Aconstruction contract refers to the agreement between two partiesthat is specifically negotiated a particular asset or somecombination of asset that nearly interrelated or that areinterdependent in their design specifications, technology used andtheir performance and function. A construction contract can either befixed-price contract or cost-plus contract. In a fixed-pricecontract, the contractor enters into an agreement with a fixedcontract price or a fixed rate per unit output. In this type ofconstruction contract, the price is subject to escalation. A costplus construction contract involves a contract where the contractoris paid the entire amount that he used when doing a project plus someother payment. The contractor is fully reimbursed for the cost of thematerial and labour and then another amount added, to sum up, thetotal cost of the contract[ CITATION Inv15 l 2057 ].
LabCo,which is a construction company that offers contracts, is currentlyfacing a challenge in deciding whether to switch from the percentageof completion method to the completed contract method for itscontract with its client, Halibut. LabCo’s contract with Halibutincludes the designing and construction of a six-axis laser cuttingmachine that would be utilized in cutting jet fighter wings. LabCorealizes that this arrangement would require some particularspecifications. However, LabCo having had similar experiences in thepast and also had worked with Halibut before, LabCo decides that themost appropriate for the contract method would be the completionmethod. Later as the project advanced, LabCo faced many challengeswith the project. LabCo’s chief accounting officer then decidedthat the amount that had been estimated for this project was not anymore reliable in estimation. The method of complete completion nolonger could be dependable in this project[ CITATION ECA l 2057 ].
Theaccounting policy that LabCo decided on for the revenue treatment ofthe contract is very fair. The company’s current policy is reliablefor if unreliable the estimate of the dependable total costs to beincurred in a particular contract cannot be calculated or bedetermined, the method of the completed-contract should be followed.The IFSR recognises not the method of the completed-contract methodbut rather requires the application of the cost recovery method asper IAS No. 11. The recovery method contracts the cost as theyincurred. The offsetting amount of the contract revenue is recognisedthat in the end it is probable that all the incurred the customerwill cover the cost. In the method of complete contract both the costincurred and the revenue are recognisable at the end of the contract.The recovery method is similar to that of the percentage ofcompletion method with the aim of reporting each steps accomplishmentover the period that the contract will live such that the totalproject cost will be the cumulative accomplishments and it will helpin predicting the future accomplishments. The profit is neitherrealized through the completed-contrast method or the recovery methoduntil the completion of the contract. LabCo will have to adopt themethod of cost recovery method for the Halibut and for othercircumstances that cannot be estimated reliably if IFRS is to befollowed. Embracing the new method will be pose challenges as some ofthe practices would change considerably. The percentage of completionmethod is only allowed when the customer has control over the asset[ CITATION Inv15 l 2057 ].
Itwas appropriate for the LabCo to change its method accounting methodsfor Halibut contract from the percentage of completion method tocomplete contract method. ASC 250-10 gives the general guidelines onthe areas where corrections of a contract that brings the switchingfrom one contract to another can be actually applied. It includes thechanges it the accounting principle, changes in the estimation andthe changes in reporting entities. LabCo faced difficulties in whendoing the former contract because it made an error in estimating thetotal cost of the project. After recognising this error, they willhave to revise or correct the contract based on the impacts of theassessment of the project progress [ASC 250-10]. However, all thechanges in estimates will not include the changes that occurred atthe time of the initial contract but those starting in the period ofchange and the changes that will occur in the future. The LabCoCompany will now have to consider the new principles and leave theformer law of the contract. The changes of principles should recastthe previous to reflect on the new principles that come with thechanges[ CITATION ECA l 2057 ].
Furthermore,from the erroneous estimation of the contract cost when labcoatentered it contract with Halibut resulted to improper application ofthe GAAP. This led to the miscomputation of that resulted inuncovered costs and expenses by the contract. All the material errorsstated in the previous contract should be restarted to reflect thenew calculation that would, determining the amount of asset and allliabilities that would not occur if the error had not been made[ CITATION USG l 2057 ].
Forlabcoat to embrace the IFRS some of its accounting policies andaccounting for Halibut will change accordingly. First, offsetting isforbidden in IFRS, but when some circumstances arise, some standardwill require offsetting when specific conditions are met. The otheraccounting policy the LabCo will change is the frequency ofreporting. The IFRS requirement is that an annual report of thefinancial progress be presented. However, some few companies wouldprefer the interim financial statements and the IFRS are sufficientlycompliant with it. The third area of change that labco will consideris the comparative information. In this, the IFRS requires that labcowill present comparative information about the preceding period forall the amount requires in the present time’s financial statements.Also, the comparative information shall be provided for a narrativeor descriptive information if there should be relevance inunderstanding the current time’s financial statements. IAS 1 alsorequires a third balance sheet when an entity applies for anaccounting policy retrospectively or when it regroups its items in afinancial statement[ CITATION USG l 2057 ].
Theother area that the labco construction contracting company would haveto change is the consistency of presentation. The IFRS has it thatall the presentation and the classification of the items inparticular financial statement is preserved from one period toanother unless for the case where it is apparent that by slightlychanging the operation of the entity or changing its financialstatement, another presentation would be better in regard to theselection and application criteria for the accounting policies [IAS8], or the IFRS requiring a change in performance. Finally, labcowill turn into a “going concern” in which the financial statementwill be presented in an ongoing concern basis.
ECAEW. (n.d.). IAS 8: Accounting policies, changes in accounting estimates and errors. Retrieved from ICAEW: http://www.icaew.com/en/library/subject-gateways/accounting-standards/ifrs/ias-08
Investopedia. (2015, Jan 7). What are the differences between the percentage of completion and the completed contract method? Retrieved from Investopedia: http://www.investopedia.com/ask/answers/101314/what-are-differences-between-percentage-completion-and-completed-contract-method.asp
USGAAPPlus. (n.d.). ASC 250 Accounting Changes and Error Corrections. Retrieved from Deloitte: http://www.iasplus.com/en-us/standards/fasb/presentation/asc250