Chapter 7

Construction Contracts

PROBLEM 1: TRUE OR FALSE

1. FALSE 6. TRUE
2. FALSE 7. TRUE
3. FALSE 8. FALSE
4. TRUE 9. FALSE
5. TRUE 10. TRUE

PROBLEM 2: FOR CLASSROOM DISCUSSION

1. D

2. D

3. A

4. C

5. D

6. C

7. D

8. C

9. D

10. C

11. C

12. Solutions:
Requirement (a):

July 1 to Construction in progress 120,000

Dec. 31, Cash (or other appropriate accounts) 120,000
20x1
to record the contract costs

The percentage of completion as of December 31, 20x1 is computed as

follows:

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➢ The gross profit earned in 20x1 is computed as follows:

Total contract price 600,000

(a) Costs incurred to date 120,000
Estimated costs to complete 240,000
(b) Estimated total contract costs (see ‘bill of materials’) 360,000
Expected gross profit from contract 240,000
Multiply by: Percentage of completion (a) ÷ (b) 33 1/3%
Gross profit earned to date 80,000
Less: Gross profit earned in previous years -
Gross profit for the year 80,000

➢ The revenue and cost of construction in 20x1 are computed as

follows:

Total contract price 600,000

Multiply by: Percentage of completion 33 1/3%
Revenue to date 200,000
Less: Revenue recognized in previous yrs. -
Revenue for the year 200,000
Cost of construction (squeezed) (120,000)
Gross profit for the year (see computation above) 80,000

The year-end adjusting entry to recognize revenue is as follows:

Dec. 31, Cost of construction 120,000
20x1 Construction in progress (gross profit) 80,000
Revenue 200,000

Dec. Receivable (600K x 33 1/3%) 200,000

31, Progress billings (given) 180,000
20x1
Contract liability 20,000

to record the billing to the customer

“Receivable” is debited instead of “Contract asset” because Contractor Co.

has an unconditional right to consideration for progress made on the
contract.

The excess of the receivable (i.e., unconditional right to consideration) over the
amount invoiced to the customer (i.e., progress billing) is recognized as a
contract liability.

Contract liability – is an entity’s obligation to transfer goods or services to a

customer for which the entity has received consideration (or the amount is
due) from the customer.

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Dec. Cash 60,000
31, Receivable 60,000
20x1
to record the collection on the billing

Requirement (b):
Contractor Co.
Statement of financial position
As of December 31, 20x1

Current assets
Receivable (200,000 - 60,000) 140,000
Contract asset* 20,000
Total current assets 160,000

Current liabilities
Contract liability (see journal entries above) 20,000
Total current liabilities 20,000

*Construction in progress (120,000 + 80,000) 200,000

Progress billing (180,000)
Contract asset 20,000

Contractor Co.
Statement of profit or loss
For the year ended December 31, 20x1

Revenue 200,000
Cost of construction (120,000)
Gross profit 80,000
Other operating expenses -
Profit for the year 80,000

13. Solutions:
20x1 20x2
Total contract price 9,000,000 9,000,000
(a) Costs incurred to date 3,900,000 6,300,000
Estimated costs to complete (squeeze) 3,900,000 1,800,000
(b) Estimated total contract costs 7,800,000 8,100,000
Expected profit (loss) 1,200,000 900,000
Multiply by: % of completion (a) ÷ (b) 50% 77.7778%
Profit (loss) to date 600,000 700,000
Profit recognized in prior years - (600,000)

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 Profit (loss) for the year 600,000 100,000

20x1 20x2
Total contract price 9,000,000 9,000,000
Multiply by: % of completion 50% 77.7778%
Contract revenue to date 4,500,000 7,000,000
Contract revenue in prior years - (4,500,000)
Contract revenue for the year 4,500,000 2,500,000
Cost of construction (squeeze) (3,900,000) (2,400,000)
Profit (loss) for the year 600,000 100,000

14. Solutions:
20x1 20x2
Contract revenue to date (a) 3,900,000 6,300,000
Contract revenue in prior years - (3,900,000)
Contract revenue for the year 3,900,000 2,400,000
Cost of construction (b) (3,900,000) (2,400,000)
Profit (loss) for the year - -

to the “Cumulative contract costs incurred.”

(a) Equal
(b)
Equal to the costs incurred during the year. The cost incurred in 20x2 is
computed as follows: (6,300,000 – 3,900,000) = 2,400,000.

15. Solution:
No revenue shall be recognized during the course of construction. Revenue
(and cost of construction) will be recognized only when the construction is
complete and legal title over the constructed building is transferred to the
customer.

16. Solutions:
➢ The costs incurred to date include the cost of an uninstalled materials (i.e.,
elevators).
➢ Because all the conditions under PFRS 15 are met, the entity shall adjust
its measure of progress to recognize revenue only to the extent of the
costs of the uninstalled elevators. The cost of goods sold recognized
in 20x1 will also include this cost. Consequently, the entity recognizes zero
profit from the elevators in 20x1.

Percentage of Total costs incurred to date

=
completion Estimated total contract costs
= (500,000 costs incurred, excluding cost of elevator) ÷ (2.5M ‘other costs’
only, excluding cost of elevator)
Percentage of completion = 20%

Requirement (a): Revenue in 20X2

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[(5M transaction price – 1.5M cost of elevator) x 20%] + 1.5M cost of elevator
= ₱2,200,000 revenue in 20X2

Requirement (b): Profit in 20X2

Cost of goods sold in 20X2
[(2.5M ‘other costs’ only, excluding cost of elevator) x 20%] + 1.5M cost of
elevator = ₱2,000,000 cost of goods sold in 20X2

Profit in 20X2 = 2.2M – 2M = ₱200,000

17. Solutions:

Analysis:
Since the additional goods or services to be provided in the modified contract
are not distinct, they are essentially a part of a single performance obligation
that is only partially satisfied. Therefore, the contract modification is accounted
for as if it were a part of the existing contract.

Accordingly, the effect of the contract modification on the transaction price, and
on the entity’s measure of progress towards complete satisfaction of the
performance obligation, is recognized as an increase or decrease in revenue
at the date of the contract modification. The adjustment to revenue is
made on a cumulative catch-up basis.

The percentage of completion is computed as follows:

Contract
modification date
20x1 in 20x2
(a) Costs incurred to date 420,000 420,000
Estimated costs to complete ignored ignored
(b) Estimated total contract costs (given) 700,000 820,000 (1)
Percentage of completion (a) ÷ (b) 60% 51.2%

(1)The revised estimated total contract costs as of the date of contract

modification in 20x2 is computed as (700K original estimate of total contract
costs + 120K increase due to the contract modification in 20x2) = 820K.

The revenue in 20x1 and the cumulative catch-up adjustment to

revenue in 20x2 are computed as follows:
Contract
modification
20x1 date in 20x2
Total contract price 1,000,000 1,350,000 (2)
Multiply by: % of completion 60% 51.2%
Revenue to date 600,000 691,200
Less: Revenue recognized in prior yrs. - (600,000)

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Revenue in 20x1 /
Cumulative catch-up adjustment to
revenue in 20x2 600,000 91,200
Cost of construction (420,000) ( - )
Gross profit for the year /
Cumulative catch-up adjustment to gross
profit in 20x2 180,000 91,200

(2)The bonus is included in the transaction price only in 20x2 when it became
highly probable that the entity will receive the bonus. The revised transaction
price on contract modification date in 20x2 is computed as (1M contract price
+ 150,000 contract modification + 200,000 bonus = 1,350,000).

PROBLEM 3: EXERCISES
1. Solutions:
Total contract price 20,000,000
(a) Costs incurred to date 2,000,000
Estimated costs to complete (squeeze) 14,000,000
(b) Estimated total contract costs 16,000,000
Expected profit (loss) 4,000,000
Multiply by: % of completion (a) ÷ (b) 12.50%
Profit (loss) to date 500,000
Profit recognized in prior years -
Profit (loss) for the year 500,000

Total contract price 20,000,000

Multiply by: % of completion 12.50%
Contract revenue to date 2,500,000
Contract revenue in prior years -
Contract revenue for the year 2,500,000
Cost of construction (squeeze) (2,000,000)
Profit (loss) for the year 500,000

2. Solutions:
Total contract price 4,500,000
(a) Costs incurred to date 1,350,000
Estimated costs to complete (given) 2,700,000
(b) Estimated total contract costs 4,050,000
Expected profit (loss) 450,000
Multiply by: % of completion (a) ÷ (b) 33 1/3%
Profit (loss) to date 150,000
Profit recognized in prior years -
Profit (loss) for the year 150,000

Total contract price 4,500,000

Multiply by: % of completion 33 1/3%

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 Contract revenue to date 1,500,000
Contract revenue in prior years -
Contract revenue for the year 1,500,000
Cost of construction (squeeze) (1,350,000)
Profit (loss) for the year 150,000

3. Solutions:
Requirement (a):
Total contract price 1,200,000
(a) Costs incurred to date 590,000
Estimated costs to complete (given) 410,000
(b) Estimated total contract costs 1,000,000
Expected profit (loss) 200,000
Multiply by: % of completion (a) ÷ (b) 59%
Profit (loss) to date 118,000
Profit recognized in prior years -
Profit (loss) for the year 118,000

Total contract price 1,200,000

Multiply by: % of completion 59%
Contract revenue to date 708,000
Contract revenue in prior years -
Contract revenue for the year 708,000
Cost of construction (squeeze) (590,000)
Profit (loss) for the year 118,000

Requirement (b):
Costs incurred 590,000
Profit recognized 118,000
Construction in progress 708,000

4. Solutions:
Requirement (a):

Contract revenue for the year (equal to cost incurred) 590,000Cost

of construction (squeeze) (590,000)
Profit (loss) for the year -

Requirement (b):
Costs incurred 590,000
Profit recognized -
Construction in progress 590,000

5. Solutions:
Requirement (a):
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 Contract revenue for the year -
Cost of construction -
Profit (loss) for the year -

Requirement (b):
Costs incurred 590,000
Profit recognized -
Construction in progress 590,000

6. Solutions:
20x1 20x2
Total contract price 6,000,000 6,000,000
(a) Costs incurred to date 2,250,000 4,800,000
Estimated costs to complete 2,250,000 -
(b) Estimated total contract costs 4,500,000 4,800,000
Expected profit (loss) 1,500,000 1,200,000
Multiply by: % of completion (a) ÷ (b) 50% 100%
Profit (loss) to date 750,000 1,200,000
Profit recognized in prior years - (750,000)
Profit (loss) for the year 750,000 450,000

20x1 20x2
Total contract price 6,000,000 6,000,000
Multiply by: % of completion 50% 100%
Contract revenue to date 3,000,000 6,000,000
Contract revenue in prior years - (3,000,000)
Contract revenue for the year 3,000,000 3,000,000
Cost of construction (squeeze) (2,250,000) (2,550,000)
Profit (loss) for the year 750,000 450,000

7. Solutions:
20x1 20x2
Contract revenue to date (a) 2,250,000 6,000,000
Contract revenue in prior years - (2,250,000)
Contract revenue for the year 2,250,000 3,750,000
Cost of construction (b) (2,250,000) (2,550,000)
Profit (loss) for the year - 1,200,000

The contract revenue to date in 20x1 is equal to the ₱2,250,000 costs

(a)

incurred during that year. The contract revenue to date in 20x2 is equal to the
₱6,000,000 contract price because the construction is 100% complete.

(b) Equal to the costs incurred during the year.

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8. Solutions:
20x1 20x2
Contract revenue to date (a) - 6,000,000
Contract revenue in prior years - -
Contract revenue for the year - 6,000,000
Cost of construction (b) - (4,800,000)
Profit (loss) for the year - 1,200,000

(a)No revenue is recognized during the construction period because the

performance obligation is satisfied at a point in time. The whole of the
transaction price is recognized as revenue only in 20x2 when the construction
is completed.

(b)The costs incurred during the construction period are deferred and
recognized in full only in 20x2 when the related revenue is recognized.

9. Solutions:
20x1 20x2
Construction in progress, ending balances 122,000 364,000
Contract costs incurred to date (a) (105,000) (297,000)
Profit to date 17,000 67,000
Profit in previous years - (17,000)
Profit for the year 17,000 50,000

(a)
The contract costs incurred to date in 20x2 is computed as follows: (105,000 +
192,000 = 297,000).

20x1 20x2
Revenue for the year (squeeze) 122,000 242,000
Cost of construction (equal to costs incurred each yr.) (b) (105,000) (192,000)
Profit for the year 17,000 50,000

Under the ‘cost-to-cost’ method of measuring progress, the “cost of

(b)

construction” each year is equal to the contract cost incurred during the year.

Requirement (b):
Solution:
Progress billings, 20x2 420,000
Receivable, 20x2 (300,000)
Total collections 120,000

10. Solution:
The costs incurred to date are computed as follows:
20x1 20x2
(a) Costs incurred to date (squeeze) 978,750 4,524,000
Estimated costs to complete ignored ignored
(b) Estimated cost at completion (given) 6,525,000 6,960,000
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 (a) ÷ (b) Percentage of completion (given) 15% 65%

The costs of construction are computed as follows:

20x1 20x2
Costs incurred to date 978,750 4,524,000
Costs incurred in previous years - (978,750)
Costs incurred during the year 978,750 3,545,250

The profits are computed as follows:

20x1 20x2
Total contract price (given) 8,700,000 8,700,000
(a) Costs incurred to date (ignored)
Estimated costs to complete (ignored)
(b) Estimated cost at completion (given) 6,525,000 6,960,000
Expected profit (loss) 2,175,000 1,740,000
Multiply by: % of completion (given) 15% 65%
Profit (loss) to date 326,250 1,131,000
Profit recognized in prior years - (326,250)
Profit (loss) for the year 326,250 804,750

11. Solution:
Contract 1 Contract 2
Contract price 420,000 300,000
Costs incurred during the year 240,000 280,000
Estimated costs to complete 120,000 40,000
Total expected contract costs 360,000 320,000
Expected loss - (20,000)

Answer: Red Hot Co. recognizes a loss of ₱20,000 in 20x1. The loss is
recognized as a provision for onerous contract in accordance with PAS 37.

12. Solution:
Contract 1 Contract 2
Total contract price 420,000 300,000
(a) Costs incurred to date 240,000 280,000
Estimated costs to complete 120,000 40,000
(b) Estimated total contract costs 360,000 320,000
Expected profit (loss) 60,000 (20,000)
Multiply by: % of completion (a) ÷ (b) 66.67% N/A
Profit (loss) to date 40,000 (20,000)
Profit recognized in prior years - -
Profit (loss) for the year 40,000 (20,000)