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2. Costs that are attributable to contract activity in general and can be allocated to contracts.
3. Such other costs as are specifically chargeable under the terms of the contract.
Common examples of costs that are considered related directly to specific contracts are
• Site labor costs, including site supervisions
• Materials used in construction
• Depreciation of machinery, plant, and equipment used in construction
• Cost of hiring plant (if not owned by the contractor)
• Cost of moving plant to and from contract site
• Design and technical assistance costs directly related to the contract
• Cost of rectification and guarantee work, including warranty costs
• Claims from third parties
These costs may be reduced by any incidental income resulting from sale of surplus material and the disposal of equipment at the end of the contract.
Costs that may be attributable to contract activity in general and can be allocated to specific contracts are insurance, construction overhead, and the like. General
contract activity costs must be allocated on a systematic and rational basis assuming a “normal” level of construction activity.
Costs that may be specifically charged to the customer under the terms of the contract include percentage of general and administrative overheads or development
costs that the customer has specifically agreed to reimburse under the terms of the contract.
Costs that cannot be attributed to contract activity or cannot be allocated to a contract are excluded from costs of construction contract. Examples of such costs are
• Selling and marketing costs
• General and administrative costs for which the reimbursement is not specified in the contract
• Research and development costs for which reimbursement is not specified in the contract
• Depreciation on idle plant and equipment whose use cannot be attributable to any construction contract
A matter of debate in this area is costs incurred in securing a contract, such as travel, promotion, and meeting costs, and the like. Usually only those costs incurred
after winning the contract are included as contract costs. However, the Standard states that if such “precontract” costs are reliably measurable and it is probable that the
contract will be secured, then such costs are included as part of the overall contract cost. In practice, if the contract has been secured by the time the financial
statements are authorized for issue, then the condition of probability of securing the contract is satisfied and the costs can be included. However, it should be noted that
once such “precontract” costs have been expensed, they cannot be reinstated once the contract is secured.
RECOGNITION OF CONTRACT REVENUE AND EXPENSES
Contract revenue and contract costs should be recognized in the income statement when the outcome of the contract can be estimated reliably.
The revenue and costs should be recognized by reference to the stage of completion at the end of the reporting period.
When it is likely that contract costs will exceed contract revenue, then the entire loss must be recognized in the income statement immediately, regardless of the stage
of completion.
The percentage of completion of a contract at any reporting date is estimated on a cumulative basis. Therefore, changes in estimates are automatically accounted for
in the period in which the change occurs and in future periods, which is in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates, and
Errors.
FIXED-PRICE CONTRACT
With respect to a fixed-price contract, the outcome can be estimated reliably when
• Total contract revenue can be measured reliably
• It is probable that the economic benefit of the contract will flow to the entity
• Both the costs to complete the contract and the stage of completion can be reliably estimated
• The costs attributable to the contract can be clearly identified and measured
With respect to a cost-plus contract, the outcome can be reliably estimated when
COST-PLUS CONTRACT
• It is probable that the economic benefit of the contract will flow to the entity.
• The costs attributable to the contract, whether specifically reimbursable or not, can be clearly identified and measured.
PERCENTAGE-OF-COMPLETION METHOD
The recognition of revenues and expenses by references to the stages of completion of a contract is referred to as the percentage of completion method. The manner
in which this method works is simple: The contract revenues are matched with the contract costs incurred in reaching the stage of completion. Such comparison results
in the reporting of revenue, expenses, and profit that can be attributed to the proportion of the work completed.