Long Term Construction Contracts

Construction Contract
- 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
and function of their ultimate purpose or use

Types:
1. Fixed Price Contract: 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 methods

2. Cost Plus Contract: the contractor is reimbursed for allowable or otherwise defined
costs, plus a percentage of these costs

Contract Revenue
1. The initial amount of revenue agreed in the contract
2. Variations in contract work, claims and incentive payments

Contract Costs
1. Costs specifically related to the contract
2. Costs that are attributable to contract activity and can be allocated to the contract
3. Other costs that are specifically chargeable to the customer under the terms of the contract

Accounting Methods/Procedures for Long Term Construction

1. Percentage of Completion Method
o Used when the outcome of construction could be estimated reliably
o Revenue and costs are recognized based on the percentage of completion
o Types:
 Input Measures/Cost to Cost Method
 Output Measure

2. Cost Recovery Method/Zero Profit Method

o Used when the outcome of the construction cannot be estimated reliably
o Revenue recognized to the extent of the contract costs

Recognition of Expected Losses

- If total contract costs exceed the total contract revenue, the expected loss should be
recognized immediately
- Requires the recognition of loss on onerous contract

Changes in Estimate
- Change in the contract costs and contract revenue shall be treated as a change in
accounting estimate (prospectively)

Financial Statement Presentation

- Contract asset: Total Revenue exceeds Total Billings
- Contract liability: Total Billings exceeds Total Revenue
Problems

1. Champ Incorporated accepted a contract to construct an expressway from Brgy. Quiling

Sur to Brgy Tabug in the City of Batac for 50 million. Construction began on 2018 and was
completed in 2020. Data with respect to this contract were as follows:
2018 2019 2020
Costs incurred 9 million 19 million 2 million
Estimated costs to complete 21 million 7 million ---
Determine the amount of revenue and the realized gross profit for the year 2018, 2019
and 2020 under the Percentage of Completion Method and the Cost Recovery Method

2. Cee Construction Company enters into a contract to build a 20-story building in 2018 for
100 million. Construction was completed on 2020. Information with respect to this contract
were as follows:
2018 2019 2020
Costs incurred 20 million 43 million 32 million
Estimated costs at completion 80 million 105 million ---
Determine the amount of revenue and the realized gross profit for the year 2018, 2019
and 2020 using the percentage of completion method and the Cost Recovery Method.

3. Neo Construction Incorporated agreed to construct a building costing 100 million on 2018.
On 2019, it was agreed to add one more floor to the contract initially entered thus
increasing the contract price to 110 million. The project was completed in 2020. Data with
respect to this construction were as follows:
2018 2019 2020
Costs incurred to date 28 million 66.3 million 92 million
Estimated costs to complete 52 million 18.7 million ---
Determine the Realized Gross Profit for the year 2018, 2019 and 2020 using the
Percentage of Completion Method and the Cost Recovery Method

4. Clay Inc. entered into an agreement to construct a bridge connecting the Island of
Bacucang and the City of Batac at a contract price for 80 million the construction was
started on 2018 and would be completed in 2020. Data with respect to this contract were
as follows:
2018 2019 2020
Costs incurred each year 13 million 18.5 million 33 million
Estimated costs to complete 52 million 38.5 million ---
Billings per year 15 million 25 million 40 million
Determine the amount of contract asset or contract liability to be presented in the
statement of financial position with respect to this construction for the year 2018, 2019
and 2020 under the Percentage of Completion and Cost Recovery Method.