Construction
- Created by: OliviaPearsonn
- Created on: 08-12-19 18:10
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- Construction contract (CC)
- IAS 11: "a contract specifically entered into for the construction of an assets that are closely interrelated or interdependent in terms of their design, and function or their end use or purpose"
- Major items of expenditure
- Take a significant period to complete
- It is VITAL to recognize when revenue/profit can be recognized
- This is to avoid distortions in periodic financial statements.
- At the same time OBSERVING the principle of prudence
- It is VITAL to recognize when revenue/profit can be recognized
- Take a significant period to complete
- Types of contract:
- Revenue
- Recognition
- Completed contracts method
- Widely used in many countries but not accepted under IAS 11
- Percentage completion method
- Required under IAS 11 -provided contracted can be predicted with reasonable certainty
- Completed contracts method
- Identification
- Contract revenue should be made up from
- Initial agreement in the contract
- Variations in contract work, claims and incentive payments -reliably measured
- Cost escalation clauses
- Additional work due to customer delays or change in design
- Incentive payments for reaching performance or safety standards
- Identification of costs
- all contracts cost are ones which are identifiable with a specific contract plus those that are directly attributable to contracting activity in general and can be allocated to the contract and those that are contractually chargeable to a customer
- Examples:
- Costs of materials used in CC
- Wages and other labour costs directly attributable to CC
- Cost of design and technical assistant
- Costs of hiring plant and machinery to complete the contract
- Depreciation charges in respect of P&M used in CC
- Insurance costs attributable to the contract
- Rectification costs
- Entities will have to incur costs to put mistakes right
- Written off to the statement of COMPREHENSIVE INCOME as soon as they are incurred
- Entities will have to incur costs to put mistakes right
- Contract revenue should be made up from
- Recognition
- Recognition of contract revenue and expenses
- IAS 11: rev and costs should be recognized as soon as outcome of contract can be estimated reliably.
- When is this possible?
- Contract revenue can be estimated reliably and benefits will flow to the enterprise
- Contract costs already incurred and those due through to completion can be measured reliably.
- Stage of completion can be identified and measured reliably - % completion method
- When is this possible?
- Estimation of completion of contracts
- May be provided by suitably qualified architect or quantity surveyor
- May be estimated by the % of costs incurred to date compared with the overall projected costs
- May be estimated by confirming the "stage of completion" against a clearly defined project plan
- IAS 11: rev and costs should be recognized as soon as outcome of contract can be estimated reliably.
- Calc. of net income for periodic report
- Where a % completion can be reliably estimated, then the appropriate proportion of total income and expenses is the calc.
- Where a loss is expected, then the full value of the loss must be recognized under the principle of prudence
- Where the contract is at too early a stage for a reliable prediction, but there is no reason to expect a loss, then an amount of revenue is anticipated, = to the costs to date, yielding net income
- Treatment of advances
- Advances, payments made ahead of work being done, should NOT be treated as income
- These SHOULD be reported as LIABILITIES, until the relevant element of work has been completed
- Advances, payments made ahead of work being done, should NOT be treated as income
- Current Developments IFRS
- Debate on revenue recognition within IASB
- Attempted to define approach which is applicable for goods, services and construction of assets
- Construction and services approaches currently uses a % of completion method, which is the approach under IAS 11
- Public-private partnerships (PPP)
- it's common for public bodies to enter contracts with priv. companies
- Such projects are inherently risky, and the aim is to transfer some or all risk to the priv. entity
- Outcome should be the PROVISION of projects efficiently, on-time with lower overall costs
- Private Finance Initiative (PFI)
- A form of PPP where both public and priv. entities have a stake in project but that the priv. service contractor arranges finance for the project
- Intention is that delivery of a project is further improved because the private contractor has put its own capital at risk
- Public Sector entity enters a contract or "concession" with a private contractor to provide services on a LT basis
- A form of PPP where both public and priv. entities have a stake in project but that the priv. service contractor arranges finance for the project
- PFI project in ann. accounts of a concession or project company
- FRS5 says that where the concession company takes a greater share of the risk associated with the asset then it is considered to be a FIXED ASSET of the concession.
- Cost of construction is capitalized, depreciated CHARGED
- Where the public sector takes the greater share of the risks the concession company accounts for the cost of constructing the asset as LT contract receivable
- FRS5 says that where the concession company takes a greater share of the risk associated with the asset then it is considered to be a FIXED ASSET of the concession.
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