Widjaja Compay is accounting for a long term construction contract using the per

Question

Widjaja Compay is accounting for a long term construction contract using the percentage of completion method. It is a 4 year contract that is currently in its second year. The latest estimates of contact costs indicate that the contact will be completed at a profit to the company.

Based on this information please answer the following:

1 What theoretical justification is there or the Widjaja Company's use of the percentage-of-completion method

2 Discuss how the progress billings will be accounted for

Explanation / Answer

Question 1: Theoretical Justification for use of percentage Completion Method

There are two methods of revenue recognition in construction contracts.

They are Completed contract method and percentage completion method.

If the company uses competed contracts method then entire contract revenue is recognised in year of completion but we have rendered services of construction from the year of inception of contract.So the company uses percentage completion method to recognise revenue because the revenue is accrued only upto the percentage of work completed. This method eliminates unnecessary recognition of revenue thereby ensuring true and fair view in financial statements.

However to apply this method there are two conditions:

1. Collections by the company must be reasonaly measured and reliable.

2. Company should estimate the percentage completed reasonably.

Question 2: How the billings will be accounted for?

In year 1 if we complete 20% of contract then 20% of total contact amount is recognised as revenue.

If in year 2 if we complete 45% of contract then only the incremental revenue of 25% will be recognised as revenue.

Thus the billing will be made only for the incremental work done in that respective year.

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