This Blog is written by Mr. Adnan Khan, Associate Audit and Assurance Services. Please read this blog and provide your valued comments.
Summary of IAS 11
IAS 11 Construction Contracts provides requirements on the allocation of contract revenue and contract costs to accounting periods in which construction work is performed. Contract revenues and expenses are recognised by reference to the stage of completion of contract activity where the outcome of the construction contract can be estimated reliably, otherwise revenue is recognised only to the extent of recoverable contract costs incurred.
Objective of IAS 11
The objective of IAS 11 is to prescribe the accounting treatment of revenue and costs associated with construction contracts.
What is a construction contract?
A construction contract is a contract specifically negotiated for the construction of an asset or a group of interrelated assets.
Under IAS 11, if a contract covers two or more assets, the construction of each asset should be accounted for separately if (a) separate proposals were submitted for each asset, (b) portions of the contract relating to each asset were negotiated separately, and (c) costs and revenues of each asset can be measured. Otherwise, the contract should be accounted for in its entirety.
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 if either (a) the additional asset differs significantly from the original asset(s) or (b) the price of the additional asset is separately negotiated.
What is included in contract revenue and costs?
Contract revenue should include the amount agreed in the initial contract, plus revenue from alternations in the original contract work, plus claims and incentive payments that (a) are expected to be collected and (b) that can be measured reliably.
Contract costs should 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 costs that can be specifically charged to the customer under the terms of the contract.
If the outcome of a construction contract can be estimated reliably, revenue and costs should be recognised in proportion to the stage of completion of contract activity. This is known as the percentage of completion method of accounting.
To be able to estimate the outcome of a contract reliably, the entity must be able to make a reliable estimate of total contract revenue, the stage of completion, and the costs to complete the contract.
If the outcome cannot be estimated reliably, no profit should be recognised. Instead, contract revenue should be recognised only to the extent that contract costs incurred are expected to be recoverable and contract costs should be expensed as incurred.
The stage of completion of a contract can be determined in a variety of ways – including the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs, surveys of work performed, or completion of a physical proportion of the contract work.
An expected loss on a construction contract should be recognised as an expense as soon as such loss is probable.
Amount of contract revenue recognised
Method used to determine revenue
Method used to determine stage of completion; and
For contracts in progress at balance sheet date
- Aggregate costs incurred and recognised profit
- Amount of advances received
- Amount of retentions
The gross amount due from customers for contract work should be shown as an asset.
The gross amount due to customers for contract work should be shown as a liability.