Question

During 2019, ABC Construction company changed from the cost-recovery method to the percentage-of-completion method for accounting purposes but not for tax purposes. Gross profit figures under both methods for the past three years appear below:

                           Cost-Recovery           Percentage-of-Completion

2017                      $   475,000                        $   900,000

2018                           625,000 1,050,000

2019                           700,000     1,050,000

                              $1,800,000 $3,000,000

Assuming an income tax rate of 40% for all years.

the effect of this accounting change on prior periods should be reported by a credit of...........

Select one:

a. $510,000 on the 2019 retained earnings statement

b. $720,000 on the 2019 income statement

c. $720,000 on the 2019 retained earnings statement

d. $510,000 on the 2019 income statement

Answer 1

	Answer:
	Year	Cost recovery	% of compeltion
	2017	4,75,000.00	$    9,00,000.00
	2018	6,25,000.00	$ 10,50,000.00
	Total	11,00,000.00	19,50,000.00
	Increase in profit		$    8,50,000.00
	Less: Tax @ 40%		$ -3,40,000.00
	Net income after tax	$    5,10,000.00
	When there is a change in method of revenue recognition, the effect of profit/loss from the change in the method should be given effect to income statement.
	i.e. due to change of method from cost-recovery to percentage of completion method,ABC construction company's gross profit increased from 11 lacs to 19.50 lacs, i.e. 8.50 lacs increase, i.e. Net profit after tax of 5.10 lacs, need to given effect to income statment
	Answer is Option-d