The calculation of the income recognized in the third year of a five-year construction contract accounted for using the percentage-of-completion method includes the ratio of: A) total costs incurred to total estimated cost. B) costs incurred in year 3 to total billings. C) costs incurred in year 3 to total estimated costs. D) total costs incurred to date to total billings to date. Your answer: C was incorrect. The correct answer was A) total costs incurred to total estimated cost. The percentage of completion method recognizes revenues in proportion to the proportion of expenses incurred. why would it be total cost if we’re only looking at the revenue of year 3?
It says income, not revenue, that may be the trick. If total costs incurred were greater than total estimated costs you would have to recognize a full net loss on the contract.
To me both A and C make sense, you can get the same answer either way. with (total costs incurred/total estimated cost) x value of contract, you can just subtract the total revenue already recognized in year 1 and 2, but this gives the same result at C anyways. (assuming total costs incurred in a = total costs up to year 3).