Friday, 18 July 2014
LONG TERM CONSTRUCTION ACCOUNTING
BECAUSE OF THE LONG PERIOD OF TIME TO FINISH A CERTAIN PROJECT BEING UNDERTAKEN BY CONSTRUCTION COMPANIES, IT BECOMES DIFFICULT TO DETERMINE HOW MUCH INCOME SHOULD BE RECOGNIZE IN THE FINANCIAL STATEMENT CONSIDERING THAT THE COMPLETION OF THE PROJECT WILL NOT BE FINISHED IN THE ORDINARY ACCOUNTING PERIOD, HENCE AN ACCOUNTING FOR SUCH SITUATION WAS DEVELOP.
THAT ARE TWO METHODS THAT WAS DEVELOP TO ANSWER FOR THIS ISSUE.
A. PERCENTAGE OF COMPLETION METHOD
B. COMPLETED CONTRACT METHOD.
UNDER THE PERCENTAGE OF COMPLETION METHOD, THE PERCENTAGE OF THE ACTUAL AMOUNT SPENT AT THE END OF THE INTERIM PERIOD IS OBTAINED AGAINST THE TOTAL ESTIMATED COST THAT IS STILL NEEDED TO COMPLETE THE PROJECT AT THE END OF THE INTERIM PERIOD.
WHAT ARE THE ACCOUNTS USED IN CONSTRUCTION ACCOUNTING
1. CONSTRUCTION IN PROGRESS -
A. DEBITED FOR THE COST OF CONSTRUCTION
B DEBITED FOR THE NET REVENUE
A. CREDITED TO NEGATIVE NET REVENUE( EXCEPT WHEN A TOTAL LOSS WILL BE INCURRED.
B. CREDITED AT THE END OF THE CONTRACT FOR THE CONTRACT PRICE BY DEBIT TO ADVANCE BILLING.
THAT MEANS THERE ARE TWO TYPES OF TRANSACTION THAT ENTERS TO THIS ACCOUNT, THE COST AND THE PROFIT , WHICH TOTALS THE CONTRACT PRICE.
AT THE END OF THE CONTRACT THE BALANCE OF THIS ACCOUNT SHALL BE CLOSED TO THE ADVANCE BILLING ACCOUNT WHICH ACCUMULATES THE REGULAR BILLING OF THE CONTRACT PRICE WHICH IS DEBITED TO ACCOUNTS RECEIVABLE AND CREDITED TO ADVANCE BILLING. NATURALLY , THE ADVANCE BILLING WILL DEFINITELY HAVE A BALANCE REPRESENTING THE CONTRACT PRICE.
2. ADVANCE BILLING ACCOUNT
CREDITED EVERY TIME A BILLING STATEMENT IS MADE AND WOULD END UP WITH THE TOTAL CONTRACT PRICE AND DEBITED AT THE END OF THE CONTRACT FOR THE CONTRACT PRICE. WITH THE CREDIT TO CONSTRUCTION IN PROGRESS
3. CONSTRUCTION EXPENSE OR COST
DEBITED TO THE AMOUNT ARRIVED AT BY MULTIPLYING THE COMPLETION PERCENTAGE OF THE PROJECT AS AGAINST THE PARTIAL AND ESTIMATED COST TO FINISH THE PROJECT. RATIO X TOTAL ESTIMATED COST OF THE PROJECT
4. CONSTRUCTION REVENUE = CREDITED TO THE AMOUNT ARRIVED AT BY MULTIPLYING THE COMPLETION RATIO AS AGAINST THE TOTAL PROJECT PRICE
:
SAMPLE:
TOTAL COST ALREADY INCURRED TODATE 300 23.1%
ADD: ESTIMATED COST STILL TO BE INCURRED UNTIL
THE PROJECT IS FINISHED 1,000
TOTAL PARTIAL ACTUAL COST AND ESTIMATED COST
TO FINISH THE PROJECT 1,300 100%
THE PERCENTAGE OF COMPLETION IS 23.1%
THIS PERCENTAGE 23.1% WILL NOW BE APPLIED TO THE TOTAL CONTRACT PRICE OF THE PROJECT TO GET THE GROSS REVENUE.( JUST LIKE GROSS SALES )
THE SAME PERCENTAGE SHALL BE APPLIED TO THE ACCUMULATED ACTUAL COST PLUS THE ESTIMATED COST STILL NEEDED TO COMPLETE THE PROJECT TO BE ABLE TO GET THE EQUIVALENT COST INCURRED AS OF THAT DATE ( JUST LIKE COST OF SALES)
EXAMPLE:
ASSUMING CONTRACT PRICE IS 5,000
MULTIPLY BY 23.1% 1,155 AS GROSS REVENUE
LESS: ESTIMATED COST TO FINISH 1,300
MULTIPLY BY 23.1% 23.1% 300.30 AS COST OF FINISHED PORTION.
EQUALS THE REVENUE FOR THIS PERIOD 854.70
CONTRACT PRICE WHOLE CONTRACT 5,000
LESS: ESTIMATED COST WHOLE CONTRACT 1,300
EXPECTED REVENUE 3,700
SINCE 23.!% IS FINISHED X 3700.00 = 854.70
IN EFFECT THIS 854.70 IS 23.!% OF THE NET REVENUE, JUST LIKE THE GROSS PROFIT IN CASE OF NON CONSTRUCTION BUSINESS.
THEN THE ORDINARY TRANSACTION WILL BE THE SAME SUCH AS:
1. THE PURCHASE OR USE OF MATERIALS , LABOR , OVERHEAD ETC. THE RECORDING SYSTEM WOULD DEPEND ON THE ACCOUNTING SYSTEM THAT THE COMPANY WOULD LIKE TO ADOPT, SAYING THEY WANT TO REFLECT THE COST OF MATERIALS, LABOR , OVERHEAD AND OTHER COST.
CONSTRUCTION IN PROGRESS 300
CASH OR PAYABLE 300
2. THE BILLING
ACCTS. RECEIVABLE 20
ADVANCE BILLING 20
3, COLLECTION
CASH 20
ACCTS. REC 20
4. THE RECOGNITION OF THE REVENUE
CONSTRUCTION IN PROGRESS 1,155
CONSTRUCTION REVENUE 1,155
5. TO RECORD THE COST OF CONSTRUCTION
CONSTRUCTION COST 300.30
CONSTRUCTION IN PROGRESS 300.30
AT THE END OF YEAR OF CONTRACT , THE TOTAL BALANCE OF THE CONSTRUCTION IN PROGRESS ACCOUNT WOULD BE THE TOTAL COST , PLUS THE NET REVENUE ( MARK UP X COMPLETION RATIO 100%.( what isbeing debited to construction in process acct is the whole cost of building that project and the profit or mark up ..
THIS CONSTRUCTION IN PROGRESS ACCOUNT WILL BE CLOSED TO ADVANCE BILLING ACCOUNT.SINCE THIS IS AN OFFSET TO ACCTS. RECEIVABLE WHICH THE TOTAL CONTRACT PRICE WILL PASSED THRU THIS ACCTS. REC. ACCT.
THE CONSTRUCTION REVENUE ACCOUNT WOULD BE THE MARK UP ITSELF.
IN EFFECT THE NET BALANCE OF THE CONSTRUCTION IN PROGRESS IN THE ENTRY IN NO. 4, 5 REPRESENTS THE REVENUE FOR THE PERIOD HANGED IN THE ASSET ACCOUNT CONSTRUCTION IN PROGRESS AS A TEMPORARY ACCOUNT UNTIL IT WILL BE CLOSED AT THE END OF THE CONTRACT.
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TO ILLUSTRATE ;
A CONSTRUCTION CO. IS CONTRACTED TO CONSTRUCT A BUILDING ESTIMATED TO COST 800,000 AT A PRICE OF 1,000,000 TO FINISHED IN 3 YEARS
2011 2012 2013 total
CUMULATIVE COST INCURRED 136,500 386,100 413,900 800,000
ESTIMATED COST TO FINISHED TO PROJECT 513,500 328,900
TOTAL PARTIAL AND ESTIMATED COST 650,000 715,000
PARTIAL BILLING 104,000 455,000 351,000
COLLECTION 65,000 429,000 416.000
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JOURNAL ENTRY
CONST. IN PROGRESS 136,500 249,600 413,900
CASH / ACCTS PYABLE ETC 136,500 249,600 413,900
cost of labor , materials etc,
ACCTS REC. 104,000 455,000 441,000
ADVANCE BILL 104,000 455,000 441,000
CASH 65,000 429,000 416,000
ACCTS. RECE 65,000 429,000 416,000
CONST IN PROGRESS 210,000 330,000 460,000
CONST REVENUE 210,000 330,000 460,000
to record revenue at 21%of contract price. revenue at 54% revenue at 100%
CONSTRUCTION COST 136,500 249,600 413,900
CONST IN PROGRESS 136,500 249,600 413,900
record cost to produce rev. 21% of cost
ADJUSTING ENTRY:
ADVANCE BILLING 1,000,000
CONSTRUCTION IN PROGRESS 1,000,000
THE 249,600 IN THE SECOND YEAR IS THE ACTUAL EXPENSES FOR THAT YEAR , SO THAT ADDING 136,500 PLUS 249,600 IS THE ACCUMULATED ACTUAL EXP. UP TO YEAR 2012 IS 386,100
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HOW THE CONSTRUCTION REVENUE ARRIVE AT:
2011 COMPLETION RATIO ON THE BASIS OF EXPENSES INCURRED
ACTUAL EXPENSES 136,500
DIVIDE total cost 650,000
EXPENSE RATIO 21%
GROSS REVENUE = CONTRACT PRICE 1.0m X 21% 210,000
FOR THE COST 650,000 X 21% ( 136,500)
NET REVENUE 73,500
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2012 EXPENSE RATIO
CUMULATIVE EXPENSES/COST 386,100
DIVIDE TOTAL EXPENSE ESTIMATE 715,000
COMPLETION RATIO 54%
cum this yr cum. lyr. this yer
GROSS REVENUE FOR THE CONT.PRICE 1,000,000 X 54% 540,000 -210,000 = 330,000
GROSS COST 715,000 X 54% 386,100 - 136,500 = 249,600
NET REVENUE 153,900 - 73,500 = 80,400
TAKE NOTE THAT YOU CANNOT COMPUTE THE NET REVENUE FOR SUCCEEDING YEAR UNLESS YOU COMPUTE THE CUMULATIVE NET REVENUE AS OF THE PRESENT YEAR , SAY THE 153,900 THEN DEDUCT THE REVENUE LAST YEAR , 73,500 TO GET 80,400
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
2013 THE LAST YEAR OF CONTRACT
FINAL CUMULATIVE EXPENSES 800,000
COMPLETION RATIO 100%
cum. thisyer cum lyr this yr
GROSS REVENUE FOR THE CONT. PRICE 1,000,000 X 100% 1,000,000 - 540,000 460,000
GROSS COST 800,000 X 100% 800,000 -386,100 413,900
net revenue 200,000 200,000 -153,900 46,100
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DONT BE CONFUSED ON THE JOURNAL ENTRY ON REVENUE, WHAT WAS ADOPTED IS JUST LIKE AN ORDINARY RECORDING OF GROSS SALES AND THE RECORDING OF COST OF SALES, HERE , THE COMPLETION RATIO IS FIRST APPLIED TO THE CONTRACT PRICE BUT ARE REDUCED BY THE COMPLETION RATIO APPLIED TO THE ESTIMATED COST OR EXPENSES AS OF THAT YEAR , THE NET EFFECT IS ALSO NET REVENUE ( CONTRUCTION REVENUE LESS CONSTRUCTION COST )
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IF YOU WE ARE GOING TO PUT THESE ENTRIES INTO T ACCOUNTS :
ACCTS RECEIVBLE CONTR. IN PROCESS CONTRUCTION REVENUE
dr cr dr cr dr cr
ADVANCE BILLING CONTRUCTION EXPENSE CONTRUCTION COST
dr cr dr cr dr cr
THE FOLLOWING WILL BE THE BALANCES END OF 2013
PROFIT AND LOSS
2011 2012 2013
CONTRUCTION REVENUE 210,000 330,000 460,000
CONSTRUCTION COST 136,500 249,600 413,900
NET REVENUE 73,500 80,400 46,100
BALANCE SHEET
ASSETS
CASH 65,000 494,000 910,000
ACCTS. REC. 39,000 65,000 90,000
CONS.PROGRESS 210,000 -
LESS: ADV. BILL 104,000) 106,000
TOTAL 210,000 559,000 1,000,000
LIABILITIES
ACCTS. PAYABLE 136,500 386,100 800,000
ADVANCE BILLING 559,000
less: const. in progress 540,000 19,000
NET INCOME 73,500 80,400 46,100
RETAINED EARNINGS 73,500 153,900
TOTAL 314,000 559,000 1,000,000
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THE ADVANCE BILLING AS A RULE MUST BE OFFSET OR CONTRA ACCOUNTS TO CONSTRUCTION IN PROGRESS, IF CONSTRUCTION IN PROGRESS ACCOUNT IS BIGGER THAT MEANS THE EXPENSES IS IN EXCESS OF THE BILLING ( put to asset side )
if the advance bill is more than the construction in progress , it means, the billing is excess of the cost. reflect to liabilities side .
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POSSIBLE LOSS ON LONG TERM CONSTRUCTION
there is a possibility that while the construction is going on, it is estimated that it will incur a loss.
there are two types of loss.
1. the estimated future cost may indicate a loss on the current period, but there will be a profit on the total contract.
2. the estimated cost may indicate that totally a loss will be incurred.
EXAMPLE of a contract that the result will be a net loss as whole, that means it may have profit on some years but in total for the whole contract it will be a net loss.
the following data is given:
YEAR 1 YEAR 2 YEAR 3 TOTAL
CONTRACT PRICE 910,000
COST TODATE 136,500 386,100 990,000 990,000
ESTIMATED COST TO COMPLETE513,500 603,900
TOTAL PARTIAL AND ESTIMATE 650,000 990,000 990,000
PERCENT OF COMPLETION 21% 39% 100%
journal entries yr. 1:
CONTRUCTION IN PROGRESS 136,500 249,600 603,900
ACCTS. PAYABLE
CONTRUCTION PROGRESS 191,100 354,900
CONST. REVENUE 191,100
CONSTRUCTION COST 136,500 386,100
CONST. IN PROGRESS 191,100 386100
THERE IS A PROFIT OF 54,600 IN YEAR 1, BUT IN YEAR TWO , THERE IS A LOSS OF 85,800.
TAKE NOTE THAT BY THE END OF YEAR 2 , IT IS ESTIMATED THE YEAR 3 WILL ALSO BE A LOSS JUST LIKE THE 2ND YEAR.
IF A LOSS IS EXPECTED FOR THE WHOLE CONTRACT , THE ENTIRE LOSS OF THE WHOLE CONTRACT SHOULD ALREADY BE RECOGNIZED IN THE YEAR WHERE IT IS DISCOVERED. THAT MEANS THE CUMULATIVE PROFIT AS THAT DATE MUST BE THE AMOUNT OF THE TOTAL LOSS
THE REGULAR ENTRY DEBITING CONSTRUCTION COST OR EXPENSE FOR YEAR 2 IS STILL NEEDED AND THE CREDIT TO CONSTRUCTION REVENUE , AND A CREDIT TO CONST. IN PROGRESS FOR THE GROSS LOSS..
IF THIS THE CASE THE COMPUTATION OF NET REVENUE IN yr. 3 Need TO BE IGNORED.. EVEN THE SUPPOSED CREDIT TO CONSTRUCTION IN PROGRESS ACCOUNT IN RECOGNIZING THE NET LOSS IN YEAR 2 NEED TO BE REVERSED BECAUSE IF THE WHOLE CONTRACT WILL BE A LOSS THERE IS NO USE to have A BALANCE FOR THE CONSTRUCTION IN PROGRESS ACCOUNT REPRESENTING A LOSS ( note that construction in progress includes the net revenue ), that is why even the profit of year 1 , debited to construction in process has to be reversed , in year 2. SO WHAT IS LEFT ON THE BALANCE OF CONSTRUCTION IN PROGRESS ACCOUNT IS THE CUMULATIVE COST OR EXPENSE IN CONSTRUCTING THE PROJECT.
NOW SINCE THE LOSS IN YEAR 3 HAS TO BE RECOGNIZED IN YEAR TWO AN ENTRY DEBITING CONST. COST OR EXPENSE AND CREDITING RESERVE FOR LOSS IS NEEDED SO THAT THE CUMULATIVE PROFIT FOR YEAR WILL APPEAR TO BE THE WHOLE TOTAL LOSS OF THE PROJECT.
IN SHORT THE ABOVE STATEMENT IN SUMMARY APPEARS LIKE THIS
CONST. COST 249,600
CONSTRUCTION REVENUE 163,800
CONST. IN PROGRESS 85,800 LOSS
to record the const. cost this year and the revenue at 39% and record the loss
CONS. IN PROGRESS 85,800
RESERVE FOR LOSS YEAR 2 85,800
to reclassify the above entry so tha the const. in progress be closed to reserve for loss
RESERVE FOR LOSS YEAR 1 54,600
CONST. IN PROGRESS 54,600
to reverse the balance of const. in progress last year and charged to reserve for loss
CONSTRUCTION COST 48,800
RESERVE FOR CONTRACT LOSS 48,800
to anticipate the loss in year 3 by crediting it to reserve for loss
IN EFFECT THIS IS THE COMPOUND ENTRY:
of the above entries:
CONST COST EXP 298,400
CONST. REVENUE 163,800
RESERVES FOR CONTRACT LOSS 80,000
CONST. IN PROGRESS 54,600
SUMMARING THESE ENTRIES , THE CONST. IN PROGRESS WOULD NOW HAVE A BALANCE REPRESENTING THE TOTAL COST OF THE PROJECT AS OF YEAR TWO OF 386,100 AND DOES NOT ANYMORE INCLUDE THE PROFIT IN YEAR 1 54,600 AND NET LOSS OF YEAR 2 OF 85,800.00, THEREFORE 54,600 IN CONST. IN PROCESS LAST YEAR IS DEBITED TO RESERVE FOR LOSS, AND THE 85,800 CREDIT TO CONST. IN PROGRESS YEAR 2 IS DEBITED AND CREDITED TO RESERVE FOR LOSS.
THE NET LOSS IN YEAR 3, OF 48,800 WILL BE RECORDED THIS YEAR 2 AND CHARGD TO RESERVE FOR CONTRACT LOSS.
IF THE RULE IS, IF THE WHOLE CONTRACT WILL BA LOSS, THEYEAR WHERE THE LOSS IS KNOWN SHOULD RECOGNIZED THE TOTAL LOSS of the whole contract THAT MEANS THE LOSS IN THE SUCCEEDING YEARS SHOULD ALSO BE CHARGED TO THE YEAR WHERE THE TOTAL LOSS WAS KNOWN. IN THIS CASE IN YEAR 2
IF THIS IS CASE THE RETAINED EARNINGS AS OF THE YEAR WHERE THE LOSS IS ANTICIPATED MUST TURNED OUT TOBE EQUAL TO THE TOTAL LOSS OF THE CONTRACT. EVEN THE CONTRACT HAS NOT YET ENDED.
IN THE YEAR 3 , THE FOLLOWING ENTRIES
CONSTRUCTION IN PROGRESS 603,900
ACCTS. PAYABLE 603,900
purchase and pay all expenses for the project year 3
RESERVE FOR CONTRACT LOSS 80,000
ADVANCE BILLING 910,000
CONSTRUCTION IN PROGRESS 990,000
to close advance billing andclose the construction in progress and the reserve for contract loss.
IF YOU TAKE THE BALANCE SHEET BALANCE AS OF YEAR 3
ACCTS. RECEIVABLE 910,000 THE CONTRACT PRICE assume no collection.
ACCTS PAYABLE 990,000 the cost assume no payment
CUMULATIVE PROFIT /LOSS ( 80,000)
TOTAL 910,000
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PROBLEM :
THE FOLLOWING DATA
YR. 1 YEAR 2 YEAR 3
CONTRACT PRICE 875,000
CONSTRUCTION COST THISYR. 125,000 232,500 455,000 812,500
ESTIMATED COST TO COMPLETE 500,000 455,000
BILLING TO BUYER 100,000 437,500 337,500 875,000
COLLECT 62,500 412,500 400,000 875,00
TAKE NOTE THE CONSTRUCTION COST IS NOT TO DATE , IT IS FOR THE CURRENT YEAR. IN COMPUTING FOR THE COMPLETION RATIO , IT MUST BE BASED ON CUMULATIVE COST SPENT.
THERE IS A LOSS IN THE 2ND YEAR , BUT THE TOTAL CONTRACT IS A PROFIT.
COMPUTE FOR THE ESTIMATED INCOME OR LOSS FOR EACH YEAR. AND THE INCOME REALIZED EACH YEAR.
MAKE JOURNAL ENTRIES.
MAKE BALANCE SHEET/ PROFIT AND LOSS.
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