liabilities under the completed contract method ??

  1. Nigella company has a 3-year contract to build a plant for $2,500. they have a reliable estimate that costs will be $2,000 over the life of the contract. The project has following info: ------------------------------------------------------------------ …Year1/ Year2/ year3/ total Billed…1,000/ 1,000/ 500/ 2,500 Cash received…700/ 1200/ 600/ 2,500 Costs incurred…700/ 900/ 400/ 2,000 ------------------------------------------------------------------- under the completed contract method of revenue recognition, the total liabilities at the end of year2 for Nigella will be: a. $0 b. $100 c. $300 d. $400 ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ this question is from 07’ Schweser sample exam. I’m quite surprised to be asked for the total liabilities under the completed contract method . I checked 08’ CFAi book, didn’t see that part. with my limited accounting knowledge, the TL at end of year 2 is $700+1200=$1,900 which is unearned revenue under the completed contract method . total revenue $2,500 won’t be recognized until contract completion.

billed amount 1,000 + 1,000 = 2,000 (actual cash received doesn’t affect liabilities) costs = 700 + 900 = 1,600 under complete contract profits are not recognized until the completion. liability = billed amount - costs = 400 -> D

© I believe there is $300 of unearned revenues to be accounted for as a liability… now i haven’t reviewed this material in a long time, so I’m going from a hazy memory. But under completed contract i believe you can recognized revenue but not profits through the periods. In which case 80% of the contract has been completed (($700+$900)/$2000) therefore 80% of the revenues has been earned (notice no profit margin included) so only $1,600 of has been earned. If $1,900 in cash has been received, then $300 in unearned revenues must be booked as a liability. Again I’m shooting from the hip here… if I’m wrong surely cpk or SuperI will pipe up.

answer from Schweser: D The liabilities are simply advance billings minus costs incurred under the completed contract method. The net liability at the end of year 1 is $300 ($1,000 - $700) and at the end of year 2it grows by an additional $100 ($1,000 -$900). The firm has billed $2,000 at the end of year 2and has incurred $1,600 of costs so the net liability at the end of year 2 is $400. Because revenues are not recognized until the project is completed, the liabilities will generally be higher under the completed contract method than under the percentage of completion method. +++++++++++++++++++++++++++++++++++++++++++++++++++++++++ one rule I remember, don’t offset asset and liability. in this question, for total liability is $2,000, asset is $1,600, so net liability is 2000-1600=$400. as the term used in Schweser explanation. However, this kind of question is very strange, I don’t see it in LOS. anyone find it in CFAi book?

Under GAAP companies are required not to record any revenues, costs or profit until the entire contract is completed. The cost incurred accumulates in inventory (construction in progress), and amount billed accumulates in advance billings (liability). For financial reporting purposes, these are netted, resulting in a net current asset or liability (that’s what my Stalla book says). Gross profit is recognized in the year of contract completion. Inventory @ end of year 2 (asset : construction in progress): $1,600 Advance billings @ end of year 2 (liability):$2,000 Net liability: $400 Under IFRS, when reliable project estimate costs are not available but is probable that the project costs will be recovered, revenue is recognized only to the extent of cost incurred - but this is not the case here, they have reliable cost estimates of $2,000. Check this link on investopedia: http://www.investopedia.com/study-guide/cfa-exam/level-1/financial-statements/cfa14.asp

What would have been the case if it would have been Percentage complete method instead of completed contract method of revenue reconization

thanks

lrb42 Wrote: ------------------------------------------------------- > What would have been the case if it would have > been Percentage complete method instead of > completed contract method of revenue reconization +++++++++++++++++++++++++++++++++++++++++++++++++++++++ the formula from investopedia is like this: construction in progress = the cumulative cost incurred since inception + (cumulative percentage of completion x total estimated net profit of the project) Less Total billings = cumulative amount billed to the client since inception if the result of the above equation is: Positive (asset) = net construction in progress Negative (liability) = net advance billings if it is Percentage completion method : construction in progress =700+900+[(700+900)/2000]*(2500-2000)=2000 less total billings=1000+1000=2000 result is $0, no asset, or liability

Thanks