ABC Ltd (“ABC”) entered into a contract on 1st January 20x6 tobuild a factory building for its customer on its customer’s landfor $20 million. The completion is expected to be in two years’time. ABC’s policy is to bill its clients based on 60% in the firstyear and the balance upon completion of the project. ABC has a 31stDecember financial year end. It has adopted FRS 115 Revenues fromContracts with Customers and adopts the input method to measure theentity’s progress towards the complete satisfaction of theperformance obligations.
At the end of 20x6, ABC has incurred actual costs of $10 million onthe construction project. The estimated costs that are required tocomplete the project was $6 million. Actual collections in 20x6amounted to $10.5 million.
In 20x7, a modification to the contract was required. To complywith new safety regulations, the concrete flooring was to bereinforced with steel. An electronic gantry and carpark structureswere also added to the existing open-air carpark area.
The contract was increased by $5 million for the reinforcedconcrete flooring and $1 million for the car-park structures. Theadditional expected costs for the reinforced flooring was $2million and the car park structure was $800,000. The commencementof work was to start in 20x8 and the completion date is expected tobe extended for an additional year in 20x8. Billings for theadditional contract price will be done in 20x8.
At the end of 20x7, the actual costs incurred and paid was $8million, fully attributable to the construction of the factorybuilding. An estimated cost of $5 million is further required tocomplete the factory building and $800,000 for the car-park. $8million were invoiced as per the original plans, and actualcollections during the year amounted to $9.5 million.
At the end of 20x8, the contracts were completed. The actual costsincurred and paid during 20x8 were as estimated during themodification agreement. A final billing of $6 million was made andactual collections amounted to $4.5 million.
Required:
(a) Discuss revenue recognition under FRS 115 Revenues fromcontracts with customers in view of its application to constructioncontracts. Please include in your discussion the costs that goesinto a construction contract and the issues involved.
(b) Discuss also the impact of modifications, common reasons formodifications and how modifications are treated. Explain how themodification of the contract to change the flooring and addition ofthe car park structure should be treated under FRS 115 Revenuesfrom contracts with customers.
(c) Compute the revenues, expenses and profits to be recognised foreach financial year ending 31st December 20x6, 20x7 and 20x8.Illustrate the accounting for this contract by preparing thenecessary journal entries to record the relevant transactions for20x6 and the final entry to record the completion of the project.Journal narratives are not required. (Answers may be rounded to thenearest thousand dollars).
