Question

Toll Brothers is building some homes in Yorba Linda. The contract price is $250 million, the total estimate costs are $200 million. If the costs incurred to date at the end of first, second, and third year are $10 million, 40 million, and $100 million respectively, what is the amount of revenue recognized in year 3 if the percentage of completion method is used?

Answer 1

So we need to understand some points before we can solve the given question:

• Contract price of 250 million is the total revenue that will be earned from the project
• Estimated cost is 200 million, which will be spent in parts over the 3 year period.
• Revenue recognition is the process of assuming that a portion of the revenue has been earned thus should be on the income statement of the given year, but the revenue will not begin till the homes are sold and therefore, the revenue will be recognized based on assumptions.
• The assumption here is percentage of completion method.

So If the total costs incurred till now is 10+40+100 = 150 million, this implies that out of 200 million , 150 have been incurred and therefore the percentage of completion is 150/200 x 100 = 75%

So we can recognize 75% of the total contract price as revenue by the end of year 3 and therefore the amount will be 0.75 x 250 = 187.5.

This is the total revenue that should be recognized by end of year 3 while during the year 3 only 100/200 x 250 = 125 million should be recognized and the rest of 187.5-125 =62.5 million should be distributed among years 1 and 2 proportionately.