Lesson Objectives:- How a loss is calculated
- Performing a journal entry for the loss
- Calculating and recording loss on the entire contract
In the previous lesson, we looked at how to perform journal entries for costs, billings, collections and revenues based on the percentage of completion method. For the building construction example that we reviewed, the company had positive gross profit figures for each year. Now we will take a look at what happens when there is a loss in an accounting period, meaning the gross profit figure is negative.
We will look at a loss situation by updating the figures for the year 2014.
We will change the cost incurred figure in 2014 from $1,200,000 to $3,500,000 instead. This will change the costs to date figure from $3,700,000 to a new total of $6,000,000. We will leave the estimated costs the same, but update the total estimated costs to $12,700,000.
Next, we will need to update the percentage complete based on the new numbers. To do this, we will simply divide the costs to date by the total estimated costs to come up with a new percentage of 47.2%.
We can then update the revenue amount by multiplying the percentage by the contract price, and in the case of 2014, we will come up with a revenue to date figure of $7,552,000. To calculate the revenue for 2014, you take the revenue to date and subtract the revenue for 2013 which gives you $3,248,000.
The cost incurred to date is subtracted from the revenues to date to come up with a gross profit figure of 1,552,000. We then subtract the profit from 2013 for gross profit to date and we show a negative gross profit for 2014 of $(252,000).
Now, let's look at how to record the loss with journal entries.
We will start by debiting the construction expense account by the costs incurred for 2014 of $3,500,000. The revenue on the LTC would be recorded as a credit of $3,248,000. The loss would need to be booked under the construction in process account for the difference between the expense and the revenue amount. Crediting the Construction in Process account for $252,000 to balance out the journal entry.
Next, let's take a look at how it would look if we have a loss on the entire contract. If we simply changed the total estimated costs to $17,000,000 and the costs for the period to $5,800,000, this would change the percentage complete to 48.8% and the revenue to date to $7,808,000.
The revenue this year would be $3,504,000 and the gross profit to date would be a loss of $(492,000). We would deduct the gross profit from the previous year to come up with a total gross profit loss of $(2,296,000).
When there is a loss for the entire contract, you must add the amount that the costs exceed the contract and the loss for the current period. In this example, the loss that we will need to record will encompass the difference between the total costs and the contract which is $1,000,000 and the loss from this year which is $(2,296,000) for a huge whopping total of $(3,296,000).
Now, that we've calculated the loss, let's finish up with the journal entry. We will use the same format as the previous entry to record the construction expense as a debit and the CIP loss and revenue on LTC as credits.
We've recorded the total loss for both the contract and the current period on this journal entry.