Question

(Change in Principle—Long-Term Contracts) Cullen Construction Company, which began operations in 2017, changed from the completed-contract to the percentage-of-completion method of accounting for long-term construction contracts during 2018. For tax purposes, the company employs the completed-contract method and will continue this approach in the future. The appropriate information related to this change is as follows.

Pretax Income Percentage-of-Completion Completed-Contract Difference 2017 \(880,000 \)590,000 $290,000 2018 900,000 480,000 420,000

Instructions (a) Assuming that the tax rate is 40%, what is the amount of net income that would be reported in 2018? (b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?

Short answer

The net income is $540,000, and the journal entry will be: construction in the process is debited, deferred tax liability and retained earnings are credited

Step-by-step solution

Calculation of net income

$$\begin{gathered} \mathbf{Net}\mathbf{}\mathbf{Income}\mathbf{=}\mathbf{Percentage}\mathbf{}\mathbf{of}\mathbf{}\mathbf{}\mathbf{completion}\mathbf{\times }\mathbf{(}\mathbf{1}\mathbf{-}\mathbf{Tax}\mathbf{}\mathbf{rate}\mathbf{)} \\ \mathbf{=}\mathbf{900}\mathbf{,}\mathbf{000}\mathbf{\times }\left(\mathbf{1}\mathbf{-}\mathbf{0}\mathbf{.}\mathbf{40}\right) \\ \mathbf{=}\mathbf{\$}\mathbf{540}\mathbf{,}\mathbf{000} \end{gathered}$$

Journal Entry

Date	Particulars	Debit ($)	Credit ($)
	Construction in process	290,000
	Deferred Tax Liability (290,000*40%)		116,000
	Retained Earnings		174,000
	(Being entry is made to record to adjust)