We all agree revenue should be recognized:
- Fixed Price Revenue is recognized when deliverables are met or on a percentage-of–completion basis,
- Cost Reimbursement revenue is recognized when the work is performed.
However, do you know when to recognize a foreseeable loss on the contract?
If a loss on the contract is expected or known, regardless of the method of accounting for the contract, you need to calculate the anticipated loss and recognize it immediately in the income statement in accordance with SOP 81-1 paragraphs .85-.89 (IAS 37 Provisions), which states:
[Contingent Liabilities and Contingent Assets which requires unavoidable losses in respect of onerous contracts to be expensed in the accounting period in which such losses become probable]
After the anticipated loss is posted, subsequent revenue and costs are recognized in offsetting amounts as contract costs are incurred and do not generate further gross profits or losses.
In general, if the total estimated contract costs (burdened with Fringe and Overhead rates) exceed the contract value, the loss would need to be calculated and taken immediately. Below is an example entry for forward loss provisions:
Entry to Record:
|Credit||Forward Loss Provision (Liability)|
As the contract continues and the costs are incurred:
|Debit||Forward Loss Provision until balance is zero|
However, forward losses can be viewed without the application of G&A in certain circumstances. Bottom line, review underperforming contracts and project possible losses in accordance with GAAP before your auditors do.