What Is A Construction Contract Accounting Essay

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Ias is an older set of standards explaining how particular types of transaction and other events should be reflected in financial statements. In the past IAS were issued by the board of international accounting standards committee.

"Since 2001, the new sets of standards have been known as IFRS and has been issued by the international accounting standards board. (Iasb)"

IAS 18

"The primary issue in accounting for revenue is determining when to recognise revenue. Revenue is recognised when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably. This Standard identifies the circumstances in which these criteria will be met and, therefore, revenue will be recognised. It also provides practical guidance on the application of these criteria. Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.

This Standard shall be applied in accounting for revenue arising from the following transactions and events:

(a) the sale of goods;

(b) the rendering of services; and

(c) the use by others of entity assets yielding interest, royalties and dividends.

"The recognition criteria in this Standard are usually applied separately to each transaction. However, in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. For example, when the selling price of a product includes an identifiable amount for subsequent servicing, that amount is deferred and recognised as revenue over the period during which the service is performed. Conversely, the recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole. For example, an entity may sell goods and, at the same time, enter into a separate agreement to repurchase the goods at a later date, thus negating the substantive effect of the transaction; in such a case, the two transactions are dealt with together. Revenue shall be measured at the fair value of the consideration received or receivable. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction."

IAS 11

IAS 11 Construction Contracts provides requirements on the allocation of contract revenue and contract costs to accounting periods in which construction work is performed. Contract revenues and expenses are recognised by reference to the stage of completion of contract activity where the outcome of the construction contract can be estimated reliably, otherwise revenue is recognised only to the extent of recoverable contract costs incurred

Objective of IAS 11

The objective of IAS 11 is to prescribe the accounting treatment of revenue and costs associated with construction contracts.

What is a construction contract?

A construction contract is a contract specifically negotiated for the construction of an asset or a group of interrelated assets. [IAS 11.3]

Under IAS 11, if a contract covers two or more assets, the construction of each asset should be accounted for separately if (a) separate proposals were submitted for each asset, (b) portions of the contract relating to each asset were negotiated separately, and (c) costs and revenues of each asset can be measured. Otherwise, the contract should be accounted for in its entirety. [IAS 11.8]

Two or more contracts should be accounted for as a single contract if they were negotiated together and the work is interrelated. [IAS 11.9]

If a contract gives the customer an option to order one or more additional assets, construction of each additional asset should be accounted for as a separate contract if either (a) the additional asset differs significantly from the original asset(s) or (b) the price of the additional asset is separately negotiated. [IAS 11.10]

What is included in contract revenue and costs?

Contract revenue should include the amount agreed in the initial contract, plus revenue from alternations in the original contract work, plus claims and incentive payments that (a) are expected to be collected and (b) that can be measured reliably. [IAS 11.11]

Contract costs should include costs that relate directly to the specific contract, plus costs that are attributable to the contractor's general contracting activity to the extent that they can be reasonably allocated to the contract, plus such other costs that can be specifically charged to the customer under the terms of the contract. [IAS 11.16]

Accounting

If the outcome of a construction contract can be estimated reliably, revenue and costs should be recognised in proportion to the stage of completion of contract activity. This is known as the percentage of completion method of accounting. [IAS 11.22]

To be able to estimate the outcome of a contract reliably, the entity must be able to make a reliable estimate of total contract revenue, the stage of completion, and the costs to complete the contract. [IAS 11.23-24]

If the outcome cannot be estimated reliably, no profit should be recognised. Instead, contract revenue should be recognised only to the extent that contract costs incurred are expected to be recoverable and contract costs should be expensed as incurred. [IAS 11.32]

The stage of completion of a contract can be determined in a variety of ways - including the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs,surveys of work performed, or completion of a physical proportion of the contract work. [IAS 11.30]

An expected loss on a construction contract should be recognised as an expense as soon as such loss is probable. [IAS 11.22 and 11.36]

Disclosure

amount of contract revenue recognised; [IAS 11.39(a)]

method used to determine revenue; [IAS 11.39(b)]

method used to determine stage of completion; [IAS 11.39(c)] and

for contracts in progress at balance sheet date: [IAS 11.40]

aggregate costs incurred and recognised profit

amount of advances received

amount of retentions

Comparison

The amount of revenue can be measured reliably in ias 18 whereas total contract revenue can be measured reliably (1as11).

"Both standards state that it is probable that the economic benefits associated with the transaction will flow to the entity"

The stage of completion of the transaction at the balance sheet can be measured reliably and costs occurred and costs to complete can be measured reliably bu in ias11 both contracts costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably

information has the quality of relevance when It influences economic decisions of users by guiding them to evaluate events in the present or past and future, or correcting their past evaluation. Such as

Accuruals.

Information has to be free from bias and material error, in order for the information to Reliable. information given. Users should be able depend on the information knowing they can represent information or use it faithfully to help them in decision making. E.g.

Prudence - in other words care management and see ahead. Being realistic in making decisions and not making any aggressive decisions without being realistic, and could lead them to problems in future. Example of of an event is the case of "Connaught PLC BBC 08/09/01"

Connaught was huge property service company that entered into administration. They entered into loss-making service contracts with housing association and local authorities with is said that is one of the main reasons to contribut to their downfall. Some say the constant change in accounting systems and other mentioned that is was due to government cutting the costs was the reason.

"they were quite aggressive in the way they recognised revenue and not very prudent in the way the recognised costs- Tim Steer, Fund Manager at Artemis".

Comparability is becoming essential in the modern society among business. The way financial information is displayed and the layout the transactions are shown and its effects must be set out consistently throughout the company and other companies in the future. If its consistent in showing the display and measurement of financial information and effects then its easier to understand and use the information to improve the process of decision making in the business.

As the primary information on statements give a overview or are mostly summarized, which emphases the importance of disclosures. In disclosures of ias11 basically shows methods used determine stage of completion and contract revenue and also shows, total cost occurred to date, amount of any retentions and amount of advances received. For the users of the financial information disclosures are quite understandable as it breaks down where is figure is coming from. It is pretty understandable; however for people in general it may be not as simple to understand. In general is helps the user to understand the situation better and helps the company to make decisions.

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