Advanced Financial Accounting CPA REVIEW SCHOOL OF THE PHILIPPINES Manila Guerrero/German/DeJesus/Lim/Ferrer/Laco/Valix LONG-TERM CONSTRUCTION Part J: Theory of Accounts ie It is a contract specifically negotiated for the construction of an asset or a combination of assets thet are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use. Construction contract Installment contract Franchise contract Consignment contract aosP It is a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit of output, which in some cases is subject to cost escalation clauses. a. Fixed price contract b, Cost plus contract c. Variable contract . Mixed contract It is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee 2 Fixed price contract . Cost plus contract ©. Variable contract d. Mixed contract ‘Aside from the initial amount of revenue agreed in the long-term construction contract, additional revenues may be recognized by the contractor (1) to the extent that it is probable that they will result in revenue and (2) they are capable of being reliably measured. Which of the following will not be considered as additional contract revenue by a contractor? a. Variation in contract work as instructed by the customer regarding the scope of work to be performed. b. Claim that the contractor may seek to collect from the customer for customer caused delays or errors in specification or design. c. Incentive payments to be paid to the contractor if specified performance standards are met or exceeded or for early completion of the contract. d. Gain on sale of scrap materials from construction Which of the following costs shall be excluded in the contract costs of construction contract? a, Costs that relate directly to the specific contract. b. Costs that are directly attributable to contract activity in general and can be allocated to the contract. ¢. Such other costs as are specifically chargeable to the customer under the terms of the contract. 4. Selling costs such as advertisement expense or commissions of real estate agents or brokers The following costs shall be capitalized as part of construction in progress or contract costs, except a. Costs of hiring and moving of plant and equipment to and from the contract site, b, Systematically, rationally and consistently allocated construction overheads and borrowing costs. c. Costs that are specifically chargeable to the customer under the terms of the contract may include some general administration costs and development costs for which reimbursement is specified in the terms of the contract. 4. Genera! and research and development costs for which reimbursement is not specified in the contract. 8707Page 2 7. When the outcome of a construction contract can be estimated reliably, how shall contract revenue and contacts costs associated with the construction contract be recognized? a. They shall be recognized as revenue and expense respectively by reference to the state of completion of the contract activity at the end of the reporting period also known as by percentage of completion method. b. They shall be recognized as revenue ani of callection of receivables from customers also known as by it c. ‘They shall be recognized as revenue and expenses respectively by the dat revenue or incurring of expenses also known as accrual method. - ; 4. Revenue shal be recognized only to the extent of contract cost incurred that itis probable will te recoverable and the contract cost shall be recognized as an expense in the period in which there are incurred also known as cost recovery or zero-profit method. 1d expenses respectively by reference to the percentage as by instalment method. e of eaming of action contract cannot be estimated reliably, how shall contract revenue and contacts costs associated with the construction contract be recognized? a They shall be recognized as revenue and expenses respectively by reference to the slate of completion of the contract activity at the end of the reporting period also known as by percentage of completion method b. They shall be recognized as revenue and expenses respectively by reference to the percentage of collection of receivables from customers also known as by instalment method, «. They shall be recognized as revenue and expenses respectively by the date of eaming of revenue or incurring of expenses also known as accrual method. 4. Revenue shall be recognized only to the extent of contract cost incurred that itis probable will be recoverable and the contract cost shall be recognized as an expense In the period in which there are incurred also known as cost recovery or zero-profit method. 8. When the outcome of a constr 9, When it is probable that total contract costs will exceed total contract revenue, how shall it be accounted for? a. The expected loss shall be recognized as an expense immediately regardless of the certainty or uncertainty of the outcome of a construction contract. b. The expected loss shall be recognized as an expense immediately construction contract cannot be estimated reliably. The expected loss shall be recognized as an expense by reference to the state of completion of the contract activity at the end of the reporting period when the outcome of a construction contract cannot be estimated reliably. d._ The expected loss shall be accounted for based on company’s policy. only when the outcome of a 10. When the company decides to change its accounting for construction contract from percentage of completion to cost recovery method, how shall the accounting change be treated? a. It shall be accounted for as a change in accounting policy treated by retrospective application or with cumulative effect in the beginning retaining earnings at the date of change. b. It shall be accounted for as a change in account estimate treated by prospective application to the date of change and future date profit or loss. . It shall be accounted for as a prior period error treated by retrospective restatement or with cumulative effect in the beginning retaining earnings at the date of discovery of error. . It shall be accounted for as an equity transaction to be adjusted in the share premium or other comprehensive income as the case may be. 11. When the company changes its percentage of completion of the construction project every year, how shall the accounting change be treated? 4. It shall be accounted for as a change in aecounting policy treated by retrospective application or with cumulative effect in the beginning retaining earnings at the date of change. b. It shall be accounted for as a change in accounting estimate treated by prospective application to the date of change and future date profit or loss. ¢. It shall be accounted for as a prior period error treated by retrospective restatement or with cumulative effect in the beginning retaining earnings at the date of discovery of error. d. It shall be accounted for as an equity transaction to be adjusted in the share premium or other comprehensive income as the case may be. 8707Page 3 12. How shall the contructor present in its statement of financial the accounts related to construction contract? ‘a. It shall present as an asset the gross amount due from customers for contract work which is the ‘net amount of cost incurred plus recognized profits less the sum of recognized losses and progress billings for all contracts in progress for which costs incurred plus recognized profits ot fess recognized losses exceeds progress billings. (Meaning: It is presented as an asset if Construction-in-Progress exceeds Progress Billings) ; b. It shall present as a liability the gross amount due to customers for contract work is the net amount of cost of cost incurred plus recognized profits less the sum of recognized losses end progress billings for all contracts in progress for which progress billings exceeds costs incurred plus recognized profits or less recognized losses. (Meaning: It is presented as a liability if Progress Billings exceeds Construction in Progress) c. Either A or B but the liabilities and assets resulting from the difference of Construction in Progress and Progress Billings shall not be netted or offsetted in the Statement of Financial Position. 4. Both A and B but the liabilities and assets resulting from the difference of Construction in Progress and Progress Billings shall be netted or offsetted in the Statement of Financial Position 13. Which of the following accounting changes shall be treated retrospectively instead prospectively by the long-term construction contractor? a, Change in the construction revenue b. Change in the estimated costs to complete the contract ¢. Change in the estimate of the outcome of the contract d. Change from percentage of completion to cost recovery method or vice versa Part II: Problem Solving. 1. On January 1, 2021, Entity A entered into @ contract for the construction of a building at an original price of P2,000,000 to be completed on June 30, 2023 subject to penalty of P500,000 on the year it becomes virtually certain that construction will not be completed on the date agreed upon. On January 1, 2022, the contract price increased by P2,500,000 due to the change in the design of the building requested by the customer. The outcome of the construction can be estimated reliably. 12/31/2021 12/31/2022 12/31/2023 Cumulative costs incurred as of the end of the year 600,000 3,075,000 3,780,000 Estimated remaining cost t ete at the end of the year Tee om wee 900,000 1,025,000 420,000 1. What is the realized gross profit (loss) to be recognized by Entity A for the year ended December 31, 2023? 200,000 (30,000) (500,000) 270,000 aegPe 2. What is the construction-in-progress balance as of December 31,2022? 3,075,000 3,375,000 3,675,000 3,975,000 8707Page 4 2. On January 1, 2020, an ‘entity entered into a long-term construction contract with fixed contract price of P5,000,000. The entity billed its client as follows: 30% during 2020, 40% during 2021 and the remainder at the year of project completion. The following data were provided by the cost accountant of the entity: 2020 2021 2022 Cumulative Cost incurred as of the end of the year 2,200,000 3,600,000 4,800,000 Estimated remaining cost to complete at the end of the ps 399 99 990,000 : year 1, What is the excess of construction in progress over progress billings on December 31, 2020 under percentage of completion method? $00,000 200,000 300,000 400,000 aege 2. What is the excess of construction in progress over progress billings on December 31, 2021 under cost recovery method? a. 100,000 b. 500,000 cc. 300,000 4. 400,000 3. On January 1, 2021, Entity A accepted a long-term construction project to build a condominium at a fixed contract price of P100,000,000. The outcome of the construction project cannot be estimated reliably. The following data are provided by the accountant and project manager conceming the construction costs for the three years of construction: Year 12/31/2021 12/31/2022 12/31/2023 Cosis incurred during the year P40,000,000 P10,000,000 + P20,000,000 Estimated cost to complete at the end of the year 90,000,000 60,000,000 P10,000,000 What is the balance of construction in progress on December 31, 2023? 60,000,000 40,000,000 50,000,000 70,000,000 4. DM, Inc. works on a P10,500,000 contract in 2022 to construct an office building During 2022, DM, Ine. uses the cost to cost method, At December 31, 2022, tie balances in certain accounts were: Construction in progress ~ P3,780,000 Accounts receivable — P360,000 Billings on construction in Process P1,800,000 Contract retention ~ P180,000 Mobilization fee ~ P140,000. At December 31, 2020, the estimated cost at completion is P7,350,000. How much is the realized gross profit in 2022? a 1,102,500 b. 1,062,500 ce. 1,242,500 d. 1,134,000 8707Page 5 |. Filvida Ine. entered into a long-term construction contract in January 1, 2020 to construct a shopping mall at a fixed contract price of PIOM. Filvida determined that the outcome of the construction cannot be estimated reliably. Filvida normally bills its customer 50% at the middle of first year, 20% at the middle of second year and the balance at the date of completion of project. A mobilization fee of 10% of the contract price (deductible from the 2021 bill) is payable 30 days afier the contract signing. The contract provides that the customer shall pay 80% of the total amount billed, on or before the December 31 subject to retention provision/withholding by customer of 5% of amount to be paid by the customer which is intended to protect the customer from the contractor failing to adequately complete its obligation under the contract. The customer satisfactorily complied with the contractual provision. Filvida's accountant provide the following data for the years ended December 31, 2020 and December 31, 2021: December 31, 2020 December 31, 2021 Costs incurred to date 4,000,000 7,000,000 Estimated costs to complete as of this date P9,000,000 4,000,000 What is the 12/31/2021 (1) Due from Customer, 12/31/2021 (2) the excess of construction in progress over progress billings in 2021 and (3) the realized gross profiti(loss) in 2021, respectively to be presented by Filvida Inc.? 680,000 and (1,000,000) and 2,000,000 400,000 and (3,000,000) and 0 1,400,000 and 4,000,000 and (3,000,000) 320,000 and (2,000,000) and (1,000,000) aes On January 1, 2021, Entity A accepted a long-term construction project to construct a building with an initial contract price of P10,000,000. The outcome of the construction project can be estimated reliably and the contractor decided to employ cost to cost method. During 2023, the contract price inoreases due to the change in the project design requested by the client. The following data are provided by the accountant and project manager concerning the construction costs for the three years of construction: Year 12/31/2021 12/31/2022 12/31/2023 Cumulative costs incurred as of the end of the year 1,000,000 2 P 10,800,000 Realized gross profit/(loss) during the year 2 350,000 —(P1,600,000) Percentage of completion as of the end of the year 12.5% 60% 90% What is the Construction cost of sales to be recognized in the Income Statement for the year ended December 31, 20237 5,400,000 4,600,000 4,800,000 5,300,000 apo . On January 1, 2021, Entity A started the construction of a building with a fixed contract price of P 10,000,000. The outcome of the construction project can be estimated reliably and the contractor decided to employ cost to cost method. ‘The following data are provided by the accountant and project manager concerning the construction costs for the three years of construction: Year 12/31/2021 12/31/2022 12/31/2023 Costs incurred during the year < ? 2 3,740,000 Realized gross profit/(loss) during the year P750,000 — (P250,000) (800,000) Percentage of completion as of the end of the year 37.5% 50% 2 What is the balance of Construction in Progress on December 31, 2023? 8,000,000 7,480,000 7,940,000 8,280,000 pegs 8707Page 6 8. On January 1, 2021, Matibay Development Corporation (MDC) entered into a contract with ‘Company B to construct a new corporate headquarters on land owned by Company B. Contractor MDC determines that control of the building is passed to Company B as it is constructed. Therefore, the performance obligation is satisfied over time. The contract price is P5,000,000, but that amount will be reduced or increased depending on when construction of the building is completed. For each day before December 31, 2023, that the building is completed, the promised consideration will increase by P25,000. For each day after December 31, 2023 that the building is incomplete, the promised consideration will be reduced by P25,000. The parties have also agreed that, when the building is complete, it will be inspected and assigned a green building certification level. If the building achieves the certification level specified in the contract, Contractor MDC will be entitled to an incentive bonus of P200,000. On December 31, 2021, MDC determined that the “expected value” better predicts the variable consideration it will receive regarding the early completion or delay of the construction because of the different outcomes possible based on MDC’s current construction schedule and its experience with past projects. MDC estimates that it is 50% likely to complete the project 10 days ahead of schedule and receive an incentive of P250,000, 25% likely to complete the project on time and. receive no incentive and 25% likely to complete the project five days past schedule and incur a 125,000 penalty ‘As of the same date, on the other hand, MDC determined that the “most likely amount” is the better predictor to estimate the variable consideration associated with the green building certification bonus because there are only two possible outcomes (P200,000 or PO). Based on its history of completing building projects that achieve the green building certification level specified in the contract and the absence of factors that may indicate the criteria will not be met, MDC decided to include the bonus in the transaction price On December 31, 2022, MDC did not change its estimate with respect to green building certification bonus but afier evaluation evaluating construction completed to date and the remaining project schedule, Contractor MDC determines it is now 75% likely to complete the project 10 days ahead of schedule and receive an incentive of P250,000 and 25% likely to complete the project on time and receive no incentive bonus. The following construction costs were provided by MDC for the years ended December 31, 2021 and 2022: December 31,2021 December 31, 2022 Costs incurred during the year 2,400,000 750,000 Estimated costs to complete at the end of the year 1,600,000 P1,350,000 Under IFRS 15, Assuming the outcome of construction can be estimated reliably, what is the realized gross profit/(gross loss) to be recognized by MDC for the year ended December 31, 2022? a, (230,000) b. (220,625) c. (250,000) d._ (155,000) 8707_ a Page 7 9. DMCT entered into a fixed price contract of P120 million for the construction of a road for Camella Corp. DMCT determines the stage of completion of construction contracts using the percentage of completion “cost to cost method”. The estimated cost at completion is P75 million. ‘The following were the total actual costs incued by DMCI during the first year of the construction: a Research and development costs for which reimbursement is not specified in the 999,999 b. Cost of negotiating the contract (charge immediately as expense) 500,000 c. Marketing costs 150,000 4. Costs of hizing equipment 700,000 fe. Costs of materials purchased but not yet used in construction 2,500,000 £ Costs of materials used in construction 15,000,000 8. Costs of moving plant, equipment and materials to and from the contract site 200,000 h, Administrative costs not expected to be reimbursed 100,000 Depreciation of equipment used in construction 600,000 Site labor costs 5,000,000 1. Site supervision costs 1,000,000 ‘What is the net income at the end of the year? 13,250,000 b. 10,790,000 c. 11,750,000 4. 9,250,000 END 8707