IAS 11 Construction Contracts

IAS 11 defines a construction contracts as a contract specifically negotiated for the construction of an asset or a combination of asset that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.

Contract :
1. Contract revenue – should comprise the initial amount of revenue agreed and variation in contract work, claim and incentive payment.

Considerations in determining contract revenues :
a. Measurement – measured at FV of the consideration received or receivable
b. Variations – is an instruction by the customer for a change in the scope of the work to be performed under the contract
c. Claims – is an amount that the contractor seeks to collect from the customer or another party as reimbursement for cost not included in contract price.
d. Incentive payments – an additional amount paid to the contractor if specified performance standard are met or exceeded.
e. Probability – is when it is more likely than not that it will occur

2. Contract cost – should comprise cost that relate directly to specific contract, cost that are attributable to contract activity in general and can be allocated to the contract, and such other costs as are specifically chargeable to customer under the terms of contract.

Types of costs
a. Costs relating directly to a contract – Ex. Labour, material, etc.
b. Costs attributable to contract activity – Ex. Insurance, overhead, etc.
c. Costs not-attributable to contract activity – Ex. Selling cost, etc.
d. Specifically chargeable costs – cost determined in contract.
Construction contract may be :
a. Fixed price contract
Definition by IAS 11 : a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit output, which is some cases in subject to cost escalation clauses.
i. Recognition
Contract revenue and contract costs associated with a construction contract should be recognized 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 contract can be estimated reliably.


Conditions the outcome can be estimated reliably :
1. Total contract revenue can be measured realibly,
2. It is probable that the economic benefits associated with the contract will flow to the entity,
3. Contract cost to complete the contract and stage of completion can be measured reliably, and
4. Contract costs attributable to the contract can be measured reliably and clearly identified, so that actual costs incurred can be compared with prior estimates.

When the outcome of a construction contract cannot be estimated reliably :
1. Revenue shoul be recognized only to the extent of contract costs incurred and if recoverable is probable, and
2. Contract cost should be recognized as an expense in the period in which they are incurred.
3. In this case, no profit is recognized.

When it is probable that total contract costs will exceed the total contract revenue, the expected loss should be recognized as an expense immediately

ii. Percentage of completion method
1. Contract revenue – recognized in the statement of comprehensive income in the accounting period in which the work is performed
2. Contract costs – recognized in the statement of comprehensive income in the accounting period in which the work to which they relate is performed

Determining the stage of completion :
1. The ratio – contract cost should incurred for work performed to date / estimated total contract cost
2. Survey of work performed
3. Completion of physical proportion of the contract work

The effect of a change in the estimate of contract revenue or contract costs, or the effect of a change in the estimate of the outcome of the contract, is used in determining the stage of completion in the period which the changes is made an in subsequent periods.

b. Cost plus contract
Definition by IAS 11 : a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs plus a percentage of these cost of a fixed fee.
i. Recognition
Conditions the outcome can be estimated reliably :
1. It is probable that the economic benefits associated with the contract will flow to the entity
2. Contract costs attributable to the contract, whether or not specifically reimbursable, can be clearly identified and measured reliably

In order to reflect the substance of a contract or a group of contracts, it is sometimes necessary to apply IAS 11 by :
a. Segmenting – apply IAS 11 separately to each one of a group of construction contracts, or to separately identifiable component of a single contract.
When a contract covers a number of assets, the construction of each asset should be treated as separate construction contract if :
i. Separate proposals have been submitted for each asset,
ii. Each asset has been subject to separate negotiation and the contractor and customer have been able to accept or reject that part of the contract relating to each asset, and
iii. The cost and revenue of each asset can be identified.
b. Combining – apply IAS 11 to a group of construction contracts
A group of contracts, whether single customer or with several customers, should be treated as a single construction contract if :
i. The group of contracts is negotiated as a single package
ii. The contract are so closely interrelated that they are, in effect, part of a single project with an overall profit margin, and
iii. The contracts are perfomed concurrently or in continuous sequence.
c. Additional assets
If customer may be or has option regarding construction of an additional asset, the construction of additional asset should be treated as separate construction contract when :
i. The asset differs significantly in design, technology or function from the asset or assets covered by the original contract, or
ii. The price of the asset is negotiated whitout regard to the original contract price.

Notes
1. IFRIC 15 agreement for the Construction of Real Estate provides guidance in determining whether a contract is within the scope of IAS 11 Construction Contract of IAS 18 Revenue.
2. An agreement for the construction contract of real estate is within scope of IAS 11 only if the buyer is able to specify the major structural elements of the design of the real estate before construction begin and / or specify major structural changes once constructin is in progress (whether it exercises that ability or not). Otherwise, if the buyer doesn’t have that ability, IAS 18 applies.