JOSE MARIA COLLEGE

Philippine- Japan Friendship Highway Sasa,

Davao City, Philippines

Advance Accounting 1
Chapters Summary in Advance Accounting

Submitted by: Dana Madilar Baranda

Submitted to: Mr. Edward Alfante, CPA

October 2015

CHAPTER 1: BASIC CONSIDERATION AND FORMATION

PARTNERSHIP: BY THE CONTRACT OF PARTNERSHIP, TWO OR MORE PERSON

BIND THEMSELVES TO CONTRIBUTE MONEY, PROPERTY, INDUSTRY TO A
COMMON FUND WITH THE INTENTION OF DIVIDING PROFITS AMONG
THEMSELVES.
1. ASSOCIATION OF TWO OR MORE PERSONS
2. TO CARRY-ON AS CO-OWNERS
CHARACTERISTICS OF PARTNESHIP

SEPARATE LEGAL PERSONALITY

EASE OF FORMATION
CO-OWNERSHIP
LIMITED LIFE
MUTUAL AGENCY
UNLIMITED LIABILITY

PARTNERS LEDGER ACCOUNTS

IN A PARTNERSHIP, IT IS DESIRABLE THAT THE FOLLOWING PARTNERS
ACCOUNT BE MAINTAINED.
1. CAPITAL ACCOUNTS
2. DRAWING IR PERSONAL ACCOUNTS
3. ACCOUNT FOR LOANS TO OR FROM PARTNERS
*THE TRANSACTIONS THAT ARE USUALLY CREDITED AND DEBITED TO
PARTNERS CAPITAL AND DRAWING ACCOUNTS MAY BE SUMMARIZED AS
FOLLOWS:
THE CAPITAL ACCOUNT IS CREDITED FOR:
a) ORIGINAL INVESTMENT
b) ADDITIONAL INVESTMENT
c) PARTNESS SHARE IN THE PROFITS (SOMETIMES THIS IS CLOSED TO
THE DRAWING ACCOUNT)

THE CAPITAL ACCOUNT IS DEBITED FOR:

PERMANENT WITHDRAWAL OR CAPITAL

a) DEBITBALANCE OF THE DRAWING ACCOUNT AT THE END OF THE
PERIOD
b) PARTNERS SHARE IN THE LOSSES (SOMETIMES THIS IS CLOSED TO THE
DRAWING ACCOUNT)
THE DRAWING ACCOUNT IS CREDITED FOR:
a) PARTNERSHIP OBLIGATIONS ASSUMED OR PAID BY THE PARTNES
b) PERSONAL FUNDS OR CLAIMS OF PARTNER COLLECTED AND RETAINED
BY THE PARTNERSHIP
c) PERIODIC PARTNERS SALARIES DEPENDING ON THE ACCOUNTING AND
DISBURSEMENT PROCEDURES AGREED UPON.
THE DRAWING ACCOUNT IS DEBITED FOR:
a) WITHDRAWAL OF ASSETS BY THE PARTNERS IN ANTICIPATION OF NET
INCOME
b) PARTNERS PERSONAL INDEBTEDNESS PAID OR ASSUMED BY THE
PARTNERSHIP
c) FUDS OR CLAIMS OF PARTNERSHIP

ACCOUNTING FOR THE FORMATION OF A PARTNERSHIP

1. FORMATION OF A PARTNERSHIP FOR THE FIRST TIME
2. CONVERSION OF A SOLE PROPRIETORSHIP TO A PARTNERSHIP
a) A SOLE PROPRIETORSHIP ALLOWS ANOTHER INDIVIDUAL,
WHO HAS NO BUSINESS OF HIS OWN TO JOIN BUSINESS
b) TWO OR MORE SOLE PROPRIETORS FORM A PARTNERSHIP
3. ADMISSION OF A NEW PARTNER

CHAPTER 2: PARTNERSHIP OPERATIONS

TYPES OF ACCOUNTING PROBLEMS FOR PARTNERSHIP OPERATIONS ARE AS

FOLLOWS:
1. DETERMINATION OF THE PROPER DISTRIBUTION OF PARTNERSHIP
PROFITS AND LOSSES AMONG THE PARTNERS.
2. PREPARATION OF FINANCIAL OF FINANCIAL STATEMENTS FOR THE
PARTNERSHIP, SUCH AS BALANCE SHEET, INCOME STATEMENT,
STATEMENT OF PARTNERS CAPITAL AND CASH FLOWS.
3. CHANGES IN THE PROFIT AND LOSS RATIOS
4. CORRECTION OF NET INCOME (LOSS) FOR PRIOR YEARS
DIVISION OF PROFITS AND LOSSES
PROFIT AND LOSS DIVISION ACCORDING TO AGREEMENT
ACCORDING TO CAPITAL CONTRIBUTIONS
METHODS OF DIVIDING NET INCOME OR LOSS AMONG PARTNERS
1. EQUALLY
2. IN AN UNEQUAL ARBITRARY RATIO.
3. IN THE RATIO OF PARTNERS CAPITAL ACCOUNT BALANCES ON A
PARTICULAR DATE, OR IN THE RATIO OF AVERAGE CAPITAL ACCOUNT
BALANCES DURING THE YEAR
4. ALLOWING INTEREST ON PARTNERS CAPITAL ACCOUNT BALANCES
AND THE REMAINING NET INCOME OR LOSS IN A SPECIFIED RATIO
5. ALLOWING SALARIES TO PARTNERS AND DIVIDING THE REMAINING NET
INCOME OR LOSS IN A SPECIFIE RATIO
6. BONUS TO MANAGING PARTNER BASED ON NET INCOME
ILLUSTRATION OF PROFIT DISTRIBUTION
CHANGES IN PARTNERS CAPITAL BALANCES
CAPITAL BALANCES, JAN 1,
2011
ADDTL
INVESTMENTS,MARCH1
ADDTL INVESTMENTS, AUG 1
WITHDRAWAL, OCT 1
WITHDRAWAL, NOV 1

SIY
P40,000
20,000
20,000
(20,000)

TIU
P60,000
50,000
40,000
(50,000)

CAPITAL BALANCES, DEC 31

P60,000

P100,000

EQUAL DISTRIBUTION OF PROFIT AND LOSS

NET INCOME OF P60,000 IS TRANSFERRED FROM THE INCOME SUMMARY TO
THE PARTNERS ACCOUNT CAPITAL BALANCES BY FOLLOWING CLOSING
ENTRY:
INCOME SUMMARY
SIY CAPITAL
TIU CAPITAL
PROFIT AND LOSS IN ARBITRARY RATIO
SIY RATIO: 60%

60,000
30,000
30,000

TIU RATIO: 40%

TO DIVIDE THE INCOME OF P60,000

SIY: 60% X P60,000= P36,000
TIU: 40% X P60,000= P24,000
P60,000
RATIO OF ORIGINAL CAPITAL CONTRIBUTION- IF NO AGREEMENT IS
MADE
SIY: P60,000 X P30,000/ P90,000= P20,000
TIU: P60,000 X P60,000/ P90,000= P40,000
RATIO OF BEGINNING CAPITAL BALANCES
SIY: P60,000 X P40,000/ P100,000= P20,000
TIU: P60,000 X P60,000/ P100,000= P40,000
RATIO OF ENDING CAPITAL BALANCES
SIY: P60,000 X P40,000/ P100,000= P20,000
TIU: P60,000 X P60,000/ P100,000= P40,000
RATIO OF AVERAGE CAPITAL BALANCES
a) SIMPLE AVERAGE METHOD- AVERAGE CAPITALS OF SIY AND TIU
USING THIS METHOD
SIY: (P40,000+60,000) / 2 = P
50,000
TIU: (P60,000+-100,000) / 2=
80,000
TOTAL
P130,000
THE NET INCOME CAN NOW BE DIVIDED AS FOLLOWS:
SIY: P60,000 X P50,000/ P130,000= P23,077

TIU: P60,000 X P80,000 / P130,000= P 36,923

b) PESO-MONTH/PESO-Day
CHAPTER 3: PARTNERSHIP DISSOLUTIONS: CHANGES IN
OWNERSHIP
PARTNERSHIP DISSOLUTION - CHANGES IN OWNERSHIP

ADMISSION OF A NEW PARTNER

AN EXISTING PARTNERSHIP MAY ADMIT A NEW PARTNER WITH THE CONSENT
OF ALL THE PARTNERS. WHEN A NEW PARTNER IS ADMITTED, THE
PARTNERSHIP IS DISSOLVED AND A NEW PARTNERSHIP IS FORMED. UPON
THE ADMISSION OF A NEW PARTNER, A NEW AGREEMENT COVERING
PARTNERS' INTERESTS, PROFIT AND LOSS SHARING AND OTHER
CONSIDERATION SHOULD BE DRAWN BECAUSE THE DISSOLUTION OF THE
ORIGINAL PARTNERSHIP CANCELS THE OLD AGREEMENT.

THE ADMISSION OF A NEW PARTNER, MAY OCCUR IN EITHER OF THE TWO

WAYS, NAMELY;

PURCHASE OF ALL OR PART OF THE INTEREST OF ONE OR MORE OF THE

EXISTING PARTNERS.
INVESTMENT OF ASSETS IN THE PARTNERSHIP BY THE INCOMING PARTNER.
PURCHASE OF INTEREST FROM ONE OR MORE PARTNERS
WHEN AN INCOMING PARTNER PURCHASES A PORTION OR ALL OF THE
INTEREST OF ONE OR MORE OF THE ORIGINAL PARTNERS, THE PARTNERSHIP
ASSETS REMAIN UNCHANGED AND NO CASH OR OTHER ASSETS FLOW FROM
THE NEW PARTNER TO THE PARTNERSHIP. THIS TRANSACTION IS RECORDED
BY OPENING A CAPITAL ACCOUNT FOR THE NEW PARTNER AND DECREASING
THE CAPITAL ACCOUNTS OF THE SELLING PARTNERS BY THE SAME AMOUNT.
THE CASH PAID BY THE BUYER IS NOT RECORDED IN THE BOOKS OF THE
PARTNERSHIP FOR THIS IS A PERSONAL TRANSACTION BETWEEN THE SELLER

PARTNERS AND THE BUYER. THE GAIN OR LOSS ARISING FROM THE
TRANSACTION IS NOT TO BE RECORDED IN THE PARTNERSHIP BOOKS.

ACQUISITION OF INTEREST BY INVESTMENT

A NEW PARTNER MAY BE ADMITTED TO THE FIRM BY INVESTING DIRECTLY TO

THE PARTNERSHIP. THIS METHOD OF ADMISSION OF A NEW PARTNER IS A
TRANSACTION BETWEEN THE PARTNERSHIP AND THE INCOMING PARTNER. IN
THIS CASE THE PARTNERSHIP RECEIVES THE CASH OR OTHER ASSETS,
THEREBY INCREASING ITS TOTAL ASSETS AS WELL THE TOTAL CAPITAL. THE
FOLLOWING PROCEDURES MAY BE USED TO RECORD THE ADMISSION OF THE
NEW PARTNER:

RECORD THE INVESTMENT (CONTRIBUTED CAPITAL) OF THE NEW PARTNER.

DETERMINE THE AGREED CAPITAL OF THE NEW PARTNER IN THE NEW FIRM
AFTER ADMISSION. TOTAL AGREED CAPITALIZATION OF THE NEW FIRM X
PERCENTAGE OF CAPITAL OF THE NEW PARTNER
DETERMINE AND RECORD GOODWILL OR BONUS IF ANY. THIS USUALLY EXIST
WHEN THE NEW PARTNERS' INVESTMENT IS NOT EQUAL TO HIS AGREED
CAPITAL IN THE NEW FIRM. THE COMPUTATION OF THE GOODWILL OR BONUS
WILL DEPEND UNDER THE FOLLOWING ASSUMPTIONS:

ASSUMPTION 1. THE TOTAL AGREED CAPITALIZATION OF THE NEW FIRM IS

SPECIALLY STATED.

ASSUMPTION 2. THE TOTAL AGREED CAPITALIZATION OF THE NEW FIRM IS

NOT SPECIALLY STATED.
ASSUMPTION 1: TOTAL AGREED CAPITALIZATION OF THE NEW FIRM IS
SPECIALLY STATED. THE AGREEMENT FOR THE ADMISSION OF NEW PARTNER
USUALLY FAIL TO SPECIFY WHETHER A BONUS OR GOODWILL IS INVOLVED.

HOWEVER THE AMOUNT OF BONUS OR GOODWILL IMPLIED BY THE

AGREEMENT CAN BE DETERMINED BY ANALYZING THE FOLLOWING DATA:

CONTRIBUTED CAPITAL OF THE NEW PARTNER.

OLD PARTNERS' CONTRIBUTED CAPITAL (NET TANGIBLE ASSETS OF THE OLD
FIRM).
TOTAL AGREED CAPITALIZATION OF THE NEW PARTNERSHIP.
AGREED CAPITAL OF THE NEW PARNER IN THE NEW PARTNERSHIP.
IN ANALYZING THE ABOVE DATA, THE FOLLOWING PROCEDURES ARE
FOLLOWED.

COMPARE THE TOTAL AGREED CAPITALIZATION OF THE PARTNERSHIP AND

THE TOTAL CONTRIBUTED OF THE OLD AND NEW PARTNERS.
IF THE TOTAL AGREED CAPITAL IS EQUAL TO THE CONTRIBUTED CAPITAL,
THEN NO GOODWILL IS TO BE RECOGNIZED.
IF THE TOTAL AGREED CAPITAL IS MORE THAN THE CONTRIBUTED CAPITAL,
THE DIFFERENCE IS TREATED AS GOODWILL.
IF THE TOTAL AGREED IS LESS THAN THE TOTAL CONTRIBUTED CAPITAL, THE
DIFFERENCE IS TREATED AS CAPITAL WITHDRAWALS BY THE PARTNERS.
COMPARE THE AGREED CAPITAL OF THE PARTNERS WITH THEIR
CONTRIBUTED CAPITALS.
IF THE AGREED CAPITAL OF THE PARTNERS ARE EQUAL TO THE
CONTRIBUTED CAPITAL, THEN NO GOODWILL OR BONUS IS TO BE
RECOGNIZED.
IF THE AGREED CAPITAL CREDIT OF THE NEW PARTNER IS MORE THAN HIS
CAPITAL INVESTMENT, THE DIFFERENCE IS TREATED AS EITHER GOODWILL
TO HIM OR BONUS (CAPITAL TRANSFER) FROM THE OLD PARTNERS.
IF THE AGREED CAPITAL OF THE NEW PARTNER IS LESS THAN HIS
CONTRIBUTED CAPITAL, THE DIFFERENCE IS TREATED AS BONUS (CAPITAL
TRANSFER) TO THE OLD PARTNERS.

ASSUMPTION 2. TOTAL AGREED CAPITAL OF THE NEW FIRM IS NOT

SPECIFICALLY STATED. PARTNERS AGREEMENT USUALLY PROVIDES THAT THE
NEW PARTNER IS TO RECEIVED AN INTEREST IN THE NEW PARTNERSHIP
EQUAL TO, GREATER OR LESSER THAN HIS INVESTMENT. HOWEVER, SUCH
AGREEMENT MAY FAILED TO SPECIFY THE TOTAL AGREED CAPITALIZATION OF
THE NEW PARTNERSHIP AFTER THE ADMISSION OF THE NEW PARTNER. IN
THE ABSENCE OF AN EXPRESSED AGREEMENTS, EITHER THE BONUS OR THE
GOODWILL METHOD MAYBE USED.
RETIREMENT OF A PARTNER
AN EXISTING PARTNERSHIP MAY ADMIT A NEW PARTNER WITH THE CONSENT
OF ALL THE PARTNERS. WHEN A NEW PARTNER IS ADMITTED, THE
PARTNERSHIP IS DISSOLVED AND A NEW PARTNERSHIP IS FORMED. UPON
THE ADMISSION OF A NEW PARTNER, A NEW AGREEMENT COVERING
PARTNERS' INTERESTS, PROFIT AND LOSS SHARING AND OTHER
CONSIDERATION SHOULD BE DRAWN BECAUSE THE DISSOLUTION OF THE
ORIGINAL PARTNERSHIP CANCELS THE OLD AGREEMENT.

WHEN A PARTNER RETIRES OR WITHDRAW FROM THE PARTNERSHIP, THE

PARTNERSHIP IS DISSOLVED, BUT THE REMAINING PARTNERS MAY CONTINUE
OPERATING THE BUSINESS. THE RETIRING PARTNERS MAY RECEIVE A
SETTLEMENT EQUAL TO HIS INTEREST, MORE THAN HIS INTEREST, OR LESS
THAN HIS INTEREST. THE INTEREST OF THE WITHDRAWING PARTNER IS
USUALLY MEASURED BY HIS CAPITAL BALANCE BEFORE HIS WITHDRAWAL,
INCREASED OR DECREASED IN THE FOLLOWING ADJUSTMENTS:

PROFIT OLD LOSS FROM OPERATION FROM THE LAST CLOSING DATE TO THE
DATE OF HIS RETIREMENT, AND
CHANGES IN THE VALUATION (FAIR MARKET VERSUS BOOK VALUE) OF ALL
ASSETS AND LIABILITIES.
IF THE NET INCOME OR LOSS OF PRIOR YEARS WERE IMPROPERLY
COMPUTED, THESE SHOULD LIKEWISE BE CORRECTED BEFORE
DETERMINING THE INTEREST OF THE RETIRING PARTNER.

DEATH OF PARTNER

AN EXISTING PARTNERSHIP MAY ADMIT A NEW PARTNER WITH THE CONSENT

OF ALL THE PARTNERS. WHEN A NEW PARTNER IS ADMITTED, THE
PARTNERSHIP IS DISSOLVED AND A NEW PARTNERSHIP IS FORMED. UPON
THE ADMISSION OF A NEW PARTNER, A NEW AGREEMENT COVERING
PARTNERS' INTERESTS, PROFIT AND LOSS SHARING AND OTHER
CONSIDERATION SHOULD BE DRAWN BECAUSE THE DISSOLUTION OF THE
ORIGINAL PARTNERSHIP CANCELS THE OLD AGREEMENT.

IN THE EVENT OF THE DEATH OF A PARTNER, THE ESTATE OF THE DECEASED

PARTNER IS ENTITLED TO RECEIVE THE AMOUNT OF HIS INTEREST IN THE
PARTNERSHIP AT THE DATE OF IF DEATH. THE DECEASED PARTNER'S CAPITAL
IS ADJUSTED USING OF HIS PROFIT AND LOSS PERCENTAGE FOR CHANGES IN
ASSETS VALUES ARISING FROM REVALUATION OF ASSETS, AND FOR THE
PROFIT FROM THE DATE THE BOOKS WERE LAST CLOSED. THE BALANCE OF
HIS CAPITAL ACCOUNT AFTER CONSIDERING THE NECESSARY ADJUSTMENTS
SHOULD BE TRANSFERRED TO A LIABILITY ACCOUNT PENDING SETTLEMENT.

THE PARTNERS MAY AGREED THAT THE SETTLEMENT WITH THE ESTATE OF
THE DECEASED PARTNER BE POSTPONED UNTIL THE END OF THE REGULAR
FISCAL PERIOD WHEN THE BOOKS ARE CLOSED, AT WHICH TIME HIS CAPITAL
ACCOUNT SHALL BE CREDITED WITH A SHARE IN THE EARNINGS. VARIOUS
METHODS MAYBE USED IN DETERMINING THE DECEASED PARTNER'S SHARE
IN THE NET INCOME. HE MAY RECEIVE A PRO-RATA SHARE OF THE PROFIT
FROM THE BEGINNING OF THE ACCOUNTING PERIOD TO THE DATE OF HIS
DEATH PLUS INTEREST ON HIS CAPITAL BALANCE FROM THE DATE OF HIS
DEATH TO THE DATE OF SETTLEMENT. IF NOT, HE MAY RECEIVE A SHARE OF
THE PROFIT FOR THE FULL PERIOD.

INCORPORATION OF A PARTNERSHIP
WHEN A PARTNERSHIP IS CONVERTED INTO A CORPORATION, THE
CORPORATION TAKES OVER THE ASSETS AND ASSUMES THE LIABILITIES OF
THE PARTNERSHIP IN EXCHANGE FOR SHARES OF STOCKS. THE STOCK
RECEIVED BY THE PARTNERSHIP ARE DISTRIBUTED TO THE PARTNERS IN
SETTLEMENT OF THEIR INTEREST. THE PARTNERS NOW BECOME
STOCKHOLDERS OF THE NEWLY FORMED CORPORATION.

THE ACCOUNTING PROCEDURES IN RECORDING THE INCORPORATION OF A

PARTNERSHIP WILL DEPEND ON WHETHER THE ORIGINAL BOOKS OF THE
PARTNERSHIP WILL BE CONTINUED BY THE CORPORATION OR NEW BOOKS
WILL BE OPENED.

PARTNERSHIP BOOKS RETAINED. IF THE PARTNERSHIP BOOKS ARE RETAINED,

THE STEPS TO BE TAKEN ARE AS FOLLOWS:

REVALUE THE ASSETS AND RECOGNIZED GOODWILL, IF ANY.

CLOSED THE PARTNERS' CAPITAL ACCOUNTS TO THE CORPORATE CAPITAL
ACCOUNTS.
NEW BOOKS OPENED FOR THE CORPORATION. IF NEW BOOKS ARE TO BE
OPENED, THE OLD PARTNERSHIP BOOKS MUST BE CLOSED. THE
ACCOUNTING PROCEDURES MAY BE OUTLINED AS FOLLOWS:

IN THE BOOKS OF THE PARTNERSHIP:

REVALUE THE ASSETS (AND ANY OTHER ITEMS AGREED ON) IN ACCORDANCE
WITH THE AGREED TRANSFER VALUES.
RECORD THE TRANSFER OF ASSETS AND LIABILITIES TO THE CORPORATION
AND THE RECEIPT OF CAPITAL STOCKS BY THE PARTNERSHIP.
RECORD THE DISTRIBUTION OF THE STOCKS TO THE PARTNERS IN
SETTLEMENT OF THE BALANCES OF THEIR CAPITAL ACCOUNTS.

CHAPTER 7: REVENUE RECOGNITION- INSTALLMENT SALES

INSTALLMENT METHOD
WHEN A SELLER ALLOWS A CUSTOMER TO PAY FOR A SALE OVER MULTIPLE
YEARS, THE TRANSACTION IS FREQUENTLY ACCOUNTED FOR BY THE SELLER
USING THE INSTALLMENT METHOD. BECAUSE OF THE LONG PERIOD OF TIME
INVOLVED, THE RISK OF LOSS FROM CUSTOMER NONPAYMENT IS HIGHER, SO
A PRUDENT PERSON WOULD DEFER THE RECOGNITION OF SOME PORTION
OF THE SALE - WHICH IS WHAT THE INSTALLMENT METHOD DOES
THE PRIMARY CIRCUMSTANCE UNDER WHICH THE INSTALLMENT METHOD IS
USED IS A TRANSACTION IN WHICH THE BUYER MAKES A NUMBER OF
PERIODIC PAYMENTS TO THE SELLER, AND IT IS NOT POSSIBLE TO
DETERMINE THE COLLECTIBILITY OF CASH FROM THE CUSTOMER. THIS IS AN
IDEAL RECOGNITION METHOD FOR LARGE-DOLLAR ITEMS, SUCH AS:
REAL ESTATE
MACHINERY
CONSUMER APPLIANCES

THE INSTALLMENT METHOD IS BETTER THAN GENERIC ACCRUAL BASIS

ACCOUNTING WHEN PAYMENTS MAY BE RECEIVED FOR A NUMBER OF YEARS,
FOR THE ACCRUAL BASIS MAY RECOGNIZE ALL OF THE REVENUE UP FRONT,
WITHOUT FACTORING IN ALL OF THE RISK INHERENT IN THE TRANSACTION.
THE INSTALLMENT METHOD IS MORE CONSERVATIVE, IN THAT REVENUE
RECOGNITION IS PUSHED OFF INTO THE FUTURE, THEREBY MAKING IT
EASIER TO TIE ACTUAL CASH RECEIPTS TO REVENUE.
AN OVERVIEW OF THE INSTALLMENT METHOD IS THAT SOMEONE USING IT
DEFERS THE GROSS MARGIN ON A SALE TRANSACTION UNTIL THE ACTUAL
RECEIPT OF CASH. WHEN ACCOUNTS RECEIVABLE ARE EVENTUALLY
COLLECTED, A PORTION OF THE DEFERRED GROSS PROFIT FROM THE
FOLLOWING CALCULATION IS RECOGNIZED:

GROSS PROFIT % X CASH COLLECTED

USE OF THE INSTALLMENT METHOD REQUIRES AN ENHANCED LEVEL OF

RECORD KEEPING FOR THE DURATION OF THE ASSOCIATED INSTALLMENT
PAYMENTS. THE ACCOUNTING STAFF SHOULD TRACK THE AMOUNT OF
DEFERRED REVENUE REMAINING ON EACH CONTRACT THAT HAS YET TO BE
RECOGNIZED, AS WELL AS THE GROSS PROFIT PERCENTAGE ON
INSTALLMENT SALES IN EACH SEPARATE YEAR.

THE FOLLOWING STEPS ARE USED TO ACCOUNT FOR AN INSTALLMENT SALE

TRANSACTION:

RECORD INSTALLMENT SALES SEPARATELY FROM OTHER TYPES OF SALES,

AND KEEP TRACK OF THE RELATED RECEIVABLES, LAYERED BY THE YEAR IN
WHICH THE RECEIVABLES WERE ORIGINALLY CREATED.
TRACE CASH RECEIPTS AS THEY ARRIVE TO THE INSTALLMENT SALES TO
WHICH THEY RELATE.
AT THE END OF EACH FISCAL YEAR, SHIFT THE INSTALLMENT SALES
REVENUES AND COST OF SALES OCCURRING IN THAT YEAR TO A DEFERRED
GROSS PROFIT ACCOUNT.

CALCULATE THE GROSS PROFIT RATE FOR INSTALLMENT SALES OCCURRING

IN THAT YEAR.
APPLY THE GROSS PROFIT RATE FOR THE CURRENT YEAR TO CASH
COLLECTED ON RECEIVABLES FROM CURRENT YEAR SALES TO DERIVE THE
GROSS PROFIT THAT CAN BE REALIZED.
APPLY THE GROSS PROFIT RATE FOR PRIOR YEARS TO THE CASH RECEIPTS
ARRIVING THAT RELATE TO INSTALLMENT SALES OCCURRING IN THOSE
PRIOR PERIODS, AND RECOGNIZE THE RESULTING AMOUNT OF GROSS
PROFIT.
ANY DEFERRED GROSS PROFIT AT THE END OF THE CURRENT YEAR IS
CARRIED FORWARD TO THE NEXT YEAR, TO BE RECOGNIZED AT A LATER
DATE WHEN THE ASSOCIATED RECEIVABLES ARE PAID.

CHAPTER 8: REVENUE RECOGNITION- CONSTRUCTION CONTRACTS

REVENUE RECOGNITION: PERCENTAGE OF COMPLETION METHOD

PERCENTAGE OF COMPLETION METHOD IS A BASIS FOR REVENUE
RECOGNITION IN LONG-TERM CONSTRUCTION CONTRACTS WHICH SPAN
OVER MORE THAN ONE ACCOUNTING PERIODS. IN CASE OF LONG-TERM
CONTRACTS, ACCOUNTANTS NEED A BASIS TO APPORTION THE TOTAL
CONTRACT REVENUE BETWEEN THE MULTIPLE ACCOUNTING PERIODS.
PERCENTAGE OF COMPLETION METHOD PROVIDES ONE OF THOSE BASES,
OTHER BEING FULL-CONTRACT METHOD.

IT DETERMINES REVENUE RECOGNIZED IN ONE ACCOUNTING PERIOD IN

ACCORDANCE WITH THE FOLLOWING FORMULA:

REVENUE RECOGNIZED
=

PERCENTAGE OF WORK COMPLETED IN THE PERIOD

TOTAL CONTRACT VALUE

TOTAL CONTRACT VALUE IS THE TOTAL REVENUE FROM THE LONG-TERM
CONTRACT.

PERCENTAGE OF WORK COMPLETED IS THE PROPORTION OF WORK

COMPLETED IN A PERIOD TO TOTAL WORK FOR THE CONTRACT. IT IS
USUALLY ESTIMATED USING THE FOLLOWING FORMULA:

PERCENTAGE OF WORK COMPLETED

=

EXPENDITURES INCURRED FROM INCEPTION TO DATE

TOTAL ESTIMATED COSTS FOR THE CONTRACT

EXPENDITURES INCURRED FROM INCEPTION TO DATE REPRESENT COSTS
INCURRED FROM THE START OF THE PROJECT TO THE DATE OF ESTIMATION.

TOTAL ESTIMATED EXPENDITURES FOR THE CONTRACT REPRESENT THE

TOTAL BUDGETED COST FOR THE PROJECT. IT INCLUDES COSTS THAT HAVE
BEEN INCURRED TO DATE AND COSTS THAT ARE EXPECTED TO BE INCURRED
IN FUTURE PERIODS.

THERE IS ANOTHER METHOD FOR ESTIMATING PERCENTAGE OF COMPLETION

CALLED SURVEY METHOD WHICH IS BASED ON THE PHYSICAL PROGRESS OF
THE CONTRACT. UNDER THIS METHOD ENGINEERS AND OTHER EXPERTS
OBSERVE THE ACTIVITIES AND DETERMINE THEIR JUDGMENT OF THE
PERCENTAGE OF WORK COMPLETED.

EXAMPLE
CONSTRUCTION INC. IS ENGAGED IN CONSTRUCTING A MASSIVE BRIDGE IN
WONDERLAND. THE CONTRACT IS WORTH $200 MILLION AND THE COMPANY
IS EXPECTED TO COMPLETE IT IN 3 YEARS. IN YEAR 1 THE COMPANY HAS
INCURRED AN AMOUNT OF $50 MILLION ON THE CONTRACT AND THE
ENGINEERS ESTIMATE THAT IN THE NEXT 2 YEARS THE COMPANY IS
EXPECTED TO EXPEND $110 MILLION MORE. BASED ON THE PHYSICAL
PROGRESS OF THE PROJECT THE ENGINEERS ALSO ESTIMATE THAT 40% OF
THE WORK HAS BEEN CARRIED OUT.

SOLUTION:
UNDER THE SURVEY METHOD THE ENGINEERS HAVE PROVIDED THEIR
JUDGMENT OF THE PERCENTAGE OF WORK COMPLETED AND IT IS 40%.
BASED ON COSTS INCURRED TO DATE AND TOTAL COSTS THE PERCENTAGE
OF COMPLETION COMES OUT TO BE:
PERCENTAGE OF WORK COMPLETED = $50 MILLION ($50 MILLION + $110
MILLION) = 31.25%.
TOTAL COSTS INCLUDE COSTS INCURRED TO DATE AND COSTS EXPECTED TO
BE INCURRED OVER THE REMAINING PERIOD.
BASED ON THE PERCENTAGE OF COMPLETION CALCULATED USING COST
DATE WE DETERMINE THAN REVENUE OF $62.5 MILLION HAS BEEN EARNED
(31.25% MULTIPLIED BY $200 MILLION TOTAL CONTRACT VALUE). ON THE
OTHER HAND BASED ON THE ENGINEER'S SURVEY THE REVENUE
RECOGNIZED SHOULD BE $80 MILLION (40% MULTIPLIED BY $200 MILLION).