Sharma Ltd., a private construction company following ASPE, is discussing with its auditor its accounting policy for the recognition of revenue in its year-end financial statements. Management's main area of contention is the requirement to estimate progress on construction contracts as of the year-end date for the percentage-of-completion method for long-term construction contracts. The Income Tax Act allows the reporting of revenue from construction contracts using the completed-contract method of revenue recognition. This method allows the reporting of gross profits earned on multi-year contracts in the taxation year when the contracts have been completed. Because the tax due on the profit of the completed contracts can be postponed, Sharma argues that most construction companies recalculate their construction revenues using the completed-contract method when filing their corporate income tax returns.
The controller explained to the auditor that the business does not need to use the percentage-of-completion method for accounting for long-term construction contracts in order to properly manage projects. Sharma's day-to- day practices allow for very strict management of costs on contracts. The controller has suggested the company get unanimous approval from all shareholders to adopt the completed-contract method for financial reporting purposes. The policy adopted could then be clearly described in the accounting policy note to the financial statements, thereby ensuring that the users of the information would not be confused by the change. The application of the policy would be done retroactively to allow for comparability between fiscal years' financial results.
Instructions
You are the auditor. Do you agree with the controller? Explain the basis for your answer. Would the adoption of the completed-contract method lead to a modified opinion in the auditor's report? Would your response change if Sharma were using IFRS?