Question

On February 1, 2021, Arrow Construction Company entered into a three-year construction contract to build a bridge for a price of $8,570,000. During 2021, costs of $2,190,000 were incurred with estimated costs of $4,190,000 yet to be incurred. Billings of $2,690,000 were sent, and cash collected was $2,440,000.

In 2022, costs incurred were $2,690,000 with remaining costs estimated to be $3,885,000. 2022 billings were $2,940,000 and $2,665,000 cash was collected. The project was completed in 2023 after additional costs of $3,990,000 were incurred. The company's fiscal year-end is December 31. Arrow recognizes revenue over time according to percentage of completion.
Compute the amount of revenue and gross profit or loss to be recognized in 2021, 2022, and 2023 using the percentage of completion method.

Answer 1

Using the percentage of completion method, Arrow Construction Company should recognize revenue and gross profit of $2,939,510 and $749,510 for 2021, $1,835,380 (leading to a loss of $854,620) for 2022, and $3,795,110 (leading to a loss of $194,890) for 2023 as the construction project progresses and reaches completion.

Step-by-step explanation:

To compute the amount of revenue and gross profit or loss to be recognized in 2021, 2022, and 2023 using the percentage of completion method for Arrow Construction Company, we need to determine the completion percentage for each year and apply it to the total contract value.

Revenue Recognition for 2021:

Total costs to date: $2,190,000
Estimated total costs: $2,190,000 + $4,190,000 = $6,380,000
Percentage of completion: $2,190,000 / $6,380,000 ≈ 34.3%
Revenue to be recognized: 34.3% of $8,570,000 ≈ $2,939,510
Gross profit for 2021: Revenue recognized - Costs incurred = $2,939,510 - $2,190,000 = $749,510

Revenue Recognition for 2022:

Total costs to date: $2,190,000 + $2,690,000 = $4,880,000
Estimated remaining costs: $3,885,000
Total estimated costs: $4,880,000 + $3,885,000 = $8,765,000
Percentage of completion: $4,880,000 / $8,765,000 ≈ 55.7%
Cumulative revenue to be recognized by 2022: 55.7% of $8,570,000 ≈ $4,774,890
Revenue recognized in 2022 alone: $4,774,890 (cumulative) - $2,939,510 (already recognized in 2021) = $1,835,380
Gross profit for 2022: Revenue recognized in 2022 - Costs incurred in 2022 = $1,835,380 - $2,690,000 = $-854,620 (loss)

Revenue Recognition for 2023:

Total costs incurred by the end of the project: $4,880,000 + $3,990,000 = $8,870,000
The project is completed, so 100% of the contract value is recognized.
Cumulative revenue to be recognized by project completion: $8,570,000
Revenue recognized in previous years: $4,774,890
Revenue recognized in 2023 alone: $8,570,000 (cumulative) - $4,774,890 = $3,795,110
Gross profit for 2023: Revenue recognized in 2023 - Costs incurred in 2023 = $3,795,110 - $3,990,000 = $-194,890 (loss)