Case 12-05

memoranda LabCo must determine if their bill indemnity for the receipts treatment of its grammatical construction twitchs is reasonable, if it is attach for LabCo to transplant its mode of be for the holibut bid from the percentage-of- shutting order to the terminatedd- swerve order and how the assortment should be treated on the priming of the focal point provided within ASC 250, and how LabCos account form _or_ system of government and be for the holibut ingest may convert low IFRS if choose in the coming year.This memorandum get out provide support for how the over wholly conclusion, base on the issues above, was reached. Facts Accounting Policy for tax income enhancement Treatment LabCo is a large construction turn outing firm, and negotiates all of its pushs with its customers on each a fixed-price or cost-plus basis. LabCo has positive an report indemnity for tax taxation cognition related to its customized construction contracts, as foll ows The ships company practises to a lower place a variety of contracts, well-nigh of which provide for reimbursement of cost plus fees, and others that atomic number 18 fixed-price-type contracts.grosss and fees on these contracts are primarily acknowledge on a contract-by-contract basis apply the percentage-of- uttermost rule of score, which is most often found on contract cost incurred to consider compared with do estimated costs at completion (cost-to-cost method). The completed-contract method of accounting is single-valued turn taild in instances in which reliably reliable estimates of the agree costs to be incurred under a specific contract cannot be do. alter in Method of Accounting for taxation TreatmentLabCo has entered into a contract with halibut to shew a six-axis laser cutting machine. The contract entered into was for a fixed-price and requires detailed and involved instruction execution specifications. Even though this was a unique(p) arrang ement that required a ample deal of customer specification, LabCo believed that with its extensive witness performing under similar contracts, including old contract with Halibut, the percentage-of-completion method of accounting for this contract was appropriate.After LabCo began experiencing significant difficulties in the design and reconcile of the six-axis laser cutting machine, (including design revisions, genuine engineering costs needing to be outsourced, and the cost of steel accustomd in the labor of the frame of the machine rising unexpectly) they placed that their estimate of the overall cost to complete the contract needed to be revised. LabCo expect that the overall forcing out would incur total costs that would be in excessiveness of the total fixed-fee contract price negotiated with Halibut.As a result, management updated its estimates phthisisd in percentage-of-completion accounting to reflect both the cost overruns incurred as well as the cost overruns judge to be incurred, and also recorded a provision for the entire loss on the contract in the period in which it became aware that the contract costs would travel by the total contract value. After six-months, LabCo delivered the six-axis laser cutting machine to Halibut. Yet, when final canvas were ran development the six-axis, the machine failed to perform up to Halibuts specifications as defined in the contract.LabCo then had to redesign, fix, and remedy the miscellaneous issues with the machine. Upon notification of these continued problems, LabCos CAO firm that total estimates of the contract costs to be incurred for the Halibut contract were no overnight able to be reliably determined. Therefore, the use of the percentage-of-completion method of accounting was deemed no protracted an appropriate method of revenue comprehension for this particular contract.As a result, the determination was gather in that LabCo would switch to a completed-contract method of revenue experience for the duration of its contract with Halibut. abbreviation Percentage-of-Completion Method Based upon review of ASC 605-35-25-56, the use of the percentage-of-completion method depends on the ability to require moderately dependable estimates, which, for purposes of this Subtopic, relates to estimates of the limit of arm toward completion, contract revenues, and contract costs.Furthermore, according to ASC 605-35-25-57, the percentage-of-completion method is considered preferable as an accounting policy in component in which fair dependable estimates can be made and in which all the following conditions dwell a. Contracts executed by the parties normally hold provisions that clearly specify the enforceable rights regarding goods or ser unrighteousnesss to be provided and authorized by the parties, the consideration to be ex substituted, and the means and terms of settlement. . The buyer can be expected to satisfy all obligations under the contract. c. The cont ractor can be expected to perform all contractual obligations. ASC 605-35-25-61 states, an entity using the percentage-of-completion method as its grassroots accounting policy shall use the completed-contract method for a single contract or a group of contracts for which evenhandedly dependable estimates cannot be made or for which inherent hazards make estimates probationary. Completed-Contract MethodBased on review of ASC 605-35-25-90, when lack of dependable estimates or inherent hazards cause forecasts to be doubtful, the completed-contract method is preferable. Inherent hazards relate to contract conditions or external factors that raise questions just about contract estimates and about the ability of both the contractor or the customer to perform all obligations under the contract. Inherent hazards that may cause contract estimates to be doubtful usually differ from inherent lineage risks.Business entities engaged in contracting, like all business entities, are exposed t o many business risks that vary from contract to contract. The reliableness of the estimating process in contract accounting does not depend on the absence seizure of such risks. Assessing business risks is a function of users of financial statements. jibe to ASC 630-35-25-97, Circumstances to be considered in determining when a project is substantially completed include, for example, delivery of the product, espousal by the customer, blendure from the site, and compliance with performance specifications. careens to and from Percentage-of-Completion and Completed-Contract Methods Based on review of ASC 605-35-25-94, the completed-contract method is preferable in dower in which estimates cannot meet the criteria for reasonable dependability discussed in paragraph 605-35-25-57 or in which at that place are inherent hazards of the nature of those discussed in paragraphs 605-35-25-65 through 25-66.An entity using the percentage-of-completion method as its basic accounting policy shall depart from that policy and use the completed-contract method for a single contract or a group of contracts merely in the circumstances draw in paragraph 605-35-25-61. In addition, 605-35-25-95 states, an entity using the completed-contract method as its basic accounting policy shall depart from that policy for a single contract or a group of contracts not having the features described in paragraphs 605-35-25-92 through 25-93 and use the percentage-of-completion method on one of the bases described in paragraphs 605-35-25-60 through 25-61.Accounting Changes and Error corrections jibe to ASC 980-250-55-3, if a regulated entity varietys accounting methods and the transfigure does not affect costs that are allowable for rate-making purposes, the regulated entity would apply the kind in the equivalent manner as would an unregulated entity. If a regulated entity changes accounting methods and the change affects allowable costs for rate-making purposes, the change generally would be implemented in the way that it is implemented for restrictive purposes.A change in the method of accounting for question and development costs, either from a policy of capitalization and amortization to one of charging those costs to expense as incurred or vice versa, is an example of that type of change. Adopting IFRS Based on review of IAS 18 Revenue, the recognition of revenue by reference to the stage of completion of a transaction is often referred to as the percentage-of-completion method.Under this method, revenue is recognized in the accounting periods in which the emoluments are rendered. The recognition of revenue on this basis provides utilitarian information on the extent of service activity and performance during a period. When the import of the transaction involving the rendering of services cannot be estimated reliably, revenue shall be recognized only to the extent of the expenses recognized that are recoverable. conclusion Accounting Policy for Reven ue TreatmentBased on the facts presented and the analysis performed, LabCos accounting policy for the revenue treatment of its construction contracts appears reasonable. On the other hand, while it makes sense to use the percentage-of-completion method for contracts that can be reasonably estimated, the completed-contract method of accounting appears to be the like method, due to the specific criteria that must be met in order to qualify for such reasonableness under the percentage-of-completion method of accounting. Change in Method of Accounting for Revenue TreatmentBased on the facts provided and the analysis performed, it is appropriate for LabCo to change is method of accounting for the Halibut contract from the percentage-of-completion method to the completed contract method. According to the guidance (stated above), An entity using the percentage-of-completion method as its basic accounting policy shall depart from that policy and use the completed-contract method for a sing le contract or a group of contracts only in the circumstances described in paragraph 605-35-25-61. The Halibut contract adheres to this policy, and because there were unexpected issues that caused for the contract to no longer be reasonably estimated, they are correct in their logical thinking for changing to the completed-contract method. On the basis of the guidance provided within ASC 250, Accounting Changes and Error Corrections (provided above), this change should be treated in one of two ways (1) If a regulated entitys change in accounting methods does not affect rate-making costs, the change would be applied in the same manner as an unregulated entity. 2) If a regulated entitys change in accounting methods does affect rate-making costs, the change would be implemented based on regulatory purposes. Adopting IFRS If LabCo decides to adopt IFRS in the upcoming year, there testament be a clear change in the Companys accounting policy, as well as their accounting for the Halibut contract. The use of the percentage-of-completion method when contracts can be reasonably estimated will remain consistent with IFRS.However, whenever these costs cannot be reasonably estimated, instead of using the completed-contract method, IFRS states that revenue shall be recognized only to the extent of the expenses recognized that are recoverable. Therefore, the accounting for the Halibut contract will change under IFRS in the same way. In this instance, kinda than switching from percentage-of-completion to the completed-contract method, LabCos contract change would consist of altering the percentage-of-completion method in order to adapt to the recognition of revenue as stated by IFRS in the paragraph above.