IAS 11 CONSTRUCTION CONTRACTS

DEFINITION

IAS 11 defines a construction contract as: 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 for their ultimate purpose or use.

IAS 11 TREATMENT

Where possible, IAS 11 applies the accruals concept to the revenue earned on a construction contract. If the outcome of a project can b reasonably foreseen, then the accruals concept is applied by recognising profit on uncompleted contracts in proportion to the percentage of completion, applied to the estimated total contract profit. If, however, a loss is expected on the contract, then an application of prudence is necessary and the loss will be recognised immediately.

OUTCOME CAN BE RELIABLY MEASURED

IAS 11 only allows revenue and contract costs to be recognised when the outcome of the contract can be predicted with reasonable certainty. This means that it should be probable that the economic benefit attached to the contract will flow to the entity. If a loss is calculated, then the entire loss should be recognised immediately. If a profit is estimated, then revenue and costs should be recognised according to the stage that the project has completed. There are two ways in which stage of completion can be calculated, and, in the exam, it is important to determine from the question scenario which method the examiner intends you to use, either the:

  work certified method (sometimes referred to as the sales basis)

work certified to date / contract price

   cost method

                        costs incurred to date / total contract costs

Step approach

Step 1: Set up extracts of the financial statements and a working paper.

Step 2: Determine at W1 whether a profit or loss is expected on the contract.

Step 3: In this example a profit will be calculated, so determine the accounting policy from the question and calculate the stage of completion.

Step 4: Calculate how much profit should be shown this year from the stage of completion and include it in the income statement extract.

Step 5: ‘Build’ up the income statement. If it is a work-certified accounting policy, then the work certified for the year should be taken to the revenue line. If it is a cost-basis accounting policy, then the costs incurred should be taken to the cost of sales line.

Step 6: Depending on what approach was taken at step 5, you are now in a position to

find the balancing figure to complete the income statement.

Step 7: Calculate the asset or liability outstanding on the construction contract.

OUTCOME CANNOT BE RELIABLY MEASURED

In following prudence, where an outcome cannot be reliably measured, any costs incurred during the financial year should be expensed immediately and revenue recognised as equivalent to the contract costs expected to be recoverable.

WHAT IS INCLUDED IN CONTRACT REVENUE AND COSTS?

Contract revenue will be the amount agreed in the initial contract, plus revenue from variations in the original contract work, plus incentive payments and claims that can be reliably measured, such as contract revenue which can be valued at the fair value of received or receivable revenue. Contract costs are to include costs relating directly to the initial contract plus costs attributable to general contract activity, plus costs that can be specifically charged to the customer under the terms of the contract.