AC316 Accounting for Special Transactions

ASSIGNMENT 3: Long Term Construction Contracts - Explore on:

PFRS 15 OR IFRS 15: REVENUE FRO CONTRACTS WITH

CUSTOMER
● IFRS 15 specifies how and when an IFRS reporter will recognize revenue as well
as requiring such entities to provide users of financial statements with more
informative, relevant disclosures. The standard provides a single, principles based
five-step model to be applied to all contracts with customers.
 Construction Contract
A construction contract is a contract specifically negotiated for the construction
of an assets or a combination of asset that are closely interrelated or
interdependent in terms of their design, technology and function or their
ultimate purpose or use.
❖ Nature and Scope
A construction contract is one for a substantial asset like a bridge, a building
an aerospace, a dam, a ship, or a tunnel. Such contracts are like to extend
over more than accounting period, and rules are needed to determine when
the profit on them can be taken.
Property Developers and Construction Companies are typical for their
contracts with customers of a long-term nature. The biggest challenge is to
decide whether the company should recognize revenue over time (spread
during individual years of construction) or at the point of time (one-time at the
completion of a contract).
 Types of Construction Contract
1) Fixed Price Contract is a contract in which the contractor agrees to a
fixed price but subject to cost escalation clauses.
2) Cost plus Contract is a construction contract in which the contractor
reimbursed for allowable or other defined cost plus a percentage of these
cost or a fixed fee.
 Criteria
A company recognizes revenue over time if at least one of the following 2
criteria met:
1. Company’s performance creates or enhances an asset that the
customer controls as the asset is created or enhanced
2. Company’s performance does not create an asset with an alternative
use, in addition at least one of the following criteria must be met:

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 a) The customer simultaneously receives and consumes the benefits
of the entity’s performance as the entity performs.
b) Another company would not need to substantially re-perform the
work the company has completed to date if that other company
were to fulfill the remaining obligation to the customer.
c) The company has a right to payment for its performance
completed to date, and if expect to fulfill the contract as promised.
❖ Accounting Method
 Percentage of Completion (Over Time)
1) Output Method are made in terms of results achieved.
2) Input Method are made in relation to the cost or efforts devoted to a
contract.
 Cost Recovery Method or Zero-Profit Approach (At a point in time)
It is used when the contract’s outcome cannot be reliably estimated.
1) Recognized revenue only to the extent of contract cost incurred
which are expected to be recoverable.
2) Recognize contract costs as an expense in the period they are
incurred.

❖ Application - Standards, Methods, and Accounting for Installment

Sales (Give Illustrative Example)
✔ Applicable Standard: PFRS 15 or IFRS 15
✔ Formula:

Cost Incurred to Date

Percentage Complete =
✔
✔
Total Estimate Cost (Most Recent)
✔

✔ Accounting Methods: Percentage of Completion and Cost Recovery

Method or Zero-Profit Approach
✔ Illustrative Example: (Percentage of Completion: Input Method)
ZAS Construction Company has a fixed price contract to build a bridge.
The initial amount of revenue agreed is PHP 1,000,000. At the beginning of
the contract on January 1, 2021 the initial estimate of the construction cost
is PHP 400,000. By the end of 2021 the estimate of the total cost has risen
to PHP 800,000.
During 2022 the customer agrees to a variation with increases expected
revenue from the contract by PHP 100,000 and causes additional cost of
PHP 50,000. At the end of 2022 there are material stored on site for use
which cost PHP 15,000 during the period.

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 ZAS Construction Company has decided to determine the stage of
completion of the contract by calculating the proportion that contract costs
incurred for work to date bear to the latest estimated total contract cost.
The contract cost incurred at the end of each year (cost incurred to date),
billings and collection for each year were as follows:

Year Direct and Allocate Cost to Date Billings Collections

2021 PHP 200,000 PHP 300,000 PHP 200,000
2022 PHP 652,500 (including materials) PHP 600,000 PHP 590,000
2023 PHP 850,000 PHP 200,000 PHP 310,000

2021 2022 2023

Contract Price:
Initial amount of Contract PHP 1,000,000 PHP 1,000,000 PHP 1,000,000
Variation - PHP 100,000 PHP 100,000
Total Contract Price PHP 1,000,000 PHP 1,100,000 PHP 1,100,000
Cost Incurred each year PHP 200,0000 PHP 452,500 PHP 197,500
Add: Cost Incurred in Prior Year - PHP 200,000 PHP 652,500
Actual Cost Incurred to date PHP 200,000 PHP 652,500 PHP 850,000
Add: Estimated Cost to Complete PHP 600,000 PHP 197,500 -
Total Estimated Cost PHP 800,000 PHP 850,000 PHP 850,000
Estimated Gross Profit PHP 200,000 PHP 250,000 PHP 250,000
Percentage of Completion 25% 75% 100%
Realized Gross Profit (Loss) PHP 50,000 PHP 187,500 PHP 250,000

Recognized in Recognized in
2021 To Date
Prior Years Current Year
Revenue PHP 250,000 - PHP 250,000
Cost/Expenses PHP 200,000 - PHP 200,000
Gross Profit PHP 50,000 - PHP 50,000
2022 To Date Recognized in Recognized in
Prior Years Current Year
Revenue PHP 825,000 PHP 250,000 PHP 575,000
Cost/Expenses PHP 637,500 PHP 200,000 PHP 437,500
Gross Profit PHP 187,500 PHP 50,000 PHP 137,500
2023 To Date Recognized in Recognized in
Prior Years Current Year

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 Revenue PHP 1,100,000 PHP 825,000 PHP 275,000
Cost/Expenses PHP 850,000 PHP 637,500 PHP 212,500
Gross Profit PHP 250,000 PHP 187,500 PHP 62,500

Journal Entry:

2021

Construction In Progress 200,000

Cash or Payables, etc. 200,000

To record cost incurred

Accounts Receivable 300,000

Progress Billings 300,000

To record progress billings

Cash 200,000

Accounts Receivable 200,000

To record collections

Construction Expense 200,000

Construction Progress 50,000

Revenue from Construction 250,000

To recognized revenue, cost and gross profit

2022

Construction In Progress 437,500

Materials Inventory 15,000

Cash or Payables, etc. 452,500

To record cost incurred

Accounts Receivable 600,000

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 Progress Billings 600,000

To record progress billings

Cash 590,000

Accounts Receivable 590,000

To record collections

Construction Expense 437,500

Construction Progress 137,500

Revenue from Construction 575,000

To recognized revenue, cost and gross profit

2023

Construction In Progress 212,500

Materials Inventory 15,000

Cash or Payables, etc. 197,500

To record cost incurred

Accounts Receivable 200,000

Progress Billings 200,000

To record progress billings

Cash 310,000

Accounts Receivable 310,000

To record collections

Construction Expense 212,500

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 Construction Progress 62,500

Revenue from Construction 275,000

To recognized revenue, cost and gross profit

Progress Billings 1,100,000

Constructions in Progress 1,100,000

To close construction in progress and progress billings account.

✔ Illustrative Example: (Percentage of Completion: Output Method)

On January 1, 2021, Zerna enters into a contract with a customer to
construct a building for consideration of PHP 10,000,000. The contract is
expected to take 2 years to complete. On December 31, 2021, Zerna has
incurred cost of PHP 2,400,000. Cost to complete are 2,000,000. In
addition to this cost, Ambo purchased plan to be used on the contract at a
cost of PHP 1,600,000. This plant was purchased on January 1, 2021 and
will have no residual value at the end of the 2-year contract. Depreciation
on the plant is to be allocated on a straight-line basis across the contract.
On December 31, 2021, the value of the work certified was PHP
4,500,000 and the customer had paid PHP 3,000,000. Zerna measures
progress on contract using an output method, based on the value of work
certified to date which is 45%.
On December 31, 2022, Zerna has incurred cost of PHP 5,500,000. The
customer had paid PHP 7,000,000. Zerna measures progress on contract
using an output method, based on the value of work certified to date which
is 80%.

2021
Contract Price PHP 10,000,000
Cost Incurred each year PHP 2,400,000
Add: Costs incurred in prior years -
Actual Cost Incurred to date PHP 2,400,000
Add: Estimated Cost to Complete
Cost to complete PHP 2,000,000
Add: Plant Asset (2-year life) PHP 1,600,000 PHP 3,600,000
Total Estimated Cost PHP 6,000,000
Estimated Gross Profit PHP 4,000,000

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Percentage of Completion 45%
Recognized Gross Profit PHP 1,800,000

Recognized in Recognized in
2021 To Date
Prior Years Current Year
Revenue PHP 4,500,000 - PHP 4,500,000
Cost/Expenses PHP 2,700,000 - PHP 2,700,000
Gross Profit PHP 1,800,000 - PHP 1,800,000

2022
Contract Price PHP 10,000,000
Cost Incurred each year PHP 5,000,000
Add: Costs incurred in prior years PHP 2,400,000
Actual Cost Incurred to date PHP 7,400,000
Add: Estimated Cost to Complete
Cost to complete -
Add: Plant Asset (2-year life) - -
Total Estimated Cost PHP 7,400,000
Estimated Gross Profit PHP 2,600,000
Percentage of Completion 100%
Recognized Gross Profit PHP 2,600,000

Recognized in Recognized in
2022 To Date
Prior Years Current Year
Revenue PHP 10,000,000 PHP 4,500,000 PHP 5,500,000
Cost/Expenses PHP 7,400,000 PHP 2,700,000 PHP 4,700,000
Gross Profit PHP 2,600,000 PHP 1,800,000 PHP 800,000

✔ Illustrative Example: (Cost Recovery Method/ Zero-Profit Approach)

Assuming the same facts given for ZAS Construction Company except at
the beginning and end of 2021 and also in 2022 the contractor cannot
estimate the outcome of the contract with sufficient reliability to estimate
the project’s percentage-of-completion (because of the uncertainties
arising from the new design and new materials the entity cannot estimate
total expected contract cost with sufficient reliability). It is likely to received
the contract price from the customer. However, it is probable that the cost
incurred in 2021 and 2022 will be recoverable. The contract was

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 completed in 2023. The following table shows the data need for further
analysis:
Year Direct and Allocate Cost to Date Billings Collections
2021 PHP 200,000 PHP 300,000 PHP 200,000
2022 PHP 652,500 (including materials) PHP 600,000 PHP 590,000
2023 PHP 850,000 PHP 200,000 PHP 310,000

2021 2022 2023

Contract Price:
Initial amount of Contract PHP 1,000,000 PHP 1,000,000 PHP 1,000,000
Variation - PHP 100,000 PHP 100,000
Total Contract Price PHP 1,000,000 PHP 1,100,000 PHP 1,100,000
Cost Incurred each year PHP 200,0000 PHP 452,500 PHP 197,500
Add: Cost Incurred in Prior Year - PHP 200,000 PHP 652,500
Actual Cost Incurred to date PHP 200,000 PHP 652,500 PHP 850,000
Add: Estimated Cost to Complete - - -
Total Estimated Cost PHP 800,000 PHP 850,000 PHP 850,000
Estimated Gross Profit PHP 200,000 PHP 250,000 PHP 250,000
Percentage of Completion - - 100%
Realized Gross Profit (Loss) - - PHP 250,000

Recognized in Recognized in
2021 To Date
Prior Years Current Year
Revenue PHP 200,000 - PHP 200,000
Cost/Expenses PHP 200,000 - PHP 200,000
Gross Profit PHP 0 - PHP 0
2022 To Date Recognized in Recognized in
Prior Years Current Year
Revenue PHP 637,500 PHP 200,000 PHP 437,500
Cost/Expenses PHP 637,500 PHP 200,000 PHP 437,500
Gross Profit PHP 0 PHP 0 PHP 0
2023 To Date Recognized in Recognized in
Prior Years Current Year
Revenue PHP 1,100,000 PHP 637,500 PHP 462,500
Cost/Expenses PHP 850,000 PHP 637,500 PHP 212,500
Gross Profit PHP 250,000 PHP 0 PHP 250,000

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Journal Entry:

2021

Construction In Progress 200,000

Cash or Payables, etc. 200,000

To record cost incurred

Accounts Receivable 300,000

Progress Billings 300,000

To record progress billings

Cash 200,000

Accounts Receivable 200,000

To record collections

Construction Expense 200,000

Revenue from Construction 200,000

To recognized revenue, cost and gross profit

2022

Construction In Progress 437,500

Materials Inventory 15,000

Cash or Payables, etc. 452,500

To record cost incurred

Accounts Receivable 600,000

Progress Billings 600,000

To record progress billings

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Cash 590,000

Accounts Receivable 590,000

To record collections

Construction Expense 437,500

Revenue from Construction 437,500

To recognized revenue, cost and gross profit

2023

Construction In Progress 212,500

Materials Inventory 15,000

Cash or Payables, etc. 197,500

To record cost incurred

Accounts Receivable 200,000

Progress Billings 200,000

To record progress billings

Cash 310,000

Accounts Receivable 310,000

To record collections

Construction Expense 212,500

Construction Progress 250,000

Revenue from Construction 462,500

To recognized revenue, cost and gross profit

Progress Billings 1,100,000

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 Constructions in Progress 1,100,000

To close construction in progress and progress billings account.

END

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