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 2021, Citation began construction of an office building for Altamont Corporation. The total contract price is $20 million. Costs incurred, estimated costs to complete at year-end, billings, and cash collections for the life of the contract are as follows:

 

Also during 2021, Citation began a development consisting of 12 identical homes. Citation estimated that each home will sell for $600,000, but individual sales prices are negotiated with buyers. Deposits were received for eight of the homes, three of which were completed during 2021 and paid for in full for $600,000 each by the buyers. The completed homes cost $450,000 each to construct. The construction costs incurred during 2021 for the nine uncompleted homes totaled $2,700,000.

Required:

1. Briefly explain the difference between recognizing revenue over time and upon project completion when accounting for long-term construction contracts.

2. Answer the following questions assuming that Citation concludes it does not qualify for revenue recognition over time for its office building contracts:

a. How much revenue related to this contract will Citation report in its 2021 and 2022 income statements?

b. What is the amount of gross profit or loss to be recognized for the Altamont contract during 2021 and 2022?

c. What will Citation report in its December 31, 2021, balance sheet related to this contract? (Ignore cash.)

3. Answer requirements 2a through 2c assuming that Citation recognizes revenue over time according to percentage of completion for its office building contracts.

4. Assume the same information for 2021 and 2022, but that as of year-end 2022 the estimated cost to complete the office building is $9,000,000. Citation recognizes revenue over time according to percentage of completion for its office building contracts.

a. How much revenue related to this contract will Citation report in the 2022 income statement?

b. What is the amount of gross profit or loss to be recognized for the Altamont contract during 2022?

c. What will Citation report in its 2022 balance sheet
 related to this contract? (Ignore cash.)

5. When should Citation recognize revenue for the sale of its single-family homes?

6. What will Citation report in its 2021 income statement and 2021 balance sheet related to the single-family home business (ignore cash in the balance sheet)?

Answer 1

Requirement 1

Recognizing revenue upon completion of long-term construction contracts is equivalent to recognizing revenue at the point in time at which delivery occurs. Recognizing revenue over time requires assigning a share of the project’s expected revenues and costs to each construction period. The share is estimated based on the project's costs incurred each period as a percentage of the project's total estimated costs.

 

Requirement 2

                                                                   2021                  2022

       Contract price                               $20,000,000      $20,000,000

       Actual costs to date                         4,000,000        13,500,000

       Estimated costs to complete       12,000,000           4,500,000

       Total estimated costs                    16,000,000         18,000,000

       Estimated gross profit                  $ 4,000,000        $ 2,000,000

 

a.    

Revenue recognition: If revenue is recognized upon project completion, Citation would not report any revenue in the 2021 or 2022 income statements.

 

b.    

Gross profit recognition:

If revenue is recognized upon project completion, Citation would not report gross profit until the project is completed. Citation would have to report an overall gross loss on the contract in whatever period it first revises the estimates to determine that an overall loss will eventually occur. Citation never estimates the Altamont contract will earn a gross loss, so never has to recognize one. 

c.

Balance Sheet At December 31, 2021
Current assets:
Accounts receivable					$ 200,000
Costs ($4,000,000*) in excess  of billings ($2,000,000)					2,000,000

 

* If revenue is recognized upon project completion, this account would only include costs of $4,000,000

Requirement 3

                                                                2021                  2022

       Contract price                             $20,000,000      $20,000,000

       Actual costs to date                       4,000,000        13,500,000

       Estimated costs to complete      12,000,000          4,500,000

       Total estimated costs                  16,000,000        18,000,000

       Estimated gross profit                $ 4,000,000       $ 2,000,000

 

a.    

Revenue recognition:

       

2021: 

                 $ 4,000,000

Revenue:                         = 25% × $20,000,000 = $5,000,000

                $16,000,000

 

       

2022: 

                $13,500,000

Revenue:                         = 75% × $20,000,000 = $15,000,000

                $18,000,000

        Less: 2021 revenue                                            5,000,000

   

        2022 revenue                                                 $10,000,000

 

b.    

Gross profit recognition:

       

2021:Gross Profit: $5,000,000 – $4,000,000 = $1,000,000

 

2022:Gross Profit: $10,000,000 – $9,500,000 = $500,000

 

c.

 

Balance Sheet At December 31, 2021
Current assets:
Accounts receivable					$ 200,000
Costs and profit ($5,000,000*)in excess  of billings ($2,000,000)					3,000,000

          * Costs ($4,000,000) + profit ($1,000,000)

 

Requirement 4

                                                                    2021                  2022

       Contract price                             $20,000,000      $20,000,000

       Actual costs to date                        4,000,000        13,500,000

       Estimated costs to complete      12,000,000           9,000,000

       Total estimated costs                  16,000,000          22,500,000

       Estimated gross profit                $ 4,000,000       ($ 2,500,000)

 

a. 

Revenue recognition:

 

Total revenue recognized to date = (percentage complete)(total revenue)

        = ($13,500,000 ÷ $22,500,000) x ($20,000,000)

         = (60%) x ($20,000,000)

         = $12,000,000

 

Revenue recognized in 2022 = total – revenue recognized in prior periods

   = $12,000,000 – $5,000,000 = $7,000,000

 

b.    

Gross profit recognition:

2022: Overall loss of ($2,500,000) – previously recognized gross profit of $1,000,000 = $3,500,000.

 

c.

Balance Sheet At December 31, 2022
Current assets:
Accounts receivable   Current liabilities:					$ 1,600,000
Billings ($12,000,000) in excess of costs and profit ($11,000,000*)					1,000,000

 

* 2021 costs ($4,000,000) + 2021 profit ($1,000,000) + 2022 costs ($9,500,000) – 2022 loss ($3,500,000)

 

Requirement 5

Citation should recognize revenue at the time of delivery, when the homes are completed and title is transferred to the buyer. Recognizing revenue over time is not appropriate in this case, because the criteria for revenue recognition over time are not met. Specifically, the customers are not consuming the benefit of the seller’s work as it is performed (criterion 1 in Illustration 5-5), the customer does not control the asset as it is created (criterion 2), and the homes have an alternative use to the seller and seller does not have the right to receive payment for progress to date (criterion 3). Until completion of the home, transfer of title does not occur and the full sales price is not received, so control of the homes has not passed from Citation to the buyers.

 

Requirement 6

Income statement:

 Sales revenue (3 x $600,000)                      $1,800,000

 Cost of goods sold (3 x $450,000)                1,350,000

 Gross profit                                                     $ 450,000

 

Balance sheet:

 Current assets:

 Inventory (work in process)                          $2,700,000

Current liabilities:

 Customer deposits (or deferred revenue)  $ 300,000*

 

            *$600,000 x 10% = $60,000 x 5 =        $300,000

Balance sheet:

 Current assets:

 Inventory (work in process)                          $2,700,000

Current liabilities:

 Customer deposits (or deferred revenue)  $ 300,000*

 

            *$600,000 x 10% = $60,000 x 5 =        $300,000