construction contract
TRANSCRIPT
CONTENTS
Objective
Scope
Definitions
Combining and segmenting construction
contracts
Contract revenue
Contract costs
Recognition of contract revenue and expenses
Recognition of expected losses
WHY NEEDED
The aim of the standard is to ensure that work in progress is valued prudently with correct matching of revenue and costs. Work in progress values both affect the balance sheet assets value and the related cost of sales.
For a construction contract one or all of the following may be highly subjective:
1. the cost to be included.
2. the stage of completion.
3. realisability of the work.
IDEAS – CONCEPT
The basic concept is that cost of work done
should be matched in an accounting period
with the related income and the resultant
profit or loss measured. Any cost of valuable
work done and not matched by income
should be carried in the balance sheet as
WIP.
OBJECTIVES
The objective of this standard is to prescribe
the accounting treatment of revenue and
costs associated with construction contracts.
The primary issue in accounting for
construction for contracts is the allocation of
contract revenue and contract costs to the
accounting periods in which the construction
work is performed.
DEFINITIONS
A construction contract is a contract
specifically negotiated for the construction of
assets 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.
DEFINITIONS
A Fixed price contract is a construction
contract in which the contractor agrees to a
fixed contract price, or a fixed rate per unit of
output.
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.
COMBINING AND SEGMENTING CONSTRUCTION CONTRACT
When a contract covers a number of assets, the construction of each asset shall be treated as a separate construction contract when:
A. Separate proposals have been submitted for each asset.
B. Each asset has been subject to separate negotiation and the contractor and customer have been able to accept or reject that part of the contract relating to each asset.
C. The cost and revenues of each asset can be identified.
CONTRACT REVENUE
Contract revenue shall comprise:
A. The initial amount of revenue agreed in the contract.
B. Variations in contract work, claims and incentive payments:
i. To the extent that it is probable that they will result in revenue
ii. They are capable of being reliably measured.
CONTRACT COSTS
Contract cost shall comprise:
A. Cost that relate directly to the specific
contract
B. Costs that are attributable to contract
activity in general and can be allocated to
the contract.
C. Such other costs as are specifically
chargeable to the customer under the terms
of the contract.
RECOGNITION OF CONTRACT REVENUE AND EXPENSES
When the outcome of a construction contract
can be estimated reliably, contract revenue
and contract costs associated with the
construction contract shall be recognized as
revenue and expenses respectively by
reference to the stage of completion of the
contract activity at the end of the reporting
period. An expected loss on the construction
contract shall be recognized as an expense.
RECOGNITION OF CONTRACT REVENUE AND EXPENSES
In the case of a Fixed price contract, the outcome of a construction can be estimated reliably when all of the conditions are satisfied:
a) Total contract revenue can be measured reliably
b) Economic benefits associated with the contract will flow to the entity
c) Contract cost to complete the contract and the stage of completion at the end of reporting period can be measured reliably
d) Contract cost attributable to the contract can be clearly identified and measured reliably so that the actual contract costs incurred can be compared with the prior estimates.
RECOGNITION OF CONTRACT REVENUE AND EXPENSES
In the case of a cost plus contract, the
outcome of a construction contract can be
estimated reliably when all the following
conditions are satisfied:
a) Economic benefits associated with the
contract will flow to the entity
b) Contract cost can be clearly identified
RECOGNITION OF EXPECTED LOSSES
When the outcome of construction cannot be
estimated reliably:
a) Revenue shall be recognized only to the
extent of contract of contract costs incurred
that it is probable will be recoverable
b) Recognized expense in the period in which
they are incurred.
DISCLOSURE
An entity shall disclose:
a) Amount of contract revenue recognized as
revenue in the period
b) Methods used to determine the contract
revenue recognized in the period
c) Method used to determine the stage of
completion of contracts in progress.
US – GAAP
Under US – GAAP construction revenue
recognition and balance sheet assets/liability
amounts could be similar, but much depends
on the entity specific detailed accounting
policies.
UK – GAAP
Both IAS 11 and SSAP 9 stocks and long
term contracts use ‘percentage of
completion’ method to recognize revenue
and expenses. IAS 11 uses the method
where the outcome of the contract can be
estimated reliably, SSAP 9 implies the use of
more prudence recognizing ‘prudently
calculated attributable profit’.
CONTRACT ACCOUNT
Contract account is the branch account of
cost accounting rather then general
accounting.
A contract is an undertaking to do certain
work. The work is done for a third party who
agrees to pay a fixed sum of money at the
completion of full work or part payment after
the work is completed partially and being
certified.
PARTIES INVOLVED
Contractor: The person who undertakes to do
work.
Contractee: The person for whom work is
done.
CONTRACT PRICE
Another important thing in contract business
is the contract price. It is the price at which
the contractor agrees to execute the
contract. The price is usually fixed and
agreed upon in advance. It is generally paid
on the completion of the contract.
PAYMENT OF CONTRACT PRICE
In case of small contracts, the contracteepays the contract price on the completion of work.
In case of large contracts, where the completion is expected to take several years , progress payment is adopted.
A certain percentage of the full contract price is retained as security for due performance of whole contract, that amount is known as retention money.
DEBIT SIDE OF CONTRACT ACCOUNT
Direct material
Direct wages
Other direct expenses
Cost of depreciation of plants and tools used
Indirect expenses
Establishment charges
INCOMPLETE CONTRACTS
There are some contract which take several
years for completion. At the end of the financial
year they may be found incomplete. The special
problems that arise from incomplete contracts
are:
Should the contractee pay any cash to
contractor?
Should profit be calculated on in completed
contracts?
Should the value of the work done be estimated
and shown in the balance sheet?
CLASSES OF INCOMPLETE CONTRACTS
Incomplete contracts that have made little
progress
Incomplete contracts that have made
appreciable progress
Nearly completed contracts
CERTIFIED AND UNCERTIFIED WORK
Work done and is certified is certified work
work certified a/c
to contract a/c
Work done but not certified is uncertified work
work uncertified a/c
to contract a/c