QUESTION 1
Explain two methods of accounting for construction contracts.
- Percentage on completion method
According to this method, revenue is recognized on the basis of completion at the end of accounting period i.e. based on percentage of completion.
Determination of percentage of completion can be done as follows:-
- Cost approach = cost to date ×100
Total cost estimated to completion
- Unit approach = units completed to date ×100
Total estimated units to completion
- Effort approach = labor hours used to date x 100
Total labor hours estimated to completion
- Value approach = work certified x 100 Contract price
- Completed contract method
Under this method, revenue and profits are recognized when the contract is completed or substantially completed i.e. when remaining costs and potential risks are insignificant in amount.
Costs and progress payments received are accumulated during the course of the contracts but profit is not recognized until the contract activity is substantially completed.
It’s appropriate for financial accounting only if:
- A contractor has primarily short-term contract which are completed in one year or less.
If estimates of input/ output measures of completion are not reasonably Dependable.
QUESTION 2
Explain the disclosure requirements for contracts in progress at the end of the reporting period in accordance with International Accounting Standard (IAS) 11, Construction Contracts.
The aggregate amount of costs incurred and recognised profits (less recognised losses) to date.
The amount of advances received.
The amount of retentions.
QUESTION 4
In the recent past, some public sector entities have converted their retirement benefits plans from “defined benefit” to “defined contribution” plans.
Required:
Differentiate between defined benefit and defined contribution plans.
Defined contribution plans are post employment benefit under which any entity pays fixed contributions into a separate entity (a fund) and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods.
Defined benefit plans are post employment plans other than defined contributions plans.
From an employee’s perspective, argue the case for or against conversion from a defined benefit to a defined contribution plan
The employee is guaranteed a fixed sum of benefit on retirement under the defined benefit plans. An entity is therefore required to make arrangements to ensure the fund created for purpose of meeting future liabilities is solvent.
Under the defined contribution plan a contribution gets paid based on the amount contributed by him and the employment inclusive of interest earned or less any losses incurred by the fund.
In this regard when an economy is booming an employee would benefit most under the defined contribution plan. However, exit benefits may be much lower in situations where an economy is not performing well, in which case a defined benefit plan may be more attractive
QUESTION 8
Explain the following methods used in accounting for construction contract
Completed contract method
The Completed Contract Method (CCM) is where no profit is recognised when the contract is in progress; profit is only recognised when the contract is completed or substantially completed; i.e. only minor work (other than warranty work) is outstanding. Cost and progress payments are accumulated during the period of contract but revenue is not recognised up to contract completion. This is in compliance with the prudence concept whereby no profit is recognised unless there is certainty on its realisation.
Percentage of completion method
The PCM method allows for recognition of revenue as the contract progresses. This is in compliance with the matching concept. It allows the contractor to report profits in financial years during which the contract is incomplete but activity has been undertaken. The risk associated with this method relates to enormous estimation of future costs.
QUESTION 10
Distinguish between “leasing” and “hire purchase” highlighting how each is accounted for.
In hire purchase the title the goodwill pass to the buyer on payment of the last installment but in lease the title will not pass to the leasee.
- In hire purchase the asset acquired is recognized in the books of the buyer while lease the asset is recognized in the books of the lessor.
- Maintenance and other capital cost in H.P are incurred by the buyer but in lease capital cost are incurred.
QUESTION 11
In the context of accounting for long-term construction contracts, briefly explain the following terms:
(i) Retention money
- This is the amount retained by the client to be paid after the completion the contract.
This is to account for any sub standard work or penalties payable due to late completion.
(ii) Escalation clause.
- This is a clause in the contract that allows for adjustment of contract the price due to changes in prices of raw materials and labor.
The objective of the escalation clause is to protect both the client and contractor from unfavorable changes in prices
