Calculating earnings FOREIGN EXCHANGE

Chapter 26 – Construction Page 361 Chapter 26 CONSTRUCTION 1 Business Context Construction contracts are common in certain industries, such as the building and aerospace industries where entities enter into contracts for the construction of a substantial asset that takes a considerable amount of time to complete. Such contracts may extend over several years. Few entities can afford to wait until the end of the contract before being paid by the customer. In practice, stage payments for work completed are agreed within the overall contract, and partial payment is received from the customer. Similarly, if profit was only recognised at the end of each contract, then reported profits in the financial statements would not represent the value of work achieved in an accounting period. It is therefore necessary to divide the overall contract over the total time it takes and to recognise an appropriate part of the contract costs, revenues and profit each period. 2 Chapter Objectives This chapter deals with the accounting and disclosure requirements in IAS 11 Construction contracts. On completion of this chapter you should be able to:  demonstrate a knowledge of the objectives and scope of IAS 11;  demonstrate a knowledge of the important terminology and definitions which relate to the valuation of construction contracts;  demonstrate an understanding of the key principles relating to the valuation of construction contracts and the allocation of contract costs and revenues to accounting periods; and  apply this knowledge and understanding in particular circumstances through basic calculations. 3 Objectives, Scope and Definitions of IAS 11 The objective of IAS 11 is to prescribe the accounting treatment of the revenues receivable and costs incurred in a construction contract. IAS 11 defines a construction contract as one specifically negotiated for the construction of an asset, for example a building, pipeline or ship, or a combination of assets that are closely related in terms of their design, technology and function or their ultimate purpose or use. Services that are directly related to the construction of an asset, for example project management, meet the definition of a construction contract, as does a contract for the demolition of an asset. [IAS 11.3] The dates on which a construction contract starts and ends usually fall in different accounting periods, so the principal concern is how to allocate revenue and costs to the different accounting periods to reflect the reality of the construction activity as it takes place.