Percentage of Completion

CFA Level I
#1

Hi all, I was looking at some prior questions to CFA, and found this odd. Now I am either thinking about it wrong, or it’s wrong on the exam?

  1. A company entered into a three-year construction project with a total contract price of $5.3 million and an expected total cost of $4.4 million. The following table provides cash flow information relating to the contract: Costs incurred and paid Yr 1. 600,000 Yr 2. 3,000,000 Yr. 3 800,000 Amounts billed and payments received 1,200,000 2,800,000 1,300,000

If the company uses the percentage-of-completion method, the amount of revenue (in $) recognized in Year 2 will be closest to: A. 2,800,000. B. 3,372,727. C. 3,616,636. Answer: C

Solution: The revenue reported is equal to the percentage of the contract that is completed in that period, where percentage completion is based on costs. In Year 2, the percent completed is $3,000,000/$4,400,000 = 68.2%, resulting in 68.2% x 5,300,000 = 3,616,636 revenue being recognized.

Now isn’t that wrong? Because you need to calcualate the Revenue the first year (%complete), and then subtract that from the second year and apply the currently completed %??

#2

Their calculation is correct.

The other approach is to calculate the total, cumulative revenue to recognize, then subtract prior years’ recognized revenues to get this year’s recognized revenue; perhaps you’re thinking of that.

That calculation would be:

Cumulative costs: $600,000 + $3,000,000 = $3,600,000

Cumulative percentage: $3,600,000 / $4,400,000 = 81.8%

Cumulative revenue: 81.8% × $5,300,000 = $4,336,364

Previous revenue: $600,000 / $4,400,000 × $5,300,000 = $722,272

Revenue recognized this year = $4,336,364 – $722,272 = $3,613,636

This latter method is better to use in a year when (total) cost estimates change; when the cost estimate remains unchanged, the methods are equally good.

#3

redacted

#4

National security?

#5

Just didn’t think the thread needed the same math twice.