Lesson 52: Percentage of Completion Method and Journalizing Losses
In this lesson, we will learn to
calculate a loss, perform a journal entry for the loss, and calculate and
record loss on the entire contract.
In the previous lesson, we looked at how to
perform journal entries for costs, billings, collections and revenues based on
the percentage of completion method. For the building construction example that
we reviewed, the company had positive gross profit figures for each year. Now
we will take a look at what happens when there is a loss in an accounting
period, meaning the gross profit figure is negative.
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We will look at a loss situation by updating the figures for the year 2014.
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We will change the cost incurred figure in
2014 from $1,200,000 to $3,500,000 instead. This will change the costs to date
figure from $3,700,000 to a new total of $6,000,000. We will leave the
estimated costs the same, but update the total estimated costs to $12,700,000.
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Next, we will need to update the percentage complete based on the new numbers.
To do this, we will simply divide the costs to date by the total estimated
costs to come up with a new percentage of 47.2%.
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We can then update the revenue amount by multiplying the percentage by the
contract price, and in the case of 2014, we will come up with a revenue to date
figure of $7,552,000. To calculate the revenue for 2014, you take the revenue
to date and subtract the revenue for 2013 which gives you $3,248,000.
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The cost incurred to date is subtracted from the revenues to date to come up
with a gross profit figure of 1,552,000. We then subtract the profit from 2013
for gross profit to date and we show a negative gross profit for 2014 of
$(252,000).
Now, let's look at how to record the loss with journal entries.
We will start by debiting the construction expense account by the costs
incurred for 2014 of $3,500,000. The revenue on the LTC would be recorded as a
credit of $3,248,000. The loss would need to be booked under the construction
in process account for the difference between the expense and the revenue
amount. Crediting the Construction in Process account for $252,000 to balance
out the journal entry.
Next, let's take a look at how it would look if we have a loss on the entire
contract. If we simply changed the total estimated costs to $17,000,000 and the
costs for the period to $5,800,000, this would change the percentage complete
to 48.8% and the revenue to date to $7,808,000.
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The revenue this year would be $3,504,000 and
the gross profit to date would be a loss of $(492,000). We would deduct the
gross profit from the previous year to come up with a total gross profit loss
of $(2,296,000).
When there is a loss for the entire contract, you must add the amount that the
costs exceed the contract and the loss for the current period. In this example,
the loss that we will need to record will encompass the difference between the
total costs and the contract which is $1,000,000 and the loss from this year
which is $(2,296,000) for a huge whopping total of $(3,296,000).
Now, that we've calculated the loss,
let's finish up with the journal entry. We will use the same format as the
previous entry to record the construction expense as a debit and the CIP loss
and revenue on LTC as credits.
We've recorded the total loss for both the contract and
the current period on this journal entry.