Intercompany Long Term Construction Contracts

One member of an affiliated group of companies may construct a plant asset for another affiliate over an extended period of time. The company constructing the asset will record progress under the completed-contract method or the percentage-of-completion method. During construction, special adjustments may be necessary when consolidating, depending on which of the two methods is used to record the contract by the constructing affiliate. From a consolidated viewpoint, such activity amounts to the self-construction of an asset to be used by the consolidated entity.

Worksheet 4-7: page 4-36

objective: 4

Demonstrate an understanding of the profit deferral issues for intercompany sales of assets under long-term construction contracts.

Once the asset has been sold to an affiliate, consolidation procedures are similar to those used for a normal intercompany sale of a plant asset.

Completed-Contract Method. The constructing affiliate using the completed-contract method records no profit on the asset until it is completed and transferred to the purchasing affiliate. However, costs incurred to date on the contract are capitalized in a special account, such as Cost of Construction in Progress. This account will appear on the trial balance of the constructing affiliate. This account should be eliminated and re-recorded as Assets Under Construction, which is the usual account for the cost of an asset being constructed for a company's own use.

The constructing affiliate may bill the purchasing affiliate for work done prior to the completion of the asset. When this occurs, the constructing affiliate will record billed amounts by debiting Contracts Receivable and crediting Billings on Long-Term Contracts. The billings account acts as a contra-account to Cost of Construction in Progress. The purchasing affiliate would debit Assets Under Construction and credit Contracts Payable for billings received. Consolidation procedures require that the constructing affiliate's account Billings on Long-Term Contracts be eliminated against Cost of Construction in Progress. Any excess of cost incurred over the amount of billings is closed to the purchaser's account, Assets Under Construction. In addition, it is necessary to eliminate any remaining intercompany receivable and payable amounts recorded on the long-term contract.

Percentage-of-Completion Method. This method allows the constructing company to recognize a portion of the total estimated profit on the contract as construction progresses. During the construction period, the contracting company debits an account usually entitled Construction in Progress for costs that are incurred to outside companies. The contractor also debits Construction in Progress and credits Earned Income on Long-Term Contracts for the estimated profit earned during each accounting period. Thus, the construction in progress account includes accumulated costs and estimated earnings. When the purchaser is billed, the contractor will debit the amount billed to Contracts Receivable and credit Billings on Construction in Progress, while the purchaser will debit Assets Under Construction and credit Contracts Payable.

To illustrate the elimination procedures when the percentage-of-completion method is used, assume a subsidiary, Company S, enters into a contract to construct a building for its parent company, Company P, for $500,000 and Company S estimates the cost of the building to be $400,000. During 20X1, the building is 50% completed and $200,000 of cost has been incurred as of December 31, 20X1, but only $150,000 has been billed. The contract is completed in 20X2 at an additional cost of $200,000. The entries on the books of the separate affiliates for December 20X1 are as follows:

Company S

Construction in Progress

200,000

Payables (to outsiders)

To record costs incurred for the long-term contract under the percentage-of-completion method.

200,000

Construction in Progress

50,000

Earned Income on Long-Term Contracts . . . . To record pro rata share of estimated profit [50% x ($500,000 - $400,000)].

50,000

Contracts Receivable

150,000

Billings on Construction in Progress

150,000

To record billing to parent for the portion of amount due under the contract.

due under the contract.

150,000

150,000

The subsidiary's balance sheet prepared at the end of 20X1 would list a net current asset of $100,000, as the $150,000 balance in Billings on Construction in Progress would be offset against the $250,000 balance in Construction in Progress. If billings exceed the amount recorded for construction in progress, a net current liability would be shown on the balance sheet.

The following partial consolidated worksheet for 20X1 shows the relevant accounts and the eliminations that would appear for this example. The elimination procedures are complex and involve answering this question: What should remain on the consolidated statements? From a consolidated viewpoint, a self-constructed asset is in progress and $200,000 has been spent to date. All that should remain on the consolidated statements is a $200,000 asset under construction and a $200,000 payable to outside interests. The income distribution schedule of the constructing affiliate would reflect the profit deferral through a debit for $50,000.

Company P and Subsidiary Company S

Partial Worksheet for Consolidated Financial Statements

For Year Ended December 31, 20X1

(Credit balance amounts are in parentheses.)

Partial Trial Balance

Eliminations & Adjustments

Company P

Company S

Dr.

Cr.

Assets Under Construction

150,000

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Responses

  • tiblets gebre
    Are innercopany assets long term?
    2 years ago

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