Revenue Recognition for Large Projects

I apologize for not really discussing Financial Accounting. At the risk of sounding a bit arrogant, a lot of this material (but certainly not all of it - liability recognition percentages for GAAP (80%) versus IFRS (50%) ) has been covered in the CFA level I (for the question that most people ask, should I do an MBA or CFA, this is part of the answer... I should post more on this sometime and why I decided to do both). Plus, as my colleague Megan so eloquently puts it:

"... it is an important and necessary subject, so I may as well learn to love it
because I can't escape it."

Currently, we are discussing different revenue (and cost and profit) recognition techniques for larger projects who span more than one reporting period. The question is how should we recognize these items in financial statements? There are two methods we are looking at: the percentage of completion method and the completed contract method.

The completed contract method is quite simple, where (intuitively) all the revenues are accounted for once the contract is completed. It is more appropriate in scenarios where the contract involves extremely high risks (and may not be completed).

Another method not yet mentioned is the cost recovery method, where revenues match costs until the last period where gross profits are recognized all at once.

[Case] Same as the case in the percentage of completion post:

Assume a construction project with the following construction cost structure:

Year 1: $5M
Year 2: $15M
Year 3: $10M

The overall contract price is $46M.How much profit should be recognized in each of the given years under different methods?

[Solution]
Case 1 - Completed contract method revenue:
Year 1: $0
Year 2: $0
Year 3: $46M

Profit:
Year 1: $0
Year 2: $0
Year 3: $46M - $30M = $16M

Case 2 - Cost recovery method PROFIT:
Year 1: $0M
Year 2: $0M
Year 3: $16M

(Although I don't know what the cost schedule looks like, the revenue recognition will be such that revenues will match and equal costs, until the last year). Note that while the profit schedules are identical in both methods, the revenue and cost recognition schedules are different in these two methods.

Continuing the class after the break, we discussed COGS and Inventory as an extention of the above concepts. Our professor is starting to do a primer (and enter into) the topic of LIFO versus FIFO, one of my top (most popular) posts. And as mentioned before, there are interesting concerns when it comes to accurately measuring performance versus position. Another major issue we are discussing is accounting for inventory costs when they haven't yet been sold, but their value moves with what happens in the market and LOCOM, the lower of cost or market as an accounting standard for both US GAAP and IFRS.