Recognising profits and losses on construction contracts

With a number of high profile construction companies recently going in to liquidation, it is a reminder that no matter what size of business you are, the need to keep accurate financial records on your construction contracts is paramount.

Outcome if the contract can be estimated reliably

If the outcome of a construction contract can be estimated reliably, an entity recognises contract revenue and contract costs by reference to the stage of completion of the contract activity at the balance sheet date.

Three potential methods in determining the stage of completion of a contract could be:

• The proportion that costs incurred for work performed to date have in relation to the estimated total costs
• Surveys of work performed; and
• Actual completion of a physical proportion of the work or the completion of a proportion of the service contract

When the business receives a progress payment from the customer, these are credited to the contract account and not revenue. Progress payments do not reflect the work performed and hence are not regarded as revenue.

Outcome if the contract is uncertain

If the outcome of a construction contract is uncertain (i.e. management do not know whether the contract will make a profit or loss):

• Revenue is recognised to the extent of contract costs incurred that is probable (i.e. more likely than not) will be recoverable; and
• The entity recognises contract costs as an expense in the period in which they are incurred

Loss-making contract

If the outcome of a contract is that contract costs will exceed total contract revenue, the expected loss is recognised as an expense immediately with a corresponding provision for an onerous contract.

It is vital that profits or losses on contracts are correctly recorded throughout the term of the contract to ensure that you don’t end up with an unexpected loss at the end of the contract.

Recognising profits on contracts is an area where judgements and estimates are made and if incorrect, once profitable looking businesses can all of a sudden be loss makers and potentially lead to liquidation.

If you would like further information on how EQ Property and Construction could assist your business, please contact one of our team. Get in contact via info@eqaccountants.co.uk or speak with your local office contact.