Question

On March 1, 2017, the Company entered into an agreement with a customer, Thornock Square Apartments, to construct a residential apartment building for a fixed price of $1.5 million. The Company estimates that it will incur costs of $1 million to complete construction of the apartment building. The apartment building will only transfer to Thornock Square Apartments once the construction of the entire building is complete. In addition, Thornock Square Apartments has various design requirements that would require Cannon to incur significant costs to rework the building prior to selling it to a customer other than Thornock Square Apartments.
To construct the apartment building, Cannon acquires standard materials that it regularly uses in construction contracts for both residential and commercial buildings. These materials are used to manufacture generic component parts for inclusion in Thornock Square Apartments’ residential buildings. These standard materials remain interchangeable with other items until they are deployed in Thornock Square Apartments building. The Company has made the following purchases and incurred the following costs throughout the construction progress:
A. As of June 30, 2017, in total, Cannon has purchased $75,000 of component parts. As of June 30, 2017, $25,000 of component parts remain in inventory and $50,000 have been integrated into the project. Further, Cannon has incurred $12,500 of direct costs to integrate the component parts into the Thornock Square Apartments construction project during the three months ended June 30, 2017.
B. During the three months ended September 30, 2017, Cannon purchased an additional $500,000 of component parts ($575,000 in total). Of the $575,000 of component parts, $325,000 remain in inventory and $200,000 have been integrated into the project during the three months ended September 30, 2017. During the three months ended September 30, 2017, Cannon incurred an additional $50,000 of direct costs to integrate the component parts into the Thornock Square Apartments construction project.
C. As of September 30, 2017, Cannon determined that the project was over budget and revised its cost estimate from $1 million to $1.25 million.
D. As of December 31 2017, the construction project was completed. During the three months ended December 31, 2017, Cannon purchased an additional $425,000 of generic component parts ($1 million in total). Of the $1 million component parts, $0 remain in inventory and $750,000 were integrated into the project during the three months ended December 31, 2017. Cannon has incurred $187,500 of direct costs to integrate the component parts into the Thornock Square Apartments construction project during the three months ended December 31, 2017.
If Thornock Square Apartments cancels the contract, Cannon will be entitled to reimbursement for costs incurred for work completed to date plus a margin of 20 percent, which is considered to be a reasonable margin. Cannon will not be reimbursed for any materials that have been purchased for use in the contract but have not yet been used and are still controlled by Cannon.

1) What amount of revenue should be recognized for the following periods: a. The three months ended June 30, 2017? b. The three months ended September 30, 2017? c. The three months ended December 31, 2017? Please explain calculations

2)Create a revenue recognition summary table which summarises the calculations used to find the revenue in each quarter

3)How should the entity recognize revenue for the satisfaction of its performance obligation in FASB code?

(All other chegg answers were wrong for this question)

Answer 1

Note:

• Revenue will be recognised using cost completion method
• Cost of materials which have been used in project will be used to calculate percentage of work completion.

Sub part 1

1. Revenue for June 2017

              Cost of Materials used -      $ 50,000.

              Other Costs incurred -         $ 12,500.

                                                            --------------

               Total costs to date- $ 62,500.

                                                             -------------

% of work completion = Total costs to date/ Total estimated costs.

                                        = $ 62,500/$ 1,000,000

                                        =6.25%

Revenue to be recognised in June = Total revenue x % of work completion

                                                             = $ 1,500,000 x 6.25%

                                                             = $ 93,750.

2. Revenue for Sept 2017

Total Revised Estimated costs – $1,250,000

Total costs incurred upto June - $62,500

Cost of Material for Sept -          $200,000

               Other costs-                                   $50,000

                                                                  -----------------

               Total costs to date -                   $ 312,500

                                                                 ------------------

% of work completion = Total costs to date/ Total estimated costs.

                                        = $ 312,500/$ 1,250,000

                                        =25%

Total revenue to be recognised till date = Total revenue x % of work completion

                                                                        = $ 1,500,000 x 25%

                                                                        = $ 375,000.

Revenue to be recognised in Sept = Revenue to be recognised till date- Revenue recognised in June

                                                             = $375,000 - $ 93,750

                                                             = $281,250

3.Revenue for Dec 2017

           Since the work gets completed in Dec, the unrecognised revenue will be recognised in Dec.

           Revenue recognised in Dec 2017 = $1,500,000 - $ 93,750 - $ 281,250

                                                                       = $1,125,000.

Sub part 2

• Revenue recognition table

Period	Amount
June	$93,750
Sept	$281,250
Dec	$1,125,000

Sub part 3

• As per FASB code, revenue should be recognised when performance obligation has been satisfied i.e., revenue should be recognised when there is transfer of control of goods to customer
• Exception.

However the entity should recognise revenue over time (i.e. work in process) if:

The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date + margin

• In the given case, Apartment has various designs which require to be reworked if sold to other customer. It means the building has no alternative use.
• And also if Thomas Square Apt cancels the contract will reimburse Cannon for contract costs incurred + 20% margin.
• Hence Canon can recognise revenue on basis of work completion method i.e over time rather than recognising the entire revenue in Dec when the apartment control transfer to customer.