Question

Case Summary

Austin, Texas has undergone a tremendous population growth over the past few years. Builders cannot construct housing fast enough. Squirrelly Builders has just contracted with SK Renting Company to build an apartment complex. The job is expected to take a year and a half to finish, with an estimated cost of 2.5 million dollars and, per the contract, a promised consideration of 3.125 million dollars (a 25% profit), with a bonus of $150,000 if the job is completed on schedule.

By the end of the first year, Squirrelly Builders had spent 1.62 million dollars on construction and estimated the total cost of the completed job to be 2.7 million dollars. The company was unsure if it would complete the job in time to collect the bonus, but was trying diligently to meet the schedule.

In the first month of the second year, SK Renting Company and Squirrelly Builders agreed upon the following modifications:

The flooring would be switched from carpeting to tile and the apartments would be upgraded to have deluxe closets and bathrooms, including whirlpool tubs. This required modifications of the currently installed bathrooms and closets. The two companies agreed that this modification would cause the total time of the project to increase to 26 months. It was agreed that Squirrelly Builders would still be given the $150,000 bonus if the project were completed in that amount of time. It was estimated by Squirrelly Builders that this would add $200,000 to the construction cost. The promised consideration was increased by $250,000 for this modification.

SK Renting Company also contracted Squirrelly Builders to construct a recreation room with an indoor heated pool and tub. This additional building was to be in an area originally designated for green space. It was decided the roof of the building should be an outdoor garden so that the residents would still have an area where they could go to relax. It was estimated that this building would take 15 months to construct, at a cost of $350,000. SK Renting Company agreed to pay Squirrelly Builders $437,500 for the building.

At the end of the second year, the following data were available:

	Apartment--Original Design	Apartment--Modification	Recreation Room/Pool/Spa/Garden
Total Cost to Date	$2,700,000	$160,000	$270,000
Estimated Additional Cost to Complete	0	$40,000	$80,000

At that time, Squirrelly Builders was finishing the modifications inside the apartments and is certain it will complete the project on schedule.

Required

Providing relevant support from the FASB ASC, discuss the proper accounting treatment for the revenue generating activities. More specifically, at what point(s) in time should revenue be recognized, for what amount(s), to which accounts, and why? (Your answer should provide this information for years 1 and 2).

Answer 1

It should be noted that revenue on construction contract is recognized on percentage of completion method i.e. contract value x percentage of contract completed

Percentage of contract completed = total cost incurred till date/total estimated cost.

Also if company is executing multiple contract and separate contract has been executed for multiple contract and separate contract value s can be identified in that case revenue on multiple contracts is to be recognised separately.

Also if there is any modification in the original contract then such modifications shall also be incorporated.

In the present case let us divide the discussion of revenue to be recognised recognized for two years.

Year 1 . In the first year we have percentage completion = cost incurred till date/total estimated cost

=1620000/2700000=60%

Total revenue to be recognized=contract value x percentage completed

=$3125000x60% = $1875000

Contract cost = $1620000

Contract profit = $255000.

It should be noted that achieving bonus is quite uncertain considering percentage of contract completed i.e. 60% and total time remianing i.e. 6 months thus bonus amount should not be recognized.

Year 2. For year 2 there has been some modifications in the contract leading to enhancement of contract value and cost.

Now percentage of completion for apartment incincluding modifications = 2860000/2900000 = 98.62%.

Thus amount to be recognized = new contract value x percentage completed

=3375000x98.62%=$3328425.

Also bonus achievement is looking quite certain now thus we can also recognize bonus amount of $150000.

In case of recreation spa pool etc

Percentage completed = 270000/350000=77.14%

Revenue to be recognized= 437500x77.14% =337490.

Thua total revenue to be recognized for 2 ND year = $3328425+$150000+$337490=$2815915.