This workout is going to explore contracts in industrial companies. You can see we've been given an industrial contract. It's got value of 6,900 and it's got a cost of 6,000. So you could reasonably expect the net cash flow to be 900 and the profit to be 900.

The difficulty is because of contract accounting and cost-to-cost systems there's going to be a mismatch potentially between those profits and cash flows, which will require some mediation in the form of contract assets and liabilities. And that's primarily our job down here. The costs are going to be incurred over a three year period and as they do, they'll attract revenue because of cost to cost accounting. We then got the milestone payment, which is the cash flows and where the various deviation between the revenue recognized and the milestone payment will require the buildup or depletion of assets and liabilities, which will show down here the contract asset and liability. Our first job is very easy, we go and fetch the cumulative costs. Initially that means just grabbing the costs, and then what we can do is add the cost to those already existing and this will create a cumulative costs. And you can see that adds up to the costs, the expected contract costs in the earlier sell. So that's quite a good sense check.

Next, there is 6,900 of revenue that can be recognized and it's going to be recognized in step with the costs recognized. If by the point I'm at now we have got a certain proportion of the costs, we can then apply that proportion to the contract value and that will help us to create the revenue. Now I need to lock that revenue there, and then when I copy to the right, what we should find is that I'm slowly mounting up the revenue recognized towards the total revenue, which we saw earlier, which again is quite nice sense check. Now, initially the revenue recognized will be the revenue recognized cumulatively, but in subsequent years, we'll need to just grab the difference between the two.

And you can see that because of the rate of change of costs slowing down, the revenue recognition also slows down because of the cost to cost system, which is being used here.

If we compare the revenue within the year to the costs within the year, we can then create a profit throughout the year. And you can see that again as a nice sense check that adds up to the 900, which we intuitively thought early on would be the total profit of the project.

And we've worked our cost-to-cost accounting method and system. What we now need to do is relate that to a more reality based view i.e. cash flows. We'll use the same trick as before where initially the milestone payment in the first year is it, and then we'll add the next milestone payment to the one from the previous year to create the cumulative total. And you can see again as a nice sense check that equals the 6,900 contract value. What we have now is revenue of 2,300 compared to cash of 3000, and there's a mismatch that will need to be fixed In the accounts. You can see we've collected 3,000, but we only have really had the right to revenue of 2,300. We've collected more cash than the revenue that we've potentially served. We've collected early, and that means you could think about it as owing the customer a bit like deferred revenue. This will be represented by a contract liability in the financial statements that again, works a lot like deferred revenue. If we pull that to the right, you can see that reverses pretty sharply, and that's because we recognize a lot of revenue in year two and we take a relatively low amount of cash. This all comes out in year three where we see the meeting of the two. And so you can see that really this system and this workout is exploring timing differences between revenue and cashflow that need to be mediated through a balance sheet item called a contract asset and liability. And you can see how wildly volatile that is. And that's primarily because the customer's being quite generous early on in the contract and paying a relatively high amount of cash compared to the work that we've actually done perhaps to get us established. Then things reverse and we get paid a relatively low amount, and this ends up reversing things and bringing things back into alignment.