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Chapter 18: Q37Q. (page 1032)

What are the two types of losses that can become evident in accounting for long-term contracts? What is the nature of each type of loss? How is each type accounted for?

Short Answer

Expert verified

In long-term contract accounting, there are two types of losses that might occur:

(1) A loss suffered in the present time as a consequence of a transaction that was not profitable

(2) A loss incurred due to a deal that was not profitable.

Step by step solution

01

Meaning of Long-Term Contract

A long-term contract is one in which you agree to work for someone else for a lengthy period. Because the parties will never need to update or renegotiate the contract as the future unfolds, a long-term contract is also considered complete.

Long-term contracts, such as construction projects, are multi-year contracts. The earnings process for these contracts spans numerous accounting periods. The final result may not be delivered for years after the project began.

02

Explanation for two types of losses, their nature and accounting type

There are two sorts of losses that might appear in long-term contract accounting:

(1) a current period loss in a contract that is anticipated to yield a profit when completed

(2) A loss incurred due to a deal that was not lucrative.

In the current quarter, the first type of loss is an adjustment to gross profit achieved on the contract in earlier periods. When the estimated total contract costs rise significantly during construction, the increase does not wipe out all contract profit. The predicted cost increase necessitates a percentage-of-completion approach current period adjustment of previously recorded gross profit, resulting in recording a current period loss. The completed-contract method does not require any changes because gross profit is only recorded once the contract is concluded.

After the present term, cost predictions may indicate that the entire contract will be a loss. The entire loss must be documented in the current period using both the percentage of completion and the completed-contract method.

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Most popular questions from this chapter

Tyler Financial Services performs bookkeeping and tax-reporting services to startup companies in the Oconomowoc area. On January 1, 2017, Tyler entered into a 3-year service contract with Walleye Tech. Walleye promises to pay \(10,000 at the beginning of each year, which at contract inception is the standalone selling price for these services. At the end of the second year, the contract is modified and the fee for the third year of services is reduced to \)8,000. In addition, Walleye agrees to pay an additional $20,000 at the beginning of the third year to cover the contract for 3 additional years (i.e., 4 years remain after the modification). The extended contract services are similar to those provided in the first 2 years of the contract.

Instructions

(a) Prepare the journal entries for Tyler in 2017 and 2018 related to this service contract.

(b) Prepare the journal entries for Tyler in 2019 related to the modified service contract, assuming a prospective approach.

(c) Repeat the requirements for part (b), assuming Tyler and Walleye agree on a revised set of services (fewer bookkeeping services but more tax services) in the extended contract period and the modification results in a separate performance obligation.

Wood-Mode Company is involved in the design, manufacture, and installation of various types of wood products for large construction projects. Wood-Mode recently completed a large contract for Stadium Inc., which consisted of building 35 different types of concession counters for a new soccer arena under construction. The terms of the contract are that upon completion of the counters, Stadium would pay \(2,000,000. Unfortunately, due to the depressed economy, the completion of the new soccer arena is now delayed. Stadium has therefore asked Wood-Mode to hold the counters for 2 months at its manufacturing plant until the arena is completed. Stadium acknowledges in writing that it ordered the counters and that they now have ownership. The time that Wood-Mode Company must hold the counters is totally dependent on when the arena is completed. Because Wood-Mode has not received additional progress payments for the counters due to the delay, Stadium has provided a deposit of \)300,000.

Instructions

(a) Explain this type of revenue recognition transaction.

(b) What factors should be considered in determining when to recognize revenue in this transaction?

(c) Prepare the journal entry(ies) that Wood-Mode should make, assuming it signed a valid sales contract to sell the counters and received at the time the $300,000 deposit.

On what basis should the transaction price be allocated to various performance obligations? Identify the approaches for allocating the transaction price.

On March 1, 2017, Parnevik Company sold goods to Goosen Inc. for \(660,000 in exchange for a 5-year, zerointerest-bearing note in the face amount of \)1,062,937 (an inputed rate of 10%). The goods have an inventory cost on Parnevik鈥檚 books of $400,000. Prepare the journal entries for Parnevik on (a) March 1, 2017, and (b) December 31, 2017.

On May 10, 2017, Cosmo Co. enters into a contract to deliver a product to Greig Inc. on June 15, 2017. Greig agrees to pay the full contract price of \(2,000 on July 15, 2017. The cost of the goods is \)1,300. Cosmo delivers the product to Greig on June 15, 2017, and receives payment on July 15, 2017. Prepare the journal entries for Cosmo related to this contract. Either party may terminate the contract without compensation until one of the parties performs
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