Construction Contracts: Chapter 10A

Chapter 10A
Construction Contracts
© 2008-16 Nelson Lam and Peter Lau Intermediate Financial Reporting: An IFRS Perspective (Chapter 10A) - 1
Agenda
1. Applicable Standard and Scope

2. Combining and Segmenting Construction
Contracts
3. What Is Contract Revenue?
4. What Are Contract Costs?
5. Recognition of Contract Revenue and Expenses
6. Recognition of Expected Losses
7. Changes in Estimates
8. Disclosure
1. Applicable Standard and Scope
• IAS 11 Construction Contracts prescribes the accounting treatment of
revenue and costs associated with construction contracts for annual
periods beginning before 1 January 2018.
• Contractors are required to account for their construction contracts in

the financial statements for such periods in accordance with IAS 11.
• Because the dates of commencement and completion of the contract

activity usually fall into different accounting periods,
– the primary issue is how to allocate contract revenue and contract costs to
the accounting periods in which the construction work is performed.
• IAS 11 uses the recognition criteria established in the Framework for

the Preparation and Presentation of Financial Statements.
Contracts
• An entity is required to apply IAS 11 to
– the separately identifiable components of a single
contract or
– a group of contracts together in order to reflect the
substance of a contract or a group of contracts
Contracts
• When a contract covers a number of assets,
an entity will treat the construction of each asset as a
separate construction contract if all the following three
conditions are satisfied:
1. separate proposals have been submitted for each asset;
2. each asset has been subject to separate negotiation and
the contractor and customer have been able to accept or
reject that part of the contract relating to each asset; and
3. the costs and revenues of each asset can be identified.
Contracts
• An entity treats a group of contracts, whether with a
single customer or with several customers, as a single
construction contract when all the following three
conditions are satisfied:
1. the group of contracts is negotiated as a single package;
2. the contracts are so closely interrelated that they are, in
effect, part of a single project with an overall profit margin;
and
3. the contracts are performed concurrently or in a
continuous sequence.
Contracts
• Construction of the additional asset is treated as a
separate construction contract when:
– the asset differs significantly in design, technology or

function from the asset or assets covered by the original
contract; or
– the price of the asset is negotiated without regard to the

original contract price.
• Contract revenue comprises:

– the initial amount of revenue agreed in the contract;
and
– variations in contract work, claims and incentive
payments
• to the extent that it is probable that they will result in
revenue; and
• they are capable of being reliably measured.
• An entity includes a variation in contract revenue

when:
– it is probable that the customer will approve the variation

as well as the amount of revenue arising from the
variation
and
– the amount of revenue can be reliably measured
Example 10A.4
• The contract has a cost escalation clause for adjusting the

fixed contract price of $100 million to general inflation rate
announced by the government.
• The government has announced the general inflation for the
current period is 3%.
• Determine the amount of contract revenue to be increased
or decreased for the current period.
Answers
• The amount of contract revenue to be increased for the
current period is:
$100 million X 3% = $3 million
• An entity includes a claim in contract revenue only

when:
– negotiations have reached an advanced stage such that

it is probable that the customer will accept the claim
and
– the amount of the claim can be measured reliably
Example 10A.5
• The contract has a penalty clause for delays caused by the

contractor in the completion of the contract.
• The initial amount of revenue agreed in the contract is $30
million.
• The penalty is agreed to be $20,000 per day of delay.
• Due to the contractor’s problem, the completion date of the
contract was 10 days after the agreed deadline.
• Determine the amount of contract revenue to be increased
or decreased.
Answers
• The amount of contract revenue to be decreased is
$20,000 X 10 = $200,000
• An entity includes an incentive payment in contract

revenue when:
– the contract is sufficiently advanced that it is probable

that the specified performance standards will be met or
exceeded
and
– the amount of the incentive payment can be measured

reliably.
Example 10A.6
• Power has won a contract to construct a building for $50
million.
• The contract allows for an incentive payment of $20,000 per
day up to a maximum of $500,000 to Power for early
completion of the contract.
• The construction of the building is at the completion stage
and it is probable that the contract will be completed eight
days before the agreed completion date.
• Determine the amount of incentive payment to be included

in Power’s contract revenue.
Example 10A.6
Answers
• The construction of the building is at the completion stage
and it is probable that the specified performance standards
(early completion) will be met.
• The amount of the incentive payment can also be measured

reliably to be $20,000 per day up to a maximum of
$500,000.
• The amount of incentive payment to be included in Power’s

contract revenue is $160,000 ($20,000 per day X 8 days)
FigureFigure
10A.2 Elements
10.2 ofContract
Elements of Contract Costs
Costs
Contract Costs
Costs directly Attributable costs Costs specifically

related to the allocated to the chargeable to the
specific contract specific contract customer
• Costs that relate directly to the specific contract may be

reduced by any incidental income that is not included in
contract revenue.
• Costs that may be attributable to contract activity in general

and can be allocated to specific contracts include:
– insurance;
– costs of design and technical assistance that is not
directly related to a specific contract; and
– construction overheads.
• Costs that are specifically chargeable to the

customer under the terms of the contract may
include some general administration costs and
development costs for which reimbursement is
specified in the terms of the contract.
• Contract costs include the costs attributable to a

contract for the period from the date of securing
the contract to the final completion of the contract.
5. Recognition of Contract Revenue and
Expenses
Outcome of contract
estimated reliably?
( Section 10A.5.1 ) no
yes
Percentage of
completion method Recognise Recognise
( Section 10A.5.2 ) revenue to the contract costs
extent contract as an expense
cost incurred are when incurred
probably ( Section
recoverable 10A.5.3 )
(Section
Match revenue and Recognise expected 10A.5.3 )
cost up to stage of loss immediately
completion ( Section 10A.6 )
( Section 10A.5.2 )
Expenses
When Outcome of Contract Can Be Estimated Reliably
• recognises contract revenue and contract costs associated
with the construction contract as revenue and expenses
respectively by reference to
– the stage of completion of the contract activity
– at the end of the reporting period
Expenses
• In the case of a fixed price contract, the outcome of a
construction contract can be estimated reliably when all the
following conditions are satisfied:
– total contract revenue can be measured reliably;
– it is probable that the economic benefits associated with the
contract will flow to the entity;
– both the contract costs to complete the contract and the stage of
contract completion at the end of the reporting period can be
measured reliably; and
– the contract costs attributable to the contract can be clearly
identified and measured reliably so that actual contract costs
incurred can be compared with prior estimates.
Expenses
• In the case of a cost plus contract, the outcome of a
construction contract can be estimated reliably when all the
following conditions are satisfied:
– it is probable that the economic benefits associated with the
contract will flow to the entity; and
– the contract costs attributable to the contract, whether or not
specifically reimbursable, can be clearly identified and measured
reliably.
Expenses
Percentage of Completion Method
• contract revenue is matched with the contract costs incurred
in reaching the stage of completion,
– resulting in the reporting of revenue, expenses and profit
which can be attributed to the proportion of work completed
• The stage of completion of a contract may be determined in
a variety of ways:
– the proportion of contract costs incurred for work performed
to date to the estimated total contract costs (see Example
10A.9);
– surveys of work performed; or
– completion of a physical proportion of the contract work.
Expenses Example 10A.9
The percentage of completion method
• A construction contractor has obtained a fixed price contract

from the Hong Kong Government for $9,000 million to build
a bridge between Hong Kong and City A on Mainland China.
• The initial amount of revenue agreed in the contract is
$9,000 million. The contractor's initial estimate of contract
costs is $8,000 million. It will take 3 years to build the
bridge.
• By the end of Year 1, the contractor's estimate of contract
costs has increased to $8,050 million.
• In Year 2, the Hong Kong Government approves a variation

resulting in an increase in contract revenue of $200 million
and estimated additional contract costs of $150 million.
• At the end of Year 2, costs incurred include $100 million for

standard materials stored at the site to be used in Year 3 to
complete the project.
• The contractor determines the stage of completion of the

contract by calculating the proportion that contract costs
incurred for work performed to date bear to the latest
estimated total contract costs.
•　
A summary of the financial data during the construction
period is as follows:
　 Year 1 $'m Year 2 $'m Year 3 $'m
Initial amount of revenue agreed in contract 9,000 9,000 9,000
Variation - 200 200
Total contract revenue 9,000 9,200 9,200
Contract costs incurred to date 2,093 6,168 8,200
Contract costs to complete 5,957 2,032 -
Total estimated contract costs 8,050 8,200 8,200
Estimated profit 950 1,000 1,000
Stage of completion 26% 74% 100%
• The stage of completion for Year 2 (74%) is determined by

excluding from contract costs incurred for work performed to
date the $100 million of standard materials stored at the site
for use in Year 3.
Required:
• Calculate the amounts of revenue, expenses and profit
recognized in the statement of comprehensive income for
each of Year 1, 2 and 3 using the percentage of completion
method.
• Prepare journal entries to account for the contract revenues
and expenses for Year 1.
　 To Date $'m Recognised in Recognised in
Answers prior years $'m current year $'m
Year 1 　　　
Revenue (9,000 x 0.26) 2,340 - 2,340
Expenses (8,050 x 0.26) 2,093 - 2,093
Profit 247 - 247
Year 2 　　　
Revenue (9,200 x 0.74) 6,808 2,340 4,468
Expenses (8,200 x 0.74) 6,068 2,093 3,975
Profit 740 247 493
Year 3 　　　
Revenue (9,200 x 1.00) 9,200 6,808 2,392
Expenses 8,200 6,068 2,132
Profit 1,000 740 260
Answers
• For Year 1, the following journal entries should be recorded
by the contractor:
Dr Contract expenses $2,093

Cr Cash or Accounts payable $2,093
To recognise the contract expenses for Year 1.
Dr Cash or Due from customers $2,340

Cr Contract revenue $2,340
To recognise the contract revenue for Year 1.
Expenses
When Outcome of Contract Cannot Be Estimated Reliably
– revenue shall be recognized only to the extent of
contract costs incurred that it is probable will be
recoverable
– contract costs shall be recognized as an expense in the
period in which they are incurred
– contract costs that are not probable of being recovered
are recognized as an expense immediately
• Contract costs that are not probable of being recovered

include contracts:
– which are not fully enforceable
– the completion of which is subject to the outcome of
pending litigation or legislation
– relating to properties that are likely to be condemned or
expropriated
– where the customer is unable to meet its obligations
– where the contractor is unable to complete the contract
or otherwise meet its obligations under the contract
6. Recognition of Expected Losses
• When it is probable that total contract costs will

exceed total contract revenue,
– an entity recognizes the expected loss as an expense
immediately.
• The amount of expected loss is determined
irrespective of:
– whether work has commenced on the contract;
– the stage of completion of contract activity; or
– the amount of profits expected to arise on other
contracts which are not treated as a single construction
contract
7. Changes in Estimates
• An entity accounts for

– the effect of a change in the estimate of contract
revenue or contract costs, or
– the effect of a change in the estimate on the outcome of
a contract
as a change in accounting estimate
8. Disclosure
• An entity is required to disclose:

– the amount of contract revenue recognized as revenue
in the period;
– the methods used to determine the contract revenue
recognized in the period; and
– the methods used to determine the stage of completion
of contracts in progress.
8. Disclosure
• An entity is also required to disclose each of the

following for contracts in progress at the end of the
reporting period:
– the aggregate amount of costs incurred and recognized
profits (less recognized losses) to date;
– the amount of advances received; and
– the amount of retentions.
8. Disclosure
• An entity should also present:

 the gross amount due from customers for contract work
as an asset, which is the net amount of:
• costs incurred plus recognized profits; less
• the sum of recognized losses and progress billings
for all contracts in progress for which costs incurred

plus recognized profits (less recognized losses)
exceeds progress billings.
8. Disclosure
 The gross amount due to customers for contract work

as a liability, which is the net amount of:
• costs incurred plus recognized profits; less
• the sum of recognized losses and progress billings
for all contracts in progress for which progress billings

exceed costs incurred plus recognized profits (less
recognized losses)
Chapter 10A
Construction Contracts

Construction Contracts: Chapter 10A

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Chapter 10A

1. Applicable Standard and Scope

• Contractors are required to account for their construction contracts in

• Because the dates of commencement and completion of the contract

• IAS 11 uses the recognition criteria established in the Framework for

– the asset differs significantly in design, technology or

– the price of the asset is negotiated without regard to the

• Contract revenue comprises:

• An entity includes a variation in contract revenue

– it is probable that the customer will approve the variation

• The contract has a cost escalation clause for adjusting the

• An entity includes a claim in contract revenue only

– negotiations have reached an advanced stage such that

• The contract has a penalty clause for delays caused by the

• An entity includes an incentive payment in contract

– the contract is sufficiently advanced that it is probable

– the amount of the incentive payment can be measured

• Determine the amount of incentive payment to be included

• The amount of the incentive payment can also be measured

• The amount of incentive payment to be included in Power’s

Costs directly Attributable costs Costs specifically

• Costs that relate directly to the specific contract may be

• Costs that may be attributable to contract activity in general

• Costs that are specifically chargeable to the

• Contract costs include the costs attributable to a

The percentage of completion method

• A construction contractor has obtained a fixed price contract

• In Year 2, the Hong Kong Government approves a variation

• At the end of Year 2, costs incurred include $100 million for

• The contractor determines the stage of completion of the

Initial amount of revenue agreed in contract 9,000 9,000 9,000

Variation - 200 200

Total contract revenue 9,000 9,200 9,200

Contract costs incurred to date 2,093 6,168 8,200

Contract costs to complete 5,957 2,032 -

Total estimated contract costs 8,050 8,200 8,200

Estimated profit 950 1,000 1,000

Stage of completion 26% 74% 100%

• The stage of completion for Year 2 (74%) is determined by

Revenue (9,000 x 0.26) 2,340 - 2,340

Expenses (8,050 x 0.26) 2,093 - 2,093

Profit 247 - 247

Revenue (9,200 x 0.74) 6,808 2,340 4,468

Expenses (8,200 x 0.74) 6,068 2,093 3,975

Profit 740 247 493

Revenue (9,200 x 1.00) 9,200 6,808 2,392

Expenses 8,200 6,068 2,132

Profit 1,000 740 260

Dr Contract expenses $2,093

Dr Cash or Due from customers $2,340

• Contract costs that are not probable of being recovered

• When it is probable that total contract costs will

• An entity accounts for

• An entity is required to disclose:

• An entity is also required to disclose each of the

• An entity should also present:

• costs incurred plus recognized profits; less

• the sum of recognized losses and progress billings

for all contracts in progress for which costs incurred

 The gross amount due to customers for contract work

• costs incurred plus recognized profits; less

• the sum of recognized losses and progress billings

for all contracts in progress for which progress billings