1. Accounting for Construction Contracts (IAS 11)
Week 4: Lecture 2
Topic:
Accounting for Construction Contracts (IAS 11)
Reference: Deegan, Aust Financial Accounting, Chapter 16.
Complied By: Mrs Maheshwari Chand;T2,2013.

2. Construction Contracts
Define Construction Contracts / jobs
When is revenue / expenses incurred and recognized…..
When should profit be realized – check standards (different methods of recognition), as jobs are spread over a number of years.
Complied By: Mrs. Maheshwari Chand, T2,2013

3. Construction contracts
Accounting issues result from construction projects taking several financial periods to complete
Should revenue be recognised progressively throughout the contract?
If so, how would the amount of revenue be determined?
Complied By: Mrs. Maheshwari Chand, T2,2013

4. Construction contracts
Deferral of revenue recognition until completion of project would result in greater volatility of reported revenues and of related profits or losses.
Applies to accounting methods adopted by a contractor for all construction contracts.
Construction contract defined (IAS 11, par. 3):
A 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 of their ultimate purpose or use.
Complied By: Mrs. Maheshwari Chand, T2,2013

5. Construction contracts
Accounting requirements;
Individual construction contracts must be accounted for separately and the requirements of the standard must be applied separately to each contract.
IAS 11 (par. 9):
A group of contracts, whether with a single customer or with several, is to be treated as a single contract when:
the group of contracts is negotiated as a single package
the contracts are so closely interrelated that they are, in effect, part of a single project with an overall profit margin; and
the contracts are performed concurrently or in a continuous sequence.
Complied By: Mrs. Maheshwari Chand, T2,2013

6. Construction contracts
IAS 11 requires the percentage-of-completion method to account for construction contracts
Profit on construction contract is recognised in proportion to the work performed in each reporting period in which construction occurs.
Construction costs plus gross profit earned to date accumulated in inventory account (construction in progress).
Progress billings accumulated in contra inventory account (billings on construction in progress account).
Complied By: Mrs. Maheshwari Chand, T2,2013

7. Construction contracts
Percentage-of-completion method should be used provided that certain conditions are met that enable the outcome of the contract to be reliably estimated.
IAS 11 (par. 22):
When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract are to be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date.
Complied By: Mrs. Maheshwari Chand, T2,2013

8. Construction contracts
Conditions of use of percentage-of-completion method (IAS 11, par. 23):
With fixed-price contract:
Total contract revenue can be measured reliably.
It is probable that economic benefits arising from the contract will flow to the contractor.
Both the contract costs to complete the contract and stage of contract completion as at reporting date can be measured reliably.
The contract costs attributable to the contract can be clearly identified and measured reliably so that actual costs can be compared with prior estimates.
Complied By: Mrs. Maheshwari Chand, T2,2013

9. Construction contracts
Conditions of use of percentage-of-completion method (IAS 11, par. 24):
With cost-plus contract:
It is probable that the economic benefits arising from the contract will flow to the contractor; and
The contract costs attributable to the contract, whether or not specifically reimbursable can be clearly identified and measured reliably.
Complied By: Mrs. Maheshwari Chand, T2,2013

10. Construction contracts
If conditions are not satisfied:
No profit is to be brought to account until they are satisfied.
At the extreme, no profit to be recognised until project completion.
Note: when outcome of construction contract cannot be estimated reliably (IAS 11, par. 32):
revenue is to be recognised only to the extent of contract costs incurred that it is probable will be recoverable; and
contract costs are to be recognised as an expense in the period in which they are incurred.
Complied By: Mrs. Maheshwari Chand, T2,2013

11. Construction contracts
Measuring progress towards completion
Percentage of completion can be measured in a number of ways (per IAS 11, par. 30):
The entity uses the method that measures reliably the work performed. Depending on the nature of the contract, the methods may include:
in the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs
surveys of work performed; or
completion of physical proportion of the contract work.
Progress payments and advances received from customers often do not reflect the work performed.
Complied By: Mrs. Maheshwari Chand, T2,2013

12. Construction contracts
Measuring progress towards completion
Cost basis:
The percentage of completion is measured by comparing costs incurred to date with the most recent estimate of the total costs to complete the contract.
Only those contract costs that reflect the work performed are included in costs incurred to date.
Examples of contract costs excluded are:
contract costs that relate to future activity on the contract, such as costs of materials delivered or set aside but as yet not installed, used or applied
payments made to subcontractors in advance of work performed.
Complied By: Mrs. Maheshwari Chand, T2,2013

13. Construction contracts
Calculation of percentage of completion
(Cost method):
Costs incurred to the end of the current period
Most recent estimate of total costs
Current period revenue or gross profit:
(estimated total revenue or gross profit from the contract) multiplied by percentage complete less (total revenue or gross profit recognized in prior periods).
Complied By: Mrs. Maheshwari Chand, T2,2013

14. Construction contracts
Accounting for long-term contract losses
When current estimates of total contract costs and revenues for any contract indicate that a loss is probable:
Provision should be made for any foreseeable loss on the contract regardless of the amount of work already performed.
Loss is to be brought to account as soon as it is foreseeable.
IAS 11 (par. 36):
When it is probable that total contract costs will exceed total contract revenue, the expected loss shall be recognised as an expense immediately.
Complied By: Mrs. Maheshwari Chand, T2,2013

15. Construction contracts
IAS 11 (par. 37):
Expected loss (excess of total contract costs over total contract revenue) arising from a construction contract is recognised as an expense irrespective of:
whether work has commenced on the project;
the stage of completion of the activity; or
the difference between total contract costs and total contract revenue expected to arise from other construction contracts.
Complied By: Mrs. Maheshwari Chand, T2,2013

16. Journals for construction contracts
Journal entries for construction contract accounting
To record costs of construction
Dr Construction in process
Cr Materials, cash, payables, etc.
To record billings to customers
Dr Accounts receivable
Cr Billings on construction in process
To record collections of billings
Dr Cash
Cr Accounts receivable
Complied By: Mrs. Maheshwari Chand, T2,2013
16-16

17. Journals for construction contracts
To record contract revenue and contract expenses
Dr Construction in process
Dr Construction expenses (costs incurred)
Cr Revenue from long-term contracts
To record final approval of contract
Dr Billings on construction in process
Cr Construction in process
Complied By: Mrs. Maheshwari Chand, T2,2013
16-17

18. Construction Contracts
IAS 11:
Lecture illustrative Example (PCM)
Complied By: Mrs. Maheshwari Chand, T2,2013

19. Calculation of percentage of completion (Fixed Price method)
Review Formula:
% Complete =
Costs incurred to the end of current period
Most recent estimate of total costs
Compiled by: Mrs. Maheshwari Chand
continued

20. Recap: Journal entries for construction contract accounting
To record costs of construction
Dr Construction in progress
Cr Materials, cash, payables, etc.
To record billings to customers (progress billings)
Dr Accounts receivable
Cr Billings on construction in progress
To record collections of billings
Dr Cash
Cr Accounts receivable
To record contract revenue and contract expenses
Dr Construction in progress (or contract costs incurred)
Dr Construction expenses (costs incurred)
Cr Revenue from long-term contracts
To record final approval of contract
Dr Billings on construction in progress
Cr Construction in progress (or contract costs incurred)
Compiled by: Mrs. Maheshwari Chand
continued

21. Lets’ look at one example :
AZ Contractors signed a contract on January 1, 2011, agreeing to build a warehouse for FSC at a contract price of $22,000,000. AZ estimated that construction costs would be as follows:
$7,000,000
$8,000,000
$5,000,000
$20,000,000
The contact provided that FSC would make payments on the December 31 of each year as follows:
2011 $ 5,000,000
2012 $10,000,000
2013 $ 7,000,000
$22,000,000
Assuming: The contract was completed and accepted on December 31, Assume that actual costs and cash collections coincided with expectations.
Compiled by: Mrs. Maheshwari Chand

22. (a) Calculate The Income to be recognised in each year: YEAR P.O.C.
2011 $0.70
2012 $0.80
2013 $0.50
$2.00
P.O.C
Revenue
(7/20)x
(15/20)x
(20/20)x
Expense
7/20 x 20 (7)
15/20 x (8.0)
20/20 x (5.0)
Profit
Note: All figures in $million
Compiled by: Mrs. Maheshwari Chand

23. (b) Journal Entries P.O.C. Method 2011 2012 2013
(i) To record costs incurred
Dr. Construction in progress 7 8 5
Cr. Cash, accounts payable
(ii) To record billings to customers
Dr. Accounts Receivable
Cr. Billings on Contracts in Progress
Compiled by: Mrs. Maheshwari Chand

24. (iii) To record cash collections 2011 2012 2013 Dr. Cash 5 10 7
Cr. Accounts Receivable
(iv) To record periodic income recognised
Dr. Construction in Progress
Dr. Construction expenses
Cr. Revenue from L.T. Contract
(or could separately show the revenue and expense)
(v) To record final approval and acceptance
Dr. Billings on Contracts in Progress
Cr. Construction in Progress
Compiled by: Mrs. Maheshwari Chand

25. Summary
Income is one of the five elements specified by the NZ framework.
Recognition is based on when associated inflow of economic benefits is probable and measureable
Also includes the risk and rewards of ownership transferral.
Where conditions apply to the sale, consideration needs to be made to see if these conditions reduce the probability of economic inflows.
Different models (such as historical cost or market values) affect when revenue is recognised.
Long term construction contract’s profits are applied using the percentage-of-completion method.
Complied By: Mrs. Maheshwari Chand, T2,2013

26. End Of Lecture
WEEK 4 Check class share for tutorial questions on this topic Thank You
Complied By: Mrs. Maheshwari Chand, T2,2013