Financial Statements - Revenue Recognition Effects on Cash Flows and Financial Ratios
Both methods - the percentage-of-completion and completed-contract methods - produce the same net cash flow effect.
Cash Flow Effects
Percentage-of-completed contract method
- Net income (NI) will be higher in the first years and lower in the last year.
- Net Income will be less volatile.
- Total assets will be greater.
- Liabilities will be lower.
Completed contract method
- Net income will be nonexistent in the first years and higher in the last year.
- Net income will be very volatile.
- Total assets will be smaller.
- Liabilities will be higher (no recognition of retained earnings).
- Stockholders equity will be lower.
- Stockholders equity will be more volatile.
Impact on Financial Ratio
|Ratio||Formula||% of Completion Method||Reason||Completed Method|
|Higher||Construction in progress includes portion of estimated profits||Lower|
|Higher||Revenues are reported||Lower - Not measurable prior to completion|
|Assets to Equity||
|Higher||Retained earnings are reported||Lower - Not measurable prior to completion|
|Total Debt Ratio||
|Lower||Liabilities are smaller and the denominator includes equity which is higher||Higher|
The Cash Flow Statement