PROBLEM 18-5

PROBLEM 18-5

(a)   The completed-contract method of revenue recognition recognizes income only upon completion of a project or shipment of a product. All associated costs are expensed at the point of sale, and there are no interim charges or credits to income. Completed-contract revenue rec­ognition is used for long-term projects when estimates of revenue and costs are not reliable.

        The percentage-of-completion method of revenue recognition recog­nizes income and associated costs in each accounting period based upon progress. This method is preferred for long-term projects when estimates of revenues and costs are reasonably dependable. Under the percentage-of-completion method, the current status of uncompleted contracts is reflected on the financial statements.

(b)   Using the data provided for the Dagmar Haze Tractor Plant, and on the assumption that the percentage-of-completion method of revenue recognition is used, the calculations of GMCB’s revenue and gross profit for 2003, 2004, and 2005, under three sets of circumstances are presented below.

        1.    Assuming that all costs are incurred, all billings to customers are made, and all collections from customers are received within 30 days of billing, the GMCB’s revenue, cost of sales, and gross profit for 2003, 2004, and 2005, are calculated as follows:

Percentage-of-Completion (Cost-to-Cost Basis)

($000 omitted)

Year	Contract Price	Costs   to Date	Estimated Total Costs	Estimated Gross Profit (Col. 2–Col. 4)	Percent              Complete         (Col. 3/Col. 4)
(1)	(2)	(3)	(4)	(5)	(6)
2003	$8,000	$2,010	$6,700	$1,300	30%
2004	8,000	5,025	6,700	1,300	75%
2005	8,000	6,700	6,700	1,300	100%

        Revenue recognition

Year	Contract Price	Percent Complete	Revenue      Recognizable	Less Prior Year(s)	Current Year
2003	$8,000	30%	$2,400	—	$2,400
2004	8,000	75%	6,000	$2,400	3,600
2005	8,000	100%	8,000	6,000	2,000

Profit recognition

Year	Estimated Profit	Percent Complete	Revenue      Recognizable	Less Prior Year(s)	Current Year
2003	$1,300	30%	$  390	—	$390
2004	1,300	75%	975	$390	585
2005	1,300	100%	1,300	975	325

2.     Assuming the same facts as in Instruction (b)1., but that cost overruns of $800,000 were experienced, GMCB’s revenue, costs of sales, and gross profit for 2003, 2004, and 2005 were calculated as follows:

Percentage-of-Completion (Cost-to-Cost Basis)

($000 omitted)

Year	Contract Price	Costs   to Date	Estimated Total Costs	Estimated Gross Profit (Col. 2–Col. 4)	Percent              Complete         (Col. 3/Col. 4)
(1)	(2)	(3)	(4)	(5)	(6)
2003	$8,000	$2,810	$7,500	$500	37.47%
2004	8,000	5,825	7,500	500	77.67%
2005	8,000	7,500	7,500	500	100%

        Revenue recognition

Year	Contract Price	Percent Complete	Revenue      Recognizable	Less Prior Year(s)	Current Year
2003	$8,000	37.47%	$2,997.6	—	$2,997.6
2004	8,000	77.67%	6,213.6	$2,997.6	3,216
2005	8,000	100%	8,000	6,213.6	1,786.4

PROBLEM 18-5 (Continued)

        Profit recognition

Year	Estimated Profit	Percent Complete	Profit             Recognizable	Less Prior Year(s)	Current Year
2003	$500	37.47%	$187.4	—	$187.4
2004	500	77.67%	388.4	$187.4	201
2005	500	100%	500	388.4	111.6

3.     Assuming the same facts as in Instructions (b)1. and (b)2., but that additional cost overruns of $540,000 are experienced, GMCB’s revenue, cost of sales, and gross profit for 2003, 2004, and 2005 are calculated as follows:

Percentage-of-Completion (Cost-to-Cost Basis)

($000 omitted)

Year	Contract Price	Costs   to Date	Estimated Total Costs	Estimated Gross Profit (Col. 2–Col. 4)	Percent              Complete         (Col. 3/Col. 4)
(1)	(2)	(3)	(4)	(5)	(6)
2003	$8,000	$2,810	$7,500	$500	37.47%
2004	8,000	6,365	8,040	(40)	79.17%
2005	8,000	8,040	8,040	(40)	100%

        Revenue recognition

Year	Contract Price	Percent Complete	Revenue      Recognizable	Less Prior Year(s)	Current Year
2003	$8,000	37.47%	$2,997.6	—	$2,997.6
2004	8,000	79.17%	6,333.6	$2,997.6	3,336
2005	8,000	100%	8,000	6,333.6	1,666.4

        Profit recognition

Year	Estimated Profit	Percent Complete	Profit             Recognizable	Less Prior Year(s)	Current Year
2003	$500	37.47%	$187.4	—	$187.4
2004	(40)	100%a	(40)	$187.4	(227.4)
2005	(40)	100%	(40)	(40)	—

        ^aWhen there is a projected loss at any time, it must be recognized in full in the period in which a loss on the contract appears probable.