Revenue Recognition

CFA Level I
#1

Nigella Company has a 3-year contract to build a manufacturing plant for $2,500. They have a reliable estimate that costs will be $2,000 over the life of the contract. The project has the following year-end billing amounts, cash received and costs incurred: Year 1 Year 2 Year 3 Total Billed $1,000 $1,000 $500 $2,500 Cash received 700 1,200 600 2,500 Costs incurred 700 900 400 2,000 Under the completed contract method of revenue recognition, the total liabilities associated with this project at the end of year 2 for Nigella will be: A. $0. B. $100. C. $300. D. $400. What is the total liabilities? Is it the total cost up to year 2?

#2

i’ll go with C. i think the liabilites in this case will be the difference between cash recieved and costs incurred. This represents unearned revenue under completion of contract.

#3

The answer is D. Is this because due to the cumulative difference between billed and costs incurred?

#4

hmm, i have no clue. this is a good question, haven’t seen this before.

#5

now i’m curious - where is this question from. it’s a little strange because if cost estimates are reliable, they shouldnt be using completed contract. but that said - under completed contract - costs incurred accumulate as inventory and customer billings appear as a liability. so maybe they are offsetting that - the 2000 billed vs the 1600 cost incurred? but you can’t offset - so i don’t know, i’m still lost.

#6

D. CIP should be netted against advanced billings to arrive at the liability. In the case of completed contract revenue recognition, CIP equals the costs incurred only. If it were a % of completion contract, CIP equals costs incurred plus pro rate profit margin based on cost incurred relative to total costs.

#7

So you’re saying: Billed $1,000 $1,000 $500 $2,500 Cash received 700 1,200 600 2,500 Costs incurred 700 900 400 2,000 1000 amt billed yr1 + 1000 amt billed yr 2 - 700 cost incurred y1 - 900 cost incurred yr2 = 400 amt left as liability on balance shet?

#8

Funny how advanced billing is a current liability and not a current asset like A/R

#9

it all goes back to the matching principle, its actually booked as deferred revenue, which is a liability

#10

that makes sense then.

#11

Thanks guys!