ias recognizes the poc

8/6/2019 IAS Recognizes the POC

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1. The Percentage Of Income Associated with The Project -Under the percentage-of-completion method, a percentage of theincome associated with a project is recognized in proportion to theestimated percentage of completion of the project. An approach underthe completed-contract method is to wait until a construction project

has been completed in all respects before recognizing any relatedrevenue. The completed-contract method is not in accordance withIFRS, but this is an allowable method of accounting for long-termconstruction contracts in the United States, Canada, and Japanandthe only method permitted in Germany.

2. The Expenses - Under the percentage-of-completion method,accounting must be performed for each project, in which the entityaccumulates all project-related expenses. At the end of each reportingperiod, the budgeted gross margin associated with each project isadded to the total expenses accumulated in each account and

subtracted from the accumulated billings to date. If the amount ofexpenses and gross profit exceeds the billings figure, then thecompany recognizes revenue, matching the difference between thetwo figures. If the expenses and gross profit figure are less than theamount of billings, the difference is stored in a liability account.

3. Construction in Progress (CIP) Asset - Under the percentage-of-completion method, the accounting staff creates a new assetconstruction-in-progress (CIP) account to accumulate costs andrecognize income. When the CIP exceeds billings, the difference isreported as a current asset. If billings exceed CIP, the difference is

reported as a current liability. Where more than one contract exists,the excess cost or liability should be determined on a project-by-project basis, with the accumulated costs and liabilities being statedseparately on the statement of financial position. Assets and liabilitiesmay not be offset unless a right of offset exists. Thus, the net debitbalances for certain contracts should not ordinarily be offset againstnet credit balances for other contracts. An exception may exist if thebalances relate to contracts that meet the criteria for combining.

4. The Contract Cost - Under the percentage-of-completion method,income should not be based on advances (cash collections) or progress

(interim) billings. Cash collections and interim billings are based oncontract terms that do not necessarily measure contract performance.Costs and estimated earnings in excess of billings should be classifiedas an asset. If billings exceed costs and estimated earnings, thedifference should be classified as a liability. Contract costs arecomprised of costs that are identifiable with a specific contract, thosethat are attributable to contracting activity in generaland can beallocated to the contractand those that are contractually chargeable
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to a customer. Generally, contract costs would include all direct costs,such as direct materials, direct labor, and direct expenses, as well asany construction overhead that could specifically be allocated tospecific contracts. Contract costs can be broken down into twocategories:

(1). Costs Incurred To Date : The costs incurred to date include pre-contract costs and costs incurred after contract acceptance. Pre-contract costs are costs incurred before a contract has been enteredinto, with the expectation that the contract will be accepted and thesecosts will thereby be recoverable through billings. Pre-contract costsinclude costs of architectural designs, costs of learning a new process,cost of securing the contract, and any other costs that are expected tobe recovered if the contract is accepted. Contract costs incurred afterthe acceptance of the contract are put toward the completion of theproject, and are capitalized in the construction-in-progress (CIP)

account. The contract does not have to be identified before thecapitalization decision is made; it is only necessary that there be anexpectation of the recovery of the costs. Once the contract has beenaccepted, the pre-contract costs become contract costs incurred todate. Nevertheless, if the pre-contract costs are already recognized asan expense in the period in which they are incurred, they are notincluded in contract costs when the contract is obtained in asubsequent period.

(2) Estimated Costs to Complete: Estimated costs to complete arethe anticipated costs required to complete a project at a scheduled

time. They would be comprised of the same elements as the originaltotal estimated contract costs and would be based on prices expectedto be in effect when the costs are incurred. The latest estimates shouldbe used to determine the progress toward completion.

Timing for Revenue Recognition

Under the percentage-of-completion method, revenues arerecognized based on the stage of completion of a contract. The

standard recognizes that the stage of completion of a contract may bedetermined in many ways and that an entity uses the method thatmeasures reliably the work performed. The standard further stipulatesthat depending on the nature of the contract, one of these threemethods may be chosen:

Cost-to-cost Method (The proportion that contract costsincurred bears to estimated total contract cost)
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Survey of Work Performed Method Completion of a Physical Proportion of Contract Work(also

called units-of-work performed) method. Note: Progresspayments and advances received from customers often do notreflect the work performed.

Each of these methods of measuring progress on a contractcan be identified as being either an input or an outputmeasure. The input measures attempt to identify progress in acontract in terms of the efforts devoted to it. The cost-to-cost methodis an example of an input measure.

Under the cost-to-cost method, the percentage of completionwould be estimated by comparing total costs incurred to dateto total costs expected for the entire job. Output measures aremade in terms of results by attempting to identify progress toward

completion by physical measures. The units of work-performed methodis an example of an output measure. Under this method, an estimateof completion is made in terms of achievements to date, but it is notconsidered to be as reliable as input measures.

When the stage of completion is determined by reference tothe contract costs incurred to date, the standard specificallyrefers to certain costs that are to be excluded from contractcosts. Examples of such costs are:

Contract costs that relate to future activity (e.g., construction

materials supplied to the site but not yet consumed duringconstruction)

Payments made in advance to subcontractors prior toperformance of the work by the subcontractor

Under the cost-to-cost method, we measure the percentage ofcompletion by dividing the total amount of costs incurred todate by the total estimated project cost. This method works wellonly if the total estimated project cost is revised regularly to reflect themost accurate cost information. Also, it tends to result inproportionately greater amounts of revenue recognition early in a

project, since this is when most of the material-related costs areincurred. A more accurate way to calculate the percentage ofcompletion when there are large up-front materials costs is to includethe materials costs only when the aspects of the project in which theyare used are completed.

Example of the Cost-to-cost Method


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The Lie Dharma Putra Construction (LDPC) is building a hotel and haselected to purchase the materials for the air-conditioning system,costing $200,000, at the beginning of the project. The total estimatedproject cost is $2 million and the amount billable to the customer is$2.5 million. After one month, LDPC has incurred a total of $400,000 in

costs, including the air conditioning equipment. This is 20% of the totalproject cost, and would entitle LDPC to recognize $500,000 of revenue(20% of $2.5 million). However, because the air-conditioningequipment has not yet been installed, a more accurate approach wouldbe to exclude the cost of this equipment from the calculation, resultingin a project completion percentage of 10% and recognizable revenueof $250,000. The resulting journal entry would be:

[Debit]. Costs and estimated earnings in excess of billings = $125,000[Credit]. Contract revenues earned = $125,000

The trouble with these methods is that one must have goodcost tracking and project planning systems in order to ensurethat all related costs are being properly accumulated for eachproject, and that cost overruns are accounted for whenderiving the percentage of completion. For example: If poormanagement results in a doubling of the costs incurred at the halfwaypoint of a construction projectfrom $5,000 up to $10,000thismeans that the total estimated cost for the entire project (of $10,000)would already have been reached when half of the project had not yetbeen completed. In such a case, one should review the remaining costs

left to be incurred and change this estimate to ensure that theresulting percentage of completion is accurate.

If the percentage-of-completion calculation appears suspectwhen based on costs incurred, one can also use a percentageof completion that is based on a Gantt chart or some otherplanning tool that reveals how much of the project has actuallybeen completed. For example: If a Microsoft Project plan revealsthat a construction project has reached the 60% milestone, then onecan reasonably assume that 60% of the project has been completed,even if the proportion of costs incurred may result in a different

calculation.

Costs that may be included in the construction-in-progressaccount include direct labor, materials, and overhead relatedto the project. Expenses included in overhead should be consistentlyapplied across multiple projects, as should the method of applyingoverhead to jobs; this keeps one from arbitrarily shifting overheadexpenses between project accounts.
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If the estimate of costs left to be incurred plus actual costsalready incurred exceeds the total revenue to be expectedfrom a contract, then the full amount of the difference shouldbe recognized in the current period as a loss, and it should bepresented on the statement of financial position as a current

liability. If the percentage of completion method has been used onthe project, then the amount recognized will be the total estimatedloss on the project plus all project profits previously recognized. If,after the loss estimate has been made, the actual loss turns out to be asmaller number, the difference can be recognized in the current periodas a gain.

Example of Project Loss Recognition

The LDPC Construction Companys cost accountant has determinedthat its construction of a new office building will probably result in a

loss of $80,000, based on his most recent cost estimates. Thecompany uses the percentage-of-completion method, under which ithad previously recorded gross profits of $35,000 for the project. Thus,the company must record a loss of $115,000 in the current period,both to record the total estimated loss and to back out the formerlyrecognized profit. The entry is:

[Debit]. Loss on uncompleted project = $115,000[Credit]. Estimatedloss on uncompleted contract = $115,000

If costs are incurred prior to the signing of a project contract, these

costs must be charged to expense at once rather than storing them inthe construction-in-progress account as an asset. It is not allowable toshift these costs retroactively from an expense account into theconstruction-in-progress account.

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