Question

Required

   (a)       Using the above data, compute the gross profit to be recognised for each of the three years, assuming that the outcome of the contract can be reliably estimated.  

   (b)   Prepare the journal entries for the 2015 financial year using the percentage-of-completion method.

   (c)   Prepare the journal entries for the 2015 financial year, assuming the stage of completion cannot be reliably assessed.

Sun City Limited commences construction of a multi-purpose water park on 1 July 2014 for Pretoria Limited. Sun City Limited signs a fixed-price contract for total revenues of $50 million. The project is expected to be completed by the end of 2017 and Pretoria Limited controls the asset throughout the period of construction. The expected cost as at the commencement of construction is $38 million. The estimated costs of a construction project might change throughout the project—in this example, they do change. The following data relates to the project (the financial years end on 30 June): Required (a) Using the above data, compute the gross profit to be recognised for each of the three years, assuming that the outcome of the contract can be reliably estimated.   (b) Prepare the journal entries for the 2015 financial year using the percentage-of-completion method. (c) Prepare the journal entries for the 2015 financial year, assuming the stage of completion cannot be reliably assessed.

Answer 1

Part A Gross profit

2015

Contract price 50

Less: estimated cost

- cost to date 10

- estimated cost to complete 28

Total estimated cost 38

Estimated total gross profit 12

Percentage complete (10/38)=26.32%

Gross profit recognised = 12000000*26.32% = 3158400

2016

Contact price 50

Less: estimated costs

- cost to date 28

- estimated cost to complete 12

Estimated total costs 40

Estimated total gross profit 10

Percentage complete (28/40)= 70%

Gross profit recognized = (10000000*70%)-3158400= 3841600

2017

Contact price 50

Less: estimated costs

- cost to date 40

- estimated costs to complete 0

Estimated total costs 40

Estimated total gross profit 10

Percentage complete (40/40)= 100%

Gross profit recognized= (10000000*100%)-3158400-3841600= 3000000

PART B

Journal entries

Dr. Construction in progress (Contract asset)10000000

Cr. Materials, cash, payables, accumulated depreciation etc.10000000

(to recognise the costs associated with the contract)

Dr. Construction in progress (Contract asset) 3158400

Dr. Construction expenses (Statement of comprehensive income) 10000000

Cr. Revenue from long-term contract (statement of comprehensive income) 13158400

(for the year, and based on the percentage of completion, 26.32% of the project has been completed. 26.32% of the total expected revenue of $50000000 is $13158400)

Dr. Accounts receivable 12000000

Cr. Construction in progress (Contract asset) 12000000

(amount payable unconditionally by the customer. Part of the contract asset is reclassified to an accounts receivable)

Dr. Cash 11000000

Cr. Accounts receivable 11000000

(amount received from customer)

Part C

Dr. Construction in progress (Contract asset)10000000

Cr. Materials, cash, payables, accumulated depreciation etc. 10000000

(to recognise the costs associated with the contract)

Dr. Construction expenses 10000000

Cr. Revenue from long-term contract 10000000

(because the stage of completion is not clear, revenue recognition is restricted to the amount of cost incurred)

Dr. Accounts receivable 12000000

Cr. Construction in progress (Contract asset) 12000000

(amount payable unconditionally by the customer. Part of the contract asset is reclassified to an accounts receivable. This entry now means that the contract asset will have a credit balance of $2 million meaning that a subsequent entry will be required to create a contract liability)

Dr. Cash 11000000

Cr. Accounts receivable 11000000

(amount received from customer)

Dr. Construction in progress (Contract asset) 2000000

Cr. Contract liability—excess of the amount received from the customer over performance completed 2000000

(this is an adjustment to reclassify the balance of the contract asset to a contract liability given that the amount billed to the customer exceeds the cost of the work completed to date)