Accounting for construction contracts (LKAS 11) Rangajewa Herath B.Sc. Accountancy and Financial Management(Sp.)(USJ) MBA-PIM(USJ)

What is a construction Contract? Contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.

Types of contract based on Pricing Method 1. Fixed Price Contract e.g: Contract Price = Rs.100 million 2. Cost plus Contract e.g: Contract Price = Cost + 20% e.g: Contract Price = Cost + Rs.20 million

The main issue in relation to accounting for constriction contracts Date of commencement Date of Completion 01/07/ 2014 01/07/ 2012 01/01 /2012 31/12 /2012 31/12 /2013 31/12 /2014 Contract period Contract Price = Rs. 100 million Contract cost = Rs.80 million Contract Profit = Rs.20 million How much revenue, cost and profit should be recognized for year ended 31/12/2012, 31/12/2013 and 31/12/2014 ?

Stage of Completion = Value of work certified x 100% (a) surveys of work performed (b) completion of a physical proportion of the contract work (c) the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs Stage of Completion = Value of work certified x 100% Total contract price Stage of Completion = Nos. of units completed x 100% Total Nos. of unit Stage of Completion = Cost incurred x 100% Total estimated Cost

Exercise 1: Answer Contract A Stage of Completion = Work Certified x 100% Contract Price = 300 x 100% 500 = 60%

Exercise 1: Answer Cont.. Contract B Stage of Completion = Cost incurred x 100% Total estimated cost = 240 x 100% 600 = 40%

Exercise 1: Answer Cont.. Contract C Stage of Completion = Cost incurred x 100% Total estimated cost = (315-15) x 100% 600 = 50%

Exercise 1: Answer Cont.. Contract D Stage of Completion = Number of houses completed X 100% Total number of houses in the contract = 200 x 100% 500 = 40%

Contract Revenue Contract Price Variation Claims Incentive payments

A variation is an instruction by the customer for a change in the scope of the work to be performed under the contract. A variation may lead to an increase or a decrease in contract revenue. Examples of variations are changes in the specifications or design of the asset and changes in the duration of the contract. A claim is an amount that the contractor seeks to collect from the customer or another party as reimbursement for costs not included in the contract price. A claim may arise from, for example, customer caused delays, errors in specifications or design, and disputed variations in contract work. The measurement of the amounts of revenue arising from claims is subject to a high level of uncertainty and often depends on the outcome of negotiations

Incentive payments are additional amounts paid to the contractor if specified performance standards are met or exceeded. For example, a contract may allow for an incentive payment to the contractor for early completion of the contract.

Contract Cost (a) Costs that relate directly to the specific contract (b) Costs that are attributable to contract activity in general and can be allocated to the contract (c) Such other costs as are specifically chargeable to the customer under the terms of the contract

Exercise 2 :Answer Contract A Revenue = 500 x 60% = 300 Cost of sales = 400 x 60% = (240) Profit = 60 Contract B Revenue = 800 x 40% = 320 Cost of sales = 600 x 40% = (240) Profit = 60

Exercise 2 :Answer Cont… Contract C Revenue = 750 x 50% = 375 Cost of sales = 600 x 50% = (300) Profit = 75 Contract D Revenue = 600 x 40% = 240 Cost of sales = 450 x 40% = (180) Profit = 60

Expected loss of a construction contract Should be recognized as an expense immediately