When you’re studying IAS 11 Construction Contracts, if a loss is expected on the contract, the entire loss should be recognised immediately in the income statement. This is an application of the prudence concept under which anticipated losses are recognised immediately in the income statement.
This is also consistent with the terms of IAS 37 Provisions, Contingent Liabilities and Contingent Assets which requires losses on onerous contracts to be expensed in the period they become probable.
If the stage of completion method is calculated using the cost method, the cost incurred to date is recognised as the contract cost. Also recognise the entire net loss immediately in the income statement. Revenue is then calculated as the difference between the costs incurred and net loss.
If the stage of completion is calculated using the sales basis or physical proportions basis, the revenue is recognised to the work certified as complete. The entire net loss should be recognised immediately and the contract cost is calculated as the difference between revenue and the net loss.
Once this takes place, in the following periods the contract costs and revenue should be the same. This means no further profit or loss will be recorded, so long as estimates remain the same.
Step 1 – Calculate expected loss on contract
Compare the total expected contract costs against the contract value. This will give you an estimate of the expected loss which must be recognised in the period.
Step 2 – Calculate the stage of completion