Labor Case Study
They were forced to redo initial designs, outsource engineering costs, and the price of steel used to construct the cutting machine unexpectedly rose. Labor had to re-estimate their costs to complete the project and concluded that the excess costs would ex. the total fixed fee contract price they negotiated with Halibut. To update their estimated costs, Labor continued using the percentage of completion method.
Labor appropriately recorded a loss in the period in which they became aware. When the current estimates of total contract revenue and contract cost indicate a loss, a provision for the entire loss on the contract shall be made. Provisions for losses shall be made in the period in which they become evident under either the percentage-of-completion method or the completed-contract method (ASS 505-35-25-46. )” Labor experienced another setback which delayed their process six more months. Hen the cutting machine was finally complete, they delivered it to Halibut to have it tested. During the final test, the machine failed to meet the specifications of Halibut.
Labor was forced to redesign and fix the various problems with the machine. At this point, Labs’ chief accounting officer decided to switch to the completed contract method, which says, “Under the completed-contract method, income is recognized only when a contract is completed or substantially completed. Accordingly, during the period of performance, billings and costs are accumulated on the balance sheet, UT no profit or income is recorded before completion or substantial completion of the work (ASS 605-35-25-88). ‘The completed contract method is preferable when lack of dependable estimates or inherent hazards cause forecasts to be doubtful (ASS 605-35-25-90)”, which was the case in the situation. The two methods, percentage of completion and completed contract, are not acceptable alternatives for the same situation (ASS 605-35-25-1).
Labor should have realized after running into unexpected costs the first time that they should have switched to the completed contract method. An entity using the argental-of-completion method as its basic accounting policy shall use the completed-contract method for a single contract or a group of contracts for which reasonably dependable estimates cannot be made or for which inherent hazards make estimates doubtful (ASS 605-35-25-61). ” Labor is able to handle this change in of accounting principle in one of the three methods; Retrospective Application, Change in Accounting Estimate, or Change in Accounting Estimate Affected by Accounting Principle.
It is clear that the percentage of completion method was not the acceptable alternative because Labor could not effectively estimate costs. The completed contract method is the preferable method because there was a lack of dependable estimates.
Labs’ decision to switch from percentage of completion to completed contract method is in accordance with FAST Codification because this transition can be handled by the Accounting Staff to apply a retrospective application to the previous year’s financial information. The application of a different accounting principle to one or more previously issued financial statements, or to the statement of financial position at the beginning of the current period, as if that principle had always been used, or a change to uncial statements of prior accounting periods to present the financial statements at a new reporting entity as it it and existed in those prior years.
Since the retrospective application is applied to this situation to show the effect of the change to completed contract method; the estimated contract costs were no longer reliably determinable, therefore, disclosure for the reasons behind this change must be included within the year’s financial statements when the change actually is incurred. The situation can also be handled with a Change in Accounting Estimate approach.
When Labor incurred significant difficulties with the design and manufacturing of the laser machine, they decided to update their estimates used in the percentage of completion method to reflect both the cost overruns incurred as Nell as the cost overruns expected to be incurred.
Handling it with this approach prohibits the retrospective treatment to the situation. It will affect only the period of change and future periods, if the change affects both, in which case it does. The effect on income from continuing operations, net income (or other appropriate captions of changes in the applicable net assets or performance indicator), and any related per-share amounts of the current period shall be disclosed for a change in estimate that affects several future periods. ” (ASS 250-10-50-4) The final approach that could have handled this situation is the Change in Estimate Affected by a Change in Accounting Principle.
Due to Labor dealing with continued problems with the Halibut contract, and prior estimates adjusted previously during the contract period, it forced the Chief Accountant of Labor to allow the change in accounting principle from percentage of completion method to completed contract method. Labor can make this change by it being impossible to determine whether a change in principle or a change in estimate has occurred.
If it is impracticable to determine the cumulative effect of applying a change in accounting principle to any prior period, the new accounting principle shall be applied as if the change was made prospectively as of the earliest date practicable. ” (ASS 250-10-45-7) After much continued research and intellectual thought, we have concluded that the Retrospective Application is not sufficient in this matter because the estimates have been altered drastically; to retrospectively apply the changes this ear would distort Net Income figures to the point where timeliness and consistency Nil no longer apply.
The Change in Accounting Estimate would seem sufficient to apply to this situation, but it will not work because a change in estimate cannot be applied retrospectively. Therefore, I have concluded that the best way to handle this issue is the Change in Accounting Estimate affected by the Change in Accounting Principle approach. I have come to this conclusion based on the facts that due too change in accounting principle and change in accounting estimate both being involved in this situation, and retrospective application not being applicable, the entire effect of the two changes should be applied in a prospective method.