Question

Citation Builders, Inc., builds office buildings and single-family homes. The office buildings are constructed under contract with reputable buyers. The homes are constructed in developments ranging from 10–20 homes and are typically sold during construction or soon after. To secure the home upon completion, buyers must pay a deposit of 10% of the price of the home with the remaining balance due upon completion of the house and transfer of title. Failure to pay the full amount results in forfeiture of the down payment. Occasionally, homes remain unsold for as long as three months after construction. In these situations, sales price reductions are used to promote the sale.

During 2018, Citation began construction of an office building for Altamont Corporation. The total contract price is $13 million. Costs incurred, estimated costs to complete at year-end, billings, and cash collections for the life of the contract are as follows:

	2018				2019				2020
Costs incurred during the year	$	2,600,000			$	6,175,000			$	2,925,000
Estimated costs to complete as of year-end		7,800,000				2,925,000				—
Billings during the year		1,300,000				6,500,000				5,200,000
Cash collections during the year		1,170,000				5,030,000				6,800,000
Also during 2018, Citation began a development consisting of 12 identical homes. Citation estimated that each home will sell for $680,000, but individual sales prices are negotiated with buyers. Deposits were received for eight of the homes, three of which were completed during 2018 and paid for in full for $680,000 each by the buyers. The completed homes cost $510,000 each to construct. The construction costs incurred during 2018 for the nine uncompleted homes totaled $3,060,000. Required: 1. Which method is most equivalent to recognizing revenue at the point of delivery? 2. Answer the following questions assuming that Citation uses the completed contract method for its office building contracts: 2-a. How much revenue related to this contract will Citation report in its 2018 and 2019 income statements? 2-b. What is the amount of gross profit or loss to be recognized for the Altamont contract during 2018 and 2019? 2-c. What will Citation report in its December 31, 2018, balance sheet related to this contract? (Ignore cash.) 3. Answer the following questions assuming that Citation uses the percentage-of-completion method for its office building contracts. 3-a. How much revenue related to this contract will Citation report in its 2018 and 2019 income statements? 3-b. What is the amount of gross profit or loss to be recognized for the Altamont contract during 2018 and 2019? 3-c. What will Citation report in its December 31, 2018, balance sheet related to this contract? (Ignore cash.) 4. Assume the same information for 2018 and 2019, but that as of year-end 2019 the estimated cost to complete the office building is $5,850,000. Citation uses the percentage-of-completion method for its office building contracts. 4-a. How much revenue related to this contract will Citation report in the 2019 income statement? 4-b. What is the amount of gross profit or loss to be recognized for the Altamont contract during 2019? 4-c. What will Citation report in its 2019 balance sheet related to this contract? (Ignore cash.) 5. Which method of accounting should Citation Builders, Inc adopt for its single-family houses? 6. What will Citation report in its 2018 income statement and 2018 balance sheet related to the single-family home business (ignore cash in the balance sheet)?

Answer 1

ANS 2. As Citation is not qualified for revenue recognition over time for its office building contracts:

(a.) Citation will recognise revenue in respect of Office building contracts as per cost of completion method:

For Year 2018,

% of Completion = Cost incurred till date / estimated cost to completed the contract

= 2600000/7800000

= 33.33%

So, Revenue for 2018 = 1300000x33.33%

= $ 433290

For Year 2019,

percentage of Completion = Cost incurred till date / estimated cost to completed the contract

= (2600000+6175000) / (7800000+2925000)

= 81.82%

So, Revenue for 2019 = (1300000+6500000)*81.82%-  $433290

= $ 6381960-$433290

= $ 5948670

(b.) Amount of gross profit or loss to be recognised for the contract of Altamont contract:

For the year 2018,

i. Revenue = $ 433290

ii. Cost incurred till date = $ 2600,000

iii. Gross profit (i-ii) = $ (433290-2600000) =-($2166710)

For the year 2019,

i. Revenue = $ 5948670

ii. Cost incurred During the year = $ 61750000

iv. Gross profit/ (loss) (i-ii) = ($5948670-6175000 )=(226330)

(c.) As per t the Companies Act, 2013 the Citation will report in its balance sheet that the company has undertaken a long term construction contract from Altamont Corporation and 33.33 % work has been completed as per the cost of completion method. Accordingly, revenue of $433290 has been recognised whereas billed has been raised of $13,00,000 and cash has been collected of $ 11,70,000.

ANS 4. If at the year end, the cost estimated to incur in the next year exceed beyond the initially estimated cost then such cost shall be recorded as the Additional cost applying the concept of prudence. Accordingly,

(a.) Revenue of 2019

percentage of Completion = Cost incurred till date / estimated cost to completed the contract

= (2600000+6175000) / (7800000+5850000)

= 76.19%

So, Revenue for 2019 = 65,00,000*76.19%-  $433290

= $4952350 -  $ 433290

= $ 4519060

(b). Amount of gross profit or loss to be recognised for the contract of Altamont contract:

i. Revenue = $ 4519060

ii. Cost incurred During the year = $ 5850000

iv. Gross profit/ (loss) (i-ii) = $4519060-$585000= -1330940

(c). The Citation will report in its balance sheet for the year end on December, 2019 ,that the company has undertaken a long term construction contract from Altamont Corporation and by 2019 it has completed 76.19 % as per the cost of completion method. Accordingly, revenue of $ 4519060 has been recognised whereas billed has been raised of $ ,6500,000 and cash has been collected of $ 5030,000.

ANS.5. Revenue for the sale of its single-family homes for the year 2018= 5* (10% of $ 680,000) + (3*680,000)

= $ 2,380,000

ANS 6. The Citation will report in its balance sheet for the year end on December, 2018 ,that the company has undertaken a long term construction contract for the sale of its single-family homes and by 2018 it has completed sold 3 flats and from 5 customers it has received 10% deposits.

ANS 1. As per AS9 " Accounting for Recognising of Revenue" issued by the Institute of Chartered Accountant of India, revenue in the long term construction contracts are recognised as per the completion cost method. It means that the contractors will recognise revenue as a percentage of cost incurred till the reporting date on the total estimated cost. However, in general business, revenues are recognised as per the matching concept principle applying the concept of conservatism. It simply means that revenue for the particular year is recognised as per the amount received or receivable for the work done in respect of that particular year. whereas in long term construction contract revenues are recognised as per cost of completion method as explained above irrespective of amount received or receivable subject to cot escalation