Ias 11 Construction Contracts

IAS 11 CONSTRUCTION CONTRACTS
for Accounting Professionals

2011
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IAS 11 Construction Contracts
CONTENTS
1. Introduction and Definitions........................................................3

1.1 Aim 3
1.2 Objective And Preparation 3
1.3 Bank accounting and construction contracts.......................6
1.4 Definitions...........................................................................7
1.5 Scope...................................................................................8
1.6 Contract Revenue............................................................10
1.7 Contract Costs.................................................................12
1.8 Recognition of Contract Revenue and Expenses........14
1.9 Stage of Completion Calculation....................................16
2 Recognition of Expected Losses and Changes in Estimates22
Changes In Estimates............................................................22
3 Disclosure 23
4 Specific Examples 24
5 Multiple Choice Questions 30
6 Exercise Questions 33
7 Solutions 36
Note: Material from the following PricewaterhouseCoopers publications has been used in this workbook:
-Applying IFRS
-IFRS News
-Accounting Solutions
Introduction and Definitions Revenue is the subject of IAS 18, and revenue for Financial
Instruments is the subject of IAS 39.

1.1 Aim
Under IAS 18, in general, revenue is recognised on
The aim of this workbook is to assist the individual in
completion of the work.
understanding Construction Contracts according to IFRS.
Construction Contracts are the subject of International Only certain construction is covered by IAS 11
Accounting Standard (IAS) 11. Construction Contracts.
If a sale agreement is for the sale of goods, revenue shall be

1.2 Objective And Preparation
recognised when all the conditions in paragraph 14 of IAS 18
have been satisfied.

The start and finish of Construction Contracts often fall into
different accounting periods. Thus, the timing of recognition of Two of the conditions for the recognition of revenue require
contract revenue and contract costs is a key issue of the the entity to have transferred to the buyer the significant risks
standard. and rewards of ownership of, and effective control over, the
goods sold.
IAS 11 is special as it enables revenue and profit to be
recognised during construction under specified conditions IAS 11 defines a construction contract as “a contract
rather than only at completion. specifically
negotiated for the construction of an asset or a combination Indications that the seller transfers control of the work in
of assets …” progress in this way may include, for example:
A sale agreement meets this definition if it is an agreement for
the seller to provide construction services to the buyer’s (i) the construction taking place on land that is owned or
specifications. leased by the buyer;
Features that, individually or in combination, may indicate that (ii) the buyer having a right to take over the work in progress
an agreement is for the seller to provide construction services (albeit with a penalty) during construction, for example to
to the buyer’s specifications include: engage a different contractor to complete the construction;
(i) the buyer being able to specify the major structural (iii) in the event of the agreement being terminated before
elements of the design of the real estate before construction construction is complete, the buyer retaining the work in
begins and/or specify major structural changes once progress and the seller having the right to be paid for work
construction is in progress (whether it exercises that ability or performed (subject to buyer acceptance).
not);
The terms of contracts for construction services tend to be
(ii) the seller transferring to the buyer control and the such that there is a continual delivery (transfer of control and
significant risks and rewards of ownership of the work in risks and rewards of ownership) from the seller to the buyer
progress in its current state as construction progresses. as construction progresses.
For example: (continuing transfer of control and risks and rewards of
-the land under construction is owned by the buyer from ownership).

the outset.
Control of the house or apartment tends to pass from seller to
-the contractor typically has no ownership claim to the
work in progress (beyond perhaps a right of lien). The buyer at a single point in time, usually when the unit is ready
contractor instead provides construction services and
materials that become attached to the land as they are for occupancy.
provided.
-the buyer typically has a right to take over the work in Features that, individually or in combination, may indicate that
progress (albeit with a penalty) before construction is
complete. an agreement is for the sale of goods (covered by IAS 18
-the seller earns the right to be paid primarily on the basis
of work performed (subject to client acceptance) rather Revenue, not IAS 11 Construction Contracts) include:
than purely for the delivery of finished goods.
(i) the negotiation between buyer and seller primarily
The building of houses and apartments by a developer may concerning the amount and timing of payments, with the
not meet the conditions of IAS 11, especially if they are to be buyer having only limited ability to specify the design of the
sold to multiple buyers, even if they have been pre-sold. real estate, for example, to select a design from a range of
options or specify minor variations to the basic design;

Here, construction takes place independently of the sale
agreement and buyers have only limited ability to influence (ii) the agreement giving the buyer only a right to acquire the
the construction and design of the real estate. There is no completed real estate at a later date, with the seller retaining
’continual delivery’ to the buyer during the construction phase control and the significant risks and rewards of ownership of
the underlying work in progress until that date.

If a project is classified under IAS 11 Construction Contracts, construction contracts. Regular reviews of costs and revisions
revenue and profit can be accrued during construction. If the of estimates are necessary throughout the contract.
project is classified under IAS 18 Revenue, generally revenue

1.3 Bank accounting and construction contracts.
and profit cannot be accrued during construction.
Summary
Bank accounting rarely involves construction contracts.

Bank clients may be involved in construction contracts. If so,
Guidance covering real estate sales is the subject of an IASB financial analysis of their IFRS financial statements would
require knowledge of IAS 11.
interpretation.
Most banks are heavily involved in property: their own
Similarly, building for your own use and speculative building property and that of their clients. Their clients often use
property as collateral, as well as using bank funds to finance
in anticipation of finding buyers or lessees is unlikely to meet the purchase and sometimes the construction of property.
the criteria of IAS 11. Building for your own use is covered in As a bank’s involvement in property increases, so does the
need for banks to employ their own property experts.
IAS 16 Property, Plant and Equipment. Speculative building
Concerns for Bankers
will normally produce inventory and be classified according to
IFRS primarily concerns the economic value and profit of
IAS 2 Inventories (see chart of property types later in this transactions, whilst bankers are deeply concerned about
liquidity and cash flows.
workbook).
Construction contracts are medium and long-term ventures.
Money from the purchaser may be received at infrequent
An effective internal financial budgeting and reporting system, intervals. This may require the contractor to provide finance
for much of the work for considerable periods of time before
which is kept up-to-date at all times, is required to control reimbursement, with a potential for liquidity problems arising
as a result.
Regular reviews of the cash flows are needed to ensure that Entity A can reliably estimate the outcome of the contract.
any slippage is quickly identified and action taken.
Solution
The contract revenue may change from one period to the Yes. The date at which contract activity is entered into and the
next, as a result of contract variations, claims, penalties, and date when the activity is completed fall into different accounting
cost-escalation clauses. The revenue may be partly or wholly periods.
accrued and therefore not matched by cash received.
The work in progress system K uses to track its production
Another major concern with construction contracts is hidden processes should be used to determine the stage of completion
losses generated by making insufficient progress, or mistakes of each contract at the balance sheet date. Revenue on
in the early or middle stages of the contract, causing cost contracts for the manufacture of the printing presses should be
overruns to appear in later accounting periods. recognised by reference to the percentage of completion method
(see below).
Hidden losses may occur from costs that are believed to be Example:
rechargeable to clients that the client refuses to accept.
Does the production of a series of assets meet the definition of a
1.4 Definitions construction contract?
Construction Contract Background

An entity entered into a contract with a retailer that sells furniture.
A construction contract is a contract made for the construction The contract will last for a period of two years. The entity is
of one or more assets that are closely-related, or required to manufacture 2,000 sofas over the two-year term to
interdependent in their design, technology, and function, or the retailer’s specification.
their purpose or use.
Solution
Example: This is not a construction contract. It is simply a contract between
a supplier and a purchaser for the production of goods. The
Should a manufacturer of plant and machinery follow the contract is for the construction of a series of assets that are not
guidance for construction contract accounting? interrelated. The sofas are not interrelated because one sofa is
not connected to, or dependent on, another sofa in any way.
Background
K is building a large currency printing press within the premises of The sofas will be delivered to the retailer over the period of two
the buyer, which can take up to 18 months to complete. A years as they are manufactured. There is no typical construction
contract can therefore be active over three accounting periods. activity. Commencement and completion of individual sofas will
fall into a single accounting period. 1.5 Scope
Construction contracts include:

Fixed-price Contract
 Services related to the construction, such as project
A fixed-price contract is a contract in which the parties agree managers and architects.
to a fixed price, or a fixed price per unit of output.  Contracts for destruction, or restoration, of assets and
Cost-escalation clauses may be a feature of these contracts. the restoration of the environment.
Example: Example:
You agree with a contractor to build an office block including a As part of a new head office complex, you are building a new
branch of your bank over a 3-year period for $10million. For road. A clause in the contract requires you to restore all grass
the contractor, at the end of years 1 & 2, unbilled revenue will areas beside the new road.
be increased by the national annual rate of inflation recorded
on the 31st of December. The restoration is part of the contract.
This is a cost escalation clause. Combining and Segmenting Construction Contracts
Cost-plus Contract When a contract covers more than a single asset, the
construction of each asset should be treated as a separate
A cost-plus contract is a contract where the contractor is contract when:
reimbursed for allowable costs, plus a percentage profit (or
fixed fee). Cost plus is the standard for some contractees (for 1. Separate proposals have been submitted for each
example, some government bodies). asset;
2. Each asset has been a separate negotiation and each
Example: party could reject the part of the contract applying to
You agree to buy a security vault for the contracted costs, that asset; and
plus a 10% profit. 3. Costs and revenues of each asset can be measured.
This is a cost-plus contract. Example:

You have a master contract to build 80 branches for a retail
banking operation over a 2-year period, in different locations
throughout the region.
The cost for each branch is negotiated separately, and you The tailoring of the software should be accounted for as a
receive a 10% profit, based on the agreed cost for each construction contract in accordance with the principles of IAS 11,
branch. and the fee for the use of the software and the maintenance
support should be recognised on a straight-line basis over the
Each branch should be treated as a separate contract. period of the licence in accordance with IAS 18.
The allocation of the total contract revenue between the tailoring

service, the right to use the software and the maintenance
Example: support should be made on the basis of the fair value of the
services. The allocation of the revenue based on fair value is
Should a contract for an asset’s construction and operation be likely to differ from an allocation based on the billing schedule.
accounted for as a single contract or separate contracts?
A group of contracts, with one client or more, should be
Background
X develops and sells computer software. The sales take the form treated as a single contract when:
of a licence to use the software for a limited period of time, and
include after-sales support during the period of the licence. The
1. The contracts were signed as a single package;
sales include a significant element of tailoring the basic software
2. The contracts are so closely related that they are, in
to meet the client’s needs.
substance, part of a single project with an overall profit
margin: and
X charges its clients a series of fees during the tailoring period.
3. The contracts are performed concurrently, or in a
An additional fee is charged at the start of the period of the
continuous sequence.
licence once the tailoring is complete and the client has accepted
the software package. No further amounts are payable during the
Example:
licence period, either for the use of the software or for the
maintenance support.
Should a group of contracts with a single customer be accounted
for as a single contract or separate contracts?
X’s management has questioned how the revenue from the
contract should be recognised.
Background
A contractor is negotiating two contracts with a single customer.
Solution
The customer must either accept both contracts or reject both.
Management should account for the tailoring, the licensing and
The first contract will be for the design of a computer centre and
the maintenance support as separate elements.
the second for the plant’s construction. The planned profit margin
on the design contract is 20%, and the planned profit margin on 1.6 Contract Revenue
constructing the centre is 10%.
Contract revenue should comprise:
Solution
The two contracts should be accounted for as a single contract. 1. The initial revenue agreed; and
The contracts were negotiated as a single package; the client 2. Variations in the contract work, claims and incentive
must accept both or reject both. The contracts are closely related payments.
and will be performed in a continuous sequence. An overall profit (These are included if it is probable that they will result
margin should be recorded as work is performed on both in revenue, and are capable of being reliably
contracts. measured).
The contract revenue may change from one period to the

Example: next, as a result of contract variations, claims, penalties, and
You have contracts to build a number of branches in shopping cost-escalation clauses.
malls. Site preparation is done by the client, and building Variations may increase, decrease, or redesign the scope of
costs are the same for each branch.
This may be treated as a single contract. the contract, with a matching change in revenue.
A contract may provide for an additional asset at the client’s
option, or by way of an amendment. This will be treated as an
additional contract when: Changes are only included in revenue when it is likely that the
1. The asset is fundamentally different from those client will approve the variation and its impact on the revenue,
included in the original contract; or and the change in revenue can be reliably measured.
2. The price of the new asset is agreed without regard to Example:

the original contract price. You are building a road. The original plan called for a bridge
over a railway, but the authorities now insist on a tunnel under
Example: the railway instead.
You are building a retail branch, and your client asks you to
build a transport distribution centre in the grounds, at a price This is a variation.
to be negotiated.
This will be treated as an additional contract.
Claims are levied by the contractor on the client for costs not You are building a head office. If the actual completion date is
a month (or more). earlier than the planned completion date,
included in the contract price. Often, these stem from your firm will earn a bonus (and the client can start operations
early)..
problems caused by the client, such as wrong specifications,
This is an example of an incentive payment.
errors in designs, and delays.
Contract estimates need to be revised, either for actual
Example: performance, or new considerations of future performance.
You have been contracted to demolish some houses, and
build a clearing house. You were promised vacant Example:
possession. When your staff arrives, they find that the tenants You are redeveloping a retail site in the city centre. You had
still occupy the old houses. It takes a month to re-house planned to work 24 hours per day, but the city has just
them, delaying the start of work. passed regulations to halt building work at night.
This may be the basis for a claim. You may have to revise your contract estimate.
Clients may contest the claims, so they should only be Example:
included in project revenue when the amount of the claim that Progress payments and advances received from clients often do
not reflect the work performed. On what basis should management
is likely to be paid can be reliably determined. assess a project’s percentage of completion?
Incentive payments are bonuses paid if the contractor meets Background

P entered into a contract with B to construct a clearing centre. The
or exceeds specific criteria, such as early completion of part, cost of the clearing centre is estimated at 150,000. The total
revenue from the contract is estimated at 200,000. P will take 3
or all, of the contract. They are included in contract revenue years to construct the clearing centre.
when it is likely that they will be earned. At the end of year 1 P incurred costs of 60,000. The client was
invoiced for 50,000 at the end of year 1. Payment of this progress
billing is due, early in year 2, in accordance with the normal credit
Example: terms that P offers.
3) Costs allocated to contract activity in general,
Management estimated the stage of completion as 33%, based on which are allocated to the contract.
the amount invoiced.
Costs relating specifically to the contract include:
Solution
The percentage of completion should be determined from: the 1. Site labour costs, including supervisors.
proportion of costs incurred to date; the percentage of physical 2. Materials used in construction.
work complete; or services performed to date. Amounts invoiced to 3. Depreciation of plant and equipment used.
clients do not necessarily influence the stage of completion. 4. Transport of staff, materials and assets to the site.
5. Hiring plant and equipment.
Based on the relationship between the costs incurred to date and 6. Contract design and technical assistance work.
total estimated costs, the contract is 40% (60,000/150,000) 7. Rectification, guarantee, and expected warranty
completed at the end of year 1. Revenue of 80,000 (40% of costs.
200,000) should be recognised at the end of year 1. 8. Claims from third parties.
The 50,000 progress billing invoiced to the client should be Incidental income (from sale of equipment at the end of the
recognised as an adjustment to construction account receivable in contact, surplus materials and scrap) will reduce these costs.
the balance sheet. The construction account receivable balance is
Example:
disclosed separately on the face of the balance sheet (SFP).
You are demolishing an old building, prior to building a call
centre. You sell the materials from the old building for scrap.
1.7 Contract Costs This is incidental income.
Contract costs should be expensed as incurred. Costs may
be carried over to future periods only if they will be Other costs chargeable to the client may include some
reimbursed in those periods. general overheads, or development costs, that the client has
agreed to be billed under the contract.
Revenue is generated as detailed in the previous section,
and matched with the costs of the period as detailed in the Example:
following section. You are building 100 branches of various sizes. Your client
asks that you spread the architects’ fees over costs of all the
Contract costs comprise: branches.
1) Costs that relate specifically to the contract.
2) Other costs chargeable to the client, under the This is an example of general development costs being
terms of the contract. spread over different contracts.
would be carried forward as an asset: prepaid expenses for
Costs allocated to contract activity in general include:
contracts.
1. Construction overheads.
2. Insurance.
3. Borrowing costs of the contractor.
Example:
Borrowing costs of the contractor should be expensed as
incurred. Expenses to be included in contract cost incurred
Borrowing costs of the owner are the subject of IAS 23 and When the stage of completion is determined by reference to the
may be capitalised according to IAS 23. contract costs incurred to date, only those contract costs that
reflect work performed are included in costs incurred to date.
Costs that are not included in the contract, and cannot be
allocated to the contract, are treated as general overheads. What amount of expenses should management include in
contract costs incurred when determining the stage of
Costs incurred in securing a contract can be included as completion?
contract costs, if they are separately identifiable, and it is
likely that the contract will be won. Background
An entity incurred the following expenses in year one of a three-

year contract:
Example:
You have 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 likely to be won. Costs for bids likely to be won
The specialist equipment is tailored according to the
requirements of the particular contract, and is therefore to be
considered in the stage of completion when it is delivered to the
site.
1.8 Recognition of Contract Revenue and Expenses
Contract revenue and costs should be recognised by

reference to the stage of completion (‘percentage of
completion’) of the contract at the balance sheet date.
Any expected loss on the contract should be recognised

immediately.
Management should determine the stage of completion by
Example:
assessing contract costs incurred to date as a portion of the
You have been notified by a subcontractor that his costs to you
estimated total contract costs.
for next year will increase by 15%. You cannot bill your client for
Solution this increase. It will cause you to lose money on the contract, and
can find no alternative supplier.
Contract cost incurred to date for the purposes of determining the
stage of completion of the contract amount to 4,400. Recognise the anticipated loss immediately.
The following expenses are not included in contract costs to date Example:
because they do not reflect on work performed in the current
year: What amount should be recognised as profit or loss for the
contract in each year?
Material delivered to the site to be used in future 300
periods Background
Provision for environmental clean-up costs at end 200 T is constructing a building for its client. The construction is in its
of construction second year of the three-year project.
Payments to sub-contactors in advance for work to 100
be performed Management had originally assessed the contract to be profitable
Total 600 and recognised a profit in year 1 of 20,000, based on the
percentage of the contract that had been completed at that time.
Management now believes the contract will incur a cumulative Any anticipated excess of total contract costs over total
loss of 30,000. contract revenue should be recognised immediately.
Management has proposed that a loss of 30,000 on the contract Contract costs that relate to future work on the contract, and
is recognised in year 2, but has questioned how the profit of for which the client will pay, can be treated as an asset,
20,000 recognised in year 1 should be treated. usually work in progress.
Solution Example:
Management should immediately recognise a loss in respect of You are building a training centre, and have imported some
the contract of 50,000 in year 2. This represents a reversal of the insulation material that will not be needed until next year.
20,000 profit recognised in year 1 and the 30,000 loss expected (This was done to avoid an imminent price rise announced
on the contract as a whole. by the supplier).
The loss has been assessed through a revision of the estimated You have also paid an advance to a subcontractor.
costs to completion. The appropriate accounting entry is therefore
to recognise the adjustment in the current year’s results rather
than record a prior-period adjustment. Both items should be booked to work in progress.
For fixed-price contracts, the result can be estimated when

the following conditions are satisfied: If there is a risk that revenue that has already been
1. Total revenue can be measured reliably. recognised may not be paid, the uncollectable amount is
2. Contract costs to complete can be measured reliably.
3. The stage of completion is known. recognised as an expense immediately on recognition. It is
4. Actual costs can be compared with prior estimates.
not an adjustment of revenue.
For cost-plus contracts, contract costs must be identifiable,
whether or not they are reimbursable.
Example:
Using the percentage of completion method, revenue is You are a subcontractor. The contractor has approved your
recognised in the income statement in the periods, in the work, and you have recognised the revenue according to the
periods in which the work is done. contract. The client is delaying payment, for reasons that are
Costs are recognised as incurred. not clear. You should create a doubtful debt provision for the
disputed revenue.
1.9 Stage of Completion Calculation Note: Progress payments and advances received from
clients often do not reflect the work done.
The contract is the main reference. Methods may include:
Example:
1. The proportion that costs incurred for the work to On signing a contract to build a credit card clearing house, you
date relate to the estimated total costs. receive a payment of 10% of the contract price.
Example: Treat this as deferred income (a liabililty), and do not recognise

You are building a new computer centre, for which your costs any revenue, at this time.
will be $10million. So far you have spent $4million. Assume
that the project is 40% complete, unless there is any When the outcome of a construction contract can be
evidence to the contrary. estimated reliably, contract revenue and contract costs
associated with the construction contract should be
recognised at the balance sheet date.
2. Surveys of the work done.
Example:
You are building a duplicate securities trading centre as part When the outcome of a Contract cannot be estimated:
of your client’s disaster plan. The client’s surveyors have
confirmed that 37% of the work is complete, and  No profit is recognised, though an expected loss
recommended payment for the work. should be recognised immediately.
3. Completion of a physical portion of the work.

 Revenue should only be recognised to the extent
Example: that it is likely to be chargeable to the client.
You are building 300 branches of similar size. 75 are
complete, and no work has been done on the other 225.
Treat your contract as 25% complete, unless there is any
evidence to the contrary.  Costs should be recognised in the period in which they
are incurred.
Costs incurred relating to future work on the contract, Example:
including advance payments to subcontractors, should not be
included in the calculation. Should an entity recognise a construction contract work in
progress balance at year-end?
Common causes of such uncertainty over the outcome
Background
E has recently started to design and construct web sites for its include:
customers. This is a new activity for E and it is not clear yet how
long such work will typically take; however, it is clear that the 1. Financial difficulties of contractor or client.
activities will be likely to start in one accounting period and end in
the subsequent one.
Solution Example:
Management should not recognise construction contract work in
progress in respect of the costs incurred on the web sites. All
Your client has not paid you for your work on the agreed date.
costs should be expensed as incurred.
Construction contract accounting also applies to rendering Arguments ensue, but you think that your client has serious
services. However, management does not have a clear and
reasonable estimate of the costs likely to be incurred in the financial problems, and the contract is at risk.
development of each web site.
The costs therefore do not meet the recognition criteria for 2. Pending litigation or legislation.
construction contract work in progress. Example:
Revenue should be recognised only to the extent that You are rebuilding on an old industrial site. The government
management believes the costs will be recovered. Management
will therefore need to defer all revenue until the end of the finds toxic effluent has been leaking from the site, and applies
contract if there is uncertainty about collectability.
to the court for an order to stop work.
Management will be able to recognise work in progress and
follow the normal principles for construction contract revenue
recognition once it has established a track record of web site 3. Lack of clarity in the contract on reimbursement of
development costs. This is likely to be after the first financial year. costs.
Example:
You are building a client service centre. Government officials Example:
You are constructing a building for a client. Project revenue is $20m.
demand additional health and safety features, which are not
Costs to date are $6m, and you estimate that additional costs to
covered by the contract. You submit a variation proposal to completion are $10m.
the client, who refuses it, claiming the cost is yours. (Costs have been accumulated in an asset account: construction
in progress. An alternative method is to expense them as incurred.)
4. Anticipated failure to complete the contract. The client has, so far, only approved $4m of the expenditure, as his
Example: staff is on holiday for the month.
You are building a call centre. Part of the site unexpectedly You believe that the $2m ($6-$4m) will be approved). No payment
has been received.
becomes flooded, and you cannot determine whether or not the call
Recognise:
centre will be completed within the contract period. $4m as expense (the amount approved)
$5m as (accrued) revenue (4/16*$20m).
$2m is left as construction in progress. ($6m-$4m=$2m)
I = Income statement, B = Balance sheet (SFP)

I/B DR CR
Cost of sales I $4m
Construction in progress B $4m
Accounts receivable B $5m
Revenue I $5m
Revenue recognition
Revisions to estimates do not mean that the financial

outcome of the transaction cannot be reliably measured.
Advances and progress payments received from clients may not
reflect the stage of completion.

Example: Percentage of Completion -1 I/B DR CR
On day 1 of a $50 million contract, $5 million is received on account. Accounts receivable B $1m
This should not be fully recognised as revenue until 10% of the work Revenue I $1m
has been successfully completed. Revenue recognition
Cost of sales I $1m
I/B DR CR Work in progress B $1m
Cash B $5m Recognising expenses
Deferred revenue B $5m
Recording cash receipt on day 1 If it is not probable that the costs will be recovered, no
Example: Percentage of Completion -2 revenue is recognised, and all costs are immediately
10% is now completed, costs total $3m
Cost of sales I $3m expensed.
Work in progress B $3m
Deferred revenue B $5m
Revenue I $5m
Revenue recognition –when 10% of
the work is completed
In the early stages of a transaction, it may be that the

profitability cannot be reliably estimated.
If it is likely that only the costs will be recovered, recognise

only enough revenue to equal the costs. (accounting for the
project as breakeven: no profit, no loss).
Example: Recovery of costs

Project revenue is a total of $100 million. $1 million has been spent
at the period end, and there are problems that indicate that no profit
will be made on the project.
Recognise $1million as accrued revenue and $1million as (actual)

expenses.
Property type- different accounting Standard Standard Name Valuation

treatment applied to properties under Number
IFRS depending on their current and
future uses and their ownership
Owner-occupied property IAS 16 Property, plant and equipment Cost or revaluation.
(see also IAS 20 Government grants)
Property acquired in an exchange of IAS 16 Property, plant and equipment Fair value or the carrying amount of the assets given
assets up.
Investment property IAS 40 Investment property Cost or fair value.
Investment property being redeveloped IAS 40 Investment property Cost or fair value.
for continuing use as investment property.
Investment property held for sale without IAS 40 Investment property Cost or fair value.
development (unless it meets the criteria
of IFRS 5 – see below).
Property held under an operating lease IAS 40 Investment property Fair value (accounted for as a finance lease under IAS
classified as an investment property 17).
Property held under a finance lease IAS 17 Leases. Owner-occupied IAS 16, The lower of fair value and the present value of the
Investment property IAS 40. minimum lease payments.
Property held under an operating lease – IAS 17 Leases Leasing costs expensed.
owner -occupied
Property lease to another party under a IAS 17 Leases Account receivable equal to the net investment in the
finance lease lease.
Property sale and leaseback IAS 17 Leases As operating lease or finance lease, as appropriate
Trading properties – property (including IAS 2 Inventories (Properties held for sale that meet the Lower of cost and net realisable value.
investment property) intended for sale in criteria of IFRS 5 should be recorded according to
the normal course of business or being IFRS 5 – see below. These are generally not in the
built or developed for that purpose normal course of business.)
Property held for sale, or included in a IFRS 5 Non-current assets held for sale and discontinued Lower of carrying amount and fair value less costs to
disposal group that is held for sale. operations sell.
Assets received in exchange for loans IFRS 5 Non-current assets held for sale and discontinued Lower of fair value less costs to sell and carrying
(taking possession of collateral) operations amount of the loan net of impairment at the date of
IAS 16 Property, plant and equipment (see Property acquired exchange.
in an exchange of assets above) (see HSBC plc Annual Report 2005 page 247)
Property provided as part of a IAS 11 Construction contracts Stage of contract completion or cost.
construction contract
Future costs of dismantling, removal and IAS 37 Provisions, contingent liabilities and contingent Present value of the expected costs, using a pre-tax
site restoration. assets (see also IFRIC 1, IFRIC 5) discount rate.
Notes to the table on the previous page. 2. The stage of completion.
Note 1: Where an asset is revalued, increases in carrying amounts 3. The amount of profits on other contracts.
above cost are recorded as revaluation surplus, in equity.
Using fair values, all changes in fair value are recorded in Example:
the income statement. You have five separate construction contracts with the same client.
Reductions below cost are recorded in the income statement Your project in France is hit by strikes, which means additional
under both methods. costs, and penalties for late completion. This will create a loss for
the project, though the four other projects will make enough profits
Note 2. In the cases of cost or revaluations, the carrying value will to cover the loss.
be reduced by accumulated depreciation and accumulated
impairment (see IAS 36). You must still recognise the loss on the French project immediately.
Workbooks are available on our website on each standard that Changes In Estimates
The percentage of completion method is calculated on a cumulative
explain each accounting treatment with examples.
basis, in each period. It is based on current estimates. A change in
2 Recognition of Expected Losses and Changes in
Estimates estimates of final revenue, or costs, is recognised in the period that
Any anticipated excess of total contract costs over total contract the change is made.
revenue should be recognised immediately.
This recognition should happen, regardless of:
1. Whether or not work has started on the contract.
Example: 3 Disclosure
You are going to build a financial services centre. You hire staff,
machinery and materials. You travel to the site, and find that the
An enterprise should disclose:
land is subsiding. The client offers another site, but for the same
contract price.
1) the amount of contract revenue recognised as revenue in
This would reduce your loss, but not eliminate it. Recognise the
the period;
loss immediately.
2) the methods used to determine the contract revenue (b. the gross amount due to clients for contract work as a
recognised in the period; and liability.
3) the methods used to determine the stage of completion of The gross amount due from clients for contract work is the net
contracts in progress. amount of:
An enterprise should disclose each of the following for contracts in (a. costs incurred plus recognised profits; less
progress at the balance sheet date:
(b. the sum of recognised losses and progress billings
1. the aggregate amount of costs incurred and recognised
(less recognised losses) to date for all contracts in progress for which costs incurred plus
recognised profits (less recognised losses) exceeds
2. the amount of advances received; and progress billings.
3. the amount of retentions The gross amount due to clients for contract work is the net amount
of:
Retentions are amounts of progress billings, which are not paid until
the satisfaction of conditions specified in the contract for the (a. costs incurred plus recognised profits; less
payment of such amounts or until defects have been rectified.
(b. the sum of recognised losses and progress billings
Progress billings are amounts billed for work performed on a
contract whether or not they have been paid by the client. for all contracts in progress for which progress billings exceed costs
incurred plus recognised profits (less recognised losses).
Advances are amounts received by the contractor before the An enterprise discloses any contingent liabilities and contingent
related work is performed.
assets in accordance with IAS 37 Provisions, Contingent Liabilities
An enterprise should disclose:
and Contingent Assets.
(a. the gross amount due from clients for contract work as an
asset; and Contingent liabilities and contingent assets may arise from such
items as warranty costs, claims, penalties or possible losses.

4 Specific Examples A summary of the financial data during the construction period is
given on the next page:
Example 1: Determination of Contract Revenue and Expenses
The stage of completion for year 2:
The following example illustrates one method of determining the
stage of completion of a contract, and the timing of the recognition 5.040/8.400 = 60%, so we recognise revenue to date of 60% -
of contract revenue and expenses. 10.000 * 60% = 6.000.
A construction contractor has a fixed-price contract for $10,000 to 60%. is determined by excluding costs incurred for work performed
build a training centre above a shopping mall. The contractor's to date the 300 of materials for use in year 3.
initial estimate of contract costs is $7,500. It will take 3 years to
build. The amounts of revenue, expenses and profit recognised in the
income statement in the three years are as follows:
By the end of year 1, the contractor's estimate of contract costs has
increased to $8,400 (and remains so the end of year 2).
At the end of year 2, costs incurred to date include $300 for

materials to be used in year 3.
The total costs at the end of year 2 are 5.340.

From this, we deduct 300 (expenses relating to year 3 - such as
materials that have not yet been used) To Recognised in Recognised in
Year 1 ($000’s) Date prior years current year
leaving 5.040 as the total costs to date.
In year 3, the client approves a variation resulting in an increase in

contract revenue of $500 and estimated additional contract costs of
$250.
The stage of completion is determined by calculating the proportion

that costs incurred for work done so far bear to the estimated total
costs.
Contract costs incurred for contract 2 include the cost of materials

Revenue (10,000 x 3,333 - 3,333
that have been purchased for a future period.
33%)
For contract 1, the client has made an advance to the contractor for
Expenses (7,500 x 2,500 - 2,500 work not yet performed.
33%)
Profit 833 - 833 The status of its contracts in progress at the end of year 1 is as
follows:
Year 2 Total
($000’s) 1 2
Revenue (10,000 x 6,000 3,333 2,667
60%) Contract Revenue 1,600 1,000 2,600
Expenses (8,400 x 5,040 2,500 2,540 Contract Expenses 1,250 1,100 2,350
60%) -
Expected Losses 60 60
Profit 960 833 127
Recognised profits less
Year 3 recognised losses 350 -160 190
Revenue (10,500 x 10,50 6,000 4,500 Contract Costs incurred in
100%) 0 the period 1,700 1,100 2,800
Expenses 8,650 5,040 3,610 Contract Costs incurred 1,250 1,100 2,350
recognised as contract
Profit 1,850 960 890
expenses in the period (as
above)
Specific example 2:
Contract Costs that relate
Contract Disclosures to a future period 450 - 450
Contract Revenue (as 1,600 1,000 2,600
In the next example, another contractor has reached the end of its above)
first year of operations.
Progress Billings 1,600 850 2,450
Its contracts’ costs incurred have been paid for in cash. Unbilled Contract Revenue - 150 150
All its progress billings and advances have been received in cash.
Advances 250 - 250
The last 2 amounts 1 2 Total

above are calculated as
follows:
The amounts to be disclosed are: Contract Costs incurred
1700 1100 2800
Contract revenue recognised in the Recognised profits less
2,600 recognised losses 350 -160 190
period
Contract costs incurred and Subtotal 2050 940 2990
recognised profits (less recognised 2,990 Progress billings 1600 1000 2600
losses) to date
Due from clients 450 - 450
Advances received 250
Due to clients - -60 -60
Gross amount due from clients for 450*
contract
work - presented as an asset Specific example 3:
Gross amount due to clients for Contract costs should comprise:
contract -60*
work -presented as a liability i) costs that relate directly to the specific contract;
ii) costs that are attributable to contract activity in general and can
* Please see the following table. be allocated to the contract; and
iii) such other costs as are specifically chargeable to the client

under the terms of the contract.
The following table highlights the types of costs that should be

included in construction work in progress:
Excluded
Description of cost Included
Labour costs (including supervision) warranty costs
Costs of materials used in construction Claims from third parties relating to the
contract
Construction overheads
* unless the reimbursement is specified in
Insurance (include contract-specific the contract
insurance and an allocation of general
insurance)
Specific example 4:
*
General administration and selling costs
Costs of variations and claims to be included in contract work
Depreciation of plant and equipment used in progress
on the contract
A variation is included in contract revenue when:
Depreciation of idle plant and equipment
that is not used on a particular contract i) it is probable that the client will approve the variation and the
amount of revenue arising from the variation; and
Costs of moving plant, equipment and ii) the amount of revenue can be reliably measured.
materials to and from the contract site
Claims are only included in contract revenue when:
Costs of hiring plant and equipment
i) negotiations have reached an advanced stage and it is probable
Costs for clean-up at end of contract that the client will accept the claim; and
*
Research and development costs
ii) the amount the client will probably accept can be measured
Borrowing costs reliably.
Costs of design and technical assistance Should the variations and claims to the contract be included in
that is directly related to the contract contract revenue?
Estimated costs of rectification and Background Solution

guarantee work, including expected
accept a claim of 2,000 due 2,000 can be included in the

to delays caused by the contract price (revenue).
At year-end the following
client itself.
variations and claims occurred
on a contract:
Specific example 5:
1. Background
i) the client approved changes Yes, all criteria are met. The
to the contract’s design 5,000 can be included in the H is building a parking area for $300,000 for its client.
specifications with a total contract price (revenue). The client has paid $250,000 so far.
cost of 5,000.
ii) due to poor weather, the No, the client will probably not $250,000 is accounted as 'payment in advance' in H's financial
contract will overrun by 3 approve the variation amount. statements.
months. This will lead to an The additional costs already
increase in costs of 3,000. incurred should be included in the But it is actually H's sales revenue, is that correct?
The client will probably not calculation of WIP if the contract is
approve the amount of still profitable. However, a lower Answer
revenue arising from the expected profit margin should be
variation. recognised because of the No, it is a 'payment in advance' shown as a liability.
additional costs incurred. The For example, if a client pays H $250,000 today in advance for a
total expected loss should be parking area that H has not started to build, and for which no costs
recognised immediately if the have been incurred, H cannot record any revenue.
additional costs will result in a loss
on the contract. Advance payments and sales contracts do not change the
iii) due to unforeseen No, negotiations have not reached percentage of completion.
circumstances the an advance stage where it is
contractor incurred probable the client will accept the H records the revenue (possibly revenue receivable) in proportion
additional costs in the claim. The contractor should to the work done as percentage of the whole work.
current year on the contract. include the additional costs in the
Negotiations to obtain the WIP calculation and recognise a The three options in calculating Revenue, depending on the level of
client’s acceptance of these lower expected profit margin due knowledge of the transaction’s final outcome are:
claims are in early stages. to the additional costs incurred.
iv) the client will probably Yes, all criteria are met. The
1. Anticipating a profit: Percentage of completion method. and the revenue will be $ 100,000,000 /$ 150,000,000 * $
2. Anticipating Break-Even: Recovery of costs, only. 300,000,000 = $ 200,000,000.
3. Anticipating a loss: Non-recovery of costs (but full expensing
of costs). Profit = $ 100,000,000
Specific example 6: Accounting entries will be:
2. Background
H will build 1,000 hotel rooms within a leisure complex, each will
cost $150,000, H will be paid $300,000 per room.
The total cost of the project estimated to be: 1,000 x 150,000 =

$150,000,000.
H has received $160,000,000 as progess payments.
As of December 31, the costs incurred on the project are: $

100,000,000
(Costs incurred relating to future work on the contract, including

advance payments to subcontractors, should not be included in the
calculation.)
Answer
Stage of completion= $ 100,000,000 / $ 150,000,000 => 66,66%
Assuming that there are no losses on the contract, (no excess

costs) the cost will be $ 100,000,000
Background
($millions.)
200
Contract Revenue The rooms are now fully built, but the hotel complex has not yet
100 been registered with the authorities.
Contract Expenses
0
Expected Losses Answer
If the rooms are ready for occupaancy, they should be considered
Recognised profits less recognised losses as complete if there is a reasonable expectation that there will be
100 no problem (other than a time delay) with the registration.
Contract Costs incurred in the period
100 Specific examples 5 + 6 were provided by Mr. Begum Kadioglu, of
100 Marmara University, Turkey
Contract Costs incurred recognised as
contract expenses in the period (as above).
5 Multiple Choice Questions
Contract Costs that relate to a future period
0 1. The start and finish of Construction Contracts normally fall into:
(This is to balance any cash paid for
expenses for work to be done in future
1) the same accounting period.
periods.)
2) different accounting periods.
200
Contract Revenue (as above).
160
Progress Billings
40 2. A key issue of the standard is:
Unbilled Contract Revenue
0
Advances (to subcontractors) 1) The timing of recognition of contract revenue and contract
(This is to balance any cash paid to costs.
subcontractors for work to be done in 2) Selection of reporting currency.
future periods.) 3) Balance sheet structure.
Further point
3. An effective internal financial budgeting and reporting system to 8. Contract revenue should comprise:
1) All cash flows.
control construction contracts is: 2) Initial revenue agreed, plus variations, claims and incentive
payments.
1) Helpful.
9. Variations can only increase revenue.
2) Unnecessary.
3) Required.
1) True.
2) False.
4. Cost-escalation clauses may be a feature of fixed-price
contracts:
10. Claims relate to costs included in the contract price.
1) True.
1) True.
2) False.
2) False.
5. In a cost-plus contract, you can charge:
11. Incentive payments can be included in the revenue at the start
of the contract.
1) All costs plus a profit margin.
2) Costs agreed under the contract, plus an agreed profit.
1) True.
2) False.
6. You can combine and segment construction contracts:
12. Contract estimates may be revised.
1) To reduce work.
2) To reflect economic reality, under specified conditions. 1) True.
2) False.
7. A contract may provide for an additional asset at the client’s
option, or by way of an amendment. 13. Contract costs only include costs that relate specifically to the
Can this be treated as an additional contract? contract.
1) No. 1) True.
2) Maybe. 2) False.
1) Can be ignored.
14. Incidental income, such as from the sale of scrap materials, 2) Should be expensed immediately.
should be shown as: 3) May be treated as an asset.
1) Revenue. 20. Advances paid to subcontractors:

2) A deduction from costs.
1) Can be ignored.
15. Development costs can be charged to contract costs. 2) Should be expensed immediately.
3) May be treated as an asset.
1) True.
2) False. 21. If revenue that has already been recognised may not be paid,
16. Borrowing costs can be charged to contract costs. the uncollectible amount:
1) True.
2) False. 1) Is deducted from revenue.
2) Is recognised as an expense.
17. Costs incurred in securing contracts may be included in contract
costs. 22. When using the stage of completion method of calculation, the
main reference is:
1) True.
2) False. 1) The client.
2) Internal records.
18. Any expected loss on the contract should be: 3) The contract.
1) Ignored. 23. When the outcome of a contract cannot be estimated:

2) Recognised at the end of the contract.
3) Spread over the life of the contract. 1) Revenue should not be recognised.
4) Recognised immediately. 2) Some revenue may be recognised.
3) All revenue can be recognised.
19. Contract costs that relate to future work on the contract:
24. Changes in estimates are:

(Please complete the table.)
1) Recognised in the period that the change is made. ($000’s) Year Year Year
2) Recognised at the end of the contract. 1 2 3
3) Ignored.
Initial amount of revenue
6 Exercise Questions agreed in contract
Variation
1. The Determination of Contract Revenue and Expenses
(Amounts expressed in $000’s). Total contract revenue
Contract costs incurred to
A construction contractor has a fixed-price contract for $30,000 to date
build a tunnel. The contractor's initial estimate of contract costs is
Contract costs to complete
$22,500. It will take 3 years to build the tunnel.
Total estimated contract 22,50 25,20 25,95
By the end of year 1, the contractor's estimate of contract costs has costs 0 0 0
increased to $25,200. Estimated profit
In year 3, the client approves a variation resulting in an increase in Stage of completion 33% 60% 100%
contract revenue of $1,500 and estimated additional contract costs
of $750. At the end of year 2, costs incurred include $900 for
materials to be used in year 3. The stage of completion for year 2 (60%. is determined by
excluding costs incurred for work performed to date the 900 of
The stage of completion is determined by calculating the proportion materials for use in year 3)
that costs incurred for work done so far bear to the estimated total
costs. The amounts of revenue, expenses and profit recognised in the
A summary of the financial data during the construction period is as income statement in the three years are as follows:
follows:
2. Contract Disclosures
(Please complete the table.) In the next example, another contractor has reached the end of its
first year of operations.
($000’s. Recognised Recognised
To
in prior in current
Date Both its contracts’ costs incurred have been paid for in cash.
years year
All its progress billings and advances have been received in cash.
Contract costs incurred for contract 2 include the cost of materials
1.1.2 Year 1
that have been purchased for a future period.
Revenue (30,000 x - For contract 1, the client has made an advance to the contractor for
33%) work not yet performed.
Expenses (22,500 x -
33%) The status of its contracts in progress at the end of year 1 is as
follows:
Profit -
Year 2
Revenue (30,000 x
60%)
Expenses (25,200 x
60%)
Profit
Year 3
Revenue (31,500 x
100%)
Expenses
Profit
Total The amounts to be disclosed are:

($000’s. 1 2
Contract Revenue 4,800 3,000 7,800
Contract Expenses 3,750 3,300 7,050 Contract revenue recognised in the
Expected Losses period
- 180 180 Contract costs incurred and
Recognised profits less recognised profits (less recognised
recognised losses 1,050 -480 570 losses. to date
Contract Costs incurred in Advances received

the period 5,100 3,300 8,400 Gross amount due from clients for
contract
Contract Costs incurred 3,750 3,300 6,950
work - presented as an asset in
recognised as contract
accordance
expenses in the period (as
above. Gross amount due to clients for
contract
Contract Costs that relate
work -presented as a liability
to a future period 1,350 - 1,350
Contract Revenue (as 4,800 3,000 7,800
above.
Progress Billings 4,800 2,550 18,00 (Please Complete the following table.
0
Unbilled Contract Revenue - 450 15,12
0
Advances 750 - 750
(Please complete the following table.)

The last 2 amounts 1 2 Total ($000’s. Year Year Year

above are calculated as 1 2 3
follows: Initial amount of revenue 30,00 30,00 30,00
Contract Costs incurred agreed in contract 0 0 0
Recognised profits less Variation - - 1,500
recognised losses Total contract revenue 30,00 30,00 31,50
Subtotal 0 0 0
Progress billings Contract costs incurred to 7,500 16,02 25,95
date 0* 0
Due from clients
Contract costs to complete 15,00 9,180* -
Due to clients
0 *
Total estimated contract 22,50 25,20 25,95
7 Solutions costs 0 0 0
Estimated profit 7,500 4,800 5,550
Answers to multiple-choice questions: Stage of completion 33% 60% 100%
1. 2. 7. 2. 13. 2. 19. 3.
2. 1. 8. 2. 14. 2. 20. 3. *The stage of completion for year 2 =
3. 3. 9. 2. 15. 1. 21. 2. 60% * 25,200= 15120 plus 900 of materials for use in year 3
4. 1. 10. 2. 16. 1. 22. 3. =16,020.
5. 2. 11. 2. 17. 1. 23. 2.
6. 2. 12. 1. 18. 4. 24. 1. ** 10,080 – 900 already incurred in year 2 = 9,180.
The amounts of revenue, expenses and profit recognised in the
income statement in the three years are as follows:
Answers to exercise questions:
1.
2. The amounts to be disclosed are:

($000’s. Recognised Recognised
To
in prior in current
Date
years year Contract revenue recognised in the
7,800
period
Year 1
Contract costs incurred and
Revenue (30,000 x 9,999 - 9,999
recognised profits (less recognised 8,970
33%)
losses. to date
Expenses (22,500 x . 7,500 - 7,500
Advances received 750
33%)
Gross amount due from clients for 1,350
Profit 2,499 - 2,499
contract
Year 2 work - presented as an asset in
Revenue (30,000 x . 18,00 9,999 8,001 accordance
60%) 0 Gross amount due to clients for
Expenses (25,200 x . *15,12 7,500 7,620 contract -180
60%) 0 work -presented as a liability
Profit 2,880 2,499 381

Year 3
Revenue (31,500 x 31,50 18,000 13,500
100%) 0
Expenses 25,95 15,120 10,830
0
Profit 5,550 2,880 2,670
* *The stage of completion for year 2 = 60% * 25,200= 15120.
Contract costs incurred to date = 16,020

Less: 900 of materials for use in year 3 = 15120.

Ias 11 Construction Contracts

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Ias 11 Construction Contracts

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IAS 11 CONSTRUCTION CONTRACTS

for Accounting Professionals

IAS 11 CONSTRUCTION CONTRACTS

1. Introduction and Definitions........................................................3

Instruments is the subject of IAS 39.

Accounting Standard (IAS) 11. Construction Contracts.

If a sale agreement is for the sale of goods, revenue shall be

have been satisfied.

rather than only at completion. specifically

of assets …” progress in this way may include, for example:

A sale agreement meets this definition if it is an agreement for

-the land under construction is owned by the buyer from ownership).

options or specify minor variations to the basic design;

the underlying work in progress until that date.

project is classified under IAS 18 Revenue, generally revenue

Bank accounting rarely involves construction contracts.

Construction Contract Background

Construction contracts include:

This is a cost escalation clause. Combining and Segmenting Construction Contracts

This is a cost-plus contract. Example:

The allocation of the total contract revenue between the tailoring

The contract revenue may change from one period to the

2. The price of the new asset is agreed without regard to Example:

This will be treated as an additional contract.

Clients may contest the claims, so they should only be Example:

Incentive payments are bonuses paid if the contractor meets Background

An entity incurred the following expenses in year one of a three-

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

1.8 Recognition of Contract Revenue and Expenses

Contract revenue and costs should be recognised by

Any expected loss on the contract should be recognised

For fixed-price contracts, the result can be estimated when

Example: Treat this as deferred income (a liabililty), and do not recognise

3. Completion of a physical portion of the work.

I = Income statement, B = Balance sheet (SFP)

Revisions to estimates do not mean that the financial

Advances and progress payments received from clients may not

reflect the stage of completion.

In the early stages of a transaction, it may be that the

If it is likely that only the costs will be recovered, recognise

Example: Recovery of costs

Recognise $1million as accrued revenue and $1million as (actual)

Property type- different accounting Standard Standard Name Valuation

This recognition should happen, regardless of:

1. Whether or not work has started on the contract.

items as warranty costs, claims, penalties or possible losses.

At the end of year 2, costs incurred to date include $300 for

The total costs at the end of year 2 are 5.340.

In year 3, the client approves a variation resulting in an increase in

The stage of completion is determined by calculating the proportion

Contract costs incurred for contract 2 include the cost of materials

The last 2 amounts 1 2 Total

iii) such other costs as are specifically chargeable to the client

The following table highlights the types of costs that should be

Labour costs (including supervision) warranty costs

Estimated costs of rectification and Background Solution

accept a claim of 2,000 due 2,000 can be included in the

Specific example 6: Accounting entries will be:

The total cost of the project estimated to be: 1,000 x 150,000 =

H has received $160,000,000 as progess payments.

As of December 31, the costs incurred on the project are: $

* The stage of completion for year 2 = 60% 25,200= 15120.