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

1. For constructions contratcs wherein the outcome of the contract for construction can be projected, then contract revenue and contract costs shall be recognized by taking into using "Stage of completed method" . all the expected losses shall be recognized immediately as expenses. If the outcome cannot be estimated on reasonable grounds then contract revenue should be recognised only to the extent that contract costs incurred are expected to be recoverable & all related cost should be taken as expense as & when the same is incurred.Here the outcome can be projected & thus " Stage of completion method" should be used. Answer to 2nd question: Completed contract method is an approach used for construction contract accounting in which the revenue is recognized only when the contract is 100% complete. Gross profit on a completed contract = total contract price – contract costs Gross profit on a completed contract = 13 - (2.6+6.175+2.295) = 1.3 2A) No revenue will be recorded in 2018 & 2019. 2B) No Profit will be recorded in 2018 & 2018. Since the project is getting completed in 2020, 100% profit i.e. $ 1300000 will be recorded in 2020. 2C) As at 31st Dec 2018, below will be recorded : Work-in-progress Dr 2.6Mio To Accounts payable and others 2.6Mio Accounts receivable Dr. 1.3 Mio To Billings 1.3 Mio Cash Dr. 1.17 Mio To Account Receivable 1.17 Mio Hence in Balance Sheet : 2018 2019 Accounts Receivable - Asset 1.13-1.17 = 0.13M 6.5-5.03 = 1.47M Accounts Payable - Liability 2.6M 6.175M Billing - Asset 1.3M 6.5M Cash = -Asset 1.17M 5.03M WIP(adjusted in stock) 2.6M 6.175M Answer 3 In percentage of completion method the revenues and expenses of long-term contracts are recognized as a percentage of the work completed during the period. % of work completed = Total construction cost to date / (Cost till date + Total estimate of cost of contract) Period Revenue = % of work Completed * Total Project Revenue Contract income = Period Revenue - Period Cost 2018 2019 % Completetion - Calculation 2600000/(2600000+7800000) (6175000+ 2600000)/(6175000 +2600000+2925000) % Completion 25% 75% Revenue - Calculations 13000000*25% 13000000*75% Revenue - to be reported 3250000 9750000-3250000 = 6500000               Period Revenue (a) 3250000 9750000-3250000 = 6500000               Period Cost(b) 2600000 6175000 Gross Profit (a) - (b) 650000 325000 Balance Sheet will be as follows : 2018 2019 Contract WIP ( Revenue in excess of Billings) - As Current Assets (a)-(b)                           1,950,000 0              Billed (a)                                    1,300,000                                                         6,500,000              Taken as revenue (b)                           3,250,000                                                         6,500,000 Answer 4 2019 % Completetion - Calculation (6175000+ 2600000)/(6175000 +2600000+5850000) % Completion 60% Revenue - Calculations 13000000*60% Revenue - to be reported 7800000 Gross Profit/(loss) = Period Revenue - Period Cost = (a) - (b) (1625000)               Period Revenue (a) 7800000-3250000 = 4550000               Period Cost(b) 6175000 Balance Sheet will be as follows : 2019 Contract WIP ( Revenue is less than Billings) - As Current Liability - Advance biling = (a) - (b)              Billed (a)                                                         6,500,000              Taken as revenue (b)                                                         4,550,000