Essay: Revenue Recognition - Long-Term Contract

DixieChick Company is accounting for a long-term construction contract using the percentage-of-completion method. It is a 4-year contract that is currently in its second year. The latest estimates of total contract costs indicate that the contract will be completed at a profit to DixieChick Company.

During the third year the project ran into some problems and there were significant cost overruns. At the end of the third year, the contract costs are estimated to exceed the contract revenues for DixieChick Company.

Required:

1. What theoretical justification is there for DixieChick Company's use of the percentage-of-completion method?

2. How would progress billings be accounted for? Include in your discussion the classification of progress billings in DixieChick Company financial statements.

3. How would the income recognized in the second year of the 4-year contract be determined using the costs-to-cost method of determining percentage of completion?

4. What would be the effect on earnings per share in the second year of the 4-year contract of using the percentage-of-completion method instead of the completed-contract method? Discuss.

What would be the effect on earnings per share in the third year of the 4-year contract of using the percentage-of-completion method instead of the completed-contract method? Discuss.