Question

When revenues, costs and gross profit are recognized at the completion of the contract rather than periodically throughout the contract:

a) Costs are higher and gross profit is lower

b) Either method results in the same revenues, costs and gross profits being recognized by the end of the project.

c) Revenues are higher and gross profit is lower

d) Revenues and gross profit are higher

What is the relationship between Construction-in-progress (CIP) and the Billings on Construction Contract account?

a) Billings is contra to CIP and reduces the balance of the CIP account.

b) CIP is contra to accounts receivable and reduces the balance of the accounts receivable account.

c) CIP is an equity account and Billings is a liability.

d) Billings is an inventory account and CIP is a financial asset, like Accounts Receivable.

Answer 1

As per the guidance provided for construction contracts, the significant features of completion of contract method are as follows :

1. Applicable overhead and direct costs should be charged to total costs thus, leading to a higher contract cost.
2. Billings and/or cash received should be adjusted advances on construction in progress account leading to lower in hand revenues hence lower gross profits.
3. At completion of the contract, gross profit or loss is recognized as follows:
Contract price - Total costs = Gross profit or loss where the total costs also includes extra and over budget costs, costs of improvements, repairs and replacements and other overheads, also the escalation clause, while the contract price is assumed to be same at the beginning of the contract. therefore, leading to lower gross profits.

4. At interim balance sheet dates, the excess of either the construction in progress account or the advances account over the other is classified as a current as current liability. It is classified as current because of the current operating cycle Concept

5. Losses should be recognized in full in the year they are discovered.

Keeping in mind the above points it's quite evident that the revenue is normally considered as the initial contract price, the costs a definately higher as it also includes escalations and other overheads and the overall gross profit is on the lower side. therefore the answer seems to be point a.

Ans 2. Construction in progess is an account that is similar to work in progress account, whre the projects in which the construction is ongoing are recorded. Considering all the costs incurred, the labor and material and overheads utilised and adding a suitable margin the total cost is then recorded in it. The account has the nature of an asset.

Once the acitvity recorded under the CIP account is completed and ready to be billed, billings on construction account is created which is nothing but the billed portion of completed works.

Therefore, the balance of CIP is lowered and Billings goes up once the projects are billed. Therefore these two accounts are contra to each other. the increase in billings would lower the balance of CIP so the answer can be (a).