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.