The correct accounting by construction companies for their contracts is important to their financial performance.

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.

Leave a Reply

Your email address will not be published. Required fields are marked *

error: Content is protected !!