[cpaswag]

Ok, so I am posting questions and explanations given. My confusion is on how we get the 80% complete (like how do we calculate that percentage) which is given in explanation 2)

Sonex Construction Co. incurred the following costs and made the following estimates in the first two years of a three-year construction project.

Year 1 Year 2

Actual current year costs incurred $ 1,200,000 $ 1,000,000

Estimated costs to complete contract 1,800,000 550,000

Contract price 5,000,000 5,000,000

Billings and collections 2,500,000 1,500,000

Using the percentage of completion method of accounting, what amount would Sonex show as either a net current asset or a net current liability as of the end of Year 2 due to its construction activity?

a. $0

b. $4,000,000 asset.

c. $1,500,000 liability.

d. $1,800,000 asset.

Explanation 1)

Choice “a” is correct. If the sum of cumulative costs incurred plus cumulative gross profit recognized exceeds cumulative billings, the excess is reported as a current asset. If cumulative billings exceeds the sum of cumulative costs incurred plus cumulative gross profit recognized, the difference is reported as a current liability. If the two amounts are equal, no asset or liability is recognized.

Explanation 2)

Basically in year one you were 40 percent done with the project based on actual and estimated costs (1,200,000 (actual costs) + 1,800,000 (Estimated costs left)=3,000,000/1,200,000=40%. So you say that this project will cost 3,000,000 to construct and so far you’ve spent 1,200,000, which means that your 40% complete with the project. Because you’ve taken

40% of the cost, you should take 40% of the total fee you are charging the client (5,000,000 *40%=2,000,000) as revenue.

The entries would be:

Construction expense Dr. 1,200,000 income statement account

Accounts Payable/Cash Cr. 1,200,000 income statement account

Construction in progress Dr. 2,000,000 Asset account

Revenue Cr.2,000,000 income statement account

Then you billed and collected from the client 2,500,000. Journal entry below

Cash Dr. 2,500,000 Asset account

Billings on construction contract Cr. 2,500,000 contra asset account.

Now the only things relevant to this question are construction in progress and billings on construction contract.

So you earned 2,000,000 worth of revenue related to construction and collect 2,500,000, which means you have a liability in year one (Deferred revenue). Billings on construction is a contra asset account of construction in progress.

So after year one you have a liability for 500,000 because you collected more cash then you earned.

Now in year two, you are 80% complete with the project. Now on a cumulative basis (year 1 and year 2 combined) you have earned 80% of the project fee (5,000,000*80%=4,000,000). So long story short, your construction in progress account should now have a cumulative (year 1 and year 2 balance of 4,000,000. Now during year 2 you billed and collected another 1,500,000 from the client, which means on a cumulative basis (year 1 and year 2) you have collected 4,000,000 from the client. Now remember that billing and collections on construction contracts is a contra asset account of construction in progress. so at this point your balance sheet looks like this:

Construction in progress Dr. 4,000,000

Billings on construction contract Cr. 4,000,000

They net each other out, and equal 0.

[Anonymous]

Here is how.

step 1. Add Year 1 and Year 2 Actual Cost -this is your numerator
step 2. Add Year 2 Estimated cost to complete to step 1 – this is your denominator
you now have 2,200,000 in numerator and 2,750,000 denominator.

[Author]

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