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Use the following information for the next three questions: Information on Red Hot Co
Use the following information for the next three questions:
Information on Red Hot Co.’s construction contracts with customers which commenced during 2021 is shown below:
|
Contract 1 |
Contract 2 |
|
|
Contract price |
420,000 |
300,000 |
|
Costs incurred during the year |
240,000 |
280,000 |
|
Estimated costs to complete |
120,000 |
40,000 |
|
Progress billings |
150,000 |
270,000 |
|
Collections |
90,000 |
250,000 |
- At contract inception, Red Hot Co. assessed that its performance obligation in each of Contract 1 and Contract 2 is satisfied over time. Red Hot Co. uses the ‘cost-to-cost’ method in measuring its progress on the contract. How much total profit (loss) is recognized from the two contracts in 2021?
- 40,000
- 20,000
- (20,000)
- 0
- At contract inception, Red Hot Co. assessed that its performance obligation in each of Contract 1 and Contract 2 is satisfied over time. However, Red Hot Co. determined that the outcome of the performance obligation in each of the contracts cannot be reasonably measured but contract costs incurred are recoverable. How much total profit (loss) is recognized from the two contracts in 2021?
- 40,000
- 20,000
- (20,000)
- 0
- At contract inception, Red Hot Co. assessed that its performance obligation in each of Contract 1 and Contract 2 is satisfied at a point in time, that is, when the construction is completed. How much total profit (loss) is recognized from the two contracts in 2021?
- 40,000
- 20,000
- (20,000)
- 0
Expert Solution
The cost to cost method is used by project accountants to determine the percentage of completion of a project, and therefore the amount of revenue that can be recognized. It is an underlying component of the percentage of completion method. The formula for the cost to cost method is to divide all costs recorded to date on a project or job by the total estimated amount of costs that will be incurred for that project or job. The result is an overall percentage of completion that is then used for billing and revenue recognition purposes.
| Contract 1 | Contract 2 | ||
| Contract price | 4,20,000 | 3,00,000 | |
| Costs incurred during the year | 2,40,000 | 2,80,000 | |
| Estimated costs to complete | 1,20,000 | 40,000 | |
| Total Estimated Costs | 3,60,000 | 3,20,000 | |
| % of completion | 67% | 88% | |
| Revenue to be recognized | 2,80,000 | 2,62,500 | |
| Costs | 2,40,000 | 2,80,000 | |
| Profit | 40,000 | -17,500 | 22,500 |
Outcome is uncertain but costs are recoverable
In some circumstances, it may not be possible to reasonably measure the outcome of a performance obligation, but there may be an expectation that the entity will be able to recover the costs incurred in satisfying the performance obligation. In such circumstances, revenue is recognised only to the extent of the costs incurred until such time that the entity can reasonably measure the outcome of the performance obligation.
| Contract 1 | Contract 2 | ||
| Contract price | 4,20,000 | 3,00,000 | |
| Costs incurred during the year | 2,40,000 | 2,80,000 | |
| Estimated costs to complete | 1,20,000 | 40,000 | |
| Total Estimated Costs | 3,60,000 | 3,20,000 | |
| % of completion | 67% | 88% | |
| Revenue to be recognized | 2,40,000 | 2,80,000 | |
| Costs | 2,40,000 | 2,80,000 | |
| Profit | 0 | 0 | 0 |
Performance Obligation satisfied at a point of time (On completion)
As performance obligation is to be completed on construction completion. No revenue is recognized.
| Contract 1 | Contract 2 | ||
| Contract price | 4,20,000 | 3,00,000 | |
| Costs incurred during the year | 2,40,000 | 2,80,000 | |
| Estimated costs to complete | 1,20,000 | 40,000 | |
| Total Estimated Costs | 3,60,000 | 3,20,000 | |
| % of completion | 67% | 88% | |
| Revenue to be recognized | 0 | 0 | |
| Costs | 2,40,000 | 2,80,000 | |
| Profit | -2,40,000 | -2,80,000 | -5,20,000 |
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