LONG TERM CONSTRUCTION CONTRACTS

PAS 11 defines construction contracts as 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 or their ultimate purpose or
use.

Construction contract may be classified into:

1. Fixed Price Contract – 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.
2. Cost Plus Contract – 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.

Contract Revenue
Revenue from long-term construction contracts is measured at the fair value of
the consideration received or receivable which includes the initial amount of
revenue agreed in the contract.

Contract Costs
Contract Costs are costs that relate directly to the specific contract; are
attributable to contract activity in can be allocated to the contract; and are
specifically chargeable to the customer under the terms of the contract.

Types of Contract Costs

1. Cost incurred to date
 These include precontract costs and costs incurred after contract
acceptance.
 The criteria for recognition for recognition of such costs are:
o They are capable of being identified separately.
o They can be measured reliably.
o It is probable that the contract will be obtained.
2. Estimated costs to complete
 These are the anticipated costs of materials, labor, subcontracting
costs, and indirect costs required to complete a project at a
scheduled time.

Accounting for contract costs is similar to accounting for inventory. Costs as

incurred would be recorded in the Construction in Progress (CIP) account. CIP
account would include both direct and indirect costs but would usually not
include general and administrative expenses or selling expenses since they are not
normally identifiable with a particular contract and should therefore be expensed.
COMPUTATION AND RECOGNITION OF CONSTRUCTION REVENUE
Two General Methods
1. Percentage of Completion (POC) Method
 Recognizes revenue based on the percentage of work done or
completed for the contract date.
 Two methods to measure the progress of the construction
o Input Measures - made in relation to the costs of efforts devoted
to a contract. They are based on an established or assumed
relationship between a unit of input and productivity.
 Cost-to-cost method - the proportion that contract costs
incurred for work performed to date bear to the
estimated total contract costs.
 Efforts-expended method - based on surveys of work
performed.
o Output Measures - made in terms of results achieved. It is
based on the completion of a physical proportion of the
contract work.
2. Zero Profit Method (Cost Recovery Method)
 Revenue should be recognized only up to the extent of contract
cost incurred that is probable to be recovered.
 Contract costs should be recognized as an expense in the period in
which they are incurred.

Construction in Progress
 Serve as the dumping ground account for cumulative costs incurred and
cumulative gross profit earned.

CIP > Progress Billings – Due from customers

CIP < Progress Billings – Due to customers

Pro-forma Computation of Gross Profit earned using POC Method

Contract price XX
Less: Cost incurred to date xx
Estimated Cost to Complete xx
Estimated Total Cost at Completion XX
Gross Profit (Initial) XX
Multiply by POC (% of Completion) %
Gross Profit earned to date XX
Less: Gross Profit earned to date (prior years) (XX)
Gross Profit earned, current XX

POC = Cost incurred to date

 Estimated Total Cost at Completion

Recognition of Expected or Anticipated Losses

When it is probable that total contract costs will exceed total contract revenue,
the expected loss should be recognized as an expense immediately.

The amount of the loss is determined irrespective of:

 whether or not work has commenced on the contract;
 the stage of completion of contract activity; or
 the amount of profits expected to arise on other contracts which are not
treated as a single construction contract.

Contract Retention
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.

Financial Statement Presentation

1. An enterprise should present:
 The gross amount due from customers for contract work as an asset;
and
 The gross amount due to customers for contract work as a liability.

2. The gross amount due from customers for contract work is the net amount
of:
 Costs incurred plus recognized profits; less
 The sum of recognized losses and progress billings for all contracts in
progress for which costs incurred plus recognized profits (less
recognized losses) exceeds progress billings.

3. The gross amount due to customers for contract work is the net amount of:
 Costs incurred plus recognized profits; less
 The sum of recognized losses and progress billings for all contracts in
progress for which progress billings exceed costs incurred plus
recognized profits (less recognized losses).