Construction contracts

According to TFRS for NPAEs and TAS 11, the terms below are defined as follows:

A construction contract is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology, and function, or their ultimate purpose or use.

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 cost escalation clauses.

A cost plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs, or a fixed fee

Keywords: Mazars, Thailand, Legal, Foreign Business Division, Foreign Business Act, DBD

26 April 2016

Contract revenue

Contract revenue shall comprise:

(a) the initial amount of revenue agreed on in the contract; and

(b) variations in contract work, claims, and incentive payments:

(i) to the extent that it is probable that they will result in revenue; and

(ii) to the extent that they are capable of being reliably measured.

Contract costs

Contract costs shall comprise:

(a) costs that relate directly to the specific contract;

(b) costs that are attributable to contract activity in general, and that can be allocated to the contract; and

(c) such other costs as are specifically chargeable to the customer under the terms of the contract.

Recognition of contract revenue and expenses

When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract shall be recognized as revenue and expenses, respectively, by referring to the stage of completion of the contract activity at the end of the reporting period. An expected loss on the construction contract shall be recognized as an expense immediately when it is probable that total contract costs will exceed total contract revenue.

In the case of a fixed price contract, the outcome of a construction contract can be estimated reliably when all the following conditions are met:

(a) total contract revenue can be measured reliably;

(b) it is probable that the economic benefits associated with the contract will flow to the entity;

(c) both the contract costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably; and

(d) the contract costs attributable to the contract can be clearly identified and measured reliably, so that actual contract costs incurred can be compared with prior estimates.

This section takes a look at how a construction contract should be accounted for.

Example:

On 1 January 2014, Company Z entered into a contract with ABC Limited to construct a sports club. The total revenue from the contract is estimated at THB 1.25 million. Company Z will take 3 years to construct the club.

The contract states that, although progress billings will be made at the end of the year, ABC Limited only has to settle the invoices when the contract is 100% complete.

Progress billings are invoiced at the end of the year to reflect the stage of completion of the contract. A summary of a progress billing invoice, the percentage of completion, and estimated costs incurred by Company Z are set out below:

Currency: Thai baht
Year Amount billed to customer Percentage of completion for each year Total Percentage of completion Expected costs incurred for this project for each year Total costs incurred to date Contract profit
2014 500,000 40% 40% 350,000 350,000 150,000
2015 400,000 32% 72% 280,000 630,000 120,000
2016 350,000 28% 100% 245,000 875,000 105,000
Total 1,250,000 100%   875,000   375,000

How should this construction contract be accounted for in the financial statements?

At the end of the period from 2014 through 2016, the accounting will be as set out below:

Currency: Thai baht
  2014 2015 2016
Accounts receivable 500,000 400,000 350,000
Billing for construction contract 500,000 400,000   350,000
To record the amounts billed to the customer
Construction in progress

350,000

 

280,000 245,000
Cast at bank 350,000 280,000 245,000
To record the costs incurred for each year
Billing for construction contract 500,000 400,000 350,000
Construction contract revenue 500,000 400,000   350,000
To record revenue and costs
Costs of construction 350,000 280,000 245,000
Construction in progress 350,000 280,000 245,000
To record the costs of construction
Reference: TFRS for NPAEs, TAS 11, and IAS 11

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