IAS 11: Construction

Contracts

Background

Effective for periods beginning on or after 1

January 1995

Prior to that revenue was recognised at the

completion of contract and costs were recognised

when incurred

This caused a conflict , not in line with the accrual

method

Was excessively prudent

Objective

To prescribe the accounting treatment of revenue

and costs associated with construction contracts.

Contracts are seldom completed within a financial

period

Hence IAS11 prescribes the method of recognising

the costs and revenues attributable to a specific

contract

Adopts the accrual method of accounting

Construction contract

Is 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 or

their ultimate purpose or use.

Construction contract (contd.)

Construction contracts include contracts for:

• Rendering of services directly related to the

construction of the asset (i.e., for project

managers and architects); and

• The destruction or restoration of assets, and

the restoration of the environment following

the demolition of assets.

Types of Contracts

Fixed price contract: is a construction contract in

which the contractor agrees to a fixed contract price,

or a fixed rate per unit of output, which in some

cases is subject to cost escalation clauses.

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Types of Contracts

Cost-plus contract: is a construction contract in

which the contractor is reimbursed for allowable or

otherwise defined costs, plus a percentage of these

costs or a fixed fee.

• A contract may be a single contract e.g.

construction of a bridge or dam and can be a

contract for a series of contracts, which are closely

interrelated or interdependent in terms of design,

technology or construction.

Contract Revenue

• the initial amount of revenue agreed in the contract; and

• variations , claims and incentive payments:

‐ to the extent that it is probable that they will result in revenue; and

‐ they can be reliably measured.

Contract revenue measurement

Contract revenue is measured at the fair value

of the consideration received or receivable.

The measurement of revenue is affected by a

variety of uncertainties that depend on the

outcome of future events.

These estimates are revised as and when the

events occur and impact on the revenue to be

recognised in the different financial periods

over the life of the contract

Contract revenue measurementVariations are included in the revenue when:

it is probable that the customer will approve the variation/amount of revenue arising from variation; and

the amount of revenue can be measured reliably.

Claims are included in the revenue only when:

negotiations have reached the advanced stage and it is probable that the customer will accept the claim; and

the amount probable to be accepted by the customer can be measured reliably.

Incentive payments are included in the revenue when:

the contract is sufficiently advanced that it is probable that the specified performance standards will be met or exceeded; and

the amount of incentive payments can be measured reliably.

Contract costs

• costs that relate directly to the specific contract e,g

labour, materials, supervision

• costs that are attributable to contract activity in

general and can be allocated to the contract; and

• such other costs as are specifically chargeable to

the customer under the terms of the contract.

• Cost of rectification after completion

Contract costs (contd.)

Contract costs do not include the following:

General administration costs (unless reimbursement is specified in contract);

Selling costs;

R&D costs (unless reimbursement is specified in contract); and

Depreciation of idle plant and equipment not used on any particular contract.

Contract costs measurement

Generally contract activity costs should be allocated

systematically and rationally, and all costs with similar

characteristics should be treated consistently. The

allocation should be based on the normal level of

construction activity.

When it is probable that total contract costs will exceed total

contract revenue, the expected loss shall be recognised as

an expense immediately.

ACCOUNTING TREATMENT

Percentage of completion method

When the outcome of a contract can be estimated reliably, the contract revenue and costs should be recognised according to the stage of completion of the contract.

The percentage of completion method is an application of the accruals assumption. Contract revenue is matched to the contract costs incurred in reaching the stage of completion, so revenue, costs and profit are attributed to the proportion of work completed.

Percentage of completion method

(Cont’d.)

We can summarise the treatment as follows:

• Recognise contract revenue as revenue in the accounting periods in which the work is performed;

• Recognise contract costs as an expense in the accounting period in which the work to which they relate is performed;

• Any expected excess of total contract costs over total contract revenue (ie a loss) should be recognised as an expense immediately;

• Any costs incurred which relate to future activity should be recognised as an asset if it is probable that they will be recovered (often called contract work in progress, ie amounts due from the customer); and

• Where amounts have been recognised as contract revenue, but their collectability from the customer becomes doubtful, such amounts should be recognised as an expense, not a deduction from revenue.

Determining the stage of completionHow should you decide on the stage of completion of any

contract?

IAS 11 gives 3 methods:

Proportion of contract costs incurred for work carried

out to date;

Costs to date/Total estimated costs

Surveys of work carried out

Work certified/Contract price

Physical proportion of the contract work completed

Contract outcome predictability

When the contract's outcome cannot be predicted reliably:

• only recognise revenue to the extent of contract costs

incurred which are expected to be recoverable; and

• recognise contract costs as an expense in the period they

are incurred.

This no profit/no loss approach reflects the situation near

the beginning of a contract, ie the outcome cannot be reliably

estimated, but it is likely that costs will be recovered.

Recognition of expected losses

Any loss on a contract should be recognised as

soon as it is foreseen. The loss will be the amount

by which total expected contract revenue is

exceeded by total expected contract costs.

The loss amount is not affected by whether work

has started on the contract, the stage of completion

of the work or profits on other contracts (unless they

are related contracts treated as a single contract).

Changes in estimates

The effect of any change in the estimate of contract

revenue or costs or the outcome of a contract

should be accounted for as a change in

accounting estimate under IAS 8 Accounting

policies, changes in accounting estimates and

errors.

Example

A contract is started on 1 March 2016 and is due for completion on 31 December

2017

• Contract value of $1,500,000

• Costs incurred for the year ended 31 December 2016 amount to $600,000

• Certified work as at 31 December 2016 is $750,000

• It is estimated with certainty that costs to completion amount to $600,000

or $1,000,000

What is the contract revenue and profit to be recognised in the financial

statements for the year ended 31 December 2016

Disclosure

An entity must disclose the following in the notes to

the financial statements:

• The methods used to determine the contract

revenue recognised in the period;

• The amount of contract revenue recognised as

revenue in the period;

• The method used to determine the stage of

completion of contracts in progress;

Disclosure

• The gross amount due from the customers for

contract work as an asset; and

• The gross amount due to the customers for

contract work as a liability.

Disclosure

Further disclosure is required for:

Contracts in progress at the end of the reporting

period, show the following:

• Total costs incurred plus recognised profits (less

recognised losses) to date;

• Advances received;

• Retentions (progress billings not paid until the

satisfaction of certain conditions); and

Disclosure

• Any contingent gains or losses, eg due to

warranty costs, claims, penalties or possible

losses, should be disclosed in accordance with IAS

37 Provisions, contingent liabilities and contingent

assets.

IFRS 15: Revenue from Contracts

with Customers

Background

As a result of the issuance of IFRS 15, the following existing

requirements in IFRSs have been superseded:

• IAS 11 Construction Contracts;

• IAS 18 Revenue;

• IFRIC 13 Customer Loyalty Programmes;

• IFRIC 15 Agreements for the Construction of Real Estate;

• IFRIC 18 Transfers of Assets from Customers; and

• SIC-31 Revenue – Barter Transactions Involving

Advertising Services.

Effective date

Effective for periods beginning on or after 1 January 2018

Early adoption is permitted

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END