Why is there risk of earnings overstatement in accounting for construction contracts?
A)The long term nature of such contracts makes them a low risk area.
B)Allocation of revenue and expenses between two or more periods simplifies the accounting.
C)Significant professional judgment is required to make estimates used in the calculations.
D)Percentage of completion method reduces the potential for earnings management, manipulation and errors.

Question

Quizplus · Accepted Answer

Accounting for construction contracts involves making estimates for costs and progress, which require significant professional judgment. This creates the potential for earnings overstatement if the estimates are not accurate. Option A is incorrect because the long-term nature of contracts actually increases the risk of earnings overstatement due to the length of time involved in completing the project. Option B is incorrect because allocating revenue and expenses between periods can actually complicate the accounting and increase the risk of errors. Option D is also incorrect because while the percentage of completion method is a recognized accounting method for construction contracts, it does not eliminate the potential for earnings management, manipulation, or errors.

Why Is There Risk of Earnings Overstatement in Accounting for Construction