Two Alternate Accounting Method Available:Long-term Construction Accounting IFRS vs US GAAPLong-term Construction ProjectsUS GAAPTwo Alternate Accounting Method Available:Per ARB #45 (1955)Percentage of Completion MethodCompleted Contract MethodPer AICPA Statement of Position No. 81-1 (1981)Recommends the use of percentage of completion when the following conditions are met. (Otherwise use completed contract.)1. Reasonably dependable estimated can be made2. Contract specifies legally enforceable rights, the consideration, and the terms of settlement3. Buyer is expected to satisfy obligations under contract4. Contractor is expected to fulfill contractual obligationsOn the surface, appears to contradict revenue recognition principles. However, percentage of completion is not an exceptionbecause of the special nature of the transaction -- a "continuous sale"1. Buyer and seller obtain enforceable rights2. Buyer usually makes progress payments to support its ownership investment3. Buyer has a right to take over work-in-progress created by T. Gordon 01/14/19 Page 1PERCENTAGE OF COMPLETION:1. Input measures:Cost to Cost: costs-to-date divided by estimated total costEfforts expended: DL hours, etc., to-date divided by estimated total DL hours2. Output measures: (better but more difficult to obtain)Example: miles completed to total miles contractedTERMINOLOGYInventory account -- Construction In ProgressAccumulates all costs incurred on project plus any recognized profit or lossLiability account -- Progress Billings (or Partial Billings or Construction Billings)Accumulates total amounts billed to customerThese two accounts are treated as a "pair" for external reporting:If CIP > PB, report as current asset with title:"Cost of Uncompleted Contracts in Excess of Related Billings"If PB > CIP, report as current liability with title:"Billings of Uncompleted Contracts in Excess of Related Costs" created by T. Gordon 01/14/19 Page 2LOSSES ON LT CONSTRUCTION CONTRACTSSpecial provision applies to both methods:If a loss is estimated for the entire project, the TOTAL estimated loss (not a percentage of that loss) must be reported in the year in which it becomes apparent that a loss will be incurred.Possible account title: "Provision for Loss on Contract" which is offset against Construction in ProgressPercentage of completion Completed contractCurrent period loss on ultimately profitable contractChange in accounting estimate – do not restate previously issued financial statements. Adjustment affects current period onlyAdjustment makes cumulative reported gain equal to percentage of completion times total estimated gainNo loss is recognizedLoss on entire contract Recognize estimated loss in the period it first becomes evident.Reverse out profits previously recognizedConsequently, current year loss may be larger than total estimated lossRecognize estimated loss in the period it first becomes evident.Record loss on income statement and reduce CIP account created by T. Gordon 01/14/19 Page 3Long-term Construction AccountingIFRS vs US GAAPUS GAAP IFRS – IAS 11Accounting methods acceptableChoice between:- Percentage of completion- Completed contractThere are some criteria provided but they are not mandatoryCompleted contract is NOT acceptable.Use percentage of completion methodIf no reasonable estimates of percentage of completioncan be made, use the Zero profit method and switch to percentage of completionlaterComparing results: Percentage of completionPercentage of completionWould be same as IFRS with respect to balance sheet and income statementPercentage of completionWould be same as US GAAP with respect to balance sheet and income statementComparing results:Completed contract vs. zero profit methodBalance sheet = sameIncome statement:Report zero revenue and zero cost (until year completed)Balance sheet = sameIncome statement:Report revenue equal to costs incurred which resultsin zero profit. Losses on contracts Always recognize 100% of loss as soon as it becomes apparentAlways recognize 100% of loss as soon as it becomes apparentSome tentative conclusions:- Percentage of completion approach is essentially the same – the difference is that it is a choice under US GAAP and required under IFRS.- The completed contract and zero profit method have basically the same result (no profit recognized) UNLESS estimates become possible later and IFRS would then begin using the percentage of completion method to recognize revenues. - Likewise, we would not recognize a percentage of a loss under either US GAAP or IFRS– instead, we’d recognize the full amount of the loss on a contract (perhaps with discounted cash flows under IFRS). created by T. Gordon 01/14/19 Page
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