Question

Cornwell Construction Company has been operating in Pennsylvania for a
Cornwell Construction Company has been operating in Pennsylvania for a number of years. During 2019, the firm contracted with the Borough of Lewisburg to build a domed sports complex. Cornwell estimated that it would take three years to complete the facility at a total cost of $25 million. The total contract price was $30 million. During 2019, construction costs of $8 million were incurred related to the sports complex; estimated additional costs to complete the project were $16 million as of December 31, 2019. Contract billings through December 31, 2019, were $9 millions of which the Borough of Lewisburg had paid $7.5 million

1. Determine the amount of revenue and income to be recognized by Cornwell Construction on the sports complex for the year ended December 31, 2019, assuming it recognizes revenue over time and uses costs incurred to measure the extent to which its performance obligation has been satisfied.

2. Determine the amount of revenue and income to be recognized by Cornwell Construction on the sports complex for the year ended December 31, 2019, assuming it recognizes revenue at a point in time when control of the completed complex is transferred to the Borough of Lewisburg

3. How should Cromwell determine which of the two approaches is appropriate?

Answer 1

1) As the company recognizes revenue over time and uses costs incurred to measure the extent to which its performance obligation has been satisfied, it means that the company uses percentage completion method for recognizing revenue over contract period.

First of all, we need to calculate the percentage of completion during the year ended December 31, 2019 which is calculated as follows:-

Percentage of completion = (Cost incurred during 2019/Total estimated cost)*100

Cost incurred during 2019 = $8 million

Additional cost estimated to incurred during contract period = $16 million

Total Estimated cost for the contract = Cost incurred during 2019+Additional cost estimated

= $8 million+$16 million = $24 million

Percentage of completion = ($8 million/$24 million)*100 = 33.33% (or 1/3)

Revenue to be recognized during 2019 should be 1/3rd of total contract price

Revenue recognized in 2019 = 1/3 of $30 million = $10 million

Income to be recognized in 2019 = Revenue recognized - Cost incurred

Income to be recognized in 2019 = $10 million - $8 million = $2

2) As the company recognizes revenue at a point in time when control of the completed complex is transferred to the Borough of Lewisburg, it means that the company uses completed contract method for recognizing revenue.

Under completed contract method, revenue is recognized when contract is completed. Therefore no revenue and income will be recognized for the year ended December 31, 2019 as contract is not completed.

3) According to Matching principle of accounting, expenses are to be recognized in income statement in the same period as the related revenues. As the expenses on construction are incurred during the whole contract period, its related revenue should also be recognized over the contract period according to percentage completion method to provide a true and fair view of financial statements.

Therefore, the first approach adopted by the Cromwell is appropriate (i.e. percentage completion method).