There is, however, a modification of this method of averaging profits which is preferable. In practice, the auditor may be unable to check every small item in all the accounts connected with these contracts; his time may be limited, or his instructions may not include it. His chief object is to see that a fair amount is carried to Profit and Loss account, and also to see that no profit is anticipated; in other words, that a proper reserve is maintained for uncompleted contracts.
This being the case, it is usually safer to calculate the unearned profits to be retained in the Reserve Profit account, and to carry all the surplus in the Gain account to Profit and Loss; rather than to calculate the earned profits to be carried to the Profit and Loss account. This calculation is formulated as follows:
balances unpaid / total selling price X total profit = unearned profits
If this plan is followed, the profit kept in reserve will always be sufficient to care for all uncollected portions of sales, and, even if no more payments be made, the Profit and Loss account will not be disturbed.