Question

Jones signs a three-year contract to construct a new office building for Smith. The contract price is $3 million and estimated cost $2 million. The contract does not qualify for revenue recognition over time. During year 1, Jones incurs costs of $800,000 and during year 2, costs of $1.2 million. At the end of year 2, Jones estimates that an additional $1.1 million will be necessary to complete the project. At the end of year 2, Jones should recognize:

Answer 1

Under the completed-contract method, Jones should not recognize any revenue or profit at the end of year 2 because the project is not yet complete. Only the costs incurred to date of $2 million ($800,000 from year 1 and $1.2 million from year 2) should be recognized on the balance sheet.

Step-by-step explanation:

The question relates to the recognition of revenue and costs for a construction contract under the completed-contract method, as revenue recognition over time is not possible. At the end of year 2, Jones has incurred a total of $800,000 in year 1 and $1.2 million in year 2 of costs. The additional estimated costs to complete the project are $1.1 million. To determine how much revenue and profit or loss Jones should recognize at the end of year 2, it is necessary to assess the total estimated costs and compare them to the contract price.

However, since the contract does not qualify for revenue recognition over time, under the completed-contract method, no profit is recognized until the contract is substantially complete. As of the end of year 2, since the contract is not complete, Jones would not recognize any revenue or profit. Instead, Jones will only recognize costs incurred to date.