Big Construction Inc. Big Construction Inc (BCI) is a medium-size construction company. BCI was approached by a local manufacturer, Strong & Bold Inc (SBI) to construct a small building next to its factory. Both the small building and the factory are located on a piece of land owned by SBI. BCI has agreed to complete the project for $1,000,000. SBI has agreed to the terms of the contract which includes a stipulation that it will take SBI 3 years to complete the project. BCI estimated that the total costs to complete this project will be $800,000. Milestone payments would be remitted to BCI throughout the three years. A final inspection when the building is completed will take place and after that SBI will release the final payment. The contract was signed on January 2, 2019, and the work commenced right away.
BCI had to obtain an investment from the founder’s relative to take on this big project. The founder has requested annual audited financial statements for his review yearly and will provide funding annually based on the financial results.
The founder revisited his estimates for the total costs to complete the project in 2020 and he realized that it will probably take $1,100,000 to complete it. He was disappointed to realize that the company will not be making any profit. Through aggressive cost-cutting measures, BCI was able to bring the project back on track and the new total costs to complete estimated in 2021 were $800,000. The following costs were incurred throughout the project: $250,000 in 2019, $300,000 in 2020 and $250,000 in 2021. SBI received invoices from BCI for the following amounts: $200,000 in 2019; $200,000 in 2020 and $600,000 in 2021.
SBI paid the first invoice promptly. The second invoice was paid only partially in the amount of $100,000 in 2020 but the rest of the amount was paid in 2021. The invoice received in 2021 was paid promptly after the final inspection was completed in December 2021.
- 1. Provide 2019, 2020, 2021 journal entries on BCI’s books for all transactions arising from this project, with supporting calculations, and prepare the income statement/balance sheet section with the accounts that are affected for each of the 3 years:
- a. Using the percentage of completion method
- b. Using the completed contract method
- c. Using the zero-profit method
- 2. Please discuss, in general, which of the methods in (1) above should be used when accounting for long-term contracts.
- 3. Please discuss, based on case facts, which method in (1) above BCI should use to account for this project if BCI follows IFRS. Please take into account IFRS 15 in your discussion (hint: only one of the 5 steps in IFRS should be discussed in detail).
- 4. Discuss, how each of the methods in (1) above will affect the company’s ability to obtain funding from the founder’s relative at the end of 2019 and 2020.