MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY

COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY

DEPARTMENT OF ACCOUNTANCY

ACT130: Accounting for Special Transactions

Part 1: Construction Contracts (PAS 11)

LESSON OBJECTIVES
At the end of this module, you will be able to:
1. Apply the principles under PFRS 15 to account for revenues for construction contracts;
2. Account for contract costs on construction contracts;
3. Account for onerous construction contracts;
4. Account for variable consideration, contract modifications, and other changes in the
transaction price of a construction contracts;
5. Account for construction contracts wherein the collectability of contract revenue is uncertain
or becomes uncertain.

OVERVIEW
Concepts in this module are from PAS 11 Construction Contracts, such concepts were not
superseded, somehow, by PFRS 15. The effects of the new standard on revenue recognition in
Construction Contracts will be discussed in the 2nd part.

ABSTRACTION
Construction Contract
These are construction project that extends over one accounting period. Problems to be
encountered here is the computation of the gross profit to be recognized each year.

Combining and Segmenting Construction Contracts

A. Segmenting Contracts
If the contracts cover two or more assets, the construction of each asset should be
accounted for separately if:
i. Separate proposal was submitted for each asset,
ii. Portions of the contract relating to each asset were negotiated separately, and
iii. Costs and revenues of each asset are separately identifiable.

Otherwise, the contract should be accounted for in its entirety. (PAS 11.8)

B. Combining Contract
A group of contracts, each with a single or even with different customers, shall be treated
as single contracts when:
i. The group of contracts is negotiable as one single package;
ii. The contracts are so closely interrelated that they are effectively (i.e., in substance)
part of one overall profit margin; and
iii. The contracts are performed either concurrently or in continuous sequence.

Construction of Additional Assets

If a contract gives the customer an option to order one or more additional assets, construction of
each additional asset should be accounted for as a separate contract either:
i. The additional asset differs significantly from the original asset(s) or
ii. The price of the additional asset is separately negotiated. (PAS 11.10)

Two Types of Construction Contract Price

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

1. Fixed Price Contract – is 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 clause.
2. Cost-plus Contract – is 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
Include the amount agreed in the initial contract, plus revenue from alternation (variations) in the
original contract work, plus claims and incentives payments that (a) are expected to be collected
and (b) that can be measured reliably, (PAS 11.11)

Variations (definition). An instruction by the customer for the change in scope of the work to be
performed in the contract,
Claim (definition). An amount that the contract seeks to collect from a customer or another party
as reimbursement for costs not included in the contract price.
Incentive Payments (definition). Additional amounts paid to the contractor if specified
performance standard is met or exceeded.

Contract Cost
Include costs that relate directly to the specific contract, plus costs that are attributable to the
contractor’s general contracting activity to the extent that they can be reasonably allocated to
the contract, plus such other cost that can be specifically charged to the customer under the
terms of the contract. (PAS 11.16)

Common examples of cost that are considered related directly to specific contracts are:
• Site labor costs, including site supervision
• Materials used in construction
• Depreciation of machinery, plant, and equipment used in construction
• Cost of hiring plant (if not owned by the contractor)
• Cost of moving plant to and from construction site
• Design and technical assistance costs directly related to contract
• Cost of rectification and guarantee work, including warranty cost
• Claims from third parties

Note: These costs may be reduced by any incidental income resulting from sale of surplus
material and the disposal of equipment at the end of the contract.

Indirect Costs or Overhead expenses included in the contract costs include:

• Construction overhead
• Cost of insurance
• Cost of design
• Technical assistance that is not related directly to specific contracts
• Costs of preparing and payroll of employees engaged in construction activities
• Borrowing costs capitalized under IAS 23.

They should be allocated using methods that are systematic and rational and are applied in a
consistent manner to costs having similar features or characters. The allocation should be
based on the normal level of construction activity, not on theoretical maximum capacity.

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

Costs Excluded from Construction Costs

Costs that cannot be attributable to contract activity or cannot be allocated to a contract are
excluded from costs of construction contract. Examples of such are:
• Selling and marketing costs
• General and administrative costs for which the reimbursement is not specified in the
contract
• Research and development costs for which reimbursement is not specified in the
contract
• Depreciation on idle plant and equipment whose use cannot be attributable to any
construction contract.

Pre-contract Costs
Cost incurred in securing a contract, such as travel, promotion and meeting cost, and the like.
Usually only those cost incurred after winning the contract are included as contract costs.

However, the standards state that if such pre-contract costs are reliably measurable and it is
probable that the contract will be secured, then such cost are included as part of overall contract
cost.

In practice, of the contract has been secured by the time the financial statement is authorized for
issue, then the condition of probability of securing the contract is satisfied and the costs are
included. However, it should be noted that once such pre-contract costs have been expensed,
they cannot be reinstated once that the contract is secured.

ACCOUNTING FOR CONTRUCTION CONTRACTS

A. If the outcome of a construction contract can be estimated reliably, revenue and costs should
be recognized in proportion to the stage of completion of contract activity. This is known as
the percentage of completion method of accounting. (PAS 11.22)

To be able to estimate the outcome of contract reliably, the entity must be able to make
reliable estimate of (a) total contract revenue, (b) the stage of completion, and (c) the costs
to complete the contract. (PAS 11.23-24)

Measuring stages of completion. The stage of completion of contract can be determined

in variety of ways – including the proportion that contract costs incurred for work performed
to date bear to the estimated total contract cost (input measures: cost-to-cost method),
surveys of work performed (input measures: efforts-expended method), or completion of a
physical proportion of the contract work (output measures). (IAS 11.30)

1. Input Measures. These are made in relation of the costs or 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 cost incurred for work performed
to date bear to the estimated total cost.
• Efforts-expended Method – this is based on survey of work performed.

2. Output Measures. Output measures are made in terms of result achieved. This is based
on the completion of the physical proportion of the contract work. Architects and

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

engineers are sometimes asked to evaluate jobs and estimated what percentage of a
job or contract is complete. Output measures are as follows:
• Proportional Cost Approach – the costs incurred computed under this method may
not equal to actual costs incurred.
• Actual Cost Approach – costs incurred completed under this method should equal
to the costs actually incurred.

The Proportional Cost Approach and Actual Cost Approach are equally acceptable,
but since the Actual Cost Approach gross profit varies from period to period would
occur if the cost to cost method were used, then proportional cost approach is
preferable. It should be noted that progress payments and advances from customers
often do no reflect the work performed.

When can the outcome of a construction contract be estimated reliably?

With respect to a fixed price contract, the outcome can be estimated reliably when:
• Total contract revenue can be measured reliably
• It is probable that economic benefit of the contract will flow to the entity
• Both costs to complete the contract and the stage of completion can be reliably estimated
• The costs attributable to the contract can be clearly identified and measured.

With respect to Cost-Plus Contract, the outcome can be reliably estimated when:
• It is probable that economic benefit of the contract will flow to the entity; and
• The costs attributable to the contract, whether specifically reimbursable or not, can be
clearly identified and measured.

If the outcome cannot be established reliably, no profit should be recognized. Instead, contract
revenue should be recognized only to the extent that contract incurred are expected to be
recoverable and contract costs should be expensed as incurred. (PAS 11.32). This is known as
the cost recovery method of accounting.

Note: The completed contract method is PROHIBITED.

Recognition of Expected or Anticipated Losses

When it is probable that total contract cost will exceed total contract revenue, the expected
(anticipated) loss should be recognized as an expense (or loss) immediately. The amount of
such loss is determined irrespective of:
1. Whether or not the work has commenced on the contract;
2. The stage of completion of contract activity or;
3. The amount of profits expected to arise on other contracts which are not treated as
single construction contract.

DISCLOSURES:
• Amount of contract revenue recognized
• Method used to determine revenue
• Method used to determine stage of completion
• For contracts in progress at balance sheet date;
o Aggregate costs incurred and recognized profit
o Amount of advance received
o Amount of retentions

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

APPLICATION
(Application of the concepts of Construction Contracts will be emphasized on our online meeting)

ASSESSMENT
DO-IT-YOURSELF: These are common problems encountered in this topic. Try to figure out the
answers provided. We’ll use these problems in our online session.

1. The company has consistently used the percentage of completion method. On January 10,
2016, they began working on P3,000,000 construction contract. At the inception date, the
estimated cost of construction contract was P2,250,000. The following data relate to the
progress of the contract:
Income Recognized at December 31, 2016 P300,000
Cost incurred January 10, 2014 through Dec. 31, 2017 1,800,000
Estimated cost to Complete, December 31, 2017 600,000

In its income statement for the year ended December 31, 2017, what amount of gross profit
should the company recognize? ANS: P150,000

2. The following information pertain to the building contract of the construction company,
wherein the fixed contract price is 80 million
2015 2016 2017
Estimated Costs 20.1M 30.15M 16.75M
Progress Billings 10M 25M 45M
Cash Collection 8M 23M 49M

Assume that all costs are incurred, all billings to customers are made, and all collections
from customers are received within 30 Days of billings, as planned. Under the percentage
of completion method of revenue recognition, how much is the income from construction
for the year 2017? ANS: P3,250,000

3. The construction company has consistently used PCM of recognizing income. During
2017, they started working on a P3,000,000 fixed-price construction contract. The
accounting records disclosed the following data for the year ended December 31, 2017
Cost incurred P930,000
Estimated cost to complete 2,170,000
Progress Billings 1,100,000
Collections 700,000
How much loss should the company recognized in 2017? ANS: 100,000

4. The company entered into a construction agreement in 2016 for the rip-rapping of Pier 4.
The original contract price was P9,600,000 but a change order was issued in 2017
increasing the contract price by P480,000. They used PCM of revenue recognition. The
following information are obtained on the project of 2016 and 2017:
2016 2017
Cost incurred TO date 4.92M 8.64M
Estimated Cost to Complete 4.92M 2.16M
Billings Made 5.28M 8.52M
Cash Collections 4.38M 7.5M

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

What is the gross profit (loss) of Diaz on the project for 2017? ANS: (480,000)

5. The company use PCM. On January 10, 2016, they began working on P3,000,000
construction contract. At the inception date, the estimated cost of construction was
P2,250,000. The following data relate to the progress of the contract:
Income Recognized at December 31, 2016 P300,000
Cost incurred January 10, 2014 through Dec. 31, 2017 1,800,000
Estimated cost to Complete, December 31, 2017 600,000

What percent was completed in 2017? ANS: 35%

REFERENCES
BALOCATING, R. (2015). Advanced Accounting. Quezon City: C&E Publishing, Inc.
Dayag, A. J. (2015). Advanced Accounting 1. Manila: Lajara Publishing House.
MILLAN, Z. V. (2018). Accounting for Special Transactions. Baguio City: Bandolin Enterprise.