Contract Accounting Illustration

Click to learn revenue recognition of long-term contracts with more examples.

We will see contract accounting in the companies that offer constructions and services. Below are the general rules:

Use percentage of completion method where outcome estimable
- Time based
- Milestones
- % complete based on estimated costs (excluding any costs performed in advance)
- Survey of work performed
- Physical completion of stages
Outcome not estimable – recognise revenue to extent of recoverable costs
Recognise expected losses immediately
Costs incurred in advance of current stage are carried as an asset

Scope of judgement

How to allocate revenue according to stage of completion?
How to determine whether a contract is for construction services or sale of goods (e.g. a property developer)?
Installation fees – stage of completion of installation (unless incidental of sale of goods)
Servicing fees (within price of product) – defer portion of original sales price – to allow for costs plus reasonable profit margin
Franchise fees for continuing support – as service is delivered
Customised software – stage of completion – for both delivery and post-delivery support.

Contract Accounting Presentation

An entity presents contract asset (may be referred to as Working in Progress WIP) or liability in the Balance Sheet for contracts:

Asset – where gross amount due from customers; or
Liability – where gross amount due to customers

The balance is calculated as:

Costs incurred plus recognised profiles	X
Less recognised losses to date	(Y)
Less progress billings	(Z)
Gross amounts due to/(from) customers	G

Case 1 – Amounts recoverable under contracts

Company A has a contract in progress at year end.

Total contract price	120,000
Costs incurred to date (all paid)	-70,000
Estimated cost to completion	-40,000
Expected profit	10,000

Progress payments receivable
Billed	64,000
Received	54,000
Percent complete (assumed)	65%

Here, we introduce an item you will see in the Balance Sheet of construction and project-based companies: Amounts recoverable under contracts. This item means cost incurred to date, plus the profit element (or less losses) less any amounts actually billed.

Profit & Loss		Dr	Cr
Turnover	65% × 120,000		78,000
Cost of sales	65% × 110,000	71,500
Gross profit	65% × 10,000		6,500

Balance Sheet
Cash	-70,000 + 54,000		16,000

Accounts receivable	64,000 – 54,000	10,000
Amounts recoverable on contracts	(70,000 + 6,500 – 64,000)	12,500
		94,000	94,000

[Recoverable under contract]=[Contract Costs]+[Margin]−[Progress Billing]

P&L
Revenue	78,000
Cost of Sales	(71,500)
Profit	6,500

Balance Sheet
Cash	(16,000)
Receivable	10,000
Recoverable under contract (WIP)	12,500
Payable
Net Equity	6,500

Case 2 – Amounts payable under contracts

Company A has a second contract in progress at year end.

Total contract price	120,000
Costs incurred to date (all paid)	-70,000
Estimated cost to completion	-40,000
Expected profit	10,000

Progress payments receivable
Billed	80,000
Received	80,000
Percent complete (assumed)	65%

Here, we introduce an item you will see in the Balance Sheet of construction and project-based companies: Amounts payable under contracts. This item means cost incurred to date, plus the profit element (or less losses) less any amounts actually billed.

Profit & Loss		Dr	Cr
Turnover	65% × 120,000		78,000
Cost of sales	65% × 110,000	71,500
Gross profit	65% × 10,000		6,500

Balance Sheet
Cash	-70,000 + 80,000	10,000

Accounts receivable	80,000 – 80,000	0
Amounts payable on contracts	(70,000 + 6,500 – 80,000)		3,500
		81,500	81,500