IAS 41

AGRICULTURE
EXAMPLE 12.2: PHYSICAL CHANGE AND PRICE CHANGE
Background
The following example illustrates how to separate physical change and price change. Separating the
change in fair value less estimated point-of-sale costs between the portion attributable to physical
changes and the portion attributable to price changes is encouraged but not required by this standard.

Example
A herd of 10 two-year-old animals was held at January 1, 20X1. One animal 2.5 years of age was
purchased on July 1, 20X1, for $108, and one animal was born on July 1, 20X1. No ani-mals were
sold or disposed of during the period. Per-unit fair values less estimated point-of-sale costs were as
follows:
Animal Details $ $

2-year-old animal at January 1, 20X1 100

Newborn animal at July 1, 20X1 70
2.5-year-old animal at July 1, 20X1 108
Newborn animal at December 31, 20X1 72
0.5-year-old animal at December 31, 20X1 80
2-year-old animal at December 31, 20X1 105
2.5-year-old animal at December 31, 20X1 111
3-year-old animal at December 31, 20X1 120
Fair value less estimated point-of-sale costs of herd on
January 1, 20X1 (10 * 100) 1,000
Purchase on July 1, 20X1 (1 *108) 108
Increase in fair value less estimated point-of-sale costs

due to price change:

10 (105 − 100) 50
1 ( 111- 108) 3
1 (72 – 70) 2 55

Increase in fair value less estimated point-of-sale costs

due to physical change:
10 (120 − 105) 150
1 (120 – 111) 9

1 (80 – 72) 8
1 70 237

Fair value less estimated point-of-sale costs of herd on

December 31, 20X1
11 120 1,320
1 80 80 1,400
EXAMPLE 12.3
In year 20X0, a farmer plants an apple orchard that costs him $250,000. At the end of year 20X1, the
following facts regarding the orchard are available:
Disease. There has been widespread disease in the apple tree population. As a result there is no active
market for the orchard, but the situation is expected to clear in six months. After the six months, it
should also be clear which types of trees are susceptible to infection and which ones are not. Until
that time, nobody is willing to risk an infected orchard.
Precedent. The last sale by the farmer of an orchard was six months ago at a price of $150,000.
He is not sure which way the market has gone since then.
Local values. The farmers in the region have an average value of $195,000 for their orchards of a
similar size.
National values. The farmer recently read in a local agricultural magazine that the average price of
an apple tree orchard is $225,000.
What is the correct valuation of the apple tree orchard?
EXPLANATION
The valuation would be the fair value less estimated point-of-sales costs. Fair value is deter-mined as follows:
 Use active market prices—there are none, due to the disease.
 Use other relevant information, such as
– The most recent market transaction $150,000
– Market prices for similar assets $195,000
– Sector benchmarks $225,000

If the fair value cannot be determined, then the valuation would be determined at cost, less accumulated
depreciation and accumulated impairment losses: $250,000.
However, there are other reliable sources available for the determination of fair value. Such sources should be
used. The mean value of all the available indicators above would be used (in the range of $150,000 to $225,000).
In addition, the farmer would consider the reasons for the differences between the various sources of other
information, prior to arriving at the most reliable estimate of fair value.
In the absence of recent prices, sector benchmarks, and other information, the farmer should calculate the fair
value as comprising the cost price, less impairments, less depreciation— resulting in a valuation of $250,000.
 IAS 11
CONSTRUCTION CONTRACT
OBJECTIVE
The primary challenge in accounting for construction contracts is to allocate contract revenue
and costs to the correct accounting periods. The objective of this standard is to give guidance
on the appropriate criteria for recognition of construction contract revenue and costs, with a
focus on the allocation of contract revenue and costs to the accounting periods in which con-
struction work is performed.

SCOPE OF THE STANDARD

This standard applies to accounting for construction contracts in the financial statements of
contractors.
KEY CONCEPTS
 A construction contract is a contract negotiated specifically for the construction of an
asset or a combination of assets that are closely interrelated or interdependent in terms of
their design, technology, and function, or in terms of their ultimate purpose or use. Construc-
tion contracts include those for the construction or restoration of assets and the restoration of
the environment.

 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.
ACCOUNTING TREATMENT
Recognition and Initial Measurement

Contract revenue is measured at the fair value of the consideration received or receivable. The
measurement of contract revenue is affected by a variety of uncertainties that depend on the
outcome of future events. The estimates often need to be revised as events occur and uncertainties
are resolved. Therefore, the amount of contract revenue may increase or decrease from one period
to the next.

Contract revenues comprise:

 the initial agreed contract amount; and
 variations, claims, and incentive payments to the extent that it is probable that these will result
in revenue and are capable of being reliably measured.
Contract costs comprise:
 direct contract costs (for example materials, site labor, or depreciation of plant and equipment
used on the contract);
 general contract costs (for example insurance, costs of design, or construction overheads); and
 costs specifically chargeable to the customer in terms of the contract (for example
administrative costs or selling costs).

Subsequent Measurement
When the outcome of a construction contract can be reliably estimated, contract revenue and
contract costs should be recognized as revenue and expenses respectively by refer-ence to the
stage of completion of the contract activity at the end of the reporting period.

The stage of completion can be determined by reference to:

• the portion of costs incurred in relation to estimated total costs;
• surveys of work performed; and
• the physical stage of completion.
In the case of a fixed-price contract, the outcome of a construction contract can be estimated
reliably when all the following conditions are met:
• total contract revenue can be measured reliably;
• it is probable that the economic benefits associated with the contract will flow to the entity;
and
• the costs attributable to the contract can be clearly identified and measured reliably so that
actual contract costs incurred can be compared with prior estimates.

 In the case of a cost-plus contract, the outcome of a construction contract can be estimated
reliably when all the following conditions are satisfied:
• it is probable that the economic benefits associated with the contract will flow to the entity;
and
• the contract costs attributable to the contract, whether or not specifically reimbursable, can be
clearly identified and measured reliably.
When the outcome of a contract cannot be reliably estimated, revenue should be recognized to the
extent that recovery of contract costs is probable. The contract costs should be recognized as an
expense in the period in which they are incurred.

Any expected excess of total contract costs over total contract revenue (expected loss) is
recognized as an expense immediately.

PRESENTATION AND DISCLOSURE

• The Statement of Financial Position and notes include:

• amount of advances received;
• amount of retention monies;
• contracts in progress being costs-to-date-plus-profits or costs-to-date-less-losses;
• gross amount due from customers (assets);
• gross amount due to customers (liabilities); and
• contingent assets and contingent liabilities (for example claims).
The Statement of Comprehensive Income includes:
• amount of contract revenue recognized.

 Accounting policies include:

• methods used for revenue recognition; and
• methods used for stage of completion
EXAMPLES: CONSTRUCTION CONTRACTS
EXAMPLE :1
A company undertakes a four-year project at a contracted price of $100 million that will be billed in
four equal annual installments of $25 million over the project’s life. The project is expected to cost
$90 million, producing a $10 million profit. Over the life of the project, the billings, cash receipts,
and cash outlays related to the project are as follows:
Year 2 Year 3 Year 4
1 ($’000) ($’000) ($’000) ($’000)
Billings 25,000 25,000 25,000 25,000
Cash receipts 20,000 27,000 25,000 28,000
Cash outlays 18,000 36,000 27,000 9,000

Financial statements and schedules must be produced under the percentage of completion contract method,
showing:
A. the cash flows from the project each year;
B. the profit or loss for the project each year;
C. the Statement of Financial Position each year; and
D. the profit margin, asset turnover, debt to equity, return on assets, return on equity, and the current ratio
Explanation
A. The cash flow is simply the difference between the cash received and paid every year as
given in the problem:

Year 1 Year 2 Year 3 Year 4

($’000) ($’000) ($’000) ($’000)

Cash receipts 20,000 27,000 25,000 28,000

Cash outlays 18,000 36,000 27,000 9,000
Cash flow 2,000 (9,000) (2,000) 19,000

Cumulative cash flow 2,000 (7,000) (9,000) 10,000

(on Statement of Financial
Position)
B. The revenues recorded in profit or loss each year are calculated as
C. In constructing the Statement of Financial Position, the following is required:
The Statement of Financial Position is as follows:
D. The following illustrates the profit margin, asset turnover, debt-to-equity, return
on assets,return on equity, and the current ratio:
Omega Inc. started a four-year contract to build a dam. Activities commenced on
February 1, 20X6. The total contract price amounted to $12 million, and it was
estimated that the work would be completed at a total cost of $9.5 million. In the
construction agreement the customer agreed to accept increases in wage tariffs
additional to the contract price

1. Costs for the year:

Material 1,400
Labor 800
Operating overhead 150
Subcontractors 180
2. Current estimate of total contract costs indicates the following:

■ Materials will be $180,000 higher than expected.

■ Total labor costs will be $300,000 higher than expected. Of this amount, only
$240,000 will be the result of increased wage tariffs. The remainder will be caused by
inefficiencies.
■ A savings of $30,000 is expected on operating overhead.

3. During the current financial year the customer requested a variation to the original contract,
and it was agreed that the contract price would be increased by $900,000. The total
estimated cost of this extra work is $750,000.

4. By the end of 20X6, certificates issued by quantity surveyors indicated a 25 percent stage
of completion.
Determine the profit to date, based on:
■ Option 1—contract costs in proportion to estimated contract costs
■ Option 2—percentage of the work certified
EXPLANATION
Contract profit recognized for the year ending December 31, 20X6, is as
follows:
d.Stage of completion Option 1 Option 2
Based on contract costs in proportion to
estimated total contract costs:

(2,530 / 10,700)× 13,140 (rounded off) 3,107

Based on work certified: 25% × 13,140 3,285