Question

itation 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 $10 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	$	2,000,000			$	4,750,000			$	2,250,000
Estimated costs to complete as of year-end		6,000,000				2,250,000				—
Billings during the year		1,000,000				5,000,000				4,000,000
Cash collections during the year		900,000				3,500,000				5,600,000

Also during 2018, Citation began a development consisting of 12 identical homes. Citation estimated that each home will sell for $620,000, 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 $620,000 each by the buyers. The completed homes cost $465,000 each to construct. The construction costs incurred during 2018 for the nine uncompleted homes totaled $2,790,000.

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 $4,500,000. 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

1. SInce this is contract based revenue where project completion is done over one year, its advisable to use percentage of completion method of accounting to recognize revenue.

2.a. With Completion method, amount of work completed in 2018 is ($2MM/$9MM)*100= 22.22%, hence, revenue recognised would be ($2MM/$9MM)*$10MM=$2,222,222.22. Similarly, amount of work completed in 2019 is ($4.75MM/$9MM)*100= 52.78%, hence, revenue recognised would be ($4.75MM/$9MM)*$10MM=$5,277,777.78

b.SInce, cost incured for this project is $2MM in 2018 and $4.75MM in 2019, Hence gross profit for 2018 is $2,222,222.22-$2,000,000= $222,222.22 annd gros profit in 2019 is $5,277,777.78- $4,750,000= $527,777.78

c.Balance sheet related to this project as on 31st December, 2018 will be as below:

Assets: Liability

A/c Receivable $100,000.00 Capital $222,222.2

Note: Since, Bill was raised for $1MM of which $900,000 was received, remaining is reported in balance sheet as A/R. Profit is transferred to balance sheet as capital.