Construction Contracts

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Introduction
Learning outcomes
1. Define a construction contract as per
CONSTRUCTION
CONTRACTS
IAS 11
2.
3.
4.
5.
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IAS 11 CONSTRUCTION CONTRACTS
IAS11
Calculate contract revenue
Calculate contract costs
Explain how to recognize profit on
construction contract
Prepare financial statement extracts
for disclosure of construction contracts
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Definition of a construction
contract
There are two types of contracts

1. Fixed price contract-the contractor agrees
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. E g construction of schools
to a fixed contract price, or a fixed rate per

unit of output, which in some cases is subject
to cost escalation clauses
2. Cost plus contract-the contractor is
reimbursed for allowable or otherwise defined
costs, plus a percentage of these costs or a
fixed fee
,roads
the contract activity starts in one financial
period and ends in another.

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Measuring Contract Revenue
Measuring Contract Costs
The initial amount of revenue is the agreed
Costs that relate directly to the specific
e contract plus
Variations in contract work and claims to
be added if
- it is probable that they will result in
revenue
- they are capable of being reliably measured
- Penalties arising from delays reduce the
contract price
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Types of Contracts
IAS 11 defines a construction contract as a
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contract(Material, labour)
Costs that are attributable to contract
activity in general and can be allocated

to the contract.
Such other costs as are specifically
chargeable to the customer under the
terms of the contract
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Recognition of contract revenue

and expenses
Recognition of contract revenue

and expenses
In long term contracts, revenue is

recognize prior to delivery of goods
or services
Recognize revenue in the accounting periods in

which the work is performed
Recognize an expense in the accounting period in
which the work to which they relate is performed
Any expected excess of total contract costs over
total contract revenue should be recognized as an
expense immediately
The stage of completion of the contract is used to
determine the allocation of revenue and costs
The objective is to show financial

statement users the economic
activity of the company during the
period being reported
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Determining the
stage of completion of a contract
Determining the stage of

completion of a contract
The percentage of completion method is
IAS 11 indicates several ways in which the
an application of the accruals

assumption.
Contract revenue is matched to the
contract costs incurred in reaching the
stage of completion,
Revenue, costs and profit are attributed
to the proportion of work completed.
percentage of completion
may be
arrived at:
1. proportion of costs incurred compared
estimated total contract costs.
2. 2.Survey
of
work performed ;
proportion of work certified to date
compared to total revenue
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2.Survey of work performed
total contract costs.

Percentage of completion =Costs to date
Total costs
The total cost should be the most recent
estimate(include additional costs if any)
10

1. proportion that contract costs incurred to
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% of completion =Work certified to date

Total contract price
Note: the work certified to date can

also be represented by billings to
date
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Question
1.
Solution a
In January 2007 CC Construction Company was

awarded a contract to construct a clinic with a total
price of K6, 000,000. Total cost for the contract were
estimated to be K5, 200,000.The contract was
completed over a 3 year period. The cost data for the
contract is given below
% completion =Costs to date

Total costs
2007
2008
2009
Cost to date 2,080,000 3,900,000 5,200,000
Total cost
5,200,000 5,200,000 5,200,000
% of completion 40 %
75%
100%
Year
2007
2008
2009
Cost incurred (K) 2,080,000
1,820,000
1,300,000
Billings
2,000,000
1,800,000
2,200,000
(work certified)
Collections
1,600,000 1,700,000
2,700,000
a) Calculate the percentage of completion if the company uses
the cost incurred to total cost method
b)Calculate the percentage of completion if the company uses
the cost incurred to total cost method
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Solution b
Work certified to date
Cost incurred to date
Revenue and gross profit
Revenue & gross profit just
2009
33%
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3,800,000
6000,000
63%
6000,000
6000,000
100%
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recognized at the point of sell

as work certified is billed
Advantages
Reported revenue is based on
final result not estimates
Disadvantage
It does not reflect current
performance when period of
the contract covers more
than 1 accounting period
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Determining revenue for the

period
Revenue for period=

% of completion total contract value, )revenue taken in previous periods.
estimated basing on costs

incurred
Advantages
reflect current performance
when period of the contract
covers more than 1
accounting period
Disadvantage
Reported revenue is based on
estimates not final result
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Journal Entry for Revenue
Total contract price less revenue

recognised in previous period
multiplied by % of completion found
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14
Comparison of the two methods
% of completion =Work certified to date

Year
2007
2008
work certified
Billings
2,000,000
Contract price 6000,000
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for each periods revenues

Dr A/C receivable
Cr revenue
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Question
Solution
In January 2007 CC Construction Company was awarded

a contract to construct a clinic with a total price of K6,
000,000. Total cost for the contract were estimated to
be K5, 200,000.The contract was completed over a 3 year
period. The cost data for the contract is given below
Year
2007
2008
2009
Cost incurred (K)
2,080,000
1,820,000
1,300,000
Billings
2,000,000
1,800,000
2,200,000
Collections
1,600,000 1,700,000
2,700,000
b) Calculate the revenue to be recognized in each of
the years ( use cost to date %)
1.
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Revenue for period=

(% to completion total contract value, )- revenue
taken in previous periods
2007
(0.4x 6m)-0
2,400,000
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for each periods cost

Dr contract cost a/c
Cr
cash/accounts
payable/inventory
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Question
Year
2007
2008
2009
Cost incurred (K)
2,080,000
1,820,000
1,300,000
Billings
2,000,000
1,800,000
2,200,000
Collections
1,600,000 1,700,000
2,700,000
c) Calculate the cost to be recognized in each of the
years
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22
Solution
1.
Journal Entry for Revenue
Total contract costs % of completion

X
Less any costs charged in previous periods (X)
Add foreseeable losses in full
(not previously charged)
X
Cost of sales on contract for the period
XX
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2009
(6mx1)-(2.4+2.1)
1,500,000
For each year Dr A/C receivable Cr revenue
Determining Cost for the period
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2008
( 6m x0.75)-2.4m
2,100,000
2007
2008
2009
total Cost 5,200,000 5,200,000 5,200,000
% complete 40%
75%
100%
Cost
2,080,000 3,900,000 5,200,000
Recognized
previously
(0 )
(2,080,000) (3,900,000)
Cost
this year
2,080,000 1,820,000
1,300,000
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Recognition of Contract profit
Recognition of Contract profit
1. Profit expected Revenue ,costs and profits
Any contract is expected to have any of

the 3 outcomes
taken according to stage of completion
1. Profit expected
2. Loss expected-Revenue taken according to
2. Loss expected
stage of completion, sufficient cost taken to

result in whole loss being recognized
3. Outcome cant be measured reliablyRevenue taken equal to recoverable costs
incurred
3. Out come cant be measured reliably

(especially at the beginning of
contract)
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Steps in profit recognition
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Question 1d
Step 1 forecast the profit/loss

Step 2 calculate % of completion
Calculate the profit to be recognized in each of the
years for the CCC project above
Step 3 multiply % of completion

to revenue and costs according
to profit recognizing rules
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solution
Question 2
1 forecast profit(6,000-5,200)= 800

2.% of completion (calculated above)
3.Cost and revenue (calculated above)
2007
2008
2009
Revenue
2,400,000
2,100,000 1,500,000
Costs
(2,080,000) (1,820,000) (1,300,000)
Profit
320,000
280,000
200,000
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CC Co is a civil engineering company. It started work on 4 road construction projects during the year
ended 31 December 2011. The following figures relate to those projects at the end of the reporting
period.
1
Contract price
9,000
8,000
3,420
2,000
Costs incurred
1,400
2,900
2,700
950
5,600
5,500
450
600
certified to date
2,800
3,600
2,280
1,000
Progress billings
2,600
3,400
1,750
1,150
Estimated costs
To completion
Value of work
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Question 2
Solution
CC accrues profit on its construction contracts using the

percentage of completion derived from the sales
earned as work certified compared to the total sales
value. Project 4 is in its initial stage so its difficult to
ascertain the stage of completion reliably
Required
Basing on IAS 11 Construction contracts ,calculate the
figures which would be recognized in the income
statement and in the statement of financial position
of CC Company in respect of these four road
Projects.(24 marks)
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Step 1 forecast the profit/loss

Profit/loss =Total revenue-Total cost
1
2
price
Total cost
Profit
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Solution
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4
2,000
1,550
450
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Step 3 multiply % of completion to revenue and costs

according to profit recognizing rules
%
31%
45%
67%
?
1
2
3
4
Revenue 2,790
3,600 2,291
1,550
Cost
2,108
4,000 2,111
1,550
682
(400) 180
0
Contract 2 all loss recognize
Contract 4 revenue up to costs incurred
Contract 1,3 stage of completion
4
1,000
2,000
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Calculating Asset /Liability
1. Gross
amount
due
from
customers represent an assetAccounts receivable
2. Gross amount due to customers
represent a liability- Deferred
income or unearned revenue
3
3,420
3,150
270
Solution
Recognition of Contract Asset

/Liability
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8,000
8,400
(400)
Note total cost =cost incured+cost to completion
Step 2 calculate % of completion

% of completion =Work certified
1
2
3
certified
2,800 3,600
2,280
Price
9,000 8,000
3,420
31%
45%
67%
9,000
6,800
2,200
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The calculation (which may result in an asset or
liability is:
Costs incurred to date
X
Add recognized profit
X
Less recognized lose
(X)
Less progress billing
(X)
Add bills not paid
X
Gross amount due to/from customer (X) X
Note: This represents unbilled revenue. Which will
be shown under
trade receivables
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Calculating Asset /Liability
Question
The amount shown as an asset could

include
Calculate Asset /liability for quastion2
Progress billing not yet paid

Contract costs relating to future
activity such as inventory of goods on
site not yet billed to the customer
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Solution2

Year
2007
2008
2009
Cost incurred (K)
2,080,000
1,820,000
1,300,000
Billings
2,000,000
1,800,000
2,200,000
Collections
1,600,000 1,700,000
2,700,000
Calculate the asset/liability to be recognized in each
of the years
2007
39
2008
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Change in the estimate
2009
In an event that the contract is revised

by changing the cost or price the
changes should be incorporated in the
year affected
Costs incurred to date 2,080 3,900

5,200
Add recognized profit 320 600
800
0
0
0
(2,000) ( 3,800) ( 6,000)
Add bills not paid
400
500
0
Gross amount due
8,00
1,200
0
Note amounts are cumulative SFP
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1.
Add recognized profit

682
180
0
(400)
Less progress billing (2,600 ) (3,400) (1,750) ( 1,150 )
Gross amount due
(518)
(900)
1,130 (200)
Solution
Question 1e
Calculate Asset / liability for question 2

1
2
3
4
Costs incurre
to date
1,400 2,900 2,700 950
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Disclosure in financial statements
Disclosure in financial statements
Income Statement
Statement of Financial Position
Revenue
Costs
Profit or loss
Calculated according to the rules given
above.(stage of completion)
Note :only Revenue and costs for the
period under review
Costs incurred to date

Add recognised profit
Less recognised lose
Gross amount due to/from customer
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Gross amount due from customers asset

Gross amount due to customers liability
Calculated as
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X
X
(X)
(X)
Steps in answering Questions
1. Calculate the total revenue and

total cost if not given
2. Calculate the stage of completion.
3 Revenue
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4. Calculate the cost of
sales on the contract

for the period.
Total contract costs percentage complete
(or follow instructions in question)
X
Less any costs charged in previous periods (X)
Add foreseeable losses in full
(not previously charged)
X
Cost of sales on contract for the period
XX
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for project
Using the percentage completed to date (or
other formula given in the question),
calculate sales revenue attributable to
the contract for the period ( percentage
complete total contract value, less
revenue taken in previous periods).
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5. Deduct the cost of sales for the period as

calculated above (including any foreseeable
loss)
from the sales revenue calculated at step 3
to give profit (loss) recognized for the
period.
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6.Calculate amounts due to/from customers as per
the working below
Contract costs incurred to date
X
Recognised profits/(losses) to date
X
Progress billings to date
(X)
Add bills not paid
X
Amounts due from/(to) customers
X
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Any questions
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50

Construction Contracts

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Construction Contracts

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8/14/2014

1. Define a construction contract as per

IAS 11 CONSTRUCTION CONTRACTS

There are two types of contracts

contract specifically negotiated for the

to a fixed contract price, or a fixed rate per

the contract activity starts in one financial

period and ends in another.

IAS 11 CONSTRUCTION CONTRACTS

Measuring Contract Revenue

Measuring Contract Costs

The initial amount of revenue is the agreed

Costs that relate directly to the specific

IAS 11 CONSTRUCTION CONTRACTS

IAS 11 defines a construction contract as a

IAS 11 CONSTRUCTION CONTRACTS

activity in general and can be allocated

IAS 11 CONSTRUCTION CONTRACTS

Recognition of contract revenue

Recognition of contract revenue

In long term contracts, revenue is

Recognize revenue in the accounting periods in

The objective is to show financial

IAS 11 CONSTRUCTION CONTRACTS

IAS 11 CONSTRUCTION CONTRACTS

Determining the stage of

The percentage of completion method is

IAS 11 indicates several ways in which the

an application of the accruals

IAS 11 CONSTRUCTION CONTRACTS

Determining the stage of

2.Survey of work performed

total contract costs.

IAS 11 CONSTRUCTION CONTRACTS

Determining the stage of

1. proportion that contract costs incurred to

IAS 11 CONSTRUCTION CONTRACTS

% of completion =Work certified to date

Note: the work certified to date can

IAS 11 CONSTRUCTION CONTRACTS

In January 2007 CC Construction Company was

% completion =Costs to date

IAS 11 CONSTRUCTION CONTRACTS

Work certified to date

Cost incurred to date

Revenue and gross profit

Revenue & gross profit just

IAS 11 CONSTRUCTION CONTRACTS

recognized at the point of sell

Determining revenue for the

Revenue for period=

IAS 11 CONSTRUCTION CONTRACTS

estimated basing on costs

IAS 11 CONSTRUCTION CONTRACTS

Journal Entry for Revenue

Total contract price less revenue

Comparison of the two methods

% of completion =Work certified to date

IAS 11 CONSTRUCTION CONTRACTS

for each periods revenues

IAS 11 CONSTRUCTION CONTRACTS

In January 2007 CC Construction Company was awarded

IAS 11 CONSTRUCTION CONTRACTS