KAS 16 – CONSTRUCTION CONTRACTS
EXPLANATORY NOTE
Explanatory notes to the Kosovo Accounting Standards are intended to provide additional understanding of the standards and technical guidance as to their use and application. In case of any divergence between Explanatory Notes and Standards, the Standards prevail.
1. Construction contracts are a specific type of service activity that extends over a period of time. Because of the nature of the activity undertaken in construction contracts, the date at which the contract activity is entered into and the date when the activity is completed usually fall into different accounting periods.
2. Therefore, the primary issue in accounting for construction contracts is the allocation of contract revenue and related contract expenditures to the accounting periods in which construction work is performed.
Construction Contracts - Classification
3. Construction contracts can be classified as one of the following:
Fixed price contract: A fixed price contract is a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit of output, which in some cases is subject to escalation clauses if the expenditures relating to the contract are greater than anticipated.
Cost plus contract: Also called an expenditure plus contract, this is a construction contract in which the contractor is reimbursed for allowable or otherwise defined expenditures, plus a percentage of these expenditures or a fixed fee.
4. Examples of Fixed Price and Cost plus Construction Contracts
Example of a fixed price contract
Company A is a construction firm. The enterprise has a contract with a city that requires Company A to build a new school. The price of the contract is 900,000. This is an example of a fixed price construction contract.
Example of a cost plus construction contract
Company A is a construction firm. The enterprise has a contract with Company B. The contract is for construction of an apartment building. The contract states that Company A will be reimbursed for all of its costs and will receive a construction fee of 150,000. This is an example of a cost plus construction contract.
Contract Revenue
5. Construction contract revenue includes the following:
· The initial amount of revenue agreed in the contract
· Variations in contract work and incentive payments
6. Contract revenue is measured at the fair value of the consideration received or receivable. The measurement of contract revenue is affected by a variety of uncertainties that depend on the outcome of future events. The estimates often need to be revised as events occur and uncertainties are resolved. Therefore, the amount of contract revenue may increase or decrease from one period to the next.
Example of Construction Contract Revenue Uncertainties
The following types of events illustrate the types of uncertainties that may result in changes to anticipated construction contract revenue.
Company A is a construction firm and is constructing a building for Company B. The contract was signed and work began in XXX1. In XXX2, Company B and Company A agreed to expand the size of the building. This is a variation that will increase Company A’s anticipated revenue on the contract to more than it had originally anticipated when the contract was signed in XXX1.
During the building construction in XXX2, Company A’s workers went on strike and as a result Company A did not complete the construction in the time period required by the contract and was penalized under the terms of the contract. The penalty will decrease Company A’s anticipated revenue on the contract to less than it had originally anticipated when the contract was signed in XXX1.
Contract Revenue - Variations and Incentive Payments
7. Variations are included in contract revenue when:
· It is probable that the customer will approve the variation and
· The amount of revenue can be reliably measured
8. Incentive payments are included in contract revenue when:
· The contract is sufficiently advanced that it is probable that the specified performance standards will be met or exceeded
· The amount of the incentive payment can be measured reliably
Contract Expenditures
9. Contract expenditures include the following components:
· Expenditures that related directly to the specific contract
· Expenditures that are attributable to contract activity in general and can be allocated to the contract
· Other expenditures as are specifically chargeable to the customer under the terms of the contract
Example of Direct Contract Expenditures
Company A is a construction firm in the process of constructing a radio tower. Direct contract expenditures for the construction project include the following:
· Construction worker salaries
· Steel girders, spanners, fasteners and all other materials used directly on the project
· Depreciation on the cutting tools and trucks used on the contract
· Costs of gas and other equipment moving expenses
· Rental fee on specialized crane that was rented to use on the project
· Fees paid to a radio tower expert hired to consult on the project
Example of Allocated Contract Expenditures
Company A is a construction firm in the process of constructing a radio tower. Allocated contract expenditures for the construction project include the following:
· Insurance on the company’s construction workers and general business construction liability coverage
· Payroll for the office design staff who review all construction plans for the company in general
· Employee costs for workers who monitor and manage project budgets for the company
· Maintenance and repair on construction equipment
· Costs of an inspector hired by the company to review all projects in process
Company A has determined that a rational basis to allocate the expenses is to first calculate the percentage of anticipated company revenue that will be received on the radio tower contract and then apply that ratio to the costs listed above.
Expenditures that are specifically chargeable to the customer under the terms of the contract may include some general administration expenditures and development expenditures for which reimbursement is specified in the terms of the contract.
Recognition of Contract Revenue and Expenses
10. When the outcome of a construction contract can be estimated reliably, contract revenue and contract expenditures associated with the construction contract should be recognized as revenue and expenses respectively by reference to the stage of completion of the contract activity at the balance sheet date.
Example - Recognition of Contract Revenue and Expenses
The following example illustrates one method of determining the stage of completion of a contract and the timing of the recognition of contract revenue and expenses.
A construction contractor has a fixed price contract for 250,000 to build a bridge. The initial amount of revenue agreed in the contract is 250,000. The contractor’s initial estimate of contract expenditures is 150,000. Building of the bridge will occur during XXX1 and XXX2.
The contractor determines the stage of completion of the contract by calculating the proportion that contract expenditures incurred for work performed to date bear to the latest estimated total contract expenditures. A summary of the financial data during the construction period is as follows:
XXX1 / XXX2Initial amount of revenue agreed in contract / 250,000 / 250,000
Contract expenditures incurred to date / 90,000 / 90,000
Contract expenditures to complete the work / 60,000
Total estimated contract expenditures / 150,000 / 150,000
Estimated profit / 100,000 / 100,000
Stage of completion / 60% / 100%
The amounts of revenue, expenses and profit recognized in the income statement in the two years are as follows:
To Date / Recognized in Prior Year / Recognized in Current Year2002
Revenue (250,000 x 60%) / 150,000 / 150,000
Expenses (150,000 x 60% / 90,000 / 90,000
Profit / 60,000 / 60,000
2003
Revenue / 250,000 / 150,000 / 100,000
Expenses / 150,000 / 90,000 / 60,000
Profit / 100,000 / 60,000 / 40,000
Recognition of Expected Losses
Example of Loss Recognition on a Contract
11. A construction firm had a fixed price contract for 150,000 to build a building. The firm’s initial estimate of contract expenditures was 100,000. Construction occurred during XXX1 and XXX2.
12. The contractor determined the stage of completion of the contract by calculating the proportion that contract expenditures incurred for work performed to date bore to the latest estimated total contract expenditures. Shortly after construction began in XXX1, the firm encountered unanticipated problems and revised its cost estimate. A summary of the financial data during the construction period is as follows:
XXX1 / XXX2Initial amount of revenue agreed in contract / 150,000 / 150,000
Contract expenditures incurred to date / 80,000 / 160,000
Contract expenditures to complete the work / 80,000
Total estimated contract expenditures / 160,000 / 160,000
Estimated loss / (10,000) / (10,000)
Stage of completion / 53% / 100%
13. The construction firm recognized a loss of 10,000 in XXX1. Any anticipated loss must be reported in the period during which it is first determined that expenditures will exceed contract revenues.
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