IAS * 11 Construction Contracts

Report
IAS – 11
Construction Contracts
- CA Avineesh Matta
26th June 2010
AICAS, New Delhi
Objective
• Addressing the primary issue of accounting for
construction contracts i.e. the allocation of
contract revenue and contract costs to the
accounting periods in which construction work
is performed
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Prevalent Practices
• Project Completion Method of Accounting
• Percentage of Contract Completion Method
• AS – 7 (Construction Contracts)
• 1983
• 2002 revised
• Exposure draft (Revised 20XX)
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Revenue recognition
HDIL - Housing Development and Infrastructure Limited
Project Completion Method of Accounting
The Group follows completed project method of
accounting (“Project Completion Method of
Accounting”). Allocable expenses incurred during the
year are debited to work-in-progress account. The
income is accounted for as and when the projects get
completed or substantially completed and then
revenue is recognized to the extent that it is probable
that the economic benefits will flow to the Company
and the revenue can be reliably measured.
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Revenue recognition
NCC - Nagarjuna Construction Company Ltd.
Percentage of Completion
Revenue from construction contracts is
recognised by reference to the percentage of
completion of the contract activity. The stage of
completion is determined by survey of work
performed and / or on completion of a physical
proportion of the contract work, as the case may
be, and acknowledged by the contractee. Future
expected loss, if any, is recognised as
expenditure.
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Scope of IAS - 11
• Shall be applied in accounting for construction
contracts in the financial statements of
contractors
– Real estate Developers
– IFRIC 15
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Construction Contract
• 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.
– Fixed Price Contracts, may be with escalation
clause
– Cost Plus Contracts – may be with fixed fee too
– May have both the features – cost plus with
agreed maximum price
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Related services
Are these construction contracts?
• Architects, Project Managers
• Contracts for destruction/ restoration of environment
Para 5
For the purposes of this Standard, construction
contracts include:
(a) contracts for the rendering of services which
are directly related to the construction of the asset, for
example, those for the services of project managers
and architects; and
(b) contracts for the destruction or restoration of
assets, and the restoration of the environment
following the demolition of assets
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Combining and segmenting
construction contracts
• Requirements of this standard are usually
applied separately to each contract
– Circumstantially may be applied to the separately
identifiable components of
• a single contract, or
• to a group of contracts
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More than a single asset
but separate contracts (para – 8)
• The construction of each asset shall be treated as a
separate construction contract when:
(a) separate proposals have been submitted for each asset;
(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
National Highway with Rail over bridge
LMN Limited has a master contract to build 800 houses for a developer
over a two year period, in different locations throughout the Country. The
cost for each group of houses is negotiated separately and it received a
10% profit, based on the agreed cost.
Each group should be treated as a separate contract.
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Group of Contracts
but single contract (para – 9)
• A group of contracts, whether with a single customer or with
several customers, shall be 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
Redevelopment of airport with metro link under single tender
ABC Limited has contracts to build 12 standard hotels. Land preparation is
done by the client. Building costs are similar for each hotel. This should be
treated as a single contract. AVA & Associates
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Additional Asset
at the option of customer (para 10)
• As part of initial contract agreed or as part of probable
amendments
• Treat separate contract, only if,
(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
ABC Limited is building an apartment building and its client asks it to build
a swimming pool in the grounds, at a price to be negotiated. This will be
treated as an additional contract.
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Contract revenue
para 11
• Contract revenue shall comprise:
(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.
• Contract revenue may change from one period to the
next
• Contract revenue is measured at the fair value of the
consideration received or receivable
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Examples
• Variations – due to change in design, specification or scope
– ABC Limited is building a bridge road. The original plan called
for a bridge over a railway, but the authorities now insist on a
tunnel under the railway instead
• Claims – cost not included in agreed contract price
– XYZ Limited has been contracted to demolish some houses and build
new ones. It was promised a vacant possession. When its staff
arrived, they found that the tenants still occupy the old houses. It
takes a month to re-house them and delaying the start of work
• Incentives – early completion in full or part
• Only to be recognized if acceptance or its probability by
customer and is reliably measurable
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Contract Cost
para 16
Contract costs shall comprise:
(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
(c) such other costs as are specifically
chargeable to the customer under the terms
of the contract
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(a) Directly Relatable Costs
• site labour costs, including site supervision
• costs of materials used in construction
• depreciation of plant and equipment used on the
contract
• costs of moving plant, equipment and materials to and
from the contract site
• costs of hiring plant and equipment
• costs of design and technical assistance that is directly
related to the contract
• the estimated costs of rectification and guarantee
work, including expected warranty costs
• claims from third parties
These costs may be reduced by any incidental income,
Dismantled material disposed of
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(b) Attributable Costs
in general
• Allocation
– Systematic and rational method
– Allocation to be applied consistently to all costs with similar
characteristics
– Should be based on normal level of activity
• Insurance
• Costs of design and technical assistance that are not directly related
to a specific contract
• Construction overheads
• Construction payroll preparation
• Borrowing Costs (para 18 of IAS – 11)
Costs that have been written off cannot be reinstated if the contract
is obtained in a subsequent period
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Exclusion from Contract Costs
• General administration costs for which reimbursement
is not specified in the contract
• Selling costs
• Research and development costs for which
reimbursement is not specified in the contract
• Depreciation of idle plant and equipment that is not
used on a particular contract
• Cost of securing contract cannot form part of contract
cost except where it is directly identifiable
• XYZ Limited has a team whose sole job is to write bids for
construction contracts and negotiate them up to the point of
signing contracts. All costs can be allocated to separate bids. Their
costs should be expensed in each period, except those costs for bids
that are likely to be won.
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Recognition of contract revenue and expenses
Para 22
• When the outcome of a construction contract can
be estimated reliably, contract revenue and
contract costs associated with the construction
contract shall be recognised as revenue and
expenses respectively by reference to the stage of
completion of the contract activity at the end of
the reporting period.
• An expected loss on the construction contract
shall be recognised as an expense immediately.
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example
• XYZ Limited has been notified by a subcontractor that his costs (to it) for next year
will increase by 15%. It cannot bill the client
for this increase, and it will cause it to lose
money on the contract and it can find no
alternative supplier. Therefore, it should
recognize the anticipated loss immediately.
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Example-1
Year (at the
end of year)
Contract
Price
(a)
Cost incurred Expected
till date
cost to be
incurred for
(b)
completion
(c)
Revenue to
be
recognised
=(b*a)/(b+c)
(Revenue Till
Date )
1
20,00,000
8,00,000
6,00,000
11,42,857
(57.14%)
2
20,00,000
12,50,000
2,00,000
17,24,138
(86.21%)
3
20,00,000
14,75,000
-
20,00,000
(100%)
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Example-2 (Loss Contract)
Year (at the
end of year)
Contract
Price
(a)
Cost incurred Expected
till date
cost to be
incurred for
(b)
completion
(c)
Revenue to
be
recognised
=(b*a)/(b+c)
(Revenue Till
Date )
1
20,00,000
12,00,000
7,00,000
12,63,158
(63.16%)
2
20,00,000
18,50,000
2,50,000
17,61,905
(88.09%)
(100,000)
3
20,00,000
21,75,000
-
20,00,000
(100%)
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Reliable Estimation of outcome of a construction contract conditions
Fixed Price
Cost Plus
Contract
Contract
Total contract revenue
can be measured
reliably
Probability of flowing
of economic benefit to
the entity
Probability of flowing
of economic benefit to
the entity
Attributable costs can
be clearly identified
and measured reliably
Cost and stage of
contract completion
can be measured
reliably at reporting
date
Attributable costs can
be clearly identified
and compared with
prior estimates
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Percentage of Completion Method
• Provides useful information
• On extent of contract activity
• Performance during the period
• Revenue is recognized by reference to stage of
completion
• Matching of contract revenue and costs
• Reporting of revenue, expenses and profit that can be
attributed to the proportion of work completed
• Contract revenue recognized in the period work is
performed
• Expected excess of total contract costs over total
revenue be recognized as expense immediately
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PCM….
Para 27 & 28
• Contract costs incurred for future activity be recognized as
an assets (WIP) provided it is probable that it shall be
recovered
• PQR Limited is building a hotel and has imported some insulation
material that will not be needed until next year. This was done to
avoid an imminent price rise, announced by the supplier. It has also
paid an advance to a sub-contractor. Both items should be booked to
work in progress
• When there is uncertainty about the collectability of an
amount already recognized as revenue that should be
recognized as expense, rather than adjustment to contract
revenue
• XYZ Limited is a sub-contractor. The contractor has approved its work
and it has recognized the revenue according to the contract. The
client is delaying payment, for reasons that are not clear. Accordingly,
it should create a doubtful debt provision for the disputed revenue
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Determination of stage of completion
para 30
• Reliability of measurement or work performed
is of supreme importance
• Proportion of contract cost incurred for the
work performed to the estimated total cost
• Surveys of the work done
• Completion of the physical proportion of the
contract work
• Progress payments and advances received
often do not reflect the work performed
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When outcome of contract cannot be estimated reliably
para 32
a) revenue shall be recognised only to the
extent of contract costs incurred that it is
probable will be recoverable; and
(b) contract costs shall be recognised as an
expense in the period in which they are
incurred.
An expected loss on the construction contract
shall be recognised as an expense immediately
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Case studies
• Financial difficulties of the contractor or the client
The client of ABC Limited has not paid it for the work
on the agreed date. Arguments ensue, but it thinks that the client
has serious financial problems and the contract is at risk.
• Pending litigation or legislation
ABC Limited is rebuilding a chemical plant. The government
finds toxic effluent has been leaking from the site and applies to the
court for an order to stop work.
• Lack of clarity in contract or reimbursement of cost
ABC Limited is building a hotel. Government officials demand
additional safety features, which are not covered by the contract. It
submits a variation proposal to the client, who refuses it, claiming
that the cost is on the part of ABC Limited.
• Anticipated failure to complete the contract
ABC Limited is building a road 200 Kms long. Part of the route
becomes flooded and it cannot determine whether or not the road
will be completed within the contract period.
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Recognition of expected losses
para 36
• When it is probable that total contract costs will
exceed total contract revenue, the expected loss
shall be recognised as an expense immediately
– The amount of such a loss is determined irrespective
of:
(a) whether work has commenced on the contract;
(b) the stage of completion of contract activity; or
(c) the amount of profits expected to arise on other
contracts
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Case studies
• Before start of the work
– XYZ Limited is going to build a hotel on a cliff. It hires staff,
machinery and materials. It travels to the cliff and find
that it has fallen into the sea. The client offers another
site, but for the same contract price. This would reduce its
loss, but not eliminate it. Accordingly, it should recognize
the loss immediately.
• Profit in other contracts
– XYZ Limited has 5 separate construction contracts with the
same client. Its project is “State A” is hit by strikes, which
means additional costs, and penalties for late completion.
This will create a loss for the project, though the 4 other
projects will make enough profits to cover the loss. It must
still recognize the loss on the “State A” immediately.
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Illustration
• Apsara Ltd. entered into an agreement with the Government for the
construction of a dam and hydel project across River Ganga.
• Contract period being 3 years.
• The consideration was agreed at Rs.200 Crores
• Initial cost estimate of the Company was Rs.190 Crores.
• The Company incurred Rs.65 Crores, Rs.90 Crores and Rs.55 Crores
respectively in the three years.
• The cost incurred in year 2 includes Rs.15 Crores towards additional
work for which the Government agreed for a price increase of Rs.18
Crores. Also, the Company is entitled to receive a 5% incentive on
the original price agreed, for completion of project within 3 years.
This incentive was also promptly received by the Company.
• Determine the Contract Revenues, Costs and Profits to be
recognised in each of the 3 years in the above situation.
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Working
Particulars
Contract Price
Variations
Incentive
A. Total Contract Revenue
Costs till date
Estimated costs to complete
(See Note 1)
B. Total Contract Costs
C. Estimated Total Profit
D. Percentage of Completion
= Cost till date/Total Contract
Costs
Year 1
200
---200
65
75 + 55 = 130
Year 2
200
18
--218
65 + 90 = 155
55
Year 3
200
18
(200 * 5%) = 1
219
155 + 55 = 210
---
195
5
65/195 = 33.33%
210
8
155/210 = 73.81%
210
9
100%
Note : 1 : Initial estimate of Rs.190 Crores is not relevant since it is made prior to the commencement
of contract work. As at the end of Year 1, the variations/additional costs of Year 2 will not be known
and hence the revised estimate cost to complete the original contract (excluding additional work) will
be taken at Rs.130 Crores
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The Contract Revenues, Costs and Profits recognised in each of the three
years
Year
First
Contract Revenue
Contract Costs
1. Contract Profits
Second Contract Revenue
Contract Costs
2. Contract Profits
Third Contract Revenue
Contract Costs
3. Contract Profits
Upto Reporting Date Recognised in
previous year
200 * 33.33% =
--66.66
65
-1.66
--218 * 73.81 = 161
66.66
155
65
6
1.66
219
161
210
155
9
6
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Recognised in
Current year
66.66
65
1.66
94
90
4
58
55
3
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First time adoption
• Percentage of completion accounting
• no change, AS – 7 compliant
• If Project completion accounting
• Change in accounting policy
• Impact on estimates due to change in accounting policy
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Differences between AS – 7 & IAS - 11
• Appendix F to exposure draft
• Existing AS - 7 permits Borrowing Costs in the costs that
may be attributable to contract activity in general and can
be allocated to specific contracts; IAS – 11 permits but not
in ED
• Existing AS - 7 does not recognise fair value concept as
contract revenue is measured at consideration
received/receivable
• Existing AS - 7 does not deal with accounting for Service
Concession Arrangements
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Real estate transactions
IFRIC 15
• An agreement for the construction of real estate
is a construction contract within the scope of IAS
11 only when the buyer is able to specify the
major structural elements of the design of the
real estate before construction begins and/or
specify major structural changes once
construction is in progress (whether it exercises
that ability or not).
• If the buyer has that ability, IAS 11 applies.
• If the buyer does not have that ability, IAS 18
applies.
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IFRIC -15…
• An agreement for the construction of real
estate in which buyers have only limited
ability to influence the design of real estate ,
for example to select a design from a options
specified by the entity , or to specify only
minor variations to the basic design, is an
agreement for sale of goods and therefore
within the scope of IAS-18.
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Land element……
IFRIC 15
• If the contract can be segmented into a
construction contract and the sale of the land,
the delivery of land follows the revenue
recognition as per IAS-18.
• Construction cost shall be followed as per IAS11.
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Disclosures
para 39 & 40
• 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.
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Disclosures
• An entity shall disclose each of the following for
contracts in progress at the end of the reporting period:
• the aggregate amount of costs incurred and recognised
profits (less recognised losses) to date;
• the amount of advances received; and
• the amount of retentions
• An entity discloses any contingent liabilities and contingent
assets in accordance with IAS 37 Provisions, Contingent
Liabilities and Contingent Assets. Contingent liabilities and
contingent assets may arise from such items as warranty
costs, claims, penalties or possible losses. (para 45)
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Presentation
para 42
• An entity shall present:
(a) the gross amount due from customers for
contract work as an asset; and
(b) the gross amount due to customers for
contract work as a liability
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Accounting Policies….ex..
Unitech
•
•
•
•
•
•
•
a) Real Estate Projects
Real Estate Projects undertaken up to 31st March, 2004.
(i) Revenue is recognized to estimate the profit @ 20% of actual receipts and installments fallen
due during the year towards booking of plots/constructed properties, subject to final
adjustment, on the completion of the respective project.
(ii) Real Estate Projects undertaken on and after 1st April, 2004.
i. Revenue from real estate projects is recognized on the "Percentage of Completion Method"
of accounting. Revenue comprises the aggregate amounts of sale price in terms of the
agreements entered into and is recognized on the basis of percentage of actual costs incurred
thereon, including proportionate land cost and total estimated cost of projects under execution,
subject to such actual costs being 20 percent or more of the total estimated cost.
ii. Where aggregate of the payment received provide insufficient evidence of buyers
commitment to make the complete payment, revenue is recognized only to the extent of
realization.
iii. The estimates of the saleable areas and costs are reviewed periodically by the management
and any effect of changes in estimates is recognized in the period such changes are determined.
However, when the total project cost is estimated to exceed total revenues from the project, the
loss is recognized immediately.
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Nagarjuna Construction
Real Estate Project:
• Revenue from the sale of properties is recognised on transfer of all significant risks
and rewards of ownership to the buyers, which coincides with the entering into a
legally binding agreement and it is not unreasonable to expect ultimate collection
and no significant uncertainty exists regarding the amount of consideration.
• However, if at the time of transfer substantial acts are yet to be performed under the
contract, revenue is recognised on the basis of percentage completion method,
measured on the basis of percentage of actual cost incurred including proportionate
land cost bears to the total estimated cost of the project under execution.
• Revenue comprises the aggregate amount of sale price as per the terms of the
agreement entered into with the customers. The recognition is subject to reaching
25% of physical progress measured in terms of estimated cost. The estimate of cost
and saleable areas is reviewed periodically by the management and any effect of
changes in estimates is recognised in the period of changes. Further, on periodical
review if any project is expected to incur loss, the entire loss is recognised
immediately.
• Cost in relation to the above includes cost of land, development cost, project over
heads, borrowing cost and all cost incurred for bringing the property to marketable
condition or its intended use.
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Thank You!
Vande Matram`
[email protected]
9811052264
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