IAS 11 : Objective And Preparation

1.1         Objective And Preparation

The start and finish of Construction Contracts often fall into different accounting periods. Thus, the timing of recognition of contract revenue and contract costs is a key issue of the standard.

IAS 11 is special as it enables revenue and profit to be recognised during construction under specified conditions rather than only at completion.

Revenue is the subject of IAS 18, and revenue for Financial Instruments is the subject of IAS 39.

Under IAS 18, in general, revenue is recognised on completion of the work. 

Only certain construction is covered by IAS 11 Construction Contracts.

If a sale agreement is for the sale of goods, revenue shall be recognised

when all the conditions in paragraph 14 of IAS 18 have been satisfied.

Two of the conditions for the recognition of revenue require the entity to have transferred to the buyer the significant risks and rewards of ownership of, and effective control over, the goods sold.

IAS 11 defines a construction contract as “a contract specifically

negotiated for the construction of an asset or a combination of assets …”

A sale agreement meets this definition if it is an agreement for the seller

to provide construction services to the buyer’s specifications.

Features that, individually or in combination, may indicate that an agreement is for the seller to provide construction services to the buyer’s specifications include:

(i) the buyer being able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether it exercises that ability or not);

(ii) the seller transferring to the buyer control and the significant risks and rewards of ownership of the work in progress in its current state as construction progresses.

Indications that the seller transfers control of the work in progress in this way may include, for example:

(i) the construction taking place on land that is owned or leased by the buyer;

(ii) the buyer having a right to take over the work in progress (albeit with a penalty) during construction, for example to engage a different contractor to complete the construction;

(iii) in the event of the agreement being terminated before construction is complete, the buyer retaining the work in progress and the seller having the right to be paid for work performed (subject to buyer acceptance).

The terms of contracts for construction services tend to be such that there is a continual delivery (transfer of control and risks and rewards of ownership) from the seller to the buyer as construction progresses.

For example:

-the land under construction is owned by the buyer from the outset.

-the contractor typically has no ownership claim to the work in progress (beyond perhaps a right of lien). The contractor instead provides construction services and materials that become attached to the land as they are provided.

-the buyer typically has a right to take over the work in progress (albeit with a penalty) before construction is complete.

-the seller earns the right to be paid primarily on the basis of work performed (subject to client acceptance) rather than purely for the delivery of finished goods.

The building of houses and apartments by a developer may not meet the conditions of IAS 11, especially if they are to be sold to multiple buyers, even if they have been pre-sold. 

Here, construction takes place independently of the sale agreement and buyers have only limited ability to influence the construction and design of the real estate. There is no ’continual delivery’ to the buyer during the construction phase (continuing transfer of control and risks and rewards of ownership).

Control of the house or apartment tends to pass from seller to buyer at a single point in time, usually when the unit is ready for occupancy.

Features that, individually or in combination, may indicate that an agreement is for the sale of goods (covered by IAS 18 Revenue, not IAS 11 Construction Contracts) include:

(i) the negotiation between buyer and seller primarily concerning the amount and timing of payments, with the buyer having only limited ability to specify the design of the real estate, for example, to select a design from a range of options or specify minor variations to the basic design;

(ii) the agreement giving the buyer only a right to acquire the completed real estate at a later date, with the seller retaining control and the significant risks and rewards of ownership of the underlying work in progress until that date.

If a project is classified under IAS 11 Construction Contracts, revenue and profit can be accrued during construction. If the project is classified under

IAS 18 Revenue, generally revenue and profit cannot be accrued during construction.

Guidance covering real estate sales is the subject of an IASB draft interpretation (draft at the time of writing)

Similarly, building for your own use and speculative building in anticipation of

finding buyers or lessees is unlikely to meet the criteria of IAS 11. Building for your own use is covered in IAS 16 Property, Plant and Equipment. Speculative building will normally produce inventory and be classified according to IAS 2 Inventories (see chart of property types later in this workbook).

An effective internal financial budgeting and reporting system, which is kept up-to-date at all times, is required to control construction contracts. Regular reviews of costs and revisions of estimates are necessary throughout the contract.