Financial Accounting II: Construction Chapter Accounting for construction Nguyễn Công Phương Required text: Barry Elliott and Jamie Elliott (2017), Chapter 21 -Construction contacts, in Financial accounting and reporting, Eighteenth edition, Prentice Hall Article 27, section 5, Circular 200/2014 Article 79, Section 1.6.11, Circular 200/2014 Chaper 4-Financial accounting 2_Nguyễn Công Phương et al., 2010 © Nguyễn Cơng Phương 2017 Introduction Contracts that span more than one accounting period Potential difficulties allocating and recognising revenue and expenses Potential conflict between prudence and accruals/matching Objective is to prescribe the accounting treatment of revenue and costs associated with construction contracts, accounting treatment for Projecting Property, Plant, and Equipment Primary issue is the allocation of contract revenue and costs to the period in which construction work is performed © Nguyễn Cơng Phương 2017 © 2017 Nguyễn Cơng Phương Financial Accounting II: Construction Revenue and costs Revenues the initial amount of revenue agreed in the contract, and variations in contract work, claims and incentive payments Costs those that relate directly to a specific contract costs that are attributable to general contract activity but can be allocated to specific contracts any other costs that can be charged to the customer under the terms of the contract Accounting for construction contracts by contractor © Nguyễn Cơng Phương 2017 © Nguyễn Cơng Phương 2017 © 2017 Nguyễn Công Phương Revenue and costs Costs (cont.) those that relate directly to a specific contract Costs of materials, Site labour, depreciation of plant and equipment used on the contract, costs of moving plant and materials to and from the contract site, costs of hiring plant and equipment, costs of design and technical as costs that are attributable to general contract activity but can be allocated to specific contracts, such as: Insurance, costs of design and technical assistance that are not directly related to a specific contract, construction overheads Costs of this nature need to be allocated on a systematic and rational basis, based on the normal level of construction activity © Nguyễn Cơng Phương 2017 What is a construction contract ? © Nguyễn Cơng Phương 2017 What is a construction contract ? Potential conflict between prudence and accruals/matching © Nguyễn Cơng Phương 2017 © Nguyễn Công Phương 2017 Potential conflict between prudence and accruals/matching © Nguyễn Công Phương 2017 Potential conflict between prudence and accruals/matching © Nguyễn Cơng Phương 2017 Potential conflict between prudence and accruals/matching Two methods of accounting to recognise the revenue and costs: According to nature of contract Percentage-of-Completion Method Recognize revenues and gross profits each period based upon the progress of the construction Buyer and seller have enforceable rights Completed-Contract Method Recognize revenues and gross profit only when the contract is completed The this method is required to provide the overall contract result can be predicted with reasonable certainty © Nguyễn Cơng Phương 2017 © Nguyễn Cơng Phương 2017 12 Percentage-of-Completion Method Companies must use Percentage-of-Completion when estimates of progress toward completion, revenues, and costs are reasonably dependable and all the following ex Contract specifies enforceable rights regarding goods or services by parties, consideration to be exchanged, and manner and terms of settlement Buyer can be expected to satisfy all obligations Contractor can be expected to perform the contractual obligations © Nguyễn Công Phương 2017 13 Completed-Contract Method Companies should use the completed-contract method when one of the following conditions applies: When a company has primarily short-term contracts, or When a company cannot meet conditions for using the percentage-of-completion method, or When there are inherent hazards in the contract beyond the normal, recurring business risks © Nguyễn Cơng Phương 2017 14 The accounting treatment of construction contracts under IAS 11 Two methods of accounting to recognise the revenue and costs: according to payment method 1) Where a construction contract stipulates that the contractor is allowed to make payments according to the set schedule (thanh toán theo tiến độ kế hoạch), and when the outcome of a construction contract can be estimated reliably, the reven (b) Where a construction contract stipulates that the contractor is allowed to make payments according to the value of performed work (thanh toán theo khối lượng thực hiện), and when the outcome of a construction contract can be estimated © Nguyễn Cơng Phương 2017 VN GAAP: not mentioned © Nguyễn Cơng Phương 2017 16 Category 1: When the outcome can be estimated reliably If the outcome of a profitable contract can be estimated reliably, contract revenue and costs should be recognised by reference to the stage of completio Options for measuring stage of completion Costs incurred as a proportion of total estimated costs Value certified as a proportion of total contract revenue Completion of physical proportion of contract work © Nguyễn Cơng Phương 2017 17 Options for measuring stage of completion Value Based Methods Value of work completed in proportion to total contract price The value of work may be determined by conduction surveys of work performed, appraisal of the stage completion, normally Stage of Completion % = (value of work certified as complete x 100)/total expected production or usage (total contract price) Physical units of work completed in comparison with total number of units to be completed under the contract Stage of Completion % = Physical Units of Work Completed/ Total Number of Units as per Contract © Nguyễn Cơng Phương 2017 18 Options for measuring stage of completion Cost Method ValueBased Based Methods (continued) Costs incurred to date comparison totalinexpected contract When value basedinmethods arewith used accounting forcosts profit making contracts and loss making contracts, revenue is recognized on the basis of work certified as complete Stage of Completion % = Costs incurred to date the amount of contract costs incurred to date that have not yet been charged to the income statement is the contract work in progress *100/Total expected costs © Nguyễn Công Phương 2017 When cost based method are used in accounting for profit making contracts and loss making contracts, cost is recognized on the basis of stage of completion whereas contract revenue is measured as the balan Where outcome in respect of a contract is not certain, stage of completion method is not used to account for the construction contract © Nguyễn Công Phương 2017 20 19 Thousand VND Measurement revenue according Example 1: Contract outcomeofestimated reliably Total contract price 2,000,000 ABC Builders LTD is a construction firm It enters into a year contract for the construction of a building for one of its customers ABC Builders LTD estimates stage of completion on percentage of cost basis Following information is available in respect Total expected costs 1,200,000 to the cost based method Revenueto date = Total price *(costs incurred to date/ Total estimated costs) Revenue period i= Revenueto date- Revenueprevious periods Costs incurred to date 800,000 Progress payments received from customer 700,000 Costperiod i= costs incurred to date – costs recognised in previous periods Stage of completion to be determined by reference to costs to date and total costs rather than duration Payments according to the set schedule © Nguyễn Cơng Phương 2017 21 © Nguyễn Cơng Phương 2017 22 Example (continued) Example (continued) 3: Calculate amounts to be recognized in the Balance Sheet for Gross Amounts due to/ from Customers and Trade Receivables Sept 1: Calculate the stageStep of completion receivable Stage of Completion (%) = [800,000Trade / 1,200,000] x 100 == 900,000 (amount billed) – 700,000 (amount received) = 200,000 66.67 % Gross amounts due from Customers: 1,333,333 (revenue) – 900,000 (amount billed) = 433,333 GrossStatement amount due for fromProfit, customer represents amount of revenue earned on a contract but yet billed to the customer Step 2: Determine the amounts to be recognized in Income Revenue andthe Cost If bove amount is negative, it is a Gross amount due to customer, represents the amount of revenue earned on a contract in excess of the amount billed to the customer Thousand VND Cost (cost incurred during the year) 800,000 Revenue (66.67%*2,000,000) 1,333,333 Profit (revenue – Cost) 533,333 © Nguyễn Cơng Phương 2017 23 © Nguyễn Cơng Phương 2017 24 Gross amount due from / to customers Present “gross amount due from/to customers for contract work” as asset/liability Gross amount due is calculated as: Costs incurred to date Plus recognised profit Minus recognised loss Minus invoiced progress billings Progress billings invoiced and still receivable at reporting date are presented as trade receivables © Nguyễn Cơng Phương 2017 25 Test your understanding ABC Builders use cost method to calculate the stage of completion of its construction contract Total estimated contract costs of their contract are $100 million In the first year of their contr Cost of purchase of raw materials worth $10 million ($5 million of which are unused by the year end) Payment of salaries and wages of $5 million ( $1 million of accrued salaries are unpaid by the year end) Payment of advances to subcontractors of $20 million (Subcontractors have performed work equal to 50% of the amount of advance by the year end) What is the percentage of Stage of Completion of the construction contract? © Nguyễn Cơng Phương 2017 26 Category 2: When the outcome cannot be estimated reliably Whenacontract‟soutcomecannotbe estimated reliably: recognise revenue to the extent of the costs incurred which are expected to be recoverable; and recognise contract costs as an expense in the period in which incurred Example 2: Outcome cannot be estimated reliably Contract Y at 31 December 2012: Commencement date:1 November 2012 Completion date:31 March 2014 Contract price:€5,000,000 Cost to date:€400,000 Cost to complete:€3,600,000 This arises during the early stages of a contract when it is difficult to reliably estimate outcome, but likely that costs will be recovered Stage of completion to be determined by reference to costs to date and total costs rather than duration Payments according to the set schedule © Nguyễn Cơng Phương 2017 27 © Nguyễn Cơng Phương 2017 28 Price: 5,000,000 Costs to date: (400,000) (3,600,00 Example (cont.) 0) Costs to complete: Step Calculate the outcome for the contract Profit: 1,000,000 Category 3: When it is probable that total contract costs will exceed total contract revenue Step Determine the stage of completion Therefore that the contract =will Cost to date/Total cost: €400,000/€4,000,000 10% incur losses Too When early to recognise any profit it is probable that costs > revenue, the Step Statement of profit or loss and other comprehensive income Revenue400,000 Cost of Sales (€4m x 10%) (400,000) Profit0Revenue = Cost expected total loss should be recognised immediately irrespective of whether work has commenc © Nguyễn Cơng Phương 2017 29 30 © Nguyễn Cơng Phương 2017 Example 3: Contract loss expected Example (cont.) Contract Z at 31 December 2012: Commencement date:1 September 2012 Step Calculate the outcome for the contract Price Contract price: €2,000,000 20% % completion: Completion date: 30 April 2014 Cost to date: €440,000 Stage of completion to be determined by reference to costs to date and total costs rather than duration Cost to complete: €1,760,000 Payments according to the set schedule © Nguyễn Cơng Phương 2017 31 2,000,000 Step Determine the stage of completion Cost to Date/Total Cost€440,000/€2,200,000 = 20% Step Statement of profit or loss and other comprehensive income Costs to date (440,000) Costs to complete (1,760,000) Loss (200,000) © Nguyễn Cơng Phương 2017 Revenue (€2m x 20%) Cost of Sales (€2.2m x 20%) Provision for foreseeable 32 400,000 (440,000) (160,000) loss (200,000) Journal entries for revenue Payments according to the set schedule At the end of accounting periods, when the outcome of a construction contract can be estimated reliably: Dr acc 337: Progress payment Cr acc 5112: revenue When amount is billed Dr acc 11X, 131: cash or receivable Cr acc 337 Cr Acc 3331: out VAT © Nguyễn Cơng Phương 2017 33 Journal entry for revenue Paymentsaccordingtothevalueof performed work When amount is billed Dr Acc 11X,131: cash or receivable Cr Acc 5112: revenue Cr Acc 3331: out VAT © Nguyễn Cơng Phương 2017 34 Journal entries forJournal costs incurred entries for costs incurred Direct costs relate to the Construction specific contract overheads or works are or of not contract directly (berelated paid) to a specific contract Dr acc.Acc 627/cr 152,153,334,214,331,352 (guarantee work); 1413,1363 (sub-contracted works of internal subcontractor) Direct materials: Dr acc 621/Cr 152, 331; 1413, 1363 (sub-contracted works of internal subcontractor) Direct labor: Dr acc 622/Cr/acc (sub-into contracted works of154 internal subcontractor) Costs334; are1413,1363 transferred the account according to the specific contract or works of contract, based on the normal level of construction Direct labor includes not the social, unemployment insurance, and union dues Its are costs of construction overheads Dr acc.healthy, 154/Cr 621,622,623,627 Machinery and equipment costs used and on a specific contract: Dr acc 623/Cr 1413,1363 (sub-contracted works of internal subcontractor) General administrative expenses: Dr.152,214,331; 642 © Nguyễn Cơng Phương 2017 © Nguyễn Công Phương 2017 35 36 activity Journal entries for costs incurred Note (continued): Costs incurred in excess of the normal level of construction activity are recognized in the income statement: Dr 632/Cr 62X If joint costs of construction machinery and overheads need to be allocated to specific contracts or works of contract: allocated on a systematic and rational basis, such as: costs of construction machinery are allocated to each contract or work of contract using used machinery unit (unit equals hours); construction overheads are allocated to each contract or work of contract based on a direct cost (such as direct materials, direct labor, cost of machinery) labor37 © Nguyễn Công Phương 2017 Cost of completed work Cost of completed work = cost of work in process at the beginning + costs incurred during the period – cost of work in process at the end (by reference) Record the entries Dr acc 632/Cr Acc.154 : completed work paid © Nguyễn Công Phương 2017 38 IFRS 15-REVENUE FROM CONTRACTS WITH CUSTOMERS IFRS 15 was issued in May 2014 and is effective for an entity's first annual IFRS financial statements for periods beginning on or after January 2017 Earlier application is permitted IFRS 15 replaces IAS 11 Construction contracts, IAS 18 Revenue and IFRIC 13 Customer Loyalty Programmes IFRS 15 moves away from a revenue model based onperiod an „earnings process‟ to an „asset-liability‟ approach based on transfer of control Amountrecognition recognised as revenue in the The core principle of IFRS 15 isMethod that anused entity will recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration (payment) to which the entity expects to to determine the revenue recognised © Nguyễn Công Phương 2017 Disclosure Method used to determine stage of completion For each contract in progress cost incurred to date and recognised profits (less losses) amount of advances received amount of retentions Gross amount due from customers for contract work where (a) > (b) This is shown as follows: cost incurred plus recognised profits, less the total of recognised losses and progress billings The gross amount due to customers, i.e where (a) < (b) © Nguyễn Công Phương 2017 39 IFRS 15-REVENUE FROM CONTRACTS WITH CUSTOMERS To apply this principle, a five-step model framework must be followed: Step 1: Identify the contract(s) with a customer Step 2: Identify the performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to the performance obligations in the contract Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation The industries most impacted by IFRS 15 are likely to be telecom, software development, real estate and other industries with long-term contracts This includes an industry where bundled contracts © Nguyễn Công Phương 2017 Accounting for Projecting Property, Plant by project company (Supplementary reading: Account 241, Circular 200/2014 © Nguyễn Công Phương 2017 42 Expenditures should be included in the cost of Projecting Property, Plant, and Equipment 1) Journal entries: in case of project company (chủ đầu tư) managing directly the project Direct costs: Its are usually easily identifiable and can be traced to the asset directly such as cost are of construction materials, to contractors, payroll and benefit cost Costs incurred recorded in the accountpayment 2412-construction in progress If employees work on several projects (e.g., several pieces of equipment), their payroll and benefit costs should be allocated to each project using labor hours Dr 2412 Cr 152: materials Indirect costs: Cr 334: costs related to the employees its are overhead cost, includes not general and administrative costs Cr 331: Notes payable to contractors Indirect costs should be allocated to each project based on a direct cost (such as direct labor) © Nguyễn Cơng Phương 2017 Cr:214: Depreciation Cr… © Nguyễn Công Phương 2017 44 1) Journal entries: in case of project company managing directly the project When project is completed (e.g., testing has been performed and Engineering Services approved putting the assets in service), the accumulated cost of th Dr 211, 213: costs of fixed assets (approved costs) Dr 138: unapproved costs to receive Dr 441: approved damages Cr 2412: accumulated costs © Nguyễn Cơng Phương 2017 45 2) In case of project company managing indirectly the project A department under project company (ban quản lý dự án) manages directly the project The project company (chủ đầu tư) uses the accounting policy applied in the company Department managing directly project (ban quản lý dự án) uses the accounting policy for project company (see Circular 195/2012/TT- BTC-Chế độ kế toán Transactions between the project company and its department are internal ones © Nguyễn Cơng Phương 2017 46 2) Journal entries: in case of project company managing indirectly the2) project Journal entries: in case of project company managing indirectly the project Accountingbydepartmentunderproject company (tại ban quản lý dự án) When project is completed (continued) Costs incurred: Dr 2411/Cr 152,334,331,… Accounting by project company (tại chủ đầu tư) When project is completed: Dr 211,213: cost of assets Dr 133: input VAT transferred from department managing project Dr (or Cr.) 413: foreign exchange transferred from department managing project Cr 341: long-term borrowing transferred from department managing project, 3388 Cr 136: put the assets in service but the project is not approved: Dr 2412/Cr 2411 When the project was approved: Dr 341,3388 (guarantee deposit),413 (or cr 413): transferred to the project company Dr 441: approved costs Dr 138: unapproved costs to receive Cr 2412 Cr 133: input VAT transferred to the project company © Nguyễn Cơng Phương 2017 47 © Nguyễn Cơng Phương 2017 48 ... 241 2/Cr 241 1 When the project was approved: Dr 341 ,3388 (guarantee deposit) ,41 3 (or cr 41 3): transferred to the project company Dr 44 1: approved costs Dr 138: unapproved costs to receive Cr 241 2... foreseeable 32 40 0,000 (44 0,000) (160,000) loss (200,000) Journal entries for revenue Payments according to the set schedule At the end of accounting periods, when the outcome of a construction. .. Dr acc.Acc 627/cr 152,153,3 34, 2 14, 331,352 (guarantee work); 141 3,1363 (sub-contracted works of internal subcontractor) Direct materials: Dr acc 621/Cr 152, 331; 141 3, 1363 (sub-contracted works