IAS 11 – Construction Contracts – Script Consultants

IAS 11 deals with the accounting treatment of revenue and costs which are associated with construction contracts. Generally, the span of projects in the construction industry exceeds one year which means that the work takes more than one accounting year to get finished. Therefore, the issue that arises is the allocation of contract revenue and contract costs to the accounting periods in which the construction is completed.

IAS 11 provides guidance for recognition of contract revenue as well as the corresponding costs in the statement of Profit and Loss.

Construction Contract

For the construction of an individual property or a group of assets that are interdependent regarding their function, structure or operating use include:

• Construction contracts for the individual asset or the group of assets.
• Construction contracts that may involve the demolition or restoration of an old asset.

Types of Contract

There are two types of contracts which are explained below as per the International Accounting Standards 11:

1. Fixed Price Contract

In such construction contracts, the contractor as well as the client can agree on a fixed price per unit output.

2. Cost Plus Contract

In cost-plus contracts, the contractor decides to acquire the allowable cost of a contract plus a specific agreed-upon percentage of the total allowable cost as their profit.

Also Read About: IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors

Combining and Segmenting

An entity needs to confirm whether the contract for construction of a group of assets is going to be treated as a single contract or each asset in the group of assets will be treated as a separate contract. For such cases, IAS 11 prescribes combining and segmenting.

Segmenting

If a group involves a group of assets then each asset shall be treated as a separate contract when:

• Each asset was accountable to a separate proposal by the contractor.
• The conditions of each asset were negotiated individually and the contractor as well as the client has the power to approve or reject the contract relating to each asset in the group of assets.
• Each asset has identifiable revenue along with the cost on an individual basis.

Combining

If a contract comprises of a group of assets then the contract will be treated as an entirety only when:

• The client and the contractor both have a single contract for the construction of a group of the asset.
• All the assets which are present in the group of assets are interdependent concerning their design or functionality and also appear to be the elements of a single contract.
• The segments of the whole contract are going to be fulfilled continuously.

Must Read: IAS 7 – Statement of Cash Flows

Amendments

International accounting standard 11 prescribed amendment clauses for both contractors and clients. If the client wishes to put some changes in the original contract to include the construction of an additional asset then it will be considered as a separate contract if:

• The additional asset is varied in regards to its use or design from the asset or group of assets under the original contract.
• The contract price for the added asset is prone to a separate negotiation irrespective of the original contract.

IAS 11 Proposes Accounting for Construction Contracts Based on Anticipated Outcomes:

When an outcome of a contract can be measured

Net Profit

If profits are expected under the original contract, revenue and costs shall be acknowledged in the income statement which is based on the stage of completion of the contract. 

Net Loss

In case if a net loss is foreseen in the contract then the entire loss shall be recognized in the income statement immediately.  The cost of revenue, as well as contracts, are acknowledged in the income statement on the basis of stage of completion of the contract.

When an outcome of a contract cannot be measured

Uncertain: No profits are recognized if the outcome of a contract is uncertain. Also, costs are recognized in the period in which they are incurred. However, revenue is acknowledged only to the extent of the cost incurred that is expected to be restored.

Disclosure

The Standard requires certain disclosures regarding the construction contract: 

• Contract revenue recognized in the current duration.
• The approach that is used by the entity in the judgment of the revenue reported in the current period.
• The strategy used by the entire in the judgement of the stage of completion of contracts at the end of the reporting period.

Also, the disclosures should include the cost incurred to date along with advances received from the client to date. The entity shall present the amount due to the customer related to the contract as an asset and amount due to customers as a liability in the financial statement.

Final Words

IAS 11 construction contracts specify accounting for construction contracts on the basis of the expected outcome. It sets the requirements for the treatment of the revenue and costs associated with the long term construction contracts.

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