IAS 2 - Wiley

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IAS 2 - Wiley
Construction Contracts: IAS 11
Wiecek and Young
IFRS Primer
Chapter 8
Construction Contracts
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Related standards
IAS 11
Current GAAP comparisons
IFRS financial statement disclosures
Looking ahead
End-of-chapter practice
Related Standards
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SAB 104 Revenue Recognition
SOP 81-1 Accounting for Performance of
Construction-Type and Certain ProductionType Contracts
CON 6 Elements of Financial Statements
Related Standards
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4
IAS 18 Revenue
IAS 11 – Overview
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Objective and scope
Combining and segmenting construction contracts
Contract revenue
Contract costs
Recognition of contract revenue and expenses
Disclosure and presentation
IAS 11 – Objective and Scope
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Standard deals with revenue recognition for construction contracts
and the special problems embedded in these contracts due to the
nature of the arrangement with the customer
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Specifically, these types of contracts often have the following
unique features:
• Signed up front before work is performed
• Customer billings are stipulated in the contract
• Long term in nature, spanning several reporting periods
• Earnings process is made up of many (often significant) events
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IAS 11 builds upon the revenue recognition criteria laid down in the
framework and also upon IAS 18 Revenue
IAS 11 – Objective and Scope
The standard provides the following term definitions:
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A construction contract 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
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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, which
in some cases is subject to cost escalation clauses
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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
IAS 11 – Combining and Segmenting
Construction Contracts
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There may be a need to group or subdivide contracts for accounting
purposes and this would depend on how the contract was negotiated
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Contracts for construction of several assets would be grouped for
accounting purposes if the contracts were:
• Negotiated together
• Closely interrelated, and
• Performed concurrently or in continuous sequence
IAS 11 – Combining and Segmenting
Construction Contracts
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Contracts covering the construction of several assets would be treated as
separate contracts for accounting purposes if:
• Separate proposals were submitted for each individual asset
• Each part of the contract was negotiated as a separate part and
• The revenues and related costs are separable
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If the contract includes an option to build an additional asset, the
arrangement would be accounted for as a separate contract if the
additional asset differs from the rest of the assets or the price is negotiated
separately
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Grouping or segregating contracts allows the accounting to follow the
economic substance of the contract negotiations and ensures that any
losses are appropriately recognized
IAS 11 – Contract Revenue
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Contract revenues include the amounts originally agreed to in the
contract plus variations, claims, and incentive payments that are
measurable and probable
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Variations, claims, and incentive payments are separately defined in
the standard and reflect the differing nature of the revenues
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Each has a different point for recognition of revenue.
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Although revenues are measured at the fair value of the
consideration received or receivable, they may change from period
to period
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Treated as a change in estimate
IAS 11 – Contract Revenue
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IAS 11 – Contract Costs
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It is important to identify all costs that are related to the contract in order to
measure profit
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Sometimes the method used to estimate revenues is based on the costs
incurred to date; therefore, if the costs are incorrectly measured, the
amount of revenue recognized will be incorrect as well
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Contract costs should include costs that are:
• Directly related to the contract (including materials and labor costs,
depreciation, and other costs
• Attributable to the contract activity in general (such as insurance,
design costs, construction overhead, payroll processing costs, and
borrowing costs) and
• Specifically chargeable under the terms of the contract (such as
general and administrative costs, development costs)
IAS 11 – Contract Costs
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Contract costs may be shown net of incidental income such as income
from resale of excess material that may have been ordered
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Costs that are attributable to the contract activity may be allocated using
systematic and rational allocation methods and must be allocated
consistently to all costs that have similar characteristics
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Selling costs and depreciation of idle plant and equipment should not be
included.
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However, costs incurred in securing the contract may be included as long
as they can be separately identified and reliably measured and as long
as it is probable that the contract will be obtained
IAS 11 – Recognition of Contract
Revenue and Expenses
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Revenue and costs are recognized when the outcome of the
contract can be estimated reliably
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Reference is made to the stage of completion of the contract and
the calculations are done cumulatively each reporting period
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Determining whether the outcome of the contract can be estimated
reliably depends on the type of construction contract
IAS 11 – Recognition of Contract
Revenue and Expenses
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IAS 11 – Recognition of Contract
Revenue and Expenses
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In general, the key terms of the contract must be established
before an entity can make reliable estimates
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Estimates by definition may require adjustment in subsequent
periods
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The percentage of completion method is used to determine how
much revenue should be recognized for fixed price contracts.
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For cost plus contracts, the percentage of completion method is
not necessary since the amount of revenue recognized each
period is equal to the costs expensed plus an agreed upon profit
margin or markup
IAS 11 – Recognition of Contract
Revenue and Expenses
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According to IAS 11.30, methods for estimating the stage of
completion include the following:
• Estimating the costs incurred to date as a percentage of total estimated
costs (based on inputs to the process)
- Exclude costs relating to future activity on the contract from the
numerator (e.g., supplies yet to be used and advance payments
made to subcontractors)
• Surveys of work performed (based on outputs) or
• Estimating the proportion physically complete, e.g., the number of
miles of highway completed (outputs)
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IAS 11 – Recognition of Contract
Revenue and Expenses
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As a default, when the outcome of the contract cannot be estimated
reliably, costs incurred to date are expensed and equal revenue may
be recognized as long as collection is probable
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This may be the case for instance in the early stages of a contract. If
total costs are likely to exceed total revenues, this excess loss must be
recognized
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Finally, any costs incurred that are not recoverable must be expensed
even if no revenue is recognized
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Illustration 8-3 (on the next slide) shows how revenue and cost
recognition changes depending on the likelihood of the outcome
IAS 11 – Recognition of Contract
Revenue and Expenses
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IAS 11 – Disclosure and Presentation
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Various disclosures are required including the following:
• Amount of revenue recognized in the period
• Method used to determine the above, as well as the
stage of completion
• For contracts in process, the amount of costs incurred and
profit recognized to date, advance received, and amount
of retentions (unpaid billings)
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• Contingent assets/liabilities
IAS 11 – Disclosure and Presentation
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On the statement of financial position:
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The gross amount due from customers is presented
as an asset if it is a debit (costs plus recognized
profits less recognized losses and progress billings),
or
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The gross amount due to customers is presented as
a liability if it is a credit
Current GAAP Comparisons
Page 102 of 164 of
http://www.kpmg.co.uk/pubs/IFRScomparedtoU.S.GAAPAnOverview(2008).pdf
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IFRS Financial Statement
Disclosures
Siemens AG
http://w1.siemens.com/annual/07/pool/download/pdf/e07_00_gb2007.pdf.
Revenue Recognition
on Construction Contracts
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page 223 of 336
Looking Ahead
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The IASB is not currently looking at accounting
for construction contracts specifically, although
the accounting may be affected by the revenues
project
End-of-Chapter Practice
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End-of-Chapter Practice
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End-of-Chapter Practice
8-3 Monday Morning Limited is a construction company. During the year, it had one very large
construction project underway. The five-year fixed price contract was signed at the beginning of the
year, and the project is on schedule and is 20% complete to date. The following costs were incurred
during the year:
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Materials costs (some of which are still on hand)
Labor costs for builders
Salary of site supervisor
Salary of head office project manager
Depreciation on construction machinery
Insurance
Head office secretarial (for typing up the contracts and doing the accounting for the contract)
Instructions
Discuss whether the costs are contract costs.
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End-of-Chapter Practice
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