CFA Practice Question

There are 534 practice questions for this study session.

CFA Practice Question

Under the percentage-of-completion method, as opposed to the completed-contract method, which of the following is true?

A. Current assets are probably smaller under the percentage-of-completion method in the earlier stages of the contract.
B. The current ratio is probably larger under the percentage-of-completion method in the later stages of the contract.
C. Current liabilities are probably smaller under the percentage-of-completion method in the earlier stages of the contract.
Correct Answer: C

In the earlier years of the project, the percentage-of-completion method will usually report a construction in progress account that is larger than billings on construction contract. When the two accounts are offset, the result is a net debit (current asset). The opposite is probably true of the completed-contract method, where a net credit (current liability) will exist.

User Contributed Comments 13

User Comment
kalps Construction in progress account > billings on construction account net asset
cbb1 Why isn't "B" correct? In the latter stages of the project, there is more and more profit "inventoried" into the CIP account, thus improving the current ratio.
raphdamico In whichever method you use to recognise revenue, you must accrue construction in progress, which is an asset because it is a claim on future revenue, and advance billings, which is cash received (i.e. current revenue). In the end the two will be equal and will offset to zero.

Construction in progress = costs incurred + profit recognised.

Thus, if you recognise profit before the end of the process (for % of completion), your construction in progress asset is higher, i.e. you recognise the claim on the future cash earlier. However, this is offset by the same amount of cash already received (advance billings), so you end up with a larger current asset/smaller current liability.
rfvo Thanks, Raphdamico
Shammel Great explanation Raphdamico!
Pchen Thanks for the explanation by Raphdamico. Forgive me if this is obvious. I understand why current asset would be higher early in the contract, but I do not see why current liabilities would be lower. What would the decrease be under, specifically (I'm thinking balance sheet)

Thanks, in advance
davcer A and B state the same with different words, so C is the right one
alexsar75 Construction in progress does not include profit! it only includes billings/costs.
alexsar75 under completed contract, that is.
xemex131 Another way to think: Under completed contract method, when you get cash, it gets reported to unearned revenue (a current liability) since you don't recognise the revenue. On the contrary, in the percentage completed method, liability does not increase.
Sagarsan88 @xemex131...that is the correct approach to look at such qstns, i feel.
TCLTC Thanks @xemex131
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