1. 18 Construction Contracts (MFRS 111) Intermediate Accounting
14th Edition
Kieso, Weygandt, and Warfield

2. Learning Objectives
Define a construction contract and discuss the role of accounting concepts in the recognition of profit.
Describe the acceptable methods of determining the stage (percentage) of completion of a contract.
Apply the percentage-of-completion method for construction contracts.
Apply the completed-contract method for construction contracts.
Identify the proper accounting for losses on long-term contracts.
Prepare financial statement extracts for construction contracts.

3. Construction contracts
Construction contract = specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of design, technology, function or their ultimate purpose or use.
Fixed cost contracts = contractor & customer agree to a fixed price or fixed rate per unit
Cost plus contracts = contractor paid the total cost incurred + a specific percentage of the project cost or a fixed fee as his profit
LO 1 Define a construction contract .

4. Combining/Segregating construction contracts
Generally, each contract is treated as a single contract
But there are alternatives
A single contract that covers a number of assets:
Construction of each asset is treated as a separate contract, when:
Separate proposals are submitted for each asset
Each asset is negotiated separately & the contractor & customer can accept/reject the contract for each part of the asset
Revenue & costs for each component can be identified
LO 1 Define a construction contract .

5. Combining/Segregating construction contracts
Construction of a group of assets treated as a single contract:
Regardless of whether it is with a single or several customers, treated as a single contract, when:
The group of contracts were negotiated as a single contract
The contracts are closely related and are in effect part of a single asset with an overall profit margin
The contracts are performed concurrently or in a continuous sequence.
LO 1 Define a construction contract .

6. Combining/Segregating construction contracts
Construction of an additional asset:
Treated as a separate contract, when:
The asset differs significantly in terms of design, technology or function from the asset/s of the original contract, OR
The contract price for the additional asset/s is negotiated independently of the original contract price
LO 1 Define a construction contract .

7. Combining/Segregating construction contracts
Example:
ZEE is going to build Ampang Sentral, which comprises a shopping mall from the ground floor to the 4th floor and offices from the 5th floor to the 40th floor.
Tenders were invited & Conlay Bhd was awarded the contract for RM300bn.
The project is expected to take 3 years to complete.
Is the construction of the shopping mall & office separate contracts?
Answer: A single contract. Subject to a single negotiation/tender process. Revenue/costs cannot be separately identified.
LO 1 Define a construction contract .

8. Contract Revenue
Measured at the fair value of consideration received/ receivable
Contract price comprises of
initial agreed price
Variations to the price due to variations in contract work, claims & incentive payments
Changes to contract price are caused by:
Increase: Cost excalations, variations & claims
Decrease: penalties due to delays caused by contractor
Changes: where the contract is expressed as a fixed price per unit of output & the no. of units changes
LO 1 Define a construction contract .

9. Contract Revenue: Variations & Claims
Changes to the scope of work requested by the customer
May increase/decrease contract price
Only recognised as part of contract price if:
It is probable that customer will approve the change to contract price
Amount can be measured reliably
LO 1 Define a construction contract .

10. Contract Revenue: Variations & Claims
Amounts that the contractor seeks to collect from customer or third party for costs not included in the contract price
E.g. arising from delays caused by customer or errors in specifications
Only included in revenue if:
It is probable that the customer will accept the claim when negotiations have reached an advanced level
Amount can be measured reliably
LO 1 Define a construction contract .

11. Contract Costs
= Costs incurred on construction activity from the date of securing the contract till final completion
Costs incurred in securing the contract:
may be included, if separately identifiable & measured reliably, and it is probable that contract can be obtained.
If already expensed off, cannot be included in contract cost when contract subsequently obtained.
LO 1 Define a construction contract .

12. Contract Costs Comprises: 1. Costs directly attributable to contract
Site labour costs (including supervision)
Materials used
Depreciation of PPE (including moving costs of P&E and material to & from sites
Plant hiring costs
Cost of design
Technical assistance costs
Estimated rectification & guarantee work
Third party claims
* These costs can be reduced by incidental income, e.g. sale of excess material
LO 1 Define a construction contract .

13. Contract Costs Comprises:
2. Costs attributable to the contract, but need to be allocated to it
These costs are incurred for a number of activities but have to be allocated to specific contracts
E.g. insurance, design costs, construction overhead
Costs are allocated based on the normal level of activity
3. Costs that are specifically chargeable to the customer
E.g. development costs
LO 1 Define a construction contract .

14. Contract Costs Comprises:
Borrowing costs incurred on funds borrowed may be included (Covered next week).
Should NOT include:
General admin expenses
Development costs not claimable from customer
Selling costs
Depreciation of idle plant
LO 1 Define a construction contract .

15. Recognition of contract revenue/costs
First, determine the outcome of the contract
Fixed cost contracts, outcome can be estimated reliably when:
Total contract revenue can be measured reliably
Probable that economic benefits will flow to entity
Costs to complete & stage of completion can be measured reliably
Contract costs can be identified & measured reliably, so that actual costs incurred can be compared with prior estimates.
Cost plus contracts, outcome can be estimated reliably when:
Contract costs can be identified & measured reliably
LO 2

16. Percentage of completion method
Revenue & expenses are recognised as the contract progresses, based on the amount of work completed
Total contract revenue > costs  allocate profit by reference to stage of completion
E.g. Contract price = RM30 million
estimated total costs = RM25 million
By the end of 1st year, 40% of the work was completed.
Total profit = RM5 million
In 1st year, revenue = 40% x RM30m = RM12m
In 1st year, costs = 40% x RM25m = RM10m
In 1st year, profit = RM2m
LO 2

17. Percentage of completion method
Total contract costs > revenue  loss is recognised immediately
E.g. Contract price = RM30m
Estimated total costs = RM32m
By the end of 1st year, 40% of the work was completed.
Total loss = RM2m  needs to be recognised in full regardless of stage of completion
In the 1st year, revenue = 40% x RM30m = RM12m
In the 1st year, cost = 40% x RM32m = RM12.8m
In 1st year, loss = RM0.8m
In the 1st year, add a provision for loss of RM1.2m
LO 2

18. Percentage of completion method
Not all work done & costs incurred up to the reporting date will be recognised as revenue/expenses
Costs could have been incurred which relate to future activity
Costs incurred but not recognised as expenses in the current period  shown as assets (amount due from customer)
Advances from the customer/material bought for the next phase  shown as liabilities
Costs incurred for a specific period, e.g. rectification work, has to be charged for that period only
LO 2

19. Percentage of completion method
Determining the percentage of completion
Cost to date/(Cost to date + Estimated cost to completion) x 100; OR
Cost to date/Estimated total costs x 100
Surveys of work performed
Physical proportion of contract work completed
LO 2

20. Percentage of completion method
If contract outcome cannot be estimated
Revenue recognised is limited to the amount of costs incurred if it is probable that the costs will be recovered
Revenue recognised = costs incurred
In other words, zero profit is recognised for the period.
If initially the outcome could not be reliably estimated, but later the outcome could be determined  revenue/expenses should be recognised based on % of completion
LO 2

21. Progress billings
Progress billings are used when a contractor sends invoices to a client multiple times during the course of a project instead of sending a single bill.
This is often the process used in a lengthy construction project, since various situations can arise during the course of such projects that can change billing estimates from their original starting point.
LO 2

22. Progress billings Amount due from customers (Asset)
= Costs incurred + recognised profit – recognised losses – Progress billings
More work done/costs incurred than payment received
Amount due to customers (Liability)
= Progress billings – (costs incurred + recognised profit – recognised losses)
More cash received than work done/costs incurred
LO 2

23. Progress billings
E.g. The costs incurred by a project, for the stage completed, was RM12 million and profit recognised was RM1.1 million. Progress billings to date was RM11 million.
In the financial statements:
Costs incurred RM12m + profit recog. RM1.1m = RM13.1m
Amount due from customer = RM13.1m – RM11m = RM2.1m
LO 2

24. Progress billings
E.g. The costs incurred by a project, for the stage completed, was RM12 million. Of this, RM500,000 was for the next stage of the project. Profit recognised was RM1.1 million. Progress billings to date was RM11 million.
In the financial statements:
Costs incurred RM11.5m + profit recog. RM1.1m = RM12.6m
Amount due from customer = RM12.6m – RM11m = RM1.6m
RM500,000 incurred for the next project stage will be disclosed as a current asset.
LO 2

25. Worked example 1 Illustration: Casper Construction Co.
A) Prepare the journal entries for 2014, 2015, and 2016
LO 3 Apply the percentage-of-completion method for long-term contracts.

26. Worked example 1 Illustration:
LO 3 Apply the percentage-of-completion method for long-term contracts.

27. Worked example 1 Illustration: Journal entries
LO 3 Apply the percentage-of-completion method for long-term contracts.

28. Worked example 1
Illustration: Presentation in the financial statements
LO 3 Apply the percentage-of-completion method for long-term contracts.

29. Worked example 1 Illustration: Notes to the financial statements
LO 3 Apply the percentage-of-completion method for long-term contracts.

30. Long-Term Contract Losses
Illustration: Loss on Profitable Contract
Casper Construction Co.
b) Prepare the journal entries for 2014, 2015, and 2016 assuming the estimated cost to complete at the end of 2015 was $215,436 instead of $170,100.
LO 5 Identify the proper accounting for losses on long-term contracts.

31. Long-Term Contract Losses
Illustration: Loss on Profitable Contract
LO 5 Identify the proper accounting for losses on long-term contracts.

32. Long-Term Contract Losses
Illustration: Loss on Profitable Contract
LO 5 Identify the proper accounting for losses on long-term contracts.

33. Long-Term Contract Losses
Illustration: Loss on Unprofitable Contract
Casper Construction Co.
c) Prepare the journal entries for 2014, 2015, and 2016 assuming the estimated cost to complete at the end of 2015 was $246,038 instead of $170,100.
LO 5 Identify the proper accounting for losses on long-term contracts.

34. Long-Term Contract Losses
Illustration: Loss on Unprofitable Contract
$675,000 – 683,438 = (8,438) cumulative loss
Plug
LO 5 Identify the proper accounting for losses on long-term contracts.

35. Long-Term Contract Losses
Illustration: Loss on Unprofitable Contract
LO 5 Identify the proper accounting for losses on long-term contracts.

36. Revenue recognised based on value of work done/surveys
On 1 Jan X1, Rose Enterprise signed a contract with Thorne to construct a refinery which was scheduled to take 3 years to complete. The agreed price was RM150m and the estimated cost was RM130m. The following data were compiled for the year ended x1:

37. Revenue recognised based on value of work done/surveys
% of completion = 67,500/150,000 = 45%
Revenue recognised = 45% x 150m = 67.5m
Cost recognised = 45% x 133m = 59.85m
Profit recognised = RM67.5m – 59.85m = RM7.65m
Amount due from customers:
Costs to date RM63m + Recog. Profit RM7.65m – Progress billings RM60.75m = RM9.9m

38. Disclosures in Financial Statements
Should include:
Contract revenue recognised in the period
Contract cost recognised in the period
Method used to determine contract revenue
Method used to determine stage of completion of contract in progress
For each contract:
Aggregate costs incurred & recognised profits
Amount of advances received
Amount of retentions
Gross amount due from/to customer
Any contingent liabilities/assets

39. Class exercise

40. Class exercise
Robotics Construction entered into a contract to bore a tunnel. The agreed contract price was RM3m. The following table shows the position of the contract at the end of years x1, x2 & x3:
Year X1
RM’000 X2 X3
Variation to the contract price (increase)
400
Cumulative costs incurred to date
945
1,800
3,100
Estimated costs yet to be incurred
2,155
1,200 -
Progress billings to date
800
1,900
3,000
The company recognises profit based on cost incurred to total estimated cost. Prepare extracts of the statements of comprehensive income & financial position for years x1 & x2.

41. Class exercise
Robotics Construction entered into a contract to bore a tunnel. The agreed contract price was RM3m. The following table shows the position of the contract at the end of years x1, x2 & x3:
Year X1
RM’000 X2 X3
Variation to the contract price (increase)
400
Cumulative costs incurred to date
945
1,800
3,100
Estimated costs yet to be incurred
2,155
1,200 -
Progress billings to date
800
1,900
3,000
The company recognises profit based on cost incurred to total estimated cost. Prepare extracts of the statements of comprehensive income & financial position for years x1 & x2.

42. Contract price RM3 million Total estimated cost RM3.1 million
Class exercise
Contract price RM3 million
Total estimated cost RM3.1 million
Loss on contract RM100,000

43. Class exercise X1 RM’000 Cost to date 945 Cost to complete 2,155
Total estimated cost
3,100
% of completion
30%
Income Statement X1
Revenue to date (30% x 3m)
900
Revenue recognised
Nil
Revenue for year
Cost to date
945
Recognised previous years
nil
Provision for loss 55
1,000
Profit/(loss)
(100)
St. of Financial Position X1
RM’000
Cost to date
945
Profit/(loss) to date
(100)
845
Progress billings
800
Due from customer (asset) 45

44. Class exercise X2 RM’000 Cost to date 1,800 Cost to complete 1,200
Total estimated cost
3,000
% of completion
60% X2
RM’000
Income Statement
Revenue to date (60% x 3.4m)
2,040
Revenue recognised
(900)
Revenue for year
1,140
Cost to date
1,800
Recognised previous years
(1,000)
Cost for year
800
Loss recognised
(100)
Profit/(loss)
340
St. of Financial Position X2
RM’000
Cost to date
1,800
Profit/(loss) to date
240
2,040
Progress billings
1,900
Due from customer (asset)
140

45. Class exercise X3 RM’000 Cost to date 3,100 Cost to complete -
Total estimated cost
% of completion
100%
Income Statement X3
Revenue to date
3,400
Revenue recognised
2,040
Revenue for year
1,360
Cost to date
3,100
Recognised previous years
(1,800)
Cost for year
1,300
Loss recognised -
Profit/(loss) 60
St. of Financial Position X3
RM’000
Cost to date
3,100
Profit/(loss) to date
300
3,400
Progress billings
3,000
Due from customer (asset)
400

46. Journal entries Illustration: Journal entries
LO 3 Apply the percentage-of-completion method for long-term contracts.