CHAPTER

BLUE NOTES
55 S
L
Construction Accounting
A contract specifically negotiated for the construction of an asset or a combination of assets that are closely
interrelated or interdependent in terms of their design, technology or their ultimate purpose or use.

2 types of construction contract

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, which in some cases are subject to cost escalation clauses.
Cost plus Contract is a construction contract in which the contractor is reimbursed for allowance or otherwise defined
costs plus a percentage of these costs or a fixed fee.

Revenue from Construction Contracts

Revenue from long-term construction contracts is measured at the fair value of the consideration received. This
includes the initial amount of revenue agreed in the contract.
This amount shall be adjusted for:
 Change in the scope of the work to be performed under the contract
 Cost escalation clauses which may increase agreed revenue
 Penalties arising from delays which may decrease revenue
 Change in number of units when the contract price involves a fixed price per unit
Note: Revenue from the contract may also include incentive payments to the contractor for early completion of the project when the contract is
sufficiently advanced that it is probable that the specific performance standards will be met or exceeds; and the amount of the incentive
payment can be measured reliably.

Contract Costs
Contract costs are costs that are directly related to the specific contract; are attributable to the contract activity in
general and can be allocated to the contract; and can be allocated to the contract; and are specifically chargeable
to the customer under the terms of the contract.
Types of Contract Costs
(1)Cost incurred to date include precontract costs and costs after contract acceptance. Precontract costs are costs
incurred before a contract has been entered into with the expectation that the contract will be accepted and these
costs will thereby be recoverable through billings. The criteria for recognition of such costs are:
a. They are capable of being identified separately
b. They can be measured reliably
c. It is probable that the contract will be obtained
(2) Costs incurred after acceptance are cost incurred towards the completion of the contract and are also
capitalized as cost of the contract. The contract does not have to be identified before capitalization; it is only necessary
that there be an expectation of the recovery of costs. However, if precontract costs are already recognized as expense
in the period in which they are incurred, they are not included in the contract costs when the contract is obtained in a
subsequent period.
Subcontractor Costs
Subcontractor costs are incurred when a principal contractor hires other contractors to perform partially in the project.
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The amount paid by the principal contractor to the other contractor shall be included in the contract cost.
Cost of Materials
Costs of materials purchased in advance of their use are only capitalized once used in the construction process.
Therefore, such cost shall be excluded from completion percentage if such costs are not yet put into construction.

Combining and Segmenting Contracts

For accounting purposes, a group of contracts may be combined if they are so closely related that in substance, they
are parts of a single project with an overall profit margin. A group of contracts may be combined if the group of
contracts:
a. Are negotiated as a single package
b. Require such closely interrelated construction activities that they are, in effect, part of a single project with an
overall profit margin
c. Are performed concurrently or in a continuous sequence
For accounting purposes, segmenting contracts is a process of breaking up larger contracts into smaller units. Once the
project is segmented, assignment of revenue shall be based on the relative value of each element or phase to the
estimated total contract revenue. Segmenting of contracts shall be done when:
a. The contractor has submitted separate proposals on the separate component of a project
b. Each asset has been subject to separate negotiation and the contractor and customer had the right to accept
or reject part of the proposal relating to a single asset
c. The cost ad revenues for each asset can be identified separately

Percentage of Completion
Percentage of completion method shall be used when the outcome of the contract can be estimated reliably, that is,
the estimate of costs to complete and the extent of progress towards completion are reasonably dependable. Under
this method, gross profit shall be recognized in relation to the completion of the project. Under this percentage of
completion, measure of completion of a project can be done through:
a. Input measures (cost to cost method). As the name suggest, degree of completion shall be based on ratio of
costs incurred to date to the total estimated cost of completing the project. However, only those costs that are
directly related to the performance of the contract shall be included. This method is applicable for contracts
that are for one large project rather than several separate projects.
b. Output measures (units of delivery). Under this method, revenue is recognized when certain phases of the
project are completed and accepted by the buyer. Income is recognized when a particular unit is completed
and accepted by the buyer.
Zero profit method
Zero profit method is used when no reasonable estimates about the percentage of completion can be made as
recommended by PAS 11. Under this method, revenue shall be recognized in exactly equal amount as to the cost
incurred until reasonable objective estimates of percentage of completion can be made.

Anticipated Losses on Long-term Construction Contracts

Losses on long-term construction occur when total estimated costs of the project exceed the total revenue from the
project. When loss on long-term construction is anticipated, PAS 11 require reporting the loss in its entirety
immediately when the loss is first anticipated. This requirement under PAS 11 is applicable to both zero profit and
percentage of completion method.

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Contract Retention
This is an amount withheld by the client to ensure the completion of the project satisfactorily.
Financial Statement Presentation
The excess of Construction in Progress account over Contract Billings account shall be classified as current asset.
However, if the amount of contract billings is greater the construction in progress, such excess shall be treated as a
current liability.
Contract retention account is classified as current asset in the financial position.

Accounting for Construction Contract

For journal entry purposes under percentage of completion:
 Progress billings are recorded as debit to receivable account and then credited to contract billings.
 Collections are recorded by crediting the whole receivable collected but cash received shall be decreased by
the amount of contract retention which is debited for the difference of cash collection and total receivable
credited.
 Cost incurred every year shall be debited to Construction in Progress. This account is just like work in process
in a manufacturing company, an inventory account.
 For revenue recognition, Construction Revenue shall be recognized for the amount of contract price
proportionately to cost completion. And upon recognition of revenue, cost shall be also recognized for the
amount incurred during the year and the residual amount between revenue and cost shall be either debited or
credited to Construction in Progress Account. With this, in no case shall Construction Revenue to date and
Construction in Progress accounts differ.
For journal entry purposes under zero profit method:
 Just like percentage of completion, progress billings are recorded as debit to receivable account and credited
to contract billings.
 Collections are recorded by crediting the whole receivable collected but cash received shall be decreased by
the amount of contract retention which is debited for the difference of cash collection and total receivable
credited.
 Cost incurred every year shall be debited to Construction in Progress. This account is just like work in process
in a manufacturing company, an inventory account.
 For revenue recognition, Construction Revenue shall be recognized for the amount equal to cost incurred
during the year.

Illustative Problem
Astral Construction Company discloses the following information relating to its construction contract with ABZ
Company.
Year 2011 2012 2013 2014
Contract Price 3, 000, 000 3, 000, 000 3, 000, 000 3, 000, 000
Cost to Date 790, 000 1, 500, 000 2, 250, 000 2, 650, 000
Costs to Complete 1, 580, 000 1, 200, 000 850, 000 -
Progress Billings 900, 000 800, 000 500, 000 800, 000
Bill Collections 500, 000 500, 000 500, 000 1, 500, 000
Contract Retention 10% 10% 10% -
Given the preceding information, computations shall be presented below comparing the percentage of

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completion and zero profit method:

For 2011: For 2012:

Percentage of Completion Method
Contract Price 3, 000, 000 Percentage of Completion Method
Total Estimated Cost: Contract Price 3, 000, 000
Cost to Date 790, 000 Total Estimated Cost:
Costs to Complete 1, 580,000 (2,370,000) Cost to Date 1, 500, 000
Gross Profit 630, 000 Costs to Complete 1, 200,000 (2,700,000)
Gross Profit 300, 000
Zero Profit Method % completed *55.56%
Construction Revenue 710, 000 Gross Profit to date 166, 680
Cost incurred each year 710, 000 GP already recognized (210,000)
Profit/(Loss) 2012 -0- Profit/(Loss) for 2012 (43, 320)
% completed *33.33% Profit/(Loss) for 2011 210, 000
Zero Profit Method
For 2013: Construction Revenue 790, 000
Cost incurred each year 790, 000
Percentage of Completion Method
Profit/(Loss) for 2011 -0-
Contract Price 3, 000, 000
Total Estimated Cost:
Cost to Date 2, 250, 000
Costs to Complete 850,000 (3,100, 000)
Gross Profit (100, 000)
% completed *72.58%
Gross Profit to date (100, 000)
GP already recognized 166, 680
Profit/(Loss) for 2013 (266, 680)
Zero Profit Method
Construction Revenue 3, 000, 000
Cost incurred to date 2, 250, 000
Costs to complete 850, 000
Profit/(Loss) for 2013 (100, 000)

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Financial Statements Presentation:

2011
Percentage of Completion Zero Profit
Statement of Financial Position
Accounts Receivable 400, 000 400, 000

Contract Retention 50, 000 50, 000

Construction in Progress 1, 000, 000 790, 000

Less: Contract Billings 900, 000 900, 000
Current Asset/(Current Liability) 100, 000 (110,000)

Statement of Comprehensive
Income
Construction Revenue 1, 000, 000 790, 000
Less: Cost of Construction 790, 000 790, 000
Gross Margin 210, 000 -0-
The same procedures shall be applied all through out.

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