Long Term Construction Contracts

ACP 311- Accounting for Special Transactions

Department of Accounting Education

UM Tagum College
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Big Picture in Focus: ULOa. Discuss the accounting for long term
construction contracts.

Metalanguage
For you to demonstrate ULOa, you will need to have an operational understanding
of the following terms below.
1. Long term Construction Contracts. Are construction projects that extend
thru more than one accounting period.
2. Construction Contract. It is a contract specifically negotiated for the
construction of an asset or a combination of assets that are closely
interrelated or interdependent in terms of their design, technology or their
ultimate purpose or use.
3. Contract Price. A price agreed by the contracting parties for the
construction of projects.
4. Fixed Price Contract. This is a construction contract in which the contractor
agrees to a fixed contract price, or a fixed rate per unit of output, which in
some cases is subject to cost escalation clauses.
5. Cost Plus Contract. This is a contract in which the contractor is reimbursed
for allowable or otherwise defined costs, plus percentage of these costs or a
fixed fee.
6. Contract Revenue. The revenue earned form the construction projects
based on its progress or the degree of completion.
7. Percentage of Completion. The degree of the completion of the project.
8. Contract Costs. A cost required to construct the project. It includes the
materials used in the construction, labor and overhead directly attributable to
the construction.
9. Costs Incurred to Date. These are the accumulated cost incurred during
the construction.
10. Estimated Costs to Complete. These are the estimated cost needed to
complete the construction of the project.
11. Progress Billings. This is the accumulated amount of billing made to the
client.
12. Construction in Progress. This the account that composed of cost incurred
to date and the gross profit to date.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Essential Knowledge

LONG TERM CONSTRUCTION CONTRACT

1. INTRODUCTION
Nowadays, many new business have shown up. They tend to expand their business
and put up their new buildings for it. This becomes the opportunity to the
construction companies to render their service to the ones who needed it. Just like
the when President Duterte advocates to put up infrastructures, it becomes favorable
to the construction companies. Construction companies probably hire accountants to
accounts all of their transactions in the construction. As a future accountant, it is
important for you to learn the basic accounting of the construction projects.

2. COMPUTING AND RECOGNITION OF CONSTRUCTION REVENUE

There are two method to account for the long term construction contracts:
a. Percentage of Completion.
This method is used when the outcome of the construction contact can be
estimated reliably, that is, the estimate of costs to complete and the extent of
progress towards completion of the project are reasonably dependable.

1. Input Measure (Cost to Cost Method)

This method is used if the contract calls for one large project rather
than several separate projects. Under this method, the degree of
completion is determined by computing the ratio of the cost already
incurred to the total estimated costs to complete the project.
2. Output Measure (Unit of Delivery)
Under this method, revenue is recognized when certain phases of the
project are completed and accepted by the buyer. This method is
useful in contracts for the construction of several units. Income is
recognized when a particular unit is completed and accepted by the
buyer, although the entire project is not yet finished.

b. Zero Profit Method.

This method is used when the outcome cannot be reasonably estimated. The
revenue to be recognized is equal to the cost incurred only until the project is
finished. No gross profit will be recognized until the project is finished.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Illustrative Problem.
AMG Construction Company agrees to build a large office building for PG Towers
for a total contract price of P5,000. PG Towers will make annual payment to AMG
but the amount of these payments cannot exceed the direct costs incurred by AMG.
The contract is signed on October 1, 2018 and AMG’s year-end is December 31.
The contract provides PG with a final inspection right to ensure compliance with the
contract terms prior to accepting the completed project.

Illustration 1-1
Total Contract Price P5,000,000
Total anticipated costs (at 10/2018) P4,500,000
Item 2018 2019 2020 Total
Cost Incurred each year P1,350,000 P2,250,000 P400,000 P4,000,000
Estimated costs to complete 3,150,000 400,000 - -
Each year.
Progress Billings each year 400,000 2,000,000 2,600,000 5,000,000
Progress payments received 275,000 2,100,000 2,625,000* 5,000,000
Each year
*Since the contract was completed and accepted in 2020, the buyer paid the
remaining balance of the total contract amount, computed as follows:

Contract amount 5,000,000

Prior progress payment
2018 275,000
2019 2,100,000 2,375,000
Remaining Balance 2,625,000
The computation of the gross profit to be realized for each year under the two
methods are presented below:

Illustration 1-2
Percentage of Completion
2018 2019 2020
Total contract price P5,000,000 P5,000,000 P5,000,000
Cost incurred to date 1,350,000 3,600,000 4,000,000
Estimated costs to complete 3,150,000 400,000 -
Total estimated costs 4,500,000 4,000,000 4,000,000
Expected gross profit 500,000 1,000,000 1,000,000
%of Completion 30% 90% 100%
Gross profit to date 150,000 900,000 1,000,000
Less: Gross profit earned from
prior years - 150,000 900,000
Gross Profit earned this year P 150,000 P 750,000 P 100,000

Zero Profit Method

2018 2019 2020

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Construction Revenues P1,350,000 P2,250,000 P1,400,000

Cost Incurred each year 1,350,000 2,250,000 1,400,000
Gross Profit earned this year P - P - P1,000,000

Journal Entries (Comparison of Percentage of Completion and Zero profit

Method)

Zero Profit Method Percentage of Completion

20 1 Contract Signed No necessary entry

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2 Costs Incurred Construction in progress 1,350,000 1,350,000

Cash 1,350,000 1,350,000

3 Progress Billings Accounts Receivable 400,000 400,000

Contract Billing 400,000 400,000

4 Billing Collections Cash 275,000 275,000

Accounts Receivable 275,000 275,000

5 Revenue Construction in Progress - 150,000

Recognition Cost of Construction 1,350,000 1,350,000
Contract Revenue 1,350,000 1,500,000

20 6 Cost Incurred Construction in Progress 2,250,000 2,250,000

19 Cash 2,250,000 2,250,000

7 Progress Billings Accounts Receivable 2,000,000 2,000,000

Contract Billings 2,000,000 2,000,000

8 Billing Collection Cash 2,100,000 2,100,000

Accounts Receivable 2,100,000 2,100,000

9. Revenue Construction in Progress - 750,000

Recognition Cost of Construction 2,250,000 2,250,000
Construction Revenue 2,250,000 3,000,000

20 10 Cost Incurred Construction in Progress 400,000 400,000

20 Cash 400,000 400,000

11 Progress Billings Accounts Receivable 2,600,000 2,600,000

Contract Billings 2,600,000 2,600,000

12 Billing Collections Cash 2,625,000 2,625,000

Accounts Receivable 2,625,000 2,625,000

13 Revenue Construction in Progress 1,000,000 100,000

Recognition Cost of Construction 400,000 400,000
Construction Revenue 1,400,000 500,000

14 Elimination of Contract Billings 5,000,000 5,000,000

Inventory Construction in Progress 5,000,000 5,000,000

3. ANTICIPATED LOSS OF LONG-TERM CONSTRUCTION PROJECTS

Anticipated loss for the entire project may arise particularly when there is change in
the total estimated cost. Anticipated loss occur when the total estimated costs

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

exceeds the total revenue from [Link] loss shall be recognized

immediately without considering the degree of completion. The same treatment
shall apply whether percentage of completion or zero profit method is used.

Case 1. Loss in the year of revision of estimated costs but profit in total
contract.
Revising the data in Illustration 1-1, assume that at the end of 2019, the estimated
cost to complete was increased to P1,260,000 and this was the actual cost incurred
in 2020. The following analysis shows the computation of the gross profit (loss) to be
recognized each year:
2018 2019 2020
Contract Price P5,000,000 P5,000,000 P5,000,000
Cost Incurred to date 1,350,000 3,600,000 4,860,000
Estimated costs to complete 3,150,000 1,260,000 -
Total estimated costs 4,500,000 4,860,000 4,860,000
Expected Gross Profit 500,000 140,000 140,000
% of Completion 30% 75% 100%
Gross profit to date 150,000 105,000 140,000
Gross profit earned in prior year(s) ______ 150,000 105,000
Gross profit (loss) during the year P 150,000 P (45,000) P 35,000

The above computation shows that the increase in estimated cost reduce the
percentage of completion in 2019 to 75%, and the cumulative gross profit at the end
of 2019 to P105,000. Since P150,000 was already recognized as gross profit in
2018, a loss of P45,000 would be recognized in 2019. The entries to record revenue
and costs for the three years under the percentage of completion method would be
as follows:
2018 2019 2020

Cost of Construction 1,350,000 2,250,000 1,260,000

Construction in Progress 150,000 45,000 35,000
Construction Revenue 1,500,000 2,205,000 1,295,000

Under zero-profit method:

2018 2019 2020

Cost of Construction 1,350,000 2,250,000 1,260,000

Construction in Progress 140,000
Construction Revenue 1,350,000 2,250,,000 1,400,000

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Case 2. Loss in the year of revision of total estimated costs but overall loss on
the contract.
Assume the same data in our previous illustration, except that in 2019 the estimated
costs to complete were P1,500,000 instead of P400,000, assume also that actual
costs equalled expected costs in2020. The computation of the gross profit to be
recognized each year would be as follows:

2018 2019 2020

Contract Price P5,000,000 P5,000,000 P5,000,000
Cost Incurred to date 1,350,000 3,600,000 5,100,000
Estimated costs to complete 3,150,000 1,500,000 -
Total estimated costs 4,500,000 5,100,000 5,100,000
Expected Gross Profit 500,000 (100,000) (100,000)
% of Completion 30% 70%* 100%
Gross profit to date 150,000 (100,000) (100,000)
Gross profit (loss)earned in prior year(s) ______ (150,000) (-100,000)
Gross profit (loss) during the year P 150,000 P P 0
(250,000)
*Ignore when computing the gross loss during the year because anticipated loss must be recognized
immediately without considering percentage of completion.

Anticipated loss is recognized immediately at the end of 2019 because there is

anticipated overall loss on the contract. To record the anticipated loss of P100,000 in
2019 would be made as follows:
Zero-Profit Method:
Cost of Construction 2,250,000
Construction in Progress 100,000
Construction Revenue (cost incurred in 2019) 2,150,000
At the end of 2020, the year of completion, the entry would be:
Cost of Construction 1,500,000
Construction Revenue (cost incurred in 2020) 1,500,000

Percentage of Completion
To properly recognize the entire loss in the year, it is first anticipated then the
cumulative cost to be deducted from cumulative revenue is not the actual cost, but
must be the cumulative revenue plus anticipated loss. Thus in our example, the
cumulative revenue at the end of 2019 would be P3,500,000 (P5,000,000x70%), and
the cumulative costs at the same year would be P3,600,000 (P3,500,000 +
P100,000). Since it is assume that P150,000 profit was recognized in 2018, then the
total loss to be recognized in 2019 is P250,000 (P150,000 + P100,000) .

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

The entry to record the total loss at the end of 2019 would be as follows:
Cost of Construction 2,250,000
Construction Revenue 2,000,000
Construction in Progress (total loss) 250,000

4. CONTRACT RETENTION
to make sure that the project will be completed, the client may retain part of the
billings and this may not be paid until the project is not completed and accepted. For
example, if the client retain the 10% of the total billing amounting P1,000,000 and the
contractor agreed for it, then only P900,000 will be collected by the contractor. The
entry to record the collection would be:
Cash 900,000
Contract Retention 100,000
Accounts Receivable 1,000,000

Contract retention is presented in the balance sheet as current asset.

Key notes:
 At the completion of the project, the Construction in Progress (CIP) and
Progress Billings (PB) must be closed and must have a zero balance.
 The difference of CIP and PB must be presented as current asset or current
liability. There is current asset when CIP is greater than PB otherwise current
liability.
 If there are several projects that are interrelated with the same client, the
Construction in Progress and Progress Billings can be combined. The
determination of current liability and current asset is the difference of the total
CIP and Total PB of all projects.
 If each project has different client, then the CIP and PB must be determined in
each project as well as the determination of the current asset and current
liability.
 If there’s change in the contract price, then treat it currently and prospectively.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Self-Help: You can also refer to the sources below to help you
further
*Dayag, A. (2013). CPA examination in practical accounting 2. Manila: GIC
Enterprises & Co., Inc.
*Guerrero, P.P. & Peralta, J.F. (2013). Advanced accounting: Principles and
procedural applications. (Vol. 1). Manila: GIC Enterprises & Co., Inc.
*Guerrero, P. P. (2013). CPA problems and procedural approaches to solutions:
Practical accounting 2. Manila: GIC Enterprises & Co., Inc.
*Hoyle, J. B., Schaefer, T.F., & Doupnik, T. S. (2013). Advanced accounting (11th
ed.). New York, NY: McGraw-Hill/Irwin.
*Valix, C.T. & Valix, C.M. (2015). CPA examination: Theory of accounts. (2015
ed.). Manila: GIC Enterprises & Co., Inc.

Let’s Check
Questions:
1. In selecting an accounting method for a newly contracted long-term
construction project, the principal factor to be considered should be
A. the terms of payment in the contract.
B. the degree to which a reliable estimate of the costs to complete and
extent of progress toward completion is practicable.
C. the method commonly used by the contractor to account for other long-
term construction contracts.
D. the inherent nature of the contractor's technical facilities used in
construction.

2. The use of the percentage of completion method of accounting for long term
construction contracts is a measurement of revenue under the
A. Cost principle.
B. Objectivity principle.
C. Realization principle.
D. Monetary principle.

3. When work to be done and costs to be incurred on a long-term contract can

be estimated dependably, which of the following methods of revenue
recognition is preferable?
A. Installment method
B. Completed-contract method
C. Percentage-of-completion method
D. None of these

4. The principal disadvantage of using the percentage-of-completion method of

recognizing revenue from long-term contracts is that it
A. is unacceptable for income tax purposes.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

B. gives results based upon estimates which may be subject to

considerable uncertainty.
C. is likely to assign a small amount of revenue to a period during which
much revenue was actually earned.
D. none of these.

5. The rationale for adoption of the percentage-of-completion method is that:

A. Results are more conservative.
B. It provides a measure of periodic accomplishment.
C. It is a better match with legal ownership.
D. It results in a lower income tax.

6. The percentage-of-completion method of inventory valuation of long-term

contracts
A. Recognizes income upon completion of work.
B. Recognizes income based on collected billings.
C. Recognizes income based on the progress of work.
D. Does not recognize income at the balance sheet date

7. The accounting method that recognizes revenue prior to the point of sale
based on either an input or an output measure of the earning process is
known as the
A. Deposit method.
B. Installment sales method.
C. Cost recovery method.
D. Percentage-of-completion method

8. The percentage-of-completion method violates the general rule on revenue

recognition that:
A. Collection is reasonably assured.
B. Costs are known or reasonably estimated.
C. The earnings process is complete.
D. Collections have been received.

9. How should earned but unbilled revenues at the balance sheet date on a
long-term construction contract be disclosed if the percentage-of-completion
method of revenue recognition is used?
A. In a footnote to the financial statements until the customer is formally
billed for the portion of the work completed.
B. As a receivable in the noncurrent asset section of the balance sheet.
C. As a construction in progress in the noncurrent asset section of the
balance sheet.
D. As construction in progress in the current asset section of the balance
sheet.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

10. Saskia Co.’s construction projects extend over several years, and collection of
receivables is reasonably certain. Each project has a firm contract price,
reliable estimated of the extent of progress and cost to finish, and a contract
that is specific as to the rights and obligations of all parties. The contractor
and the buyer are expected to fulfill their contractual obligations on each
project. The method that the company should use to account for construction
revenue is
A. Installment sales.
B. Completed-contract.
C. Percentage-of-completion method.
D. Point-of-sale.

Let’s Analyze
On January 2, 2015, QUICKBUILD ERECTORS entered into contract to construct
two projects. The following data relate to the construction activities.
Project A Project B
Contract price P945,000 P675,000
Cost incurred during 2015 540,000 630,000
Estimated costs to complete 270,000 157,500
Billings to customer 337,500 607,500

1. What amount of gross profit should QUICKBUILD ERECTORS report in its 2015
income statement under the following methods?
Percentage of Zero Profit
Completion Method Method
A. P 0 P (90,000)
B. P (112,500) P (22,500)
C. P ( 22,500) P 0
D. P ( 22,500) P(112,500)

2. BEST - EVER CONSTRUCTION, INC .recognizes construction revenue and

costs using the percentage of completion method. During 2014, a single long-
term project was begun which continued through 2015. Information on the project
follows:
20142015
Accounts receivable P350,000 P1,050,000
Incurred costs during year 367,500 672,000
Construction in progress 427,000 1,274,000
Billings on contract 350,000 1,470,000
The construction accounts are at amounts t0-date.
What is the gross profit recognized from this long-term contract?
2014 2015
A. P 77,000 P 798,000
B. 77,000 350,000
C. 59,500 448,000

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

D. 59,500 175,000

3. CIGNAL ERECTORS began operations on January 2, 2015. During the year, the
company entered into a contract with TEAM Company to construct a
manufacturing facility. At that time CIGNAL estimated that it would take five years
to complete the facility at a cost of P3,937,500. The total contract price for the
construction of the facility is P5,468,750. During the year, the company incurred
P962,500 in construction costs related to the construction project. The estimated
cost to complete the contract is P2,730.000 TEAM was billed and paid 30% of the
contract price subject to a 10% retention.

Using the percentage of completion method, how much is the excess of

Construction in Progress over Contract Billings or Contract Billings over
Construction in Progress?
A. P273,437 (current liability)
B. P273,437 (current asset)
C. P437,500 (current asset)
D. P437,500 (current liability

4. CONCRETE CONSTRUCTION COMPANY began construction work in 2014 for

a project with a contract price of P8,000,000. CONCRETE uses the cost-to-cost
percentage of completion method. The financial for 2014 relating to the contract
shows the following:
Accounts receivable P500,000
Construction in Progress 1,600,000
Progress billings to date 1,500,000
Gross profit earned in 2014 200,000
Calculate the following items for the year 2014.
A. B. C. D.
Cash collections P1,000,000 P1,000,000 P1,400,000 P7,500,000
Cost incurred to P1,400,000 P1,600,000 P1,600,000 P1,400,000
date

5. On March 1, 2011, GG Company contracted to construct a factory building fàr HH

Mfg. For a total contract price of P1, 344, 000. The building was completed by
October 31, 2013. The company uses percentage of completion method.

2011 2012 2013

Contract costs incurred during the year P512, 000 P416, 000 P232, 000
Estimated costs to complete the contract 512, 000 , 000 -
Billings during the year 512,000 560, 000 272, 000
What is the amount of profit or loss to be recognized or the year ended December
31, 2013?
A. P36,000 B. (P12,800) C. P184,000 D. P171,200

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

6. RAM Corp. recognizes construction revenue and cost using the percent-of-
completion method. During 2013, a single long term project begun which
continue through 2013.
Information on the project follows:
2013 2014
Collections 200,000 600,000
Construction in progress net of billings 44,000 112,000
Contract billings 00,000 840,000
Current year gross profit 34,000 100,000.
How much is the cost incurred during 2013
A. 210,000 C. 210,000
B. 125,000 D. 125,000

7. Based on the information in number 6, how much is the cost incurred in year
2014?
A. 684,000 B. 356,000 C. 384,000 D. 796,000

SOLID ERECTORS started work on three job sites during the current year. Any
costs incurred are expected to be recoverable.
Data relating to the three jobs are given below:
Estimated Collection
Contract Actual Cost toBillings on from
Site Price Cost Complete Contract Customers
Cebu P 500,000P 375,000 - P 500,000P 500,000
Bohol 600,000 254,167 P 381,250 180,000 100,000
Davao 250,000 100,000 100,000 150,000 100,000
8. Calculate the net amount to be reported on the balance sheet for the above
projects under the percentage of completion method:
A. Due to Customers P (13,750) C. Due from customers P 11,250
B. Due to Customers P (11,250) D. Due from customers P 13,750

9. Calculate the net amount to be reported on the balance sheet for the above
projects under the zero profit method.
A. Due to Customers P(13,750) C. Due from Customers P 11,250
B. Due to Customers P(11,250) D. Due from customers P 13,750

10. Calculate the difference in net income for 2014 between using the % of
completion method and using the zero profit method over the afore-mentioned
transactions.
A. P25,000 C. P 35,417
B. P34,715 D. P 45,317
In a Nutshell
1. Saskia Co.’s construction projects extend over several years, and collection
of receivables is reasonably certain. Each project has a firm contract price,
reliable estimated of the extent of progress and cost to finish, and a contract
that is specific as to the rights and obligations of all parties. The contractor
and the buyer are expected to fulfill their contractual obligations on each
project.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

What method that the company should use to account for construction
revenue? Why?
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2. Dilla Construction Company's projects extend over several years and

collection of receivables is reasonably certain. Each project has a contract
that specifies a price and the rights and obligations of all parties. Both the
contractor and the customer are expected to fulfill their contractual obligations
on each project. Reliable estimates can be made of the extent of progress
and cost to complete each project.
What method that the company should use to account for construction
revenue? Why?
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______________________________________________________________
______________________________________________________________
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Q&A List

Do you have any issues/ clarifications?

Questions/Issues Answer

Keyword Index

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Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

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