Reference no: EM132218475

Quesiton: ABC Ltd (“ABC”) entered into a contract on 1st January 20x6 to build a factory building for its customer on its customer's land for $20 million. The completion is expected to be in two years' time. ABC's policy is to bill its clients based on 60% in the first year and the balance upon completion of the project. ABC has a 31st December financial year end. It has adopted FRS 115 Revenues from Contracts with Customers and adopts the input method to measure the entity's progress towards the complete satisfaction of the performance obligations.

At the end of 20x6, ABC has incurred actual costs of $10 million on the construction project. The estimated costs that are required to complete the project was $6 million. Actual collections in 20x6 amounted to $10.5 million.

In 20x7, a modification to the contract was required. To comply with new safety regulations, the concrete flooring was to be reinforced with steel. An electronic gantry and carpark structures were also added to the existing open-air carpark area.

The contract was increased by $5 million for the reinforced concrete flooring and $1 million for the car-park structures. The additional expected costs for the reinforced flooring was $2 million and the car park structure was $800,000. The commencement of work was to start in 20x8 and the completion date is expected to be extended for an additional year in 20x8. Billings for the additional contract price will be done in 20x8.

At the end of 20x7, the actual costs incurred and paid was $8 million, fully attributable to the construction of the factory building. An estimated cost of $5 million is further required to complete the factory building and $800,000 for the car-park. $8 million were invoiced as per the original plans, and actual collections during the year amounted to $9.5 million.

At the end of 20x8, the contracts were completed. The actual costs incurred and paid during 20x8 were as estimated during the modification agreement. A final billing of $6 million was made and actual collections amounted to $4.5 million.

Required: (a) Discuss revenue recognition under FRS 115 Revenues from contracts with customers in view of its application to construction contracts. Please include in your discussion the costs that goes into a construction contract and the issues involved.

(b) Discuss also the impact of modifications, common reasons for modifications and how modifications are treated. Explain how the modification of the contract to change the flooring and addition of the car park structure should be treated under FRS 115 Revenues from contracts with customers.

(c) Compute the revenues, expenses and profits to be recognised for each financial year ending 31st December 20x6, 20x7 and 20x8. Illustrate the accounting for this contract by preparing the necessary journal entries to record the relevant transactions for 20x6 and the final entry to record the completion of the project. Journal narratives are not required. (Answers may be rounded to the nearest thousand dollars).