Construction Contracts: Calculating Percentage of Completion and Revenue Recognition

Question:

XYZ Ltd signed a contract to build a bridge for ABC Limited at a price of $40 million. How do we calculate the percentage of completion for each year and the revenue to be recognized?

Answer:

In order to calculate the percentage of completion for each year and the revenue to be recognized, we first need to determine the cost incurred to date and the estimated total cost for each year.

Explanation:

For the year ending 30 June 2016, the cost incurred was $10,000,000 out of the estimated total cost of $32,000,000. Therefore, the percentage of completion for 2016 is 31% ($10,000,000 / $32,000,000).

For the year ending 30 June 2017, the cost incurred was $16,000,000 out of the estimated total cost of $32,000,000. Thus, the percentage of completion for 2017 is 50% ($16,000,000 / $32,000,000).

Lastly, for the year ending 30 June 2018, the cost incurred was $6,000,000 out of the estimated total cost of $32,000,000. This results in a percentage of completion of 19% ($6,000,000 / $32,000,000).

Based on the percentage of completion calculated for each year, we can then determine the revenue to be recognized in each of the three years following the terms of the contract.

Year 2016: 31% of $40,000,000 = $12,400,000

Year 2017: 50% of $40,000,000 = $20,000,000

Year 2018: 19% of $40,000,000 = $7,600,000

To calculate the gross profit or loss, subtract the total construction costs incurred from the revenue recognized for each year.