Construction contracts computations

Construction contracts computations explains some newer features in IFRS 15 such as contract reporting lines and their computations as examples.

As part of the replacement of IAS 11 Construction contracts, IAS 18 Revenue and related interpretations by IFRS 15 Revenue from contracts with customers the presentation and disclosure regarding construction contracts has significantly changed.

The good news for contractors is that the progressive revenue recognition similar to current stage-of-completion accounting is largely retained for many long-term construction contracts. Therefore, in their Financial Statements 2018, contractors have found that applying the new standard to a traditional construction contract results in an accounting outcome broadly similar to IAS 11.

Nevertheless, the devil is in the details. IFRS 15 introduced many new concepts for revenue and cost recognition that are different from IAS 11. Contractors should not assume that their accounting for revenue and costs are not affected by IFRS 15. The new standard completely overhauls the way revenue is estimated and measured and what costs qualify for capitalisation.

Contract assets, contract liabilities, and provision for onerous contracts

Under IAS 11 entities operating in the construction industry reported the net position for each contract as either an asset or liability. A contract represented an asset where cost incurred plus recognised profits (less recognised losses) exceed progress billings; a contract represented a liability where the progerss billings exceed cost incurred plus recognised profits (less recognised losses).

Provision for onerous contracts were included within the net contract position. Under IFRS 15 the provisions for onerous contracts are reclassified from the net contract position to a separate provision for onerous contracts. These provisions show the amount of the onerous contracts result which relates to future obligations to be fulfilled under the contracts. The provision is determined based on the progress of the performance obligations identified in the contract.

Contract revenues and costs

When the outcome of a construction contract can be estimated reliable, the contract revenue is highly probable and the contract is estimated to be profitable, contract revenue and costs are recognised over the period of the contract, by reference to the stage of completion using the ‘percentage-of-completion method’, to determine the appropriate amount to recognise in a certain period.

However, when it is probable that total estimated cost will exceed total estimated contract revenue, the complete estimated loss (including future losses) based on the ‘percentage-of-completion method’ is recognised as an expense immediately, while the future expected loss is included in a provision for onerous contracts.

When the outcome of a construction contract cannot be estimated reliably, for instance in the early stages of a contract or with many claims against the customer and against the construction company at the end of a contract, but it is expected that the costs incurred in satisfying the performance obligations in the construction contract will be recovered, then construction revenue will be recognised to the extent of costs incurred, until the outcome of a contract can be reliably measured

Example in numbers

The first table illustrates the computation and disclosure of the revenue, costs of construction and gross profit for a profitable contract. In this example Moreira Construction Company receives a fixed-price contract to build an office building for six million dollars at the beginning of 2010. The project is expected to take three years to complete and results in the following projected income statement presentation and disclosure (in Table 1 below more detailed data is included):

(All amounts are in thousands of dollars)	2010	2011	2012	Total
Revenues	2,520	1,680	1,800	6,000
Cost of construction	1,995	1,645	1,460	5,100
Gross profit / Project gross profit	525	35	340	900

During the second year, it is estimated that the contract will result in an overall loss because of cost overruns and time delays then the calculations for the projection of the period revenue, period costs of construction and period gross profit are given in the second table. The period profit or loss amounts for the project are estimated as follows (in Table 2 below more detailed data is included):

(All amounts are in thousands of dollars)	2010	2011	2012	2013	Total
Period revenues	2,520	780	1,500	1,200	6,000
Period cost of construction	1,995	1,405	1,600	1,350	6,350
Period gross profit / Project gross profit	525	-625	-100	-150	-350

The project result to completion changed from $900K profit to a loss of $350K, of which $525K was realised in 2010 (check gross profit: loss to be allocated to 2011 – 2013 is $875K ($350K – estimated project loss plus $525K – 2010 realised profit). Revenue allocation remains the same (based on ‘percentage-of-completion method’ planning of revenue recognition based on output method), but cost have to be adjusted, because of the cost overruns and time delays.

Total costs is estimated to be $6,350K to complete in 2013 (Note the provision is determined based on the progress of the performance obligations identified in the contract), in addition, costs to be allocated to 2012 and 2013 are maximum $1,500K respective $1,200K (equal to period revenues (=maximum)), hence the costs allocatable to 2011 are $1,655K ($1,405K (original estimate for 2011), plus the allocations from 2012 and 2013), see the following table as summary:

(All amounts are in thousands of dollars)	2010	2011	2012	2013	Total
Period cost of construction	1,995	1,405	1,600	1,350	6,350
Provision for future losses (PNL) allocated to Provision for onerous contracts (BS)	0	250	0	0	250
Release from Provision for onerous contracts (BS) to reversal of the previously recorded provision (PNL)	0	0	-100	-150	-250
Cost of construction	1,995	1,655	1,500	1,200	6,350

The project now takes four years to complete and results in the following project to complete income statement presentation and disclosure over 2011 – 2013 (2010 already realised and closed):

(All amounts are in thousands of dollars)	2010	2011	2012	2013	Total
Revenues	2,520	780	1,500	1,200	6,000
Cost of construction	1,995	1,655	1,500	1,200	6,350
Gross profit	525	-875	0	0	-350

Note: check gross profit: loss $875K in 2011 equals loss to be allocated to 2011 – 2013 $875K (see above)

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Table 1 Construction contracts computations: 2010 Project start to complete in 2012 of the construction contract allocated to their period of origination

(All amounts are in thousands of dollars) Construction contracts computations	2010	2011	2012
a. Construction costs incurred during the year	1,995	1,645	1,460
b. Construction costs incurred in prior years Construction contracts computations	0	1,995	3,640
c. Cumulative Construction costs	1,995	3,640	5,100
d. Estimated costs to complete Construction contracts computations	2,755	1,560	0
e. Total estimated construction cost	4,750	5,200	5,100
f. Percentage of completion [= c / e] Construction contracts computations	42%	70%	100%
g. Construction price Construction contracts computations	6,000	6,000	6,000
h. Less: Total estimated construction costs (see e) Construction contracts computations	4,750	5,200	5,100
i. Estimated total gross profit/(loss)	1,250	800	900
j. Total gross profit/(loss) recognized to date [= f x i]	525	560	900
k. Less: Previously recognized	0	-525	-560
l. Gross profit to be recognized in the current year	525	35	340

Income statement presentation and disclosure of the above calculations:

(All amounts are in thousands of dollars) Construction contracts computations	2010	2011	2012
Revenues [= f x g]	2,520	1,680	1,800
Cost of construction (see a)	1,995	1,645	1,460
Gross profit (see l)	525	35	340

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Table 2. Construction contracts computations: Actuals 2010 and estimate to complete in 2011 of the construction contract allocated to their period of origination

During 2011, it is estimated that the contract will result in an overall loss because of cost overruns and time delays. The revised project calculations for the projection of the period revenue, period costs of construction and period gross profit are given in the below table.

(All amounts are in thousands of dollars)	2010	2011	2012	2013
a. Construction costs incurred during the year	1,995	1,360	1,605	1,390
b. Construction costs incurred in prior years	0	1,995	335	4,960
c. Cumulative Construction costs	1,995	3,355	4,960	6,350
d. Estimated costs to complete	2,755	2,745	1,240	0
e. Total estimated construction cost	4,750	6,100	6,200	6,350
f. Percentage of completion [= c / e]	42%	55%	80%	100%
g. Construction price	6,000	6,000	6,000	6,000
h. Less: Total estimated construction costs (see e)	4,750	6,100	6,200	6,350
i. Estimated total gross profit/(loss)	1,250	-100	-200	-350
j. Total gross profit/(loss) recognized to date [= f x i]	525	-100	-200	-350
k. Less: Previously recognized	0	-525	100	200
l. Projected gross profit to be recognized in each year	525	-625	-100	-150

Projected Income statement presentation and disclosure of the above calculations:

(All amounts are in thousands of dollars)	2010	2011	2012	2013
Revenues [= f x g]	2,520	780	1,500	1,200
Cost of construction (see a)	1,995	1,405	1,600	1,350
Gross profit (see l)	525	-625	-100	-150

Construction contracts computations