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I am doing an auditing question and in this i have to explain the client the correct treatment, so i am posting the question here, as i am unable to understand the double entries he is making: (Please Explain it to me all four entries)
Besides Hows the inventory is 25% ?
Thanks.Q: In January 2009 Hubbub commenced a major contract to fit 2,000 windows to the head office and factory of Jorgon. By 30 June 2009 all the windows had been manufactured, but only 1,500 windows had been installed. The contract price in cash terms is £2 million, but Jorgon agreed, in addition, to supply Hubbub, free of charge, with the plastic for manufacturing the
windows for the contract. The total cost of the plastic to Jorgon was £300,000 and its fair value is £400,000. The total production cost to Hubbub, other than the plastic, was £1 million and the total installation cost for the entire contract is estimated to be £600,000.
A contract with the government for a similar amount and type of windows as the Jorgon contract has been completed recently with a total price £2.6 million.
Jorgon has already paid £1 million in cash to Hubbub. The contract is due to be completed by the end of September 2009.
Hubbub has not recognised any revenue or profit on the contract in the draft financial statements for the year ended 30 June 2009, as the finance director regards it as incomplete.
Costs incurred to 30 June 2009 have been recognised as inventory in the draft financial statements and the cash amounts received from Jorgon have been recognised as ‘payments on account’ within current liabilities.Ans: The entire contract should thus be recognised as:
Total 75% complete Total 75% Complete
Revenue (£2m + £0.4m) £2.4m £1.8m
Costs (1.6m + £0.4m) £2.0m £1.5m
Profit £0.4m £0.3mThe £1.4m would be recognised as receivables (being the £1.8m revenue less the £0.4m of goods received Free Of Charge) and the £1m received to date as a partial settlement of that amount.
Inventory would be 25% of the total contract product cost excluding installation ie
(£1m + £0.4m) x 25% = £350,000
The adjustments required are:
Dr Inventory 400,000
Cr Revenue 400,000Dr Receivables 1,400,000
Cr Revenue 1,400,000Dr Inventory 1,450,000
Cr Cash 1,450,000Dr Cost of sales 1,500,000
Cr Inventory 1,500,000Hmmm …..
I think it works like this:
Open a Contract “T” Account
On the debit side, put in entries as follows (the words indicate the account to be credited under double entry principles)
Purchases Account (a transfer from the Purchases Account where the original purchase of the raw materials would have been debited and are now being transferred to the Contract Account) 1,000,000
Wages Account ( a transfer from the Wages Account where the installation costs will have been recorded and are now being transferred to the Contract Account) 450,000
Revenue Account (Statement of Income – the same amount that you have calculated ie 75% of (2m +400,000)) 1,800,000
On the credit side of the Contract Account, put in these entries:
Cost of Sales (Statement of Income – (1.6m direct costs + 400,000) * 75%) as per your calculation 1,500,000
Receivables Account 1,400,000 (the amount received of 1,000,000 + 400,000 received by way of plastic material donated)
Carry down the value of the closing inventory (as you have calculated it – 25% * (1,000,000 + 400,000 donated materials))
I believe that that now balances the Contract Account with total amounts of 3,250,000
Further, the Receivables have been settled by the receipt of 1,000,000 cash and 400,000 donated materials
The Statement of Income amounts (1,800,000 revenue and 1,500,000 costs now gives a profit recognised amount of 300,000 – the same as your calculation)
The only thing left to do is to undo the two incorrect entries so far processed by Hubbub
Is that ok?
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