Construction contracts expenses and revenues reporting

Abstract

According to the Conceptual Framework of the International Accounting Standards, expenses are recognized when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. Under the matching principle between revenue and expenses, the latter are recognized based on the direct relation between the actually paid expenses and the earned revenue during the reporting period. In this context, expenses forming the value of finished goods are recognized when the revenue received from the sale of such goods is earned. In cases when the economic benefits are expected to be acquired during several reporting periods, expenses should be deferred and recognized during different reporting periods within which the acquisition of economic benefits is converted to cash. To defer them, a certain allocation base which is an item of the accounting policy followed by the entity should be applied. The key issue in the accounting of expenses and revenues under construction contracts is related to the allocation of the contract revenues and expenses between the reporting periods during which such works have been executed. Accounting standards outline the criteria for when to recognize expenses and revenue so that to identify the correct time when they should be recognized in the financial statements of the entity carrying out the works. The main concept underlying the accounting standards is that contract revenues and expenses associated with a construction contract are to be recognized as revenues and expenses by reference to the stage of completion of the contract activity at the end of the reporting period. Construction contracts applied in practice are classified as fixed-price contracts and cost-plus contracts. A fixed-price contract is a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit of output, which in some cases is subject to cost escalation clauses. A cost-plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee.