ReSA The Review School of Accountancy R. Papa Cor. S. H. Loyola Sts. , Sampaloc, Manila # Tel Nos. 734-39-89 & 735-98-07 Advanced Financlal Accounting & Reporting Construction Accounting dayag/caiga/ngina Construction Accounting What is a Construction Contract? A construction contract is @ contract specifically negotiated for the construction of an esset ora combination of assets that are closely interrelated or interdependent in terms of their design. technology or function or their ultimate purpose or use. Iwo Types of Construction Contract or Contact Piice: 1 fixed Price Contract ~ is a construction contract in which the contractor agrees 10 a fixed contract price. or a fixed 1ate per unit of output, which in some cases is subject 40 cost escalation clauses. Cost-plus Contract ~ is a construction ontract in which the contractor is reimbursed {or allowable or otherwse defines costs plus @ percentage of these costs oro fixed 2 tong-term contracts frequently provide that seller (builder) may bill the customer at intervals. The most common examples are as follows + Development of military arid commercial aircraft Highrise buildings Skyways, roads. and brides Weapons-delivery systems Space exploration hardware Revenue recognition depends on the peiformance obligation(s): ‘+ Over Time / Percentage of Completion ‘+ Point in Time / Cost Recovery Method or Zero-Profit Approach In Summary Form: Over Time ‘A. Revenue should be recognized over time if goods and services are trorsterred ‘over time to the customer. 8. Revenve can be recognized over fime it at least one of the following criteria is met 1. The customer consumes the benef of the seller's work as itis performed, or 2. The customer controls the asset as it is created or enhanced i.e. when the company’s performance creates or enhances an asset, (e.g. work in process or when a contacto: builds cx extension into a customer's existing schoo! builkling). or 3, The seller is creating on asset that has no alternative use fo the seller. and the seller can receive payment tor its progress 10 date even if the customer cancels the contiact as when a company manufactures customized Product in Summary Form: Point in Time ‘A. Revenue should be recognized ot a point in Hime when it does not quality for recognizing revenue ove: time. B. The performance obligation is sulistied when control of the goods or services is transterved trom the seiier to the customer. Usually transfer of control is ob ious, and coincides with delivery Other indicators of transter of control: the customer has 1. An obligation to pay the seller. 2. Legal tile to the asset 3. Physical possession of the asset 4. Assumed the risks and rewards of ownership. 5. Accepted the asset Ihe indicators as mentioned iv letter "D” above indicates that control has been tronsterred from the seller to the cusi« mer {the customer is more likely to control a good oF service if the customer has those indicators). Po Sellers should evaluate these indicators individually and in combination to decide. whether control has been transtermed anc! revenue can be recognized. AFAR-05Advanced Financial Accounting & Reporting page? Method of Recognizing Revenue in Construction Accounting: A. Percentage-ol-compietion method (Over Time) - when the outcome of the constuction contract can be estinated reliably. contract revenue and costs associated with the contract should be recognized as revenue and expenses. respectively, by reterence to the stage of completion of the contract activity at the balonce shee! dute since there is @ reasonable estimate of its progress toward satisfaction of ihe performance obligation. ‘Measuring Stage of Completion. the stage of completion of a contract may be determined in a variety of ways. The enterprise uses the method that measures reliably the work periormed. Depending on the nature if the contract, the methods may include: 1 Input Measures/Cost basis. input measures are made in relation to the costs oF etforts devoted tc a conticcl. Input methods recognize revenue on the basis of Ihe efforts or inputs to satisty the performance obligation relative to the total expected inputs. Examples of input methods include labor-hours worked: costs incurred: time elapsed: resources consumed. Revenue can be Fecognized on a straight-line basis if inputs are used evenly throughout the performance period ©. Cost-to-cost method (Proportion of contract costs incurred). Perhaps the most popular of the input measures is the: cost-to-cost method. Under this, method, the degree of completion is determined by comparing costs heady incurred with ttre most recent estimates of total expected costs to complete the project ‘The percentage that costs incurred bear 10 fotal expected costs is cpplied to Me contiact price to determine the revenue to be recognized to date 5 well as to the expected net income on the project in arriving ct eamings to date. Some of the costs incurted, particularly in the early stages of the contract. should be disregarded in applying this method because they do not relate directly fo effort expended on the contract. These include such iterns as subcontract costs for work that has yet to be Performed and standor4 fabricated material that have not yet been installed. One of the most difficul problems in using this method is estimating the costs ,2! fo be incuned Engineers ate often consulted to help provide estimates as to c project's percentage of completion. How difficult the estimation process may be i is required in reporting income. regardless of how the ercentage of completion is computed b. Eflorts-expended methods. Ihe etforts-expended methods are based on some measure of work performed. ihey inchide labor hours, labor pesos, machine hours, or material quantities In each case, the degree of completion is measured na way similar to the use in the cost-to-cost approach the ratio of th exported 10 date to the estimated total efforts to be expended on the entre contract For example. if the measure of work performed is fabor hours, the ratio of hours worked fo date to the tolal estimated hours would produce the percentage for use i measuring income earned, 2. Output Mecsures/Sales Basis. Output measures are made in terms of results achieved. Examples of output methods incivde: surveys of work performed or performance comoieted 10 date (the value of "work certified” to date may be a measure used to dently ihe degree of completion and therefore revenue to be recognized in picfit oF 1058), units produced or delivered: tons produced: storey’s of a building completed: appraisals of results achiev Kiometers of a highway completed: contact milestones reached or achieved: fime elopsed and values added For example. if the contract calls for units of output, such as kilometers toadway. a measute of completion would be a ratio of the mites comple {0 the total kilometers in he contract Output metnods should only be used when the output selected represents pertommance towares te sanstaction of the performance obtgation AFAR-05 ledAdvanced Financial Accounting & Reporting poge 3 The disadvantage of output methods is that the outputs used may not be available or directly observabie. When this is the case, an input method may be necessary. Architects and engineers are sometimes asked fo evaluate jobs and estimate the percentage of a job completed (surveys of work performed). These estimates are, in reality, ovipui measures and usually are based on the physical progress made on the contract. This may be appropriate for the Construction of buildings. Ovtput measures are of two lypes: : a, Proportional Cost Approach - the costs incued computed under this method may not equal to the actual costs incurred. b. Actual Cost Approach - the costs incuted computed under this method should be equal to the custs actually incurred. The Proportional Cost and Actual Cost Approach are equally acceptable. It should be noted that progress payments and advances from customers often do not reflect the work performed. 8. Cost Recovery Method/Zero-Frottt Approach (Point in Time). Cost recovery method Pointin time No perlormance obligation 3. Crown Construction Company enter d ny a contract with Star Hotel for building 0 highly sophisticaieg, customized contevence oom fo be completed for a fixed price Of P400 000. Nonrefundabie rrogi::ss payments ore made on a monthly basis for work Completed during the monity tec tie te the conference room equipment is held by Crown until the end of the conte aticr. pryect, but if the contract is terminated before the conference room 1s finished, Stor retains the partially completed job and must pay for any work comitetec! *o cee, When should tevenue be recognized? 3. No tansaction © Pointin time b. Norevenue 4 Overime 4, Regent Company entered nto u con-uct with Stor Hotel for constructing and instaling 9 standard desianed ayin fe 2 trea pace of P400.000. Nonretundabie Progress payments cre meds on a m.nthiy bass for work completed during the month. Legal fille io the gunn. Stor upon compietion of the building process. Hf Star cancels the coniract bet-re the gyin construction is completed, Regent femoves all the installed equipment ured S ie" must compensate Regent lor any oss of Profil on sale of the gym 16, another customer When should Silica recognize revenue? @. No transaction &. Pointin Time . b Norevenue @ Overlime 5. Assume DUD International fowe, {hase il s developing tuxury residential real estate ‘and begins to market inaiveduc. spcinerts dung their constuction, The Tower entered infe a contract wit Edw crc: it the sale of a specitic aparlment. Edwards Pays @ deposit that is :efiracbir oniy if the Tower fais 10 deliver the completed apartment in accordance vath the contac The remainder of the purchase price is Paid on completion of the contoct when Fdwards obtains possession of the apartment, When should revenue be re. ognized? @. No transaction © Pointin Time b Notevenve Over time 6 On January |. 20x6, Siiver Construction Company signed a contract 10 build a custom garage for a custorne arJ 1¢->Fivs G PIC 990 in advance lor the job. The new garage will be built on the “store's rt Io Complete this project. Siver must fis! buid a concrete floor, consti wooUeN pillars and wols, and finally install a root Silver normally charges stand aren puces 31 P3009 4.000, and P5.000. respectively for each of these three wnalor tasks if done separately. How many performance obligations exist in this contract? 0 0 ce 2 bol a 4 2. VID Construction specializes in designing and instaling customzed manulactunng equipment. On February |, 2077. signs a contact fo design a tuly automated wtistwatch assembly line tor P? mor. wc: hw" be sefled in cash upon completion Of construction. VID Constr 11 vat si at the equioment on the client's property fumnsh it with @ custome sctiware package “hal 1s integral to operations, and provide consulting services thc! alegicte the eawipment with VID Construchon's other assembly ines How snoy verformanc's obeys extn ts Contac 0 0 Bt + AFAR-05‘Advanced Financial Accounting & Repoiting page 7 il- Transaction Price 1 DJ Builders Construction enters into 0 contract with a customer to build a warehouse for P850,000 on March 30, 2025 with a performance bonus of P50,000 if the building is completed by July 31, 20x5. The bonus is reduced by P10,000 each week that completion is delayed. D4 Builders commonly includes these completion bonuses in its contracts nd, based on prior experience, estimates the following completion outcomes: [Completed by __| Probability July 31, 20x8 55% 25% SS =a 5%. a. P8?5,000 c. 585,000 b. P8S0,000 d. P552,500 2. DID Builders Construction Company enters into a contract with a customer to build a 50 kilometers road for 100,000,000 with @ performance bonus of P60,000,000 that will be paid based on the timing of the amount of the performance bonus decreases by 10% per week for 9v 2’ week beyond the agreed-upon completion dete. The contract requitements ore similar 10 contracts that DJD Builders hos Performed previously. and management believes that such experience is predictive for this contract. Management estimates that there is c 60% probability that the contract will be completed by the agreed-upon completion date, a 30% probability that it will be completed one week Inte, and only a 10% probability that it will be completed two weeks late. Determine the probabllty-welghted amount for the management fo determine ine transaction price. ‘a. 96,000,000 ©. F142, 200,000 b.P111,000.000 «8 157,000,000 il ~ Enitles, Revenue anc Gross Profit Computation In 2019. DJ Builders Consiruction agreed t> construct cn apartment building at a price of 2,000,000. The information relating to ihe cosis and bilings for the contract is as follows: 20192020 2021 Direct and allocable costs to date 560,000 P 1,200,000 1,570,000 Estimated costs yet to be incurred...... 1,049,000 400,000 -0- Customer billings each year. 750,000 560.000 730,000 Collection of billings each year 560,000 640,000 840,000 During 2020 the customer agrees to ct variation with increases expected revenue from the contract by P40,000 and cauies aci ional costs of P20,000. A the end of 2020 there ore moterials stored on site for use in 2021 v-"iclh cost P16,000 during the period. Required: A. Prepare joumal entries each year using 1. Percentage-ol-completion method/Over-Time 2. Cost recovery method of construction accounting (Point in Time/Hybrid Method oF Zero-profit Approach). Assuming that at the beginning and end of 2019 (also in 2020) the contractor canno! estimate ine outcome of the contract with sufficient reliabilty fo estimate the project's percentage of compietion (i.e... because of the uncertainties arising from the ne design and new materials the entity cannot estimate total expected contac costs with sufficient reliability). It is highly likely that the contract price will b= 1ece'ved fom the customer. However it is probable that the costs incuted in 2019 and 2020 will be recoverable. The contract was completed in 2021. B. For each year show how, the detcils relured fo this contract would be disclosed on the balance sheet and on the income statement: Percentage-of-completion Method/Over Tir 1. Inits December 31, 2019 balance shel. DJ Builders would report: a. The cuent/contract asset, Cost cd profits n excess of billings. P50,000. b. The curent/contract liability, pilings in excess ot Cost and profits P50,000. c. The cument/coniract ase. antici amount in excess of bilings, of 1,250,000. @. The curent/contract asset. deferred profit of 290,000. AFAR-05Advanced Financial Accounting & Reporting page 2. nits December 31, 2076 bak 201, D! Builders would report @ The cuent/contract asset. cost and profits 9 excess of balings. P199 600. b_ the curent/contiact tut! 'v bingy i excess of cost and protts, P199 600 ¢. The cunent/contract asset Coniact umount in excess of billngs. of P149.600, 2 The curent/comtrect tabhiy deicad graft of PIES 600, 3 ints Decen ber3 202; Rolai.ce sneet DJ Builders would report in relation to the Construction in Progress anc! Contract B ings Acount 2. The current/conttact Gsset P2.000,000 b. The curent/contract liaksuity, 20,000, The Construction.n-Frogress Account of 2,000,000 and Contract Bil P1.370000 21 wD “7020. 2021 . 2700.000 F869 6D) P -C40% c, 2546.00 PI 200.090 PI 570,000 ©. P140.000 P 325e0U P a0K, aP OP 0 2.040.000 5. Inits December 31 yearly ir staternont, the Construction Costs) zi? 2020 2 2020 2021 2 P 560.000 © 640.000 » 370.007 P $40,000 P 386,000 ©.P 560.000 + 624000 P 386000 « PO 1.570.000 S.Inits December 31 yearly ne ome statenent the gioss prolt would be. 2019 2020 2021 2033 2020 2021. 2. P149000 P300,000 P430.000 530.900 P640.000 800,000 b P140.000 P185600 PiteadD dP Cc P 0 — 430,000 Cost Recovery Method of Construction Accounting/Point in Time ts December 312015 hatar ce sieet, : Ruiders report The cuner’ the curent The curent/-cntract asset, contract amount in €/cess of Blings. of P!,250.000 The curent/contract asset, P540 000" Gefered protit of P750.000. its December 31 2079 ralance sheet, DJ Buidess report The curent/centrac assat. cost anc profis in excess of billings 124,000 ost. 126,000. pity detenea @ ance 3a000 500.000 9. inits Dece: butoree sheet, DJ Builders would report in relation to the: Construction in Progress anna Contract Bilings Account. 3 the cuner € the constuction 0 ana Contact Biings ot 570000 3 Nore 10 in ts December 31 yearly ncome statement the recoanze revenue would be: m9 209 22h woe 20202021 @. P560.000 P 624,000 F an 0% © P560000 F 160.000 P 800.000 .P560.000 71.2000 °2%0UR cs 9 -P 9 P2.000.000 11 nits December 33 yearly income s'aterniont the Constuction Costs mie eeu 9 L202 ©.P 560.000 P 62450 © WOOK <> P1 200.000 1.570.000 ©.P1.600,000 PIeONdK FISTONR GP GO) BO P1S70.000 12. nits December 31 yeory income staiement. Ine gioss piott 2012 220 a. P140,000 300,000 P43°.600 Pi40.000 P160000 P:30.000 ¢. P530,000 640.000 F800 ap 0 PO Pa/0% W- Reconsirection 12019. PAD Constu.cton Comparat cn n=gan consiecticn work under 0 3-yeor contact The contact pice war #4200000 "10 ses tha. percentage-of.compleiion method/over- fine tor financia! as countina p: poses The income to be recognized ach year is based on the proportion of coWs ir cUITeG 10 ‘otal estimated costs for completing the contract. The financial statement presentation relating to this contract at December 31, 2019 was as follows: AFAR-05‘Advanced Financial Accounting & Reporting page? Balance Sheet Accounts Receivable - construction contract billings. P 86.000 Constuction-in-progress . : 260,000 Less: Contract Billings. zi 246,000 Costs of uncompleted contract in excess of billngs... 14,000 Income statement Gross profit (before tax) recognizea in 20 " P 72,800 |. How much was collected ir 2019 on this contract? . P14,000 . P160,900 b. P86,000 d. P246,000 What was the initiat estimated arcs profit before tax on this contract? a. P 72,800 cP 260,000 b.P187,200 6. P1.120,000 3. What is the percentage of compietion for the year ended? ©. 6.50% ¢. 28.00% b, 13.00% . 100.00% 4, What is the gross profit icte o: nfract? 9. 6.50% ©. 28.00% b. 13.00% 4. 10.00% 5. What is the recognized revenue io date at the end of 2019 «0. P 72,800 ©. P_260,000 b. P187,200 1,120,000 4. What is the recognized revenue in 20192 9. P 72,800 . P 260,000 b. P187,200 d. P!.120.000 V~ Reconstruction Di Builders Construction Company ha, sed the cost-to-cost percentage of completion (over-time) method of recognizing revenue. Ambrose assumed leadership of the business after the recent death ot his tater. In reviewing the records, Ambrose finds the following information regarding a recently completed building project for which the total contract was P2,000,000. = = ols 2020 _ 202), ‘Gross profit (loss) each year 40,000 —-P'140,000__P/ 20,000) Costs incurred each year 360: z 820,000 Ainbrose wants fo know how offecively The company opSvaled Guring The tast 3 yeors On this project and since the inforraation i nct complete, nas osked for answers to the following questions: 1. How much cost was incurred in 202012 2. P1.840,000 .P1,180,000 b. P 820,000 660,000 2. What percentage of the project was completed by the end of 20208 2. 90% 2.51% b. 40% 4.60% ‘3. What was the percentage of completion during Ine year 20208 0. 20% ©. 40% b. 60% 100% 4. What was the estimated gioss jiofit cn the project by the end of 2020 ‘a. P140,000 ‘¢.P 180,000 b. P160,000 4. P300,000 5. What was the estimated cost to complete the project at the end of 2020? ‘2. P1,700,000 ¢.P1,020,000 b. P 660,000 dP. 680,000 VI- Unprofttable Contract GEI Enterprise entered into a consiruction agreement in 20x4 that called for o contract price of 9,400,000. A! the beginning of 20x, 0 change order increase the intial controct pice by 480,000. 1n relation to the project, the following dita were obtonedt 1 are 000 Estimated costs to compte» | 492000 2.160.000 Billings made to dote . $.280,000 8,700,000 Collections made fo date 920,000 8,700,000 ‘Compute the amount of consinicion in progress (nel}/conlract owels or progress bilings (net}/contract liabilities for the year 20x5: AFAR-05