IAS 11

IAS 11: Construction Contracts

IAS 11, issued by the International Accounting Standards Board (IASB), outlines the accounting treatment for construction contracts. The objective of IAS 11 is to prescribe the accounting for revenue and costs associated with construction contracts. The standard defines a construction contract as 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.

Scope of IAS 11

IAS 11 applies to accounting for construction contracts in the financial statements of contractors. The standard does not apply to:

• Contracts for the supply of goods or services that are not directly related to the construction of an asset.
• Contracts for the routine sale of inventory.

Key Definitions

• Construction Contract: 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.
• Fixed Price Contract: 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.
• Cost Plus Contract: 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.
• Contract Revenue: Includes the initial amount of revenue agreed in the contract and variations in contract work, claims, and incentive payments to the extent that it is probable that they will result in revenue and they are capable of being reliably measured.
• Contract Costs: Include costs that relate directly to the specific contract, costs that are attributable to contract activity in general and can be allocated to the contract, and such other costs as are specifically chargeable to the customer under the terms of the contract.

Revenue and Cost Recognition

The crucial aspect of IAS 11 is the recognition of contract revenue and contract costs as revenue and expenses respectively, by reference to the stage of completion of the contract activity at the reporting date (often referred to as percentage of completion method), when the outcome of a construction contract can be estimated reliably.

If the outcome of a construction contract cannot be estimated reliably:

• Revenue should be recognized only to the extent of contract costs incurred that it is probable will be recoverable.
• Contract costs should be recognized as an expense in the period in which they are incurred.

Reliable Estimation of Outcome

The standard specifies conditions for when the outcome of a construction contract can be estimated reliably. For fixed price contracts, reliable estimation requires that all the following conditions are satisfied:

• Total contract revenue can be measured reliably.
• It is probable that economic benefits associated with the contract will flow to the entity.
• Both the contract costs to complete the contract and the stage of contract completion at the reporting date can be measured reliably.
• 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.

For cost plus contracts, reliable estimation requires that all the following conditions are satisfied:

• It is probable that economic benefits associated with the contract will flow to the entity.
• The contract costs attributable to the contract, whether or not specifically reimbursable, can be clearly identified and measured reliably.

Changes in Estimates

The effects of changes in estimates of contract revenue, contract costs, and the outcome of a construction contract are accounted for as changes in accounting estimates (see IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors). The revised estimates are used to determine the amount of revenue and expenses recognized in the statement of profit or loss in the period of the change and in future periods.

Disclosure Requirements

IAS 11 requires extensive disclosures, including:

• The amount of contract revenue recognised in the period.
• The methods used to determine the contract revenue recognised in the period.
• The methods used to determine the stage of completion of contracts in progress.
• For contracts in progress at the reporting date: the aggregate amount of costs incurred plus recognised profits (less recognised losses) to date; the amount of advances received; and the amount of retentions.

Superseded Standard

IAS 11 was superseded by IFRS 15, Revenue from Contracts with Customers, which provides a comprehensive framework for revenue recognition and applies to all contracts with customers except for those within the scope of other standards, such as leases and insurance contracts. IFRS 15 became effective for annual periods beginning on or after 1 January 2018.