Essay on Revenue Recognition

Submitted By snakhla
Words: 3221
Pages: 13


IAS 11 – Construction Contracts

ISSUE: The primary issue in accounting for construction contracts is the allocation of contract revenue and contract costs to the accounting periods in which construction work is performed.

CAUSE: Because of the nature of the activity undertaken in construction contracts, the date at which the contract activity is entered into and the date when the activity is completed usually fall into different accounting periods.

SOLUTION: Standard helps determine when contract revenue and contract costs should be recognized as revenue and expenses in the statement of comprehensive income.

SCOPE: This Standard shall be applied in accounting for construction contracts in the financial statements of contractors.

Definitions: construction contract – contract negotiated for construction of an asset or combination of assets closely interrelated fixed price contract – contractor agrees to fixed contract price (fixed rate per unit of output) cost plus contract – contractor reimbursed for allowable defined costs + percentage of theses costs or a fixed fee
Note: Some contracts may contain characteristics of both a fixed price and a cost plus contract, for example in the case of a cost plus contract with an agreed maximum price.

Contract Revenue
Contract revenue shall comprise:
(a) the initial amount of revenue agreed in the contract
(b) variations in contract work, claims and incentive payments to the extent that it is probable that they will result in revenue and they are capable of being reliably measured
A variation is an instruction by the customer for a change in the scope of the work to be performed under the contract.
A claim is an amount the contractor seeks to collect from the customer or another party as reimbursement for costs not included in the contract price. For example: customer caused delays, errors in specifications or design, and disputed variations in contract work.
Incentive payments are additional amounts paid to the contractor if specified performance standards are met or exceeded.
Contract revenue is measured at the fair value of the consideration received or receivable.
The amount of contract revenue may increase or decrease from one period to the next (can be revised as events occur or uncertainties are resolved).
For example: contractor and customer may agree variations or claims that increase/decrease contract revenue in a period subsequent to which the contract was initially agreed contract revenue may decrease as a result of penalties arising from delays caused by the contractor

Contract Costs
Contract costs shall comprise:
(a) costs that relate directly to the specific contract site labour costs (including site supervision); cost of materials used in construction; depreciation of plant & equipment; costs of moving to and from contract site; cost of hiring plant & equipment; cost of design and technical assistance directly related to the contract; estimated costs of rectification and guarantee work (including expected warranty costs); claims from third parties
(b) costs attributable to contract activity in general and can be allocated to the contract insurance; cost of design & technical assistance not directly related to specific contract; construction overheads
(c) such other costs as are specifically chargeable to customers under terms of contract some general administration costs and development costs for which reimbursement is specified in the terms of the contract.
Costs that cannot be attributed to contract activity/cant be allocated to a contract are excluded from the costs of a contract. Such costs include: general admin costs for which reimbursement not in contract; selling costs; R&D for which reimbursement not specified in contract; depreciation of idle plant & equipment that is not used on a particular contract
Recognition of Contract Revenue & Expenses
When outcome of a contract can estimated reliably, contract revenue & contract