Question

Your construction company entered into a four year contract to build a store for a fixed price of $7,000,000. You estimated your costs at 6,200,000. It is now the end of the 2nd year and you estimate that you are 50% complete and your estimate to complete will be 7,500,000 because of labor problems. What are the two alternative methods that can be used to record revenue on this multi-year project and what is the affect if:

1.estimate a total loss on the project ?

. 2. You believe that the estimated costs can be reduced and you will make an overall profit on the project. explain

Answer 1

Ans-

According to the GAAP rules and IAS 18, revenues are recognized when earned or when cash is received.In the case of long-term contracts, revenue may be recognized using the following two alternative method i.e. completion (sales method) and percentage of completion method.The use of sales basis would result into the distortion of the periodic income figures.A shift to percentage of completion method therefore is most warranted by many accountants since it is an objective evidence of the amount of revenue earned in the periods before completion is available .This is again in tandem with the matching principle stipulated in the GAAP rules and as such percentage of completion method is preferred to completed contract method.

The method of revenue recognition would effected if there is estimated total loss on the project and when there is an estimation that costs can be reduced and overall profit will be made. In these two scenarios, the choice of the method would affect the treatment of either the loss or profit estimates. To be able to match revenues and costs, percentage of completion method would still be preferred.