Review Part 2

Percentage-of-completion and completed-contract methods. On February 1, 2007, Nance Contractors agreed to construct a building at a contract price of $6,000,000. Nance estimated total construction costs would be $4,000,000 and the project would be finished in 2009. Information relating to the costs and billings for this contract is as follows: 2007 2008 2009 Total costs incurred to date $1,500,000 $2,640,000 $4,600,000 Estimated costs to complete 2,500,000 1,760,000 -0Customer billings to date 2,200,000 4,000,000 5,600,000 Collections to date 2,000,000 3,500,000 5,500,000 Solution: Year 1: Profit on contract: 6,000,000 – (1,500,000 + 2,500,000) = 2,000,000 1,500,000/(1,500,000 + 2,500,000) = 37.5% x 2,000,000 = 750,000 profit recognized Year 2: Profit on contract: 6,000,000 – (2,640,000 + 1,760,000) = 1,600,000 2,640/(2,640 + 1760) = = 60% x 1,600,000 = 960 – 750 = 210,000 Year 3: 6,000 – 4,600 = 1,400 – 960 = 440,000 profit recognized. Completed Contract CIP 1,500,000 Cash 1,500,000 AR Cash

2,200,000 Billings

Percentage of completion CIP 1,500,000 Cash 1,500,000 AR

2,200,000

2,000,000 AR 2,000,000

Cash

2,200,000 Billings

2,000,000 AR 2,000,000

Const Exp. 1,500,000 CIP 750,000 Const. Revenue Balance Sheet: AR Liability (2,200 – 1,500)

200,000 700,000

AR Inventory (2,250 – 2,200)

2,200,000

2,250,000

200,000 50,000

CIP

1,140,000 Cash 1,140,000

CIP

1,140,000 Cash 1,140,000

AR

1,800,000 Billings

AR

1,800,000 Billings

Cash

1,800,000

1,500,000 AR 1,500,000

Cash

1,500,000 AR 1,500,000

Const Exp. 1,140,000 CIP 210,000 Const. Revenue Balance Sheet:

1,800,000

1,350,000

AR Liabilities (4,000 – 2,640)

500,000 1,360,000

AR Liability (4,000 – 3,600)

10,000 400,000

CIP

1,960,000 Cash 1,960,000

CIP

1,960,000 Cash 1,960,000

AR

1,600,000 Billings

AR

1,600,000 Billings

Cash

1,600,000

2,000,000 AR 2,000,000

Billings

Cash

6,000,000 Const. Revenue 6,000,000 Const. Exp. 4,600,000 CIP 4,600,000

1,600,000

2,000,000 AR 2,000,000

Const Exp. 1,960,000 CIP 440,000 Const. Revenue 2,400,000 Billings 6,000,000 CIP 6,000,000

The board of directors of Dodd Construction Company is meeting to choose between the completed-contract method and the percentage-of-completion method of accounting for long-term contracts in the company's financial statements. You have been engaged to assist Dodd's controller in the preparation of a presentation to be given at the board meeting. The controller provides you with the following information: 1. 2.

Dodd commenced doing business on January 1, 2008. Construction activities for the year ended December 31, 2008, were as follows: Project A B C D E

Project A B C D E

Total Contract Price $ 515,000 690,000 475,000 200,000 480,000 $2,360,000

Billings Through 12/31/08 $ 340,000 210,000 475,000 100,000 400,000 $1,525,000

Contract Costs Incurred Through 12/31/08 $ 424,000 195,000 350,000 123,000 320,000 $1,412,000

Estimated Additional Costs to Complete Contracts $101,000 455,000 -097,000 80,000 $733,000

Cash Collections Through 12/31/08 $ 310,000 210,000 390,000 65,000 400,000 $1,375,000

3. Each contract is with a different customer. 4. Any work remaining to be done on the contracts is expected to be completed in 2009. Instructions (a) Prepare a schedule by project, computing the amount of income (or loss) before selling, general, and administrative expenses for the year ended December 31, 2008, which would be reported under: (1) The completed-contract method. (2) The percentage-of-completion method (based on estimated costs). (c) Indicate the balances that would appear in the balance sheet at December 31, 2008 for the following accounts for Project D (fourth project), assuming that the percentage-of-completion method is used. Accounts Receivable Billings on Construction in Process Construction in Process (d) How would the balances in the accounts discussed in part (c) change (if at all) for Project D (fourth project), if the completed-contract method is used?

Solution (a) (1) and (2) Projects E Contract price Contract costs incurred Additional costs to complete 80,000 Total cost Total gross profit or (loss) 80,000

A

B

C

D

$515,000 $480,000 424,000 320,000

$690,000

$475,000

$200,000

195,000

350,000

123,000

101,000

455,000

-0-

97,000

525,000 400,000

650,000

350,000

220,000

$ 40,000

$125,000

$ (20,000)

$ (10,000)

The amount reported as income (loss) under the completed-contract method for 2008 is: Project A B C D

$(10,000) -0125,000 (20,000)

$

E

-0$ 95,000

The amount reported as income (loss) under the percentage-of-completion method for 2008 is: Project A B C D E (b)

$(10,000) 12,000 125,000 (20,000) 64,000 $171,000

$40,000 × ($195,000 ÷ $650,000) $80,000 × ($320,000 ÷ $400,000)

Construction in Process................................................................... Construction Expenses.................................................................... Revenue from Long-term Contracts............................................... 207,000

12,000 195,000

(c) Billings $100,000

(d)

Cash collections Accounts receivable Billings on Construction in Process

65,000 $ 35,000 100,000

Costs incurred Loss reported Construction in process

$123,000 (20,000) $103,000

The account balances would be the same.

Klugg, Inc. appropriately uses the installment-sales method of accounting to recognize income in its financial statements. Some pertinent data relating to this method of accounting include: 2007 2008 Installment sales $750,000 $720,000 Cost of installment sales 570,000 504,000 Gross profit $180,000 $216,000 Rate of gross profit Cash collected 300,000

24% 300,000

30%

60,000 Profit recognized in 2007: 300,000 x 24% = 72,000 Profit recognized in 2008: 300,000 x 24% = 72,000 + 60,000 x 30% = 18,000 Singer Company sells plasma-screen televisions on an installment basis and appropriately uses the installment-sales method of accounting. A customer with an account balance of $5,600 refuses to make any more payments and the merchandise is repossessed. The gross profit rate on the original sale is 40%. Singer estimates that the television can be sold as is for $1,750. The loss on repossession is Deferred GP 2,240 Repo. Merch 1,750 Loss on rep 1,610 Install. AR 5,600 Wilbratte Corp. began 2007 with a $ 92,000 balance in the Deferred Tax Liability account. At the end of 2007, the cumulative temporary difference amounts to $ 350,000 and it will reverse evenly over the next two years. Pretax accounting income for $ 525,000, the tax rate for all years is 40%, and taxable income for 2007 is $ 405,000. • Compute income taxes payable for 2007 • Prepare the journal entry for 2007 • Prepare the income tax expense section in the income statement (a)

Taxable income for 2007 Enacted tax rate Income tax payable for 2007

(b) Future taxable (deductible) amounts Tax Rate Deferred tax liability (asset)

$405,000 40% $162,000 Future Years 2008 2009 $175,000 $175,000 40% 40% $ 70,000 $ 70,000

Total $350,000 $140,000

Deferred tax liability at the end of 2007 $140,000 Deferred tax liability at the beginning of 2007 92,000 Deferred tax expense for 2007 (increase required in deferred tax liability) 48,000 Current tax expense for 2007 162,000 Income tax expense for 2007 $210,000 Income Tax Expense............................................................................ Income Tax Payable............................................................. 162,000 Deferred Tax Liability............................................................ 48,000 Income before income taxes $525,000 Income tax expense Current Deferred 210,000 Net income $315,000

210,000

(c)

$162,000 48,000

Benjamin Company has two temporary differences as follows: Pretax financial income Excess depreciation for tax Excess warr. Exp. For financial Taxable income

2007 840,000 (30,000) 20,000 830,000

2008 910,000 (40,000) 10,000 880,000

2009 945,000 (10,000) 8,000 943,000

The income tax rate is 40% for all years a. Prepare journal entries for all three years (a)

2007

Income Tax Expense...................................................................................

336,000

Deferred Tax Asset ($20,000 X 40%)..........................................................

8,000

Deferred Tax Liability ($30,000 X 40%)........................................... 12,000 Income Tax Payable ($830,000 X 40%).......................................... 332,000 2008 Income Tax Expense...................................................................................

364,000

Deferred Tax Asset ($10,000 X 40%)..........................................................

4,000

Deferred Tax Liability ($40,000 X 40%)........................................... 16,000 Income Tax Payable ($880,000 X 40%).......................................... 352,000 2009 Income Tax Expense...................................................................................

378,000

Deferred Tax Asset ($8,000 X 40%)............................................................

3,200

Deferred Tax Liability ($10,000 X 40%)........................................... 4,000 Income Tax Payable ($943,000 X 40%).......................................... 377,200