Question

The Nathan Company is involved in the construction of an asset under a longterm construction contract. At the end of the third year of the five year contract, the cost estimates indicate that a loss will result on the completion of the entire contract. In accounting for this contract, the entire expected loss must be recognized in the current period under the:

1) Percentage of completion method
2) Completed contract method
3) Installment sales method
4) Cost recovery method

Answer 1

The entire expected loss on a long-term construction contract must be recognized in the current period under the percentage of completion method, as it requires immediate recognition of foreseeable losses.

Step-by-step explanation:

The student's question pertains to recognizing a loss on a long-term construction contract using different accounting methods. Specifically, the Nathan Company must recognize the entire expected loss in the current period under one of these methods. Under the percentage of completion method, companies recognize revenue and expenses proportionate to the completion of the contract at the end of reporting periods. If a loss is anticipated, the entire loss must be recognized immediately, regardless of the amount of work completed. In contrast, the completed contract method defers all profit and loss recognition until the contract is complete. However, an exception is made for losses; when an overall loss on the contract is expected, it must be recognized immediately. This is different from the installment sales method and the cost recovery method, which are used for recognizing revenue when collection is uncertain and not applicable to long-term construction contracts.