ACCA P2 (INT) Corporate Reporting - Study text

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Chapter 18: Other accounting standards

Contract revenue

Contract revenue is the amount payable by the customer. All of the contract price,

or a large part of it, may be a fixed amount (a price agreed in the terms of the

contract). Provided that the outcome of the contract can be estimated reliably,

revenue is taken to profit or loss as the contract progresses. The two most common

methods of recognising revenue in each accounting period are the costs basis and

the sales basis.

 The costs basis. Revenue is taken to profit or loss in line with the percentage of

total costs incurred to date. (This is the more common method in examination

questions.)

 The sales basis. Revenue is taken to profit or loss in line with ‘work certified’ to

date by a third party.

As a contract progresses, at periodic intervals, an independent expert such as a

surveyor may inspect the work, and issue a certificate stating the amount or value of

the work done so far. The most recent certificate issued by the independent expert

provides a basis for judging the proportion of the contract work that has been

completed.

Contract costs

Contract costs are:

 the direct costs of the contract (such as labour costs, costs of materials,

depreciation of plant used in construction), and

 a reasonable proportion of indirect costs (such as insurance costs, general design

costs that are not attributable to specific contracts, and other general overheads).

Measuring revenue and cost in each period

To calculate the figures for contract revenue and contract costs to be included in

profit or loss, the following steps should be taken:

Step 1: Calculate the total profit expected on the contract.

Contract price X

Minus: Costs to date (X)

Estimated future costs (X)

Total expected profit/(foreseeable loss) X/(X)

If the contract in total shows a loss, the whole loss should be written off and taken

to profit or loss immediately.

If the outcome of the contract is uncertain, possibly because it is too early in the life

of the contract to make a reasonable estimate, there should be no profit and no loss

for the contract. (In Step 3 below, a nil profit is obtained for a contract in its early

stages by making revenue equal to the costs for the contract so far.)

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Step 2: Calculate the proportion of the work completed to date using either the costs

basis or the sales basis. An examination question will indicate which basis to use.

Step 3: The figures to include in profit or loss are normally calculated in the

following order:

 first, a figure for revenue, and

 next, the figure for profit.

 Costs are then a balancing figure, equal to the difference between revenue and

profit (or loss).

For a long-term contract, figures are calculated first of all for total revenue, total

profit and total costs to date. The revenue, profit and costs for the current financial

period are then calculated as the difference between:

 the total revenue, profit and costs to date, and

 the total revenue, profit and costs as at the end of the previous financial period.

Year 1

Year 2 Year 3

$ $ $

Cumulative profit to year end X X X

Minus: Amounts taken to profit in previous years - (X) (X)

Profit this year (balancing figure) X X X

Summary: possible situations

The following table outlines the possible revenue and cost measurement principles:

Situation Revenue measurement Cost measurement

Profitable Stage (%) of completion Stage (%) of completion

Expected loss Stage (%) of completion Balancing figure to capture the full loss

Uncertain Revenue to equal costs Costs incurred in the period

2.4 IAS 11: Disclosure requirements

IAS 11 requires disclosure of the following information about construction contracts:

 The amount of contract revenue recognised as revenue in the period.

 The methods used to determine the amount of revenue and the stage of

completion of contracts in progress (for example, the costs basis)

 For each contract in progress at the end of the reporting period, the total costs

incurred and profits recognised (net of any losses recognised) to date

In relation to the statement of financial; position, IAS 11 requires disclosure of the

following items:

 The amount of advances received (amounts received from customers before the

related work has been carried out).

 The amount of retentions (amounts not paid by the customer until the contract is

completed to his satisfaction).

Chapter 18: Other accounting standards

 The gross amount due from customers or the gross amount due to customers for

contract work. This is calculated as follows:

$ $

Costs incurred X X

Plus recognised profits to date/(or minus recognised losses) X/(X) X/(X)

Minus progress billings (X) (X)

–

–––

= Inventories: Due from customers on contracts

––––

Non-current liabilities: Due to customers on contracts

––––

(X)

–

–––

(Note: ‘Progress billings’ are the amounts that the customer has been invoiced

already, during the progress of the contract to date.)

Note the calculations carefully: (1) Costs incurred (2) plus profits taken to date (3)

minus amounts billed to the customer (4) equals inventory in the statement of

financial position.

Receivables may also include amounts recoverable on contracts where progress

billings exceed cash received from the customer. This amount may include

retentions, disclosed above. For example, if progress billings have been $3 million

but the customer has paid only $2.5 million of the amounts billed, there will be a

receivable for $0.5 million in the statement of financial position, for ‘amounts

recoverable on contracts’.



Example

A construction contractor has a fixed price contract for $9,000 to build a bridge. The

initial amount of revenue agreed in the contract is $9,000. The contractor’s initial

estimate of contract costs is $8,000. It will take three years to build the bridge.

By the end of year 1, costs incurred were $2,093 and the anticipated costs to

complete the project were $5,957.

In year 2, costs incurred to date were $6,168 and the estimated total costs had risen

to $8,200. As a result the customer approves a variation in the contract revenue to

cover the over-run on costs (the excess costs above the original estimate). This

results in an increase in contract revenue of $200.

At the end of year 2, costs incurred include $100 for standard material stored at the

site. This material will be used in year 3 to complete the project.

The contract is completed in year 3, and the final costs incurred were $8,200.

Payments were made in stages. An advance payment of $2,500 was made at the start

of year 1. A progress payment of $4,000 was made in Year 2. The final payment

(including the $200 variation) was made at the end of year 3.

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The contractor determines the stage of completion of the contract by calculating the

proportion that the contract costs incurred for work performed to date bear to the

latest estimated total contract costs:

Stage of completion % = (Contract costs incurred to date/Estimated total contract

costs) × 100%.

Required

(a) Calculate the revenue, costs and profit to recognise in profit or loss in each

year

(b) Calculate the amounts to be disclosed in the statement of financial position at

the end of each year.



Answer

(a) Profit or loss

Key data provided in question

Year1 Year2 Year3

$ $ $

Initialrevenueagreedinthecontract 9,000 9,000 9,000

Variation

‐ 200 200



––––––––––––– ––––––––––––– –––––––––––––

Totalcontractrevenue 9,000 9,200 9,200

–

––––––––––––

–––––––––––––

Costsincurredtodate 2,093 6,168 8,200

AnticipatedcoststocompleteYear1

(8,050–2,093):Year2(8,200–6,168)

5,957 2,032 0



––––––––––––– ––––––––––––– –––––––––––––

Totalestimatedcosts 8,050 8,200 8,200

–

––––––––––––

–––––––––––––

 

Estimatedprofit(revenuelesscosts) 950 1,000 1,000

Stage 1: Calculate the attributable revenue

Revenue is recognised according to the percentage completion which is based

on costs incurred to date as a percentage of total estimated costs.

Year1 Year2 Year3

$ $ $

Costsincurredtodate 2,093 6,068 8,200

Totalestimatedcosts

8,050 8,200 8,200

Stageofcompletion(note)

26% 74% 100%

Attributablerevenuetodate

(%completion×totalrevenue)

(26%×9,000) (74%×9,200)

2,340 6,808 9,200

Minus:revenuerecognisedtodate

‐ 2,340 6,808



––––––––––––––––– ––––––––––––––––– –––––––––––––––––

Revenuefortheyear 2,340 4,468 2,392



––––––––––––––––– ––––––––––––––––– –––––––––––––––––

Chapter 18: Other accounting standards

Note: The percentage completion in year 2 is based on costs incurred to date

of $6,168 less the $100 of inventory carried forward to year 3.

Stage 2: Calculate the attributable profit

If the project is expected to be profitable, profit will be recognised according to

the stage of completion. If the project is expected to be loss-making, the loss

must be recognised in full.

Year1

Year2

Year3

Stageofcompletion

26%

74%

100%

Estimatedprofit(seeKeydata) 950

1,000

Cumulativeattributableprofittodate

(%completion×estimatedprofit)

247

740

1,000

MInus:profitrecognisedtodate

‐

247

740

Profitfortheyear

247

493

260

Stage 3: Determine cost of sales

Cost of sales will be the costs charged to the contract in the year

Year1

Year2

Year3

Costsincurredtodate

(excludinginventoryinYear2)

2,093

6,068

8,200

Minus:Costsrecognisedtodate ‐

2,093

6,068

Costofsalesfortheyear

2,093

3,975

2,132

Extract from the statement of comprehensive income (or income statement)

Year1

Year2

Year3

Revenuefortheyear

2,340

4,468

2,392

Costofsalesfortheyear 2,093

3,975

2,132

Profitfortheyear

247

493

260

(b) Statement of financial position disclosures

The gross amount due from or to customers will be recognised as an asset or

liability in the statement of financial position. The amount due comprises:

 costs incurred

 plus recognised profits or minus recognised losses

 minus amounts billed to customers.

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Year1

Year2

Year3

Costsincurredtodate

(excludinginventoryinYear2)

2,093

6,068

8,200

Plus:Profitrecognisedtodate 247

740

1,000

2,340

6,808

9,200

Minus:Cumulativeamountsbilled 2,500

6,500

9,200

Asset/(Liability)

(160)

308

Extract from the statement of financial position

Year1 Year2 Year3

Currentassets

Grossamountsduefromcustomers

308

Inventoriesofrawmaterials

100

Currentliabilities

Grossamountsduetocustomers 160

2.5 IFRIC Interpretation 12: Service concession arrangements

In many countries, organisations in the public sector (state sector) are responsible

for infrastructure projects for public services - such as roads, bridges, tunnels,

prisons, hospitals, airports, water distribution facilities, energy supply and

telecommunication networks.

However in some countries, the government enters into contracts with companies or

other private sector entities for the development, financing, operation and

maintenance of infrastructure. The infrastructure may already exist, or it may be

constructed during the period of the service arrangement.

These arrangements are covered by IFRIC Interpretation 12. Arrangements within

the scope of IFRIC Interpretation 12 typically involve a private sector entity (an

operator):

 constructing an item of infrastructure for the public service, such as a state

hospital

 upgrading it (for example, by increasing its capacity), and

 operating and maintaining it for a specified period of time.

A feature of these arrangements is the public service nature of the obligation that is

undertaken by the operator. The service arrangement contractually obliges the

operator to provide the services to the public on behalf of the government.

IFRIC 12 provides guidance on accounting by operators for these types of

concession agreements.

Chapter 18: Other accounting standards

Accounting treatment

The operator should recognise and measure revenue from the contract in

accordance with IASs 11 and 18 for the services it performs.

 If the operator performs more than one service (i.e. construction or upgrade

services and operation services) under a single contract, the consideration for

each service should be allocated by reference to the relative fair values of the

services delivered.

 If the operator provides construction or upgrade services the consideration

received or receivable by the operator shall be recognised at its fair value.

The operator shall recognise a financial asset (under IAS 32, 39 and IFRS 7) to the

extent that it has an unconditional contractual right to receive cash or another

financial asset from the customer

The operator should recognise an intangible asset (under IAS 38) to the extent that it

receives a right (e.g. a licence) to charge users for their use of the public service. A

right to charge users of the public service is not an unconditional right to receive

cash because the amounts are contingent on the extent that the public uses the

service

The operator should account for revenue and costs relating to operation services in

accordance with IAS 18.

The operator may have contractual obligations it must fulfil as a condition of its

licence:

 to maintain the infrastructure to a specified level or standard

 to restore the infrastructure to a specified condition before it is handed over to

the customer (government) at the end of the service arrangement.

These contractual obligations to maintain or restore infrastructure should be

recognised and measured in accordance with IAS 37, at the best estimate of the

expenditure that would be required to settle the present obligation as at the end of

the reporting period.

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IAS 41:

Agriculture

 Scope and definitions

 Accounting treatment

 Government grants

3 IAS 41: Agriculture

3.1 Scope and definitions

Scope

IAS 41: Agriculture covers the following agricultural activities:

 biological assets

 agricultural produce at the point of harvest, and

 government grants for agriculture (in certain situations).

IAS 41 does not apply to:

 the harvested agricultural product (IAS 2 Inventory applies)

 land relating to the agricultural activity (IAS 16 or IAS 40 applies)

 intangible assets related to agricultural activity (IAS 38 Intangible assets applies).

Definitions

The following definitions are relevant to IAS 41:

 Biological asset – a living animal or plant, such as sheep, cows, rice, wheat,

potatoes and so on.

 Biological transformation means the processes of growth, production,

degeneration and procreation that cause changes in the quality or the quantity of a

biological asset

 Agricultural activities – the management by an entity of the biological

transformation of biological assets

− for sale, or

− into agricultural produce, or

− into additional biological assets.

 Agricultural produce is the harvested product of the entity’s biological assets.

 Harvest – the detachment of produce from a biological asset or the cessation of a

biological asset’s life.

Chapter 18: Other accounting standards



Example

A farmer has a field of lambs (‘biological assets’). As the lambs grow they go

through biological transformation. As sheep they are able to procreate and lambs

will be born (additional biological assets) and the wool from the sheep provides a

source of revenue for the farmer (‘agricultural produce’). Once the wool has been

sheared from the sheep (‘harvested’), IAS 2 requires that it be accounted for as

regular inventory.

Further examples

Biologicalassets

Agriculturalproduce Harvestedproducts

Treesinaplantationforest Logs Lumber

Plants Harvestedcane Sugar

Dairycattle Milk Cheese

Vines Grapes Wine

Bushes Leaf Teaortobacco

3.2 Accounting treatment

Recognition of a biological asset or agricultural produce

An entity should recognise a biological asset or agricultural produce when (and

only when):

 the entity controls the asset as a result of past events

 it is probable that future benefits will flow from the asset to the entity, and

 the fair value or cost of the asset can be measured reliably.

(Note: the probability of future benefits can be an important factor in the recognition

of these items.)

Measurement

 A biological asset should be measured initially and subsequently at the end of

each reporting period at its fair value minus ultimate selling costs (unless the

fair value cannot be measured reliably). The gain or loss arising on initial

recognition and subsequent revaluation should be included in profit or loss for

the period in which it arises.

 Agricultural produce harvested from an entity’s biological assets is measured at

its fair value minus estimated ultimate selling costs. The gain or loss on initial

recognition is included in the profit or loss for that period.

 Ultimate selling costs include commissions to brokers and dealers, levies to

regulators, transfer taxes and duties.

 Fair value is the quoted price in an active market. It is presumed that fair values

can be measured reliably for biological assets. If this is not so, the biological asset

should be measured at its cost minus any accumulated depreciation or

impairment.

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 Once the fair value becomes available, the entity should measure the asset at fair

value minus ultimate selling costs. This could arise where a vineyard owner

buys some vines that have no value until they are several years old and start to

produce grapes.



Example

Using the earlier example of a sheep farmer, lambs should initially be measured

when they are born at their fair value minus costs to sell.

As they grow and their value changes, this gain or loss should be reflected in the

biological asset value and also in profit or loss.

The sheep may be used for obtaining wool. Once the wool has been sheared from

the sheep, as an agricultural produce the wool should be valued at fair value minus

costs to sell.

If the wool is then turned into yarn or carpet its value is then transferred to

inventory and IAS 2 will provide any further accounting rules.

3.3 Government grants

Agricultural entities (for example, farms) often benefit from government grants in

the form of cash payments. An unconditional grant relating to a biological asset that

is being measured at fair value should be recognised as income when the grant

becomes receivable.

A grant may be dependent on certain conditions being met. For example, the entity

may be asked not to engage in a specific agricultural activity. In such cases, the

grant should be recognised only when the conditions are met.

If the biological asset has been measured at cost because fair value could not be

measured reliably, then the requirements of IAS 20: Accounting for government grants

should be applied.

ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)

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