IAS 11

Construction contracts

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 1
Why IAS 11-Construction Contracts

The period of execution of most construction contracts

extends to more than one accounting period,
therefore the primary issue in accounting for
construction contracts is the allocation of contract
revenue and contract cost to the accounting period
in which the construction work is performed.

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved. IAS 11 - 2
Definitions

A construction contract is ...

... 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 or their
ultimate purpose or use.

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 3
Construction Contracts

Classification

Fixed Price Contracts Cost plus Contracts

Contractor and customer Contractor is reimbursed for
agreed to allowable or otherwise
a fixed price or defined costs plus
a fixed rate per unit of a percentage of these
output costs or a fixed fees

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 4
IAS 11 - 4
Segmenting Construction Contracts

When a contract covers a number of assets, the

construction of each asset should be treated as a
separate construction contract when:
Separate proposals have been submitted for each
asset;
Each asset has been subject to separate negotiation
with the possibility of separate rejection; and
Costs and revenues of each asset can be identified

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 5
IAS 11 - 5
Combining Construction Contracts

A group of contracts should be treated as a single

construction contract when:
The group of contracts is negotiated as a single
package;
The contracts are so closely interrelated that they are,
in effect, part of a single project with an overall profit
margin; and
The contracts are performed concurrently or in a
continuous sequence

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 6
IAS 11 - 6
Additional asset – customer option

A contract to construct an additional asset at the

option of the customer should be separated when:
The additional asset differs significantly in design,
technology or function from the asset(s) covered by
the original contract; or
The price of the additional asset is negotiated without
regard to the original contract price

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 7
IAS 11 - 7
Contract Revenue

Contract revenue comprises:

The initial amount of revenue agreed in the contract
Variations: Instruction for a change in the scope of the
work
Claims: Amount that the contractor seeks to collect
from the customer
Incentive Payment: Additional amounts paid to the
contractor if specified performance standards are met
Contract revenue is measured at the fair value of the
consideration received or receivable

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 8
IAS 11 - 8
Contract Costs

Contract costs comprise:

Costs that relate directly to the specific contract or that
are attributable to contract activity in general
Such costs that are chargeable to the customer under
the terms of the contract
Cost incurred to secure the contract are attributed to
contract costs

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 9
IAS 11 - 9
Costs Excluded from Contract Costs

The following costs cannot be attributed to contract

costs and are excluded:
General administration cost for which reimbursement
is not specified in the contract
Selling costs
R&D costs for which reimbursement is not specified in
the contract
Depreciation of idle plant and equipment that is not
used on a particular contract

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 10
IAS 11 - 10
Reliable Measurement of Revenue and Costs

When the outcome of a construction contract can be

estimated reliably, the contract revenues and contract
costs are recognised by reference to the stage of
completion
An expected loss should be recognised as an expense
immediately

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 11
IAS 11 - 11
Reliable Measurement of Revenue and Costs

Fixed price contract: Cost plus contract:

total contract revenue probable that economic
measurable reliably benefits will flow to the
probable that economic entity
benefits will flow to the contract costs (whether or
entity not specifically
contract costs and stage of reimbursable) clearly
completion measurable identifiable/measurable
reliably
contract costs clearly
identifiable/measurable:
actual vs. estimates

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 12
IAS 11 - 12
No Reliable Measurement of Revenue and
Costs

When the outcome of a construction contract cannot be

estimated reliably:
revenue should be recognised only to the extent of
contract costs incurred that it is probable will be
recoverable
contract costs should be recognised as an expense in
the period in which they are incurred
An expected loss should be recognised as an expense
immediately

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 13
IAS 11 - 13
Stage of Completion (1)

The stage of completion can be determined in a variety

of ways. Depending on the nature of the contract, the
methods may include:
the proportion that contract costs incurred for work
performed to date bear to the estimated total contract
costs
surveys of work performed
completion of a physical proportion of the contract
work

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 14
IAS 11 - 14
Stage of Completion (2)

In most cases the stage of completion is determined by

reference to the costs already incurred compared to the
total costs
Revenue of the period:
Costs incurred * Total revenues – PRR
Total costs
(PRR=Previously Recognised Revenue)

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 15
IAS 11 - 15
Recognition of Contract Revenue and
Expenses – Example (1)

ABC enters into a contract to build a road for $ 90 million.

ABC‘s initial estimate of contract costs is $ 74 million.
The contract starts early in 20x2
If, at the end of 20x2, ABC can estimate reliably the
outcome of the contract, it recognises revenue and
expenses by reference to the stage of completion of the
contract activity. Therefore, if the contract is half
completed, ABC recognises revenue of $ 45 million and
expenses of $ 37 million. The assessment that half the
contract is completed would normally be made by one
half the costs being incurred, that is $ 37 million

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 16
IAS 11 - 16
Example 1

Year1 Year2
Contract Amount 90 90
Cost incurred to date 37 74
Total estimated cost 74 74
% of completion 50% 100%

Revenue recognized 45 45 (90- 45)

Cost recognized (37) (37) (74- 37)
Gross profit 8 8

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 17
IAS 11 - 17
Recognition of Contract Revenue and
Expenses.

On the other hand, if at the end of 20x2, ABC is unable to

estimate reliably the outcome of the contract but has
incurred costs of $ 30 million which it is probable will be
recovered, ABC recognises revenue of $30 million and
expenses of $30 million

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 18
IAS 11 - 18
Recognition of contract revenue and expenses
Subsequent change in estimates-Example 2

Assume that ABC has been able reliably to estimate its costs and
expenses for 20X2 and has recorded revenue of $45 million and
expenses of $37 million by reference to stage of completion (costs
incurred method)

In 20X3 ABC’s total costs incurred are $74 million. The estimated total
contract costs to build the road are now $80 million, therefore the
contract will be finished during 20X4

Using a consistent stage of completion method, A will record revenue

of (74/80 * 90) – 45 = $38.25 million

A will record profit in 20X3 of $1.25 million (revenue $38.25 million,

costs $37 million) compared with a profit of $8 million in 20X2. The
increase in total contract costs is not attributed to 20X2, but recognised
in 20X3 (cumulative
and a member firm of KPMG catch
International, aup)
© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,
Swiss cooperative. All rights reserved.
IAS 11 - 19
IAS 11 - 19
 Example 2

Y1 Y2 Y3
Contract amount 90 90 90

Cost incurred 37 74 80
Total est. cost 74 80 80
% of completion 50% 92.5% 100%

Rev. recognized 45 38.25 6.75

Cost recognized (37) (37) (6)
Gross profit 8 1.25 0.75

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 20
IAS 11 - 20
Expected Losses – Example (3)

ABC enters into a contract to build a road for $ 90 million.

ABC‘s initial estimate of contract costs is $ 74 million.
The contract starts early in 20x2 and will be finished at
the end of 20x3
Before the contract starts, expected costs increase to $
95 million, with no increase in contract revenue. ABC has
to recognise the expected loss of $ 5 million immediately
Cost incurred during 20x2 is 37

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 21
IAS 11 - 21
Example 3

Y1 Y2
Contract amount 90 90
Cost incurred 37 95
Total est. cost 95 95
loss=5

% of completion 39% 100%

Rev. recognized 35 55
Cost recognized (40) (55)
Gross profit/(loss) (5) -

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 22
IAS 11 - 22
Presentation (1)

An entity presents the gross amount due from customers

as an asset which is the net amount of:
costs incurred plus recognised profits; less
the sum of recognised losses and progress billings
for all contracts in progress for which costs incurred plus
recognised profits (losses) exceed progress billings

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 23
IAS 11 - 23
Presentation (2)

An entity presents the gross amount due to customers as

a liability which is the net amount of:
costs incurred plus recognised profits; less
the sum of recognised losses and progress billings,
for all contracts in progress for which progress billings
exceed costs incurred plus recognised profits (losses)

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 24
IAS 11 - 24
Disclosure (1)

Amount of contract revenue recognised as revenue in the

period
Methods used to determine the contract revenue
recognised in the period
Methods used to determine the stage of completion of
contracts in progress

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 25
IAS 11 - 25
Disclosure (2)

For contracts in progress:

Aggregate amount of cost incurred and recognised
profits (less recognised losses) to date
Amount of advances received
Amount of retentions

© 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee,

and a member firm of KPMG International, a Swiss cooperative. All rights reserved.
IAS 11 - 26
IAS 11 - 26