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
Current Ratio

Current Assets
Current Liabilities

Higher Construction in progress includes portion of estimated profits Lower

Average Receivables

Higher Revenues are reported Lower - Not measurable prior to completion
Assets to Equity

Total Assets

Higher Retained earnings are reported Lower - Not measurable prior to completion
Total Debt Ratio

Total Liabilities
Total Liabilities + Total Equity

Lower Liabilities are smaller and the denominator includes equity which is higher Higher
The Cash Flow Statement
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