Question

On January 1, 2018 The Village of Port Jefferson engaged to Frog Construction company to construct a municipal office complex. The three-year a to receive 10 million in cash payments from the city in three installments: 25% when the project was 30% complete; 25% when the project was 60% complete; and50% when the project was fully complete. The contract required that Frog's completion estimates be certified by an independent consultant before payments were made.

During the first year of the contract, Frog completed 30% of the contract and incurred costs of 2,490,000. During the second year, the project was certified as being 60% complete and Frog incurred costs of 3,100,000.
During the third year, Frog completed the project and incurred costs of 3,110,000.

Assuming Frog had no other revenues or expenses, determine the profit on construction for 2018, 2019, and 2020 under the following methods:

1. Percentage of Completion'

2. Completed Contract

3. Which method best represents the profitability of Frog from 2018 to 2020.

Answer 1

1) Percentage Completion Method :

Gross Profit/(Loss) for the year 2018
	To date	Recognized in prior year	Recognized in 2018
Constuction Revenue ($10000000*30%)	$3,000,000	$0	$3,000,000
Constuction Expense	$2,490,000	$0	$2,490,000
Gross Profit (Loss)	$510,000	$0	$510,000

Gross Profit/(Loss) for the year 2019
	To date	Recognized in prior year	Recognized in 2019
Constuction Revenue ($10000000*60%)	$6,000,000	$3,000,000	$3,000,000
Constuction Expense	$5,590,000	$2,490,000	$3,100,000
Gross Profit (Loss)	$410,000	$510,000	($100,000)

Gross Profit/(Loss) for the year 2020
	To date	Recognized in prior year	Recognized in 2020
Constuction Revenue ($10000000*100%)	$10,000,000	$6,000,000	$4,000,000
Constuction Expense	$8,700,000	$5,590,000	$3,110,000
Gross Profit (Loss)	$13,00,000	$410,000	$890,000

2) Completed Contract Method :

Year	Revenue Recognition	Gross Profit/(Loss) Recognized
2018	$0	$0
2019	$0	$0
2020	$10,000,000	$1,300,000

There is no difference is total profit under both method.

The percentage of completion method is easier to plan for and stabilizes company cash flow.

The completed contract method is unique, in that it allows all revenue and expense recognition to be deferred until the completion of a contract. Revenue recognition is postponed, tax liabilities are also postponed, in kind. Expense recognition, which can reduce taxes, is likewise delayed.

So we can conclude that completed contract method is more beneficial as corporate mostly wants to postpone their tax liability.