Ias11

Construction Contracts: IAS 11 COACHING CLASSES FOR PROFESSIONAL STUDENTS

JOIN KHALID AZIZ
ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.
CONTACT:
0322-3385752
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.

Construction Contracts
Related standards
IAS 11
Current GAAP comparisons
IFRS financial statement disclosures
Looking ahead
End-of-chapter practice

Related Standards
HB 3400 Revenue
EIC 78 Construction Contractors—Revenue Recognition when the Percentage of Completion Method is Applicable
EIC 141 Revenue Recognition
EIC 142 Revenue Arrangements with Multiple Deliverables

Related Standards
SAB 104 Revenue Recognition
SOP 81-1 Accounting for Performance of Construction-Type and Certain Production-Type Contracts
CON 6 Elements of Financial Statements

Related Standards
IAS 18 Revenue

IAS 11 – Overview
Objective and scope
Combining and segmenting construction contracts
Contract revenue
Contract costs
Recognition of contract revenue and expenses
Disclosure and presentation

IAS 11 – Objective and Scope
Standard deals with revenue recognition for construction contracts and the special problems embedded in these contracts due to the nature of the arrangement with the customer
Specifically, these types of contracts often have the following unique features:
• Signed up front before work is performed
• Customer billings are stipulated in the contract
• Long term in nature, spanning several reporting periods
• Earnings process is made up of many (often significant) events
IAS 11 builds upon the revenue recognition criteria laid down in the framework and also upon IAS 18 Revenue

IAS 11 – Objective and Scope
The standard provides the following term 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
A fixed price contract is a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit of output, which in some cases is subject to cost escalation clauses
A cost plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee

IAS 11 – Combining and Segmenting Construction Contracts
There may be a need to group or subdivide contracts for accounting purposes and this would depend on how the contract was negotiated
Contracts for construction of several assets would be grouped for accounting purposes if the contracts were:
• Negotiated together
• Closely interrelated, and
• Performed concurrently or in continuous sequence

IAS 11 – Combining and Segmenting Construction Contracts
Contracts covering the construction of several assets would be treated as separate contracts for accounting purposes if:
• Separate proposals were submitted for each individual asset
• Each part of the contract was negotiated as a separate part and
• The revenues and related costs are separable
If the contract includes an option to build an additional asset, the arrangement would be accounted for as a separate contract if the additional asset differs from the rest of the assets or the price is negotiated separately
Grouping or segregating contracts allows the accounting to follow the economic substance of the contract negotiations and ensures that any losses are appropriately recognized

IAS 11 – Contract Revenue
Contract revenues include the amounts originally agreed to in the contract plus variations, claims, and incentive payments that are measurable and probable
Variations, claims, and incentive payments are separately defined in the standard and reflect the differing nature of the revenues
Each has a different point for recognition of revenue.
Although revenues are measured at the fair value of the consideration received or receivable, they may change from period to period
Treated as a change in estimate

IAS 11 – Contract Revenue

IAS 11 – Contract Costs
It is important to identify all costs that are related to the contract in order to measure profit
Sometimes the method used to estimate revenues is based on the costs incurred to date, therefore, if the costs are incorrectly measured, the amount of revenue recognized will be incorrect as well
Contract costs should include costs that are:
• Directly related to the contract (including materials and labour costs, depreciation, and other costs
• Attributable to the contract activity in general (such as insurance, design costs, construction overhead, payroll processing costs, and borrowing costs) and
• Specifically chargeable under the terms of the contract (such as general and administrative costs, development costs)

IAS 11 – Contract Costs
Contract costs may be shown net of incidental income such as income from resale of excess material that may have been ordered
Costs that are attributable to the contract activity may be allocated using systematic and rational allocation methods and must be allocated consistently to all costs that have similar characteristics
Selling costs and depreciation of idle plant and equipment should not be included.
However, costs incurred in securing the contract may be included as long as they can be separately identified and reliably measured and as long as it is probable that the contract will be obtained

IAS 11 – Recognition of Contract Revenue and Expenses
Revenue and costs are recognized when the outcome of the contract can be estimated reliably
Reference is made to the stage of completion of the contract and the calculations are done cumulatively each reporting period
Determining whether the outcome of the contract can be estimated reliably depends on the type of construction contract

In general, the key terms of the contract must be established before an entity can make reliable estimates
Estimates by definition may require adjustment in subsequent periods
The percentage of completion method is used to determine how much revenue should be recognized for fixed price contracts.
For cost plus contracts, the percentage of completion method is not necessary since the amount of revenue recognized each period is equal to the costs expensed plus an agreed upon profit margin or markup

According to IAS 11.30, methods for estimating the stage of completion include the following:
• Estimating the costs incurred to date as a percentage of total estimated
costs (based on inputs to the process)
- Exclude costs relating to future activity on the contract from the
numerator (e.g., supplies yet to be used and advance payments
made to subcontractors)
• Surveys of work performed (based on outputs) or
• Estimating the proportion physically complete, e.g., the number of
kilometres of highway completed (outputs)

As a default, when the outcome of the contract cannot be estimated reliably, costs incurred to date are expensed and equal revenue may be recognized as long as collection is probable
This may be the case for instance in the early stages of a contract. If total costs are likely to exceed total revenues, this excess loss must be recognized
Finally, any costs incurred that are not recoverable must be expensed even if no revenue is recognized
Illustration 8-3 on the proceeding slide shows how revenue and cost recognition changes depending on the likelihood of the outcome

IAS 11 – Disclosure and Presentation
Various disclosures are required including the following:
• Amount of revenue recognized in the period
• Method used to determine the above, as well as the
stage of completion
• For contracts in process, the amount of costs incurred and
profit recognized to date, advance received, and amount
of retentions (unpaid billings)
• Contingent assets/liabilities

IAS 11 – Disclosure and Presentation
On the statement of financial position:
The gross amount due from customers is presented as an asset if it is a debit (costs plus recognized profits less recognized losses and progress billings), or
The gross amount due to customers is presented as a liability if it is a credit

Current GAAP Comparisons
Page 55 of 91of
http:// www.kpmg.co.uk/pubs/CanadianGAAPCompOview.pdf
Page 53 of 102 of
http:// www.cica.ca/download.cfm?ci_id =39765&la_id=1&re_id=0
Page 102 of 164 of
http://www.kpmg.co.uk/pubs/IFRScomparedtoU.S.GAAPAnOverview(2008).pdf

Current GAAP Comparisons
Main differences:
IFRS gives guidance as to when/how contracts may be combined or treated separately
No guidance under Canadian GAAP
IFRS requires the use of the percentage of completion method unless the outcome not reliably estimable in which case recognize revenues equal to costs incurred as long as recoverable
Under Canadian GAAP use completed contract method

IFRS Financial Statement Disclosures
Siemens AG
http://w1.siemens.com/annual/07/pool/download/pdf/e07_00_gb2007.pdf .
Revenue Recognition
on Construction Contracts page 223 of 336

Looking Ahead
The IASB is not currently looking at accounting for construction contracts specifically, although the accounting may be affected by the revenues project

End-of-Chapter Practice

JOIN KHALID AZIZ
ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.
CONTACT:
0322-3385752
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.

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Ias11

by Khalid Aziz on Nov 21, 2011

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