bk108

IAS 11-Construction ContractsPresented by: Rabih ShalabiJuly 21, 2005

2005 KPMG IFRG Limited, a UK registered company, limited by guarantee, and a member firm of KPMG International, a Swiss cooperative. All rights reserved.

Why IAS 11-Construction Contracts

The period of execution of most construction contracts extends to more than one accounting period, therefore the primary issue in accounting for construction contracts is the allocation of contract revenue and contract cost to the accounting period in which the construction work is performed.


DefinitionsA 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.


Construction ContractsFixed Price ContractsContractor and customer agreed to a fixed price ora fixed rate per unit of outputCost plus ContractsContractor is reimbursed forallowable or otherwise defined costs plusa percentage of these costs or a fixed feesClassification


Segmenting Construction ContractsWhen a contract covers a number of assets, the construction of each asset should be treated as a separate construction contract when:Separate proposals have been submitted for each asset;Each asset has been subject to separate negotiation with the possibility of separate rejection; andCosts and revenues of each asset can be identified


Combining Construction ContractsA group of contracts should be treated as a single construction contract when:The group of contracts is negotiated as a single package;The contracts are so closely interrelated that they are, in effect, part of a single project with an overall profit margin; andThe contracts are performed concurrently or in a continuous sequence


Additional asset customer optionA contract to construct an additional asset at the option of the customer should be separated when:The additional asset differs significantly in design, technology or function from the asset(s) covered by the original contract; orThe price of the additional asset is negotiated without regard to the original contract price


Contract RevenueContract revenue comprises:The initial amount of revenue agreed in the contractVariations: Instruction for a change in the scope of the workClaims: Amount that the contractor seeks to collect from the customerIncentive Payment: Additional amounts paid to the contractor if specified performance standards are metContract revenue is measured at the fair value of the consideration received or receivable


Contract CostsContract costs comprise:Costs that relate directly to the specific contract or that are attributable to contract activity in generalSuch costs that are chargeable to the customer under the terms of the contractCost incurred to secure the contract are attributed to contract costs


Costs Excluded from Contract CostsThe following costs cannot be attributed to contract costs and are excluded:General administration cost for which reimbursement is not specified in the contractSelling costsR&D costs for which reimbursement is not specified in the contractDepreciation of idle plant and equipment that is not used on a particular contract


Reliable Measurement of Revenue and CostsWhen the outcome of a construction contract can be estimated reliably, the contract revenues and contract costs are recognised by reference to the stage of completionAn expected loss should be recognised as an expense immediately


Reliable Measurement of Revenue and CostsFixed price contract:total contract revenue measurable reliablyprobable that economic benefits will flow to the entitycontract costs and stage of completion measurable reliablycontract costs clearly identifiable/measurable: actual vs. estimates Cost plus contract:probable that economic benefits will flow to the entitycontract costs (whether or not specifically reimbursable) clearly identifiable/measurable


No Reliable Measurement of Revenue and CostsWhen the outcome of a construction contract cannot be estimated reliably:revenue should be recognised only to the extent of contract costs incurred that it is probable will be recoverablecontract costs should be recognised as an expense in the period in which they are incurredAn expected loss should be recognised as an expense immediately


Stage of Completion (1)The stage of completion can be determined in a variety of ways. Depending on the nature of the contract, the methods may include:the proportion that contract costs incurred for work performed to date bear to the estimated total contract costssurveys of work performedcompletion of a physical proportion of the contract work


Stage of Completion (2)In most cases the stage of completion is determined by reference to the costs already incurred compared to the total costsRevenue of the period:Costs incurred* Total revenues PRR Total costs (PRR=Previously Recognised Revenue)


Recognition of Contract Revenue and Expenses Example (1)ABC enters into a contract to build a road for $ 90 million. ABCs initial estimate of contract costs is $ 74 million. The contract starts early in 20x2If, at the end of 20x2, ABC can estimate reliably the outcome of the contract, it recognises revenue and expenses by reference to the stage of completion of the contract activity. Therefore, if the contract is half completed, ABC recognises revenue of $ 45 million and expenses of $ 37 million. The assessment that half the contract is completed would normally be made by one half the costs being incurred, that is $ 37 million


Example 1Year1Year2Contract Amount9090Cost incurred to date3774Total estimated cost7474% of completion50%100%

Revenue recognized4545 (90- 45)Cost recognized (37) (37) (74- 37)Gross profit88


Recognition of Contract Revenue and Expenses.On the other hand, if at the end of 20x2, ABC is unable to estimate reliably the outcome of the contract but has incurred costs of $ 30 million which it is probable will be recovered, ABC recognises revenue of $30 million and expenses of $30 million


Recognition of contract revenue and expensesSubsequent change in estimates-Example 2Assume that ABC has been able reliably to estimate its costs and expenses for 20X2 and has recorded revenue of $45 million and expenses of $37 million by reference to stage of completion (costs incurred method)

In 20X3 ABCs total costs incurred are $74 million. The estimated total contract costs to build the road are now $80 million, therefore the contract will be finished during 20X4

Using a consistent stage of completion method, A will record revenue of (74/80 * 90) 45 = $38.25 million

A will record profit in 20X3 of $1.25 million (revenue $38.25 million, costs $37 million) compared with a profit of $8 million in 20X2. The increase in total contract costs is not attributed to 20X2, but recognised in 20X3 (cumulative catch up)


Example 2 Y1 Y2 Y3Contract amount 90 90 90

Cost incurred 37 74 80Total est. cost 74 80 80% of completion 50% 92.5% 100%

Rev. recognized 45 38.25 6.75Cost recognized (37) (37) (6)Gross profit 8 1.25 0.75


Expected Losses Example (3)ABC enters into a contract to build a road for $ 90 million. ABCs initial estimate of contract costs is $ 74 million. The contract starts early in 20x2 and will be finished at the end of 20x3Before the contract starts, expected costs increase to $ 95 million, with no increase in contract revenue. ABC has to recognise the expected loss of $ 5 million immediatelyCost incurred during 20x2 is 37


Example 3Y1Y2Contract amount9090Cost incurred3795Total est. cost9595loss=5

% of completion39% 100%Rev. recognized3555Cost recognized (40) (55)Gross profit/(loss)(5) -


Presentation (1)An entity presents the gross amount due from customers as an asset which is the net amount of:costs incurred plus recognised profits; lessthe sum of recognised losses and progress billingsfor all contracts in progress for which costs incurred plus recognised profits (losses) exceed progress billings


Presentation (2)An entity presents the gross amount due to customers as a liability which is the net amount of:costs incurred plus recognised profits; lessthe sum of recognised losses and progress billings,for all contracts in progress for which progress billings exceed costs incurred plus recognised profits (losses)


Disclosure (1)Amount of contract revenue recognised as revenue in the periodMethods used to determine the contract revenue recognised in the periodMethods used to determine the stage of completion of contracts in progress


Disclosure (2)For contracts in progress:Aggregate amount of cost incurred and recognised profits (less recognised losses) to dateAmount of advances received Amount of retentions

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 2005 KPMG IFRG Limited, a UK registered company, limited by guarantee, and a member firm of KPMG International, a Swiss cooperative. All rights reserved.Contact detailsKPMG IFRG Limited+44 (0)20 7694 8871www.kpmgifrg.com

bk108

Documents

kpmg ifrg limited

separate construction

single construction

uk registered company

construction work

swiss cooperative

contract cost

original contract price