Construction

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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
    • 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
      • 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
    • 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
      • 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
    • 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
    • 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
    • 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

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