1.6 Contract Revenue
Contract revenue should comprise:
1.
The initial revenue
agreed; and
2.
Variations in the
contract work, claims and incentive payments.
(These
are included if it is probable that they will result in revenue, and are
capable of being reliably measured).
The contract revenue may change from
one period to the next, as a result of contract variations, claims, penalties,
and cost-escalation clauses.
Variations
may increase, decrease, or redesign the scope of the contract, with a matching
change in revenue.
Changes are only included in revenue
when it is likely that the client will approve the variation and its impact on
the revenue, and the change in revenue can be reliably measured.
Example:
You
are building a road. The original plan called for a bridge over a railway, but
the authorities now insist on a tunnel under the railway instead.
This
is a variation.
Claims
are levied by the contractor on the client for costs not included in the
contract price. Often, these stem from problems caused by the client, such as
wrong specifications, errors in designs, and delays.
Example:
You
have been contracted to demolish some houses, and build a clearing house. You
were promised vacant possession. When your staff arrives, they find that the
tenants still occupy the old houses. It takes a month to re-house them,
delaying the start of work.
This
may be the basis for a claim.
Clients
may contest the claims, so they should only be included in project revenue when
the amount of the claim that is likely to be paid can be reliably determined.
Incentive
payments are bonuses paid if the contractor meets or exceeds specific criteria,
such as early completion of part, or all, of the contract. They are included in
contract revenue when it is likely that they will be earned.
Example:
You
are building a head office. If the actual completion date is a month (or more).
earlier than the planned completion date, your firm will earn a bonus (and the
client can start operations early)..
This
is an example of an incentive payment.
Contract estimates need to be revised,
either for actual performance, or new considerations of future performance.
Example:
You
are redeveloping a retail site in the city centre. You had planned to work 24
hours per day, but the city has just passed regulations to halt building work
at night.
You
may have to revise your contract estimate.
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Example:
Progress
payments and advances received from clients often do not reflect the work
performed. On what basis should management assess a project’s percentage of
completion?
Background
P
entered into a contract with B to construct a clearing centre. The cost of
the clearing centre is estimated at 150,000. The total revenue from the
contract is estimated at 200,000. P will take 3 years to construct the
clearing centre.
At
the end of year 1 P incurred costs of 60,000. The client was invoiced for
50,000 at the end of year 1. Payment of this progress billing is due, early
in year 2, in accordance with the normal credit terms that P offers.
Management
estimated the stage of completion as 33%, based on the amount invoiced.
Solution
The
percentage of completion should be determined from: the proportion of costs
incurred to date; the percentage of physical work complete; or services
performed to date. Amounts invoiced to clients do not necessarily influence
the stage of completion.
Based
on the relationship between the costs incurred to date and total estimated
costs, the contract is 40% (60,000/150,000) completed at the end of year 1.
Revenue of 80,000 (40% of 200,000) should be recognised at the end of year 1.
The
50,000 progress billing invoiced to the client should be recognised as an
adjustment to construction account receivable in the balance sheet. The
construction account receivable balance is disclosed separately on the face
of the balance sheet.
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