Question

Nailed It! Construction (Nailed It! or the "Company"), an SEC registrant, is a construction company that manufactures commercial and residential buildings. On March 1, 20X1, the Company entered into an agreement with a customer, Village Apartments, to construct a residential apartment building for a fixed price of $1.5 million. The Company estimates that it will incur costs of $1 million to complete construction of the apartment building. The apartment building will only transfer to Village Apartments once the construction of the entire building is complete. In addition, Village Apartments has various design requirements that would require Nailed It! to incur significant costs to rework the building prior to selling it to a customer other than Village Apartments. To construct the apartment building, Nailed It! acquires standard materials that it regularly uses in construction contracts for both residential and commercial buildings. These materials are used to manufacture generic component parts for inclusion in Village Apartments’ residential buildings. These standard materials remain interchangeable with other items until they are deployed in a Village Apartments building. The Company has made the following purchases and incurred the following costs throughout the construction progress:

As of June 30, 20X1, in total, Nailed It! has purchased $75,000 of component parts. As of June 30, 20X1, $25,000 of component parts remain in inventory and $50,000 have been integrated into the project. Further, Nailed It! has incurred $12,500 of direct costs to integrate the component parts into the Village Apartments construction project during the three months ended June 30, 20X1. •During the three months ended September 30, 20X1, Nailed It! purchased an additional $500,000 of component parts ($575,000 in total). Of the $575,000 of component parts, $325,000 remain in inventory and $200,000 have been integrated into the project during the three months ended September 30, 20X1. During the three months ended September 30, 20X1, Nailed It! incurred an additional $50,000 of direct costs to integrate the component parts into the Village Apartments construction project. •As of September 30, 20X1, Nailed It! determined that the project was over budget and revised its cost estimate from $1 million to $1.25 million.•As of December 31 20X1, the construction project was completed. During the three months ended December 31, 20X1, Nailed It! purchased an additional $425,000 of generic component parts ($1 million in total). Of the $1 million component parts, $0 remain in inventory and $750,000 were integrated into the project during the three months ended December 31, 20X1. Nailed It! has incurred $187,500 of direct costs to integrate the component parts into the Village Apartments construction project during the three months ended December 31, 20X1.
If Village Apartments cancels the contract, Nailed It! will be entitled to reimbursement for costs incurred for work completed to date plus a margin of 20 percent, which is considered to be a reasonable margin. Nailed It! will not be reimbursed for any materials that have been purchased for use in the contract but have not yet been used and are still controlled by Nailed It!.
Does the performance obligation meet any of the criteria or recognition of revenue over time?

Answer 1

The performance obligation of Nailed It! Construction with Village Apartments may meet the criteria for recognizing revenue over time if the building has no alternative use, if control is transferred over time, and if there is an enforceable right to payment with a reasonable margin for completed work to date.

Step-by-step explanation:

The question asks whether the performance obligation of Nailed It! Construction company in its agreement with Village Apartments meets any of the criteria for the recognition of revenue over time according to revenue recognition standards. In this case, there are potential criteria met which could allow revenue to be recognized over time. Firstly, if Nailed It! performs tasks that do not create an asset with an alternative use to the Company due to the design requirements of Village Apartments and the Company is entitled to payment for performance completed to date, it may meet the first criterion.

Secondly, if the company is continuously transferring control of the asset as it is being created or enhanced, which could be the case if Village Apartments is taking control of the building as it is being constructed, then it meets the second criterion for recognizing revenue over time. Finally, if the construction work performed to date does not have an alternative use and Nailed It! has an enforceable right to payment for performance completed to date, including a reasonable profit margin, it aligns with the third criterion. These factors suggest that Nailed It!'s performance obligation could indeed meet the criteria for recognizing revenue over time.