1. Submitted By :- Dushyant Chaturvedi

2. Flow Of Information I. Purpose of Introduction of Standard. II. Applicability of Standard III. Combining and Segmenting of Contracts IV. Major Definitions V. Recognition of Revenue and Costs VI. Disclosure Requirements VII. Detailed Example of one Contract for three years covering each area of Standard

3. Purpose of Introduction of Standard. Construction Contracts are generally long term in nature and the activity usually falls into different accounting periods. Thus the date on which the contract is entered and the date when the activity is completed fall into different accounting periods. Therefore an approach, different from as earned approach as prescribed in IAS 18 for revenue recognition, was required to account for long term construction contracts. Thus the primary purpose of introduction of IAS 11 is To Prescribe the Accounting Treatment of Revenue & Cost Associated with Construction Contracts. and To provide practical guidance on the application of above mentioned criteria.

4. Does that mean a contract shall last for more than One Accounting Period ? No e.g. A company completes a material short term contract just after the year end, but a substantial part of the work is completed before the year end. In such a case IAS-11 shall apply because if revenue & cost is not attributed to the current period, this might not give a fair picture of its results & financial position. e.g. Whether IAS 11 would apply to short term contracts, which do not take 3 months to complete? Assuming that these contracts complete in same accounting period, allocation of contract revenue & cost to different accounting period does not arise. However, disclosure requirement of IAS 11 would nevertheless apply to such standards. CONCLUSION If a short term contract straddle an accounting period - then both accounting & disclosure requirement IAS 11 applies. If it doesn't - only disclosure requirement of IAS 11 applies. THUS IAS 11 APPLIES TO CONSTROCTION CONTRACTS IRRESPECTIVE OF THE TIME OF EXECUTION OF THE CONTRACT.

5. Applicability of the Standard Applied in accounting for construction contracts in the financial statements of contractors. Where a Construction Contract i s a contract specifically negotiated for the construction of an asset or combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use. and includes: 1) Contract for rendering of services which are directly related to the construction of asset(e.g. Architect ). 2) Contract for destruction or restoration of assets, and the restoration of environment following the demolition if asset.

6. Further Analysis Of Applicability Thus IAS 11 applies in case of Construction of asset and not Manufacturing. Manufacturing is a process dominated approach where manufacturer tends to make same product over and over. Whereas construction implies a project dominated approach, where constructor makes a unique product one at a time. Thus if a company constructs a piece of equipment for : A third party in accordance with the specific needs of a customer - IAS 11 applies Future sale - IAS 2 applies Own use- IAS 16 applies Standard gives example of construction contracts such as a bridge, a building, a dam, a road, a ship, a tunnel etc.

7. Further Analysis Of Applicability Also a construction contract may be for a number of asset that are closely related or interdependent. For e.g. Construction of a Refinery would entail construction of various types of complex equipments and machineries. But the ultimate use of construction of all such individual assets is to assist the process of refining. Hence these could be said to be closely interrelated and interdependent. Contracts for rendering of indirect service would not attract the applicability of IAS11. For e.g.Providing of strategic consulting service to an enterprise would not attract applicability of IAS 11. Whereas those for the service of project manager can be directly related to the construction of asset and hence accounted for in accordance with IAS 11.

8. Combining & Segmenting A contract is generally negotiated as one package deal and therefore the margin on the contract as a whole is considered to be the margin of its individual components too. Thus usually IAS 11 applies to each construction contract separately. However,in certain circumstances, it is necessary to apply IAS 11 to Separate identifiable components of a single contract Or to a group of contracts together In order to reflect the substance of contract or a group of contracts And hence the need for combining and segmenting.

9. Combining & Segmenting Contd…. Segmenting If a single contract covers no. of assets, each asset should be treated as separate construction contract if -SEPARATE PROPOSAL has been submitted for each asset; And -Each contract is subject to SEPARATE NEGOTIATION**; And -Cost / Revenue of each asset can be IDENTIFIED. **If neither the contractor nor the customer has the power to accept or reject a part of contract - then the contract cannot be said to subject to separate negotiation. Combining Group of contract to be treated as a single construction contract when - Group of contracts is NEGOTIATED as a SINGLE package And -The contracts are closely INTERRELATED. And -Contracts are performed CONCURRENTLY or CONTINUOUSLY. Combining / Segmenting are not optional but depends upon the criteria discussed above.

10. Illustration (Combining & Segmenting) Suppose a company has invited tenders for construction of a factory and a township that includes a residential complex, school, garden, hospital, club, sewage system etc. The tender offer requires estimates to be made and disclosed in the tender for each of these components separately. However the contract will be awarded lump-sum. Following are the noteworthy points in this contract: 1).The group of contracts in this case is negotiated as a single package; And 2).The group of contract are closely interrelated, in effect, part of a single project with an overall profit margin; And 3).The factory & township will be constructed simultaneously and will be completed almost at the same time. Since all these conditions are fulfilled, this becomes a perfect example of Combining of Construction Contracts. In the above case construction of each asset cannot be treated as separate construction contracts because: Neither a separate proposal for each asset was submitted. Nor they has been subject to separate negotiation.

11. Combining & Segmenting Contd…. When a single contract covers several elements of a transaction- they are needed to be unbundled and accounted for separately. But unbundling could be done only if:- 1).These several components are sold separately in ordinary course of business of the entity. (+) 2).Fair value of each component could be objectively determined. For e.g. Under a single contract an entity may supply customised computer system and also provides maintenance services for period after the system has been delivered. In such a situation it may be necessary to unbundle the element of the contract relating to the supply of the system from the element relating to the maintenance service. Presuming that the above mentioned conditions have been duly fulfilled. Here, construction of customized computer system shall be accounted for as construction contract under IAS 11 & the maintenance services will be recognised as per IAS 18.

12. Major Definitions Contract Revenue Initial amount + Variations + Claims + Incentives As agreed by customer and Due to instructions of Reimbursement for cost Additional amount contractor customer for change in not included in contract payable for meeting scope of work price the standards

13. Major Definitions Contd….. Contract Revenue – is measured at the fair value** of the consideration received or receivable. The measurement of contract revenue is affected by variety of uncertainties that depend on outcome of future events. Therefore the estimates often need to be revised when these uncertainties are resolved. ** Since the IAS follows the fair value concept, then where the payment is received in arrears to such an extent that the fair value of the consideration is less than the nominal amount of cash received or receivable Than it would be necessary to discount the revenue to fair value. Such discount shall be credited to Finance Income.

14. Major Definitions Contd…. Contract Cost Directly Related + Attributable Cost + Specifically Chargeable e.g. Labour cost, Supervision, e.g. Insurance, Construction Overhead, e.g. Any Reimbursement Specified in Depreciation, Warranty etc. Borrowing cost as per IAS-23the Contract.

15. Major Definitions Contd…. Cost of Securing a Contract. Cost incurred for preparing/presenting the bid including external consultancy fees etc. Included as a Part of Contract Cost If Such Cost – Is Separately Identifiable. Could be Measured Reliably & it is Probable that the Contract will be Obtained. Therefore significant costs are treated as recoverable once the management consider that it is probable that the contract will be won. This is generally presumed to be when preferred bidder status is awarded. Generally if a contract is won before the date of signing of balance sheet than all costs related to securing such contract can be included as a part of contract cost. But where costs of obtaining the contract have been written off in a period prior to that in which contract is obtained than such cost is not capable of any reversal in the subsequent period.

16. Major Definitions Contd…. Contract Cost shall be Reduced by Incidental Income that is Not Included in Contract Revenue. For e.g. A construction contract for land reclamation involves clearing old collieries. As a by-product the company is entitled to sell of any coal that it recovers. Here incidental income from coal shall be reduced from the contract cost. As per IAS-2 Valuation of Inventories - If cost of main & by-product are not separately identifiable, the allocation of the cost may be based on the value of relative sales. -But most of the by-products are immaterial. Hence they are measured at NRV & their value is reduced from the cost of the main product. As a result carrying amount of main product is not materially different from its cost.

17. Major Definitions contd…. Following shall be Excluded from Cost of Construction:- 1) General Admin Cost for which reimbursement is not specified in the contract. 2) Selling Costs. 3) R&D Cost for which reimbursement is not specified in the contract. 4) Depreciation of Idle Plant & Equipment. Period for which Cost is Recognised :- 01.01.2006 01.04.2006 31.03.200706.11.200731.03.2008 Date of Securing the Contract Date of Reporting Date of completion Date of Reporting Cost Incurred in This Period Shall be Recognised as Contract Cost. * Cost incurred to secure the contract, if separately identified and reliable measured can form part of contract cost.

18. Recognition of Contract Revenue and Contract Costs Conditions for Recognition of contract cost and revenue. Fixed Price Contracts Contract revenue can be reliably measured + It is probable that economic benefit flow to the enterprise + Contract cost and stage of completion at B/S date can be reliable measured + actual cost can be identified and compared with prior estimates. Cost Plus Contracts It is probable that economic benefit will flow to enterprise + contract cost can be clearly identified and reliably measured.

19. Recognition of Contract Revenue and Contract Costs Conditions satisfied? Yes - Then final outcome of a contract can be reliably estimated. Recognize revenue/cost with respect to stage of completion* No Revenue equal to Recoverable Cost incurred will be recognized. Contract cost will be recognised in the period they are incurred.* * If it is probable that contract cost will exceed contract revenue – Expected losses will be recognised immediately.

20. Recognition of Contract Revenue and Contract Costs It is usually assumed that during the early stages of the contract the outcome of contract cannot be reliably estimated. These early stages could range between 20-25% of the contract revenue. But these limits are subjective and to an extent a judgment have to be made. Contractor with a high degree of experience may ignore these thresholds.

21. Recognition of Contract Revenue and Contract Costs Variation, Claims, Incentives to be recognised :- -to the extent that it is probable that they will result in revenue. & -they are capable of being reliably measured. Other Conditions to be Satisfied For recognising the claims negotiations shall reach an advanced stage. For recognising incentives contract should be sufficiently advanced that it is probable that the specified performance standards will be met or exceeded.

22. Recognition of Contract Revenue and Contract Costs Conditions for Including Cost of Variation in Contract Cost? Where it is appropriate to include the amount in contract revenue To the extent such cost are considered to be recoverable. A degree of skepticism should be used in assessing the recoverability of such amount.

23. An Extract from Annual Report and Account of Aker ASA (31 December,2005) Revenue related to construction contracts is recognised using the percentage of completion method, based primarily on contract cost incurred to date, compared to estimated overall contract cost. If the final outcome of a contract cannot be estimated reliably, contract revenue is recognised only to extent cost incurred are expected to be recovered. Any projected losses on future work done under existing contracts are expensed and classified as accrued costs/provision in the B/S under short term debt. Losses on contracts are recognised in full when identified. Recognised contract profit includes profit derived from change orders and disputed amounts when, in managements assessment, realisation is probable and reasonable estimate can be made.

24. Some Concepts Methods used for Measuring the Stage of Completion Proportionate Cost Incurred Survey of Work Performed Completion of Physical Proportion of Contract Work Concepts of CWIP Contract Cost that Relates to Future Activity Recognised as an Asset (since such Amount is Due from the Customer) Uncollectable Amount Sometimes Uncertainty Arises about the Recovery of an Amount Will be Recognised as an Expense (not as an adjustment to cost revenue) Costs to be Excluded Cost Relating to Future Activity Advance Payment to Sub Contractors Contract Costs – Recovery of Which is Not Probable will be Recognised as an Expenses Immediately Contracts Which are Not Fully Enforceable Subject to Litigation Properties Likely to be Condemned or Expropriated.

25. Disclosures The Amount of Contract Revenue Recognised. Method Used to Determine the Contract Revenue and Stage of Completion. For Contract in Progress it should also Disclose: Costs Incurred and Recognised Profits upto the reporting date. Amount of Advance Received. Amount of Retentions. Gross Amount Due to the customer. Gross Amount Due from the customer.

26. ILLUSTRATION YEAR I YEAR I I YEAR I I I Initial amount of revenue agreed in contract 9000 Variation -200 Total Contract Revenue 90009200 Contract Costs incurred upto the reporting date 209861688200 Contract costs to complete 595720320 Total Estimated costs 80508200

27. Illustration cont …….. YEAR I YEAR I I YEAR I I I Estimated Profit 9501000 Stage of Completion 26%74%100%

28. Illustration cont ………… Upto Reporting date Recognised in prior year Recognised in current year Year I Revenue (9000 x 0.26) 2340 Expenses (8050 x 0.26) 2093 Profit247

29. Illustration cont ………… Upto Reporting date Recognised in prior year Recognised in current year Year II Revenue (9200 x 0.74) 680823404468 Expenses (8200 x 0.74) 606820933975 Profit740247493

30. Illustration cont… Upto Reporting date Recognised in prior year Recognised in current year Year III Revenue (9200 x 1.00) 920068082392 Expenses (8200 x 1.00) 820060682132 Profit1000740260

31. ILLUSTRATION - DISCLOSURE WORKING ABCDETOTAL A. Contract Revenue recognised 145520380200551300 B. Contract Expenses recognized 110450350250551215 C. Expected Losses recognized 403070 D. Recognized Profits less losses 357030(90)(30)15 E. Contract Costs incurred in the period 1105104502501001420 F. Contract Costs incurred recognized as contract expense in the period 110450350250551215

32. ILLUSTRATION - DISCLOSURE WORKING ABCDETOTAL G. Contract Costs that relate to future activity 6010045205 H. Contract Revenue 145520380200551300 I. Progress Billing 100520380180551235 J. Unbilled Contract Revenue 45--20-65 K. Advances -8020-25125

33. Thank You