If the contract is a fixed price and is expected to make a profit; the steps to follow for IAS 11 are as follows:
Step 1 – Calculate the total profit expected on the contract
This is calculated by deducting the total contract value from the expected contract costs.
Step 2 – Calculate the state of completion
As noted earlier, stage of completion can be calculated either using:
- Costs basis
- Sales basis
- Physical proportions
Step 3 – Determine amounts to be recognised in income statement
Once the stage of completion is calculated, calculate revenue based on the stage of completion multiplied by the contract value. Then calculate the profit to recognised by multiplying the stage of completion by the expected profit. The balancing figure will be the contract cost to recognise in the period.
Don’t double count.
When you’re calculating the figures to use for revenue and costs, make sure you deduct any previous amounts already recognised in earlier financial statements.
So if a company was 40% of the way through the contract last year, and is 70% through at the end of this year, only recognise the revenue and costs on the basis of the 30% of the contract carried out this year.
Step 4 – Calculate receivables/payables
Once you know the stage of completion, the revenue recognised should be the amount of progress payments billable on the contract. Compare this to the amount of progress payments actually received by the customer.
This will show you if there’s a receivable or payable to the customer in relation to the contract.