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IAS 11 distinguishes between the two types of contract in terms of the criteria to be met for measurement to be reliable.
For a fixed price contract the contractor should be able to measure reliably the total contract revenues and be able to identify and measure reliably both the costs that
have been incurred and those that will be incurred to complete the project. The contractor should also assess whether it is probable that payment will be received
under the contract. [IAS 11.23]
Under a cost plus contract the outcome of the contract is capable of reliable measurement where it is probable that the contractor will receive payment for the
revenues under the contract and the costs can be both clearly identified and reliably measured. [IAS 11.24]
Illustration 1
The following information relates to a contract. CU000
Estimated contract revenue 100
Costs to date 48
Costs to complete 32
Total estimated costs 80
Using the “costs incurred” method, the stage of completion is 60 CU48,000 as a percentage of CU80,000
The amounts to be recognised in the statement of comprehensive income are: CU000
Revenue 60
60 of CU100,000 Cost of sales costs to date
48 60 of CU80,000
Profit 12
60 of CU100,000 – CU80,000
Illustration 2
The following information relates to a cost plus contract obtained by a business with a 30 June year end:
2007 2008
CU000 CU000
Cumulative costs incurred on work to date 100
150 Agreed profit as a percentage of costs
20 20
The outcome of the contract can be estimated reliably at both year ends. To prepare the statement of comprehensive income for each of the two years, the business
calculates the costs incurred, assesses the profit that should be recognised and inserts
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revenue as the balancing figure. In the second year deductions are made for values already recognised in profit or loss.
2007
Costs CU100,000
Profit CU100,000 x 20 = CU20,000
Revenue Costs + profit = CU100,000 + CU20,000 = CU120,000
2008
Costs CU150,000 to date, less CU100,000 recognised in 2007 = CU50,000
Profit CU50,000 x 20 = CU10,000
Revenue Costs + profit = CU50,000 + CU10,000 = CU60,000
Where the outcome of the project cannot be measured reliably, which may be the case during the early stages of construction, then revenue should only be recognised to the extent that
costs are recoverable, although the costs should be recognised as an expense as they are incurred. As the project progresses, the likelihood of being able to assess reliably the
outcome of the project will improve, to the point where the stage of completion method should be used to assess the revenue and costs that should be recognised. [IAS 11.32, 11.35]
Illustration 3
A business is not able to measure reliably the outcome of a contract, but estimates that all costs incurred are recoverable from the customer. The following details are
available:
CU000 Estimated contract revenue
100 Costs to date
30 The amounts to be recognised in the statement of comprehensive income are:
CU000 Revenue
30 Cost of sales costs to date
30 Profit
Nil
5.3 Loss making contracts
Where the revenue and costs in a contract have been assessed and it is expected that a loss will be incurred, that loss should be recognised as an expense immediately. The loss should
not be deferred until the project is completed or spread over the period of the contract. [IAS 11.32, 11.36]
This means that when a loss has been identified, there is no need to estimate the contract’s stage of completion.
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Illustration 4
The following details relate to a contract expected to be loss making: CU000
Estimated contract revenue 100
Costs to date 72
Costs to complete 48
Total estimated costs 120
Stage of completion 60
costs incurred method Estimated overall loss
20 CU120,000 – CU100,000
The amounts to be recognised in the statement of comprehensive income are: CU000
Revenue 60
60 of CU100,000 Cost of sales costs to date
72 Loss
12 Provision for full contract loss
8 CU20,000 – CU12,000
Expected contract loss 20
6 Disclosure
A breakdown of amounts recognised in respect of construction contracts should be disclosed. Such amounts include the amount of contract revenue recognised in the period, the total
costs incurred to date i.e. on a cumulative basis rather than for the period and the aggregate profits recognised to date. [IAS 11.39, 11.40]
The entity should clearly explain the methods used to determine both contract revenues and the stage of completion. [IAS 11.39]
Amounts recognised in the statement of financial position in relation to the contract should also be disclosed, including the gross amounts due from customers and recognised as an
asset and any amounts that are due to the customer that have been recognised as a liability at the end of the reporting period. [IAS 11.42]
Other disclosable amounts which may arise under a contract are any advances received from customers and any retentions, being amounts held back by the customer as security for any
rectification work required, under the contract. [IAS 11.40]
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7 Chapter Review
This chapter has been concerned with the key issues relating to construction contracts, including how profits are accounted for over the accounting periods in which construction
work is performed.
This chapter has covered: the objectives, scope, definitions and disclosure requirements of IAS 11;
what can and cannot be treated as contract costs under IAS 11; the requirement that contract revenues and contract costs and therefore contract
profit should be recognised once the outcome of the contract can be estimated reliably;
the application of the recognition criteria to fixed price and cost plus contracts; how to deal with contract revenues and costs under the stage of completion method
when the outcome can be measured reliably; and the requirement to recognise contract losses immediately.
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8 Self Test Questions
Chapter 26
1. According to IAS11 Construction contracts, an entity should disclose which
TWO of the following?
A
For each material contract, the aggregate costs incurred
B The methods used to determine the contract revenue recognised in
the period
C
Advances received in cash, analysed according to each material contract
D
Total amount of contract revenue recognised in the period
2. Under IAS11 Construction contracts, when it is probable that total contract
costs on a fixed price contract will exceed total contract revenue, the expected loss should be
select one answer
A set off against profits on other contracts where available
B recognised as an expense immediately, unless revenue to date
exceeds costs to date
C apportioned to the years of the contract according to the stage of
completion method
D
recognised as an expense immediately
3. The Hogbean Company is a construction company that has the following
costs on its contracts: 1
Project managers costs 2
Destruction of an existing building 3
Restoration of an old factory. According to IAS11 Construction contracts, which costs may be included
within contract costs?
A
Cost 1 and cost 2 only
B Cost 1 and cost 3 only
C
Cost 2 and cost 3 only
D
Costs 1, 2 and 3
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4. The Donovan Company is nearing completion of a construction contract. The
work has not gone to plan due to the issues outlined below. 1
The client has requested a variation in the contract by requiring new security devices to be fitted, at an additional cost to Donovan of CU1.0 million. The client has accepted
responsibility for these additional costs even though they were not originally agreed.
2 Donovan has carried out additional work on the contract as there had been building errors.
This cost CU2.5 million and the client refuses to accept responsibility. Which, if either, of the above issues should be included in contract revenue,
according to IAS11 Construction contracts?
A Neither issue
B Issue 1 only
C
Issue 2 only
D Both issue 1 and issue 2
5. According to IAS11 Construction contracts, which ONE of the following
projects undertaken by an entity should be accounted for as a construction contract?
A
An item of plant and machinery being constructed to be sold as inventory
B
An office block being constructed as an investment property
C
A warehouse being constructed for the entitys own use
D A large boat being constructed for a third party under a specifically
negotiated contract
6. The Phalangium Company, a construction company, has a 31 December year
end. It is to build a factory for a client and has scheduled its work as follows:
Date Description
20 March 20X8 Contract to be awarded and signed
25 April 20X8 Construction work to commence
27 November 20X8 Principal construction work to be completed
30 December 20X8 Final completion of contract
In accordance with IAS11 Construction contracts, the maximum expected period over which the costs attributable to the contract should accumulate is
A 20 March 20X8 to 30 December 20X8
B
25 April 20X8 to 27 November 20X8
C
25 April 20X8 to 30 December 20X8
D 20 March 20X8 to 27 November 20X8
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7. According to IAS11 Construction contracts, which TWO of the following could
be valid reasons why the expected revenue from a fixed price construction contract has increased from the original contract value?
A
The costs in the contract have increased and the contract includes cost escalation clauses
B
The contractor has incurred additional costs due to errors made by its employees
C The contractor has agreed variations to the contract with the client
D
The contractor would receive an incentive payment if work continues at the present rate for the next two years
8. The Tigridia Company has entered into a 5 year fixed price construction
contract to build a factory. The contract value is CU20.0 million and the estimated costs are CU16.0 million.
At the end of the first year, Tigridia can estimate the outcome of the contract reliably. It has received cash payments to the value of CU8.6 million and
incurred costs of CU6.0 million.
At the end of the first year, what amount should be recognised as revenue in the financial statements, according to IAS11 Construction contracts?
A CU3.20 million
B
CU7.50 million
C
CU6.00 million
D CU8.60 million
9. The Toucan Company has just completed a 4 year contract to which the
following relate:
CU000
Labour and materials costs 1,800
Machinery cost 600
Initial design costs 100
Disposal proceeds of machinery 50
What are the total contract costs, according to IAS11 Construction contracts?
A CU2,350,000
B CU1,900,000
C CU2,450,000
D CU2,500,000
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10. The Pine Company is attempting to determine the total revenue on a contract
to build a factory for The Aster Company. All calculations are in accordance with IAS11 Construction contracts, and Pine has identified the following:
Initially agreed fixed contract price
CU800,000 Variation in the contract see
Note 1 CU100,000
Penalty see Note 2 CU30,000
Note 1 – During the contract Aster changed the specification of the air conditioning systems. The changed specification has been agreed but a new
contract with the new price has not yet been signed, although an increase in the contract price of around CU100,000 is highly probable.
Note 2 – A strike at Pine caused a delay for which the penalty in the original contract was CU30,000. This was agreed by both parties.
At what amount should the total contract revenue be stated?
A CU770,000
B CU900,000
C CU800,000
D CU870,000
11. The Otsembor Company has the following amounts relating to construction
contracts:
Item CU
Costs incurred 670,000
Recognised profits 60,000
Progress billings 250,000
Under IAS11 Construction contracts, what is the gross amount due from customers for contract work?
A CU480,000
B CU360,000
C CU730,000
D CU980,000
