# Accounting For Construction Companies & Contracts

While most of the goods or services sold are standardised, there might be cases where two companies enter into a construction contract. International Accounting Standard (IAS) 11 provides a framework and sets the rules for the accounting treatment for construction companies and their construction contracts.

## Accounting for Construction Contracts

IAS 11 sets very straightforward accounting rules for revenue recognition when companies enter into construction contracts. The first thing that needs to be considered is whether a profit or loss is expected to be made from this contract. If the contract is expected to be profitable, then IAS 11 gives two options:

• Recognize revenue based on the costs incurred to date (% as of total costs expected); or
• Recognize revenue based on the stage of completion.

The percentage of costs incurred might be more accurate if we can create a straightforward and reliable budget. On the other hand, a completion stage can be easily determined when the project, for example, relates to a highway where the stage of completion is simple the miles of the road built to date.

If the project is expected to be loss-making, then the company should recognise any loss expected all at once. For example, if a loss of \$10m is expected from a contract at the year-end, we should immediately recognise the total loss.

Finally, if we cannot determine whether a contract will be profitable, we must recognise the full costs immediately. The revenue that we would then need to recognise should be the expected costs to be recovered.

## Examples for Accounting Treatment

Two examples are set out below. The first is for a profitable contract, and the second is for a loss-making contract.

### Accounting Example For Profitable Construction Contract

Let’s assume that company A enters into a construction contract with company B. The company chooses to recognise revenue based on the costs incurred up to date. The contract is expected to cost \$50m total for company A. Company B has agreed to pay in total \$70m. Company A has completed around 25% of the work but has incurred approximately \$10m costs until now.

Solution: Company A chose to recognise revenue based on the level of costs incurred, which is 20% of the total costs (10/50). Therefore, Company A should recognise revenue equal to:

\$70m x 20 per cent =\$14m

### Accounting Example For Loss Making Construction Contract

Now, let’s change the scenario and instead of \$50m costs, we will assume that the total costs expected are \$80m giving a loss of \$10m. The company will need to recognise revenue equal to \$8.75m (70 x (10/80)) since it uses the costs incurred. The loss will need to be recognised immediately. Therefore, the expenses recognised during the year are \$10m (the loss) plus \$8.75 (the revenue) or \$18.75m.