CHAPTER
8
Construction contracts
(IAS 11 and IFRIC 15)
Contents
1 Background ..........................................................................................................
2 Nature of construction contracts ...........................................................................
3 Measurement of contract revenue and costs .......................................................
3.1
Contract revenue .......................................................................................
3.2
Contract costs ............................................................................................
3.3
Agreements for the construction of real estate ..........................................
4 Recognition of contract revenue and costs ..........................................................
4.1
Estimating the outcome of a contract ........................................................
4.2
Method of profit recognition .......................................................................
4.3
Collectability ...............................................................................................
4.4
Uncompleted contract work and irrecoverable costs .................................
4.5
Expected losses .........................................................................................
4.6
Changes in estimates ................................................................................
5 Payments by customers .......................................................................................
5.1
An advance structured as a loan in the contractual agreement .................
5.2
A normal advance .....................................................................................
5.3
Claims ........................................................................................................
5.4
Progress payments ....................................................................................
5.5
Retention monies .......................................................................................
6 Comprehensive example without tax implications ................................................
7 Tax implications ....................................................................................................
8 Comprehensive example with tax implications .....................................................
9 Disclosure .............................................................................................................
10 Comprehensive example ......................................................................................
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1 Background
In most manufacturing and commercial industries the production period or the period for
which inventories is held will be relatively short. In the case of construction contracts, the
activities surrounding the development of the product take place over a much longer period,
while the final product – the building, bridge, pipeline or dam wall – is visibly developed and
completed.
Standard IAS 2, that prescribes the accounting treatment and disclosure of inventories, is
not applicable to construction contracts, as construction contracts in progress have particular characteristics that differ substantially from normal inventories. Furthermore, contracts in
progress are not measured at the lower of cost and net realisable value as is the case with
inventories.
1
2 Descriptive Accounting – Chapter 8
2 Nature of construction contracts
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:
• design;
• technology and function; or
• the ultimate purpose or use of the asset(s).
This includes contracts for the supply of services in connection with the construction process, for example contracts with quantity surveyors. The demolition or restoration of assets,
or the restoration of the environment after demolition, are also accounted for as construction
contracts.
According to IAS 11.3, there are two categories of contract that fall within the scope of the
standard, namely:
• fixed price contract: the contractor accepts a fixed contract price or a fixed tariff per unit that
in most instances is subject to cost escalation clauses; and
• cost plus contract: the contractor is compensated for the allowable costs or otherwise
defined costs plus a percentage on these costs, or a fixed compensation.
Some construction contracts may contain aspects of both the fixed price contract and the
cost-plus contract, for example a cost plus contract with an agreed maximum price.
In terms of the standard, the completed contract method, which only recognises profits
once the contract is completed, is prohibited.
Although a construction contract is normally negotiated for an individual asset, such as a
tunnel, it can also deal with several assets that are closely related or interdependent
regarding design, technology and function, or their eventual use. An example is a contract to
develop an air-defence system that includes a runway, aeroplanes, logistical support, radar
equipment, etc.
The requirements of IAS 11.7 are usually applied separately to each construction contract.
Sometimes it is necessary to apply the standard to each separately identifiable
component of the contract when a single contract covers several assets and:
• separate submissions were made for each asset;
• each asset was subject to separate negotiation and the contractor and the customer may
accept or reject the part of the contract that applies to each asset; and
• the cost and revenue of each asset can be identified.
By contrast, a group of contracts that deals with a single customer or several customers
should be treated as a single construction contract when:
• it was negotiated as a single package;
• the contracts are so closely connected that they are part of one project with an overall profit
margin; and
• the contracts are completed simultaneously or in a continuous order.
A contract may also provide for the construction of an additional asset, or may be amended
to incorporate the construction of an additional asset. This should be accounted for as a
separate construction contract when:
• the asset differs significantly in design, technology or function from the assets covered by
the original contract; or
• the price is negotiated independently of the original contract.
A measure of judgement may be required in determining the accounting treatment of single
and multiple contracts.
Some of the terminology of construction contracts requires some explanation. The progress of contracts is usually certified by engineers, architects or quantity surveyors and is
Construction contracts 3
referred to as work certified or certified progress reports. In many contracts, the certified
progress reports form the basis for invoicing the customer and are also called progress
billings. The payments made by the customer on these invoices are called progress
payments. A portion of the payments is retained by the customer until certain specified
contractual conditions are met and is called retention monies or retention debtors. In
certain instances, the customer makes payments to the contractor before the related contract work is done. This practice, used especially where the contract is particularly large and
the contractor requires bridging finance, is called advances.
3 Measurement of contract revenue and costs
3.1 Contract revenue
Contract revenue consists of:
• the initial amount of revenue agreed in the contract; and
• variations in contract work, claims and incentive payments to the extent
– that it is probable that they will result in revenue; and
– the amount involved can be measured reliably.
The initial amount of revenue may vary due to events occurring and uncertainties being
resolved. The following examples are provided in IAS 11.12:
• A contractor and a customer may in the period subsequent to that in which the contract was
initially signed, agree to variations or claims which decrease or increase contract revenue.
• The revenue amount of a fixed price contract may increase due to cost escalation clauses.
• Contract revenue may decrease due to penalties arising from delays caused by the
contractor in the completion of the contract.
• Where a fixed price contract contains a fixed price per unit output clause, contract revenue
increases as the number of units increases.
A variation to the contract arises when a customer instructs the contractor to effect a
change in the scope of the work to be performed under the contract, for example:
• changes in the specifications or design of the asset; and
• changes in the duration of the contract.
Such a variation may result in either an increase or a decrease in contract revenue.
A claim is an amount that the contractor seeks to collect from the customer or third party
as reimbursement for costs not originally included in the contract price. Claims arise from:
• delays caused by the customer;
• the incorrect specifications or design of the asset; and
• disputed variations in contract work.
Such claims frequently involve a higher level of uncertainty than encountered with variations
and incentive payments. Claims should be included in contract revenue only when negotiations with the customer are at a sufficiently advanced stage, and it is probable that the
claims will be assented to by the customer, and the amount can be measured reliably.
Incentive payments are additional amounts paid to the contractor when specified performance standards, for example the early completion of the contract, are met or exceeded. Incentive
payments should be included in contract revenue only when it is probable that the specified
performance standards will be met or exceeded and the amount can be measured reliably.
Contract revenue is measured at the fair value of the consideration received or
receivable. As it is in the nature of the construction business that revenues may change,
contracts are assessed annually on a cumulative basis, and compared to the cumulative
4 Descriptive Accounting – Chapter 8
revenue and expenses recognised in the previous period. The difference is recognised as
revenue and expenses in the current period in the profit or loss section of the statement of
comprehensive income.
3.2 Contract costs
With the recognition, measurement and allocation of costs to specific construction contracts,
two matters of importance should be considered:
• the period of the allocation of attributable costs of a contract; and
• the identification of attributable contract cost.
According to IAS 11.21, the costs attributable to a contract commence with the securing of
the contract, and end with the final completion of the contract. Both the processes of negotiation and settlement may last weeks, even months, and this creates the danger that institutions may manipulate costs if the actual securing of the contract and settlement dates have
not yet been determined.
As a general rule, expenditure such as tender costs incurred by the contractor prior to the
signing of the contract must be recognised in the profit or loss section of the statement of
comprehensive income as period cost. An exception is the cost that relates to the securing
of the contract if it can be separately identified and reliably estimated and it is probable
that the contract will be obtained. Costs recognised in one period as an expense in the profit
or loss section of the statement of comprehensive income may not subsequently be included in contract costs, if the contract is obtained in a subsequent financial period.
Not all the expenses of a construction company can be recognised as costs to be
allocated to contracts. According to IAS 11.16, construction costs are divided into three
categories, namely:
• Costs that relate directly to a specific contract, for example labour, material, subcontractors costs, site supervision costs, warranty costs, costs connected to the moving of construction equipment to the building site, depreciation on assets used on a specific project,
finance costs on funds that were specifically borrowed for a project in terms of IAS 23,
materials that were custom-made for the contract, even if they have not been installed,
and claims from third parties. These costs may be reduced by any incidental income derived
from the contract which has not been included in contract revenue. Examples are: income
from the sale of equipment at the end of the contract, or the sale of surplus material. The
total estimated cost of the contract will be reduced by these proceeds.
• Costs that are attributable to contract activity in general and can be allocated to the
contract, for example insurance, design, technical assistance and construction overheads
such as the processing of the payroll of construction personnel. The latter cost includes
administrative costs that are directly related to contract activities and a borrowing cost that
was incurred for the funding of contract activities in terms of IAS 23. These costs should
be allocated on the normal level of construction activity on a systematic and rational basis,
which should be applied consistently.
• Other costs which are specifically chargeable to the customer under the terms of the
contract, for example general administration and development costs.
Costs that cannot be allocated to a specific contract since their link to the contract activities
is fairly remote, for example finance charges, research and development costs, selling and
administrative expenses, and depreciation on idle assets, will not be accounted for as
contract expenses, but will be expensed in the profit or loss section of the statement of
comprehensive income.
3.3 Agreements for the construction of real estate
Developers in the real estate industry often undertake the construction of real estate after
agreements have been signed with one or more buyers. The marketing of individual units
(flats or houses) may commence before construction has begun (so-called "off plan"
purchases) or once construction is in progress. The buyer usually pays a deposit, that is
Construction contracts 5
refundable only if the entity fails to deliver the completed unit in accordance with the terms
of the agreement, to reserve a particular unit.
IFRIC 15 provides guidance on whether these agreements should fall within the scope of
IAS 11 on construction contracts, or within the scope of IAS 18 on revenue. The terms of the
agreement and surrounding facts and circumstances determine which standard should be
used to account for the agreement, and such classification requires professional judgment
for each agreement.
IAS 11.3 applies when the agreement meets the definition of a construction contract. An
agreement to construct real estate usually meets the definition of a construction contract
when:
• the buyer is able to specify (need not exercise the ability) the major elements of the
design of the real estate before construction commences; and/or
• the buyer may specify major structural changes once construction is in progress.
IAS 18 on revenue applies when the agreement for the construction of real estate only
provides buyers with limited ability to influence the design of the real estate. Limited ability
implies selecting a design from a range of specified options, or specifying minor variations to
the basic design.
If the agreement meets the definition of a construction contract and IAS 11 is used, the
entity recognises revenue by reference to the stage of completion. If the agreement does
not meet the definition of a construction contract, the entity determines whether the
agreement is for the rendering of services or for the sale of goods.
In instances where the entity is not required to acquire and supply construction materials,
the agreement is usually an agreement for the rendering of services in accordance with
IAS 18.20 and .21, and revenue is recognised by reference to the stage of completion of the
transaction using the percentage of completion method.
In instances where the entity provides both the construction materials and the services to
deliver the real estate to the buyer, the agreement is a sale of goods in accordance with
IAS 18.14. If the entity transfers control and significant risks and rewards of ownership of the
work-in-progress to the buyer as construction progresses, the entity recognises revenue by
reference to the stage of completion, using the percentage of completion method. If,
however, the entity transfers control and significant risks and rewards of ownership of the
real estate at a single time, such as at completion, on delivery or after delivery, the entity
recognises revenue only once all of the criteria of IAS 18.14 are satisfied.
Sometimes the entity has to perform further work on real estate already delivered to the
buyer. In such instances, a liability measured in accordance with IAS 37, and an expense
measured in accordance with IAS 18.18, are recognised. The additional goods and services
rendered may be separately identifiable from the real estate already delivered to the buyer
and would therefore be identified as a separate component of the sale (IFRIC 15.8).
The entity discloses the following for agreements meeting the criteria of IAS 18.14:
• how it determines whether all criteria have been met continuously as construction
progresses;
• the amount of revenue arising; and
• the method used to determine the stage of completion.
If the above agreements are still in progress at reporting date, the entity also discloses:
• the aggregate amount of costs incurred and recognised profits to date; and
• the amount of advances received.
Refer in this regard to the illustrative examples in IFRIC 15.
6 Descriptive Accounting – Chapter 8
4 Recognition of contract revenue and costs
When the outcome of a construction contract can be estimated reliably, the contract revenue
and associated costs of the contract should be recognised in the financial statements as
revenue and expenses with reference to the stage of completion (the percentage of completion method) of the contract activity at the date of the statement of financial position.
The outcome of the contract can be estimated reliably only when it is probable that economic benefits associated with the contract will flow to the entity. The application of the
percentage of completion method contributes to the reliable measurement of contract profit
to date. Therefore the two basic criteria for recognising a transaction should be met.
4.1 Estimating the outcome of a contract
The outcome of a construction contract can be estimated reliably only if it is probable that
economic benefits will flow to the entity. Aspects to be considered beforehand are the
predictability of the cost, the accuracy of cost allocations to the contract, the accuracy with
which the contract completion is established, and the duration of the contract. Generally
reliable estimates where a contract has been secured can be made if the following aspects
are specified:
• the enforceable rights of each party regarding the asset to be constructed;
• the consideration to be exchanged; and
• the manner and terms of settlement (paragraph 29).
In addition to the above, IAS 11.23 prescribes specific conditions that are to be met before
the outcome of the contract can be estimated reliably. The following conditions apply for fixed
price contracts:
• the total contract revenue can be reliably measured;
• it must be probable that economic benefits related to the contract will flow to the entity;
• both the contract cost to complete the contract and the stage of completion of the contract on
date of the statement of financial position must be measured reliably; and
• contract costs attributable to the contract must be clearly identifiable and measurable, so that
the actual cost incurred can be compared to prior estimates.
In the case of a cost plus contract, the following conditions apply in terms of IAS 11.24:
• it must be probable that the economic benefits related to the contract will flow to the entity;
and
• the contract costs attributable to the contract, whether specifically reimbursable or not,
must be clearly identifiable and reliably measurable.
When current estimates of the result of a contract indicate a loss, the entire loss should be
recognised as an expense. This loss is in fact an onerous contract in terms of IAS 37, as the
expected future revenue is less than the future unavoidable costs.
When the outcome of a construction contract cannot be estimated reliably, for example,
during early stages of construction, no profit will be recognised, but:
• revenue will be recognised only to the extent of contract costs incurred, where it is probable
that it will be recoverable; and
• contract costs should be recognised as an expense in the period in which they are incurred.
When the uncertainties that initially prevented the outcome of the contract from being reliably estimated no longer exist, the revenue and expenses associated with the construction
contract should be recognised (IAS 11.35).
Construction contracts 7
4.2 Method of profit recognition
The most important matter in accounting for construction contracts is the correct recognition
of contract revenue and costs. The question here is whether the profit has to be determined
periodically as the construction of the asset proceeds, or at the completion of the project.
Contracts that do not run over more than one accounting period usually do not present
any problem, as the revenue and costs are recognised in the same accounting period.
Construction contracts, however, often run over more than one accounting period and most
of these contracts provide for payment on certified work, which indicates that revenue is
realised before the project is completed.
It is therefore unrealistic to take profit only at the completion of construction contracts. The
results of activities are then based on actual information and not on estimates, but the
disadvantage is that the profit at the end of the project does not reflect the activity level of
the construction entity for a specific accounting period, and therefore the financial
statements will not present a true reflection of the activities during the period.
The percentage of completion method is therefore used to ensure that the contract
revenue is recognised in accordance with the specific stage of completion of the project. This
leads to the reporting of contract profit attributable to the portion of the project completed. In
terms of this method, both contract revenue and costs are recognised in the profit or loss
section of the statement of comprehensive income in the accounting period in which the
work is done.
The stage of completion of a contract can be determined using different methods. The
method that most reliably measures the work performed should be used. The most
important methods are the following:
• Proportion of costs incurred, that is:
Cost to date
Total estimated cost
Cost to date excludes costs related to future activities – for example, unused material on site
or advance payments to subcontractors. However, it includes materials which have been
made specially for the contract, even though they have only been delivered on site and not
yet used.
• Percentage of work certified, that is:
Work certified to date
Contract price
• Completion of a physical portion of the contract, for example a number of units in a
housing scheme. Note that progress payments and advances received from customers
often do not reflect the level of work performed.
4.3 Collectability
If there is any uncertainty about the recoverability of an amount already recognised as
contract revenue in a previous period, the amount is deemed as probably being irrecoverable. This amount is recognised as an expense and a corresponding provision is created.
Note that the amount is not treated as an adjustment to contract revenue, as it does not
affect the level of work performed on the contract.
4.4 Uncompleted contract work and irrecoverable costs
Although contract cost is normally recognised as an expense in the accounting period in
which the work was completed, a contractor sometimes incurs costs connected to future
activities of the contract (IAS 11.27). These contract costs are recognised as an asset, on
condition that they are recoverable. This cost represents an amount that is due by the
8 Descriptive Accounting – Chapter 8
customer, and is described as uncompleted contract work or contract work in progress, and
classified under current assets.
Contract costs that will probably not be recovered are, however, recognised immediately
as an expense. Examples of such instances include contracts such as:
• those whose validity is seriously questioned;
• those whose completion is subject to pending litigation or legislation;
• those relating to property that is likely to be condemned or expropriated;
• those where the customer cannot meet his obligations; or
• those where the contractor cannot complete the contract or meet his obligations under the
contract (paragraph 34).
4.5 Expected losses
If it becomes probable that the project will be running at a loss during the contract period,the
full amount of the expected loss is recognised immediately in the profit or loss section of
the statement of comprehensive income. When a project takes up a major portion of a
contractor’s capacity for an extended period, indirect costs are sometimes allocated as
losses to the completion of the project.
According to IAS 11.37, provision must be made for losses without considering the
following:
• whether the work has started in accordance with the contract;
• the stage of completion of the contract activities; and
• the amount of profit expected from other contracts.
Actual and expected losses are provided for immediately if it is possible that they will arise
and if they can be estimated reliably. Even if the outcome of the contract cannot be estimated reliably, the total contract cost can exceed the total contract revenue. In such a case,
the excess of the total cost over the revenue of the contract is recognised immediately as an
expense. Other losses or contingencies are disclosed in the financial statements in accordance with the requirements of IAS 37.
Example 8.1: Recognising losses
Contract price: R1 800 000
Actual cost incurred
Estimated total cost
Actual total cost
Profit/(loss) to date:
• Revenue*
• Cost
Additional loss provided
Profit for year 1
Total loss in year 2
Year 1
R’000
960
1 600
–
Year 2
R’000
300
1 850
–
Year 3
R’000
490
–
1 750
1 080
(960)
1 226
(1 260)
1 800
(1 750)
120
(34)
50
(16)
** (50)
120
(170)
NOTE: When the actual cost to date exceeds the contract price, the full loss is taken to the statement of comprehensive income (profit or loss). This includes future costs.
continued
Construction contracts 9
Comment
• The following results are reflected in the statement of comprehensive income:
Year 1: Profit R120 000
Year 2: Loss R50 000 + R120 000 = R170 000
Year 3: Profit R100 000
• The total profit recognised for 3 years is R50 000 (R120 000 – R170 000 + R100 000). This is
equal to the contract price less actual total cost.
* 960/1 600 × 1 800; 1 260/1 850 × 1 800;
** 1 800 – 1850
4.6 Changes in estimates
Construction entities must have effective internal financial budgeting and reporting systems.
They must evaluate and revise, where necessary, the estimates of contract revenues and
costs as the contract proceeds. The need for such revisions does not necessarily indicate
that the outcome of the contract cannot be estimated reliably.
A change in the estimate of contract costs or revenue, or in the expected outcome of the
contract, must be accounted for as a change in estimate in accordance with IAS 8. The
cumulative annual assessment of each contract is based on the best estimates available at
the date of the statement of financial position.
The example below provides an overview of the accounting recognition of uncompleted
construction work, using the percentage of completion method.
Example 8.2: Accounting treatment
Alpha Ltd obtained a contract to the value of R725 000 to build a bridge in the Eastern Cape. Activities commenced on 1 March 20.7 and are estimated to be completed in November 20.9 at a
calculated cost of R600 000.
The information below refers to the contract activities for the year ended 31 December 20.7.
R
Cash income as per bank statement during the year:
Amounts transferred from head office
106 000
Progress payments as per certificates
364 000
Refund by supplier for material rejected
17 000
Material sold
20 000
Payments by cheque during the year:
Salaries
16 500
Wages
94 000
Materials
188 500
Equipment
80 000
Sundry expenses
29 500
Money transferred to head office
110 500
On 31 December 20.7, the retentions amounted to R16 000. No other amounts were due by the
contract debtors.
The material was sold at a profit of R2 000.
Equipment was bought on average on 1 July 20.7.
Salaries were paid to administrative personnel on the construction site.
Except for the above, the following expenses were paid by head office with regard to the contract:
Materials transferred to the site R18 000.
Indirect costs allocated R23 500.
continued
10 Descriptive Accounting – Chapter 8
Equipment with a carrying amount of R24 000 was transferred to the site at the start of the project.
The following were the balances as at 31 December 20.7:
R22 000 due to creditors for materials purchased.
There was unused material on site valued at R52 000. Of this amount, R20 000 was for purposemade material for the project.
The following accounting policy aspects are important:
• Depreciation is provided on equipment at 25% annually, on the reducing balance method.
• The stage of completion is measured in accordance with costs incurred.
The applicable ledger accounts for the year ended 31 December 20.7 are as follows:
Contract expenses
R
16 500
94 000
188 500
29 500
18 000
23 500
15 000
22 000
Bank (Salaries)
Bank (Wages)
Bank (Materials)
Bank (Sundries)
Material control
Overheads allocated
Depreciation
Sundry creditors (Materials)
Bank (Materials sold)
Bank (Materials returned)
Materials (52 – 20)
Statement of comprehensive
income (P/L)
407 000
R
20 000
17 000
32 000
338 000
407 000
NOTE: The contract costs are reduced by the total proceeds of the materials sold, which include
the profit of R2 000. (IAS 11.17). Custom-made materials are part of contract costs that
should be recognised in the statement of comprehensive income (profit or loss) section because the concomitant income was recognised in terms of IAS 11.31(a).
Contract revenue
R
Statement of comprehensive income
(P/L)
408 417
R
Uncertified contract
revenue
408 417
Retention debtors
Uncertified contract revenue
R
16 000
Uncertified contract revenue
Contract revenue
R
408 417
Contract debtors
Retention debtors
Balance c/f
408 417
R
364 000
16 000
28 417
408 417
Contract debtors
Uncertified contract revenue
R
364 000
Bank
R
364 000
Calculations
1. Work certified: Cash received + retention money
= R364 000 + 16 000
= R380 000
continued
Construction contracts 11
2. Contract revenue recognised:
3. Depreciation:
338
= 56,33% × 725 000
600
= R408 417
R24 000 × 25% for 10 months
R80 000 × 25% for 6 months
R
5 000
10 000
15 000
4. Contract profit for the year:
R408 417 – 338 000
= R70 417
5 Payments by customers
Most construction contracts stipulate that certain payments should be made at specific stages
of completion, in accordance with certified progress certificates issued by a professional firm.
The following payments occur frequently:
5.1 An advance structured as a loan in the contractual agreement
When an amount is received, it is recorded as a liability. Depending on the contractual
agreement, the contractor may be obliged to pay interest on an advance. The contract
should also indicate whether the loan should be repaid or be offset against a progress
certificate as payment. This type of advance is normally negotiated by a contractor when the
contract is capital-intensive and the contractor does not have sufficient funds.
5.2 A normal advance
A contractor may request a client to pay an advance before the related work is completed.
This usually occurs when a contractor experiences a temporary cash flow problem.
5.3 Claims
The agreement between a customer and a contractor sometimes makes provision for claims
to be instituted by the contractor for the customer’s non-compliance with certain contractual
clauses, or for additional work done due to an alteration of the contract. These claims are
seen as revenue additional to the contract and are increases to the contract price.
5.4 Progress payments
Progress payments are that part of progress billings levied that are payable by the customer. Raised progress accounts are amounts debited for work performed on the contract to
contract debtors, irrespective of whether the customer has paid.
5.5 Retention monies
Construction contracts usually contain a clause that allows a customer to retain a certain
amount until certain specified contractual conditions have been satisfied. Retention monies
are portions of progress billings issued, which are not paid until the conditions of the contract have been complied with, or until the defects are rectified. These amounts should be
classified as retention debtors in the financial statements. This money is paid by a customer
after the expiry of a certain period after the completion of the contract or after additional
costs have been incurred to rectify defective work.
12 Descriptive Accounting – Chapter 8
Example 8.3: Contract and retention debtors
Suppose a contract is signed to build a bridge for R400 000. The accounting period is
31 December 20.7. On 30 November 20.7, the engineers issued a progress certificate of 35%.
Retention monies of 10% are payable three months after the completion of the contract. The client
paid R60 000 on 28 December 20.7.
Journal entries
Dr
R
30 Nov
Contract debtors
Retention debtors
Uncertified contract revenue
28 Dec
Bank
Contract debtors
Cr
R
126 000
14 000
140 000
60 000
60 000
Calculation
Total debtors (35% × R400 000)
Client retains 10% as retention monies
140 000
(14 000)
Total amount payable
Already paid
126 000
(60 000)
Outstanding amount due to be paid immediately
66 000
Statement of financial position as at 31 December 20.7
R
Assets
Current assets
Receivables
Contract debtors
Retention debtors
80 000
*66 000
14 000
* This amount must be added to other trade debtors.
6 Comprehensive example without tax implications
Blues Ltd obtained a fixed price contract (“main project”) in July 20.5 to build pedestrian
bridges near a rugby stadium for the fanatical rugby supporters. The expected date of
completion is February 20.7.
The total contract price was initially R7 200 000, based on a total estimated contract cost
of R6 120 000.
On 31 December 20.6, the following balances appeared on the trial balance of Blues Ltd
in respect of the main project:
Balances on 1 Jan 20.6:
Machinery and equipment @ carrying value (cost R1 850 000)
Current assets
Raw materials
Contract debtor
Retention debtor (10%)
Current liability
Contract income certified in advance
Contract costs incurred during the year (excluding costs regarding machinery, equipment
and raw materials)
Purchase of raw materials
R’000
1 295
380
50
90
180
3 019,2
1 125
continued
Construction contracts 13
R’000
Other balances
Profit from smaller contracts
Administrative expenses
20.5
20.6
20.5
20.6
410
632
80
120
As a result of the increase in the price of petrol in 20.6, and the accompanying increase in
transport costs of raw materials, the costs to complete the contract were re-estimated at
R2 114 000 (including closing inventory at 31 December 20.6).
The total contract costs (including depreciation and consumed raw materials) for the year
ended 31 December 20.5 with regard to the main project were R612 000.
In the current year, Blues Ltd did not submit to pressure from their employees’ trade union
to increase salaries. Consequently, the employees went on strike and Blues Ltd could not
complete the first group of bridges on time.
Botha & Co, the company commissioning the project, fined Blues Ltd R50 000. The
penalty is included in the contract costs for 20.6.
The machinery and equipment shown in the trial balance were used as follows: 80% on
the main project and 20% on the other smaller contracts.
Machinery and equipment is depreciated at 20% per annum on a straight-line basis.
The raw materials purchased during the current year included custom-made Blues emblems
for the bridges, valued at R100 000. At the date of the statement of financial position, the
inventory of raw materials amounted to R260 000 (including the custom-made emblems of
R20 000).
During the year ended 31 December 20.6, the following work was certified on the main
contract:
Work certified to date
Work certified to 31 Dec 20.5
R’000
5 000
(900)
Work certified for the year
Less: Retention debtors (10%)
4 100
(410)
Invoiced
3 690
During the year, cash received on the main project amounted to R3 490 000 (20.5: R760 000).
The profits from smaller contracts can be accepted as correct and are based on contract
prices of R853 200 (20.5: R500 000). These contracts were all completed and fully paid for
by the reporting date.
It is the accounting policy of the company to use the percentage of completion method to
recognise the profits on contracts. The percentage of completion is calculated using the ratio
of costs incurred to total estimated costs.
For the purposes of this illustration, the income tax implications are ignored.
The first step is to calculate the total cost to date, the cost for the year, and the total
estimated cost of the project, and to compare that to the purchase price:
continued
14 Descriptive Accounting – Chapter 8
Cost for the year 20.6
Amount given
Fine
Depreciation (1 850 000 × 80% × 20%)
Raw materials
R’000
3 019,2
(50)
296
1 265
• Opening inventory
• Purchases
• Closing inventory (260 000 – 20 000)
380
1 125
(240)
Total cost of the year
Total cost of previous year (given)
4 530,2
612
Total cost to date
Cost to completion (2 114 – 20)
5 142,2
2 094
Total cost of contract
Contract price (7 200 000 – 50 000)
Estimated loss
7 236,2
(7 150)
86,2
Comment
• The fine reduces the contract income in terms of IAS 11.12(c). The fine can be payable
immediately, or at the end of the contract. If the fine meets the definition of a liability, it
should be recognised as a decrease of contract income in the statement of comprehensive income (profit or loss). When the amount is paid is not important, because of the application of the accrual concept.
There may be instances where there is uncertainty about the recognition of the fine (either
concerning the timing or amount). In such an instance, it is treated as a provision in terms
of IAS 37. The provision should be reassessed at each statement of financial income date,
and may be adjusted against contract revenue as appropriate.
In exceptional instances, the recognition of a fine may be contingent on a future event.
The level of uncertainty associated with such a fine indicates that it is a contingent liability
that should be disclosed in the notes to the financial statements.
• The total cost of the contract of R7 236 200 differs from the original estimate of R6 120 000
because of the escalation in transport costs. This change in estimate results in a contract
price that is lower than the expected contract costs, and thus in a possible loss. In terms
of the prudence concept and IAS 11.36, the loss is recognised immediately in the
statement of comprehensive income (profit or loss).
• Customised materials are part of contract costs that should be recognised in the
statement of comprehensive income (profit or loss) because the concomitant income was
reognised in terms of IAS 11.31(a), resulting in a matching of income and expenses.
The loss still to be provided for is calculated as:
Total estimated loss (7 236 200 – 7 150 000)
Loss recognised to date (5 142 200 – 5 062 000)
Provision for additional loss
R’000
86,2
(80,2)
6,0
The next step is to calculate the percentage of completion and the contract income to date
and for the year:
Stage of completion ((5 122 200 + 20 000)/7 236 200)
71%
continued
Construction contracts 15
R’000
The contract income for the year is calculated as:
Contract income to date (71% × 7 200 000 – 50 000)
Contract income of previous year already recognised (612 000/6 120 000 × 7 200 000)
5 062
(720)
Income from other smaller contracts
4 342
853,2
Total contract income for the year
5 195,2
Comment
• In the calculation of the percentage of completion, the closing inventory of customised
emblems is reversed, as these are made specifically for use on the contract (refer to
IAS 11.31(a)).
The profit or loss section of the statement of comprehensive income of Blues Ltd for the
year ended 31 December 20.6 is as follows:
Statement of comprehensive income for the year ended 31 December 20.6
Contract revenue (4 342 000 + 853 200)*
Contract costs (4 530 200 + 853 200 – 632 000)**
Gross profit
Provision for additional loss
Administrative expenses
Profit before tax
20.6
R’000
5 195,2
(4 751,4)
20.5
R’000
1 220
(702)
443,8
(6,0)
(120,0)
518
–
(80)
317,8
438
* 20.5: 720 000 + 500 000
** 20.5: 612 000 + 500 000 – 410 000
In step 3, the balances for uncertified contract income, contract debtors and retention debtors
on the statement of financial position, are calculated. (As the information in the question is so
comprehensive, it is possible to do the calculations either cumulatively or as a movement for
the current year).
Contract debtor
Work certified to date (5 000 000 × 90%)
Cash received (3 490 000 + 760 000)
R’000
4 500
(4 250)
250
OR
Opening balance
Work certified for the year (4 100 000 × 90%)
Cash received
50
3 690
(3 490)
250
Retension debtor
Work certified to date (5 000 000 × 10%)
500
OR
Opening balance
Work certified for the year (4 100 000 × 10%)
90
410
500
Uncertified contract income
Contract income to date (4 342 000 + 720 000)
Work certified to date
5 062
(5 000)
62
continued
16 Descriptive Accounting – Chapter 8
OR
Opening balance
Contract income for the year
Work certified for the year
(180)
4 342
(4 100)
62
An extract from the statement of financial position of Blues Ltd at 31 December 20.6 is as follows:
Statement of financial position as at 31 December 20.6
Notes
Assets
Non-current assets
Property, plant and equipment (1 850 000 – 555 000 – 370 000)
Current assets
Incomplete contract work (260 – 20)
Retention debtor
Contract debtor
Uncertified contract revenue
Equity and liabilities
Current liabilities
Provision for loss on contract
Contract revenue certified in advance (720 – 900)
Provision for penalty
3
3
3
20.6
R’000
20.5
R’000
925
1 295
240
500
250
62
380
90
50
–
6
–
50
–
180
Notes
1.
Accounting policy
1.1
Income recognition on construction contracts
Income on fixed price contracts is recognised in accordance with the percentage of completion
method. The total cost incurred to date is used in relation to the total estimated contract cost to
calculate the percentage of completion.
1.2
Revenue
Income consists of contract revenue recognised during the year on the percentage of completion
method.
20.6
R’000
Profit before tax
Disclosable items include:
370
Depreciation – Machinery and equipment
2.
3.
Uncompleted construction contracts
Cost to date and recognised profit (losses) to date (5 142 200 + 240 000 – 86 200)
Owed by customers (5 296 000 – 5 000 000)
5 296
296
Comment
• The amount owed by the customers may be tested as follows:
Uncompleted contract work
Uncertified contract income
Provision for loss on contract
R’000
240
62
(6)
Contract revenue certified in advance
• Only the notes to the financial statements for 20.6 are given for illustrative purposes.
296
Construction contracts 17
7 Tax implications
The rules below represent a brief summary of the stipulations of the Income Tax Act 58 of
1962 (the Income Tax Act) that are applicable to construction contracts:
• The South African Revenue Service (SARS) taxes the larger of:
– cash received; or
– amount accrued (work certified less retention money)
(called “tax turnover” for convenience).
• SARS allows all actual costs as a deduction. A possible exception may occur where the
amount for depreciation is not determined according to tax regulations.
• A section 24C allowance is determined according to the following formula:
(Total estimated cost
× “Tax turnover” to date) – Cost to date
Contract price
This allowance has the following characteristics:
– It is an allowance for future expenditure on taxable income in the current year.
– The previous year's allowance must be added back.
– The allowance must not cause an assessed loss.
– The allowance causes temporary differences and therefore results in deferred tax.
– On the calculation of a section 24C allowance, losses on individual contracts are not
allowed separately. All uncompleted contracts must be added for this purpose to
calculate provisional taxable income of contracts before section 24C allowances
may be claimed.
– The allowance is based on cumulative figures.
Note the logic of the formula. The portion between brackets refers to the portion of cash
received to date, which will be expected to become costs. This portion thus becomes a
deduction, but it is decreased by the cost allowed to date.
The Income Tax Act and other authoritative tax textbooks contain no guidelines about the
fact that SARS could allow for any changes in the calculated total cost and the contract price
in the calculation of the allowance. Tax experts are of the opinion that SARS will allow these
changes if a good motivation is supplied.
Example 8.4: Section 24C allowance
“Tax turnover”
Expenses
Preliminary taxable income
Contract 1 Contract 2
R
R
60 000
90 000
(33 000)
(64 000)
27 000
26 000
Contract 3
R
100 000
(148 000)
(48 000)
Section 24 – allowance(s)
8 900
4 500
–
Incorrect calculation:
(R27 000 – R8 900) + (R26 000 – R4 500) – R48 000 = assessed loss of R8 400
Correct calculation:
R27 000 + R26 000 – R48 000 = R5 000
The section 24C allowance is limited to R5 000 and therefore there is no taxable income or
assessed loss.
A matter that is really problematic is the uncompleted work of a contractor. This applies especially to the work that is completed but has not been certified. For the contractor it is in the
nature of normal trade inventory; indeed, for the purpose of the statement of financial position,
the contract balance, in accordance with IAS 2, is recorded as inventory, but legally this
asset no longer belongs to the contractor. If the building material is permanently fixed to
the customer’s site, it belongs to the customer. It is however correct to include it in the
18 Descriptive Accounting – Chapter 8
statement of financial position of the contractor as inventory, despite the fact that right of
ownership has already been transferred, and SARS should not tax the closing inventory for
this reason.
The value of uncompleted work or raw materials already delivered on site but for which
the contractor cannot claim payment is considered to be inventory in terms of section 22(3A). The balance of inventory for tax purposes is calculated as follows:
GAAP costs to date
Minus: Cumulative gross income*
Minus: Cumulative retention (limited to a maximum of 15%)*
xxx
(xx)
(xx)
xx
* or work certified to date
In terms of section 22(3A)(c) of the Income Tax Act, the loss of income on contracts may be
deducted from the inventory calculated in terms of section 22(3A).
The change of tax legislation is more a tax than an accounting problem. The application of
section 22(3A) is illustrated in the example below.
Example 8.5: Tax of construction contracts
Alpha Ltd signed a contract to build a bridge over a period of 3 years on 1 May 20.0. The following
detail is applicable to the contract for the year ended 28 February 20.1:
R’000
Contract cost incurred for the year ended 28 February 20.1
Materials bought
450
Labour cost
620
Overheads
210
Work certified to date
1 200
Cash received to date
1 180
Raw material inventory on hand: 28 February 20.1
50
Total contract price
6 000
Total estimated cost
4 500
The accounting profit from the contract for the year ending 28 February 20.1 is calculated as follows in accordance with the percentage of completion method:
R
Revenue to 28 February 20.1: (1 230/4 500 × 6 000)
1 640 000
Cost to 28 February 20.1: (450 – 50 + 620 + 210)
(1 230 000)
Profit to 28 February 20.1
410 000
The taxable amount of the contract is as follows:
Tax turnover – work certified
Contract expenses (450 + 620 + 210)
Uncompleted construction work on 28 February 20.1 (section 22(3A))
Total expenses to date
Work certified to date
Raw material inventory on hand
Taxable income
R
1 200 000
(1 280 000)
(80 000)
30 000
1 230 000
(1 200 000)
50 000
–
Comment
• From the above calculations, it can be concluded that SARS succeeded, with the introduction of
section 22(3A) legislation, in preventing the taxpayer from deducting the surplus expenses of
R80 000 in excess of work certified from the other taxable income.
• The formulae used in sections 24C and 22(3A) are mutually exclusive. This implies that a taxpayer
will in one tax year have either a section 24C allowance or a section 22(3A) closing inventory balance.
Construction contracts 19
8 Comprehensive example with tax implications
Refer to the information on Blues Ltd in the previous comprehensive example. If certain
assumptions are made, it is possible to calculate the current tax and the deferred tax of
Blues Ltd for 20.5 and 20.6.
Assume the following:
• A tax rate of 30%.
•The section 12C allowance is equal to the accounting depreciation.
• The fine is deductible for tax purposes in 20.6. Section 23 of the Income Tax Act disallows
the deduction of fines, however, it is important to notice that this is only applicable to
criminal offences. In this case, the fine is not paid for a criminal offence. Contractors are
often willing to pay fines in order to tender successfully for a contract. It is therefore a
payment for trade purposes, in the production of income and not of a capital nature and
may qualify for deduction under section 11(a).
• The inventory on hand at year-end has not been used on the construction site and the
risks and rewards of ownership remain with Blues Ltd.
• It is assumed that SARS will not allow any changes in the cost percentage used for tax
purposes in previous years.
Step 4 is to calculate the current tax for 20.5 and 20.6 as follows:
Tax turnover
The larger of:
900 000 × 90% = 810 000 and 760 000
Deductible expenses (sections 11(a) and 12C)
Section 22 (3A): Work-in-progress (612 000 – 810 000 – 90 000)
Section 24C allowance (6 120 000/7 200 000 × 810 000 – 612 000)
Taxable income from other contracts
Administrative expenses (section 11(a))
20.5
R
810 000
(612 000)
–
(76 500)
410 000
(80 000)
451 500
Current tax @ 30%
135 450
The current tax for 20.6 is:
Tax turnover
The larger of:
5 000 000 × 90% = 4 500 000 and 3 490 000 + 760 000 = 4 250 000
Minus: 810 000
Deductible expenses (sections 11(a) and 12C)
(4 530 200 + 50 000 (fine) – 20 000 (inventory))
Section 22(3A) Work-in-progress (4 530 200 + 612 000 – 4 500 000 – 5 000 000 × 10%)
Section 24C allowance (6 120 000/7 200 000 × 4 560 200 – 4 560 200 – 612 000)
Section 24C allowance 20.5
Taxable income from other contracts
Administrative expenses (section 11(a))
20.6
R
3 690 000
(4 560 200)
142 200
–
76 500
632 000
(120 000)
(139 500)
Current tax @ 30%
–
continued
20 Descriptive Accounting – Chapter 8
In step 5, deferred tax is calculated as follows:
Carrying
20.5
amount
R
Machinery
1 295 000
Raw materials
380 000
Contract debtors
50 000
Retention debtors
90 000
Contract work certified in advance
(180 000)
Section 24C
–
Tax
base
R
1 295 000
380 000
50 000
–
–
(76 500)
Temporary
difference
R
–
–
–
90 000
(180 000)
76 500
(13 500)
20.6
Machinery
Raw materials
Contract debtors
Retention debtors
Uncertified contract work
Uncertified work
Fine liability
925 000
240 000
250 000
500 000
12 000
925 000
260 000
250 000
–
(50 000)
–
(20 000)
–
500 000
62 000
62 000
(50 000)
–
(50 000)
62 000
–
–
–
142 200
–
139 500
–
(142 200)
(6 000)
(139 500)
Section 24C
Section 22(3A) inventory
Provision for loss
Assessed loss
(6 000)
–
254 300
Statement of comprehensive income (P/L)
Deferred
tax
R
–
–
–
–
–
–
(4 050) dr
–
–
–
–
–
–
–
–
–
76 290 cr
80 340 cr
Step 6 is the memorandum calculation to be shown as a note to the statement of comprehensive income (profit or loss):
Cost to date
Profit/(loss) to date
Plus: Inventory
Contract cost and profit to date
Minus: Work certified to date
Owed by customers
20.6
R
5 142 200
(86 200)
240 000
20.5
R
612 000
108 000
380 000
5 296 000
(5 000 000)
1 100 000
(900 000)
296 000
200 000
20.6
R
–
80 340
20.5
R
135 450
(4 050)
80 340
131 400
Notes to the financial statements
3. Income tax expense
Main components of income tax expense:
SA Normal
Current
Deferred
No reconciliation of the tax rate is required since there are no permanent differences.
4. Uncompleted construction contracts (see memorandum calculation)
Cost to date and recognised profits to date
Owed by customers
20.6
R
5 296 000
296 000
20.5
R
1 100 000
200 000
Construction contracts 21
9 Disclosure
The following will be disclosed in the financial statements:
Accounting policy:
• the method in terms of which contract revenue is recognised; and
• the method that was used in determining the stage of completion of incomplete contracts.
Statement of comprehensive income (profit or loss):
• the amount of contract revenue recognised during the period.
Statement of financial position:
• the total amount of cost incurred and profit recognised (less recognised losses) to date;
• the amount of advance payments received; and
• the amount of retention monies.
Notes:
• the total amount due by the clients for contract work (accounted for as an asset);
• the total amount due to clients for contract work owed (accounted for as a liability); and
• contingent liabilities and assets that arise from items such as warrant payments, claims,
fines, etc.
The gross amount due from customers is the net amount of costs incurred, plus recognised
profits, less the sum of recognised losses and progress billing where the costs incurred and
recognised profits or losses exceed progress billings.
The gross amount due to customers is the net amount of costs incurred, plus recognised
profits, less the sum of recognised losses and progress billing where the progress billings
exceed the recognised profits and costs.
10 Comprehensive example
Thirion Builders (Pty) Ltd was engaged on two buildings during this year. The details are as
follows:
Contract amount
Initial cost estimate
Year ending 31 Dec 20.1:
Materials
Labour
Subcontractors
Other costs, including depreciation of R20 000
Work certified
Cash and advance payment received
Final estimated cost
Year ending 31 Dec 20.2:
Materials
Labour
Subcontractors
Other costs, including depreciation of R40 000
Work certified
Cash received
Final estimated cost
Vos
building
R’000
1 000
850
Els
building
R’000
2 500
2 100
200
160
70
40
490
550
860
190
150
40
10
510
400
590
620
240
70
1 700
1 700
2 160
Included in the payment of R240 000 to subcontractors of the Els building is an amount of
R30 000 for services that will be rendered in 20.3.
The sundry administrative expenses amounted to R20 000 and R30 000 for 20.1 and 20.2
respectively. Other profits on smaller completed contracts were R40 000 and R50 000
respectively. The depreciation is equal to the wear-and-tear allowance allowed by SARS.
continued
22 Descriptive Accounting – Chapter 8
The company recognises profit on contracts using the percentage of completion method,
to the nearest R1 000. If there is a retention clause, an amount equal to the retention for the
period, for the probable repair of defects, will be provided from the date of completion of the
contract.
A retention of 5% until 6 months after completion applies to the Vos building. Construction
of the Vos building was completed in August 20.2. In October 20.2. Thirion Builders spent
R18 000 on the repair of defects, which was not mentioned above.
The section 24C allowance will be allowed, where applicable. All costs and expenses are
deductible for tax purposes and all amounts are material. Debit balances may be created for
deferred tax. Assume a tax rate of 30%.
The relevant ledger accounts that can be compiled from this information – these accounts
would not normally be published by companies – will be as follows:
Contract expenses: Vos Building
20.1
Materials
Labour cost
Subcontractors
Other costs
R’000
200
160
70
40
20.1
Statement of comprehensive income
(P/L)
470
20.2
Materials
Labour cost
Subcontractors
Other costs
Provision for defects
190
150
40
10
50
R’000
470
470
20.2
Statement of comprehensive income
(P/L)
440
440
440
Incomplete contract work
20.2
Subcontractors
R’000
30
Contract debtor: Vos Building
20.1
Uncertified contract revenue (95% × 490)
Balance c/f
R’000
466
84
20.1
Cash
550
20.2
Uncertified contract revenue (95% × 510)
484
R’000
550
550
20.2
Balance b/d
Cash
484
84
400
484
Retention debtor: Vos Building
20.1
Uncertified contract revenue (5% × 490)
20.2
Uncertified contract revenue (5% × 510)
R’000
24
26
50
20.3
Balance b/d
R’000
20.2
Balance c/f
50
50
50
continued
Construction contracts 23
Provision for defects
20.2
Bank (Maintenance)
Balance c/f
R’000
18
32
20.2
Contract expenses
50
R’000
50
50
20.3
Balance b/d
32
Contract expenses: Els Building
20.2
Materials
Labour cost
Subcontractors (240 – 30)
Other costs
R’000
590
620
210
70
20.2
Statement of comprehensive income
(P/L)
1 490
R’000
1 490
1 490
Contract debtors: Els Building
20.2
Uncertified contract revenue
R’000
1 700
Cash
R’000
1 700
Uncertified contract revenue
20.1
Contract revenue (470/860 × 1 000)
R’000
547
20.1
Contract debtors: Vos building
Retention debtors: Vos building
Balance c/f
547
20.2
Balance b/d
Contract revenue (1 000 – 547) +
(1 490/2 160 × 2 500)
57
2 178
R’000
466
24
57
547
20.2
Contract debtors:
Vos building
Els building
Retention debtors: Vos building
Balance c/f
2 235
484
1 700
26
25
2 235
Contract revenue
20.1
Statement of comprehensive income (P/L)
R’000
547
20.1
Uncertified contract revenue
R’000
547
20.2
Statement of comprehensive income (P/L)
2 178
20.2
Uncertified contract revenue
2 178
continued
24 Descriptive Accounting – Chapter 8
The tax position will be as follows:
Current tax
Vos
Building
R’000
550
(470)
(3)
20.1
Tax turnover (cash received)
Cost
Section 24C: (860 × 550/ 1 000) – 470
Els
Building
R’000
77
40
(20)
Other profits
Administrative expenses
Taxable income
97
Current tax @ 30%
29,1
20.2
Tax turnover (balance of contract less retention)
Section 24C allowance in 20.1
Work certified
Cost actually incurred including repairs: Vos: (190 + 150 + 40 + 10 + 18)**
Els: (1 490 + 30)
400
3
(408)
(5)
1 700
(1 520)
180
Comment
• It is probable that SARS will allow the increased total estimated cost of R860 000 for this
calculation.
• It is also possible that SARS will allow the balance of R32 000 (50 000 – 18 000) as a
deduction, if the expense has been incurred.
• The section 24C allowance in 20.2 is calculated as follows:
(2 160 000 × 1 700 000/2 500 000) – 1 520 000 = (51 200), therefore no allowance is
claimed.
20.2
Contract revenue (180 – 5)
Other profits
Administrative expenses
175
50
(30)
Taxable income
195
Current tax @ 30%
58,5
Deferred tax
20.1
Retention debtors
Uncertified contract revenue
Section 24C
Advance payments
Carrying
amount
R’000
24
57
–
(84)
Tax
base
R’000
–
–
3
–
Temporary
difference
R’000
24
57
3
(84)
–
Deferred tax balance @ 30%
20.2
Retention debtors/receivables
Uncertified contract revenue
Uncompleted contract work
Provisions
–
50
25
30
(32)
–
–
–
–
50
25
30
(32)
73
Deferred tax balance @ 30%
21,9 cr
continued
Construction contracts 25
The accounting policy will be reported as follows:
Revenue recognition of construction contracts
Revenue on fixed price construction contracts is recognised in terms of the percentage of
completion method, measured by comparing the percentage of incurred cost to date with the
total estimated cost of the contracts.
Deferred tax
Deferred tax is raised on the financial position liability method, using the comprehensive basis.
The statement of comprehensive income (profit or loss) will, among other things, show the
following:
Notes
20.2
R’000
xxx
(xxx)
xxx
(xxx)
20.2
R’000
xxx
(xxx)
xxx
(xxx)
1
xxx
(80,4)
xxx
(21,9)
58,5
21,9
21,9
–
xxx
–
xxx
xxx
–
xxx
Revenue (contract revenue plus turnover on smaller contracts)
Contract cost
Gross profit
Administrative expenses
Profit before tax
Income tax expense
Current
Deferred
Profit for the year
Other comprehensive income for the year, net of tax
Total comprehensive income for the year
The statement of financial position will, among other things, show the following:
20.2
R’000
20.2
R’000
Assets
Current assets
Receivables
75
81
• Retention debtors/receivables
• Other receivables (including uncertified contract revenue)
50
25
24
57
Incomplete contract work
Equity and Liabilities
Non-current liabilities
Deferred tax
Current liabilities
Advance payments received
Provisions
30
–
21,9
–
–
32
84
–
Notes will show the following:
1.
Profit before tax
Disclosable items include:
Depreciation
17. Uncompleted construction contracts
Cost incurred and recognised profits to date
[ 470 + (547 – 470) ] and [ 590 + 620 + 240 + 70 + (1 725 – 1 490) ]
Total amount due by clients for contract work (547 – 490) and
(1 755 – 1 700)
Uncompleted contract work
Uncertified contract revenue
40
20
1 755
547
55
57
30
25
–
57
Comment
• The accounting policy for a cost plus contact may be the following:
“Revenue from cost plus contracts is recognised by reference to the recoverable costs
incurred during the period plus the fee earned, measured by the proportion that costs
incurred to date bear to the estimated total costs to the contract”.
• Review the additional example of construction contracts in the Appendix to IAS 11.