LECTURE WEEK THREE

1. LECTURE WEEK THREE TOPIC 3: FINANCIAL INFORMATION DISCLOSURE II – THE BALANCE SHEET

2. FRS 111 (2004): CONSTRUCTIONS CONTRACTS • Contract for the constructions of an assets or a combination of assets which constitute a single construction project • Eg. highways, dams, bridges and buildings. • To contractor/developer – the project is the current assets (same characteristic to stock and WIP) • Using the specific identification method of measurement – individually significant

3. For each CC - a separate contract/project account will be opened for cost accumulation and income determination The main issues: • measuring the amount of contract revenue/cost • determining the amount of revenue, expenses and profits to be recognized when the contract takes more than one accounting period to complete. • relevant disclosure

4. The Requirement of Statues • 9th Schedule Co Act 1965: not specify any accounting method but require a disclosure upon the stock of assets including the long term contract. • FRS 111 (2004) : Construction Contract • Defines: “a contract specifically negotiated for the construction of an assets or a combination of assets…….” • Contract: a services rendering, which directly related to the construction of an assets and destruction or restoration of assets and restoration after demolition of assets

5. Segmenting and Combining Contracts • Contract with a number of assets are accounted as separate when: • Separate proposals submitted • Subject to separate negotiation (accept or reject part of the contract) • Costs and revenue of each assets can be identified. Contract of additional assets should be accounted separate when: • The assets differ significantly in design, technology or function • Price negotiated without regard to the original contract price.

6. Group contract with a single or several customer treated as single construction: • Group contract has negotiated as single package • Contract interrelated as part of a single project with overall profit margin. • Contract performed concurrently or continuous Eg: contract of built up 10 lot of terrace house.

7. Measurement: • Contract Revenue: • Initial amount agreed • Additional amount arising from variations in contract work. (probable future revenue and measured reliably) • Contract Cost: • Cost directly related to specific contract • Cost attributable to the contract activity • Costs chargeable to the customer

8. In Practice: - the initial measurement is not a problem - most contract provide progress billings Journal entry: Billed to customer for amount due: Dr Account Receivable xx Cr Progress billings xx Payment Received: Dr Bank xx Cr Account Receivable xx

9. Recognitions: Contract Revenue and Expenses • Stage of completion - by reference to the completion of the contract activity at the balance sheet date • Fixed price contract: revenue can be measured reliably, probable future benefit, cost to complete the contract can be measured reliably and clearly identified. • Cost-plus contract: probable future benefit and cost attributable to the contract can be measured reliably and clearly identified.

10. Construction Contract: • Fixed Price Contract - the contractor agrees to a fixed contract price, which subject to cost escalation • Cost Plus Contract - The contractor reimbursed for allowable or otherwise defined costs plus a percentage of these costs or a fixed fee

11. Recognition of Expected Loss: • Total expected contract cost exceed the total contract revenue • Recognized as expense immediately

12. Disclosure Requirements: • Amount of contract revenue/cost in the period • Method used to determine the contract revenue recognition • Methods used to determine the stage of completion of contract in progress. • Disclosure for contract in progress: • Aggregate amount of cost incurred and profits • Amount advances received and • Amount of retentions

13. The enterprise should present: • Gross amount due from customer (assets) • Gross amount due to customers (liability) Extract from Notes to Account: Contract In Progress: RM’000 Cost Incurred to date 500,000 Attributable Profits 48,000 Less: Prov. For foreseeable loss (15,000) Progress Billings (425,250) 107,750

14. Variations in Contract Revenue: The increase.decrease of contract revenue: • Cost escalation - increase • Penalties arising from delays caused by contractor - decrease • Incentive payments for early completion of the contract - increase • Subsequent changes in the design of assets or duration of the contract – increase/decrease

15. Accounting for Construction Contracts • Measurement of Contract Cost Eg: Material used 3,000 Site labor 2,000 Cost of secured 500 Allocated construction ohd 500 Plant and equipment purch 2,500 (-) Net Book Value (2,250) 250 Contract Cost 6,250

16. Accounting Treatment under FRS 111 • FRS 111 (2004) : allowed only the percentage of completion method being used. • IAS 11: allowed a free choice either the completed contract method or percentage of completion method.

17. Percentage of Completion Method • Upon the contract activities progress. • Cost incurred are matched with this revenue. Journal Entry: Dr Contract Cost Cr Cash/Payroll (cost assigned to a contract)

18. Dr Construction material,supplies Cr Contract Cost The net contract cost will be closed off to the profit and loss Billed to customer for amount due: Dr Account Receivable Cr Progress billings Payment Received: Dr Bank Cr Account Receivable

19. At the end of period, contract revenue is recognized based on stage of completion Dr Progress billing Cr Contract Revenue (p/l)

20. How to measure a percentage of completion? • Measure a percentage of completion at the end of accounting period • Use a method reflect the work performed • Methods include: • Contract cost incurred to date as a proportion of the estimated total contract cost • Surveys of work performed (value of work certified/total contract revenue) • Completion of physical proportion of the contract work

21. Estimates for outcome of Contract: • At the stage of completion the outcome of contract can be estimated reliably • If the contract cannot be estimated reliably, the recognition only to the extent of costs incurred that are recoverable • Only applied when there are a significant uncertainties. • When the certainties exist the revert to recognition of revenue based on stage of completion must be done.

22. Contract A Contract B Total Revenue Recog 15,000 15,000 30,000 Cost Incurred (15,000) (20,000) (25,000) - (5,000) (5,000) Eg. A contractor has two contract, A and B, in which the outcome cannot be measured reliably. Cost incurred for A were RM15,000 and the amount is fully recoverable. Cost for B is RM20,000 of which RM5,000 is not recoverable.

23. Recognition of Expected Loss • The loss must be recognized as expense immediately • Recognition in full both for stage of completion reached and for the future loss. Eg: A contractor has fixed price contract with a value of RM15,000,000. As at 31 December 2004, contract cost incurred is amounted RM8,000,000. Estimate of further cost to complete is RM12,000,000. Using stage of completion. Calculate the amount of revenue, cost and loss

24. Stage of completion: 8,000,000 8,000,000 + 12,000,000 = 40% Estimated total loss on contract: RM15,000,000 – RM20,000,000 = RM5,000,000

25. Revenue,cost and loss recognition : RM’000 Contract rev. (40% x 15,000) 6,000 Contract cost (40% x 20,000) (8,000) Loss incurred on contract (2,000) Estimated future loss on con. [(1-0.40 x 4,000,000)] (2,400) Total loss recognised (4,400)