Making a Decision as a Manager: Choosing among Alternative Recognition Points
When companies involved in long-term construction projects can estimate the percentage of work completed and the total expected costs with reasonable accuracy, GAAP allows them to recognize revenues based on the incurred contract costs to date divided by the estimated total contract costs. This is called the percentage of completion method. When total costs cannot be accurately estimated, the companies must wait until the contract is completed to recognize all contract revenue in the period of completion. These revenue recognition points correspond to continuous recognition and the end of the earnings process.
Required:
1. Assume that a construction company works on a single construction project at a time and that each project takes three years to complete. Do you think that the choice between the two revenue recognition policies would materially affect the reported earnings? Why or why not?
2. Given your answers to requirement (1), under what conditions would that answer change?
3. Which revenue recognition rule for financial reporting purposes would you prefer as a manager? Why?