Uncertainties about collectibility
Year 01
On Jan 01, 01, entity E concludes a fixed price contract. Under this contract, E constructs a special-purpose machine for customer C according to C”s specifications. Total contract revenue is CU 39. The total contract costs of CU 30 will be incurred in thirds in each of the years 01–03. It is agreed that the billing for the whole price will be effected at the beginning of 04. When E prepares its financial statements as at Dec 31, 01, C has a high degree of creditworthiness.
Years 02 and 03
In 02, C”s creditworthiness declines dramatically. At the end of Dec 02, E expects that it will not receive any part of the agreed price. Since E is entitled to stop performing the contract in such cases, construction of the machine is stopped. However, E negotiates with C about continuing construction because two thirds of the contract costs have already been incurred and there are no other customers who would need the machine.
Finally, it is agreed that construction will be continued. However, the price is reduced from CU 39 to CU 30. C provides a top bank guarantee for this payment. This agreement is achieved after E has authorized its financial statements as at Dec 31, 02 for issue.
Required
(a) Prepare any necessary entries in E”s financial statements as at Dec 31 for the years 01–03. The stage of completion is determined according to the cost-to-cost method (IAS 11.30a). E prepares its separate income statement in accordance with the function of expense method (= cost of sales method).
(b) Presume alternatively to (a) that the agreement to continue construction is achieved before E”s financial statements as at Dec 31, 02 are authorized for issue. Describe how the solution of (b) differs from the solution of (a).
(c) Presume alternatively to (a) that on May 01, 02 an amount of CU 13 is billed for work performed in 01, as stipulated. Due to the problems relating to C”s creditworthiness, payment of this amount is deferred until the beginning of 04.