CHAPTER 12
CONSTRUCTION CONTRACTS
Connolly – International Financial Accounting and Reporting – 4th Edition
12.1 INTRODUCTION
•
•
•
Contracts that span more than one accounting period
Potential difficulties allocating and recognising revenue and
expenses
Potential conflict between prudence and accruals/matching
Connolly – International Financial Accounting and Reporting – 4th Edition
12.2 IAS 11 CONSTRUCTION CONTRACTS
•
•
Objective is to prescribe the accounting treatment of revenue
and costs associated with construction contracts
Primary issue is the allocation of contract revenue and costs
to the period in which construction work is performed
Connolly – International Financial Accounting and Reporting – 4th Edition
Contract revenues and costs
•
Revenues
 the initial amount of revenue agreed in the contract, and
 variations in contract work, claims and incentive
payments
•
Costs



those that relate directly to a specific contract
costs that are attributable to general contract activity
but can be allocated to specific contracts
any other costs that can be charged to the customer
under the terms of the contract
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
12.2 IAS 11 CONSTRUCTION CONTRACTS
•
Three categories of construction contract
1. When the outcome can be estimated reliably
2. When the outcome cannot be estimated reliably
3. When it is probable that total contract costs will exceed
total contract revenue and therefore that the contract will
incur losses
Connolly – International Financial Accounting and Reporting – 4th Edition
When the outcome can be estimated reliably
Category 1
If the outcome of a profitable contract can be estimated
reliably, contract revenue and costs should be recognised by
reference to the stage of completion at the end of each
reporting period.
Connolly – International Financial Accounting and Reporting – 4th Edition
Stage of completion
•
Options for measuring stage of completion



Costs incurred as a proportion of total estimated
costs
Value certified as a proportion of total contract
revenue
Completion of physical proportion of contract work
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.1: Contract outcome estimated reliably
Contract X at 31 December 2012:
Commencement date
1 January 2012
Completion date
31 December 2013
Contract price
€3,000,000
Cost to date
€1,000,000
Cost to complete
€1,000,000
Stage of completion to be determined by reference to
costs to date and total costs rather than duration.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.1: Contract outcome estimated reliably
Step 1 Calculate the outcome for the contract
€
Price
3,000,000
Costs to date
(1,000,000)
Costs to complete
(1,000,000)
Profit
1,000,000
Step 2 Determine the stage of completion
Cost to date/Total cost
€1,000,000/€2,000,000 = 50%
Step 3 Statement of profit or loss and other comprehensive income
€
Revenue (€3m x 50%)
1,500,000
Cost of sales (€2m x 50%)
(1,000,000)
Profit
500,000
Connolly – International Financial Accounting and Reporting – 4th Edition
When the outcome cannot be estimated reliably
Category 2
When a contract’s outcome cannot be estimated reliably:


recognise revenue to the extent of the costs incurred which
are expected to be recoverable; and
recognise contract costs as an expense in the period in
which incurred.
This arises during the early stages of a contract when it is
difficult to reliably estimate outcome, but likely that costs will be
recovered.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.2: Outcome cannot be estimated reliably
Contract Y at 31 December 2012:
Commencement date
1 November 2012
Completion date
31 March 2014
Contract price
€5,000,000
Cost to date
€400,000
Cost to complete
€3,600,000
Stage of completion to be determined by reference to
costs to date and total costs rather than duration.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.2: Outcome cannot be estimated reliably
Step 1 Calculate the outcome for the contract
€
Price
5,000,000
Costs to date
(400,000)
Costs to complete
(3,600,000)
Profit
1,000,000
Step 2 Determine the stage of completion
Cost to date/Total cost
€400,000/€4,000,000 = 10%
 Too early to recognise any profit.
Step 3 Statement of profit or loss and other comprehensive income
€
Revenue
400,000
Cost of Sales (€4m x 10%)
(400,000)
Profit
0
Revenue = CoS
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When it is probable that total contract costs will exceed total contract
revenue and therefore that the contract will incur losses
Category 3
When it is probable that costs > revenue, the expected total
loss should be recognised immediately irrespective of whether
work has commenced and the stage of completion.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.3: Contract loss expected
Contract Z at 31 December 2012:
Commencement date
1 September 2012
Completion date
30 April 2014
Cost to date
€440,000
Cost to complete
€1,760,000
Contract price
€2,000,000
% completion
20%
Stage of completion to be determined by reference to
costs to date and total costs rather than duration.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.3: Contract loss expected
Step 1 Calculate the outcome for the contract
€
Price
2,000,000
Costs to date
(440,000)
Costs to complete
(1,760,000)
Loss
(200,000)
Step 2 Determine the stage of completion
Cost to Date/Total Cost €440,000/€2,200,000 = 20%
Step 3 Statement of profit or loss and other
comprehensive income
€
Revenue (€2m x 20%)
400,000
Cost of Sales (€2.2m x 20%)
(440,000)
Provision for foreseeable loss
(160,000)
(200,000)
Connolly – International Financial Accounting and Reporting – 4th Edition
FURTHER EXAMPLES
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.6: Recognising contract revenue, expenses and profit
A contractor had a fixed price contract for €9,000,000 to build a
bridge. The initial amount of revenue agreed in the contract is
€9,000,000. The contractors initial estimate of contract costs is
€8,000,000. It will take three years to build the bridge. By the end of
Year 1, contractor’s estimate of contract costs has increased to
€8,050,000, In Year 2, the customer approves a variation resulting in
an increase in contract revenue of €200,000 and estimated additional
contract costs of €150,000. At the end of Year 2, costs incurred
include €100,000 for standard materials stored at the site to be used
in Year 3 to complete the project.
The contractor determines the stage of completion of the contract by
comparing the proportion of contract costs incurred for work
performed to date with the latest estimated total contract costs
incurred for work performed to date with the latest estimated total
contract costs. In accordance with IAS 11, the company recognises
profit in construction contracts when completion is more than 20%.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.6: Recognising contract revenue, expenses and profit
Cont’d.
A summary of the financial data during the construction period
is as follows:
Year
1
€’000
Initial amount of revenue
agreed in contract
2
€’000
3
€’000
9,000
9,000
9,000
Nil
200
200
Total contract revenue
9,000
9,200
9,200
Contract costs incurred to date
2,093
6,170
8,200
Contract costs to complete
5,957
2,030
Nil
Total estimated contract cost
8,050
8,200
8,200
Variation
Prepare the figures for the SPLOCI – P/L for years 1–3.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.6: Recognising contract revenue, expenses and profit
Solution – Year 1
Step 1 Calculate the overall profit or loss on the contract
€
Contract price
9,000
Total cost
(8,050)
Profit
950
Step 2 Stage of Completion
Cost incurred to date / Total cost = €2,093 / €8,050 = 26%
Step 3 SPLOCI – P/L
Revenue (€9,000 X 26%)
Cost of sales (€8,050 X 26%)
Gross profit
€
2,340
(2,093)
247
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.6: Recognising contract revenue, expenses and profit
Solution – Year 2
Step 1 Calculate the overall profit or loss on the contract
€
Contract price
9,200
Total cost
(8,200)
Profit
1,000
Step 2 Stage of Completion
Cost incurred to date / Total cost = €6,070 / €8,200 = 74%
Step 3 SPLOCI – P/L
Revenue (€9,000 X 74%)
Cost of goods sold (€8,200 X 74%)
Gross profit
Cumulative
€
Year 1
€
Year 2
€
6,808
(2,340)
4,468
(6,070)
2,093
(3,975)
738
Connolly – International Financial Accounting and Reporting – 4th Edition
493
Example 12.6: Recognising contract revenue, expenses and profit
Solution – Year 3
Step 1 Calculate the overall profit or loss on the contract
€
Contract price
9,200
Total cost
(8,200)
Profit
1,000
Step 2 Stage of Completion
Cost incurred to date / Total cost = €8,200 / €8,200 = 100%
Step 3 SPLOCI – P/L
Revenue
Cost of goods sold
Gross profit
Cumulative
€
Years 1 & 2
€
Year 3
€
9,200
(6,808)
2,392
(8,200)
6,070
(2,130)
1,000
Connolly – International Financial Accounting and Reporting – 4th Edition
262
Example 12.7: Contract outcome uncertain
ABC Limited commenced Contract C in 2012 and has the following
details for the year ended 31 December 2012:
€m
Total contract value
40
Costs incurred to date
3
Estimated total costs
30
Completion
10%
Requirement
Calculate the profit / loss to be recognised in the Statement of profit
or loss and other comprehensive income for the year ended 31
December 2012 in respect of Contract C, assuming that costs
incurred to date are recoverable
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.7: Contract outcome uncertain
Solution
Step 1 Calculate the overall profit or loss on the contract
€
Contract price
40
Total cost
(30)
Profit
10
Step 2 Stage of Completion
Cost incurred to date / Total cost = €3 / €30 = 10%
The contract is at too early a stage to recognise any profit. 10%
of the contract revenue is €4, but the revenue in the SPLOCI –
P/L is limited to the amount of the costs incurred to date.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.7: Contract outcome uncertain
Solution
SPLOCI – P/L
€
Revenue
3
Cost of goods sold
(3)
Gross profit
Nil
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.8: Recognising contract losses
ABC Limited commenced Contract B during 2013 and will
complete it in 2013. It has the following details for the year
ended 31 December 2012:
Total Contract Value
€70m
Costs incurred to date
€40m
Estimated costs to complete
€39m
Completion
50%
Requirement
Calculate the profit or loss to be recognised in the statement of
profit or loss and other comprehensive income for the year
ended 31 December 2012 and 2013 in respect of Contract B.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 12.8: Recognising contract losses
Solution
Step 1 Calculate the overall profit or loss on the contract
€
Contract price
70
Total cost
(79)
Profit / (Loss)
(9)
Step 2 Stage of Completion 50% (per question)
Step 3 SPLOCI – P/L
Cumulative
€
Revenue (€70 X 50%)
35
Cost of goods sold (€39.5 + €4.5)
(44)
Gross profit
(9)
Connolly – International Financial Accounting and Reporting – 4th Edition
Gross amount due from / to customers
•
•
Present ‘gross amount due from/to customers for contract
work’ as asset/liability
Gross amount due is calculated as:
Costs incurred to date
Plus recognised profit
Minus recognised loss
Minus invoiced progress billings
•
Progress billings invoiced and still receivable at reporting
date are presented as trade receivables
See Chapter 12, Examples 12.9 – 12.11
Connolly – International Financial Accounting and Reporting – 4th Edition
12.4 DISCLOSURES
1. Amount recognised as revenue in the period
2. Method used to determine the revenue recognised
3. Method used to determine stage of completion
4. For each contract in progress
a) cost incurred to date and recognised profits (less losses)
b) amount of advances received
c) amount of retentions
5. Gross amount due from customers for contract work where
5 (a) > (b). This is shown as follows:
a) cost incurred plus recognised profits, less
b) the total of recognised losses and progress billings
6. The gross amount due to customers, i.e. where 5 (a) < 5 (b)
Connolly – International Financial Accounting and Reporting – 4th Edition
IFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS
•
•
•
•
IFRS 15 was issued in May 2014 and is effective for an
entity's first annual IFRS financial statements for periods
beginning on or after 1 January 2017. Earlier application is
permitted.
IFRS 15 replaces IAS 11 Construction contracts, IAS
18 Revenue and IFRIC 13 Customer Loyalty Programmes
IFRS 15 moves away from a revenue recognition model
based on an ‘earnings process’ to an ‘asset-liability’
approach based on transfer of control
The core principle of IFRS 15 is that an entity will
recognise revenue to depict the transfer of promised
goods or services to customers in an amount that reflects
the consideration (payment) to which the entity expects to
be entitled in exchange for those goods or services.
Connolly – International Financial Accounting and Reporting – 4th Edition
IFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS
To apply this principle, a five-step model framework must be
followed:
• Step 1: Identify the contract(s) with a customer.
• Step 2: Identify the performance obligations in the contract.
• Step 3: Determine the transaction price.
• Step 4: Allocate the transaction price to the performance
obligations in the contract.
• Step 5: Recognise revenue when (or as) the entity satisfies
a performance obligation.
• The industries most impacted by IFRS 15 are likely to be
telecom, software development, real estate and other
industries with long-term contracts. This includes an
industry where bundled contracts of ‘product + service’ are
quite common.
Connolly – International Financial Accounting and Reporting – 4th Edition
ADDITIONAL QUESTIONS
Connolly – International Financial Accounting and Reporting – 4th Edition
Question 1
NECTAR Limited (NECTAR) entered into a €15,000,000 contract to
build a multi-storey car park, with a completion date of 30 June 2013,
on 1 February 2012. NECTAR has not yet accounted for the contract
in its financial statements for the year ended 31st December 2012. It is
company policy to adjust cost of sales by the amount of attributable
profit or loss to be recognised in the period to arrive at contract
revenue. Further details in relation to the contract at 31 December
2012 are as follows:
€’000
€’000
Amount invoiced
9,500 Costs incurred
9,250
Amount received
9,000 Costs certified
8,500
Costs to complete
4,000
Requirement
How should NECTAR reflect the contract in its financial statements for
the year ended 31 December 2012?
Connolly – International Financial Accounting and Reporting – 4th Edition
Question 1
€’000
NECTAR
(a) Total profit/loss
Contract price
15,000
Costs to date
(9,250)
Estimated to complete
(4,000)
Estimated contract profit/loss
1,750
(b) Attributable profit/loss
Stage of completion
11/17 = 64.7%
Costs cert. / Est. total costs
9,250/13,250 = 69.8%
Turnover
9,500/15,000 = 63.3%
Cash received
Therefore attrib. profit/loss
9,000/15,000 = 60%
Take say (65.7%)
Connolly – International Financial Accounting and Reporting – 4th Edition
€1,150
Question 1
NECTAR (cont’d)
€’000
(c) Revenue
Costs cert. to date
8,500
Attributable profit
1,150
9,650
(d) Gross Amount Due From Customer
Costs to date
9,250
Recognised profit
1,150
Progress billings
(9,500)
900
(e) Trade Receivable
(€9,500 - €9,000)
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500
Question 2
PINBALL began work on a long-term construction contract during the year
ended 31 December 2013 to construct a by-pass around two towns. Details
of the contract are as follows:
€’000
Contract price
16,000
Costs incurred to date
5,800
Estimated costs to completion
10,400
Value of work certified to date
6,000
Amounts invoiced and received
6,800
PINBALL recognises revenue and profit on long-term contracts on the basis
of work certified to date.
Requirement
Calculate the figures to be included in PINBALL’s SPLOCI for the year ended
31 December 2013 and SFP as at that date.
Connolly – International Financial Accounting and Reporting – 4th Edition
PINBALL
SPLOCI – P/L (extract):
€’000
Revenue
6,000
Cost of sales
(6,200)
Loss (W1)
(200)
Statement of Financial Position (extract):
€’000
Gross amounts due to customers [CL and/or NCL]
Costs incurred
5,800
- losses to date (w1)
(200)
- progress billing
(6,800)
1,200
W1:
Contract price
16,000
Costs incurred
(5,800)
Estimated costs to completion
(10,400)
(200)
Connolly – International Financial Accounting and Reporting – 4th Edition