Construction Contracts
(HKAS 11)
By Kathy Sze
AGENDA
1. Objective and Scope
2. What is Contraction Contract?
3. Combining or Segmenting
Construction Contracts?
4. Contract Revenue & Contract Costs
5. Recognition of Contract Revenue &
Costs
6. Recognition of Expected Losses
7. Changes in Estimates
8. Disclosure
Construction Contract (HKAS 11)
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1. Objective and Scope

Objective

To prescribe the accounting treatment of revenue
and costs associated with construction contracts.
(the primary issue in accounting for construction
contracts is the allocation of contract revenue and
contract costs to the accounting periods in which
construction work is performed.)

Scope

HKAS 11 shall be applied in accounting for
construction contracts in the financial statements
of contractors. (e.g. Sun Hung Kai Properties Ltd)
Construction Contract (HKAS 11)
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2. What is Contraction Contract?

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.)
Construction Contract (HKAS 11)
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2. What is Contraction Contract?

Usually 2 kinds of
contracts:

1. A fixed price contract
- is a construction contract in which the
contractor agrees to a fixed contract price,
i.e. the price is not usually subject to
adjustment because of costs incurred by
the contractor.

2. A 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.
Construction Contract (HKAS 11)
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2. What is Contraction Contract?

For the purposes of HKAS 11,
construction contracts
include:
a.
contracts for rendering of services
- which are directly related to the construction of the
asset, e.g. those for the services of project
managers and architects; and
b.
contracts for the destruction or restoration of
assets, and the restoration of the environment
following the demolition of assets.
Construction Contract (HKAS 11)
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3. Combining or Segmenting
Construction Contracts?

The requirements of HKAS 11 are
usually applied separately to each
construction contract.

However, in certain circumstances, it
is necessary to apply HKAS 11
a.
to the separately identifiable components of a
single contract, or (Each part of a single contract)
to a group of contracts together (2 or more
contracts together)
b.
in order to reflect the substance of a
contract or a group of contracts.
Construction Contract (HKAS 11)
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3. Combining or 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:
(Each part of a single contract)
a.
b.
c.
separate proposals have been submitted for each
asset;
each asset has been subject to separate
negotiation and the contractor and customer have
been able to accept or reject that part of contract
relating to each asset; and
the costs and revenues of each asset can be
identified.
Construction Contract (HKAS 11)
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3. Combining or Segmenting
Construction Contracts?

A group of contracts, whether with
single customer or with several
customers, shall be treated as a
single construction contract when:
(2 or more contracts together)
a.
b.
c.
the group of contracts is negotiated as a single
package;
the contracts are so closely interrelated that they
are, in effect, part of a single project with an
overall profit margin; and
the contracts are performed concurrently or in a
continuous sequence.
Construction Contract (HKAS 11)
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3. Combining or Segmenting
Construction Contracts?

A contract may provide for the construction
of an addition asset at the option of the
customer or may be amended to include the
construction of an addition asset.

The construction of the additional asset
shall be treated as a separate
construction contract when:
a.
the asset differs significantly in design, technology or
function from the asset or assets covered by the
original contract; or
The price of the asset is negotiated without regard to
the original contract price.
b.
Construction Contract (HKAS 11)
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4. Contract Revenue &
Contract Costs

Contract revenue shall comprises:
a.
The initial amount of revenue agreed in the
contract; and
b.
Variations in contract work, claims and incentive
payments:
i) to the extend that it is probable that they will result
in revenue; and
ii) they are capable of being reliably measured.
Construction Contract (HKAS 11)
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4. Contract Revenue &
Contract Costs

Contract costs shall comprises:
a.
costs that relate directly to the specific contract;
e.g. direct materials, direct labour, costs of
subcontracting, and appropriate proportion of variable
and fixed construction overheads.
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
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

When the outcome of a construction
contract can be estimated reliably,

Contract revenue and contract costs associated
with the construction contract shall be
recognised as revenue and expenses respectively
by reference to the stage of completion of the
contract activity at the balance sheet date.

An expected loss on the construction
contract

Shall be recognised as an expense immediately in
accordance with HKAS 11
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

How can fulfill “estimated reliably” ?

In the case of a fixed price contract, the outcome
of a construction contract can be estimated
reliably when all the followings 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
balance sheet date can me measured reliably; and
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.
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

How can fulfill “estimated reliably” ?

In the case of a cost plus contract, the outcome of
a construction contract can be estimated reliably
when all the followings 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.
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

The outcome of a construction contract can
only be estimated reliably
when it is probable that the economic benefits
associated with the contract will flow to the entity.

However, when an uncertainty arises about
the collectibility of an amount already
included in contract revenue, and already
recognised in the income statement,
the uncollectable amount or the amount in respect of
which recovery has ceased to be probable is
- recognised as an expense
- rather than as an adjustment of the amount of contract
revenue
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

The recognition of revenue and
expenses by reference to the
stage of completion of a
contract is often referred to as
The % of completion method
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

The stage of completion of a contract may be
determined in a variety of ways.

The entity uses the method that measures
reliably the work performed.

Depending on the nature of the contract, the
methods may include:
a) the proportion that contract costs incurred for work
performed to date bear to the estimated total
contract costs;
b) surveys of work performed; or
c) completion of a physical proportion of the contract
work
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

Example

On 1 Jan 2007, Co. A signed a construction
contract with a customer for 3 years with an
agreed contract consideration of $200 million.
The cost of the contract was estimated at
$150 million.
During the year to 31 Dec 2007, Co. A
incurred contract cost of $70 million.
The surveyor certified that 40% of the
contract work had been completed on 31 Dec
2007.
On 31 Dec 2007, Co. A received a progress
payment of $100 million.




Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

Example

Which basis can be used as stage of
completion of the contract???
a) Cost incurred to date
i.e. $70/$150 = 46.7% completion
b) Survey of Work
i.e. 40% completion
c) Progress payments and advances
received from customers
i.e. $100/$200 = 50% completion
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

Example

Which basis can be used as stage of
completion of the contract???
a) Cost incurred to date
i.e. $70/$150 = 46.7% completion 
b) Survey of Work
i.e. 40% completion 
Progress payments and
advances received
from customers often
do not reflect the
work performed.
c) Progress payments and advances
received from customers
i.e. $100/$200 = 50% completion 
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

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 in
accordance with HKAS 11.

When the uncertainties that prevented the
outcome of the contract being estimated reliably
no longer exist,
- revenue and expenses associated with the construction
contract shall be recognised in as usual rather than as above.
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

Example





Contract revenue
Contract cost
Contract cost incurred
Progress billings
% complete
Construction Contract (HKAS 11)
$600M
$500M
$450M
$400M
60%
23
5. Recognition of Contract
Revenue & Costs

Example





Contract revenue
$600M
Contract cost
$500M
Contract cost incurred
$450M
Progress billings
$400M
% complete
60%
To record contract revenue:




Dr. Work-in progress
$360M
Cr. P/L
$360M
($600M x 60% completion)
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

Example





Contract revenue
Contract cost
Contract cost incurred
Progress billings
% complete
To record contract cost:




$600M
$500M
$450M
$400M
60%
Dr. P/L
$300M
Cr. Work-in-progress
$300M
($500M x 60% completion)
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

Example





Contract revenue
$600M
Contract cost
$500M
Contract cost incurred $450M
Progress billings
$400M
% complete
60%
To record progress billings:






Dr. Debtor
$400M
Cr. Work-in-progress
$360M
Cr. Progress billings
40M
(Progress billings CR balances  advance)
(Progress billings DR balances  unbilled revenue)
Construction Contract (HKAS 11)
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5. Recognition of Contract
Revenue & Costs

Example





Contract revenue
Contract cost
Contract cost incurred
Progress billings
% complete
To record cost incurred:




$600M
$500M
$450M
$400M
60%
Dr. Work-in-progress
$450M
Cr. Cash/creditor
$450M
(Work in progress DR balances  asset)
Construction Contract (HKAS 11)
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6. Recognition of Expected
Losses

When it is probable that total contract costs
will exceed total contract revenue,
- the expected loss shall be recognised as an
expense immediately.

The amount of such as loss is determined
irrespective of:
a) whether work has commenced on the
contract;
b) the stage of completion of contract activity; or
c) the amount of profits expected to arise on
other contracts which are no treated as a
single construction contract in accordance
with HKAS 11.



Construction Contract (HKAS 11)
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7. Changes in Estimates

The % of completion method is applied on a
cumulative basis in each accounting period to the
current estimates on contract revenue and
contract costs.
- Therefore, the effect of a change in estimate of
contract revenue or contract costs, or the effect of
a change in the estimate on the outcome of a
contract, is accounted for as a change in
accounting estimate.

The changed estimates are used in the
determination of the amount of revenue and
expenses recognised in the income statement

-

in the period in which the change is made and
in subsequent periods.
Construction Contract (HKAS 11)
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8. Disclosure

An entity should disclose:
a)
b)
the amount of contract revenue recognised as revenue in the period;
the methods used to determine the contract revenue recognised in
the period; and
The methods used to determine the stage of completion of contracts
in progress.
c)

An entity shall disclose each of the following for
contracts in progress at the balance sheet date:
a)
b)
c)
the aggregate amount of costs incurred and recognised profits (less
recognised losses) to date;
The amount of advances received; and
The amount of retentions

An entity shall present:
a)
The gross amount due from customers for contract work as an asset;
and
the gross amount due to customers for contract work as a liability.
b)
Construction Contract (HKAS 11)
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8. Disclosure

The gross amount due from customers for
contract work is the net amount of:
a)
b)
costs incurred plus recognised profits; less
The sum of recognised losses and progress billings for all contracts in
progress for which costs incurred plus recognised profits (less
recognised losses) exceeds progress billings.

The gross amount due to customers for contract
work is the net amount of:
a)
b)
costs incurred plus recognised profits; less
The sum of recognised losses and progress billings for all contracts in
progress for which progress billings exceed costs incurred plus
recognised profits (less recognised losses).

An entity discloses any contingent liabilities and
contingent assets in accordance with HKAS 37.
Contingent liabilities and contingent assets may
arise from such items as warranty costs, claims,
penalties or possible losses.
Construction Contract (HKAS 11)
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8. Disclosure

Example on Contract Disclosures
The status of a contractor’s 5 contracts
in progress at the end of 1st year 2008
is as follows:
A
B
C
D
E
Total
$M
$M
$M
$M
$M
$M
Contract revenue
145
520
380
200
55
1300
Contract expenses
110
450
350
250
55
1215
Expected losses
0
0
0
40
30
70
Recognised profits less
recognised losses
35
70
30
(90)
(30)
15
Construction Contract (HKAS 11)
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8. Disclosure
A
B
C
D
E
Total
$M
$M
$M
$M
$M
$M
Contract costs incurred in the
period
110
510
450
250
100
1420
Contract costs incurred recognised
as contract expenses in the
period
110
450
350
250
55
1215
Contract cost that relate to future
activity recognised as an asset
0
60
100
0
45
205
Contract revenue (as above)
145
520
380
200
55
1300
Progress billings
100
520
380
180
55
1235
45
0
0
20
0
65
0
80
20
0
25
125
100
600
400
180
80
1360
Unbilled contract revenue
Advances
Payments received
Construction Contract (HKAS 11)
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8. Disclosure
The amounts to be disclosed in
accordance with HKAS 11 are as follows:
$M
Contract revenue recognised as revenue in
period
1,300
Contract costs incurred and recognised
profits (less recognised losses) to date
1,435
Advances received
125
Gross amount due from customers for
contract work presented as an asset
220
Gross amount due to customers for contract
work presented as a liability
(20)
Construction Contract (HKAS 11)
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8. Disclosure
The amounts to be disclosed are
calculated as follows:
A
B
C
D
E
Total
$M
$M
$M
$M
$M
$M
Contract costs incurred
110
510
450
250
100
1420
Recognised profits less
recognised losses
35
70
30
(90)
(30)
15
145
580
480
160
70
1,435
Progress billings
100
520
380
180
55
1235
Due from customers
45
60
100
0
15
220
Due to customers
0
0
0
(20)
0
(20)
Construction Contract (HKAS 11)
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THE END
  
Construction Contract (HKAS 11)
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