Lesson Objectives:- The use of construction in process and billings on construction in process accounts
- Why the billings on CIP account is important
- How to create the journal entries for billing, collections and revenue transactions
In the previous lesson, we reviewed how to fill out the percentage of completion template in order to calculate the costs, percentage complete, revenue and gross profits figures for each year. We now will need to record journal entries for the billing, collections and revenue transactions that we calculated using the percentage of completion method.
There are two new accounts that we need to learn about when it comes to long term contracts, such as the government building example: construction in process and billings on construction in process.
- Construction in Process - This is an inventory account that defines the cost of the building activities. This account will also keep track of the gross profits based on the percentage of completion.
- Billings on Construction in Process - Also abbreviated as billings on CIP, this is a contra inventory account that decreases the construction in process account.
On the balance sheet, the contra inventory account of Billings on CIP will always be listed below the Construction in Process account. The purpose of this account is to balance out the asset listed on the balance sheet because technically the CIP account belongs to the customer and the company.
For example, if the Construction in Process amount on the balance sheet is $3,000,000, this would be considered an asset. Without the billings on CIP, it would appear that the company has an asset that gives them a future benefit which is not truly the case. The billings on CIP will net the gross profit figure that belongs to the company.
Now, let's proceed to creating the journal entries for the same example that we reviewed in the previous lesson. I have listed the completed template above that we will be referencing for the transaction amounts.
We will go ahead and walk through the journal entries step-by-step, starting with the costs.
1. Let's start with the journal entry for 2013 to report the assets. The cost incurred in this period will be debited for the amount of $2,500,000 against the CIP account. To pay for these costs, the company will need to credit the accounts payable or cash account for the same amount.
2. The next entry for 2013 will be for the accounts receivables which accounts for the billings to the customer. The accounts receivable would be debited by $2,000,000 and the billings on CIP would be credited by $2,000,000. The billings to the customer include the costs and the service that the company is providing.
3. The third entry will be for collections to account for the cash that has been collected for the year. This is a simple collections entry where we will debit the cash account and credit the accounts receivable to show that the funds have been collected.
4. The final entry will be to show the revenue and expense amounts. The construction expense account is debited by $2,500,000 and the revenue on the long term contract is recorded as a credit for $4,304,000. In order to balance out the transaction, the gross profit amount of $1,804,000 is recorded through the construction in process account for this entry.
We would then use the same process to record the journal entries for 2014 and 2015. As time goes on, you will get more familiar with these accounts and the types of entries that are required for long term contracts.