage-of-completion
method, the gross profit recognized during the first year would be the estimated total gross
profit from the contract, multiplied by the percentage of the costs incurred during the year to
the
a. total costs incurred to date.
c. unbilled portion of the contract price.
b. total estimated cost.
d. total contract price.
K, W & W

Recognized Profit
First Year
7
. A company uses the percentage-of-completion method of accounting for a 4-year construction
contract. Which of the following items should be used in the calculation of the income
recognized in the first year?
AICPA, adapted
a.
b.
c.
d.
Progress Billings
Yes
Yes
No
No
Collections on Progress Billings
Yes
No
No
Yes

Third Year
9
. The calculation of the income recognized in the third year of a 5-year construction contract
accounted for using the percentage-of-completion method includes the ratio of
a. Total costs incurred to date to total estimated costs.
b. Total costs incurred to date to total billings to date.
c. Costs incurred in year 3 to total estimated costs.
d. Costs incurred in year 3 to total billings to date.
AICPA 1193 T-38

*.

*.

Under the percentage of completion method, the net income to be recognized for the first year
of a three-year construction contract is to be determined on the basis of the ratio of
a. Estimated cost to complete to total estimated costs.
b. Costs incurred to date to total estimated costs.
c. Actual costs incurred to total estimated costs.
d. Total estimated costs to estimated costs to complete.
RPCPA 1086

72. In arriving at the gross profit during the first year using the percentage of completion method of
accounting for a long-term construction contract, the estimated total gross profit from the
contract is multiplied by (E)
A. The percentage of the costs incurred during the year to the total contract price.
B. The percentage of the costs incurred during the year to the total estimated cost
C. The percentage of the costs incurred during the year to the total costs incurred to date.
D. The percentage of the costs incurred during the year to the unbilled portion of the total
contract price.
CPAR
Second Year
8
. A company used the percentage-of-completion method of accounting for a 4-year construction
contract. Which of the following items should be used to calculate the income recognized in
the second year?
AICPA 1192 T-8, RPCPA 0593
a.
b.
c.
d.
Income Previously Recognized
Yes
No
Yes
No
Progress Billings to Date
Yes
Yes
No
No
8. If the percentage-of-completion method is used, what is the basis for determining the gross
profit to be recognized in the second year of a three-year contract?
a. Cumulative actual costs incurred only.
b. Incremental cost for the second year only.
c. Cumulative actual costs and estimated costs to complete.
d. No gross profit would be recognized in year 2.
S, S & S

A company used the percentage-of-completion method of accounting for a 5-year construction

contract. Which of the following items will the company use to calculate the income
recognized in the third year?
AICPA 1192 T-8
a.
b.
c.
d.
Progress billings to date
Yes
No
No
Yes
Income previously recognized
No
Yes
No
Yes

10

. The calculation of the income recognized in the third year of a five-year construction contract
accounted for using the percentage-of-completion method includes the ratio of
a. Total costs incurred to date to total estimated costs.
b. Total costs incurred to date to total billings to date.
c. Costs incurred in year 3 to total estimated costs.
d. Costs incurred in year 3 to total billings to date.
AICPA 1193 T-38

Final Year
11
. Which of the following is used in calculating the income recognized in the fourth and final year
of a contract accounted for by the percentage-of-completion method?
AICPA 0595 F-26
a.
b.
c.
d.
Actual total costs
Yes
Yes
No
No
Income previously recognized
Yes
No
Yes
No
10. Which of the following would be used in the calculation of the gross profit recognized in the
third and final year of a construction contract that is accounted for using the percentage-ofcompletion method?
S, S & S
A.
B.
C.
D.
Actual Contract Price
Yes
Yes
Yes
No
Total Costs
Yes
Yes
No
Yes
Income Previously Recognized
No
Yes
Yes
Yes

Anticipated Loss
40. NATIONAL Corp. is faced with an impending loss on a long-term construction project and has
asked for advice on how to book the impending loss. Assuming that NATIONAL Corp.
employs the percentage-of-completion method, when should the loss be taken up in
NATIONAL Corp.s books?
a. Immediately.
b. Over the period of the project.
c. Upon completion of the project.
d. When progress billings exceed contract costs incurred.
RPCPA 0597
Journal Entries
Use the following to answer questions 58-60:
S, S & T
Moon View Desert Homes constructed a subdivision of upscale homes north of Cave Creek,
Arizona, during 2003 and 2004 under contract with Empire Development. Relevant data are
summarized below:
Contract Amount
$2,000,000
2003
2004
Cost
800,000
600,000
Gross Profit
350,000
250,000
Contract Billings
1,000,000
1,000,000
Moon View uses the percentage-of-completion method to recognize revenue.
58. What would be the journal entry made in 2003 to record revenue?
A. Accounts receivable
1,000,000
Revenue from long-term contracts
B. Accounts receivable
1,350,000
Gross profit
Revenue from long-term contracts
C. Construction in progress
350,000
Cost of construction
800,000
Revenue from long-term contracts
D. Accounts receivable
1,000,000
Billings in excess of cost
350,000
Revenue from long-term contracts
12

. In its December 31, 2003 balance sheet, Moon View would report:
A. The asset, cost and profits in excess of billings of $150,000.
B. The liability, billings in excess of cost of $200,000.
C. The asset, contract amount in excess of billings of $1,000,000.

1,000,000
350,000
1,000,000

D. The asset, deferred profit of $ 400,000.

60. What would be the journal entry to record revenue in 2004?
A. Accounts receivable
1,000,000
Revenue for long-term contracts
B. Construction in progress
250,000
Cost of construction
600,000
Revenue for long-term contracts
C. Cost of construction
1,400,000
Gross profit
600,000
Revenue for long-term contracts
D. Accounts receivable
1,000,000
Cost of construction
Gross profit
Deferred revenue

1,000,000
850,000
2,000,000
600,000
250,000
150,000

COMPLETED-CONTRACT METHOD
Criteria
14. The completed-contract method of accounting for long-term construction-type contracts is
preferable when
a. a contractor is involved in numerous projects.
b. the contracts are of a relatively long duration.
c. estimates of costs to complete and extent of progress toward completion are reasonably
dependable.
d. there are inherent uncertainties in the contract beyond normal business risks.
S, S & S
Recognized Revenue
13
. The accounting method most clearly consistent with basic revenue recognition principles is the
A. Percentage-of-completion method.
C. Completion-of-production method.
B. Installment sales method.
D. Completed-contract method.
Gleim

1,150,000
14

1,350,000

. A company uses the completed-contract method to account for

contract. Revenue is recognized when recorded progress billings
AICPA 0592 T-44
a.
b.
Are collected
Yes
No
Exceed recorded costs
Yes
No

15

a long-term construction
c.
Yes
No

d.
No
Yes

. A company uses the completed-contract method to account for a long-term construction

contract. Revenue is recognized when progress billings are

AICPA, Adapted
Recorded
Collected

a.
No
Yes

b.
Yes
Yes

c.
Yes
No

d.
No
No

14. Under the completed-contract method

a. revenue, cost, and gross profit are recognized during the production cycle.
b. revenue and cost are recognized during the production cycle, but gross profit recognition
is deferred until the contract is completed.
c. revenue, cost, and gross profit are recognized at the time the contract is completed.
d. none of these.
K, W & W
9. If the completed-contract method is used, what is the basis for determining the income to be
recognized in the second year of a three-year contract?
a. Cumulative actual costs incurred only.
b. Incremental cost for the second year only.
c. Latest available estimated costs.
d. No income would be recognized in year 2.
S, S & S
Anticipated Loss
16
. Felidae Co. uses the completed-contract method to account for a 4-year construction contract
that is currently in its third year. Progress billings were recorded and collected in the third year.
Based on events occurring in the third year, a loss is now anticipated on the contract. When
will the effect of each of the following be reported in the companys income statement?
AICPA 0589 T-13
a.
b.
c.
d.
Third-year Progress Billings Not third year
Not third year
Third year
Third year
Anticipated Loss
Third year
Fourth year
Third year
Fourth year
17. Cost estimates at the end of the second year indicate a loss will result on completion of the
entire contract. Which of the following statements is correct?
a. Under the completed-contract method, the loss is not recognized until the year the
construction is completed.
b. Under the percentage-of-completion method, the gross profit recognized in the first year
must not be changed.
c. Under the completed-contract method, when the billings exceed the accumulated costs,
the amount of the estimated loss is reported as a current liability.
d. Under the completed-contract method, when the Construction in Process balance
exceeds the billings, the estimated loss is added to the accumulated costs.
K, W & W
PERCENTAGE-OF-COMPLETION VS. THE COMPLETED CONTRACT METHOD

Advantage of Percentage-of-Completion Method

52. The percentage-of-completion method is preferable to the completed contract method
because it is a better measure of:
A. Costs and completion rates.
C. Assets and equities.
B. Receivables and inventory.
D. Effort and accomplishment.
S, S & T
Similarities
20. When comparing the percentage-of-completion and completed-contract methods of
accounting for long-term construction contracts, both methods will report
a. the same balances each period in the Progress Billings account.
b. the same expense for cost of construction each year.
c. the same amount of income in the year of completion.
d. the same inventory carrying value each year during the construction period.
S, S & S
Difference
26. In accounting for a long-term construction contract for which there is a projected profit, the
balance in the Construction in Progress account at the end of the first year of work using the
percentage-of-completion method would be
a. zero.
b. the same as the completed-contract method.
c. higher than the completed-contract method.
d. lower than the completed-contract method.
S, S & S
17

. The percentage-of-completion and the completed-contract methods of accounting for longterm construction projects in progress differ in that
A. It is only under the percentage-of-completion method that progress billings are
accumulated in a contra-inventory account called billings on construction in progress.
B. It is only under the completed-contract method that accumulated construction costs are
included in a construction in progress inventory account.
C. Only the percentage-of-completion method recognizes all revenues and gross profit on
the contract when the contract is completed.
D. It is only under the percentage-of-completion method that gross profit earned to date is
accumulated in the construction in progress inventory account.
CIA 0594 IV-26

16. Which of the following is not a difference between the percentage-of completion and
completed-contract methods of accounting for long-term construction contracts?
a. They report different amounts for inventory during the construction period.
b. They report different amounts for progress billings during the construction period.
c. They cause a different cash inflow during the construction period.
S, S & S

d. They report different amounts for accounts receivable during the construction period.
Anticipated Loss
16. Cost estimates on a long-term contract may indicate that a loss will result on completion of the
entire contract. In this case, the entire expected loss should be
a. recognized in the current period, regardless of whether the percentage-of-completion or
completed-contract method is employed.
b. recognized in the current period under the percentage-of-completion method, but the
completed-contract method should defer recognition of the loss to the time when the
contract is completed.
c. recognized in the current period under the completed-contract method, but the
percentage-of-completion method should defer the loss until the contract is completed.
d. deferred and recognized when the contract is completed, regardless of whether the
percentage-of-completion or completed-contract method is employed.
K, W & W
36. When should an anticipated loss on a long-term contract be recognized under the percentageof-completion method and the completed contract method, respectively?
RPCPA 1082, 0593
Percentage-of-completion
Completed Contract
a.
Over life of the project
Completion of contract
b.
Immediately
Completion of contract
c.
Over life of the project
Immediately
d.
Immediately
Immediately
18

. An organization has a long-term construction contract in process. During the current period,
the estimated total contract cost has increased sufficiently so that there is a current-period
loss, even though the contract is still estimated to be profitable overall. Under these
circumstances, the [List A] method of revenue recognition would require a [List B] period
adjustment of expected gross profit recognized on the contract.
CIA 1195 IV-16
List A
List B
A.
Percentage-of-completion
Prior
B.
Percentage-of-completion
Current
C.
Completed-contract
Prior
D.
Completed-contract
Current

19

. During 1990, Tidal Co. began construction on a project scheduled for completion in 1992. At
December 31, 1990, an overall loss was anticipated at contract completion. What would be
the effect of the project on 1990 operating income under the percentage-of-completion method
and the completed-contract method?

AICPA 1191 T-5

Percentage-of-completion
Completed-contract

a.
No effect
No effect

b.
No effect
Decrease

c.
Decrease
No effect

d.
Decrease
Decrease

JOURNAL ENTRIES
FINANCIAL STATEMENT PRESENTATION & REQUIRED DISCLOSURES
Financial Statement Presentation
Progress billings and construction in process
20
. How should the balances of progress billings and construction in progress be shown at
reporting dates prior to the completion of a long-term contract?
a. Progress billings as deferred income, construction in progress as a deferred expense.
b. Progress billings as income, construction in progress as inventory.
c. Net, as a current asset if debit balance and current liability if credit balance.
d. Net, as income from construction if credit balance, and loss from construction if debit
balance.
AICPA 1178 T-40
Construction in Progress
13. How should earned but unbilled revenues at the balance sheet date on a long-term
construction contract be disclosed if the percentage-of-completion method of revenue
recognition is used?
a. As construction in progress in the current asset section of the balance sheet.
b. As construction in progress in the noncurrent asset section of the balance sheet.
c. As a receivable in the noncurrent asset section of the balance sheet.
d. In a note to the financial statements until the customer is formally billed for the portion of
work completed.
K, W & W
Required Disclosure
Completed Contract Method
18. If a company uses the completed-contract method of accounting for long-term construction
contracts, then during the period of construction, financial information related to a long-term
contract will
a. appear on both the income statement and balance sheet during the construction period.
b. appear only on the income statement during the period of construction.
c. appear only on the balance sheet during the period of construction.
d. not appear on the financial statements.
S, S & S

. Answer (D) is correct. The revenue recognition principle states that revenue should be recognized (recorded)
when realized or realizable and earned. Revenue is earned when the earning process is essentially complete. In
effect, revenue is recorded when the most important event in the earning of that revenue has occurred. Thus,
revenue is normally recorded at the time of the sale or, occasionally, at the time cash is collected. However,
sometimes neither the sales basis nor the cash basis is appropriate, such as when a construction contract extends
over several accounting periods. As a result, contractors ordinarily recognize revenue using the percentage-ofcompletion method so that some revenue is recognized each year over the life of the contract. Hence, this method is
an exception to the general principle of revenue recognition, primarily because it better matches revenues and
expenses.
Answer (A) is incorrect because the percentage-of-completion method attempts to match revenues and expenses
with the appropriate periods. Answer (B) is incorrect because the going-concern assumption is appropriate for a
contractor using the percentage-of-completion method, as for any other type of company. Answer (C) is incorrect
because the economic-entity assumption is appropriate for a contractor using the percentage-of-completion method,
as for any other type of company.

. Answer (D) is correct. Revenue is recognized when realized or realizable and the earning process is
substantially complete. This ordinarily occurs at the time of sale and delivery of goods or services. Thus, the
percentage-of-completion method is essentially an exception to the revenue recognition principle. Production rather
than sale and delivery is considered to be the culmination of the earning process.
Answer (A) is incorrect because the percentage-of-completion method attempts a more accurate association of cost
incurrence and revenue recognition. Answer (B) is incorrect because the percentage-of-completion method is
completely consistent with the going concern assumption. Answer (C) is incorrect because the percentage-ofcompletion method is completely consistent with the historical cost principle.

. Answer (D) is correct. SFAC 5 states that revenue should be recognized when it is both realized or realizable
and earned. If a project is contracted for before production and covers a long time period in relation to reporting
periods, revenues may be recognized by a percentage-of-completion method as they are earned (as production
occurs), provided reasonable estimates of results at completion and reliable measures of progress are available.
Thus, contractors traditionally use the percentage-of-completion method because some revenue can be recognized
during each period of the production process. In a sense, the earning process is completed in various stages; thus,
revenues should be recorded in each stage.
Answer (A) is incorrect because, depending upon the terms of the contract, the assets may not be readily
convertible into cash. Answer (B) is incorrect because, on a large construction project, the production process often
cannot be easily divided into definite stages. Answer (C) is incorrect because cash is sometimes not received until
the project is completed.

. REQUIRED: The method appropriate to account for construction revenue.

DISCUSSION: (B) SFAC 5, Recognition and Measurement in Financial Statements of Business Enterprises, states
that revenue should be recognized when it is both realized or realizable and earned. If a project is contracted for
before production and is long in relation to reporting periods, revenues may be recognized by a percentage-ofcompletion method as they are earned (as production occurs), provided reasonable estimates of results at
completion and reliable measures of progress are available. This method results in information that is more relevant
and representationally faithful than that based on waiting for delivery, completion of the project, or payment.
Answer (A) is incorrect because the installment method is appropriate if collectibility is doubtful. Answer (C) is
incorrect because the completed-contract method is appropriate if reasonable estimates of results at completion and
reliable measures of progress are not available. Answer (D) is incorrect because the point-of-sale method is
appropriate when the product or merchandise is delivered or services are rendered directly to customers.

. Answer (B) is correct. Under the percentage-of-completion method, revenues and expenses are recognized
based on the stage of completion at the balance sheet date if the outcome of the contract can be estimated reliably.
For a fixed-price contract, the outcome can be estimated reliably if (1) total revenue can be measured reliably, (2) it
is probable that the economic benefits of the contract will flow to the enterprise, (3) contract costs to complete and
stage of completion can be measured reliably, and (4) contract costs can be clearly identified and measured reliably
so that actual and estimated costs can be compared.
Answer (A) is incorrect because revenue is not recognized until progress has been made toward completion.
Answer (C) is incorrect because the cash basis is inappropriate. An accrual method, that is, the percentage-ofcompletion method, should be used. Answer (D) is incorrect because the completed-contract method is not a

permissible method.
6

. REQUIRED: The reporting of the difference between construction in progress and progress billings.
DISCUSSION: (B) Progress billings is an offset to construction in progress (or vice versa) on the balance sheet.
The difference between construction in progress (costs and recognized income) and progress billings to date is
shown as a current asset if construction in progress exceeds total billings, and as a current liability if billings exceed
construction in progress. Because progress billings exceed construction in progress, the difference should be
reported as a current liability of $20,000 [$400,000 ($300,000 + $80,000)].
Answer (A) is incorrect because progress billings exceed construction in progress. Answers (C) and (D) are
incorrect because $100,000 ignores the revenue already recognized.

. REQUIRED: The effect that progress billings and collections have on the determination of earnings.
DISCUSSION: Under GAAP, revenue should be recognized when it is realized or realizable and earned. For longterm construction contracts, these criteria are met in accordance with either the percentage-of-completion method or
the completed-contract method. Neither the issuance of a progress billing (debit accounts receivable, credit
progress billings) nor the collection of cash (debit cash, credit accounts receivable) results in recognition of income.
Answers (A), (B), and (D) are incorrect because neither progress billings nor collections on progress billings should
be used to calculate income.

. REQUIRED: The item(s) used in computing income in the second year using the percentage-of-completion
method.
DISCUSSION: (C) The percentage-of-completion method provides for the recognition of income based on the
relationship between the costs incurred to date and estimated total costs for the completion of the contract. The
amount of income (based on the latest available estimated costs) recognized in the second year of a 4-year contract
is calculated as follows: The total anticipated income is multiplied by the ratio of the costs incurred to date to the
total estimated costs, and the product is reduced by previously recognized income. Income previously recognized is
therefore used to calculated income to be recognized in the second year. However, progress billings to date have
no effect on the amount of income to be recognized in the second year.
Answers (A), (B), and (D) are incorrect because income previously recognized is used to calculate the income
recognized. Progress billings to date are not.

. REQUIRED: The ratio used in the calculation of income recognized for a construction contract using the
percentage-of-completion method.
DISCUSSION: (A) According to ARB 45, the percentage-of-completion method provides for the recognition of
income based on the relationship between costs incurred to date and estimated total costs for completion of the
contract. (But ARB 45 permits any other measure of progress as may be appropriate having due regard to work
performed.) The amount of income recognized in the 3rd period of a 5-year contract is calculated as follows: The
total anticipated income (based on the latest available estimated costs) is multiplied by the ratio of costs incurred to
date to the latest available total estimated costs, and the product is reduced by the previously recognized income.
Answer (B) is incorrect because the ratio of total costs incurred to date to total billings to date is not relevant.
Answer (C) is incorrect because total costs incurred must be used. Answer (D) is incorrect because neither the
issuance nor the collection of billings results in income recognition.

10

. REQUIRED: The ratio used in the calculation of income recognized for a construction contract using the
percentage-of-completion method.
DISCUSSION: (A) According to ARB 45, the percentage-of-completion method provides for the recognition of
income based on the relationship between costs incurred to date and estimated total costs for completion of the
contract. (But ARB 45 permits any other measure of progress as may be appropriate having due regard to work
performed.) The amount of income recognized in the third year of a 5-year contract is calculated as follows: The
total anticipated income (based on the latest available estimated cost) is multiplied by the ratio of costs incurred to
date to the latest available total estimated costs, and the product is reduced by previously recognize income.
Answer (B) is incorrect because the ratio of total costs incurred to date to total billings to date is not relevant.
Answer (C) is incorrect because total costs incurred must be used. Answer (D) is incorrect because neither the
issuance nor the collection of billings results in income recognition.

11

. REQUIRED: The items used to calculate income in the last year of a contract using the percentage-ofcompletion method.

DISCUSSION: (A) The percentage-of-completion method recognizes revenues, costs, and income depending on
the progress made on the contract. Income recognized in the last year of the contract equals the contract price,
minus actual total costs, minus income previously recognized.
Answers (B), (C), and (D) are incorrect because income previously recognized and actual total costs are used.
12

.
=
Billings:
Excess:

(A)
$1,150,000

Costs + profits:

$800,000 + 350,000

1,000,000
$150,000

13

. Answer (D) is correct. According to the revenue recognition principle, revenue should be recognized when (1)
realized or realizable and (2) earned. Under the completed-contract method, revenue is not recognized until a longterm construction contract is complete. At this stage, the entity is most clearly entitled to the resulting revenues and
is most likely to have been involved in an exchange.
Answer (A) is incorrect because the percentage-of-completion method allows for revenue to be recognized at
various stages of the contract although the entire job is not complete. Answer (B) is incorrect because, if the
collectibility of assets is relatively uncertain, revenues and gains may be recognized as cash is received using the
installment sales method.
Answer (C) is incorrect because the completion-of-production method is an appropriate basis for recognition if
products or other assets are readily realizable, e.g., precious metals and some agricultural products.

14

. REQUIRED: The effect of the completed-contract method on revenue recognition.

DISCUSSION: (B) Under the completed-contract method of accounting for long-term construction contracts,
recorded progress billings have no effect on the recognition of income.
Answers (A), (C), and (D) are incorrect because under the completed-contract method, progress billings are
recorded when issued and removed at the completion of the contract.

15

. REQUIRED: The effect of progress billings on the recognition of revenue.

DISCUSSION: (D) GAAP requires that revenue be recognized when it is realized or realizable and earned. Under
the completed-contract method, revenue recognition is appropriate only at the completion of the contract. Neither
the recording nor the collection of progress billings affects this recognition.
Answers (A), (B), and (C) are incorrect because neither the issuance of a progress billing (debit accounts
receivable, credit progress billings) nor the collection of cash (debit cash, credit accounts receivable) results in
recognition of income.

16

. REQUIRED: The effect of progress billings and an anticipated loss on the companys income statement.
DISCUSSION: (A) Under the completed-contract method, the gross profit on the contract should be recognized
upon the completion of the contract. If a loss is anticipated, however, the loss should be recognized immediately.
Under GAAP, the entries to record progress billings and their collection do not affect the recognition of profit or loss.
Thus, the 3rd year progress billings have not effect on the income statement, but the loss anticipated in the 3rd year
should be recognized in full in that year.
Answers (B), (C), and (D) are incorrect because, under the completed-contract method, progress billings have not
effect on the recognition of income, and an anticipated loss should be recognized in the year it occurs.

17

. Answer (D) is correct. The completed-contract method does not recognize any gross profit until the contract is
completed. The percentage-of-completion method recognizes a portion of revenues and gross profit each period,
based upon the ratio of costs incurred to date to total estimated costs of completion. Accumulated gross profit and
accumulated construction costs are included in the construction in progress inventory account under the
percentage-of-completion method.
Answer (A) is incorrect because progress billings are accumulated in the billings on construction in progress account
under both methods. Answer (B) is incorrect because accumulated construction costs are included in the
construction in progress inventory account under both methods. Answer (C) is incorrect because the percentage-ofcompletion method recognizes a percentage of revenues and gross profit each period.

18

. Answer (B) is correct. Under the percentage-of-completion method, a current-period loss on a profitable
contract is treated as a change in accounting estimate. Thus, a current-period adjustment is required. Prior-period
adjustments are made to correct errors, not to reflect changes in estimates.

Answer (A) is incorrect because, under the percentage-of-completion method, a current-period loss on a profitable
contract requires a current-period adjustment. Answer (C) is incorrect because, under the completed-contract
method, no profit is recognized until the contract is completed. Cost estimate adjustments while construction is in
progress do not result in profit or loss recognition prior to completion unless an overall loss is expected on the
contract. Answer (D) is incorrect because, under the completed-contract method, no profit is recognized until the
contract is completed. Cost estimate adjustments while construction is in progress do not result in profit or loss
recognition prior to completion unless an overall loss is expected on the contract.
19

20

. REQUIRED: The effect of the project on 1990 operating income under the percentage-of-completion method
and the completed-contract method.
DISCUSSION: (D) When the current estimate of total contract costs indicates a loss, an immediate provision for the
entire loss should be made regardless of method. Thus, under either method, 1990 operating income is decreased
by the projected loss.
Answers (A), (B), and (C) are incorrect because, under either method, 1990 operating income is decreased by the
projected loss.
. REQUIRED: The proper balance sheet presentation of progress billings and construction in progress.
DISCUSSION: (C) ARB 45, Long-Term Construction-Type Contracts, requires that the difference between
construction in progress (costs and recognized income) and progress billings to date be shown as a current asset if
construction in progress exceeds total billings, and as a current liability if billings exceed construction in progress.
Separate recognition is required for each project.
Answers (A) and (B) are incorrect because progress billings and construction in progress should be netted for
balance sheet presentation as a current asset or liability. Answer (D) is incorrect because neither income nor loss
results from progress billings.