Question

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):

	2015 ($m)	2016 ($m)	2017($m)
Costs for the year	10	18	12
Costs incurred to date	10	28	40
Estimated costs to complete	28	12	–
Progress billings during the year	12	20	18
Cash collected during the year	11	19	20

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 for the three years

	2015 ($ m)	2016 ($ m)	2017 ($ m)
Contract price	50	50	50
Less: estimated costs
- Costs to date	10	28	40
-estimated costs to complete	28	12	-
-estimated total costs	38	40	40
Estimated total gross profit	12	10	10
Percentage complete (%)	26.32 (10/38)	70.00 (28/40)	100.00 (40/40)

Gross profit recognised in:

		2015	2016	2017
2015	(12000000*26.32%)	3158400
2016	(10000000*70%)		7000000
	Less: gross profit already recognised		3158400
	Gross profit in 2016		3841600
2017	(10000000*100%)			10000000
	Less : gross profit already recognised			7000000
	Gross profit in 2017			3000000

The sum of the profits recognised in each year equals $10000000($3158400 + $3841600 + $3000000), which is the total profit of the contract.

Part B

Account titles and explanation	debit	credit
Construction in progress (contact asset)	10000000
Materials, cash payables, accumulated depreciation, etc.		10000000
(to recognize the costs associated with the contract)
Construction in progress (contract asset)	3158400
Construction expenses	10000000
Revenue from long-term contract		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)
Accounts receivable	12000000
Construction in progress (contract asset)		12000000
(amount payable unconditionally by customers. Part of contract asset reclassified to accounts receivable)
Cash	11000000
Accounts receivable		11000000
(amount received from the customer)

Part C

Account titles and explanation	debit	credit
Construction in progress (contract asset)	10000000
Materials, cash payable and Accumulated depreciation, etc.		10000000
(to recognize the costs associated with the contract)
Construction expenses	10000000
Revenue from long-term contract		10000000
(because the stage of the completion is not clear, revenue recognised is restricted to cost incurred)
Accounts receivable	12000000
Construction in progress (contract asset)		12000000
(amount payable unconditionally by the customers. Part of contract asset reclassified to accounts receivable)
Cash	11000000
Accounts receivable		11000000
(amount received from the customer)
Construction in progress (contract asset)	2000000
Contract liability - excess of the amount received from the customer		2000000