Percentage of Completion Method
Course: Income Tax Planning
Lesson 10: Recognition of Expenses, Losses, and Deductions
Student Question:
Question 5 (below) did not make sense to me. I started out by breaking down by year — 400,000/2,100,000*3,000,000 and so forth, but did not arrive at the correct answer. So then I tried adding up 3 year — 400+650+700/2100000*3,000,000. That wasn’t correct either.
Could you help me arrive at the correct answer?
Weiss Enterprises signs a $3 million contract in June Year 1 to construct a new office building. The project is scheduled to be completed in March of Year 4 at a cost to Weiss of $2,100,000. Actual costs resulted as follows:
Year 1: $400,000
Year 2: $650,000
Year 3: $700,000
Year 4: $350,000
Using the percentage of completion method, how much gross profit will Weiss Enterprises report in Year 3?
Top of Form
$0
$50,000
$300,000
$400,000
Weiss Enterprise cannot use the percentage of completion method
Instructor Response:
The percentage of completion method for accounting for long term contracts can be counter-intuitive.
We need to know two things to recognize profits in any one year.
- How much of the contract was completed in the current year and
- The total estimated gross profit for the contract.
We determine % complete by determining % of total costs expended in the current year.
- We know that estimated total costs for the entire contract equals $2.1MM and we know that $700M in costs were incurred in year 3.
- Dividing the latter by the former tells us that the contract was 33% completed in year 3.
We know that the estimated gross profit for the entire contract is $900,000 ($3MM – 2.1MM).
- We multiply 33% by $900,000 to arrive at $300,000 in recognized gross profit.
Let me know how fully this answers your question.
