Construction Contract
Question 1: Construction contract
Suppose that a contract is started on 1st January 2001, with an estimated
completion date of 31st December 2002. The final contract price is $2m.In the
first year, to 31st December 2001:
(a)
Cost incurred amounted to $800,000.
(b) Half the work on the contract was completed.
(c) Certificate of work completed have been issued, and if it is satisfactory, to
issue certificates. This will then be the notification to the customer that
progress payments are due to the contractor.
Progress payments are commonly the amount of valuation on the work
certificates issued minus a precautionary retention of 10%.
(d) It is estimated with reasonable certainty that further costs to completion in
2002 will be $800,000.
** Required:
What is the expected profit in 2001 and what entries would be made for
the contract at 31 December 2001 if:
(a)profits are deferred until the completion of the contract?
(b)a proportion of the estimated revenue and profit is credited to profit
or loss in 20x1?
Question 1: Answer
Expected Profit in 2001:
Recognized Revenue
$2,000,000*50%
$1,000,000
Costs
$800,000
Profit
$200,000
Entries:
(a) Dr. Contract work in progress
$800,000
Cr. Accounts Payable Cash*
Dr. Accounts Receivable $1,000,000*90%
$800,000
$900,000
Cr. Progress Billings (no this answer
given from QP
*Question states” (a) Cost incurred” rather than “Cost Unpaid”
$900,000
Question 1: Answer (Con’t)
Entries:
Dr WIP 800,000
Cr cash 800,000
(b)
Dr. Contract costs-I/S
$800,000
Dr. Contract work in progress
$200,000
Cr.
Contract revenue-I/s
*$1,000,000
The proportion of the estimated revenue and profit is credited to profit in
Student answer is also acceptable as they comply with accounting standard.
20X1.
SOL: Dr. Cost of sales
Cr. Cash
Dr. Account receivable
Cr. Sales
*Price = sales meaning
$800,000
$800,000
$1,000,000
$1,000,000
Question 2
Example: Profitable contract with reliably estimated outcome
Andy Co has a fixed price contract to build a tower block. The initial amount of
revenue agreed is $220 millions. At the beginning of the contract on 1 January
20X9 the initial estimate of the contract costs is $200 millions. At the end of
20X9 the estimate of the total costs has risen to $202 millions.
During 20Y0 the customer agrees to a variation which increases expected
revenue from the contract by $5 millions and causes additional costs of $3
millions. At the end of 20Y0 there are materials stored on site for use
during the “following” period which cost $2.5 millions.
It is decided to determine the stage of completion of the contract by calculating the
proportion that contract costs incurred for work to date bear to the latest
estimated total contract costs. The contract costs incurred at the end of each
year were 20X9: $52.52 million, 20Y0: $154.2 million (including materials in
store), 20Y1 $205 millions.
** Required:
Calculate the stage of completion for each year of the contract and show how
revenues, costs and profits will be recognised in each year.
5
Question 2: Answer
Stage of Completion
Contract costs incurred to date
20X9
20Y0
20Y1
$M
$M
$M
52.52
Contract costs to complete
149.48
Total estimated contract costs
202.00
Stage of completion
Estimated profit
($52.52 / $202) 26%
18,000
254.30 154.20* 205.00
47.80 50.80(205m – 154.2m)
--202.00 205.00 205.00
75.1% 74%
100%
20,000 ($154.2-$2.5)/$205 20,000
Material stored on site for use next year
*The contract cost incurred at the end of year = accumulated figure (20x9 +20y0)
If you feel the question not clear, you could double check by 205 –52.52.
The contract cost incurred during that year = not accumulated figure
Question 2: Answer (Con’t)
To Date
$m
20X9
Construction revenue (220*26%)
Construction costs (202*26%)
Profit
($225m x 74%)
20Y0
Construction revenue (220*75.1%)
Construction costs (202*75.1%)
($205m x 74%)
Profit
Recognized
in prior years
$m
Recognized in
current year
$m
-------
57.20
52.52
4.68
57.20
52.52
4.68
X neither 225m*26%=108m nor
202m*26%=
166.5
151.7
14.8
165.22
151.70
13.52
57.20
52.52
4.68
X 154.2
That is incurred but not completion
20Y1
Construction revenue (220+5)
Construction costs
Profit
225.00
205.00
20.00
109.30 108.02
99.18
10.12
99.18
8.84
154.2-52.52-2.5
166.5
151.70
14.80
165.22
151.70
13.52
58.5
53.30
5.20
59.78
53.30
6.48
Question 2: Explain in three scenario
First year
Second year
26%
48%
Third year
26%
If the total revenue is $220m, then
$220m *26%
$220m * 48%
$220m *26%
$225m * 48%
$225m *26%
If the total revenue is $225m, then
$225m *26%
If the total revenue is change from $220m to $225m meanwhile, then
$220m *26%
$225m * 48%
($225m *74%)= ($220m*26% +225m*48%)
($225m *74%)= ($225m*26% +225m*48%)
$225m *26%
Assumption: second year total sales correct
To solve the problem regard change in total estimation on total revenue or cost,
Please use the schedule that I teach you. Please refer the power point for format.
Question 3: Background
2.4 Construction contracts in the statement of financial position
The accounting treatment of construction contracts is profit or loss driven.
Any amount included in the statement of financial position is a balancing
amount, calculated as:
Contract costs incurred to date
Recognized profits less recognized losses
Progress billing
Amounts due from/ to customers
X
X/(X)
(X)
X/(X)

Where an amount due from customers is calculated, this is normally
shown within inventories.

Where an amount due to customers is calculated, this is normally shown
as ‘payments on account’ within payables.

Any amount invoiced but unpaid is shown as a receivable*.
Dr receivable
Cr Progress billing
9
Question 3
Change in estimates
HKAS 8- the effect of any change in the estimate of contract revenue, costs or the
outcome of a contract should be treated as a “change in accounting estimate”.
Example: Change in estimates
The example below shows the effect of a change in estimate of costs on the figures
that appear in the statement of comprehensive income and statement of
financial position
Junket Co enters into a three- year contract.
Estimated total revenue = $100,000
Estimated total cost= $ 70,000
However, during Year 2 , management revises its estimate of total costs
incurred and thus the outcome of the contract. As a result, during Year 2, a
loss is recognized on the contract for the year, even though the contract will
still be profitable overall.
This case is not total overall loss. This case is overall profit
10
Question 3 (Con’t)
(60,000+20,000)
Year 1
Year 2
Year 3
$
$
$
100,000
100,000
100,000
70,000
80,000
80,000
Estimated total profit
30,000
20,000
20,000
Cost incurred to date
42,000
60,000
80,000
60%
75%
18,000
(3,000)
Estimated total revenue
Change in estimate
Estimated total cost
(42,000+28,000)
Percentage of completion
Recognized profit/(loss)for that
year
Cumulated recognized profit
100,000*0.6
-42,000
Not 80,000*0.15
18,000
15,000
60,000
80,000
100%
5,000
100,000*0.15
-(60,000-42,000)
20,000
Progress billing of 50,000 , 30,000 and 20,000 are made on the last day of each year,
and are received in the first month of the following year. The asset at the end of each
year is.
(a) Prepare schedule between Year 1 and Year 3 and disclosure.
100,000*0.75
-80,000*0.75
100,0
-(80,0
Question 3: Answer
Change in estimates
To Date
Recognized
in prior year
Recognized
in current
year
Year 1
Recognized revenue $100,000*60%
Cost $70,000*60%
Gross Profit
$60,000
$42,000
$18,000
-------
$60,000
$42,000
$18,000
Year 2
Recognized revenue $100,000*75%
Cost $80,000*75%
Gross Profit
$75,000
$60,000
$15,000
$60,000
$42,000
$18,000
$15,000
$18,000
($3,000)
Year 3
Recognized revenue $100,000*100%
Cost
Gross Profit
$100,000
$80,000
$20,000
$75,000
$60,000
$15,000
$25,000
$20,000
$5,000
Question 3: Answer (Con’t)
*Disclosure represents “accumulate amount”. It is not just that current year amount.
Disclosure:*
$60,000*
Year 1
Contract costs incurred
Add: Recognized profit less recognized
loss
Less: Progress billings
Year 2
$42,000
$80,000
Year 3
$18,000
$15,000(18,000-3,000)
$20,000
$20,000(23,000-3,000)
$18,000
($3,000)
$5,000
$60,000
$75,000 $15,000
$60,000$25,000
$50,000
$80,000$30,000 $100,000$20,000
$10,000 ($5,000)($15,000)
0
$5,000
Included in current assets/(liabilities)
Due from customers on construction
contracts
Due to customers on construction
contracts
---
--$5,000
--- ($5,000)($15,000)
---
$10,000
In addition, at each year end, the company recognizes a “Trade Receivable” for the amount outstanding
at the end of the year of of $50,000, $30,000 and $20,000. (Dr AR Cr Progress Billings)
Question 3: Explain in three scenario
First year
Second year
60%
15%
Third year
25%
If the total cost is $70,000, then
$70,000 *60%
$70,000 * 15%
$70,000 *25%
$ 80,000 * 15%
$ 80,000 *25%
If the total revenue is $80,000 m, then
$ 80,000 *60%
If the total revenue is change from $70,000 to $80,000 meanwhile, then
$70,000 *26%
$80,000m * 15%
$80,000 *25%
($80,000 *75%)= ($70,000*60% +80,000*15%) Assumption: second year total sales correct
($80,000 *75%)= ($80,000*60% +80,000*15%)
To solve the problem regard change in total estimation on total revenue or cost,
Please use the schedule that I teach you. Please refer the power point for format.
Double entry for 3 years

Material Purchases

Dr WIP –FP 42,000 (Y1) , 18,000 (Y2) ,20,000 (Y3)

Cr Cash 42,000 (Y1) , 18,000 (Y2) ,20,000 (Y3)

Recognized in I/S


Cr Contract revenue –I/S 60,000 (Y1) , Cr15,000 (Y2) , 25,000 (Y3)
Dr Contract cost -I/S 42,000 (Y1), Dr18,000 (Y2),20,000 (Y3)

Dr WIP -FP 18,000 (Y1) , Cr 3,000 (Y2) , Dr 5,000 (Y3) -- Balance figure

Progress

Dr AR 50,000 (Y1),30,000 (Y2) ,20,000 (Y3)
Cr Progress Billing 50,000 (Y1),30,000 (Y2), 20,000 (Y3)

Question 4: Self test question 1
The main business of Hing Yip Co is construction contracts. At the end of
September 20x9 there is an uncompleted contract on the books, details of
which are as follows:
Contract A
 Date commenced: 1 April 20x7
 Expected completion date: 23 December 20x9
 Final Contract price
 Costs to 30 September 20x9
 Value of work certified to 30 September 20x9
 Progress billings to 30 September 20x9
 Cash received to 30 September 20x9

Estimated costs to completion at 30 September 20x9
$420,000
$315,000
$357,000
$310,000
$298,000
$30,600
** Prepare calculations showing the amount to be included in the statement of
financial position at 30 September 20x9 in respect of above contract, assuming
that the stage of completion is assessed based on work certified.
16
Question 4: Self test question 1: Answer
Stage of Completion:
$357,000 / $420,000*100% = 85%
You can not make double entry as
the information is not sufficient.
For example, you don’t know the previous double entry.
So how can you know the % of work you complete this year.

Dr. Contract Cost
$315,000
Contract WIP
$42,000
Cr. Contract Revenue
$357,000

Dr. Cash
Accounts Receivable
Cr. Progress Billings
$298,000
$12,000
$310,000
No accumulated figure in double entry

Dr. Contract WIP
Cr. Cash
$315,000
$315,000
The estimated final profit is:
Final contract price
420,000
Less: costs to date
315,000
estimated future costs
Estimated final profit
30,600
74,400
Attributable profit =
Estimated profit x Work certified*/Total contract price
*Notified customer
$74,400 total profit x $357,000/$420,000
= $63,240 Estimated accumulated profit at Sept 2009
Question 4: Answer (Con’t)
Hing Yip Company
Statement of Financial Position (extract)
Current Asset:
Contract receivables $310,000 - $298,000
$12,000
Due from customer on construction contract *W1
$47,000
Working 1:
Contract costs incurred plus attributable profits less
foreseeable losses to date
$357,000
Less: Progress billings to date
$310,000
$47,000
Costs to date
Attributable profit
Less: Progress billings
Amount due from customers
$
315,000
63,240
310,000
68,240
Question 5: Self-test question 2
Aero company has the following information in respect of a construction
contract:
Total contract price-----------------------------$100,000
Cost incurred to date---------------------------$48,000
Estimated cost to completion-----------------$32,000
Progress billings---------------------------------$58,000
(of which $50,000 has been received)
Percentage complete (cost basis)-----------60%
** Required:
a)Prepare relevant extracts from the statement of comprehensive income and
statement of financial position
b)Show how the statement of financial position would differ if progress billings
were $64,000 (of which $50,000received)
Self-test question 2
(a)
Question 5: Answer
Aero Company
Statement of Comprehensive Income (extract) for the year ended
Construction revenue $100,000*60%
$60,000
Construction costs
$48,000
Profit
$12,000
Aero Company
Statement of Financial Position (extract)
Current Asset
Due from customer on construction contract *W1
$2,000
Contract receivables $58,000 - $50,000
$8,000
Or Accounts Receivable
Working 1:
Contract costs incurred plus attributable profits less
(48,000+12,000)
foreseeable losses to date
$60,000
Less: Progress billings to date
$58,000
$2,000
Question 5: Answer (Con’t)
Self-test question 2
(b)
Aero Company
Statement of Financial Position (extract)
Current Asset
Contract receivables $64,000 - $50,000
$14,000
Or Accounts Receivable
Current Liability
Due to customer on construction contract *W1
$4,000
Working 1:
Contract costs incurred plus attributable profits less
foreseeable losses to date
$48,000+$12,000
Less: Progress billings to date
$60,000
$64,000
($4,000)
Question 6:Exam practice:




(a) “It is not prudent to recognize profit on outstanding work in
progress in construction contracts. Revenue and cost should be
recognized upon completion of the construction work.’
At 30 June 2009, Vertical Construction Company ("VC") had a fixed price
construction contract in progress, named Waterfall Golf Villa, a project to
construct 80 condominium units. 60 units have been completed and the
remaining 20 units are expected to be completed in the last quarter of 2009.
A survey of completed construction work will be carried out upon
completion of all units. Construction was begun in April 2008 and the
outcome of the contract could not be estimated reliably at 30 June 2008.
According to the original bid estimate, VC would have a profit margin of
20%. Based on the actual costs incurred and the latest information, there
will be an increase in the estimated total costs because of a 15% increase in
the price of construction material. However, a loss is not anticipated. An
instalment contract sum for the construction has been received by VC in
accordance with the contracted payment schedule.
Required:
(B)Explain how VC should account for this construction contract in
the financial statements for the year ended 30 June 2009.
(7
marks)
Question 6:Exam practice answer

(a) “It is not prudent to recognize profit on outstanding work in
progress in construction contracts. Revenue and cost should be
recognized upon completion of the construction work.’

Answer:The statement is incorrect.

Paragraph 37 of the Framework for the Preparation and
Presentation of Financial Statements states that "...Prudence is
the inclusion of a degree of caution in the exercise of the judgments
needed in or making the estimates required under the conditions of
uncertainty... However, the exercise of prudence does not allow, for
example, the creation of
hidden reserves or excessive provision, the deliberate
understatement of assets or income, ... because the financial
statements would not be neutral and therefore, not have the quality
of reliability."
HKAS 11.22 states that when the outcome of a construction
contract can be estimated reliably, contract revenue and contract
costs associated with the construction contract shall be recognised
as revenue and expenses respectively by reference to the stage of
completion of the contract activity at the end of reporting period.


Question 6:Exam practice answer





HKAS 11.25 states that the recognition of revenue and expenses by
reference to the stage of completion of a contract is often referred to
as the percentage of completion method.
Under this method, contract revenue is matched with the contract
costs incurred in reaching the stage of completion, resulting in the
reporting of revenue, expenses and profit which can be attributed to
the proportion of work completed.
This method provides useful information on the extent of contract
activity and performance during a period.
Even when the outcome of a construction contract cannot be
estimated reliably, revenue shall be recognised only to the extent of
contract costs incurred that it is probable will be recoverable and
contract costs shall be recognised as an expense in the period in
which they are incurred.(HKAS 11.32)
Under both circumstances, an expected loss on the construction
contract shall be recognised as an expense immediately when it is
probable that total contract costs will exceed total contract revenue.
(HKAS 11.22, 32 and 36)
Question 6:Exam practice answer






B)It is considered that the outcome of the Waterfall Golf Villa
construction contract can be estimated reliably as:
(a) the total contract revenue can be measured reliably evidence/indicator:
contract sum has been agreed upfront between VC and the employer.
(b) it is probable that the economic benefits associated with the contract
will flow to the entity.evidence/indicator: VC has collected the contracted
instalment from the employer on time.
(c) both the contract costs to complete the contract and the stage of
contract completion at the end of reporting period can be measured
reliably.
evidence/indicator: the information given indicated that VC has reassessed
the total costs against with the original bid estimate and forecast that the
total cost would increase because the price of construction material has
been 15% higher than the price in the budget. Besides, it is stated that 60
units have been completed and the remaining 20 units are expected to be
completed in the last quarter of 2009.
(d) the contract costs attributable to the contract can be clearly identified
and measured reliably so that actual costs incurred can be compared with
prior estimates.evidence/indicator: same as (c).
Question 6:Exam practice answer





B)The stage of completion of the contract may be determined by
reference to:(a) the proportion that contract costs incurred for work
performed to date bear to the revised estimated total contract costs.
(b) completion of a physical proportion of the contract work (i.e. 60 units
completed and 20 units in progress).
For the year ended 30 June 2009, the contract revenue and contract costs
shall be recognised as revenue and expenses respectively by reference to
the stage of completion as determined above at 30 June 2009 less the
contract revenue and contract costs that were recognised in the prior year.
For the year ended 30 June 2008, revenue should have been recognised
only to the extent of contract costs incurred that it is probable will be
recoverable and contract costs should have been recognised as an expense
in the prior year in which they were incurred.
For financial statements presentation, where contract costs incurred to 30
June 2009 plus recognised profits exceed (less than) progress billings, the
surplus is shown as amounts due from (to) customers for contract work.
Amounts billed for work performed but not yet settled by the customer are
included in the statement of financial position as receivable, while amounts
received before the related work is performed are included as a liability, as
advances received.