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Unformatted text preview: Acc 406 Long-term Contracts and Installment Sales Illustrations This extends the Chapter 3 Review File by providing supplemental examples of special revenue recognition applications. For completeness, some specific reference notes are included in this file, followed by problem type illustrations. Long-term Contracts In most circumstances, revenue is recognized at the point of sale because most of the uncertainties related to the earnings process are removed and the exchange price is known. One of the exceptions to the general rule of recognition at point of sale is caused by long-term construction-type projects. The accounting measurements associated with long-term construction projects are difficult because events and amounts must be estimated for a period of years. Two basic methods of accounting for long-term construction contracts are recognized by the accounting profession: (a) the percentage-of completion method, and (b) the completed-contract method. The percentage-of-completion method must be used when estimates of progress toward completion, revenues, and costs are reasonably dependable and all the following conditions exist: a. The contract clearly specifies the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement. b. The buyer can be expected to satisfy all obligations under the contract. c. The contractor can be expected to perform contractual obligations. Under the percentage-of-completion method, revenue on long-term construction contracts is recognized as construction progresses. Costs pertaining to the contract plus gross profit earned to date are accumulated in a Construction in Process account. The amount of revenue recognized in each accounting period is based on a percentage of the total revenue to be recognized on the contract. The most popular method of estimating the amount of revenue to recognize is based on the costs incurred on the contract to date divided by the most recent estimated total costs (cost-to-cost basis). a. The journal entry to recognize revenue under the percentage-of-completion method is as follows: Construction in Process Construction Expenses Revenue from Long-Term Contracts b. In any subsequent year, total revenue to recognize to date is estimated based on the current cost-to-cost basis, and any revenue recognized in prior years in subtracted, leaving revenue to recognize in the current year (that is, only incremental revenue is recognized each year). c. The Billings on Construction in Process account is subtracted from the Construction in Process accounts; if the amount is a debit it is reported as a current asset, if the amount is a credit it is reported as a current liability....
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