College of Accountancy

LONG-TERM CONSTRUCTION CONTRACTS (LTCC)

Learning Objectives:
1. Explain what is a construction contract.
2. Enumerate the accounts used in recording LTCC transactions.
3. Present the major events in a LTCC.
4. Illustrate the accounting of LTCC transactions.
5. Explain the accounting for anticipated losses.
6. Explain the accounting for incentives, cost escalation and penalties.

Lesson 1: Construction Contract

PAS 11 defines construction contract as contract specifically negotiated for the construction of an
asset or a combination of assets that are closely interrelated or interdependent in terms of their design,
technology or their ultimate purpose or use.
Long term construction contracts are construction project that extend thru more than one
accounting period. Usually, these are construction of water dams, bridges, flyover, and the metro railway
transit.
Lesson 2: Accounts Used for Recording
The accounts used in accounting for long-term construction contract are as follow:

a. Construction in progress – this account is used to accumulate contract costs incurred and recognized
profits (less recognized losses) to date. The account is debited for construction expenses incurred and
profit earned while credited for loss.
b. Progress billings/ Contract billings – this account is used to record amounts billed for work
performed whether or not they have been paid by the customer.

Note:
- Total construction in progress and total progress billings will be equal with each other if the
construction is fully complete. The two accounts will be eliminated by debiting progress billings
and crediting construction in progress.

c. Construction Revenue – used to record the portion of contract price earned during the year.
Recognized during year end adjustment.
d. Cost of construction/ construction expense – used to record the construction expenses incurred.
Recognized during the year end adjustment together with revenue.
e. Cash – used to record actual cash collection from clients and cash payments of expenses.

f. Accounts receivable – used to record an entity’s right to consideration that is unconditional. Right to
consideration is unconditional if only the passage of time is required and not the transfer of goods or
performance of service. Used when there are no further performance obligations required to be
satisfied before the entity the entity has right to collect the customer’s consideration.

g. Contract Retention – used to record retention made by the customer to ensure satisfactory
completion of the project. This can be used in lieu of contract asset account under PFRS 15

*Retention – amounts of progress billings that are not paid until the satisfaction of conditions
specified in the contract for the payment of such amounts or until defects have been rectified.
h. Advances from customers – used to record amounts received by the contractor before the related
work is performed. Such amount includes mobilization fee. This account may be used in lieu of
contract liability account under PFRS 15.
*Mobilization fee – advance payment of the contract price.
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Contract asset – used to record an entity’s right to consideration in exchange for goods or services that
the entity has transferred but no consideration is received or it is not yet due. The right to consideration is
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conditioned on something other than the passage of time. This account best be used for recording
retention fee.
Contract liability – used to record an entity’s obligation to transfer goods or services to a customer for
which the entity has received consideration (or the amount is due) from the customer.

Note:
• The use of the terms “Contract asset” or “Contract liability” is not required by PFRS 15 but
sufficient disclosure must be provided so that users of FS can clearly distinguish between an
unconditional right to consideration (a receivable) and a conditional right to receive consideration
(a contract asset)

Lesson 3: Major Events in a Long-Term Construction Contract:

1. Agreeing the contract.
2. Receipt of mobilization fee.
3. Acquisition of materials, supplies, and/or equipment.
4. Incurrence of construction cost.
5. Progress billing.
6. Collection of bills.
7. Recognizing revenue.
8. FS preparation
9. Elimination of CIP and Progress billings accounts

A. Agreeing the Contract

There are two concerns for the contractor before agreeing to a construction contract. First is the
total estimated construction cost and second is the transaction/Contract price.

Construction Cost
Construction cost comprise of:
a. Costs that relate directly to the specific contract;

• Site labor cost, including site supervision (direct labor)

• Cost of materials used in construction (direct materials)
• Payment to subcontractors
• Depreciation of plant and equipment used in the contract
• Cost of moving plant, equipment and materials to and from the contract site
• Cost of hiring plant and equipment
• Costs of design and technical assistance that is directly related to the contract
• The estimated cost of rectification and guarantee work, including expected warranty cost, and
claims from third parties
b. Costs that are attributable to contract activity in general and can be allocated to the contract;
and
• Insurance
• Costs of design and technical assistance that are not directly related to a specific contract
• Costs of contract management and supervision
• Borrowing costs capitalized in accordance with PAS 23 Borrowing costs
• Construction overheads
c. Such other costs that are specifically chargeable to the customer under the terms of the contract.
Note:

- Any incidental income derived from the construction that is not included in contract revenue
shall be accounted for as reduction of0contract costs.
0 For example, income from the sale of excess

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materials or scrap materials and gain on sale of plant and equipment at the end of the contract
shall be accounted for as reduction of contract costs.
Transaction Price/Contract Price
Construction contract may be classified into:

a. Fixed Price Contract. This 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.
b. Cost Plus Contract. This is a construction contract in which the contractor is reimbursed for
allowable or otherwise defined costs, plus a percentage of these costs (Cost-plus-variable-dee
Contract) or a fixed fee (Cost-pus-fixed-fee Contract).
B. Receipt of mobilization fee.
For the contractor to have a start-up cash, the contract may stipulate advance payment from the
customer. The mobilization fee will be used by the contractor to ready the construction operation.
C. Acquisition of materials, supplies, and/or equipment.
Note: Construction materials purchased in advance but are not actually used in construction should
not be treated as costs incurred for purposes of computing the percentage of completion ratio until the
materials have been physically used in production.
D. Incurrence of construction cost.
When the items of construction cost identified above are actually incurred, they are recorded using
the Construction in Progress account.
E. Progress billing.
The contractor asks the customer for additional cash through progress billings.
F. Collection of bills.
The progress billing collected might be reduced by a retention required by the customer which will be
given soon when conditions for the retention are satisfied.
G. Recognizing revenue.
At the end of the period, an adjusting entry is prepared to recognized the revenue, cost of
construction and realized gross profit (if any).
The two methods used in accounting for LTCC revenue are Percentage-of-Completion Method
and Zero Profit Method.

1. Percentage of Completion
- Under this method, contract revenue and contract costs associated with the construction
contract are recognized as revenue and expenses, respectively, by reference to the stage of
completion of the contract activity at the balance sheet date. (This method is used if the
percentage of completion can be determined reliably.)
Methods of Measuring Stage of Completion/ Measure of progress
a. Input measures – made in relation to the costs of efforts devoted to the contract.
1. Cost-to-cost method – the proportion that the contract costs incurred for work
performed to date bear to the estimated total contract (Cost incurred to date ÷
estimated cost to complete = percentage of completion);

2. Efforts – extended method – this is based on surveys of work performed.

(Resources consumed, labor hours expended, machine hours used, time elapsed)
(Actual direct labor hours0÷ estimated
0 total direct labor hours)

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b. Output Measures - made in terms of results achieved. This is based on the proportion of
the contract work. (Actual kilometers ÷ total estimated kilometers; no. of units ÷ total
estimated units; engineer’s or architect’s estimate)

2. Cost Recovery/Hybrid/Zero-profit
- This method is used when the outcome of a construction contract cannot be estimated
reliably:
a. Revenue is recognized only to the extent of contract costs incurred that it is probable will
be recoverable; and
b. Contract costs is recognized as an expense in the period in which they are incurred.
(Note: Some book authors and reviewers have different views with regards to the application of PFRS 15. For others,
percentage of completion method is used when performance obligation is satisfied overtime and cost recovery method
is used when performance obligation is satisfied at a point in time. On the other hand, for others, both percentage of
completion and cost recovery method is used when performance obligation is satisfied over time, there use depends on
whether reliable percentage of completion is determined or not, while revenue is recognized only when the
construction is done if the performance obligation is satisfied at a point in time. For our discussion, we will stick with
the use of percentage of completion for revenue recognized over time and cost recovery for revenue recognized at a
point in time.)

Computation Format

1. Gross Profit:

Year 1 Year 2 Year 3

Total Contract Price (TCP) Pxxx Pxxx Pxxx
Less: Total Estimated Costs (TEC)
Actual costs incurred to date (CITD) Pxxx Pxxx Pxxx
Add: Estimated costs to complete xxx xxx xxx
Total Estimated costs at completion Pxxx Pxxx Pxxx
Estimated Gross Profit Pxxx Pxxx Pxxx
Multiplied by: Percentage of completion % % %
Recognized gross profit(loss) to date Pxxx Pxxx Pxxx
Less: Recognized gross profit in prior year - xxx xxx
Recognized gross profit each year Pxxx Pxxx Pxxx

*Percentage of completion = CITD/TEC or CIP/TCP

2. Revenue

Revenue Year 1 Year 2 Year 3

Actual Cost Incurred – Current Year Pxxx Pxxx Pxxx
Add: Realized Gross Profit – Current Year xxx xxx xxx
Revenue Pxxx Pxxx Pxxx

(Note: This is appropriate to use especially if the method used is other than cost-to-cost
method such as input method wherein engineer’s estimate is used.)
Or,

Year 1 Year 2 Year 3

Total Contract Price Pxxx Pxxx Pxxx
Multiply by: % of completion % % %
Contract Revenue to Date Pxxx Pxxx Pxxx
Contract Revenue in Prior Year - (xxx) (xxx)
Contract Revenue for the Year Pxxx Pxxx Pxxx
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(Note: This is appropriate only if cost-to-cost percentage of completion method is used.)

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3. Construction in Progress

CIP Year 1 Year 2 Year 3

ACI – to date Pxxx Pxxx Pxxx
Add: RGP to date xxx xxx xxx
Construction in Progress Pxxx Pxxx Pxxx

H. FS preparation.

FS Presentation:
a. If Construction in progress (CIP) > Progress billings (PB) = difference is presented in the
financial statements as “Due from client”.

Due from client account represents a receivable, a current asset.

b. If CIP < PB = difference is presented in the financial statements as “Due to client”.

Due to client account represents a liability, a current liability.

I. Elimination of CIP and Progress Billings accounts
Once the construction is done, the constructed structure is transferred to the customer. The
construction in progress and the progress billings accounts will now be eliminated from the records of
the contractor.

Lesson 4: Accounting for LTCC Transactions

Story:
On January 1, 2021, Matibay Builders Company enters into a contract with a customer for the
construction of a building. The total contract price is P6,000,000, with an estimated cost to complete the
project of P5,000,000. The company uses cost-to-cost percentage of completion method. Information on
the contract is as follows:

• A 10% mobilization fee is due upon signing of the contract. This will be deducted from the final
billing.
• The customer shall withhold 10% of the subsequent progress billings. The cumulative amount
withheld will be paid to Matibay Builders Company upon final acceptance of the construction by the
customer.
The following data are available for the year 2021 to 2023:
Year Actual Cost for the Estimated Cost to Progress Billings
Current Year Complete
2021 P2,000,000 P3,000,000 P2,000,000
2022 1,500,000 1,500,000 2,000,000
2023 1,500,000 0 1,000,000

During January, the company purchased materials amounting to P300,000.

Required: Prepare journal entries to record the transactions above.

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Journal Entries:
Percentage of Cost Recovery/ Zero
2021 JOURNAL ENTRIES Completion Profit
Transaction Accounts Dr. Cr. Dr. Cr.

Contract signed Ne entry

Receipt of Cash 600,000 600,000
mobilization fee Advances from customer 600,000 600,000
Acquisition of Raw materials 300,000 300,000
materials Cash 300,000 300,000
Incurrence of Construction in progress 2,000,000 2,000,000
construction costs Raw materials 300,000 300,000
Cash/appropriate account 1,800,000 1,800,000
Progress billing Accounts receivable 2,000,000 2,000,000
Progress billings 2,000,000 2,000,000
Billing collections Cash 1,800,000 1,800,000
Contract retention 200,000 200,000
Accounts receivable 2,000,000 2,000,000
Revenue Construction in progress 400,000
recognition Cost of construction 2,000,000 2,000,000
Construction revenue 2,400,000 2,000,000
Note:
a. Materials unused are not part of the cost of construction until it is actually used in the
construction so it is recorded first as raw materials. Once it is used it will now enter the
construction in progress. It is assumed that aside from raw materials worth P300,000, the
remaining P300,000 from the advance payment made by the customer is used for other
construction costs.
b. Cash is credited for incurrence of construction costs assuming that other expenses are paid in cash
but payable can also be used if the costs are not yet paid.
c. Not all progress billings are collected because 10% is retained which will be returned upon
acceptance of the construction by the customer.
d. Revenue is determined as follows:

Realized Gross Profit:

2021 2022 2023
Total Contract Price (TCP) P6,000,000
Less: Total Estimated Costs (TEC)
Actual costs incurred to date (CITD) P2,000,000
Add: Estimated costs to complete 3,000,000
Total Estimated costs at completion P5,000,000
Estimated Gross Profit P1,000,000
Multiplied by: Percentage of completion 40%
Recognized gross profit(loss) to date P400,000
Less: Recognized gross profit in prior year -
Recognized gross profit each year P400,000

*Percentage of completion = CITD/TEC

𝐴𝑐𝑡𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑖𝑛𝑐𝑢𝑟𝑟𝑒𝑑 𝑡𝑜 𝑑𝑎𝑡𝑒 𝑃2,000,000
= = 40%
𝑇𝑜𝑡𝑎𝑙 𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 𝑡𝑜 𝑐𝑜𝑚𝑝𝑙𝑒𝑡𝑒 𝑃5,000,000
Revenue: Percentage of Completion Method
Revenue 2021 2022 2023
Actual Cost Incurred – Current Year P2,000,000
Add: Realized Gross Profit – Current Year 400,000
0 0
Revenue P2,400,000

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