1. IAS 11: Construction Contracts
Roshankumar S Pimpalkar
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2. This standard prescribes the accounting of costs and revenues associated
with construction contracts.
Key Definitions:
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 design, technology and function or their ultimate
purpose or use.
Fixed Price contract is a construction contract in which the contractor agrees
to a fixed contract price or a fixed rate per unit of output, which in some cases
is subject to cost escalation clauses.
Cost Plus contract is a construction contract in which a contractor is
reimbursed for allowable or otherwise defined costs, plus a percentage of
these costs or a fixed price.
Guidance by IFRIC 15: Agreements for Construction of Real Estate.
An agreement for construction of a 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 the construction begins and/or
specify major structural changes once construction is in progress (whether he
exercises that ability or not). If the buyer does not have that ability then IAS 18
applies.
Combining and Segmenting Construction Contracts
When a contract covers number of assets construction of each asset should
be considered as a separate construction contract when:
Separate proposals have been submitted for each asset
Each asset has been submitted for separate negotiation and the
contractor and customer have been able to accept or reject that part of
the contract relating to each asset and
The costs and revenues of each asset can be identified.
A group of contract, whether with a single customer or with several
customers, should be treated as single construction contract when:
The group of contract is negotiated as single package
The contracts are so closely interrelated that they are, in effect, a part
of a single project with an overall profit margin, and
The contracts are performed concurrently or in a continuous sequence.
A contract may provide construction of an additional asset at the option of the
customer or may be amended to include the construction of an additional
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3. asset. The construction of an additional asset should be treated as a separate
construction contract when:
The asset differs significantly in design, technology or function from the
asset or asset covered by the original contract, or
The price of the asset is negotiated without regard to the original
contract price.
Contract Revenue
Contract revenue should comprise:
The initial amount of revenue agreed in the contract; and
Variations in the work, claim and incentive payments:
o To the extent that is probable that they will result in revenue i.e.
the customer will approve the variation and amount of
revenue arising out of variation; and
o They are capable of being reliably measured
Incentive payments are additional amounts paid to the contractor is
specified performance standards are met or exceeded. It is included in
the contract revenue when:
o The contract is sufficiently advanced that it is probable that the
specified performance standards will be met or exceeded, and
o The amount of incentive payment can be measured reliably.
A claim is an amount which a contractor seeks from the customer or
another party as a reimbursement for costs not included in contract
price. It is included in contract price when:
o Negotiations have reached advanced stage such that it is
probable that the customer will accept the claim; and
o The amount of claim can be measured reliably.
Probability means more likely than not.
Contract Cost
Contract costs should comprise of
Costs that relate directly to the specific contract
Costs that are attributable to the contract in general and can be
allocated to the contract, and
Such other costs as are specifically chargeable to the customer under
the terms of the contract
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4. Costs incurred in securing the contract are also included in contract
costs they can be identified, reliably measured and it is probable that
the contract will be obtained. However if such costs are recognised as
an expense in the period in which they are incurred then they are not
included in contract cost when the contract is obtained in a subsequent
period.
Recognition
Contract revenue and contract costs associated with a construction contract
should 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 when the outcome of the construction contract can be estimated
reliably.
Any expected loss on the contract should be recognised as an expense
immediately.
Fixed Price Contract
In this type of contract the outcome can be estimated reliably when all of the
following conditions are satisfied:
Total contract revenue can be measured reliably
It is probable that economic benefits associated with contract will flow
to the enterprise
Both the contract cost to complete the contract and stage of
completion can be measured reliably, and
Contract costs attributable to the contract can be measured reliably
and can be identified clearly, so that the actual costs incurred can be
compared with prior estimates.
Cost Plus Contract
In this type of contract outcome can be estimated reliably when all of the
following conditions are satisfied
It is probable that the economic benefits associated with the contract
will flow to the enterprise; and
Contract costs attributable to the contract, whether or not specifically
reimbursable, can be clearly identified and measured reliably.
Capitalisation of costs
Contract costs incurred that relate to future activity on the contract are
recognised as an asset provided it is probable that they will be recovered.
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5. Such costs represents amount due from customer and are classified as work
in progress.
When an uncertainty about the collectability of revenue already
recognised in the statement of comprehensive income arises, the
uncollectable amount is recognised as an expense rather than an adjustment
to contract revenue.
When the outcome of the construction contract cannot be estimated
reliably:
Revenue should be recognised only to the extent of contract costs
incurred and if the recovery is probable; and
Contract costs should be recognised as an expense in the period in
which they are incurred
In this case no profit is recognised. Once the outcome of construction
contract can be estimated reliably, profit can be recognised.
When it is probable that that total contract cost will exceed total contract
revenue, the expected loss should be recognised as an expense
immediately. In such case amount of loss to be recognised is expected loss
plus profit recognised earlier less loss recognised in current year.
Determining the stage of completion
Depending on the nature of construction contract the method used to
determine the stage of completion of the contract are as follows:
The ratio – contract cost incurred to for the work performed to date /
estimated total contract cost
Surveys of work performed; or
Completion of physical proportion of contract
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