Construction in Progress Journal Entry
The accounting for construction in progress is the process the company keeps a record of the construction cost of the non-current asset. If the company constructs assets for the client, they have to properly record the revenue as well.
The construction in progress can be complex, but it is essential for accurate financial reporting. Once the construction begins, those costs must be reclassified as “work in progress”. This can be done by a variety of methods, but the most common is to use the percentage of completion method. This method involves estimating the percentage of work that has been completed at the end of each reporting period and then recognizing that amount of revenue and expense.
While accounting for construction in progress may require a lot of work, it is important to remember that accurate financial reporting is essential to the success of any business. By taking the time to properly account for all costs associated with a construction project, businesses can ensure that they are making informed decisions about where to allocate their resources.
The construction in progress is very important for the company that constructs the fixed assets for their own use such as buildings, warehouses, and other buildings. Moreover, it also applies to the construction contractor who builds the assets for their client.
IAS 11 Construction in Progress
When it comes to construction contracts, it’s important to understand that each asset is treated as a separate contract if specific conditions are fulfilled. This means that if a construction contract relates to two or more assets, each asset will be treated as a separate contract.
Two assets are considered as one contract unless they are negotiated as a single deal. The construction of all assets will be made together.
The IAS 11 regulation on construction contracts is an important step toward ensuring that companies are financially responsible for their projects. It dictates how revenues and expenses should be allocated among different stages of work, as well as which items arise from a particular contract type. Construction Contracts are crucial pieces in understanding company finances because it determines what income comes from them while also deciding when cost recoveries occur.
What is construction in progress?
Construction in progress refers to all the costs that company spends to build the non-current assets but not yet completed.
Construction in progress includes all the costs that company spends such as material, labor, and others. The company cannot record them as expenses as they are part of the assets. They cannot capitalize on the fixed assets as well, the construction is not yet finished, so the total cost is also not yet measure reliable.
The company should record it as assets on the balance sheet. Its category is the construction in progress under the fixed assets group. These assets will be reversed to the actual fixed assets when the construction is finished and total costs are measured reliable.
What is included in contract revenue and costs?
When considering revenue for a construction contract, it is important to include the amount agreed in the initial contract, plus revenue from alternations in the original contract work, plus claims and incentive payments that may be due.
All of the components must be measured reliable which enables the accountant to record them into the financial statement.
This will give you the most accurate picture of the potential revenue for the project. It is also important to keep in mind that there may be some costs associated with these revenue streams, such as the cost of materials or labor for the original contract work or alternations.
However, these costs should be offset by the revenue generated from the contract. Ultimately, including all potential sources of revenue will give you the best chance of accurately predicting the financial outcome of your construction project.
In order to ensure that a contract is cost-effective, it is important to include all relevant costs in the calculation. Direct costs are those that can be attributed directly to the specific contract, and these should always be included. Indirect costs are those relating to the contractor’s general contracting activity, and these can often be reasonably allocated to the contract in question.
Finally, there may be other costs that can be specifically charged to the customer under the terms of the contract – these should also be taken into account. By taking all of these factors into consideration, it is possible to develop a clear picture of the true cost of a contract and ensure that it represents good value for money.
Accounting for Construction in progress – Percentage of Completion
The percentage of completion method is an accounting technique used to estimate the revenue and costs associated with a construction contract. Under this method, revenue and costs are recognized in proportion to the stage of completion of contract activity.
This approach is based on the premise that if the outcome of a contract can be estimated reliably, then it is possible to allocate revenue and costs according to the work that has been completed.
There are a number of benefits to using this method, including improved accuracy and transparency. In addition, it provides a more accurate picture of a company’s financial position as construction projects progress. However, there are also some drawbacks to using this technique, including the need for well-trained staff and the potential for errors.
Overall, the percentage of completion method is a useful tool for managing construction contracts and estimating revenue and costs.
If the outcome of a contract cannot be estimated reliably, then no profit should be recognized. This is because recognizing profit would give a misleading picture of the contract’s true financial status. Instead, contract revenue should only be recognized to the extent that contract costs are expected to be recoverable. Contract costs should be expensed as they are incurred. This approach may not always result in the highest reported profits in the short term, but it should give a more accurate picture of a contract’s true financial position over time.
Percentage of Completion Methods
To calculate the percentage of completion, the company may use different methods as follows:
- Cost-to-Cost Method:
It is the comparison between cost incurred and the total cost to complete the construction. If the company has properly estimated the total cost of construction, they will be able to get the percentage of completion. It is the percentage of cost incurred over the expected total cost.
Company can use this percentage to estimate the work completion and record the revenue. If it is an old project from prior years, we need to exclude the cost that incurs in previous years. Only new costs are included in the calculation.
- Efforts-expended method
Similar to the cost-to-cost method, this method tries to estimate the percentage of completion based on the work performed. But instead of the total cost, they trace the other parameter such as labor hours, machine hours, and units of materials.
The concept is similar, we calculate the percentage from the incurred unit and compare it with the total unit expected. It is more accurate than the cost as it may be impacted by other factors such as inflation and price increase.
- Units-of-delivery method
In this method, the construction will be split into smaller jobs. Each small job will be considered as finished only after they are delivered to the customers. It requires the company to separate the work into small units which are not practical for all construction.
Journal Entry for Construction in Progress
During the construction, company needs to record revenue, expense and accounts receivable. All of these accounts will depend on the percentage of completion.
Revenue
The company’s record revenue depends on the total construction revenue multiplied by the percentage of completion. It will reflect the company’s performance during the accounting period. If the company has made huge progress, they will record the revenue base on the actual result as well.
On the other side, the transaction will impact the accounts receivable as the customers may not yet make payment. The progress of payment will depend on the contract which may be related to the specific result.
The journal entry is debiting unbilled accounts receivable and credit construction revenue.
| Account | Debit | Credit |
|---|---|---|
| Unbill Accounts Receivable | $$$ | |
| Construction Revenue | $$$ |
We used the unbilled accounts receivable account to prevent confusion with the bill receivable which represents the amount we already bill to customers.
Expense
Similar to revenue, the expense will be recorded based on the total cost of construction multiplied by the percentage of completion. It is to ensure the same proportion of expense is recorded and it will comply with the matching principle as well. The company will not be able to over or under-record the expense on income statement.
Most of the time, company record the expense base on the actual cost and they use the cost estimate as the percentage of completion. After that, they use the percentage to estimate the revenue.
The other side of the transaction will impact the cash or accounts payable balance. It will depend on the nature of purchase that which company has with the suppliers.
The journal entry is debiting expense and credit cash/accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Construction Cost | $$$ | |
| Cash/Accounts Payable | $$$ |
