IAS 11 construction contract
1,When you’re trying to build this tower it may take you more than 1 year to finish. After finishing off this tower and you may try to sell off to the client.
So before finishing off this tower will you keep it as a inventory?(IAS2)
The answer is no! Remember inventory is current asset which is less than 1 accounting year.
2,Next question is because the contractor is building this tower so he may have to pay for material, labor costs etc. So when is the cost being recognized?
The contractor can get the sales revenue only when after selling off this tower to client. So before selling off this tower, the contractor gets no cash from the client. So does the contractor recognize no revenue at all?
To answer this question:
According to Prudence concept, the sales revenue should be recognized after this tower has been sold off to the client.
According to Accruals concept, the expenses relating to the building of the tower should be matched with the revenue from the tower.
So one is contradict with another. But here in this case, Accruals concept wins.
3,But how much does the revenue and expenses should be recognized?
IAS 11 Construction Contract gives us the guidance.
Guidance by IAS 11 construction contract (Diagram)
5, Stage of completion
Sales basis method (work certified method):
work certified to date
costs incurred to date
total contract costs