LONG-TERM CONSTRUCTION CONTRACTS (LTCC)

 Construction contracts which take longer than one year to complete.

 In accounting for long-term construction contracts, the method that is commonly followed is the
percentage-of-completion method.

Types of Construction Contracts

1. Fixed Price Contract
o Agreed to a fixed price
o Subject to cost escalation clauses
2. Cost plus Contract
o Reimbursed for allowed or otherwise defined costs plus a % of these costs or a fixed fee.
3. Construction Revenue – total amount of consideration receivable under the contract.
4. Variation – instruction by the customers for a change in the scope of the work to be performed
under the contract.
5. Incentive Payment – additional amounts paid to the contractor is specified are met or exceeded.

Construction Costs
 Relate directly to the specific contract.
 Attributable to contract activity in general and can be allocated to the contract.
 Chargeable to the customers.
 Costs that are direct:
o Site labor costs
o Materials used
o Depreciation
o Moving PPE
o Hiring PPE
o Design and technical assistance
o Rectification and guarantee work
o Claims from third parties

Completion estimates
 Input measures
o Based on an established or assumed relationship between a unit of input and productivity.
o Cost-to-Cost method – degree of completion is determined by comparing costs already incurred
with the most recent estimates of total costs expected to complete the project.
o Effort-expended method – based on some measure of work performed.
 Output measures – measured in terms of results achieved. It was based on units produced.

Percentage of Completion Method

 The percentage-of-completion method should be used when estimates of the bases upon which
progress is measured are reasonably dependable and all the following conditions exist:

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 o The contract clearly specifies the enforceable rights regarding goods or services to be provided
and received by the parties, the consideration to be exchanged, and the manner and terms of
settlement.
o The buyer can be expected to satisfy all obligations under the contract.
o The contractor can be expected to perform the contractual obligation.
 The revenue recognized on a long-term construction contract under the percentage-of-completion
method is determined by applying a percentage representing the degree of completion to the total
contract price at the end of the accounting period.
 The percentage may be derived by dividing the costs incurred to date by the total estimated costs
of the entire contract based on the most recent information. The revenue so derived is then
reduced by the direct contract costs to determine the gross profit recognized in the initial period.
 In subsequent periods, since the percentage-of-completion method described produces cumulative
results, revenue and gross profit recognized in prior periods must be subtracted to obtain current
revenue and gross profit to be recognized.
 If it is expected that a loss will occur on the contract, a provision for loss should be recognized
immediately.
 Under the percentage-of-completion method, a schedule is made of the contracts in process,
showing the total costs incurred as of the end of a given period, the estimated gross profit
recognized based on the degree of completion, and the total billings rendered on each individual
contract.

Cost-Recovery Method
 Recognize revenue only to the extent of contract costs incurred in which are expected to be
recoverable.
 Recognize contract costs as an expense in the period they are incurred.

Financial Statement Presentation

 If costs incurred plus recognized profits exceed the related billings on a contract, this net figure is
shown as a current asset. This treatment shows that the contractor has not fully billed the
customer for work performed to date and has a claim against the customer for that portion of work
completed but not yet billed.
 If billings on a contract exceed costs incurred plus estimated profits, this net figure is shown as a
current liability, which means that the contractor has overbilled the customer for work done to date
and must complete the work represented by the excess billings.

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