Professional Work Based on Percentage of Completion
A house contractor may ask a homeowner to pay at least 25% of the contract price before construction work commences. Since part of the money will be used to buy construction materials and pay for labor, the deposit received cannot be recognized as the contractor’s income.
The contractor can claim the succeeding advance payment from the homeowner if the agreed portion of the house under construction has been satisfactorily completed. This would mean that the money previously received has been exhausted in order to attain the completion, although a portion of this deposit was already projected by the contractor as his potential income for the completed segment of the construction job.
To illustrate how the unearned revenue is recorded, the following are given as examples:
The contract price for the house is $100,000, 25% advance payment for 25% completion. The 25% advance payment for 25% completion is allotted as follows: $12,000 is for materials, $5,000 for labor, and $3,000 for miscellaneous expenses. This leaves $5,000 free from allotment and thus become the contractor’s potential income from the 25% completion.
(1) Accounting entry to record the advance deposit received:
Dr. Cash __________ $25, 000
Cr. Advances for Cost of Materials and Labor __________ $12,000
Cr. Advances for Cost of Labor __________ $5,000
Cr. Advances for Miscellaneous Expenses __________ $3,000
Cr. Unearned Revenue from Construction Project __________ $5,000
(2) Upon completion of the portion for which the deposit was made, the following entry will be taken-up to recognize the expenses and the earned income:
Dr. Advances for Cost of Materials and Labor __________ $12,000
Dr. Advances for Cost of Labor __________ $5,000
Dr. Advances for Miscellaneous Expenses __________ $3,000
Dr. Unearned Revenue from Construction Project __________ $5,000
Cr. Cash __________ $20,000
Cr. Income from Construction Project __________ $5,000
Note to this entry: Only $20,000 is recognized as reduction against the $25,000 cash originally deposited, as it represents the costs paid for materials, labor, and miscellaneous expenses. The $5,000 balance remains intact as the contractor’s actual income for the 25% completed project.