IAS 11 : Recognition of Contract Revenue and Expenses

1.8 Recognition of Contract Revenue and Expenses

Contract revenue and costs should be recognised by reference to the stage of completion (‘percentage of completion’) of the contract at the balance sheet date.

Any expected loss on the contract should be recognised immediately.

Example: You have been notified by a subcontractor that his costs to you for next year will increase by 15%. You cannot bill your client for this increase. It will cause you to lose money on the contract, and can find no alternative supplier. Recognise the anticipated loss immediately.

Example: What amount should be recognised as profit or loss for the contract in each year? Background T is constructing a building for its client. The construction is in its second year of the three-year project. Management had originally assessed the contract to be profitable and recognised a profit in year 1 of 20,000, based on the percentage of the contract that had been completed at that time. Management now believes the contract will incur a cumulative loss of 30,000. Management has proposed that a loss of 30,000 on the contract is recognised in year 2, but has questioned how the profit of 20,000 recognised in year 1 should be treated. Solution Management should immediately recognise a loss in respect of the contract of 50,000 in year 2. This represents a reversal of the 20,000 profit recognised in year 1 and the 30,000 loss expected on the contract as a whole. The loss has been assessed through a revision of the estimated costs to completion. The appropriate accounting entry is therefore to recognise the adjustment in the current year’s results rather than record a prior-period adjustment.

For fixed-price contracts, the result can be estimated when the following conditions are satisfied:

1.     Total revenue can be measured reliably.

2.     Contract costs to complete can be measured reliably.

3.     The stage of completion is known.

4.     Actual costs can be compared with prior estimates.

For cost-plus contracts, contract costs must be identifiable, whether or not they are reimbursable.

Using the percentage of completion method, revenue is recognised in the income statement in the periods, in the periods in which the work is done.

Costs are recognised as incurred.

Any anticipated excess of total contract costs over total contract revenue should be recognised immediately.

Contract costs that relate to future work on the contract, and for which the client will pay, can be treated as an asset, usually work in progress.

Example:

You are building a training centre, and have imported some insulation material that will not be needed until next year. (This was done to avoid an imminent price rise announced by the supplier).

You have also paid an advance to a subcontractor.

Both items should be booked to work in progress.

If there is a risk that revenue that has already been recognised may not be paid, the uncollectable amount is recognised as an expense immediately on recognition. It is not an adjustment of revenue.

Example:

You are a subcontractor. The contractor has approved your work, and you have recognised the revenue according to the contract. The client is delaying payment, for reasons that are not clear. You should create a doubtful debt provision for the disputed revenue.