Chapter 5, Problem 5.18E

Long-term contract; revenue recognition over time vs. upon project completion

• LO5–9

On June 15, 2018, Sanderson Construction entered into a long-term construction contract to build a baseball stadium in Washington, D.C., for $220 million. The expected completion date is April 1, 2020, just in time for the 2020 baseball season. Costs incurred and estimated costs to complete at year-end for the life of the contract are as follows ($ in millions):

Required:

1. How much revenue and gross profit will Sanderson report in its 2018, 2019, and 2020 income statements related to this contract assuming Sanderson recognizes revenue over time according to percentage of completion?

2. How much revenue and gross profit will Sanderson report in its 2018, 2019, and 2020 income statements related to this contract assuming this project does not qualify for revenue recognition over time?

3. Suppose the estimated costs to complete at the end of 2019 are $80 million instead of $60 million. Determine the amount of revenue and gross profit or loss to be recognized in 2019 assuming Sanderson recognizes revenue over time according to percentage of completion.

To determine

Contract

Contract is a written document that creates legal enforcement for buying and selling the property. It is committed by the parties to performing their obligation and enforcing their rights.

Revenue recognized point of long term contract

A long-term contract qualifies for revenue recognition over time. The seller can recognize the revenue as per percentage of the completion of the project, which is recognized by revenue mines cost of completion until date.

A contract does not meet the performance obligation norm. The seller cannot recognize the revenue till the project complete.

The revenue recognition principle

The revenue recognition principle refers to the revenue that should be recognized in the time period, when the performance obligation (sales or services) of the company is completed.  

The amount of revenue and gross profit or loss will report in 2018, 2019, and 2020 income statement of S Contraction, and assume revenue recognize over time according to percentage of completion.

Explanation of Solution

Recognized revenue

In the year 2018:

Given,

The contract price is $220,000,000

Actual cost to date is $4,000,000

Calculated total estimated cost is $160,000,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\\ \text{=}\$\text{220},000,000\times \frac{\$40,000,000}{\$160,000,000}\\ =\$220,000,000\times 25\%\\ =\$55,000,000\end{array}$

Hence, the calculated revenue recognition is $55,000,000.

In the year 2019:

Given,

The contract price is $220,000,000

Actual cost to date is $120,000,000

Calculated total estimated cost is $180,000,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =}\left[\begin{array}{l}\left[\text{Contract price}\times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\right]-\\ \text{Previous year revenue}\end{array}\right]\\ \text{=}\left(\$\text{220},000,000\times \frac{\$120,000,000}{\$180,000,000}\right)-\$55,000,000\\ =\left(\$220,000,000\times 25\%\right)-\$55,000,000\\ =\$91,670,000\end{array}$

Hence, the calculated revenue recognition is $91,670,000.

In the year 2020:

Given,

Contract price is $220,000,000

Calculated revenue recognition in 2018 is $55,000,000

Calculated revenue recognition in 2019 is $91,670,000

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =Contractprice}-\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{18+}\\ \text{Revenue recognition in 2}0\text{19}\end{array}\right)\\ =\$\text{220},000,000-\left(\$55,000,000-\$91,670,000\right)\\ =\$73,330,000\end{array}$

Hence, the calculated revenue recognition is $73,330,000.

Recognized gross profit

In the year 2018:

Given,

Estimated gross profit in 2018 is $60,000,000 (1)

Total estimated cost is $160,000,000

Actual cost to date is $40,000,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{18}\end{array}\right)\times \left(\frac{\text{Actual costto date}}{\text{Total estimated cost}}\right)\\ =\$60,000,000\times \frac{\$40,000,000}{\$160,000,000}\\ =\$60,000,000\times 25\%\\ =\$15,000,000\end{array}$

Hence, the calculated gross profit recognition is $15,000,000.

In the year 2019:

Here,

Estimated gross profit in 2019 is $40,000,000 (1)

Total estimated cost is $180,000,000

Gross profit recognition in 2018 is $15,000,000

Actual cost to date is $120,000,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\left(\begin{array}{l}\text{Estimated gross }\\ \text{profit in 2}0\text{19}\end{array}\right)\\ \times \left(\frac{\text{Actual costto date}}{\text{Total estimated cost}}\right)\\ -\left(\begin{array}{l}\text{Gross profit }\\ \text{recognition in 2}0\text{18}\end{array}\right)\end{array}\right)\\ \text{=}\left(\left(\$4\text{0},000,000\right)\times \left(\frac{\$12\text{0},000,000}{\$\text{180},000,000}\right)-\$15,000,000\right)\\ =\left(\left(\$60,000,000\times 66.67\%\right)-\$15,000,000\right)\\ =\$26,670,000-\$15,000,000\end{array}$

$=\$11,670,000$

Hence, the calculated gross profit recognition is $11,670,000.

In the year 2020:

Here,

Estimated gross profit in 2018 is $50,000,000 (1)

Gross profit recognition in 2016 is $15,000,000

Gross profit recognition in 2017 is $11,670,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Estimated gross profit in 2}020\\ -\left(\begin{array}{l}\text{Gross profitrecognition in 2}0\text{18 }\\ +\text{ Gross profit recognition in 2}0\text{19}\end{array}\right)\end{array}\right)\\ \text{=}\left(\$\text{5}0,000,000-\left(\begin{array}{l}\$\text{15},000,000\\ +\$\text{11},\text{67}0,000\end{array}\right)\right)\\ =\left(\$50,000,000-\$26,670,000\right)\\ =\$23,330,000\end{array}$

$=\$11,670,000$

Hence, the calculated gross profit recognition is $11,670,000.

Working note:

Calculate the value of gross profit (in millions)

Particulars	2018		2019		2020
Contract price		$220		$220		$220
Actual costs to date	$40		$120		$170
Estimated costs to complete	$120		$60		$0
Less: Total estimated cost		$160		$180		$170
Estimated gross profit		$60		$40		$50

Table (1)

(1)

To determine

To calculate: The amount of revenue and gross profit or loss to be recognized in 2018, 2019 and 2020 assuming the project does not qualify for revenue recognition over time.

Explanation of Solution

Revenue recognition:

In this case, there is no revenue recognition because the project does not qualify for revenue recognition overtime.

Recognized gross profit:

In the year 2018 and 2019:

In this case, there is no recognized profit, because the contract is not yet completed. Hence, the gross profit in the year 2018 and 2019 is $0.

In the year 2020:

Here,

The contract price is $220,000,000

Actual cost to date is $170,000,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Contract price}\\ -\text{ Actual cost to date}\end{array}\right)\\ =\$220,000,000-\$170,000,000\\ =\$50,000,000\end{array}$

Hence, the calculated gross profit recognition is $50,000,000.

To determine

The amount of revenue and gross profit or loss to be recognized in 2019, and assume S Construction recognizes revenue over time according to percentage of completion.

Explanation of Solution

Revenue recognition in the year 2019:

Here,

Contract price is $220,000,000

Actual cost to date is $120,000,000

Total estimated cost is $200,000,000

Revenue recognition is $55,000,000 $\left(\$15,000,000+\$40,000,000\right)$

Profit recognizes is $15,000,000.

Now, calculate the revenue recognition:

$\begin{array}{c}\text{Revenue recognition =}\left(\begin{array}{l}\text{Contract price}\\ \times \left(\frac{\text{Actual cost to date}}{\text{Total estimated cost}}\right)\end{array}\right)-\text{Revenue recognition}\\ \text{=}\left(\begin{array}{l}\$\text{220},000,000\\ \times \frac{\$\text{12}0,000,000}{\$\text{2}00,000,000}\end{array}\right)-\$\text{55},000,000\\ =\left(\$220,000,000\times 60\%\right)-\$\text{55},000,000\\ =132,000,000-\$\text{55},000,000\end{array}$

$=\$77,000,000$

Hence, the calculated revenue recognition is $77,000,000.

Recognized gross profit in the year 2019:

Here,

Revenue recognition in 2019 is $77,000,000

Actual cost to date is $80,000,000

Now, calculate the gross profit recognition:

$\begin{array}{c}\text{Gross profit recognition =}\left(\begin{array}{l}\text{Revenue recognition in 2}0\text{17}\\ -\text{ Actual cost to date}\end{array}\right)\\ =\$77,000,000-\$80,000,000\\ =-\$300,000\end{array}$

Hence, the calculated gross loss recognition is $300,000.