OPPOSITE FLOW

Samia Shams

Aqsa Shafique

Hina Habib

Rabail Iqbal

Asma Shouqat

CONSTRUCTION CONTRACT

Long term WIP- IAS 11

CONTENTS

Objective

Scope

Definitions

Combining and segmenting construction

contracts

Contract revenue

Contract costs

Recognition of contract revenue and expenses

Recognition of expected losses

WHY NEEDED

The aim of the standard is to ensure that work in progress is valued prudently with correct matching of revenue and costs. Work in progress values both affect the balance sheet assets value and the related cost of sales.

For a construction contract one or all of the following may be highly subjective:

1. the cost to be included.

2. the stage of completion.

3. realisability of the work.

IDEAS – CONCEPT

The basic concept is that cost of work done

should be matched in an accounting period

with the related income and the resultant

profit or loss measured. Any cost of valuable

work done and not matched by income

should be carried in the balance sheet as

WIP.

OBJECTIVES

The objective of this standard is to prescribe

the accounting treatment of revenue and

costs associated with construction contracts.

The primary issue in accounting for

construction for contracts is the allocation of

contract revenue and contract costs to the

accounting periods in which the construction

work is performed.

DEFINITIONS

A construction contract is a contract

specifically negotiated for the construction of

assets 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.

DEFINITIONS

A 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.

A 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.

COMBINING AND SEGMENTING CONSTRUCTION CONTRACT

When a contract covers a number of assets, the construction of each asset shall be treated as a separate construction contract when:

A. Separate proposals have been submitted for each asset.

B. Each asset has been subject to separate negotiation and the contractor and customer have been able to accept or reject that part of the contract relating to each asset.

C. The cost and revenues of each asset can be identified.

CONTRACT REVENUE

Contract revenue shall comprise:

A. The initial amount of revenue agreed in the contract.

B. Variations in contract work, claims and incentive payments:

i. To the extent that it is probable that they will result in revenue

ii. They are capable of being reliably measured.

CONTRACT COSTS

Contract cost shall comprise:

A. Cost that relate directly to the specific

contract

B. Costs that are attributable to contract

activity in general and can be allocated to

the contract.

C. Such other costs as are specifically

chargeable to the customer under the terms

of the contract.

RECOGNITION OF CONTRACT REVENUE AND EXPENSES

When the outcome of a construction contract

can be estimated reliably, contract revenue

and contract costs associated with the

construction contract shall be recognized as

revenue and expenses respectively by

reference to the stage of completion of the

contract activity at the end of the reporting

period. An expected loss on the construction

contract shall be recognized as an expense.

RECOGNITION OF CONTRACT REVENUE AND EXPENSES

In the case of a Fixed price contract, the outcome of a construction can be estimated reliably when all of the conditions are satisfied:

a) Total contract revenue can be measured reliably

b) Economic benefits associated with the contract will flow to the entity

c) Contract cost to complete the contract and the stage of completion at the end of reporting period can be measured reliably

d) Contract cost attributable to the contract can be clearly identified and measured reliably so that the actual contract costs incurred can be compared with the prior estimates.

RECOGNITION OF CONTRACT REVENUE AND EXPENSES

In the case of a cost plus contract, the

outcome of a construction contract can be

estimated reliably when all the following

conditions are satisfied:

a) Economic benefits associated with the

contract will flow to the entity

b) Contract cost can be clearly identified

RECOGNITION OF EXPECTED LOSSES

When the outcome of construction cannot be

estimated reliably:

a) Revenue shall be recognized only to the

extent of contract of contract costs incurred

that it is probable will be recoverable

b) Recognized expense in the period in which

they are incurred.

DISCLOSURE

An entity shall disclose:

a) Amount of contract revenue recognized as

revenue in the period

b) Methods used to determine the contract

revenue recognized in the period

c) Method used to determine the stage of

completion of contracts in progress.

US – GAAP

Under US – GAAP construction revenue

recognition and balance sheet assets/liability

amounts could be similar, but much depends

on the entity specific detailed accounting

policies.

UK – GAAP

Both IAS 11 and SSAP 9 stocks and long

term contracts use ‘percentage of

completion’ method to recognize revenue

and expenses. IAS 11 uses the method

where the outcome of the contract can be

estimated reliably, SSAP 9 implies the use of

more prudence recognizing ‘prudently

calculated attributable profit’.

CONTRACT ACCOUNT IN ACCOUNTING

Practical Implications

CONTRACT ACCOUNT

Contract account is the branch account of

cost accounting rather then general

accounting.

A contract is an undertaking to do certain

work. The work is done for a third party who

agrees to pay a fixed sum of money at the

completion of full work or part payment after

the work is completed partially and being

certified.

PARTIES INVOLVED

Contractor: The person who undertakes to do

work.

Contractee: The person for whom work is

done.

CONTRACT PRICE

Another important thing in contract business

is the contract price. It is the price at which

the contractor agrees to execute the

contract. The price is usually fixed and

agreed upon in advance. It is generally paid

on the completion of the contract.

PAYMENT OF CONTRACT PRICE

In case of small contracts, the contracteepays the contract price on the completion of work.

In case of large contracts, where the completion is expected to take several years , progress payment is adopted.

A certain percentage of the full contract price is retained as security for due performance of whole contract, that amount is known as retention money.

DEBIT SIDE OF CONTRACT ACCOUNT

Direct material

Direct wages

Other direct expenses

Cost of depreciation of plants and tools used

Indirect expenses

Establishment charges

CREDIT SIDE OF CONTRACT ACCOUNT

Contract price

Cash received

INCOMPLETE CONTRACTS

There are some contract which take several

years for completion. At the end of the financial

year they may be found incomplete. The special

problems that arise from incomplete contracts

are:

Should the contractee pay any cash to

contractor?

Should profit be calculated on in completed

contracts?

Should the value of the work done be estimated

and shown in the balance sheet?

CLASSES OF INCOMPLETE CONTRACTS

Incomplete contracts that have made little

progress

Incomplete contracts that have made

appreciable progress

Nearly completed contracts

CERTIFIED AND UNCERTIFIED WORK

Work done and is certified is certified work

work certified a/c

to contract a/c

Work done but not certified is uncertified work

work uncertified a/c

to contract a/c