In: Accounting
Cannon Construction (Cannon or the “Company”), an SEC
registrant, is a construction company that manufactures commercial
and residential buildings. 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.
Question from scenario:
1)Does the performance obligation meet any of the criteria for recognition of revenue over time? Discuss which criteria (if any) is met and how is met.
2)How should the entity recognize revenue for the satisfaction of its performance obligation? 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?
3) create a schedule summarizing your calculations to arrive at revenue to be recognized each year.
1. The three criteria mentioned in ASC 606-10-25-27 requires an entity to recognize revenue over time, even if one criteria is met:
In this case, Criteria 3 is met since in the event of cancellation of contract, Cannon has a right to reimbursement for cost of work incurred till date plus 20% margin.
2. a. Revenue to be recognized for quarter ended June 30, 2017
=$500,000x(50,000+12,500)/1,000,000= $31, 250
b. Revenue to be recognized for quarter ended September 30, 2017
= $250,000x(200,000+12,500+50,000)/1,250,000 = $52,500
c. Revenue to be recognized for quarter ended December 31, 2017
= Total Revenue-Total Actual Cost-Profit Recognized in previous quarters
= $1,500,000-($1,000,000+12,500+50,000+187,500)-($31,250+52,500)
= $166,250