• MOHSIN MUMTAZ

• SADDAM HUSSAIN

• MUHAMMAD ISHFAQ

• ABDUL QAYYUM

• ADNAN SULEMAN

• WHY NEEDED• IDEA CONCEPTKEY CONTENTS:• OBJECTIVE• DEFINITIONS• REQUIRED PRACTICE• RECOGNITION OF CONTRACT REVENUE AND

EXPENSES• DISCLOSURE• US GAAP• UK GAAP

IMPORTANT TERMS

• [1] Contractee : Who gives the contract. • [2] Contractor : Who takes the contract. • [3] Tender Price & Deposit: Will not be shown in

Contract A/c. • [4] Contract Price : Will be credited to contract a/c.

when Contract is completed. • [5] Work completed : Will not be shown (Calculate on

the basis of Contract price) in Contract Account. • [6] Work Certified : Will debited to WIP a/c and

Credited to Contract a/c. • [work completed and also certified by the architect]

• [7] Work uncertified : Will be shown under “WIP” Account.

[Work completed but not certified] • To calculate the profit on uncompleted contract • 1. When contract is completed “ Whole profit or loss is

carried to General Profit & Loss Account”. • 2. When contract is uncompleted : (on the basis of

contract price) • A. When certified work is less than 25 % : Profit carried

forward to WIP A/c. No profit should be transferred to Profit & Loss A/c.

• B. When certified work is more than 25 % and less than 75 %. (On the basis of 2/3 cash ) received

Contract Accounts

• “Each Contract has a separate identity and, therefore it becomes essential to analyses and segregate costs according to each contract ”

• - P. Dasgupta

• Construction projects or more generically work in progress (WIP) figures, are often a material balance sheet asset and also critical to the reporting of profits or losses at the correct amount and in the correct period. Clear definition of terms with clearly defined accounting is required.

• The aim of the Standard is to ensure that work in progress is valued prudently with correct matching of revenue and costs.

• Work in progress values affect both the balancesheet asset value and the related cost of sales. Ifyou wanted to manipulate profit (and assets)then WIP valuation would be an obvious choice.For a construction contract one or all of thefollowing may be highly subjective:

• • The costs to be included.• • The stage of completion.• • Realisability of the work.• Thus the value of WIP is very often subjective.

There is sample scope for manipulating figures!

SADDAM HUSSAIN

• The basic concept is that costs of work done should be matched in an accounting period with the related income (or putative income), and a resultant profit or loss measured. Any costs of valuable work done and not matched by income should be carried in the balance sheet as WIP.

• If you wait till the final completion and signing off of a contract or project then the profit or loss can be accurately determined. However, there is a need to calculate what profit (or loss) is being made as a project progresses. For statutory reporting purposes, it is necessary to report the profit earned in a year and the resultant asset/liability position at the balance sheet date.

• A common term used in the context ofcontract or project sales or profits is ‘earnedvalue’. An issue with the Standard is thatgeneral principles are described but not thedetailed assessment of profit (or margin)earned. The detailed definitions andcalculations of ‘earned value’, attributableprofit etc., vary considerably amongcompanies..

• Objective• The objective of this Standard is to prescribe the

accounting treatment of revenue and costs associatedwith construction contracts. Because of the nature ofthe activity undertaken in construction contracts, thedate at which the contract activity is entered into andthe date when the activity is completed usually fall intodifferent accounting periods. Therefore, the primaryissue in accounting for construction contracts is theallocation of contract revenue and contract costs to theaccounting periods in which construction work isperformed.

• This Standard uses the recognition criteriaestablished in the Framework for thePreparation and Presentation of FinancialStatements to determine when contractrevenue and contract costs should berecognised as revenue and expenses in thestatement of comprehensive income. It alsoprovides practical guidance on the applicationof these criteria.

ADNAN SULEMAN

• A 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.

Fixed price contracts

Cost plus contracts

• 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.

• EXAMPLE:• K Ltd gets a contract to construct a bridge for a

tender amount of $5 million. This $5 million is given by the local authority to K Ltd over a period of the construction. If the minimum labour wages increase during the construction period, a reimbursement to that extent is given to K Ltd.

• 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.

• EXAMPLE:

• K Ltd gets a contract from the government to construct a missile. Since it is a new technology to be used for the missile, the costs thereof are not identifiable at the initial stage. Hence, K Ltd has quoted a cost plus 5% pricing to the government. The government has agreed with K Ltd to execute this construction.

• COMBINING AND SEGMENTING CONSTRUCTION CONTRACTS

• When a contract covers a number of assets, the construction of each asset shall be treated as a separate construction contract

• when:a) Separate proposals have been submitted for each asset;b) Each asset has been subject to separate negotiation and

the contractor and customer have been able to accept or reject that part of the contract relating to each asset; and

c) The costs and revenues of each asset can be identified.

ABDUL QAYYUM

Contract revenue shall comprise:

a) The initial amount of revenue agreed in the contract; and

b) Variations in contract work, claims and incentive payments:

• i) to the extent that it is probable that they will result in revenue; and

• ii) they are capable of being reliably measured.

Contract costs shall comprise:

a) Costs that relate directly to the specific contract;

b) Costs that are attributable to contract activity in general and can be allocated to the contract; and

c) Such other costs as are specifically chargeable to the customer under the terms of the contract.

• When the outcome of a construction contract canbe estimated reliably, contract revenue andcontract costs associated with the constructioncontract shall be recognised as revenue andexpenses respectively by reference to the stage ofcompletion of the contract activity at the end ofthe reporting period. An expected loss on theconstruction contract shall be recognised as anexpense immediately.

In the case of a fixed price contract

• In the case of a fixed price contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied:

a) Total contract revenue can be measured reliably;b) It is probable that the economic benefits associated with

the contract will flow to the entity;c) Both the contract costs to complete the contract and the

stage of contract completion at the end of the reporting period can be measured reliably; and IAS 11;

d) The contract costs attributable to the contract can be clearly identified and measured reliably so that actual contract costs incurred can be compared with prior estimates.

In the case of a cost plus contract

• In the case of a cost plus contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied:

• a) it is probable that the economic benefits associated with the contract will flow to the entity; and

• b) the contract costs attributable to the contract, whether or not specifically reimbursable, can be clearly identified and measured reliably.

MOHSIN MUMTAZ

• When the outcome of a construction contract cannot be estimated reliably:

a) Revenue shall be recognised only to the extent of contract costs incurred that it is probable will be recoverable; and

b) Contract costs shall be recognised as an expense in the period in which they are incurred.

• An expected loss on the construction contract shall be recognised as an expense immediately.

• An entity shall disclose:

• a) The amount of contract revenue recognisedas revenue in the period;

• b) The methods used to determine the contract revenue recognised in the period; and

• c) The methods used to determine the stage of completion of contracts in progress.

Recognition before delivery –construction contracts

General

Construction accounting applies to building construction as well as the construction of other assets.

Expected contract losses are recognized in income as soon as it becomes probable that the entity will experience a loss on the contract.

Similar

Similar

IFRSUS GAAP

Costs directly related to a contract, which are incurred in securing the contract, are included as part of the contract costs if they can be identified and measured separately, and it is probable that the contract will be obtained and the costs are recoverable.

Similar

IFRS

► Contracts are classified as fixed-price or cost-plus contracts.

► Time-and-materials-type contracts would most likely be classified as cost-plus contracts.

► Units-of-production contracts would most likely be classified as fixed-price contracts.

► Contracts are segmented if certain criteria are met. These criteria are different from the criteria under US GAAP.

US GAAP

► Contracts can be classified as fixed-price, cost-plus, time-and-materials and units-of-production contracts.

► Contracts may be segmented if certain criteria are met, but it is not required.

Recognition before delivery –construction contracts

General

IFRS

► The revenue-cost approach is allowed.

► The gross-profit approach is not allowed.

US GAAP

► With respect to contracts that are profitable, both revenues and costs can be recognized according to the project’s stage of completion. This is often referred to as the revenue-cost approach.

► An entity can also recognize expenses as actually incurred and recognize revenue based on the estimated gross-profit percentage earned during the period. This is often referred to as the gross-profit approach.

Recognition before delivery – construction contracts

Percentage-of-completion method

Revenue-cost and gross-profit approach example

EXAMPLE– revenue-cost and gross-profit approach

A company enters into a contract with expected revenues of $5.6 million and expected costs of $4.9 million. The contract is 30% complete in the first year, 65% complete in the second year and 100% complete in the third year. The costs incurred for the three years are $1.4 million, $1.65 million and $1.85 million, respectively. ► Using the revenue-cost approach,

compute the revenues and costs that will be recognized each year under US GAAP and IFRS.

► Using the gross-profit approach, compute the revenues and costs that will be recognized each year under US GAAP and IFRS.

Revenue-cost and gross-profit approach example

Example solution:

The revenue-cost approach is acceptable under both US GAAP and IFRS.

Year Revenues Costs

One $5,600,000 x 30% = $1,680,000 $4,900,000 x 30% = $1,470,000

Two ($5,600,000 x 65%) - 1,680,000 = $1,960,000 ($4,900,000 x 65%) - 1,470,000 = $1,715,000

Three($5,600,000 x 100%) - (1,680,000 + 1,960,000) = $1,960,000

($4,900,000 x 100%) - (1,470,000 + 1,715,000) = $1,715,000

The gross-profit approach is acceptable under US GAAP but is not acceptable under IFRS.

Estimated total gross profit = $5.6 million less $4.9 million = $700,000

Year Costs Gross Profits Revenues

One $1,400,000 $700,000 x 30% = $210,000 $1,400,000 + $210,000 = $1,610,000

Two $1,650,000 ($700,000 x 65%) - $210,000 = $245,000 $1,650,000 + $245,000 = $1,895,000

Three $1,850,000 ($700,000 x 100%) - ($210,000 + $245,000) = $245,000

$1,850,000 + $245,000 = $2,095,000

• IAS 11/IAS 18 – the future• Frankly UK GAAP and IFRS as they exist are

pretty lax on how revenue and profit might be recognised – this is an area for considerable change – probably in 2011.

• Significant differences in GAAP• US GAAP• Under US GAAP construction contract revenue

recognition and balance sheet asset/liability amounts could be similar, but much depends on the entity specific detailed accounting policies.

UK GAAP

• Both IAS 11 and SSAP 9 Stocks and long term contracts use the ‘percentage of completion’ method to recognise revenue and expense.

• IAS 11 uses the method where the outcome of the contract can be estimated reliably,

• SSAP9 implies the use of more prudence – recognising‘prudently calculated attributable profit.

• Both standards require zero profit to be recognised where outcome is uncertain.

• Because of UK company law presentation differs under UK GAAP. The amount due for WIP is shown split between debtors (amounts recoverable on contracts) and WIP (long term contact balances). IAS 11 shows one gross amount due from customers for contract work.