Megan Corp. recognizes revenue over time to account for long-term contracts. At the date the contract is signed, the price is $600,000 and the expected costs to complete the contract are $400,000. The following information is available: Year 1 Year 2 Year 3 Costs incurred to date $200,000 $350,000 $500,000 Estimated costs to complete 200,000 150,000 0 Progress billings 200,000 200,000 200.000
What is the amount of gross profit or loss that is recognized in year 2?
a. $30,000 loss
b. $40,000 gross profit
c. $150,000 loss
d. $200,000 gross profit

a. $30,000 loss

Explanation:

Calculation to determine What is the amount of gross profit or loss that is recognized in year 2

First step is to calculate the Year 1 Cost to cost ratio using this formula

Year 1 Cost to cost ratio = 200,000 / ( Costs incurred + Cost to complete)

Let plug in the formula

Year 1 Cost to cost ratio= 200,000 / (200,000 + 200,000)

Year 1 Cost to cost ratio= 50%

Second step is to calculate the Gross profit or loss using this formula

Gross profit/Loss = 50% * ( Price - estimated cost to complete)

Let plug in the formula

Gross profit/Loss= 50% ( 600,000 - 400,000)

Gross profit/Loss= $100,000

Third step is to calculate the Year 2 Cost to cost ratio

Using this formula

Year 2 Cost to cost ratio = 350,000 / ( Costs incurred + Cost to complete)

Let plug in the formula

Year 2 Cost to cost ratio = 350,000 / (350,000 + 150,000)

Year 2 Cost to cost ratio = 350,000 / 500,000

Year 2 Cost to cost ratio = 70%

Now let calculate the gross profit or loss using this formula

Gross profit = 70% * ( Price - estimated cost to complete) - Previous Gross

Let plug in the formula

Gross profit= 70% ( 500,000 - 400,000) - 100,000

Gross profit= -$30,000

Gross Loss of $30,000 in Year 2

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