CONSTRUCTION ACCOUNTING

REVENUE RECOGNITION
CONSTRUCTION CONTRACT

 Point of view of contractor

Construction Contract – 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 ad function or their ultimate
purpose or use.
This includes:
 Rendering services directly related to construction of assets – services of project managers/architects
 Destruction of restoration of assets and restoration of environment after demolition of assets
CONSTRUCTION CONTRACT

 TYPES:

a. Fixed Price Contract

Contractor agrees to a:
• Contract Priceor; or
• Rate per Unit of Output
b. Cost Plus Contract
Contractor is reimbursed for:
• Allowable or otherwise defined costs;
• Plus:
1. A percentage of allowable or otherwise defined costs; or
2. A fixed fee
CONTRACT REVENUE

PAS 11 defines contract revenue:

  as the initial amount of revenue agreed in the contract and variations in contract work, claims and incentive
payments.
Composition:
1. Bid Contract Price
a. Initial amount of revenue agreed in the contract
b. Submitted by the contractor during the bidding process
2. Variations in Contract Work
Included in contract revenue when:
1. It is probable  that the customer will approve (a) the variation and (b) the amount of revenue arising fromthe variation
2. the amount of revenue can be measured reliably.
CONTRACT REVENUE

Composition:
3. Claims
Amount that the contractor seeks to collect from (1) the customer or (2) another party as reimbursement for costs excluded  in the
contract price
Included in contract revenue when:
1. negotiations have reached an advanced stage such that it is probable that the customer will accept the claim
2. the amount of the probable claim can be measured reliably.
4. Incentive Payments
Included in contract revenue when:
1. The contract is sufficiently advanced that it is probable that the specified performance standards will be met or exceeded.
2. the amount of incentive payment can be measured reliably.
CONTRACT COSTS

a. Costs that are incurred in the construction project

b. Contract Cost Groups:
1. Costs that relate directly to the specific contract
 Site Labor Costs, including Site Supervision
 Cost of Materials Used in Production
 Depreciation of Plant and Equipment Used on the Contract
 Costs of Moving Plant, Equipment and Materials To and From the Contract Site
 Costs of Hiring Plant and Equipment
 Costs of Design and Technical Assistance that is Directly Related to the Contract
 Estimated Costs of Rectification and Guarantee Work, including Expected Warranty Costs
 Claims from Third Parties
CONTRACT COSTS

2. Costs that are attributable to contract activity in general and can be allocated to the contract
 Insurance
 Costs of Design and Technical Assistance that is Indirectly Related to the Contract
 Construction Overheads such as Cost of Preparing and Constructing Personnel Payroll

3. Such other costs as are specifically chargeable to the customer (reimbursable) under the terms of the
contract
 General Administration Costs
 Development Costs
CONSTRUCTION CONTRACT TERMINOLOGIES

1. Contract Price
 Price agreed upon by the contractor and the client for the construction of a specific project
 Represents Contract Revenue

2. Cost Incurred To Date – actual cumulative construction costs incurred by the contractor from the time the
project started up to a particular balance sheet date
3. Estimated Cost To Complete
 Additional construction costs reasonably expected to be incurred to complete the project
 Made by engineers at every balance sheet date
CONSTRUCTION CONTRACT TERMINOLOGIES

4. Total Estimated Cost

 Cost Incurred To Date + Estimated Cost to Complete
 Total Estimated Cost upon completion of the project

5. Total Estimated Gross Profit

 Contract Price – Total Estimated Cost; where CP > TEC
 Excess of contract price over total estimated cost

6. Total Estimated (Anticipated) Loss

 Total Estimated Cost – Contract Price; where TEC > CP
 Excess of total estimated cost over contract price
 ACCOUNTS USED BY A CONSTRUCTION COMPANY

Normal
Account Title Used Nature of Account Balance
Construction in Progress Asset (Inventory) Debit
Accounts Receivable Asset (Receivable) Debit
Liability [Deferred (Unearned)
Progress Billings on Construction Contracts Revenue] Credit
Revenue from Long-Term Construction
Contracts Revenue Credit
Cost of Long-Term Construction Contracts Expense Debit
CONSTRUCTION ACTIVITIES

To record purchase of construction materials

Construction Materials xxx  
Cash (or Accounts Payable)   xxx
To record cost of materials incurred in construction
Construction in Progress xxx  
Construction Materials   xxx
To record cost of construction labor
Construction in Progress xxx  
Payroll   xxx
To record payment of construction overhead costs
Construction in Progress xxx  
Cash   xxx
CONSTRUCTION ACTIVITIES

To record other construction overhead costs

Construction in Progress xxx  
Accrued Expenses/Various Accounts   xxx
To record billings on customers
Accounts Receivable xxx  
Progress Billings on Construction Contracts   xxx
To record collections from customers
Cash xxx  
Accounts Receivable   xxx
MEASUREMENT OF CONTRACT REVENUE

1. Measured at the fair value of the consideration:

 Received
 Receivable

2. Affected by some uncertainties that depend on the outcome of future events

3. Estimates may need to be revised as:
 Events occur
 Uncertainties are resolved

4. Some items that affect measurement of revenue, as previously discussed

 Variations in Contract Work
 Claims
 Incentives
CONSTRUCTION CONTRACTS

 Long-term contracts
 Can span more than one accounting period

 Accounting treatment implications?

 How much revenue to include in income statement?
 How much should be charged for related costs?
 How much profit should be recognised in an accounting period?
RECOGNITION OF CONTRACT REVENUE AND EXPENSES

 PAS no. 11 Guidelines

a. When the outcome of a construction contract can be estimated reliably:

 Use the percentage-of-completion method

b. When the outcome of a construction contract cannot be estimated reliably:

 Use the cost recovery method
PERCENTAGE-OF-COMPLETION METHOD

Recognition Guidelines:
1. Contract Revenue, Cost of Contract Revenue, and Gross Profit
a. Recognized by contractor as the work progresses proportionate to the work completed
b. Recognized as revenue (expense) in the income statement in the accounting period in which the work is performed (related
revenue is recognized)
2. Anticipated loss
a. Should be recognized in full in the period it is determined
b. Occurs when Contract Price < Total Estimated Cost
3. Operating expenses – recognized in the income statement in the period they are incurred
 To record recognized revenue, cost of revenue, and gross profit
Cost of Long-Term Construction Contracts (Cost of Revenue) xxx  
Construction in Progress (Realized Gross Profit) xxx  
Revenue from Long-Term Construction Contracts (Recognized Revenue)   xxx
To record recognized revenue, cost of revenue and anticipated loss
Cost of Long-Term Construction Contracts (Cost of Revenue) xxx  
Construction in Progress (Full Anticipated Loss) xxx  
Revenue from Long-Term Construction Contracts (Recognized Revenue)   xxx
To close the balances of construction in progress and progress billings on construction contracts
Progress Billings on Construction Contracts (Total Contract Price) xxx  
Construction in Progress [Total Cost of Revenue + Gross Profit ( - Anticipated Loss)]   xxx
COST RECOVERY METHOD

 Revenue is recognized only to the extent of the contract costs incurred that is probable of recovery (may be <
actual cost incurred to date)
1. If Actual Cost Incurred To Date > Probably Recoverable Contract Costs, the difference would be recognized as a loss
2. If Actual Cost Incurred To Date < Probably Recoverable Contract Costs, the difference would be ignored since recognizing
such would lead to a gross profit, which would violate the cost recovery (zero-profit) method