Topic for Today Percentage Contractor Percentage of Completion Method Case

1. FIR1 2013 Topic for TodayPercentage ContractorPercentage of Completion Method Case Aleš Tomek Faculty of Civil Engineering Department of Economics and Management Czech Technical University in Prague

2. 1. Significant Accounting Policiesof Percentage Contractor Corp. Company's activities and operating cycle. The company is engaged in a single industry:the construction of industrial and commercial buildings. The work is performedunder cost-plus-fee contracts, fixed-price contracts, and fixed-price contracts modifiedby incentive and penalty provisions. These contracts are undertaken by the company orits wholly owned subsidiary alone or in partnership with other contractors throughjoint ventures. The company also manages, for a fee, construction projects of others. The length of the company´s contracts varies but is typically about two years. Therefore, assets and liabilities are not classified as current and noncurrent becausethe contract-related items in the balance sheet have realization and liquidation periods extending beyond one year.

3. Principles of Consolidation. The consolidated financial statements include the company's majority-owned entities, a wholly owned corporate subsidiary and a 75 percentownedjoint venture (a partnership). All significant intercompany transactions areeliminated. The company has a minority interest in a joint venture (partnership), which is reported on the equity method.

4. Revenue and cost recognition. Revenues from fixed-price and modified fixed-price constructioncontracts are recognized on the percentage-of-completion method, measured by the percentage oflabor hours incurred to date to estimated total labor hours for eachcontract. This method is used because management considers expended labor hours tobe the best available measure of progress on these contracts. Revenues from costplusfeecontracts are recognized on the basis of costs incurred during the period plus the feeearned, measured by the cost-to-cost method. Contracts to manage, supervise, or coordinate the construction activity of others arerecognized only to the extent of the fee revenue. The revenue earned in a period is basedon the ratio of hours incurred to the total estimated hours required by the contract.

5. Contracts to manage, supervise, or coordinate the construction activity of others are • recognized only to the extent of the fee revenue. • the revenue earned in a period is basedon the ratio of hours incurred to the total estimated hours required by the contract. Contract costs include all direct material and labor costs and those indirect costsrelated to contract performance, such as indirect labor, supplies, tools, repairs, anddepreciation costs. Selling, general, and administrative costs are charged to expense asincurred. Provisions for estimated losses on uncompleted contracts are made in theperiod in which such losses are determined. Changes in job performance, job conditions,and estimated profitability, including those arising from contract penalty provisions,and final contract settlements may result in revisions to costs and income andare recognized in the period in which the revisions are determined.

6. There are various other alternatives to the percentage of labor hours method for measuringpercentage of completion, which, in many cases, may be more appropriate in measuringthe extent of progress toward completion of the contract (labor dollars, units of output, andthe cost-to-cost method and its variations).

7. Profit incentives are included in revenues when their realization is reasonably assured. An amountequal to contract costs attributable to claims is included in revenues when realizationis probable and the amount can be reliably estimated. The asset, "Cost and estimated earnings in excess of billings on uncompleted contracts," represents revenues recognized in excess of amounts billed. The liability,"Billings in excess of costs and estimated earnings on uncompleted contracts," representsbillings in excess of revenues recognized.

8. Property and equipment.Depreciation and amortization are provided principally onthe straight-line method over the estimated useful lives of the assets. Amortization ofleased equipment under capital leases is included in depreciation and amortization. • Pension plan. The company has a pension plan covering substantially all employeesnot covered by union-sponsored plans. Pension costs charged to earnings include current-year costs and the amortization of prior-service costs over 30 years. The company'spolicy is to fund the costs accrued. • Income taxes. Deferred income taxes are provided for differences in timing in reportingincome for financial statement and tax purposes arising from differences in themethods of accounting for construction contracts and depreciation.Construction contracts are reported for tax purposes on the completed-contractmethod and for financial statement purposes on the percentage-of-completion method.Accelerated depreciation is used for tax reporting, and straight-line depreciation isused for financial statement reporting.

9. 2. Contract Receivables

10. Contract receivables (continuation) Contract receivables at December 31, 19X8, include a claim, expected to be collectedwithin one year, for $290,600 arising from a dispute with the owner over design andspecification changes in a building currently under construction. The changes weremade at the request of the owner to improve the thermal characteristics of the buildingand, in the opinion of counsel, gave rise to a valid claim against the owner. The retained and unbilled contract receivables at December 31, 19X8, included$38,600 that was not expected to be collected within one year

24. Explanation: Minority interest • 1. In accounting terms, if a company owns a minority interest in another company but only has a minority passive position (i.e. it is unable to exert influence), then all that is recorded from this investment are the dividends received from the minority interest. If the company has a minority active position (i.e. it is able to exert influence), then both dividends and a percent of income are recorded on the company's books. • 2. If ABC Corp. owns 90% of XYZ inc, which is a $100 million company, on ABC Corp.'s balance sheet, there would be a $10 million liability in minority interest account to represent the 10% of XYZ Inc. that ABC Corp does not own.

25. Cashflow part1

26. Cashflow part 2 cf12