When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. An expected loss on the construction contract should be recognised as an expense immediately.
With a fixed price contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied:
- Total contract revenue can be measured reliably;
- It is probable that the economic benefits associated with the contract will flow to the enterprise;
- Both the contract costs to complete the contract and the stage of contract completion at the reporting date can be measured reliably; and
- 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.
In the case of a cost plus contract, the outcome of a construction contract can be estimated reliably when both the following conditions are satisfied:
- It is probable that the economic benefits associated with the contract will flow to the enterprise; and
- The contract costs attributable to the contract, whether or not specifically reimbursable, can be clearly identified and measured reliably.
When an uncertainty arises about the collectability of an amount already included in contract revenue, and already recognised in the statement of profit and loss, the uncollectable amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense rather than as an adjustment of the amount of contract revenue. The stage of completion of a contract may be determined in a variety of ways. The enterprise uses the method that measures reliably the work performed. Depending on the nature of the contract, the methods may include:
- The proportion that contract costs incurred for work performed upto the reporting date bear to the estimated total contract costs; or
- Surveys of work performed; or
- Completion of a physical proportion of the contract work.
Progress payments and advances received from customers may not necessarily reflect the work performed. When the outcome of a construction contract cannot be estimated reliably:
- Revenue should be recognised only to the extent of contract costs incurred of which recovery is probable; and
- Contract costs should be recognised as an expense in the period in which they are incurred.
An expected loss on the construction contract should be recognised as an expense immediately. During the early stages of a contract it is often the case that the outcome of the contract cannot be estimated reliably. Nevertheless, it may be probable that the enterprise will recover the contract costs incurred. Therefore, contract revenue is recognised only to the extent of costs incurred that are expected to be recovered. As the outcome of the contract cannot be estimated reliably, no profit is recognised. However, even though the outcome of the contract cannot be estimated reliably, it may be probable that total contract costs will exceed total contract revenue. In such cases, any expected excess of total contract costs over total contract revenue for the contract is recognised as an expense immediately.
The percentage of completion method is applied on a cumulative basis in each accounting period to the current estimates of contract revenue and contract costs. Therefore, the effect of a change in the estimate of contract revenue or contract costs, or the effect of a change in the estimate of the outcome of a contract, is accounted for as a change in accounting estimate.
Disclosure
An enterprise should disclose:
- The amount of contract revenue recognised as revenue in the period;
- The methods used to determine the contract revenue recognised in the period; and
- The methods used to determine the stage of completion of contracts in progress.
An enterprise should disclose the following for contracts in progress at the reporting date:
- The aggregate amount of costs incurred and recognised profits to date
- The amount of advances received; and
- The amount of retentions.
Advances are recognized as liabilities until the related revenue is earned. ‘Retentions’ are amounts of progress billings that are not paid until the satisfaction of conditions specified in the contract for the payment of such amounts or until defects have been rectified. Retentions are recognized as receivables in the balance sheet of the contractor. An enterprise should present:
- The gross amount due from customers for contract work as an asset; and
- The gross amount due to customers for contract work as a liability.
