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    lesson

    Copyright:

    © All Rights Reserved
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    11 views20 pages

    LTCC

    Uploaded by

    Cm
    lesson

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
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    hE CF Pe Permit TCE) ene Long term construction contracts are construction projects that extend thru more than one accounting period. Usually, these are construction projects for the government. Example of these projects is the construction of water dams, bridges, flyover, and the metro railway transit. On many long term construction projects, the buyer and seller (contractor) agree in. advance on the contract price. In agreeing to the contract price, the construction company must have some reasonable basis for estimating the cost to be incurred under the contract so as to assure a. satisfactory return, In agreeing to perform the contract work, the construction compary must {eel that the probability of collecting the contract price. from the buyer is sufficiently high to warrant the investment of capital and labor services. Under these conditions, the criteria for revenue recognition are met prior fo completion of the Contract, Recognition of revenue during the period of construction is therefore justified in most cases. This chapter will discuss the accounting procedures to vietermine the revenue to be recognized each year of construction. Construction Contract PAS 11 defines construction contract as contract specifically negotiated for the ‘bination of assets that are closely interrelated or construction of an asset or a. com? t are interdependent in terms of their design. technology or their ultimate purpose or use. Construction contract may be classified into: . Fleed Price sract Thisisa construction contact in which the contractor poset Pree Contract price, or finer per unitof ops, which in Some eriesis subject to cost escalation clauses. _ : i ate +t. This is a construction contract in which the contractor is Contrac! * Cost Plus forallowablear otherwise defined cos plus a percentage of these costs or a fixed fee. a7 378 See z Contract Revenue ‘evenue from term i is measured at the fair vah -term construction contracts is meas 7 . der oa aaa Morreale This include the initial amount of considerat UE Of thy inthecontract.Thisamount may increase or decease ffom one period oth next tomer may agree to change the Scope of the work t be : ‘ bein comet Such as, changes in the specifications, design feat and changes in the duration of the contract. ; b, The amount oftevenue agreed may increase as result ofcost escalation 6. Theamount of contract revenue may decrease asa result of penalties ar “from delays caused by the contractor in the completion of the contractor a. When the contac price invlvesa fixed price per unit of output, contact tae increases.as the number of units is increased. + Construction revenue may also include incentive payments to the. contractor foreaty completion ofthe contract when the contract i sufficiently advanced that itis probable that the specified 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: relate directly to the sj contract activity in general and can be allocated t chargeable o the customer under the temns of the are: ipecific contract; are: attributable to (the contract; and are specifically ‘contract. Examples of contract: costs Depreciation of plant and equipment used on the contract. ; Costs of moving plant, “quipment and materials to and from the contract site. Costs of hiring plant and equipment Costs of design and technical assistance. The estimated costs 1 of rectifcati including expe ae ‘Catton and guarantee work, including: Claims from third parties Insurance rome empapep Construction overheads feneral administrative costs — at is specified in the terme ofthecony opment costs for which reimbursem Long Term Construction Contracts (PAS 11) 379 ‘Types of Contract Costs, Contract costs can be broken down into two categ to be broke te sured to date legories: costs inct date and Costs incurred to date. These include precontract costs and costs incurred 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: 1. They are capable of being identified separately. 2. They can be measured reliably. 3. Itis probable that the contract will be obtained. Precontract costs include costs of architectural designs, cost of securing the contract, and any other costs that are expected to be recovered if the contract is accepted. Contract costs incurred after the acceptance of the contractare costs incurred toward the completion of the project and are also capitalized in the Construction in Progress (ClP) account. The contract does not have tobe idemified before the capitalization itis only necessary that there be an expectation ofthe recovery ofthe costs. Once the contract has been accepted, the precontract costs become contract costs incurred to tae. However, if the precontract costs are already recognized as an expense in the period in which they are incurred, they are not included in contract costs when the contract is obtained in a subsequent period. Estimated costs to complete. These are the anticipated cost of materials, labor, subcontracting costs, and indirect costs (overhead) required to complete a project ata Scheduled time. They are composed of the same clementsas the original total estimated contract costs and would be based on prices expected to be in effect when the costs are incurred. The latest estimates should be used to determine the progress toward ‘completion. Accounting for contract. costs is similar to accounting for inventory. Costs as incurred would be recorded in the Construction in Progress account. Construction in Progress account would include general and administrative €xPer identifiable with a particular contract ‘oth direct and indirect costs but would usually nor include ges or selling expenses since they are not normally and should therefore be expensed. 1’ 380 ion projects, the principal contractor will hire other con Taihiiese s ee of the construction project. This Process at subcontracting, The subcontractor may have important technical skills ot po by the principal contractor. The amount billed to the principal contractor or ea by the subcontractor should be included in contract costs. The amount billed isinet traceable to the project and would be included in the CIP account, Similar to ding materials and direct labor, Cost of Materials Purchased in Advance of Their Use Construction materials may be purchased several weeks or Months before Combining and Segmenting Contracts For accounting purposes, a group of contracts may be combined if they are so closely related that they are, in substance, parts of a: single project with an. overall profit margin A group of contracts, whether with asingle customer or with several: ‘Customers, should be combined and treated as a Single contract if the group of contracts 1. Arenegotiated asa Single package 2.” Require such closely interrelated construction activities that they are, ineffect, Part of asingle project with an overall Profit margin, 3. Are performed Concurrently or in acontinuous. sequence Segmenting acontract is a Process of breaking up a larger unit into smaller units for Fins Purposes. Ifthe project ig scemented, revenues can be assigned to the different elements or phases, loachieve different Tates of profitability based on the relative value of each element or Phase to the estimated total contract Tevenue. A contract may rae rntlerefttels. Thecenat a on ofeach asset should be treated as a separie construction, ‘contract when 1. The contractor has submitted separate Proposals on the separate componeit of the project, 2. Ea i ich asset has been Subject to Separate negotiati the contractor and fe Botiation and the contractor seuomer had the right loaccept or reject Part of the proposal relating to single Long Term Construction Contracts (PAS 11) 381 Se Computation and Recognition of Construction Revenue Ce nce f revenue eamed is particularly difficult in the area oflong- mm consi cts. Even if the revenue is collectible and eamed through ie eee naj ail tartic eamed and the related costs associated withthe Der oed each scvmtine be determinable. The amount of revenue and expenses eet ene pei during the production procssriate 0 the degree finishing the project. Project and to the remaining costs and effort to be incurred in ‘Two basic methods are used to account for long-t : + the percentage-of-completion method and ene ae Percentage-of-Completion Method. This method is to be used when the outcome of the Srnerre contract can be estimated reliably, that is, the estimate of costs to ov a eee of progress toward completion of long-term contracts are Under this method, gross profit is recognized as construction progresses. In practice, contractors use two basic methods to measure the progress ofthe ‘construction. 1. Input measures (cost to cost method). This method is used if the contract calls for one large project rather than several separate projects. Under this tnethod the degree of completion is determined by computing the ratio of the costs already incurred to the total estimated costs to complete the project. The percentage of completion is then applied tothe estimated gross profit (contract price less total estimated costs) to determine the goss profito be recognized Fodate, Some ofthe costs incurred, particularly in the early stages of the contract should be excluded in using this method, because’ they do not relate directly to the work performed on the contract. These include such items as payments ‘subcontractors in advance for work that has set to be performed; and fabricated ‘materials that has been delivered to the contract site but not yet installed, used or applied during contract performance, unless the ‘materials have been made specifically for the contract. However, this estimation is required in reporting eeome, regardless of how the percentage of completion is computed. This method is used throughout the chapter. 2. Output measures (units of delivery). The progress is based on the results ohieved. Under this method revenue isrecognized when certain phases of the project are completed and accepted by the buyer: This method is useful in Pro forthe consruction of several condominium units. Inoome recog contocipariculer unitis complcted and delivered and accepted by the buyer although the entire project isnot yet finished. Thus, ifaconstruction company signsa contract for ten condominium units and completes three units at the end Signs amt year and accepted by uhe buyers, then 30% ofthe otal revenue provided under the contract should be recognized 382 s Chepte 5 is protected inthis manner butis unable to make reasonable ess, jee Of eompletion, PAS No. W Tecommends this method. This met described asthe percentage-of-completion method based on a zero profit main this method, revenue is recognized in an amount exactly equal 0 costs incured a reasonable objective estimates ofthe percentage of completion are available Performance during the period is included inthe Statement Of Comprehensivelncom, although the method does not effect net income because revenue and costs nen ars equal The 2eo profit margin approach indicates to financial statement ae the volume of the company’s business while deferring the recognition of gross Profitunn ‘more reliable estimates of the degree of completion can be made. Mlustrative Problem To illustrate the appropriate accounting procedures for the Percentage-of-completion and zero profit methods, assume the following: AMG Construction Company agrees to builda large office building for PG Towers for pate ontraet price of PS,000,000. PG Towers will make annual peyrmeninee AMG Pitthe amounts ofthese payments cannot exceed the direct costs poet by AMG. The contract is signed on October 1, 2014 and AMG's year-end December31. The term riPf vides PG witha final inspection right to ensure compliance widvirec uae, separ edt © accepting the completed project. Illustration 9-1 below gives further information about the contract, Mlustration 9-1 Total contraci price 5,000,000 Total anticipated costs (at 10/2014) hem 2014 2015 2016 ~_Toral Cost incurred ‘each year P1350.000 2.250.000 —_pgo,000 Ps,000000 Estimated costs, ° to complete (at year-end) 3,150,000 - . Progress billings bie each year 400,000 2,000,000 2,600,000 Progress paymems . Feceived each year 275,000 i *Since the contract was com i i ‘Sit pleted and accepted in 2016, the buyer paid the remaining balance of the total contract amount, computed as follows: Contract amount Prior progress payment oe =“ : P 275,000 2,100,000 _ 2375000 Remaining balance 2,625,000 The computation of the gross profitto be realized for each year under the two methods are presented below: Mustration 9-2, Percentage-of-Completion Method 2014 2015 : 2016 (1) Total contract price 5,000,000 5,000,000 (2) Cost incurred to date 1,350,000 4,000,000 G) Estimated costs to complete 3,150,000 = (4) Total estimated costs 4,500,000 4,000,000 (5) Expected gross profit 500,000 1,000,000 Multiply by the percentage ‘of completion (2+4) 30% 0% 100% Gross profit earned to date 150,000 900,000 1,000,000 Less: Gross profit earned in prior years - 150,000 900,000 Gross profit earned this year _B 150.000 _P_750,000 —_P_100.000 Zero Profit Method 2014 2015 2016 Construction Revenues 1,350,000 2,250,000 1,400,000 ‘Cost incurred each year 1,350,000 _2,250,000 ___400,000 Gross profit earned this year P Se = _P1,000,000 384 Cheer y Tnngemputation in Ilustration 9-2 shows thatthe ony difference between the hon isto Methods Tact, Both methods ultimate ‘ihe timing of the recognition of gross profit oa the contract ata recognition ofthe mane ul eat ‘of gross profit, P1,000,000. tte ‘ted that under the percentage of completion method, comet pee competion is computed sae coy rae percent rd as Profit which willalso vary a revised estihaes ofexpenses made). The difference between the cumulative 055 profi and the gross Previous year(s) isthe current year's gross prof renee broftmethod th recognition of profs deferred Lntil the project is com, re Treen cae aka ‘Costs incurred to date in 2014 and 201 «1° O™Pleted, by Alternative Procedure The realize the formula computed using a rC—™r—”—_ 2013 2016 Contract Price 5,000,000 P5,000,000 5.000000 Multiply by percentage of completion 30% se Te¥ised estimate of ge is applied oe Cost © be incuredt rot recognized in gt 4 £f0Ss profit under the percentage of completion method may also be below: 90% 100% Value of contract eamed 1,500,000 4,500,000 5,000,009 Less: Cost incurred to date 1;350,000, 3,600,000 4,000,000, Gross profit earned to date 150,000 900,000 1,000.00 ‘88: Gross profit eared in prior years - 150,000 000 Gross profit earned this year P 150,000 the costs incurred each the contract, 1,000,000 completion. 4. On the other hand revenue is recognized ach year by debiti the. Hion in Progress account, under the percentage, of completion method Wiens contacts vonplces i oe eustomer has ben fully billed, {he amount in the Construct in Progress account (actu total costs incurre Plus cumulative incor 1e. i - accom Ce Billings me recognized) should ‘be equal to the amount (contract price) 5 The Construction in Project accent Jeet both methods is removed from the books ay and it i, ther closing he rene crediting Construction in Progress account ‘Companies may employ acco unt titles and contai i procedures ‘Mlustrated here are representative of a "womeiod, Nt MRO vraons, but the Long Term Construction Contracts (PAS 11) = an Mustration 9-3 ‘Comparison of Zero Profit Method and Percentage-of-Completion Journal Entries Fourval Enrica ercenage-of | : Zero Profit Method ‘Completion ‘Date Event Accounts Dr. Cr. Dr. Ge. 2014 1 Contmct Signed No enrymeesy to record conract commimen 21.Coms Icured —Consnction a Progress 1,350.00 1.380.000 Cash 350,000 1,350,000 3 Propest Billings Accounts Recenoble 400.000 400,000 Cone Blige 400.000 «00,000 4 Biting Colecions Cash 273.000 173,000 diecvors Mesintie 273,000 275.000 5 Revenue Recognition Conaructonn Proes - 10000 Cost of Coutrcion 1,380,000 1.330,000 Contrection vem 1.350.000 1,300,000 2015 6 Cons cured Contin tn Progress 2,250,000 2.250.000 Cash 2.250.000 2.250.000 1 Progess Bilings Accounts Recenable 2,000,000 2,000,000 ° ‘Coniract Billings 2,000,000 2,000,000 8 biting Coletins Cash 2,100,000 2,100,000 “ecouts Receivable 2,100,000 2.100.000 9 Revenve Recaption Constracion im Progress 70,000 Ce opCouircron 2250, 2.380.000 Coutruction Revere 2.280.000 4,000,000 2016 10 Cons Incomes Contraction m Progress 400,000 400,000 ar 400,000 400,000 1 Press Bilings Accounts Recesmle 7,600,000 2.600.000 " a Contract Billings 2,600,000 2,600,000 Collections Cash 2.625.000 2.423.000 he ‘Account Receivable 2,625,000 2,623,000 _ ion Comircin m Progress 1,000,000 100.000 1 Reve een Coe of Comicon +00,000 400.000 Coxrecton Revert 1,400,000 500.000 - conrec mags 3.000.000 1.000.000 Meteor st Cee rma seen sasasse 386 Mustration 9-4 Zero Profit Method Construction in Progress ACCOUNS Receive Cun 3) 400,000] 295 0 -P2L400,000 } 275,099 ( 27sem [soa ay razon T2509 | 22 8) 2,100,000 |2.280,000 (6) Eee (2) 2,000,000 | 2,100,099 (12) 2,628,000 [1,400,000 (10) (6) 2.250,0 £12-2.00.000 Hie ane 4) wnn.sonseo| 12) 400.000.000.000 (14) 112,600,000 | 269596 {131,000900 2.625.000 Perse 000.000 | 50007000 = = BR Contract Billings Construction Revenue Cost of Construction 400,060 (3) 4,350,000 (5) (5) 1,350,000 400,000 2,250,000 (9) (9) 2,250,000 2,000,000 7) 4,400,000 (13) (13) "450,000 2,400,000 (15) 5.000.000 2,600,000 «11) —_ 5.000006 | 5,000,000 — Percentage of Completion Method Cash Construction in Progress Account Rectvabe () 275,00011.380,000 (2) (2) 1,380,000 2_400.000} 275000 a (8) 2.100.000 2,250,000 (6) (5) ‘Is0.v00 125.000 (12) 2.625,000|1,400.000 (10) “Tinos $2 2,000,000 | 2,100,000 « (6) 2,250,000 2.125.000 | 2,100,000 9) 730:000 25,000 4500.00 112,600,000 | 2,625,000 12) (10) 400.000|5,000,000 c4y {1113690.000 25,000 | 2,625,000 _ 60.000 =— 5,000,000 | 900-65 ==.000.000 | 00,005 — Contract Billings Construction Revenve Cost of Construction oe 400,000 $$00.000 (5) (5) 1,350,000 Fae : 2.000.009 (9) (9) 250,000 5.000, 00 Ferre 13) 13) "450,000 2.640.000 (14 (24 5.000.000 5000-000 SS aa ong Term Construction Contracts (PAS 11) 387 eee FINANCIAL STATEMENT PRESENTATION ‘The resulting financial statement : [lustration 9-5 below: t presentation for both methods are summarized in Mustration 9-5 Comparison of Zero Profit Method Financial Statement Presentation {and Percentageof-Completion Method December 3 Tole Decener 3 3015 Deemer 3 7016 oie Percentage ‘Percentage dar rat af daar tee oe hed Completion Method Completion Method Completion Statement of Financial Position ‘Accounts Receivable 125,000 125,000 25,000 25,000 — Inventory —_ —— Construction in ae 1,350,000 1,500,000 3,600,000 4,500,000 0 -0- Contract Billings 400,000 2,400. 000 -0- <0 Excess "950,000 1.100.000 200,000 2,100,000 ~0- =0- Statement of Compreh Construction Revenue Cost of Construction 2,250,000 3,000,000 1,400.00 2'250,000 400.000 750,000 1,000,000 Gross Margin 1,300,000 350.000 150,000 Inthe above illustration, the excess ‘of the Construction in Progress account over: ‘the Contract Billings is treated as a ‘current asset (due from customer). ‘The “current” classification of this item is based ‘onthe operating cycle definition. Anasset iscurrent if itis expected to be used, consumed or converted into cash within the next year (or operating cycle, ifthe cycle exceed one Yyear), The period of the accounting cycle for Jong-term: ‘contracts which frequently exceeds one year is typically used to ‘identify current assets. If the contract provide in Progress account could be less than difference is presented as a current lial riate title. othe percentage-of-completion method is preferable when reasonably dependable esti ape te degree of completion can be made Pecavs describes the company’s ainsaetions and events more clearly and more timely than does the zero profit method. ‘The percentage-of-completion method

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