11 Global Konstrukshen

Tutor's hint. Calculate profit or loss on the contract and cost of sales comes out as a balancing figure. You
can then work out the accrued cost of sales and accrued future losses.

(a) Alpine bypass World Ecology centre

$'000 $'000
Turnover 2,800 3,000
Profit/(loss) (W) 622 (100)
Cost of sales 2,178 3,100
Current assets
Amount recoverable on contract (2,800 – 2,600) 200 –
Current liabilities
Payment on account (3,400 – 3,000) – (400)
Accrued cost of sales (2,178 – 1,400) (778) –
Accrued future losses (3,100 – 2,900) – (200)
2,800
(W) Alpine: (9,000 – (1,400 + 5,600) = 622
9,000
World Ecology: 8,000 – (2,900 + 5,200) = 100
(b) Construction contracts are recognised as such when they cover at least two accounting periods. If
they were not to be treated as they are under IAS 11 then the costs incurred during the early years
of the contract would be recognised but with no corresponding turnover. This would lead to several
years of losses then one year of high profits regardless of how profitable the contract really was.
The advantage of this approach however would be that there would be no need to use estimates
and forecasts.
The current treatment matches an element of the turnover to the costs incurred. There is an
attempt to maintain prudence by ensuring that any foreseeable losses are accounted for
immediately. This gives a fairer representation of the underlying financial substance of the
transaction and makes it easier for the user of the accounts to assess the financial position of the
company.

12 Provisions
Tutor's hint. A good knowledge of IAS 37 is needed in this question. Do not disregard the discounting
aspects, these calculations are quite straightforward as you are given the formulae in the exam.

(a) Why there was a need for an accounting standard dealing with provisions
IAS 37 Provisions, contingent liabilities and contingent assets was issued to prevent entities from
using provisions for creative accounting. It was common for entities to recognise material
provisions for items such as future losses, restructuring costs or even expected future expenditure
on repairs and maintenance of assets. These could be combined in one large provision (sometimes
known as the 'big bath'). Although these provisions reduced profits in the period in which they
were recognised (and were often separately disclosed on grounds of materiality), they were then
released to enhance profits in subsequent periods. To make matters worse, provisions were often
recognised where there was no firm commitment to incur expenditure. For example, an entity
might set up a provision for restructuring costs and then withdraw from the plan, leaving the
provision available for profit smoothing.

526 Exam answer bank