IAS 11 CONSTRUCTION CONTRACTS
1 INTRODUCTION
IAS 11 specifies the accounting for construction contracts from the contractor's perspective (IAS 11.1). A construction contract may be specifically negotiated for the construction of a single asset such as a bridge, building, dam, pipeline, road, ship or tunnel. However, a construction contract may also be specifically negotiated for the construction of a number of assets that are closely interrelated or interdependent in terms of their design, technology, and function or their ultimate purpose or use (e.g. the construction of a refinery) (IAS 11.3–11.4). The scope of IAS 11 also includes construction contracts with a short duration that are started in the reporting period and are completed after the reporting period.
Contracts for the construction of real estate meet the definition of a construction contract if the buyer is able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress. If the definition of a construction contract is not met, IAS 18 applies instead of IAS 11 (IFRIC 15).
IAS 11 does not apply to service contracts (e.g. the specifically negotiated programming of software and the preparation of a tax return or of a legal opinion). However, the concept of IAS 18 for recognizing revenue and the associated expenses for transactions involving the rendering of services is generally consistent with the requirements of IAS 11 (IAS 18.21).
IAS 11 distinguishes between fixed price contracts and cost plus contracts (IAS 11.3):
- In the case of a fixed price contract, 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).
- In the case of a cost plus contract, the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee.
According to IAS 11, contract revenue and the profit margin are generally recognized by reference to the stage of completion of the contract activity at the end of the reporting period. This means that profit is recognized on a continuing basis and is not deferred until the date of completion of the contract. This method is referred to as “percentage of completion method” or “PoC-method.” This method is described in more detail in Section 4. In Sections 2 and 3, the concepts “contract revenue” and “contract costs” are defined.
2 CONTRACT REVENUE
Contract revenue comprises not only the initial amount of revenue agreed in the contract, but also (IAS 11.11–11.15):
- variations in contract work (i.e. a change in the scope of the work to be performed under the contract)
- claims (arising for example from a customer caused delay), and
- incentive payments (e.g. for early completion of the contract)
to the extent that it is probable that they will result in revenue and they are capable of being measured reliably.
Since the measurement of contract revenue is often affected by estimates, it may be necessary to revise these estimates from one period to the next. Such a change is accounted for as a change in accounting estimate according to IAS 8 (IAS 11.12 and 11.38).
3 CONTRACT COSTS
One component of contract costs comprises the costs that relate directly to the contract. Examples are site labor costs, costs of materials used in construction, and depreciation of plant and equipment used on the contract. Moreover, contract costs include costs that are attributable to contract activity in general and can be allocated to the contract (e.g. construction overheads) (IAS 11.16–11.18).
Abnormally high costs (e.g. abnormal amounts of wasted materials) and depreciation of idle plant and equipment that is not used on a particular contract are treated as part of the contract costs only if they relate directly to the contract (IAS 11.16a and 11.20d).
Contract costs also comprise such other costs that are specifically chargeable to the customer under the terms of the contract. These costs may include some general administration costs and development costs for which reimbursement is specified under the contract (IAS 11.16c and 11.19).
Selling costs do not constitute contract costs (IAS 11.20b).
Contract costs comprise the costs attributable to a contract from the date of securing the contract to its final completion. However, costs that relate directly to a contract and are incurred in securing the contract also constitute contract costs if they can be separately identified and measured reliably, and it is probable that the contract will be obtained. When costs incurred in securing a contract are recognized as an expense in the period in which they are incurred without the offsetting effect of revenues recognized, they must not be included in contract costs when the contract is obtained in a subsequent period (IAS 11.21).
A change in the estimate of contract costs is accounted for in accordance with IAS 8 (IAS 11.38).
4 PERCENTAGE OF COMPLETION METHOD
4.1 Introduction
When the outcome of a construction contract can be estimated reliably, the percentage of completion method (PoC-method) is applied. When using this method, at first, the stage of completion is determined that reflects the completion progress of the contract at the end of the reporting period (IAS 11.22). For example, if an entity starts fulfilling a contract in the year 01 and performs one third of the contract in 01 (i.e. the stage of completion is 33.33% at the end of 01), one third of contract revenue, one third of the contract costs, and hence also one third of the profit margin are recognized in that period. Consequently, profit is recognized on a continuing basis and is not deferred until the date of completion of the contract.
4.2 Reliable Estimate of the Outcome of a Contract
The percentage of completion method is only applied if the outcome of the contract can be estimated reliably. This is the case if it is probable that the economic benefits associated with the contract will flow to the entity. Moreover, it is necessary that the contract costs attributable to the contract can be clearly identified and measured reliably. In the case of fixed price contracts it is necessary in addition that total contract revenue can be measured reliably and that both the contract costs to complete the contract and the stage of completion at the end of the reporting period can be measured reliably (IAS 11.22–11.24).
4.3 Determining the Stage of Completion
No specific method is prescribed for determining the stage of completion. An entity may use the more appropriate of input measures (consideration of the efforts devoted to a contract) or output measures (consideration of the results achieved) (IAS 11.30).
The following methods are based on input measures:
- Cost-to-cost method: According to this method the stage of completion is calculated by dividing the contract costs incurred for work performed until the end of the reporting period by the estimated total contract costs (IAS 11.30a). Consequently (IAS 11.31):
- Costs of materials or components that have been made specifically for the contract by the entity are included in the costs incurred until the end of the reporting period.
- Standardized materials or components made by the entity (these have not been made specifically for the contract) are excluded when determining the costs incurred until the end of the reporting period. The same applies to purchased materials or components, irrespective of whether they are standardized. These materials or components are only included once they have been installed, used or applied during contract performance.
- Payments made to subcontractors in advance of work performed under the subcontract are excluded when determining the costs incurred until the end of the reporting period.
- Efforts-expended method: According to this method the efforts incurred until the end of the reporting period are divided by the total efforts for performing the whole contract, whereby the efforts are not expressed in monetary units. Working hours may be used as a measure of other efforts expended (which makes sense in the case of labor-intensive activities) as well as machine hours (which makes sense in the case of capital-intensive activities).
The following methods are based on output measures:
- Physical proportions of an entire object (e.g. whether, for instance, the bridge supports have already been constructed when building a bridge).
- Stipulated milestones of an entire object.
- Units already produced in the case of a sum of similar objects that are produced consecutively (e.g. 20 similar one-family houses).
The method applied by the entity has to result in a reliable measurement of the work already performed (IAS 11.30). The application of methods other than the cost-to-cost method is only appropriate if there is approximately a linear relation between the costs and the physical measure or if such a relation can be established via weighting factors. If the stage of completion is not determined according to the cost-to-cost method, the expenses recognized are adjusted to the stage of completion (IAS 11.22).
4.4 Recognition of Expected Losses
When it is probable that total contract costs will exceed total contract revenue, the expected loss has to be recognized as an expense immediately (IAS 11.22 and 11.36). In this case, at first, the contract costs and the contract revenue are recognized according to the stage of completion at the end of the reporting period. This leads to the recognition of that part of the loss that corresponds to the stage of completion. However, in addition, it is necessary to recognize the loss attributable to future periods (future loss) as an expense at the current balance sheet date. The amount of the loss is determined irrespective of whether work has commenced on the contract (IAS 11.37a).
4.5 Uncertainties in Collectibility
The outcome of a construction contract can only be estimated reliably when it is probable that the entity will receive the economic benefits associated with the contract. When uncertainty arises about the collectibility of an amount already recognized as revenue, the uncollectible amount or the amount that will probably not be recovered is recognized as an expense rather than as an adjustment of contract revenue (IAS 11.23b, 11.24a, and 11.28). Impairment losses and reversals of impairment losses with regard to progress billings (IAS 11.41) that have not yet been paid are treated according to IAS 39.
4.6 Presentation and Disclosure
It is necessary to distinguish between advances and progress billings (IAS 11.41):
- Advances are amounts received by the contractor before the related work is performed.
- Progress billings are amounts billed for work performed on a contract whether or not they have been paid by the customer.
The following amounts are compared for each contract (IAS 11.42–11.44):
(a) The costs incurred plus recognized profits less recognized losses.
(b) The total of the progress billings.
If (a) exceeds (b), the net amount is included in the “gross amount due from customers for contract work.” If (b) exceeds (a), the net amount is included in the “gross amount due to customers for contract work.” The amounts due from customers must not be offset with the amounts due to customers. Advances are not taken into account in the previous calculation. Instead, they are recognized as liabilities.
Gross amounts due from customers are generally presented as receivables and not as inventories. Gross amounts due to customers and advances represent liabilities.
Contract costs that relate to future activity on the contract are recognized as an asset, if it is probable that they will be recovered (IAS 11.27). Such costs are included in determining the gross amount due from or due to customers (IAS 11IE). However, they are not taken into account in determining the stage of completion. Gross amounts due from customers that result from such costs represent inventories and not receivables (IAS 11.27, 11.31a, and 11.IE). This procedure applies when the stage of completion is calculated according to the cost-to-cost method.
In the statement of comprehensive income, the expenses are generally presented as cost of sales when the function of expense method (= cost of sales method) (IAS 1.99 and 1.103) is applied.
5 WHEN THE OUTCOME OF A CONTRACT CANNOT BE ESTIMATED RELIABLY
If it is not possible to estimate the outcome of a construction contract reliably (IAS 11.32–11.34):
- the contract costs are recognized as an expense in the period in which they are incurred,
- revenue is recognized only to the extent of contract costs incurred for which recovery is probable, and
- no profit is recognized.
When it is probable that total contract costs will exceed total contract revenue, the expected loss has to be recognized as an expense immediately irrespective of whether work has commenced on the contract (IAS 11.32, 11.36, and 11.37a). This means that also the loss attributable to future periods (future loss) has to be recognized as an expense at the current balance sheet date.
6 EXAMPLES WITH SOLUTIONS
Example 1
Contract with progress billings and an advance
On Jan 01, 01, entity E concludes a fixed price contract. Total contract revenue is CU 120. The total contract costs of CU 90 will be incurred in thirds in each of the years 01–03. At the end of 01, E bills an amount of CU 35 to its customer, which is paid on Jan 15, 02. In 02, an amount of CU 45 is billed to the customer, which is paid promptly. Moreover, on Dec 31, 02, the customer pays an advance of CU 20 for work, which is performed in 03. The billing for the remaining amount of CU 20 that is still outstanding on Dec 31, 03 is effected at the beginning of 04.
Required
Prepare any necessary entries in E's financial statements as at Dec 31 for the years 01–03. The stage of completion is determined according to the cost-to-cost method (IAS 11.30a). E prepares its separate income statement in accordance with the function of expense method (= cost of sales method).
Hints for solution
In particular Sections 4.3 and 4.6.
Solution
Year 01
The gross amount due from the customer is calculated by adding the recognized profit of CU 10 (= revenue of CU 40 – expenses of CU 30) to the costs incurred (CU 30) and deducting the billing of CU 35 (IAS 11.43).
Year 02
In 02 revenue of CU 40 is recognized. This amount reflects the change in the stage of completion (CU 40 = CU 120 · 1/3).
The gross amount due from the customer as at Dec 31, 02 is calculated as follows (IAS 11.43):
| Costs incurred in 01 and 02 |
60 |
| Profits recognized in 01 and 02 |
20 |
| Progress billings in 01 and 02 (CU 35 + CU 45) |
−80 |
| = Gross amount due from the customer |
0 |
Hence, the gross amount due from the customer has to be reduced from CU 5 (carrying amount as at Dec 31, 01) to zero. The advance is recognized as a liability and is not taken into account in determining the gross amount due from the customer (IAS 11.43).
Year 03
On Dec 31, 03, the liability arising from the advance is derecognized because the work for this payment has already been performed in 03.
Example 2
Expected loss on a contract with progress billings
On Jan 01, 01, entity E concludes a fixed price contract. Total contract revenue is CU 180. When E prepares its financial statements as at Dec 31, 01, the estimate of total contract costs is CU 160 which are estimated to be incurred in fourths in each of the years 01–04.
However, in 02 contract costs of CU 70 are ultimately incurred. On the basis of a new estimate, E expects that contract costs of CU 50 will be incurred in 03 and that contract costs of CU 40 will be incurred in 04. Consequently, total contracts will be CU 200.
At the end of 02 there is a progress billing in the amount of CU 80. This amount is paid by the customer on Jan 15, 03.
The billing for the remaining amount of CU 100, which is still outstanding on Dec 31, 04, is effected at the beginning of 05.
Required
Prepare any necessary entries in E's financial statements as at Dec 31 for the years 01–04. The stage of completion is determined according to the cost-to-cost method (IAS 11.30a). E prepares its separate income statement in accordance with the function of expense method (= cost of sales method).
Hints for solution
In particular Sections 4.3, 4.4, and 4.6.
Solution
Year 01
Year 02
Revenue to be recognized in 02:
On Dec 31, 02, the stage of completion is 55% (= contract costs incurred in 01 and 02 of CU 110 : total contract costs of CU 200). Hence, cumulative contract revenue to be recognized in 01 and 02 is CU 99 (= 55% · CU 180). Because contract revenue of CU 45 was recognized in 01, contract revenue of CU 54 has to be recognized in 02.
Loss to be recognized in 02:
In 01 and 02, contract revenue of CU 99 and contract costs of CU 110 are recognized. Hence, a cumulative loss of CU 11 is automatically recognized in 01 and 02, which can also be calculated as follows:
| Total contract revenue |
180 |
| Total contract costs |
−200 |
| Total loss on the contract |
−20 |
| Stage of completion as at Dec 31, 02 |
55% |
| Loss for the years 01 and 02 determined according to the stage of completion (−) |
−11 |
The loss of CU 11 consists of the profit of CU 5 recognized in 01 (= CU 45 – CU 40) and of the loss of CU 16 that is recognized in 02 (= CU 54 – CU 70). The amount of CU 16 represents:
- a loss of CU 11 that has to be recognized in 02 according to the stage of completion, and in addition
- the reversal of the profit of CU 5 recognized in 01.
The total loss on the contract is CU 20 (= total contract revenue of CU 180 – total contract costs of CU 200). By Dec 31, 02, only a loss of CU 11 would be recognized according to the stage of completion. However, the standard requires the total loss on the contract to be recognized immediately as an expense (IAS 11.22 and 11.36). Hence, in 02 also the future loss on the contract of CU 9 [= CU 20 – CU 11 or CU 20 · (100% – 55%)] has to be recognized.
Gross amount due from the customer (IAS 11.43):
| Costs incurred in 01 and 02 |
110 |
| Total loss to be recognized in 01 and 02 (see above) |
−20 |
| Progress billing in 02 |
−80 |
| Gross amount due from the customer as at Dec 31, 02 |
10 |
| Gross amount due from the customer as at Dec 31, 01 |
45 |
| Reduction |
35 |
Years 03 and 04
Revenue to be recognized:
On Dec 31, 03, the stage of completion is 80% (= CU 160 : CU 200). Hence, cumulative contract revenue for the years 01–03 is CU 144 (= 80% · CU 180). Cumulative contract revenue for 01 and 02 is CU 99. This means that contract revenue of CU 45 has to be recognized in 03 (= CU 144 – CU 99) and contract revenue of CU 36 has to be recognized in 04 (= CU 180 – CU 144).
Reversing the future loss of CU 9 recognized as an expense in 02:
The total loss on the contract of CU 20 (which includes the loss of CU 9 attributable to the years 03 and 04) has already been recognized in 01 and 02. Consequently, no further loss is recognized in 03 and 04. However, in 03, recognition of the contract costs of CU 50 and of the contract revenue of CU 45 would result in the recognition of an additional loss of CU 5 [= (80% – 55%) · CU 20]. Similarly, in 04 recognition of the contract costs of CU 40 and of the contract revenue of CU 36 would result in the recognition of an additional loss of CU 4 [= (100% – 80%) · CU 20]. According to that procedure, the loss of CU 9 that has already been recognized as other expense in 02 would be recognized once again. In order to avoid this effect the amounts of CU 5 and CU 4 are recognized as other income in 03 and 04, respectively.
Gross amounts due from the customer (IAS 11.43):
| Costs incurred in the years 01–03 |
160 |
| Total loss recognized in the years 01–03 (see above) |
−20 |
| Progress billing in 02 |
−80 |
| Gross amount due from the customer as at Dec 31, 03 |
60 |
| Gross amount due from the customer as at Dec 31, 02 |
10 |
| Increase |
50 |
| Costs incurred in the years 01–04 |
200 |
| Total loss recognized in the years 01–04 (see above) |
−20 |
| Progress billing in 02 |
−80 |
| Gross amount due from the customer as at Dec 31, 04 |
100 |
| Gross amount due from the customer as at Dec 31, 03 |
60 |
| Increase |
40 |
The gross amount due from the customer as at Dec 31, 04 corresponds with the contract revenue which has not been billed until Dec 31, 04 (CU 180 less the billing in 02 of CU 80).
Example 3
Uncertainties about collectibility
Year 01
On Jan 01, 01, entity E concludes a fixed price contract. Under this contract, E constructs a special-purpose machine for customer C according to C's specifications. Total contract revenue is CU 39. The total contract costs of CU 30 will be incurred in thirds in each of the years 01–03. It is agreed that the billing for the whole price will be effected at the beginning of 04. When E prepares its financial statements as at Dec 31, 01, C has a high degree of creditworthiness.
Years 02 and 03
In 02, C's creditworthiness declines dramatically. At the end of Dec 02, E expects that it will not receive any part of the agreed price. Since E is entitled to stop performing the contract in such cases, construction of the machine is stopped. However, E negotiates with C about continuing construction because two thirds of the contract costs have already been incurred and there are no other customers who would need the machine.
Finally, it is agreed that construction will be continued. However, the price is reduced from CU 39 to CU 30. C provides a top bank guarantee for this payment. This agreement is achieved after E has authorized its financial statements as at Dec 31, 02 for issue.
Required
(a) Prepare any necessary entries in E's financial statements as at Dec 31 for the years 01–03. The stage of completion is determined according to the cost-to-cost method (IAS 11.30a). E prepares its separate income statement in accordance with the function of expense method (= cost of sales method).
(b) Presume alternatively to (a) that the agreement to continue construction is achieved before E's financial statements as at Dec 31, 02 are authorized for issue. Describe how the solution of (b) differs from the solution of (a).
(c) Presume alternatively to (a) that on May 01, 02 an amount of CU 13 is billed for work performed in 01, as stipulated. Due to the problems relating to C's creditworthiness, payment of this amount is deferred until the beginning of 04.
Hints for solution
In particular Sections 4.3, 4.5, 4.6, and 5.
Solution (a)
Year 01
On Dec 31, 01, it is probable that the economic benefits associated with the contract will flow to E (IAS 11.23b) because there are no uncertainties about collectibility. Consequently, all the criteria for the application of the PoC-method are met in this example (IAS 11.23). Consequently, revenue of CU 13 (= CU 39 · 1/3), costs of CU 10 (= CU 30 · 1/3), and a profit of CU 3 are recognized. The gross amount due from the customer is CU 13 (= costs incurred of CU 10 + recognized profit of CU 3) (IAS 11.43).
Year 02
E expects that it will not receive any part of the agreed price. Consequently, it is not probable any more that the economic benefits associated with the contract will flow to E, which means that the PoC-method cannot be applied (IAS 11.22–11.23). Hence, revenue is recognized only to the extent of contract costs incurred for which recovery is probable (IAS 11.32). Since no costs are expected to be recoverable, only the costs are recognized, but no revenue.
The amount of CU 13 already recognized as contract revenue in 01 for which recovery has ceased to be probable is recognized as an expense rather than as an adjustment of the amount of contract revenue (IAS 11.28):
In summary, in 02 a loss of CU 23 is recognized (= cost of sales of CU 10 + other expenses of CU 13). This means that in 02, also the profit of CU 3 (= CU 13 – CU 10) recognized in 01 is reversed.
Year 03
Due to the agreement to continue construction under which C provides the top bank guarantee, the outcome of the contract can be estimated reliably again meaning the PoC-method is applied (IAS 11.22–11.23).
Total contract revenue is CU 30. This means that in the years 01–03, revenue of CU 30 has to be recognized in total. Up to now, only revenue of CU 13 has been recognized (CU 13 in 01 and zero in 02). Hence, the remaining amount of CU 17 is recognized in 03:
Also, the effect of the other expenses of CU 13, recognized in 02, is reversed:
After these entries, the gross amount due from the customer is correctly CU 30:
| Costs incurred in the years 01–03 |
30 |
| Total loss/total profit |
0 |
| Gross amount due from the customer as at Dec 31, 03 |
30 |
Separate income statements
Solution (b)
In this case, it is presumed alternatively to (a) that the continuation of construction (including the provision of the top bank guarantee) is agreed before E's financial statements as at Dec 31, 02 are authorized for issue. Consequently, it has to be assessed whether this constitutes an adjusting or a non-adjusting event after the reporting period. Regarding the distinction it is crucial whether an event provides evidence of conditions that existed at the end of the reporting period or whether it is indicative of conditions that arose after the reporting period (IAS 10.3). The bank guarantee is obtained after Dec 31, 02. Thus, the receipt of the guarantee is a non-adjusting event. Consequently, the solutions of (a) and (b) are the same.
Solution (c)
Year 01
Year 02
As in version (a), in 02, only the costs are recognized but no revenue.
On May 01, 02, there is a progress billing in the amount of CU 13. Therefore, this amount does not represent a gross amount due from the customer, any more (IAS 11.43).
In contrast to gross amounts due from customers, receivables arising from progress billings are subject to the impairment rules of IAS 39 (IFRS 9.5.2.2):
Year 03
The impairment loss recognized in 02 relating to the receivable from the progress billing is reversed (IAS 39.65):
Example 4
Cost-to-cost method: specific topics
Entity E constructs both standard and customized solar panels. The latter are constructed specifically for a particular contract. The solar panels are used as part of the façade of buildings and are installed at the building site of the customer, ready-to-use.
In 01, E receives orders A and B (among others). Contract A requires customized solar panels, whereas standard solar panels are needed in respect of contract B. Both contracts are fixed price contracts with contract revenue of CU 1,100 and contract costs of CU 1,000 for each contract. In the case of both contracts, all of the solar panels have been delivered to the respective contract site by Dec 31, 01. However, only 20% of them have been installed by Dec 31, 01.
In the case of contract A (B), the costs of constructing the solar panels are CU 800 (CU 600) and the costs of the installation of the solar panels are CU 200 (CU 400).
The remaining solar panels are installed in 02. After the completion of both contracts in June 02, the billing is effected.
Posting status (contract A):
Posting status (contract B):
Required
Prepare any necessary entries in E's financial statements as at Dec 31 for the years 01 and 02. The stage of completion is determined according to the cost-to-cost method (IAS 11.30a). E prepares its separate income statement in accordance with the function of expense method (= cost of sales method).
Hints for solution
In particular Sections 4.3 and 4.6.
Solution – contract A
When determining the stage of completion, the costs of the customized solar panels are included in the costs incurred until the end of 01, irrespective of whether they have been installed. This is because these solar panels have been made by E specifically for the contract (IAS 11.31a).
| Costs of the construction of the solar panels |
800 |
| Costs of the installation of the solar panels (= 20% of CU 200) |
40 |
| Contract costs incurred until Dec 31, 01 |
840 |
| Total contract costs |
1,000 |
| Stage of completion |
84% |
| Total contract revenue |
1,100 |
| Contract revenue in 01 |
924 |
Solution – contract B
The standard solar panels constructed by E are only taken into account in determining the stage of completion to the point that they have already been installed (IAS 11.31a).
| Costs of the construction of the solar panels (= 20% of CU 600) |
120 |
| Costs of the installation of the solar panels (= 20% of CU 400) |
80 |
| Contract costs incurred until Dec 31, 01 |
200 |
| Total contract costs |
1,000 |
| Stage of completion |
20% |
| Total contract revenue |
1,100 |
| Contract revenue in 01 |
220 |
The standard solar panels that have been delivered to the contract site but have not yet been installed (80% of CU 600 = CU 480) are recognized as an asset (under the presumption that it is probable that they will be recovered) (IAS 11.27). The costs of the standard solar panels are included in determining the gross amount due from the customer (IAS 11.27 and 11.IE), but are presented as inventories and not as a receivable in E's statement of financial position. They are not included in determining the stage of completion. Since they are recognized as an asset, the costs of sales are reduced by the same amount:
Example 5
Output measures
(a) In 01, entity E agrees on a fixed price contract to program customized software. The contract defines 100 features of the software. By the end of 01, 80% of these features have been programmed. Thus, E intends to recognize 80% of the contract revenue in its separate income statement and only recognize the costs (primarily salaries for the year 01) actually incurred. Programming for the remaining 20% of the features will take approximately as many hours as were necessary for the 80% already completed. It is presumed that the same hourly rate applies to the employees involved in programming.
(b) In 01, entity F concludes a fixed price contract to construct 10 miles of a highway. For these 10 miles of the highway no bridges or tunnels are necessary. Consequently, the same costs will be incurred approximately for constructing each of the 10 miles. By the end of 01, three miles of the highway have been built.
(c) In 01, entity G closes a fixed price contract to build a railroad tunnel that will have a length of five miles. By the end of 01, two miles of the tunnel have been built. G wants to recognize contract revenue on the basis of a stage of completion of 40% in its separate income statement (= two miles : five miles). The first two miles represent the part of the tunnel for which the construction requires the lowest amount of time per mile.
Required
Assess whether determining the stage of completion by means of output measures is possible according to IAS 11 in the situations described above.
Hints for solution
In particular Section 4.3.
Solution
(a) IAS 11 does not apply to service contracts like the specifically negotiated programming of software. However, in this case, the same considerations apply according to IAS 18. It is not possible to use a stage of completion of 80% based on the output measure (features) because there is no approximate linear relation between the costs and the output measure. Instead, the stage of completion is 50%.
(b) Since there is an approximately linear relation between the costs and the output measure (miles), it is possible to use a stage of completion of 30% based on the output measure (= three miles : 10 miles).
(c) Since there is no approximately linear relation between costs and the output measure (miles) it is not possible to use a stage of completion of 40% based on the output measure (= two miles : five miles).
See KPMG, Insights into IFRS, 7th edition, 4.2.290.10.
IFRS 9 did not yet replace the impairment requirements of IAS 39. Consequently, the same procedure applies with regard to impairment losses and reversals of impairment losses whether or not IFRS 9 and its consequential amendments are applied early (IFRS 9.5.2.2).
For simplification purposes, the exact presentation requirements of IAS 1 are ignored in this example.
See the chapter on IAS 10.
IFRS 9 did not yet replace the impairment requirements of IAS 39. Consequently, the same procedure applies with regard to impairment losses and reversals of impairment losses whether or not IFRS 9 and its consequential amendments are applied early (IFRS 9.5.2.2).
See Lüdenbach, PiR 2005, p. 111–112 with regard to this example. PiR (= Praxis der internationalen Rechnungslegung) is a practice-oriented IFRS journal, which is published in the German language.
If E had purchased solar panels from a third party they would have to be treated in the same way irrespective of the degree of their standardization (IAS 11.31a).
