Final answer:
In the percentage-of-completion method, Billings on Construction in Progress represents billed but not recognized income, while Construction in Process accounts for all costs incurred in a project. Revenue is recognized proportionally as projects progress, based on the percentage completion of the project. The balance sheet reports either an asset or liability depending on whether revenue recognized exceeds billings or vice versa.
Step-by-step explanation:
Under the percentage-of-completion method, the reporting of balances of Billings on Construction in Progress (C-I-P) and Construction in Process accounts should reflect the income earned to date. Generally accepted accounting principles (GAAP) require that companies use this method when they can reasonably estimate the stages of construction.
Billings on C-I-P is a liability account that represents the amount billed to customers but not yet recognized as income because the project is not complete. Conversely, Construction in Process is an asset account that captures all costs related to a construction project, including labor, materials, and overhead. As costs are incurred, this asset account is debited. As the project progresses, companies will recognize revenue proportionally.
The total costs incurred and the estimated total costs of the project are used to determine the percentage of completion. To recognize revenue, this percentage is applied to the total estimated revenue from the project. The difference between the revenue recognized to date and the billings to date results in either an asset (if the revenue recognized is greater) or a liability (if billings are greater).
Here is a simplified example:
- Total Estimated Revenue of the project: $1,000,000
- Total Estimated Costs of the project: $800,000
- Costs Incurred to date: $400,000
- Percentage of completion (costs to date over total estimated costs): 50%
- Revenue to be recognized to date (percentage of completion * total estimated revenue): $500,000
If the company billed the customer $300,000 to date, the company would report a Construction in Process balance of $500,000 and a Billings on C-I-P balance of $300,000. The excess amount of revenue over billings, which is $200,000 ($500,000 - $300,000), would be reported on the balance sheet as an asset under "Costs and recognized profit in excess of billings."