 Hello and welcome to this session. This is Professor Farhad in which we would look at this long term construction project where I would compute revenues, expenses and profit using the percentage of completion method as well as the completed contract. Now specifically for this exercise, I'm only going to focus on the income statement accounts simply put, I'm going to compute how much revenue you would need to recognize for a particular year, deduct the expenses and give you the profit and obviously compute the degree of completion. I will not work any balance sheet accounts because I believe the balance sheet account are straightforward and I did cover them in the prior recording when I covered percentage of completion method. So you could view the prior recording if you're interested in the balance sheet entries. Let's go ahead and get started on April 1st. Adam Construction year X1 entered into a contract to build a warehouse for Avi for a total contract price of 8.5 million. That's the contract price. The building was completed by November 20 X3. The annual contract costs are as follow for X1, X2 and X3. So X1, X2 and X3. We have the contract cost incurred during the year for any particular year. And as of that year, what's the remaining to be completed because that's important in order to compute the degree of completion. So what I'm going to do now I'm going to switch to an Excel sheet and work this problem starting with the degree of completion in order to find out how much revenues I can recognize revenues and obviously profit for each particular period. Before I proceed, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true false questions as well as exercises. Go ahead, start your free trial today, no obligation, no credit card required. So this is the data that we have on the PowerPoint slides, the cost for each particular year and revenue. So we're going to find out is what is the degree of completion? How much did we completed in year X1? What's the degree of completion? And based on the degree of completion, we can figure out how much revenue to recognize. So how do we compute this? Well, the formula goes cost incurred to date divided by the total cost to complete the project. So let's go ahead and find out what is the cost to date. The cost to date is cost incurred to date is three million cost to complete the project we need additional three million five hundred and ninety. Therefore, the total cost to complete is six million five hundred and ninety. So if I take cost incurred to date, which is the three million divided by the total cost estimated for this project as of X1, I finished 46% of the project as of year one. Now I can recognize 46% of the revenue and as a result recognize some profit for year X1. So let me show you how do we recognize the revenue. So for the revenue, I'm going to take 8.5 million eight, which is the revenue for the project times 46%. So 8.5 million times 46%. That's going to give me the revenue and the cost is three million. Therefore, my profit for year one is 869,499. So I'm going to go ahead and show you the journal entry to book this entry. So to book this entry, I'm going to recognize revenue, expense and profit. So the revenue is three million five hundred, 69,499. The construction cost is the construction cost that I incurred and the difference between them is I'm going to put here in quote profit. Now you have to understand that we park the profit in an account called construction in progress. So simply put the entry for the profit is construction in progress, which is an inventory account, which is an inventory account. So in the inventory account, we put the profit and we also include the cost in that account. Again, in the prior recording, I focus more on construction and progress. But this is just to show you how much profit I recognize. Now bear in mind, although I put 869,499 on the balance sheet as part of inventory on the income statement, I reported revenues, I reported expenses, the difference between them also is profit recognized for year X1. So this is X1. Let's take a look at year X2. In year X2, I incurred two million three hundred and thirty thousand and the remaining cost to complete the project is two million one hundred and ninety thousand. Now I'm going to use the same formula and what's that formula cost incurred to date divided by the total estimated cost to complete the project. So what is the cost to date? Let me show you the cost to date. The cost to date is three million in year one, three million in year one, three million in year one and two million three hundred and thirty in year two. So the cost incurred to date is five million three hundred and thirty which is cost incurred in year one plus cost incurred in year two divided by the total cost to complete the project. Now I need to compute what's that and that number seven million five hundred and twenty. Hold on a second. My cost was six million five hundred and ninety total cost to complete the project. In year two, it's seven million five hundred and twenty. My cost went up. Yes, that could happen, especially these days with inflation. Labor cost is going up, material going up, so on and so forth. So that could easily happen in the real world. So what happened in year two, first let's compute my degree of completion. So my degree of completion is seventy one percent. So for as of year two, I completed seventy one percent taking cost incurred to date divided by the total estimate that cost to complete the project. Now let me recognize my revenue and my expense for that particular year. My revenue is eight point five million eight point five million times seventy one percent. So it's eight point five million eight point five million times seventy one percent minus the prior revenue. The prior revenue is three million eight hundred sixty nine four ninety nine. Remember, I'm computing my revenue based on seventy one percent, but I already recognize forty six. Therefore, my revenue for year two is using the formula two million one hundred fifty five thousand one oh two. My cost incurred for year two is two million three hundred and thirty. Wow. Hold on a second. I think in year two, notice in year two, my cost is greater than my revenue. So what I have in year two is not a profit. In year two, I have a loss and my loss is one hundred seventy four thousand eight ninety eight. Every time you incur a loss, the company will have to stop and ask themselves, is this loss for the whole project or is this loss only for the interim period? What does that mean? It means is with this loss make my project unprofitable or with this loss make only this year unprofitable? Well, let's see. My my project is eight point five million in revenue and if I compute all my current cost and future cost, which is cost in year one, cost in year two and my estimated cost in year three, if you do so, let's let's just add them up kind of just to tell you how much they will be. If I sum those, they sum up to seven million five hundred and twenty thousand. So what does that mean? It means although I am incurring a loss. So year two is a loss. That's fine. But overall, the project is still profitable, not as profitable as I thought initially. It's still profitable. So let's compute the journal entry for year for year two. So for year two, I am going to debit my construction expense. I'm going to credit my revenue for the amount of two point three million thirty thousand revenue two million one hundred fifty five thousand one oh two. Now what's going to happen is I am going to credit my construction in process. So I am going to credit construction in process for the loss. So this is again the loss that I booked for year two. The book I year two and I reduce my CIP and the loss will be reported on the income statement. But the overall project is still profitable. For year three, I'm going to have to do the same thing for year three. And year three, which is the last year, year three, it's always going to be one hundred percent. Although it's one hundred percent, I would still like to show you the computation. You will take cost incurred to date. Cost incurred to date is year one, year two, year three, you add them all these up divided by the total cost to complete the project. The total cost to complete the project is seven million five hundred and twenty. Therefore, as of year three, you completed one hundred percent of the project. Now what you do you will need to compute your revenue. Your revenue will be your revenue, which is eight point five million eight point five million eight point five million times one hundred percent minus year two revenue minus year one revenue. Okay. So this is what we do is we'll take the eight point five basically eight point five million minus the three million eight hundred sixty nine thousand four ninety nine two million one hundred fifty five thousand one oh two, which is the prior year revenue. So year three revenue is two million four hundred seventy five thousand three ninety nine minus the cost incurred in year two, year three, which is right here two million one hundred and ninety. So in year three, I had a profit of two hundred eighty five thousand three ninety nine. Now I'm ready to book the last year journal entry for my income statement. So let me show you the journal entry, which is credit revenue for two million four hundred seventy five thousand three forty four. Debit might construction expense two million one hundred and ninety and the difference is the profit, which is again a CIP account of two hundred eighty five thousand three ninety nine. Now this method is the percentage of completion method. So I was able to recognize my revenue as time goes by. Now if I'm using the completed contract method, the completed contract method is a conservative method. The completed contract method state don't recognize any revenue or any expense and as a result any profit until the project is completed. So what's going to happen if you're using the percentage of completion method, there's no entry for year one as far as the income statement, there's no entry for year two as the income statement and year three, year three, you would include all the revenue, which is eight point five million, all the expenses seven million five hundred and twenty thousand and you will book the profit. So this is under the completed contract method, completed contract. The completed contract is a conservative method. The completed contract says don't recognize any profit until the project is done. The project is done. I can recognize nine hundred and eighty thousand and if you want to you can add up where I come up with all these revenues. So where did that entry came? If you add up all the revenues year one, year two and year three you will come up with eight point five million. Same thing with the expenses. If you add up year one expenses plus year two expenses plus year three and if you add up the profit from year one minus the loss plus the profit of year three you will get nine hundred and eighty thousand which is the construction and process. So you will make one journal entry only in year x three. So in this exercise what I did is I incurred the loss but the loss is not for the whole project. The loss is for it's called an interim loss. You could also have a scenario where the loss is for the whole project. It means the project became unprofitable. How do you book the journal entries? I might work a problem like this but for now go to farhatlectures.com work MCQs true false look at additional exercises and resources that's going to help you understand this topic. Invest in yourself invest in your career. 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