IAS 11 CONSTRUCTION CONTRACTS

This standard is related to the revenue recognition standard (IAS 18). it basically deals with revenue recognition by the contractor who constructs assets on behalf of clients. Since the contractor is not the owner of the assets, he cant capitalise the assets. He only records revenues, costs and profits. The only challenge is that since the contract usually takes several years, he has to use approximations to determine what to recognise in the periods before contract is complete.
In addition, if there are progress payments, then at any one time he will be in a receivable or payable position.

There are sequential steps to follow when dealing with revenue recognition in construction contracts.
Step 1: Determine whether the contract outcome can be reliably determined:

Contract outcome refers the overall profit/loss on the contract once its completed.
if the contract outcome cant be determined reliably, then we cant record any profits (prudence concept: better to understate revenues and profits than to overstate them). As such, we record an equal amount of revenues and cost of sales so that the profit recorded is Nil. We first determine the ACTUAL costs incurred and record them. We then record sales equivalent to the costs recorded that we expect to recover. if we expect to recover our entire costs, then our profit will be nil. if we expect to recover only a portion of our costs, then we will post a loss.

If the contract outcome can be determined reliably, we proceed to step 2.

Step 2: Determine the contract outcome.
if the outcome is a loss, then we record the ENTIRE loss immediately. We then record the cost of sales incurred and derive mathematically the sales figure.

if the outcome is a profit, proceed to step 3.

Step 3: Determine the stage of completion.
There are several ways of determining the stage of completion;
- with regard to physical units eg two floors out of five are complete = 40%
- with regard to costs i.e costs incurred to date/estimated TOTAL costs
-with regards to revenues i.e work certified/contract price.

Step 4: Record the sales, cost of sales and profits using the percentage of completion.
Note that we record the % of ESTIMATED TOTAL COSTS and not the ACTUAL COSTS INCURRED.

Determining the receivable/payable balance:

if the contractor has done some work valued at 100/- and has received payments of 60/-, then he has a receivable of 40/-. if he has received progress payments of 120/-,then he has a payable of 20/-.
The mathematical formula is;

Costs incurred to date + profits recognised - any losses recognised = value of work done.
This value of work done is then compared with the progress payments to date.