corporate financial reporting presentation on IAS 11 construction contract

3. • MOHSIN MUMTAZ
• SADDAM HUSSAIN
• MUHAMMAD ISHFAQ
• ABDUL QAYYUM
• ADNAN SULEMAN

5. • WHY NEEDED
• IDEA CONCEPT
KEY CONTENTS:
• OBJECTIVE
• DEFINITIONS
• REQUIRED PRACTICE
• RECOGNITION OF CONTRACT REVENUE AND
EXPENSES
• DISCLOSURE
• US GAAP
• UK GAAP

6. IMPORTANT TERMS
• [1] Contractee : Who gives the contract.
• [2] Contractor : Who takes the contract.
• [3] Tender Price & Deposit: Will not be shown in
Contract A/c.
• [4] Contract Price : Will be credited to contract a/c.
when Contract is completed.
• [5] Work completed : Will not be shown (Calculate on
the basis of Contract price) in Contract Account.
• [6] Work Certified : Will debited to WIP a/c and
Credited to Contract a/c.
• [work completed and also certified by the architect]

7. • [7] Work uncertified : Will be shown under “WIP”
Account.
[Work completed but not certified]
• To calculate the profit on uncompleted contract
• 1. When contract is completed “ Whole profit or loss is
carried to General Profit & Loss Account”.
• 2. When contract is uncompleted : (on the basis of
contract price)
• A. When certified work is less than 25 % : Profit carried
forward to WIP A/c. No profit should be transferred to
Profit & Loss A/c.
• B. When certified work is more than 25 % and less than
75 %. (On the basis of 2/3 cash ) received

8. Contract Accounts
• “Each Contract has a separate identity and,
therefore it becomes essential to analyses
and segregate costs according to each
contract ”
• - P. Dasgupta

11. • Construction projects or more generically work in
progress (WIP) figures, are often a material
balance sheet asset and also critical to the
reporting of profits or losses at the correct
amount and in the correct period. Clear definition
of terms with clearly defined accounting is
required.
• The aim of the Standard is to ensure that work in
progress is valued prudently with correct
matching of revenue and costs.

12. • Work in progress values affect both the balance
sheet asset value and the related cost of sales. If
you wanted to manipulate profit (and assets)
then WIP valuation would be an obvious choice.
For a construction contract one or all of the
following may be highly subjective:
• • The costs to be included.
• • The stage of completion.
• • Realisability of the work.
• Thus the value of WIP is very often subjective.
There is sample scope for manipulating figures!

13. SADDAM HUSSAIN

14. • The basic concept is that costs of work done should be
matched in an accounting period with the related income
(or putative income), and a resultant profit or loss
measured. Any costs of valuable work done and not
matched by income should be carried in the balance sheet
as WIP.
• If you wait till the final completion and signing off of a
contract or project then the profit or loss can be accurately
determined. However, there is a need to calculate what
profit (or loss) is being made as a project progresses. For
statutory reporting purposes, it is necessary to report the
profit earned in a year and the resultant asset/liability
position at the balance sheet date.

15. • A common term used in the context of
contract or project sales or profits is ‘earned
value’. An issue with the Standard is that
general principles are described but not the
detailed assessment of profit (or margin)
earned. The detailed definitions and
calculations of ‘earned value’, attributable
profit etc., vary considerably among
companies..

16. • Objective
• The objective of this Standard is to prescribe the
accounting treatment of revenue and costs associated
with construction contracts. Because of the nature of
the activity undertaken in construction contracts, the
date at which the contract activity is entered into and
the date when the activity is completed usually fall into
different accounting periods. Therefore, the primary
issue in accounting for construction contracts is the
allocation of contract revenue and contract costs to the
accounting periods in which construction work is
performed.

17. • This Standard uses the recognition criteria
established in the Framework for the
Preparation and Presentation of Financial
Statements to determine when contract
revenue and contract costs should be
recognised as revenue and expenses in the
statement of comprehensive income. It also
provides practical guidance on the application
of these criteria.

18. ADNAN SULEMAN

19. • 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.

20. Fixed price
contracts
Cost plus
contracts

21. • 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.
• EXAMPLE:
• K Ltd gets a contract to construct a bridge for a
tender amount of $5 million. This $5 million is
given by the local authority to K Ltd over a period
of the construction. If the minimum labour wages
increase during the construction period, a
reimbursement to that extent is given to K Ltd.

22. • 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.
• EXAMPLE:
• K Ltd gets a contract from the government to construct
a missile. Since it is a new technology to be used for
the missile, the costs thereof are not identifiable at the
initial stage. Hence, K Ltd has quoted a cost plus 5%
pricing to the government. The government has agreed
with K Ltd to execute this construction.

23. • COMBINING AND SEGMENTING CONSTRUCTION
CONTRACTS
• When a contract covers a number of assets, the
construction of each asset shall be treated as a separate
construction contract
• when:
a) Separate proposals have been submitted for each asset;
b) 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
c) The costs and revenues of each asset can be identified.

24. ABDUL QAYYUM

25. Contract revenue shall comprise:
a) The initial amount of revenue agreed in the
contract; and
b) Variations in contract work, claims and
incentive payments:
• i) to the extent that it is probable that they
will result in revenue; and
• ii) they are capable of being reliably
measured.

26. Contract costs shall comprise:
a) Costs that relate directly to the specific
contract;
b) Costs that are attributable to contract activity
in general and can be allocated to the contract;
and
c) Such other costs as are specifically chargeable
to the customer under the terms of the
contract.

27. • When the outcome of a construction contract can
be estimated reliably, contract revenue and
contract costs associated with the construction
contract shall be recognised as revenue and
expenses respectively by reference to the stage of
completion of the contract activity at the end of
the reporting period. An expected loss on the
construction contract shall be recognised as an
expense immediately.

28. In the case of a fixed price contract
• 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:
a) Total contract revenue can be measured reliably;
b) It is probable that the economic benefits associated with
the contract will flow to the entity;
c) 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 IAS 11;
d) 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.

29. In the case of a cost plus contract
• 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:
• a) it is probable that the economic benefits
associated with the contract will flow to the
entity; and
• b) the contract costs attributable to the contract,
whether or not specifically reimbursable, can be
clearly identified and measured reliably.

30. MOHSIN MUMTAZ

31. • When the outcome of a construction contract
cannot be estimated reliably:
a) Revenue shall be recognised only to the extent of
contract costs incurred that it is probable will be
recoverable; and
b) Contract costs shall be recognised as an expense
in the period in which they are incurred.
• An expected loss on the construction contract
shall be recognised as an expense immediately.

32. • An entity shall disclose:
• a) The amount of contract revenue recognised
as revenue in the period;
• b) The methods used to determine the
contract revenue recognised in the period;
and
• c) The methods used to determine the stage
of completion of contracts in progress.

33. Recognition before delivery –
construction contracts
General
US GAAP IFRS
Construction accounting applies to
building construction as well as the
construction of other assets.
Expected contract losses are recognized in
income as soon as it becomes probable
that the entity will experience a loss on
the contract.
Similar
Similar
Costs directly related to a contract, which
are incurred in securing the contract, are
included as part of the contract costs if
they can be identified and measured
separately, and it is probable that the
contract will be obtained and the costs are
recoverable.
Similar

34. Recognition before delivery –
construction contracts
IFRS
► Contracts are classified as fixed-price
or cost-plus contracts.
► Time-and-materials-type
contracts would most likely be
classified as cost-plus contracts.
► Units-of-production contracts
would most likely be classified as
fixed-price contracts.
► Contracts are segmented if
certain criteria are met. These
criteria are different from the
criteria under US GAAP.
US GAAP
► Contracts can be classified as
fixed-price, cost-plus, time-and-materials
and units-of-production
contracts.
► Contracts may be segmented if
certain criteria are met, but it is
not required.
General

35. Recognition before delivery – construction
contracts
Percentage-of-completion method
IFRS
► The revenue-cost approach is
allowed.
► The gross-profit approach is not
allowed.
US GAAP
► With respect to contracts that
are profitable, both revenues
and costs can be recognized
according to the project’s stage
of completion. This is often
referred to as the revenue-cost
approach.
► An entity can also recognize
expenses as actually incurred
and recognize revenue based on
the estimated gross-profit
percentage earned during the
period. This is often referred to
as the gross-profit approach.

36. Revenue-cost and gross-profit
approach example
EXAMPLE– revenue-cost and gross-profit approach
A company enters into a contract with expected revenues of $5.6 million and
expected costs of $4.9 million. The contract is 30% complete in the first year,
65% complete in the second year and 100% complete in the third year. The
costs incurred for the three years are $1.4 million, $1.65 million and $1.85
million, respectively.
► Using the revenue-cost approach,
compute the revenues and costs that
will be recognized each year under US
GAAP and IFRS.
► Using the gross-profit approach,
compute the revenues and costs that
will be recognized each year under US
GAAP and IFRS.

37. Revenue-cost and gross-profit
approach example Example solution:
The revenue-cost approach is acceptable under both US
GAAP and IFRS.
Year Revenues Costs
One $5,600,000 x 30% = $1,680,000 $4,900,000 x 30% = $1,470,000
Two ($5,600,000 x 65%) - 1,680,000 = $1,960,000 ($4,900,000 x 65%) - 1,470,000 = $1,715,000
Three
($5,600,000 x 100%) - (1,680,000 +
1,960,000) = $1,960,000
($4,900,000 x 100%) - (1,470,000 +
1,715,000) = $1,715,000
The gross-profit approach is acceptable under US GAAP but is not acceptable
under IFRS.
Estimated total gross profit = $5.6 million less $4.9 million = $700,000
Year Costs Gross Profits Revenues
One $1,400,000 $700,000 x 30% = $210,000 $1,400,000 + $210,000 = $1,610,000
Two $1,650,000 ($700,000 x 65%) - $210,000 = $245,000 $1,650,000 + $245,000 = $1,895,000
Three $1,850,000
($700,000 x 100%) - ($210,000 + $245,000)
= $245,000
$1,850,000 + $245,000 = $2,095,000

38. • IAS 11/IAS 18 – the future
• Frankly UK GAAP and IFRS as they exist are
pretty lax on how revenue and profit might be
recognised – this is an area for considerable
change – probably in 2011.
• Significant differences in GAAP
• US GAAP
• Under US GAAP construction contract revenue
recognition and balance sheet asset/liability
amounts could be similar, but much depends on
the entity specific detailed accounting policies.

39. UK GAAP
• Both IAS 11 and SSAP 9 Stocks and long term contracts use
the ‘percentage of completion’ method to recognise revenue
and expense.
• IAS 11 uses the method where the outcome of the contract
can be estimated reliably,
• SSAP9 implies the use of more prudence – recognising
‘prudently calculated attributable profit.
• Both standards require zero profit to be recognised where
outcome is uncertain.
• Because of UK company law presentation differs under UK
GAAP. The amount due for WIP is shown split between
debtors (amounts recoverable on contracts) and WIP (long
term contact balances). IAS 11 shows one gross amount due
from customers for contract work.