Question

Mary is the production manager of the potato chip division. She gets bonus equal to 10% of her base salary if the division meets its target profit. She realized that the preliminary profit figures for the division is $10,000 below the target profit. She is considering changing the estimated percentage completion with respect to materials and conversion in ending work in process inventory of the final processing department to increase the profit. Does Mary want the percentage completion to be increased or decreased? Briefly explain your reasoning. Do you think Mary should change the percentage completion? Why or why not?

Write at least 600 words.

Answer 1

According to the question, Mary want the percentage to increased so that the target profit of the potato chip division can be achieved. According to my opinion, Mary shouldn't change the percentage completion in this case. Reasons behind this answer is explained below.

First of all, we need to understand the concept of Percantage Completion.The Percentage Completion (POC) method of revenue recognition is a concept in accounting that refers to a method by which a business recognizes revenue on an ongoing basis depending on the stages of a project's completion. In other words, it is an accounting method for recognizing not only revenue but also expenses for long-term projects which span overmore than one accounting year. In this method, the revenue is recognized on a yearly basis as a percentage of work completed during that year.

There are two conditions to use the percentage of completion method:

1. Collections by the company must be reasonably assured.
2. Costs and project completion must be reasonably estimated.

Revenue for a particular year is calculated as follows:

Revenue to be recognized = (Percentage of work completed in the given peroid)*(Total Contract Value)

The perecentage of completion method recognized as income that percentage of total income that matches the percentage of completion of a project. The percentage of completion may be measured in any of the following ways:

• Cost to cost method: This is a comparison to the contact cost incurredti date to the total expected contract cost. The cost of items already purchased for a contractbut which have not been yet installed should not be included in the determination of the percentage of completion of a project, unless they were specifically produced for the contract.
• Efforts expended method: This is the proportion of effort expended to date in comparison to the total effort expected to be expended for the contract.
• Units of delivery method: This is the percentage of units delivered to the buyer to the total number of units to be delivered under the terms of a contract.it should only be used when the contractor produces a number of units to the specifications of a buyer. The recognition is based on:

1. For revenue, the contarct price of units delivered
2. For expeses, the costs reasonably allocable to the units delivered.

The steps needed for the percentage of completion method are as follows:

1. Substract total estimated contract costs from total estimated contract revenues to arrive at the total estimated gross margin.
2. Measure the extent of progress towardcpompletion, using one the methods that are discussed above.
3. Multiply total estimated contract revenue by the estimated completion percentage to arrive at the total amount of revenue that can be recognized.
4. Substract the contract revenue recgnized to date through the preceding peroid from the total amount of revenue that can be recognized. Recognize the result in the current accounting peroid.
5. Calculate the cost of earned revenue in the same manner . this means multiplying the same percentage of completion by the total completion by the total estimated contract cost, and substracting the amount of cost already recognized in the current accounting peroid.

Example of the Percentage of Completion Method

XYZ is building a maintenance facility on a military base. XYZ has thus far accumulated $4,000,000 of costs related to the project and billed the customer $4,500,000. The estimated gross margin ont he project is 20%. Therefore, the total of expenses and estimated gross profit for the project is:

$4,000,000 Expenses / (1-0.20 Gross margin) = $5,000,000

Since, this figure is higher than the to-date billings of $4,500,000. Logger can recognize additional revenue of $500,000, using the following journal entry:

Particulars	Debit ($)	Credit ($)
Unbilled contarct receivables	500,000
To Contract revenue earned		500,000

The Work In Progress (WIP) report is an accounting schedule that’s a component of a company’s balance sheet. It’s calculated for each accounting period and required (according to GAAP principles) on projects where the Percentage of Completion (POC) accounting method is used. Though the format of the WIP varies from company to company, it usually includes current period and project-to-date financial metrics that detail each contract that the company is working on (Components of a WIP Schedule). The four basic elements necessary to prepare a WIP Schedule are transaction price, costsincurred to date estimated cost to complete and billings to date.

The goal of the WIP schedule is to have a financial reporting tool that shows if you are “over- or under-billed and cash positive or negative,” not only for each project but when all of the individual project WIPs are taken together, for the entire company as a whole. If the WIP is done accurately and in a timely manner, it should also serve as an early indication or warning if and when a project appears to be heading over budget.

Conclusion: The percentage of completion method is a preferred alternative to the completed contract method as our job completion is measured by costs, not at all by the opinions. The main advantage of this method of reporting long-term contracts is that we don't have to waitfor project completion for receiving compensation for work completed. It is used by the business entities whose business acceots long term projects where they book the revenue and exepenses related to that particular project in more than one accounting year taking the percentage of the project completed as the criterion or base for recognition of revenue and booking of expenses.