Question

Red Builders agrees to construct a new building for Blue Co. for a total contract price of $6,000,000. The estimated construction costs at inception was $4,000,000. The construction project was completed after two years. Below are the actual costs for years 1 and 2:

Description Cumulative
Year 1 Year 2
Cost incurred to date 1,200,000 2,500,000
Estimated additional costs to complete 3,600,000 2,100,000
Billings 1,050,000 2,300,000
Cash Collections 1,000,000 1,900,000

Red has determined that this contract qualifies for revenue recognition over time (as opposed to upon completion). As a result, Red Builders should have recognized profit at the end of year 1 in the amount of:

a. $300,000
b. $600,000
c. $1,050,000
d. $1,000,000

Answer 1

Using the percentage of completion method, Red Builders should have recognized a profit of $300,000 at the end of year 1 for the construction project for Blue Co.

Step-by-step explanation:

To calculate the profit recognized by Red Builders at the end of year 1 for the construction project with Blue Co., we should use the percentage of completion method since revenue recognition over time is applied. This method recognizes revenue and profit based on the progress towards completion of the contract. The formula to calculate the profit recognized is:

Profit = (Cost incurred to date / Total estimated costs) × Total contract price - Cost incurred to date

Let's calculate it:

Total estimated costs at the end of year 1 are the cumulative costs incurred plus the estimated additional costs to complete, which is $1,200,000 + $3,600,000 = $4,800,000.

Calculate the percentage of completion, which is $1,200,000 (cost incurred to date) divided by $4,800,000 (total estimated costs), giving 25%.

Apply this percentage to the total contract price to get the revenue recognized, which is 25% of $6,000,000 = $1,500,000.

Profit recognized at the end of year 1 is therefore $1,500,000 (revenue recognized) - $1,200,000 (cost incurred to date) = $300,000.

The answer is (a) $300,000.

Answer 2

Gross Profit at the end of year 1 in the amount of $300,000

Step-by-step explanation:

Computation of recognized profit at the end of year 1 :

Particular year 1 amount

Cost incurred to date (1) $1,200,000

Estimated additional cost (2) $3,600,000

Total Expected costs(1+2=3) $4,800,000

Percentage completion [(1 / 3)=4] 0.25

Control price (revenue) (5) $6,000,000

Profit (5-3=6) $1,200,000

Cumulative Gross Profit (6x4) $300,000

Gross Profit $300,000