IPSAS
11—CONSTRUCTION CONTRACTS
CONTENTS
Objective
Scope
Definitions
Construction
Contracts
Contractor
Combining and
Segmenting Construction Contracts
Contract Revenue
Contract Costs
Recognition of
Contract Revenue and Expenses
Recognition of
Expected Deficits
Changes in
Estimates
Disclosure
Effective
Date
Comparison
with IAS 11
IPSAS 11 CONSTRUCTION CONTRACTS
International
Public Sector Accounting Standard 11, Construction Contracts, is set out
in the objective and paragraphs 1-58. All the
paragraphs have equal authority. IPSAS 11 should be read in the context of its
objective and the Preface to International Public Sector Accounting
Standards. IPSAS 3, Accounting Policies, Changes in Accounting Estimates
and Errors provides a basis for selecting and applying accounting policies
in the absence of explicit guidance.
OBJECTIVE
The objective of
this Standard is to prescribe the accounting treatment of costs and revenue
associated with construction contracts. The Standard:
·
Identifies
the arrangements that are to be classified as construction contracts;
·
Provides
guidance on the types of construction contracts that can arise in the public
sector; and
·
Specifies
the basis for recognition and disclosure of contract expenses and, if relevant,
contract revenues.
Because of the
nature of the activity undertaken in construction contracts, the date at which
the contract activity is entered into and the date when the activity is
completed usually fall into different reporting periods.
In many jurisdictions,
construction contracts entered into by public sector entities will not specify
an amount of contract revenue. Rather, funding to support the construction
activity will be provided by an appropriation or similar allocation of general
government revenue, or by aid or grant funds. In these cases, the primary issue
in accounting for construction contracts is the (a) Allocation of construction
costs to the reporting period in which the construction work is performed, and
(b) The
recognition of related expenses.
In some
jurisdictions, construction contracts entered into by public sector entities
may be established on a commercial basis or a noncommercial full or partial
cost recovery basis. In these cases, the primary issue in accounting for
construction contracts is the allocation of both contract revenue and contract
costs to the reporting periods in which construction work is performed.
SCOPE
1. A contractor that prepares and presents
financial statements under the accrual basis of accounting shall apply this
Standard in accounting for construction contracts.
2. This Standard applies to all public sector
entities other than Government
Business Enterprises.
3. The Preface
to International Public Sector Accounting Standards issued by the IPSASB
explains that Government Business Enterprises (GBEs) apply IFRSs issued by the
IASB. GBEs are defined in IPSAS 1, Presentation of Financial Statements.
Definitions
4. The following terms are used in this Standard
with the meanings specified:
Construction contract is a contract, or a
similar binding arrangement, 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.
Contractor is an entity that performs construction work pursuant to a construction
contract.
Cost plus or
cost-based contract is a construction
contract in which the contractor is reimbursed for allowable or otherwise
defined costs and, in the case of a commercially based contract, an additional
percentage of these costs or a fixed fee, if any.
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.
Terms defined in other IPSASs are used in this Standard with the same
meaning as in those Standards, and are reproduced in the Glossary of
Defined Terms published separately.
CONSTRUCTION CONTRACTS
5. A construction
contract (the terms construction contract and contract are used interchangeably
in the remainder of this Standard) may be negotiated for the construction of a
single asset such as a bridge, building, dam, pipeline, road, ship, or tunnel.
A construction contract may also deal with 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 – examples of
such contracts include those for the construction of reticulated water supply
systems, refineries, and other complex infrastructure assets.
6. For the
purposes of this Standard, construction contracts include:
(a) Contracts
for the rendering of services that are directly related to the construction of
the asset, for example, those for the services of project managers and
architects; and
(b) Contracts
for the destruction or restoration of assets, and the restoration of the environment following
the demolition of assets.
7. For the
purposes of this Standard, construction contracts also include all arrangements
that are binding on the parties to the arrangement, but which may not take the
form of a documented contract. For example, two government departments may
enter into a formal arrangement for the construction of an asset, but the
arrangement may not constitute a legal contract because, in that jurisdiction,
individual departments may not be separate legal entities with the power to
contract. However, provided that the arrangement confers similar rights and
obligations on the parties to it as if it were in the form of a contract, it is
a construction contract for the purposes of this Standard. Such binding
arrangements could include (but are not limited to) a ministerial direction, a
cabinet decision, a legislative direction (such as an Act of Parliament), or a
memorandum of understanding.
8. Construction
contracts are formulated in a number of ways that, for the purposes of this
Standard, are classified as fixed price contracts and cost plus or cost-based
contracts. Some commercial construction contracts may contain characteristics
of both a fixed price contract and a cost plus or cost based contract, for
example in the case of a cost plus or cost-based contract with an agreed
maximum price. In such circumstances, a contractor needs to consider all the
conditions in paragraphs 31 and 32 in order to determine when to recognize
contract revenue and expenses.
9. Cost plus and
cost-based contracts encompass both commercial and non commercial contracts. A
commercial contract will specify that revenue to cover the agreed constructor’s
construction costs and generate a profit margin will be provided by the other
parties to the contract. However, a public sector entity may also enter into a
noncommercial contract to construct an asset for another entity in return for
full or partial reimbursement of costs from that entity or other parties. In
some cases, the cost recovery may encompass payments by the recipient entity
and specific purpose construction grants or funding from other parties.
10. In many
jurisdictions, where one public sector entity constructs assets for another
public sector entity, the cost of construction activity is not recovered
directly from the recipient. Rather, the construction activity is funded
indirectly (a) by way of a general appropriation or other allocation of general
government funds to the contractor, or (b) from general purpose grants from
third party funding agencies or other governments. These are classified as
fixed price contracts for the purpose of this Standard.
CONTRACTOR
11. A contractor
is an entity that enters into a contract to build structures, construct
facilities, produce goods, or render services to the specifications of another
entity. The term “contractor” includes a general or prime contractor, a
subcontractor to a general contractor, or a construction manager.
COMBINING AND SEGMENTING CONSTRUCTION CONTRACTS
12. The
requirements of this Standard are usually applied separately to each construction
contract. However, in certain circumstances, it is necessary to apply the
Standard to the separately identifiable components of a single contract, or to
a group of contracts together, in order to reflect the substance of a contract
or a group of contracts.
13. When a contract covers a number of assets,
the construction of each asset shall be treated as a separate construction
contract when:
(a)
Separate
proposals have been submitted for each asset;
(b) Each asset has been subject to separate
negotiation, and the contractor and customer have been able to accept or reject
that part of the contract relating to each asset; and
(c)
The
costs and revenues of each asset can be identified.
14. A group of contracts, whether with a single
customer or with several customers, shall be treated as a single construction
contract when:
(a)
The
group of contracts is negotiated as a single package;
(b) The
contracts are so closely interrelated that they are, in effect, part of a single project with an overall margin,
if any; and
(c) The contracts are performed concurrently or
in a continuous sequence.
15. A contract may provide for the construction
of an additional asset at the option of the customer, or may be amended to
include the construction of an additional asset. The construction of the
additional asset shall be treated as a separate construction contract when:
(a) The asset differs significantly in design,
technology, or function from the asset or assets covered by the original contract;
or
(b) The price of the asset is negotiated without
regard to the original contract price.
CONTRACT REVENUE
16. Contract revenue shall comprise:
(a) The initial amount of revenue agreed in the
contract; and
(b) Variations in contract work, claims, and
incentive payments to the extent that:
(i) It is probable that they will result in
revenue; and
(ii) They are capable of being reliably measured.
17. Contract
revenue is measured at the fair value of the consideration received or
receivable. Both the initial and ongoing measurement of contract revenue are
affected by a variety of uncertainties that depend on the outcome of future
events. The estimates often need to be revised as events occur and
uncertainties are resolved. Where a contract is a cost plus or cost-based contract,
the initial amount of revenue may not be stated in the contract.
Instead, it may
need to be estimated on a basis consistent with the terms and provisions of the
contract, such as by reference to expected costs over the life of the contract.
18. In addition,
the amount of contract revenue may increase or decrease from one period to the
next. For example:
(a) A contractor
and a customer may agree to variations or claims that increase or decrease
contract revenue in a period subsequent to that in which the contract was
initially agreed;
(b) The amount
of revenue agreed in a fixed price, cost plus, or cost based contract may
increase as a result of cost escalation or other clauses;
(c) The amount
of contract revenue may decrease as a result of penalties arising from delays
caused by the contractor in the completion of the contract; or
(d) When a fixed
price contract involves a fixed price per unit of output, contract revenue
increases or decreases as the number of units is increased or decreased.
19. A variation
is an instruction by the customer for a change in the scope of the work to be
performed under the contract. A variation may lead to an increase or a decrease
in contract revenue. Examples of variations are changes in the specifications
or design of the asset, and changes in the duration of the contract. A
variation is included in contract revenue when:
(a) It is
probable that the customer will approve the variation and the amount of revenue
arising from the variation; and
(b) The amount
of revenue can be reliably measured.
20. A claim is
an amount that the contractor seeks to collect from the customer or another
party as reimbursement for costs not included in the contract price. A claim
may arise from, for example, customer-caused delays, errors in specifications
or design, and disputed variations in contract work. The measurement of the
amounts of revenue arising from claims is subject to a high level of
uncertainty, and often depends on the outcome of negotiations.
Therefore,
claims are only included in contract revenue when:
(a) Negotiations
have reached an advanced stage, such that it is probable that the customer will
accept the claim; and
(b) The amount
that it is probable will be accepted by the customer can be measured reliably.
21. Incentive payments are additional amounts paid to the contractor if specified
performance standards are met or exceeded. For example, a contract may allow
for an incentive payment to the contractor for early completion of the contract.
Incentive payments are included in contract revenue when:
(a) The contract
is sufficiently advanced that it is probable that the specified performance
standards will be met or exceeded; and
(b) The amount
of the incentive payment can be measured reliably.
22. Contractors
should review all amounts relating to the construction contract that are paid
directly to subcontractors by third party funding agencies, to determine
whether they meet the definition of, and recognition criteria for, revenue of
the contractor under the terms of the contract. Amounts meeting the definition
and recognition criteria for revenue should be accounted for by the contractor
in the same way as other contract revenue. Such amounts should also be
recognized as contract costs (see paragraph 25). Funding agencies may include
national and international aid agencies and multilateral and bilateral
development banks.
CONTRACT COSTS
23. Contract costs shall comprise:
(a) Costs
that relate directly to the specific contract;
(b) Costs that are attributable to contract activity in general, and can be allocated to the contract on a
systematic and rational basis; and
(c) Such other costs as are specifically chargeable to the customer under the
terms of the contract.
24. Costs that
relate directly to a specific contract include:
(a) Site labor costs, including site
supervision;
(b) Costs of materials used in
construction;
(c) Depreciation of plant and equipment
used on the contract;
(d)Costs of moving plant, equipment, and
materials to and from the contract
site;
(e) Costs of hiring plant and equipment;
(f) Costs of
design and technical assistance that are directly related to the contract;
(g) The estimated costs of rectification
and guarantee work, including expected warranty costs; and
(h) Claims from third parties.
These
costs may be reduced by any incidental revenue that is not included in contract
revenue, for example, revenue from the sale of surplus materials at the end of
the contract.
25.
Contractors should review all amounts relating to the construction contract paid
directly by subcontractors and which are reimbursed by third party funding
agencies, to determine whether they qualify as contract costs.
Amounts
meeting the definition of, and recognition criteria for, contract expenses
should be accounted for by the contractor in the same way as other contract
expenses. Amounts reimbursed by third party funding agencies that meet the
definition of, and recognition criteria for, revenue should be accounted for by
the contractor in the same way as other contract revenue (see paragraph 22).
26.
Costs that may be attributable to contract activity in general and can be allocated
to specific contracts include:
(a)
Insurance;
(b)
Costs of design that are not directly related to a specific contract; and
(c)
Construction overheads.
Such
costs are allocated using methods that (a) are systematic and rational, and (b)
are applied consistently to all costs having similar characteristics.
The
allocation is based on the normal level of construction activity. Construction
overheads include costs such as the preparation and processing of construction
personnel payroll. Costs that may be attributable to contract activity in
general and can be allocated to specific contracts also include borrowing costs
when the contractor adopts the allowed alternative treatment in IPSAS 5, Borrowing
Costs.
27.
Costs that are specifically chargeable to the customer under the terms of the contract
may include some general administration costs and development costs for which
reimbursement is specified in the terms of the contract.
28.
Costs that cannot be attributed to contract activity or cannot be allocated to a
contract are excluded from the costs of a construction contract. Such costs include:
(a)
General administration costs for which reimbursement is not specified in the
contract;
(b)
Selling costs;
(c)
Research and development costs for which reimbursement is not specified in the
contract; and
(d)
Depreciation of idle plant and equipment that is not used on a particular
contract.
29.
Contract costs include the costs attributable to a contract for the period from
the date of securing the contract to the final completion of the contract.
However,
costs that relate directly to a contract and that are incurred in securing the
contract are also included as part of the 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, they are not included in
contract costs when the contract is obtained in a subsequent period.
RECOGNITION OF CONTRACT REVENUE AND
EXPENSES
30. 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 reference to the stage of completion of the contract activity
at the reporting date. An expected deficit on a construction contract to which paragraph
44 applies shall be recognized as an expense immediately in accordance with
paragraph 44.
31. In the case of a fixed price contract, the
outcome of a construction contract can be estimated reliably when all the
following conditions are satisfied:
(a) Total contract revenue, if any, can be
measured reliably;
(b) It is probable that the economic benefits or
service potential 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 reporting date 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.
32. In the case of a cost plus or cost-based
contract, the outcome of a construction contract can be estimated reliably when
all the following conditions are satisfied:
(a) It is probable that the economic benefits or
service potential associated with the contract will flow to the entity; and
(b) The contract costs attributable to the
contract, whether or not specifically reimbursable, can be clearly identified
and measured reliably.
33.
The recognition of revenue and expenses by reference to the stage of completion
of a contract is often referred to as the percentage of completion method.
Under this method, contract revenue is matched with the contract costs incurred
in reaching the stage of completion, resulting in the reporting of revenue,
expenses, and surplus/deficit that can be attributed to the proportion of work
completed. This method provides useful information on the extent of contract
activity and performance during a period.
34.
Under the percentage of completion method, contract revenue is recognized as
revenue in the statement of financial performance in the reporting periods in
which the work is performed. Contract costs are usually recognized as an
expense in the statement of financial performance in the reporting periods in
which the work to which they relate is performed.
However,
where it is intended at inception of the contract that contract costs are to be
fully recovered from the parties to the construction contract, any expected
excess of total contract costs over total contract revenue for the contract is
recognized as an expense immediately in accordance with paragraph 44.
35.
A contractor may have incurred contract costs that relate to future activity on
the contract. Such contract costs are recognized as an asset provided it is probable
that they will be recovered. Such costs represent an amount due from the
customer and are often classified as contract work in progress.
36.
The outcome of a construction contract can only be estimated reliably when it
is probable that the economic benefits or service potential associated with the
contract will flow to the entity. However, when an uncertainty arises about the
collectability of an amount already included in contract revenue, and already
recognized in the statement of financial performance, the uncollectable amount
or the amount in respect of which recovery has ceased to be probable is
recognized as an expense rather than as an adjustment of the amount of contract
revenue.
37.
An entity is generally able to make reliable estimates after it has agreed to a
contract that establishes:
(a)
Each party’s enforceable rights regarding the asset to be constructed;
(b)
The consideration, if any, to be exchanged; and
(c)
The manner and terms of settlement.
It
is also usually necessary for the entity to have an effective internal financial
budgeting and reporting system. The entity reviews and, when necessary, revises
the estimates of contract revenue and contract costs as the contract
progresses. The need for such revisions does not necessarily indicate that the
outcome of the contract cannot be estimated reliably.
38.
The stage of completion of a contract may be determined in a variety of ways.
The entity uses the method that measures reliably the work performed. Depending
on the nature of the contract, the methods may include:
(a)
The proportion that contract costs incurred for work performed to date bear to
the estimated total contract costs;
(b)
Surveys of work performed; or
(c)
Completion of a physical proportion of the contract work.
Progress
payments and advances received from customers often do not reflect the work
performed.
39.
When the stage of completion is determined by reference to the contract costs
incurred to date, only those contract costs that reflect work performed are
included in costs incurred to date. Examples of contract costs that are excluded
are:
(a)
Contract costs that relate to future activity on the contract, such as costs of
materials that have been delivered to a contract site or set aside for use in a
contract, but not yet installed, used, or applied during contract performance,
unless the materials have been made especially for the contract; and
(b)
Payments made to subcontractors in advance of work to be performed under the
subcontract.
40. When the outcome of a construction contract
cannot be estimated reliably:
(a) Revenue shall be recognized only to the
extent of contract costs incurred that it is probable will be recoverable; and
(b) Contract costs shall be recognized as an
expense in the period in which they are incurred.
An expected deficit on a construction contract to
which paragraph 44 applies shall be recognized as an expense immediately in
accordance with paragraph 44.
41.
During the early stages of a contract, it is often the case that the outcome of
the contract cannot be estimated reliably. Nevertheless, it may be probable that
the entity will recover the contract costs incurred. Therefore, contract revenue
is recognized only to the extent of costs incurred that are expected to be
recoverable. As the outcome of the contract cannot be estimated reliably, no
surplus or deficit is recognized. However, even though the outcome of the
contract cannot be estimated reliably, it may be probable that total contract
costs will exceed total contract revenues. In such cases, any expected excess
of total contract costs over total contract revenues for the
contract is recognized as an expense immediately in accordance with paragraph
44.
42.
Where contract costs that are to be reimbursed by parties to the contract are not
probable of being recovered, they are recognized as an expense immediately.
Examples of circumstances in which the recoverability of contract costs
incurred may not be probable, and in which contract costs may need to be
recognized as an expense immediately, include contracts:
(a)
That are not fully enforceable, that is, their validity is seriously in question;
(b)
The completion of which is subject to the outcome of pending litigation or
legislation;
(c)
Relating to properties that are likely to be condemned or expropriated;
(d)
Where the customer is unable to meet its obligations; or
(e)
Where the contractor is unable to complete the contract or otherwise meet its
obligations under the contract.
43. When the uncertainties that prevented the
outcome of the contract being estimated reliably no longer exist, revenue and
expenses associated with the construction contract shall be recognized in accordance
with paragraph 30 rather than in accordance with paragraph 40.
RECOGNITION OF EXPECTED DEFICITS
44. In respect of construction contracts in which
it is intended at inception of the contract that contract costs are to be fully
recovered from the parties to the construction contract, when it is probable
that total contract costs will exceed total contract revenue, the expected
deficit shall be recognized as an expense immediately.
45.
Public sector entities may enter into construction contracts that specify that the
revenue intended to cover the construction costs will be provided by the other
parties to the contract. This may occur where, for example:
(a)
Government departments and agencies that are largely dependent on appropriations
or similar allocations of government revenue to fund their operations are also
empowered to contract with GBE’s or private sector entities for the
construction of assets on a commercial or full cost recovery basis; or
(b)
Government departments and agencies transact with each other on an arm’s length
or commercial basis as may occur under a “purchaser-provider” or similar model
of government. In these cases, an expected deficit on a construction contract
is recognized immediately in accordance with paragraph 44.
46.
As noted in paragraph 9, in some cases a public sector entity may enter into a
construction contract for less than full cost recovery from the other parties to
the contract. In these cases, funding in excess of that specified in the construction
contract will be provided from an appropriation or other allocation of
government funds to the contractor, or from general purpose grants from third
party funding agencies or other governments. The requirements of paragraph 44
do not apply to these construction contracts.
47.
In determining the amount of any deficit under paragraph 44, total contract revenue
and total contract costs may include payments made directly to subcontractors
by third party funding agencies in accordance with paragraphs 22 and 25.
48.
The amount of such a deficit is determined irrespective of:
(a)
Whether or not work has commenced on the contract;
(b)
The stage of completion of contract activity; or
(c)
The amount of surpluses expected to arise on other commercial construction
contracts that are not treated as a single construction contract in accordance
with paragraph 14.
CHANGES IN ESTIMATES
49.
The percentage of completion method is applied on a cumulative basis in each
reporting period to the current estimates of contract revenue and contract
costs. Therefore, the effect of a change in the estimate of contract revenue or
contract costs, or the effect of a change in the estimate of the outcome of a
contract, is accounted for as a change in accounting estimate (see IPSAS 3, Accounting
Policies, Changes in Accounting Estimates and Errors.) The changed
estimates are used in the determination of the amount of revenue and expenses
recognized in the statement of financial performance in the period in which the
change is made and in subsequent periods.
DISCLOSURE
50. An entity shall disclose:
(a) The amount of contract revenue recognized as
revenue in the period;
(b) The methods used to determine the contract
revenue recognized in the period; and
(c) The methods used to determine the stage of
completion of contracts in progress. SECTOR
51. An entity shall disclose each of the
following for contracts in progress at the reporting date:
(a) The aggregate amount of costs incurred and
recognized surpluses (less recognized deficits) to date;
(b) The amount of advances received; and
(c) The amount of retentions.
52.
Retentions are amounts of progress billings that are not paid until the satisfaction
of conditions specified in the contract for the payment of such amounts, or
until defects have been rectified. Progress billings are amounts of contract
revenue billed for work performed on a contract, whether or not they have been
paid by the customer. Advances are amounts of contract revenue received by the
contractor before the related work is performed.
53. An entity shall present:
(a) The gross amount due from customers for
contract work as an asset; and
(b) The gross amount due to customers for
contract work as a liability.
54.
The gross amount due from customers for contract work is the net amount of:
(a)
Costs incurred plus recognized surpluses; less
(b)
The sum of recognized deficits and progress billings for all contracts in
progress for which costs incurred plus recognized surpluses to be recovered by
way of contract revenue (less recognized deficits) exceed progress billings.
55.
The gross amount due to customers for contract work is the net amount of:
(a)
Costs incurred plus recognized surpluses; less
(b)
The sum of recognized deficits and progress billings for all contracts in
progress for which progress billings exceed costs incurred plus recognized
surpluses to be recovered by way of contract revenue (less recognized
deficits).
56.
Guidance on the disclosure of contingent liabilities and contingent assets can
be found in IPSAS 19, Provisions, Contingent Liabilities and Contingent
Assets. Contingent liabilities and contingent assets may arise from such
items as warranty costs, claims, penalties, or possible losses.
EFFECTIVE DATE
57. An entity shall apply this Standard for
annual financial statements covering periods beginning on or after July 1,
2002. Earlier application is encouraged. If an entity applies this Standard for
a period beginning before July 1, 2002, it shall disclose that fact.
58.
When an entity adopts the accrual basis of accounting as defined by IPSASs for
financial reporting purposes subsequent to this effective date, this
Standard
applies to the entity’s annual financial statements covering periods beginning
on or after the date of adoption.
COMPARISON WITH IAS 11
IPSAS 11, Construction
Contracts is drawn primarily from IAS 11, Construction Contracts.
The main differences between IPSAS 11 and IAS 11 are as follows:
·
Commentary
additional to that in IAS 11 has been included in IPSAS 11 to clarify the
applicability of the standards to accounting by public sector entities.
·
IPSAS
11 uses different terminology, in certain instances, from IAS 11. The most
significant examples are the use of the terms “revenue,” and “statement of
financial performance” in IPSAS 11. The equivalent terms in IAS 11 are “income,”
and “income statement.”
·
IPSAS
11 includes binding arrangements that do not take the form of a legal on tract
within the scope of the Standard.
·
IPSAS
11 includes cost-based and noncommercial contracts within the scope of the
Standard.
·
IPSAS
11 makes it clear that the requirement to recognize an expected deficit on a
contract immediately it becomes probable that contract costs will exceed total
contract revenues applies only to contracts in which it is intended at
inception of the contract that contract costs are to be fully recovered from
the parties to that contract.
·
IPSAS
11 includes additional examples to illustrate the application of the Standard
to noncommercial construction contracts.