Accounting for construction contracts mainly includes treatment in respect of contract revenue, contract costs, trade receivables, gross amount due to / from customers, advances from customers and retention money.
Contract Revenue
Contract Revenue recognized in the income statements includes:
- Amount of revenue initially agreed in the contract
- Incentive Payments considered likely to accrue to the contractor
- Approved variations in contract revenue
- Amount of claims that are considered likely to be accepted by the customer
Revenue in respect of construction contracts is recognized according to stage of completion in respect of contracts whose outcome is reliably measured.
Contract Costs
All attributable costs of a contract must be recognized as construction costs. Other costs that cannot be reasonably attributed to contract activity shall be charged as general and administration expense in the accounting period they are incurred. Contract costs consist of the following:
- Direct or Specific Costs of the construction contract. Examples of direct costs include:
- Direct material consumed on a specific project
- Direct labor allocated to a particular contract (e.g. project in charge, site engineers, etc)
- Insurance cost specifically incurred on a construction contract
- Depreciation of machinery and equipment used on a specific contract
- Indirect Costs that may be allocated to individual contracts on a reasonable basis. Examples of such costs include:
- Allocation of the cost of central technical assistance department based on for example number of hours spent by technical staff on various contracts
- Insurance cost allocation in respect of machinery used on multiple sites
- Construction overheads
- Allocation of salary of staff employed on multiple contracts (e.g. project supervisors)
- Indirect costs must be allocated on the basis of normal level of construction activity. Similar to the requirements of IAS 2 Inventory, any abnormal wastage must not be included in the contract costs. This is to prevent recognition of any such costs as construction assets which are not likely to be recoverable in the future.
- Any other costs specifically allowable under the contract.
Contract Costs are recognized according to the method of stage of completion used. Contract costs incurred but not recognized in income statement are included in the Gross Amount Due from Customers as explained below.
Trade Receivables
Trade Receivables are calculated by finding the difference between amount billed to the customer for as progress billings and the amount of progress payments received from the customer.
Trade Receivables are therefore calculated as follows:
Trade Receivables = Amount Billed to Customer as progress billings – Progress Payments Received
Note that according to the Accruals Concept, any advance outstanding from customer in respect of contractual work to be performed at a future date is not included as trade receivables.
Gross Amount Due to / From Customers
Gross Amount Due from Customer represents the amount of revenue earned on a contract but yet billed to the customer (if any billed amount is outstanding, it is included in trade receivables as explained above). It also includes the amount of contract costs incurred to date that have not yet been charged to the income statement. It therefore represents the contract work in progress (inventory).
Gross Amount Due from Customer is calculated as follows:
| $ | |
|---|---|
|
Contract Costs Incurred |
X1 |
|
Add: Profit Recognized |
X1 |
|
Less: Losses Recognized |
(X) |
|
Less: Progress Billings |
(X) |
|
Gross Amount Due From Customer |
X |
Conversely, Gross Amount Due to Customer represents the amount of revenue earned on a contract in excess of the amount billed to the customer. It also includes the amount of contract costs incurred in excess of the amount charged to the income statement.
Gross Amount due to Customer is calculated in the same way as gross amount due from customer:
| $ | |
|---|---|
|
Contract Costs Incurred |
X1 |
|
Add: Profit Recognized |
X1 |
|
Less: Losses Recognized |
(X) |
|
Less: Progress Billings |
(X) |
|
Gross Amount Due From Customer |
(X) |
Advances from Customers
Advance received from customers in respect of contract work that is yet to be performed must be recognized as a liability until the work in respect of which the advance was given has been performed.
Retention Money
Customers may retain an amount specified in the construction contract that may be returned to the contractor after successful completion of the contract. Retention money may be recognized as a receivable in the financial statements of the contractor until it is returned.