Use the following information for questions 44 and 45.
Dream Home Inc., a real estate developing company, was accounting for its long-term contracts using the completed contract method prior to 2015. In 2015, it changed to the percentage-of-completion method.
The company decided to use the same for income tax purposes. The tax rate enacted is 40%.
Income before taxes under both the methods for the past three years appears below.
-Which of the following will be included in the journal entry made by Dream Home to record the income effect?
A) A debit to Retained Earnings for $150,000
B) A credit to Retained Earnings for $150,000
C) A credit to Retained Earnings for $100,000
D) A debit to Retained Earnings for $100,000

Question

Use the following information for questions 44 and 45.
Dream Home Inc., a real estate developing company, was accounting for its long-term contracts using the completed contract method prior to 2015. In 2015, it changed to the percentage-of-completion method.
The company decided to use the same for income tax purposes. The tax rate enacted is 40%.
Income before taxes under both the methods for the past three years appears below. 
-Which of the following will be included in the journal entry made by Dream Home to record the income effect?
A) A debit to Retained Earnings for $150,000 
B) A credit to Retained Earnings for $150,000 
C) A credit to Retained Earnings for $100,000 
D) A debit to Retained Earnings for $100,000

Quizplus · Accepted Answer

The journal entry will include a credit to Retained Earnings for $150,000. This is because the company is switching from the completed contract method (where income is recognized only when the project is completed) to the percentage-of-completion method (where income is recognized as work is done on the project). As a result, there will be a catch-up adjustment where income that was not recognized under the completed contract method will now be recognized. This catch-up adjustment will increase Retained Earnings by the total amount of income that was not recognized in prior years, which is $150,000 in this case.

Use the Following Information for Questions 44 and 45