Question

Explain the key difference between recording losses and profits for long term contracts.

Answer 1

Key difference between recording losses and profits for long term contracts =

Profits -

Where long term contracts are carried out, following points are to be noted =

(a). Outcome of the contract can be reasonably assessed, and

(b). There is reasonable certainty.

Then, the profit of the long term contract is computed on the basis of prudence, which means, the profit is calculated on the basis of the proportion of the work carried out up to the end of the accounting year. For every separate accounting year, the proportion of the work carried out is measured.

An appropriate proportion of total contract amount is recognised as turnover in the profit and loss account as the work progresses. The cost incurred in completing that part or stage of contract are also recognised along with the recognised turnover for that part. The difference between the turnover recognised and its associated costs is profit.

Suppose 40% of the contract is completed. Then, at the end of accounting year, 40% of the contract value will be recognised as turnover. The cost incurred will be deducted. The difference is the profit.

Losses -

If the loss is estimated or expected, then all of the loss should be recognised as soon as it is foreseen. The forseeable loss is deducted from the work in progress of the long term contract.

If loss exceeds work in progress, then it is recorded under " Provision for liabilities.

The concepts of conservatism and prudence are considered for recording profits and liabilities.