Cost and Revenue recognition on Sales Basis

Cost and Revenue recognition on Sales Basis

Under this method revenues and profit is recognized on the bases of work certified as proportion to the contract price and cost is recognized as balancing figure. It important to remember that cost and revenue is recognized on the bases of stage of completion only in case of profit making contract, in case of loss making contract loss is recognized in full.

Contract Price	$ 400 Million
Work completed	$ 200 million
Work Certified	$ 150 million
Cost incurred	$ 100 million
Further Cost	$200 million
Calculate the profit and revenue is to be recognized on sales bases	?

Solution

The example will be solved in three steps

1.      Calculation of Stage of Completion

2.      Revenue recognition on the bases of stage of completion

3.      Cost recognition as balancing figure

1. Calculation of Stage of Completion

Work Certified	$ 150 million
Contract Price	$ 400 Million
Stage of completion ( 150 million / 400 million)	37.5 %

2. Revenue and profit Recognition

Revenue Recognition (400 x 37.5%)	$ 150
Profit Recognition (400-300) x 37.5%	$ 37.5
Cost Recognized (Balancing)	$ 112.5

Example of Stage of Completion Cost Basis

Example of Stage of Completion

The stage of completion can be measured in three ways i.e. cost incurred to date as proportion to total estimated cost , certified work as proportion to contract revenues and physical completion. The first and second methods are also known as cost bases and sales bases respectively.

Example of Stage Completion Cost Basis

ABC & Company entered into contract of bridge construction. The bridge is to be completed within five years. At the end of first year the total costs incurred on the project was 1.2 million. The total cost to be incurred is 5 Million. Calculate the stage of completion

Solution

Cost incurred to date	1.2 million
Total expected cost	5 Million
Stage of completion ( 1.2 million/5 million)	24%

Example of Stage Completion Cost Basis

XYZ & Co bid for a project to build a housing scheme, XYZ is required to construct 100 houses of 1800 sq feet each. The cost per sq feet is $ 200. At the end of first year all 100 houses are partly completed and cost incurred to date is 200 million a further cost of $ 300 million is expected to be incurred in next year. Calculate the stage of completion.

Solution

Cost incurred to date	$ 200 million
Further Cost	$ 300 Million
Total cost	$ 500
Stage of completion ( $ 200/$ 500)	40%

Example of Contract Revenue

Example of Contract Revenue

The contract revenue is recognized which is expected to be received by the contract and can be measured reliably. The penalties for any delay must be deducted from the revenue.

Contract Price	120,000
Due to financial constraint only 100,000 is expected to released	100,000
ABC is fine for delayed construction	10,000

Solution

Contract Price	100,000
Less : Fine for delayed in construction	(10,000)
Revenue	90,000

Examples of costs of Contract

Examples of costs of Contract

The contract cost may be classified into three category .i.e. directly allocated cost, General activity allocated to contract other cost which is to be refunded under term of contract.

Example of Contract Costs

Material	120,000
Rent for storing site material	20,000
Labor	10,000
Plant and machinery ( 2 Years)	50,000
Insurance of Plant	2,000
Administration Manager Salary	5,000

Solution

Material	120,000	Direct allocated
Rent for storing site material	20,000	Direct allocated
Labor	10,000	Direct allocated
Plant and machinery ( 2 Years)	25,000	Direct allocated
Insurance of Plant	2,000	General Activity
Administration Manager Salary	Nil	General Activity
Total Contract Cost	177,000

Insurance cost is general activity which can be allocated. However, Manager Salary is not directly allocated to contract therefore it is not part of contract cost.

Example of Non Contract Costs

The following are the typical examples of non cost, administration expenses, selling expenses, research and development cost. For Example ABC & company is awarded to construct a tunnel, the cost incurred during the year on tunnel construction

Material Cost	$  150,000
Plant imported but could not utilized	$  200,000
Research to reduce material costs	$  6,000
Accounts Manager Salary	$  2,000
Skilled Labor	$   4,000

  

Solution

Material Cost	$  150,000
Plant imported but could not utilized	$  Nil
Research to reduce material costs	$  Nil
Accounts Manager Salary	$  Nil
Skilled Labor	$   4,000
Contract Cost	$ 154,000