Construction Contracts - Ias 11

PMR NOTES | HTK Consulting
CONSTRUCTION CONTRACTS: IAS 11

Definition
 construction contract is a contract specifically negotiated for the construction of an asset or a
combination of assets
 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
 cost plus contract is a construction contract in which the contractor is reimbursed for allowable
defined costs, plus a percentage of these costs or a fixed fee
Combining and segmenting construction contracts

When a contract covers a number of assets, the construction of each asset is treated as a separate
construction contract when:
(a) separate proposals have been submitted for each asset; and
(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; and
(c) the costs and revenues of each asset can be identified
A group of contracts, whether with a single customer or with several customers, is treated as a single
construction contract when:
(a) the group of contracts is negotiated as a single package;
(b) the contracts are so closely interrelated that they are, in effect, part of a single project with an
overall profit margin; and
(c) the contracts are performed concurrently or in a continuous sequence
A contract may provide for the construction of an additional asset at the option of the customer or may
be amended to include the construction of an additional asset. The construction of the additional asset
is treated as a separate construction contract when:
(a) the asset differs significantly in design, technology or function from the asset or assets covered
by the original contract; or
(b) the price of the asset is negotiated without regard to the original contract price
Contract revenue
 Contract revenue includes:
(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
 variation is when customer requests a change (it can lead to an increase or decrease in revenue)
 claim is an amount contractor collects from the customer due to delays, unexpected costs, etc.
 Incentive payments additional amounts paid to contractor (i.e. for early completion of contract)
Contract costs
 Contract costs includes:
a) costs that relate directly to the specific contract;
b) costs that are attributable to contract activity in general and can be allocated to the contract;
and
Notes Prepared by HTK Consulting | www.htkconsulting.com

c) such other costs as are specifically chargeable to the customer under the terms of the
contract.
 Directly attributable costs
o site labour costs, including site supervision
o costs of materials used in construction
o depreciation of plant and equipment used on the contract
o costs of moving plant, equipment and materials to and from the contract site
o costs of renting plant and equipment
o costs of design and technical assistance that is directly related to the contract
o the estimated costs of rectification and guarantee work, including expected warranty costs
o claims from third parties
 general attributable costs
o insurance;
o costs of design and technical assistance that are not directly related to a specific contract
o construction overheads
o borrowing costs
 the allocation of overhead is based on normal operating capacity
 costs that are specifically chargeable to the customer
o general administration costs and development costs for which reimbursement is specified in
the terms of the contract
 Costs that cannot be attributed or allocated to contract activity are excluded. Examples:
o general administration costs for which reimbursement is not specified in the contract;
o selling costs (commission, advertisement)
o research and development costs for which reimbursement is not specified in the contract;
o depreciation of idle plant and equipment that is not used on a particular contract
Recognition of contract revenue and expenses
Fixed price contract

Revenues and costs associated with a fixed price contract are recognized when all of the following are
met:
1. total contract revenue can be measured reliably;

2. it is probable that the economic benefits associated with the contract will flow to the entity;
3. both the contract costs to complete the contract and the stage of contract completion at the
end of the reporting period can be measured reliably; and
4. the contract costs attributable to the contract can be clearly identified and measured reliably so
that actual contract costs incurred can be compared with prior estimates.
Cost plus contract

Revenues and costs associated with a cost plus contract are recognized when all of the following are
met:
1. it is probable that the economic benefits associated with the contract will flow to the entity; and
2. the contract costs attributable to the contract, whether or not specifically reimbursable, can be
clearly identified and measured reliably.
Percentage of Completion Method

 must use the percentage of completion method for fixed price contracts
 revenues/expenses are recognized by reference to stage of completion

o stage of completion can be determined by referring to:
 the proportion that contract costs incurred for work performed in relation to the
estimated total contract costs
 surveys of work performed; or
 completion of a physical proportion of the contract work
 the following example will help you understand the percentage of completion method
contract price $ 10,000

Total estimated contract costs 5,000
cost incurred to date 3,000
costs incurred in previous years 1,000
Revenue to date = (3000/5000)*10,000 = $6,000

Revenue already recognized in previous years = (1000/5000)*10,000 = $2,000
Revenue for current period = 6,000-2,000=$4,000
dr. construction in progress………………….2,000

cr. Cash/AP…………………………………………..2,000
dr. Cost of goods sold…………………………….2,000

dr. construction in progress.…………….…..2,000
cr. Revenue………………………………………….4,000
 only costs that relate to current period activity is recognized as cost of goods sold
 costs that relate to future activity are recognized in the construction in progress account (asset) –
i.e. you may purchase materials to be used in the future
 When it is probable that total contract costs will exceed total contract revenue, the expected loss
shall be recognised as an expense immediately
o the recognised loss = expected loss (contract price less estimated costs) + all previously
recognized profit (revenue less cogs – i.e. the $2,000 above)
 for fixed price contracts, if the criteria for expense and revenue recognition is not met
o recognize contract costs based on the amount incurred
o recognize revenue = costs incurred (i.e. the cost recovery method)
 for cost plus contracts there is no need to use the percentage of completion because the amount
of revenue = cost + an additional amount
Changes in estimates
 changes to the contract price and contract costs are handled prospectively
Comparison to ASPE
 this material is covered in ASPE section 3400 – Revenues

 ASPE allows the completed contract method (under IFRS only percentage of completion allowed)

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What are the two main types of construction contracts discussed?

What are the criteria for combining or segmenting construction contracts?

PMR NOTES | HTK Consulting

CONSTRUCTION CONTRACTS: IAS 11

Combining and segmenting construction contracts

Notes Prepared by HTK Consulting | www.htkconsulting.com

Recognition of contract revenue and expenses

Fixed price contract

1. total contract revenue can be measured reliably;

Cost plus contract

Percentage of Completion Method

 revenues/expenses are recognized by reference to stage of completion

contract price $ 10,000

Revenue to date = (3000/5000)*10,000 = $6,000

dr. construction in progress………………….2,000

dr. Cost of goods sold…………………………….2,000

 this material is covered in ASPE section 3400 – Revenues

Notes Prepared by HTK Consulting | www.htkconsulting.com

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