IAS 11 Construction Contracts

IAS 11 Construction Contracts


This Standard is effective for financial statementscovering periods beginning on or after 1 January 1995.
In May 1999, IAS 10 (revised 1999), Events After theBalance Sheet Date, amended paragraph 45. The amended text becomeseffective when IAS 10 (revised 1999) becomes effective - i.e., for annualfinancial statements covering periods beginning on or after 1 January 2000.
International Accounting Standard 11 ConstructionContracts (IAS 11) is set out in paragraphs 1-46 and Appendix A. All theparagraphs have equal authority but retain the IASC format of the Standard whenit was adopted by the IASB. IAS 11 should be read in the context of itsobjective, the Preface to International Financial Reporting Standards and the Frameworkfor the Preparation and Presentation of Financial Statements. These provide abasis for selecting and applying accounting policies in the absence of explicitguidance.

Objective


The objective of this Standard is to prescribe theaccounting treatment of revenue and costs associated with constructioncontracts. Because of the nature of the activity undertaken in constructioncontracts, the date at which the contract activity is entered into and the datewhen the activity is completed usually fall into different accounting periods.Therefore, the primary issue in accounting for construction contracts is theallocation of contract revenue and contract costs to the accounting periods inwhich construction work is performed. This Standard uses the recognitioncriteria established in the Framework for the Preparation and Presentation ofFinancial Statements to determine when contract revenue and contract costsshould be recognised as revenue and expenses in the income statement. It alsoprovides practical guidance on the application of these criteria.













Scope


1. This Standard should beapplied in accounting for construction contracts in the financial statements ofcontractors.
2. This Standard supersedes IAS 11, Accountingfor Construction Contracts, approved in 1978.

Definitions


3. The following terms areused in this Standard with the meanings specified:
A construction contract is acontract specifically negotiated for the construction of an asset or acombination of assets that are closely interrelated or interdependent in termsof their design, technology and function or their ultimate purpose or use.
A fixed price contract is aconstruction 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 costescalation clauses.
A cost plus contract is a constructioncontract in which the contractor is reimbursed for allowable or otherwisedefined costs, plus a percentage of these costs or a fixed fee.
4. A construction contract may be negotiatedfor the construction of a single asset such as a bridge, building, dam,pipeline, road, ship or tunnel. A construction contract may also deal with theconstruction of a number of assets which are closely interrelated orinterdependent in terms of their design, technology and function or theirultimate purpose or use; examples of such contracts include those for theconstruction of refineries and other complex pieces of plant or equipment.
5. For the purposes of this Standard,construction contracts include:
(a) contracts for the rendering of serviceswhich are directly related to the construction of the asset, for example, thosefor the services of project managers and architects; and
(b) contracts for the destruction orrestoration of assets, and the restoration of the environment following thedemolition of assets.
6. Construction contracts are formulated ina number of ways which, for the purposes of this Standard, are classified asfixed price contracts and cost plus contracts. Some construction contracts maycontain characteristics of both a fixed price contract and a cost pluscontract, for example in the case of a cost plus contract with an agreedmaximum price. In such circumstances, a contractor needs to consider all theconditions in paragraphs 23 and 24 in order to determine when to recognisecontract revenue and expenses.

The amounts to be disclosed in accordance with paragraphs 40(a),42(a) and 42(b) are calculated as follows:

	A	B	C	D	E	Total
Contract Costs incurred	110	510	450	250	100	1,420
Recognised profits less recognised losses	35	70	30	(90)	(30)	15
	145	580	480	160	70	1,435
Progress billings	100	520	380	180	55	1,235
Due from customers	45	60	100	-	15	220
Due to customers	-	-	-	(20)	-	(20)

The amount disclosed in accordance with paragraph 40(a) isthe same as the amount for the current period because the disclosures relate tothe first year of operation.

Contract Disclosures


A contractor has reached the end of its first year ofoperations. All its contract costs incurred have been paid for in cash and allits progress billings and advances have been received in cash. Contract costsincurred for contracts B, C and E include the cost of materials that have beenpurchased for the contract but which have not been used in contract performanceto date. For contracts B, C and E, the customers have made advances to thecontractor for work not yet performed.
The status of its five contracts in progress at the end ofyear 1 is as follows:

	A	B	C	D	E	Total
Contract Revenue recognised in accordancewith paragraph 22	145	520	380	200	55	1,300
Contract Expenses recognised inaccordance with paragraph 22	110	450	350	250	55	1,215
Expected Losses recognised in accordancewith paragraph 36	-	-	-	40	30	70
Recognised profits less recognised losses	35	70	30	(90)	(30)	15
Contract Costs incurred in the period	110	510	450	250	100	1,420
Contract Costs incurred recognised ascontract expenses in the period in accordance with paragraph 22	110	450	350	250	55	1,215
Contract Costs that relate to futureactivity recognised as an asset in accordance with paragraph 27	-	60	100	-	45	205
Contract Revenue (see above)	145	520	380	200	55	1,300
Progress Billings (paragraph 41)	100	520	380	180	55	1,235
Unbilled Contract Revenue	45	-	-	20	-	65
Advances (paragraph 41)	-	80	20	-	25	125

The amounts to be disclosed in accordance with the Standardare as follows:

Contract revenue recognised as revenue inthe period (paragraph 39(a))	1,300
Contract costs incurred and recognisedprofits (less recognised losses) to date (paragraph 40(a))	1,435
Advances received (paragraph 40(b))	125
Gross amount due from customers forcontract work - presented as an asset in accordance with paragraph 42(a)	220
Gross amount due to customers forcontract work - presented as a liability in accordance with paragraph 42(b)	(20)

The amounts of revenue, expenses and profit recognised inthe income statement in the three years are as follows:

	To Date	Recognised inprior years	Recognised incurrent year
Year 1
Revenue (9,000 x .26)	2,340		2,340
Expenses (8,050 x .26)	2,093		2,093
Profit	247		247
Year 2
Revenue (9,200 x .74)	6,808	2,340	4,468
Expenses (8,200 x .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

The contractor determines the stage of completion of thecontract by calculating the proportion that contract costs incurred for workperformed to date bear to the latest estimated total contract costs. A summaryof the financial data during the construction period is as follows:

	Year 1	Year 2	Year 3
Initial amount of revenue agreed incontract	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 byexcluding from contract costs incurred for work performed to date the 100 ofstandard materials stored at the site for use in year 3.

Appendix A
The appendix is illustrative only and does not form part of the Standard. The purpose of the appendix is to illustrate the application of the Standard to assist in clarifying its meaning.
Disclosure of Accounting Policies
The following are examples of accounting policy disclosures:
Revenue from fixed price construction contracts is recognised on the percentage of completion method, measured by reference to the percentage of labour hours incurred to date to estimated total labour hours for each contract.
Revenue from cost plus contracts is recognised by reference to the recoverable costs incurred during the period plus the fee earned, measured by the proportion that costs incurred to date bear to the estimated total costs of the contract.
The Determination of Contract Revenue and Expenses
The following example illustrates one method of determining the stage of completion of a contract and the timing of the recognition of contract revenue and expenses (see paragraphs 22 to 35 of the Standard).
A construction contractor has a fixed price contract for 9,000 to build a bridge. The initial amount of revenue agreed in the contract is 9,000. The contractor's initial estimate of contract costs is 8,000. 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.
In year 2, the customer approves a variation resulting in an increase in contract revenue of 200 and estimated additional contract costs of 150. At the end of year 2, costs incurred include 100 for standard materials stored at the site to be used in year 3 to complete the project.

45. An enterprise discloses any contingent liabilities and contingent assets in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets. Contingent liabilities and contingent assets may arise from such items as warranty costs, claims, penalties or possible losses.
Effective Date
46. This International Accounting Standard becomes operative for financial statements covering periods beginning on or after 1 January 1995.

42. An enterprise should present:
(a) the gross amount due from customers for contract work as an asset; and
(b) the gross amount due to customers for contract work as a liability.
43. The gross amount due from customers for contract work is the net amount of:
(a) costs incurred plus recognised profits; less
(b) the sum of recognised losses and progress billings
for all contracts in progress for which costs incurred plus recognised profits (less recognised losses) exceeds progress billings.
44. The gross amount due to customers for contract work is the net amount of:
(a) costs incurred plus recognised profits; less
(b) the sum of recognised losses and progress billings
for all contracts in progress for which progress billings exceed costs incurred plus recognised profits (less recognised losses).

Disclosure
39. An enterprise should 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.
40. An enterprise should disclose each of the following for contracts in progress at the balance sheet date:
(a) the aggregate amount of costs incurred and recognised profits (less recognised losses) to date;
(b) the amount of advances received; and
(c) the amount of retentions.
41. Retentions are amounts of progress billings which are not paid until the satisfaction of conditions specified in the contract for the payment of such amounts or until defects have been rectified. Progress billings are amounts billed for work performed on a contract whether or not they have been paid by the customer. Advances are amounts received by the contractor before the related work is performed.

Recognition of Expected Losses
36. When it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognised as an expense immediately.
37. The amount of such a loss is determined irrespective of:
(a) whether or not work has commenced on the contract;
(b) the stage of completion of contract activity; or
(c) the amount of profits expected to arise on other contracts which are not treated as a single construction contract in accordance with paragraph 9.
Changes in Estimates
38. The percentage of completion method is applied on a cumulative basis in each accounting period to the current estimates of contract revenue and contract costs. Therefore, the effect of a change in the estimate of contract revenue or contract costs, or the effect of a change in the estimate of the outcome of a contract, is accounted for as a change in accounting estimate (see IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies). The changed estimates are used in the determination of the amount of revenue and expenses recognised in the income statement in the period in which the change is made and in subsequent periods.