UNIVERSITY OF THE EAST

College of Business Administration

Manila Campus

BSA 3101 – ACCOUNTING FOR SPECIAL TRANSACTIONS

Prepared by: VINCENT F. RAMISO, CPA

REVENUE RECOGNITION: LONG-TERM CONSTRUCTION CONTRACTS

Point-in-Time / Cost Recovery Method / Zero-Profit Approach

This method of construction accounting is used when the contract’s outcome cannot be reliably
estimated. The treatment below should be followed:

1. Recognize revenue only to the extent of the contract costs incurred which are expected to be
recoverable; and
2. Recognize contract costs as an expense in the period they are incurred.

In other words, the point-in-time / cost recovery method gives rise to zero profit. This approach
involves recognizing revenues equal to the amount of costs incurred during the period so that no
profit is recognized. But as soon as the ultimate outcome of a contract can be estimated, the
percentage-of-completion is applied.

Contract costs that cannot be recovered should be recognized as an expense immediately. The
following are situations where this might occur:

1. The contract is not fully enforceable, i.e. its validity is seriously questioned.
2. The completion of the contract is subject to the outcome of pending litigation or legislation.
3. The contract relates to properties which will probably be expropriated or condemned.
4. The customer is unable to meet its obligations under the contract.
5. The contractor cannot complete the contract or in any other way meets his/her obligations
under the contract.

When these uncertainties cease to exist, the contract revenue and costs should be recognized
as normal by reference to the stage of completion.

As work progress on the contract, the actual costs incurred are charged to inventory account
“Construction in Progress”. The amount of profit earned each period is charged to this asset
account. Thus, the inventory account is valued at its net realizable value – the sales (or contract)
price less the cost to complete the contract and less the unearned profit on the unfinished contract.

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Reference: Advanced Financial Accounting revised 2021 Edition by Antonio J. Dayag
If a company projects a loss on the tract prior to completion, the full amount of the loss should
be recognized immediately. This loss recognition results in a write-down of the asset to its
estimated net realizable value. If only a percentage of the loss were recognized, the asset value
would exceed the net realizable value. This would violate the lower-of-cost-or-market-value.

Financial Statement Presentation

During the life of the contract, the difference between the Construction in Progress and the
Progress Billings reported in the statement of financial position as follows:

▪ Current asset – Contract asset

➢ It comprises of total costs incurred on the contract less progress billings (the amounts
actually invoiced to customers for work performed on a contract whether or not they have
been paid by the customers).

▪ Current liability – Contract liability

➢ It comprises of progress billings less total costs incurred on the contract.

Long-term Contract Losses

Two types of loses can become evident under the long-term contracts:

1) Loss in Current Period on a Profitable Contract

➢ This situation happens when, during the construction, there is a significant increase in
the estimated total contract costs but the increase does not eliminate all profits on the
contract.

Illustrative Example:

Assuming that ABC Construction was awarded a contract with a total price of P1,500,000. The
construction will be completed over a three-year period. The costs incurred an the estimated costs
to complete, billings and collections for 2013, 2014, and 2015 are as follows:

Estimated costs to
Year Costs Incurred Billings
complete
2013 P520,000 P780,000 P500,000
2014 455,100 417,900 450,000
2015 417,900 - 550,000

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Reference: Advanced Financial Accounting revised 2021 Edition by Antonio J. Dayag
The gross profit (loss) recognized each year may be computed as follows:

2013 2014 2015

Contract price P1,500,000 P1,500,000 P1,500,000
Costs incurred each year P 520,000 P 455,100 P 417,900
Add: Costs incurred previous year - 520,000 975,100
Actual costs incurred to date (1) P 520,000 P 975,100 P1,393,000
Add: Estimated costs to complete 780,000 417,900 -
Total estimated costs (3) P1,300,000 P1,393,000 P1,393,000
Estimated gross profit (loss) P 200,000 P 107,000 P 107,000
Percentage of completion (1 / 3) 40% 70% 100%
Gross profit (loss) to date P 80,000 P 74,900 P 107,000
Less: Gross profit (loss) in prior years - 80,000 74,900
Gross profit (loss) in current year P 80,000 P( 5,100) P 32,100

Entries:

2013

Construction Expenses 520,000

Construction in Progress 80,000
Revenue from Construction 600,000

2014

Construction Expenses 455,100

Construction in Progress 5,100
Revenue from Construction 450,000

2015

Construction Expenses 417,900

Construction in Progress 32,100
Revenue from Construction 450,000

2) Unprofitable Contract – Anticipated Contract Losses

➢ This condition arises when the estimated at the end of the current period may indicate
that a loss will result on completion of the entire contract. The loss will be the amount by
which total estimated contract revenue exceeded by total estimated contract costs.

➢ When a loss on the total contract is anticipated, GAAP requires reporting the loss in its
entirety in the period when the loss is first anticipated. This is true under either the
percentage-of-completion method or the cost-recovery method.

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Reference: Advanced Financial Accounting revised 2021 Edition by Antonio J. Dayag
Illustrative Example

Assuming the same data in the previous example of ABC Construction except that the estimated
costs to complete the contract at then end of 2014 was P650,000. The costs incurred , estimated
costs to complete, billings and collections for 2013, 2014, and 2015 are as follows:

Estimated costs to
Year Costs Incurred Billings
complete
2013 P520,000 P780,000 P500,000
2014 455,000 650,000 450,000
2015 700,000 - 550,000

The following analysis is to determine the percentage of completion:

2013 2014 2015

Contract price P1,500,000 P1,500,000 P1,500,000
Costs incurred each year P 520,000 P 455,000 P 700,000
Add: Costs incurred previous year - 520,000 975,000
Actual costs incurred to date (1) P 520,000 P 975,000 P1,675,000
Add: Estimated costs to complete 780,000 650,000 -
Total estimated costs (3) P1,300,000 P1,625,000 P1,675,000
Estimated gross profit (loss) P 200,000 P( 125,000) P( 175,000)
Percentage of completion (1 / 3) 40% 60% 100%

The revenue, expenses (costs) and profit (loss) will be recognized in profit or loss as follows:

Recognized in Recognized in
2013 To date
prior years current year
Revenue (1,500,000 x 40%) P600,000 - P600,000
Costs/expenses (1,300,000 x 40%) 520,000 - 520,000
Gross Profit (200,000 x 40%) P 80,000 - P 80,000

Recognized in Recognized in
2014 To date
prior years current year
Revenue (1,500,000 x 60%) P 900,000 P600,000 P300,000
Costs/expenses* 1,025,000 520,000 505,000
Gross Profit P(125,000) P 80,000 P(205,000)
*recognized revenue plus anticipated loss

Recognized in Recognized in
2015 To date
prior years current year
Revenue (1,500,000 x 100%) P1,500,000 P 900,000 P600,000
Costs/expenses* 1,675,000 1,025,000 650,000
Gross Profit P(175,000) P(125,000) P(50,000)
*recognized revenue plus anticipated loss

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Reference: Advanced Financial Accounting revised 2021 Edition by Antonio J. Dayag
Contract Retention

To guarantee the completion of the contract in a satisfactory manner, part of the billings may be
withheld until the project is completed and accepted to conform to the acceptable standards.

Illustrative Example

Assume that a contract billings amounted to P500,000 and part of the agreement is that 10% is
withheld upon collection. The entry to record the above billings and collections respectively is as
follows:

Accounts receivable 500,000

Progress billings 500,000

Cash 450,000
Contract Retention 50,000
Accounts Receivable 500,000

The contract retention account is presented in the Statement of Financial Position as a current
asset.

Once completed, the balance of this account will be collected from the customer by debiting Cash
and crediting the Contract Retention account.

It should be observed that contract retention does not affect the revenue, costs and gross profit
accounts.

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Reference: Advanced Financial Accounting revised 2021 Edition by Antonio J. Dayag
Self-Test

PROBLEM 1 – Methods of Construction Accounting

Beavis Construction Company was the low bidder on a construction project to build an earthen
dam for P1,800,000. The project was begun in 2014 and completed in 2015. Cost and other data
are presented below:

2014 2015
Costs incurred during the year P 450,000 P1,100,000
Estimated costs to complete 1,200,000 -0-
Billings during the year 400,000 1,400,000
Cash collections during the year 300,000 1,500,000

Required: Compute the amount of gross profit recognized during 2014 and 2015.

1. Assume that Beavis uses the overtime (percentage-of-completion) method for revenue
recognition.
2. Assume that Beavis uses the point-in-time (cost recovery) method for revenue recognition.

PROBLEM 2 – Methods of Construction Accounting – Unprofitable Contract (Estimated

Gross Loss)

Ambo Contractors received a contract to construct a mental health facility for P2,500,000.
Construction was begun in 2014 and completed in 2015. Cost and other data are presented
below.

2014 2015
Costs incurred during the year P1,500,000 P1,300,000
Estimated costs to complete 1,200,000 -0-
Billings during the year 1,200,000 1,300,000
Cash collections during the year 1,000,000 1,500,000

Required:

1. Prepare journal entries, under:

a. Over Time / Percentage-of-completion method using cost-to-cost method.
b. Point-in-Time / Cost-recovery method

2. Compute the Current asset – Contract Asset / Current liability – Contract liability:
a. Over Time / Percentage-of-completion method using cost-to-cost method.
b. Point-in-Time / Cost-recovery method

3. Compute the gross profit.

a. Over Time / Percentage-of-completion method using cost-to-cost method.
b. Point-in-Time / Cost-recovery method

----Thank you----

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Reference: Advanced Financial Accounting revised 2021 Edition by Antonio J. Dayag