Page | 1

Chapter 7 and 8
Construction Contracts and Accounting for Franchise Operations
NAME: Date:
Professor: Section: Score:

LONG QUIZ:
1. e-Tag Co. enters into a construction contract with a customer. PFRS 15 requires e-Tag to do all of
the following at contract inception, except
a. assess the customer’s ability and intention to pay the contract price on due date.
b. assess whether the promised goods and services in the contract are individually distinct.
c. determine if the performance obligation(s) identified in the contract is(are) satisfied over
time or at a point in time.
d. estimate the total construction costs at completion.

2. “Step 2” of the revenue recognition principles of PFRS 15 requires an entity to identify the
performance obligations in the contract at the inception of the contract. Which of the following
statements is not correct regarding this step?
a. An entity shall treat each promise in the contract to transfer a distinct good or service as a
separate performance obligation.
b. An entity shall treat a promise to transfer a distinct bundle of goods or services as a separate
performance obligation.
c. An entity shall treat a promise to transfer a series of distinct goods or services that are
substantially the same and have the same pattern of transfer to the customer as a separate
performance obligation.
d. An entity shall treat all promises in a single contract as a single performance obligation
regardless of the nature of those promises, if those promises are negotiated with the
customer as a single package.

3. A construction contract may be

a. a fixed price contract
b. a cost plus contract.
c. a combination of a and b
d. any of these

Use the following information for the next three questions:

In 20x1, Metallica Co. enters into a construction contract with a customer. The transaction price in
the contract is ₱1,200,000. At contract inception, Metallica Co. estimates a total contract cost of
₱944,000. The actual costs incurred in 20x1 are ₱590,000. The estimated cost to complete on
December 31, 20x1 is ₱410,000. Progress billings during the year amount to ₱70,000, ₱60,000 of which
is collected.

4. At contract inception, Metallica Co. determines that its performance obligation in the contract is
a single performance obligation that is satisfied over time. Metallica Co. uses the cost-to-cost
method to measure its progress in the contract. How much is the profit recognized in 20x1?

5. Metallica Co.’s performance obligation in the contract is satisfied over time. However, the
outcome of the performance obligation cannot be measured reasonably but contract costs
incurred are recoverable. How much is the revenue recognized in 20x1?
 Page | 2

6. Metallica Co.’s performance obligation in the contract is satisfied at a point in time, i.e., when the
construction is completed and control over the promised good is transferred to the customer.
How much is the revenue recognized in 20x1?

7.
VALEDICTION Construction Co. entered into an ₱80M fixed price contract for the construction of a
private road for FAREWELL SPEECH, Inc. The performance obligation on the contract is satisfied
over time. VALEDICTION measures its progress on the contract using the “cost-to-cost” method.
The estimated total contract cost is ₱40M. VALEDICTION incurred the following costs in the first
year of the construction:

Costs of negotiating the contract (charged immediately as expense) 400,000

Costs of materials used in construction 12,000,000

Costs of materials purchased but not yet used in construction 2,000,000

Site labor costs 4,000,000
Site supervision costs 800,000
Depreciation of equipment used in construction 480,000
Depreciation of idle equipment not used in the contract 240,000
Costs of moving equipment and materials to and from the construction site 160,000
Costs of hiring equipment 560,000
Advance payment to subcontractor (the subcontracted work is not yet
started) 80,000

How much revenue is recognized in the first year of the contract?

Use the following information for the next two questions:

On July 1, 20x1, Contractor Co. enters into a contract with a customer for the construction of a
building. At contract inception, Contractor Co. assesses the contract in accordance with the
principles of PFRS 15 and concludes that it has a single performance obligation that is satisfied over
time. Contractor Co. then determines that the appropriate measure of its progress on the contract is
input method based on costs incurred. Information on the contract is shown below:

Contract price 600,000

Contract costs incurred during 20x1 120,000
Estimated remaining costs as of Dec. 31,
20x1 240,000
Billings to the customer during 20x1 180,000

Collections on billings during 20x1 60,000

8. What amount of revenue is recognized on the contract in 20x1?

9. What amounts are presented in Contractor Co’s. statement of financial position under <List A:
Traditional accounting> and <List B: PFRS 15>?
Gross amount due from (to) cust. Contract asset(liability)
a. (20,000) (20,000)
b. 20,000 20,000
c. 20,000 (20,000)
d. (40,000) (40,000)

10.
 Page | 3

In 20x1, Silverchair Co., a construction company, enters into a contract with a customer for the
construction of a building. The contract states a fixed fee of ₱8,700,000. Silverchair’s performance
obligation in the contract is satisfied over time. Silverchair uses the ‘cost-to-cost’ method in
measuring its progress in the contract. Information on the contract follows:

  20x1 20x2
Estimated total costs at completion 6,525,000 6,960,000
Percentage of completion 15% 65%

How much is the profit recognized in 20x2?

Use the following information for the next two questions:

In 20x1, Gorgeous Too Co. enters into a fixed-price construction contract with a customer. At
contract inception, Gorgeous Too Co. assesses its performance obligations in the contract and
concludes that it has a single performance obligation that is satisfied over time. Gorgeous Too Co.
determines that the measure of progress that best depicts its performance on the contract is input
method based on costs incurred.

Information on the contract follows:

  20x1 20x2
Cumulative contract costs incurred 2,250,000 4,800,000
Cumulative profits recognized 750,000 1,200,000
Progress billings 2,400,000 3,600,000
Collections on progress billings 2,000,000 4,000,000

The contract is completed in 20x2.

11. What amount of revenue is recognized in 20x2?

12. How much is the transaction price in the contract?

Use the following information for the next two questions:

In 20x1, ABC Co. was contracted to build a railroad. The contract price is equal to the construction
costs incurred plus 20% thereof. However, if the project is completed within 4 years, ABC will
receive an additional payment of ₱200,000. Information on the project is shown below:

  20x1 20x2 20x3

Costs incurred to date 2,400,000 4,575,000 6,125,000
Estimated costs to complete 3,600,000 1,525,000 125,000

In 20x1 and 20x2, it was not highly probable that the project will be completed on time. However, in
20x3, ABC assessed that the project will be completed earlier than originally expected and thus it is
now highly probable that the incentive payment will be received.

13. How much revenue is recognized on the contract in 20x3?

14. How much profit is recognized on the contract in 20x3?

Use the following information for the next two questions:

In 20x1, Salamagi Co. entered into a contract with a customer. The contract stipulates the following:
● Contract price of ₱20,000,000
 Page | 4

● 5% mobilization fee due upon signing of the contract, to be deducted from the final billing
● 10% customer retention on all subsequent progress billings, to be paid to Salamagi on
completion of the project

Salamagi Co. estimated a ₱5,000,000 gross profit from the project. The percentage of completion
method will be used. In 20x1, Salamagi billed the customer for 50% completion of the project. The
customer accepted all the billings, except one for 10% which was accepted on January of the
following year. All the accepted billings were collected during the year except an 8% billing which
was due January of the following year.

15. What is the amount of profit recognized from the contract in 20x1?

16. What is the total amount of collections from the billings in 20x1?

Use the following information for the next two questions:

In November 20X2, an entity contracts with a customer to refurbish a 3-storey building and install
new elevators for a total consideration of ₱5,000,000. The promised refurbishment service, including
the installation of elevators, is a single performance obligation satisfied over time. Total expected
costs are ₱4,000,000, including ₱1,500,000 for the elevators. The entity determines that it acts as a
principal because it obtains control of the elevators before they are transferred to the customer.

A summary of the transaction price and expected costs is as follows:

Transaction price ₱5,000,000

Expected costs:
Elevators ₱1,500,000
Other costs 2,500,000
Total expected costs ₱4,000,000

The entity uses an input method based on costs incurred to measure its progress towards complete
satisfaction of the performance obligation. The customer obtains control of the elevators when they
are delivered to the site in December 20X2, although the elevators will not be installed until June
20X3. The costs to procure the elevators are significant relative to the total expected costs to
completely satisfy the performance obligation. The entity is not involved in designing or
manufacturing the elevators.

As of December 31, 20X2, the entity has incurred total costs of ₱500,000, excluding the cost of the
elevators.

17. How much revenue is recognized in 20X2?

18. How much profit is recognized from the contract in 20X2?

19.
An entity, a construction company, enters into a contract to construct a commercial building for a
customer, on customer-owned land, for a promised consideration of ₱1 million and a bonus of
₱200,000 if the building is completed within 24 months. The entity accounts for the promised bundle
of goods and services as a single performance obligation satisfied over time because the customer
controls the building during construction. At the inception of the contract, the entity expects the
following:
Transaction price ₱1,000,000
 Page | 5

Expected costs 700,000

Expected profit (30%) 300,000

At contract inception, the entity does not expect to receive the bonus because it cannot conclude that
it is highly probable that a significant reversal in the amount of cumulative revenue recognized will
not occur. Completion of the building is highly susceptible to factors outside the entity’s influence,
including weather and regulatory approvals. In addition, the entity has limited experience with
similar types of contracts.

The entity determines that the input measure, on the basis of costs incurred, provides an appropriate
measure of progress towards complete satisfaction of the performance obligation.

Information as of the end of the first year is as follows:

Costs incurred to date ₱420,000
Total expected costs ₱700,000

The entity reassesses the variable consideration and concludes that the amount is still constrained.

In the first quarter of the second year, the parties to the contract agree to modify the contract by
changing the floor plan of the building. As a result, the fixed consideration and expected costs
increase by ₱150,000 and ₱120,000, respectively. In addition, the allowable time for achieving the
₱200,000 bonus is extended by 6 months to 30 months from the original contract inception date. At
the date of the modification, on the basis of its experience and the remaining work to be performed,
which is primarily inside the building and not subject to weather conditions, the entity concludes
that it is highly probable that including the bonus in the transaction price will not result in a
significant reversal in the amount of cumulative revenue recognized. In assessing the contract
modification, the entity concludes that the remaining goods and services to be provided using the
modified contract are not distinct from the goods and services transferred on or before the date of
contract modification; that is, the contract remains a single performance obligation.

How much is the cumulative catch-up adjustment to revenue recognized on the date of contract
modification? (round-off percentage of completion to one decimal place only)

20.
ABC Co. started work on a construction contract in 20x1. The contract price is ₱10M. However, the
contractual agreement stipulates that if the cumulative inflation reaches or exceeds 26%, the contact
price shall be adjusted upwards by 10%. Additional information on the contract is shown below:
  20x1 20x2
Costs incurred to date 2,400,000 4,500,000
Estimated costs to complete 3,600,000 1,500,000
Cumulative inflation rate 18% 27%

How much is the profit recognized in 20x2?

21. PFRS 15 requires how many steps in recognizing revenue from contracts with customers?

22. Which of the following is not within the criteria required in ‘Step 1: Identify the contract with the
customer’ of PFRS 15?
a. The contract is approved by the contracting parties, either in writing, orally or implied in
customary business practices.
b. The rights of each of the contracting parties and the payment terms are identifiable.
 Page | 6

c. The contract has commercial substance.

d. There is a significant uncertainty in the collectability of the consideration in the contract.

23. The consideration received on a contract with a customer that does not meet the criteria under
‘Step 1’ of PFRS 15 is
a. recognized as liability.
b. recorded through memo entry only.
c. disclosed only.
d. b and c

24. According to PFRS 15, a good or service is distinct if

I. the customer can benefit from it, either on its own or together with other resources that are
readily available to the customer
II. the good or service is separately identifiable.
a. True, True
b. True, False
c. False, True
d. False, False

25. An entity, a movie distribution company, licenses Movie XYZ to a customer. The customer, an
operator of cinemas, has the right to show the movie in its cinemas for six weeks. In exchange for
providing the license, the entity will receive a portion of the operator’s ticket sales for Movie
XYZ. Which of the following statements is incorrect?
a. The only performance obligation in the contract is the promise to grant the license.
b. The fact that the performance obligation in the contract is satisfied over time or at a point in
time is irrelevant when determining how revenue is recognized on the contract.
c. The transaction price is a variable consideration.
d. The entity shall estimate the variable consideration, subject the estimate to the “constraining’
principle of PFRS 15, and recognize the resulting amount at the point in time when the
license is transferred to the customer.

26. On Nov. 1, 20x1, DRINK Co. entered into a franchise contract with TIPPLE Co. The franchise
agreement requires an initial franchise fee that is payable as follows: 20% down payment at the
signing of the contract, and the balance due in four equal annual payments starting November 1,
20x2. The license period is 4 years. The franchise contract requires DRINK Co. to undertake
pre-opening activities necessary to setup the contract and post-opening activities that would
further improve the intellectual property to which the franchisee has rights. All the preopening
activities are completed, and TIPPLE Co. started operations, on January 31, 20x2. How should
DRINK Co. recognize revenue from the initial franchise fee?
a. The sum of the cash down payment and the present value of the deferred balance are
recognized as revenue in full on January 31, 20x1.
b. The sum of the cash down payment and the present value of the deferred balance are
recognized as revenue over the license period.
c. The cash down payment is recognized in full on January 1, 20x2 but the balance is amortized
over the license period.
d. The cash down payment is recognized in full on January 31, 20x2 but the balance is
amortized over the license period.

27. On December 1, 20x1, CANOROUS Co. granted a 5-year franchise right to MELODIOUS, Inc. for
an initial franchise fee of ₱400,000 and a 10% sales-based royalty. The initial franchise fee is
non-refundable and due upon signing of the contract. At contract inception, CANOROUS
determines that the nature of its promise to grant the license is to provide the customer with the
right to access CANOROUS’s intellectual property as it exist throughout the license period. As
of December 31, 20x1, CANOROUS has no remaining obligation or intent to refund any of the
 Page | 7

cash received, all the initial services necessary to setup the contract have been performed, and
MELODIOUS started operating the franchised business. MELODIOUS reported sales of ₱800,000
for 20x1. How much revenue shall CANOROUS recognize in 20x1? (rounded to the nearest
peso)

JOURNAL ENTRIES:
Use the following information for the next three questions:
On January 1, 20x1, Sunbathe Co. entered into a contract with a customer to transfer a license.
● The initial franchise fee is ₱100,000 payable as follows: 20% cash down payment upon signing of
the contract and the balance is payable in 4 equal annual installments starting December 31,
20x1. The appropriate discount rate is 12%.
● The contract states that the initial franchise fee consists of ₱30,000 consideration for the
equipment that Sunbathe Co. will transfer to the customer and the ₱70,000 balance for the
franchise rights.
● Sunbathe Co. regularly sells the equipment and the license separately. The stand-alone selling
prices are ₱40,000 for the equipment and ₱38,000 for the license.
● The license provides the customer the “right to use” Sunbathe’s intellectual property as it exists at
the point in time at which the license is granted.
● The equipment is transferred to the customer on January 15, 20x1, while the license is transferred
to the customer on February 1, 20x1.

28. The journal entry on Jan. 1, 20x1 includes credit to Contact Liability account amounting to?
(Sunbathe Co. uses an ’Unearned interest income’ account.)

29. The journal entry on Jan. 15, 20x1 includes credit to Revenue account amounting to? (Sunbathe
Co. recognizes interest income only at year-end.)

30. The journal entry on February 1, 20x1 includes debit to Contact Liability account amounting to?

“Come to Me, all you who labor and are heavy laden, and I will give you rest.” (Matthew 11:28)
- END -
 Page | 8

ANSWERS:
1. D
2. D
3. D
4.
Solution:

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

5. 590,000 – equal to the costs incurred during the year

6. 0 – no revenue is recognized until the project is completed and turned over to the customer

7.
Solution:
Costs of materials used in construction 12,000,000
Site labor costs 4,000,000
Site supervision costs 800,000
Depreciation of equipment used in construction 480,000
Costs of moving equipment and materials 160,000
Costs of hiring equipment 560,000

Contract costs incurred to date 18,000,000

Divide by: Estimated total contract costs 40,000,000
Percentage of completion 45%
Multiply by: Contract price 80,000,000
Revenue in first year 36,000,000

8.
Solution:
Total contract price 600,000
Multiply by: Percentage of completion (a) 33 1/3%
Revenue to date 200,000
Less: Revenue recognized in previous yrs. -
Revenue for the year 200,000

(a)
Costs incurred to date (1) 120,000
Estimated costs to complete 240,000
Estimated total contract costs (2) 360,000
Percentage of completion (1) ÷ (2) 33 1/3%

9. B
Solution:
 Page | 9

⮚ Traditional accounting:
Construction in progress
Costs
incurred 120,000  
Gross profit
(b)
80,000  
12/31/x1 200,000  

(b)
Revenue for the year (see previous
solution) 200,000

Cost incurred during 20x1 (120,000)

Gross profit - 20x1 80,000

Construction in progress 200,000

Progress billing 180,000

Gross amount due from customer 20,000

⮚ PFRS 15:
Contract liability
180,00 Progress
0 billing
Revenue in 20x1 (see prev. 200,00
sol.) 0
Debit balance - Asset 20,000

10.
Solution:
  20x1 20x2
Contract price 8,700,000 8,700,000
Estimated total costs at completion (6,525,000) (6,960,000)
Expected total gross profit 2,175,000 1,740,000
Percentage of completion 15% 65%
Profit to date 326,250 1,131,000
Profit in prior yr. (326,250)
Profit for the yr. 326,250 804,750
 Page | 10

11.
Step 1: Pro-forma computation
  20x1 20x2
Revenue to date ? ?
Contract costs incurred to date (2,250,000) (4,800,000)
Profit to date 750,000 1,200,000
Profit in previous years - (750,000)
Profit for the year ? ?

Step 2: ‘Squeeze’ for the missing information

  20x1 20x2
Revenue to date 3,000,000 6,000,000
Contract costs incurred to date (2,250,000) (4,800,000)
Profit to date 750,000 1,200,000
Profit in previous years - (750,000)
Profit for the year 750,000 450,000

Step 3: Compute for the requirement

Revenue to date in
20x2 6,000,000
Revenue to date in
20x1 (3,000,000)

Revenue in 20x2 3,000,000

12. Since the contract is 100% complete in 20x2, the transaction price must be equal to the ‘revenue
to date in 20x2’ of ₱6,000,000 (see previous solution).

13.
Solution:
  20x1 20x2 20x3
Costs incurred to date (a) 2,400,000 4,575,000 6,125,000
Estimated costs to complete 3,600,000 1,525,000 125,000
Estimated total contract costs (b) 6,000,000 6,100,000 6,250,000
Multiply by: Cost + Var. fee 120% 120% 120%
Total 7,200,000 7,320,000 7,500,000
Incentive payment 200,000
Estimated total contract price 7,200,000 7,320,000 7,700,000
Multiply by: % of completion (a) ÷ (b) 40% 75% 98%
Revenue to date 2,880,000 5,490,000 7,546,000
Less: Revenue in prior yrs. - (2,880,000) (5,490,000)
Revenue for the year 2,880,000 2,610,000 2,056,000
Cost of construction (1) (2,400,000) (2,175,000) (1,550,000)
Gross profit for the year 480,000 435,000 506,000
 Page | 11

(1)
The costs incurred each year are computed as follows:
20x1: 2.4M costs incurred to date – 0 costs incurred in previous yrs. = 2.4M
20x2: 4.575M – 2.4M = 2.175M
20x3: 6.125M – 4.575 = 1.55M

14. 506,000 – see solution in preceding question

15. Solution:
  20x1
Expected gross profit (given)
5,000,000
Multiply by: % of completion
50.00%
(given)
Profit to date
2,500,000
Profit in previous years
-
Profit for the year
2,500,000

16. Solution:
Collection from mobilization fee (20M x 5%) 1,000,000

Unadjusted progress billings (20M x 50%) 10,000,000

Billing not accepted in 20x1 (20M x 10%) (2,000,000)
Billing due in the following yr. (20M x 8%) (1,600,000)
Adjusted progress billings 6,400,000
Multiply by: (100% - 10% retention) 90%
Collections from progress billings 5,760,000
Total collections in 20x1   6,760,000

17.
Solution:
Control over the elevators is already transferred to the customer (as stated in the problem). However, the
incurrence of the cost of the elevators does not properly reflect the percentage of completion of the
contract because the elevators are not yet installed. Accordingly, 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 20X2 will also include this cost. As a result, the entity recognizes zero profit from the
elevators in 20X2.

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

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

18.
Solution:
Cost of goods sold in 20X2:
[(2.5M ‘other costs’ only, excluding the costs of elevators) x 20%] + 1.5M costs of elevators = ₱2,000,000
cost of goods sold in 20X2

Profit in 20X2 = 2.2M revenue in 20x2 – 2M = ₱200,000

 Page | 12

Or
(5M transaction price – 1.5M cost of elevator) x 20% = 700K revenue excluding elevator – 500K costs
excluding elevator = 200K

19.
Solution:
  20x1 20x2
Original contract price 1,000,000 1,000,000
Bonus - 200,000
Contract modification 150,000
Total 1,000,000 1,350,000
Percentage of completion (a) 60% 51.20%
Revenue to date 600,000 691,200
Revenue in prior yr. (600,000)
Revenue for the year 600,000 91,200

 (a) 20x1 20x2

Costs incurred to date 420,000 420,000
Total expected costs 700,000 820,000(b)
Percentage of completion 60% 51.20%

(b)
700,000 + 120,000 increase due to contract mod. = 820,000

20.
Solution:
    20x1 20x2  
Total contract price 10,000,000 11,000,000 *
(a) Costs incurred to date 2,400,000 4,500,000  
Estimated costs to complete 3,600,000 1,500,000
(b
) Estimated total contract costs 6,000,000 6,000,000  
Expected profit (loss) 4,000,000 5,000,000
Multiply by: % of completion (a) ÷
(b) 40% 75%
  Profit (loss) to date 1,600,000 3,750,000  
Profit recognized in prior
years - (1,600,000)
  Profit (loss) for the year 1,600,000 2,150,000  
*10M initial contract price x 110%, including the cost escalation.

21. 5
22. D
23. A
24. A
25. D Regardless of whether a license provides the customer the ‘right to access’ or ‘right to use’,
revenue from a sales-based (or usage-based) royalty is recognized when the sales (usages) occur,
so long as the license is already effectively transferred to the customer.
 Page | 13

26. B
27. [(400,000 ÷ 5 yrs.) x 1/12] + (800,000 x 10%) = 86,667

28.29.30
Solution:

Step 2:
The license and the equipment are individually distinct. This is evidenced by the fact that the two
are sold separately.
The grant of license is satisfied at a point in time. This is evidenced by the fact that the
customer has the “right to use” Sunbathe’s intellectual property.
The transfer of equipment is also satisfied at a point in time.

Step 3:
The transaction price is computed as follows:

Cash down payment (100,000 x 20%) 20,000

PV of note receivable:
[(100K x 80%) ÷ 4] x PV of ordinary annuity @12%, n=4 60,747
Transaction price 80,747

Step 4:
The stated considerations of ₱30,000 for the equipment and ₱70,000 balance for the franchise rights
do not reflect the stand-alone selling prices of ₱40,000 and ₱38,000, respectively. This may be, in part,
of the fact that the customer is provided a significant benefit of financing the transfer of the goods
and services.
Accordingly, the ₱80,747 transaction price is allocated to the equipment and license on the
basis of their stand-alone selling prices. The allocation is done as follows:

Performance Stand-alone selling

obligations prices Allocation As allocated
Equipment 40,000 (80,747 x 40K/78K) 41,409
License 38,000 (80,747 x 38K/78K) 39,338
Totals 78,000 80,747

Step 5:
The ₱41,409 amount is recognized as revenue on Jan. 15, 20x1 when the customer obtains the
equipment, while the ₱39,338 amount is recognized as revenue in full on Feb. 1, 20x1 when the
customer obtains the license.

Journal entries:
Jan. 1, 20x1 Cash on hand 20,000
Note receivable 80,000
Contract liability 80,747
Unearned interest income 19,253
Jan. 15, 20x1 Contract liability 41,409
Revenue 41,409

Feb. 1, 20x1 Contract liability 39,338

Revenue 39,338