Response to the following problem:
Long-term contract; revenue recognition over time vs. upon project completion
Willingham Construction is in the business of building high-priced, custom, single-family homes. The company, headquartered in Anaheim, California, operates throughout the Southern California area. The construction period for the average home built by Willingham is six months, although some homes have taken as long as nine months.
You have just been hired by Willingham as the assistant controller and one of your first tasks is to evaluate the company's revenue recognition policy. The company presently recognizes revenue upon completion for all of its projects and management is now considering whether revenue recognition over time is appropriate.
Required:
Create a 1- to 2-page memo to Virginia Reynolds, company controller, describing the differences between the effects of recognizing revenue over time and upon project completion on the income statement and balance sheet. Indicate any criteria specifying when revenue should be recognized. Be sure to include references to GAAP as they pertain to the choice of method. Do not address the differential effects on income taxes nor the effect on the financial statements of switching between methods.