Financial Accounting 2 > CONSTRUCTION CONTRACTS > Flashcards

Flashcards in CONSTRUCTION CONTRACTS Deck (17):

Why are construction contracts different to other contracts?

Generally last over a long period of time, longer than one accounting period.



Deals with profit allocation - focus on the income statement.
IASB Framework concentrates on identification of assets and liabilities - Focus on SofP


Why are special rules required for construction contracts?

To recognise a true and fair view, profit from the activity should be recognised over the period that the contract activity takes place.
This would imply recognition of turnover & matching of costs and consequently the recognition of profit.
To avoid manipulation of results (IS)
-Delay recognition delaying completion
-By separation/aggregation of project or accelerating profit.



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.


What are the two types of construction contract?

Fixed price contract
Cost plus 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.



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.


What happens when more than one item is being constructed?

Many contracts can cover the construction of a number of assets and in these cases each asset must be treated as a separate contract if (para 8):

-separate proposals have been submitted for each asset.
-each asset has been subject to separate negotiations and the contractor and customer have been able to accept or reject that part of the contract relating to each asset
-The costs and revenues of each asset can be identified


What should contract revenue comprise of?

para 11:
Contract revenue shall comprise:
a) the initial amount of revenue agreed in the contract; and
b) variations in contract work, claims and incentive payments:
i) to the extent that it is probable that they will result in revenue; and
ii) they are capable of being reliably measured.

variations are common due to the time taken to complete these contracts
Can only be included if it is probable the customer will accept the claim AND amount can be reliably measured.


What do contract costs comprise of?

para 16:
Contract costs shall comprise:
a)costs that relate directly to the specific contract;
e.g. material, labour, Depn of P&M used on construction, plant hire etc.

b)costs that are attributable to contract activity in general and can be allocated to the contract;
e.g. insurance, overheads (such as processing payroll) provided these are allocated systematically.

c) such other costs as are specifically chargeable to the customer under the terms of the contract.


How much do we recognise as revenue and expenses?

IAS 11 (para 22)
When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract shall be recognised 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 recognised as an expense immediately in accordance with para 36.


How do we judge the stage of completion?

Revenue and expenses are calculated by reference to stage of completion.

The stage of completion of a contract is determined by the method that measures reliably the work performed and this could be:
-proportion that costs incurred for work to date bear to total estimated costs
-surveys of work performed; or
-completion of a physical proportion of the contract work


Assessment of percentage completion method.

The percentage completion method:
-Smooths the profit over the life of the contract rather than taking all profit at the end of the contract life.
-Depends on reliable assessment by management of percentage complete
-Depends on a subjective judgement by management on the future outcome of the contract

useful information will be provided if the percentage completion method provides relevant information that gives a faithful representation of the transaction.


Conceptual Framework considerations

-Information given in relation to construction contracts is prudent
-information given tries to follow the accruals concept with revenue and expenses matched with the period they are earned.
-information should be relevant, but is there a question over faithful representation of the transaction? (complete, neutral and free from error?)



41 Appropriate methods of measuring progress include output methods and input methods



B15 ... Output methods include methods such as surveys of performance completed to date
B17 The disadvantages of output methods... outputs used to measure progress may not be directly observable and the information required to apply them may not be available to an entity without undue cost/ Therefore and input method may be necessary.



B18 Input methods recognise revenue on the basis of the entity's efforts or inputs to the satisfaction of a performance obligation.