Profit on Construction Contracts

• Accounting
• Managing a Business

We work with a large number of construction businesses and we always find major variations in the treatment of Work in Progress. To assist in clarifying the best accounting methodology, which is supported and accepted by the Tax Office, we outline below the ‘Estimated Profits Approach”. Calculating the profit on a construction project at each month-end.

The Estimate Profits Approach uses the expense as the method to determine the percentage complete of the project. The actual costs incurred to date divided by the total project cost provides the percentage complete.

The percentage complete is then multiplied by the total expected revenue, to result in the revenue which should be recognised in the Profit and Loss Statement. If the actual revenue is higher or lower, then an adjustment is required to make the revenue equal the required revenue.

If Revenue needs to be increased, this is reflected as a Work in Progress asset account. If Revenue needs to be decreased, this is recognised as an Unearned Revenue liability account.

Outlined below is an example of how we calculated the Work in Progress adjustment at month-end:

Revenue	$	Notes
Initial Contract Value	800,000	Initial Contract Sum
Approved Variations	150,000	Approved Contract Variations
Unapproved Variations	50,000	Estimate of Unapproved Variations that will be accepted
Total Revenue	1,000,000
Costs
Costs Incurred to Date	500,000	Actual costs incurred to date (materials, sub-contractors and wages)
Forecast Costs to Completion	300,000	Estimate of costs to complete, including variations (materials, sub-contractors and wages)
Total Costs	800,000
Forecast Profit	200,000
Forecast Profit Margin	20.0%	Forecast total Profit margin
Costs incurred to date	500,000	Actual Costs per Profit & Loss Statement (as above)
% Complete	62.50%	Percentage complete ($500,000 / $800,000 total cost estimate)
Total Revenue Expected	1,000,000	As shown above
% Complete	62.50%	As shown above
Target Revenue FY17	625,000	This is the revenue which should be recorded in the Profit & Loss, based on being 62.5% complete
Actual Amount Invoiced to date	550,000	Actual Revenue in the Profit & Loss
Work in Progress (asset)	75,000	WIP adjustment to increase Revenue from $550,000 to $625,000

If the project is estimated to make a loss, the entire loss must be recognised as an expense immediately, rather than spread over the life of the contract.

The above approach is consistent with AASB 111: Construction Contracts and is accepted by the ATO in TR2017/D8 Income Tax: Tax Treatment of Long-Term Construction Contracts (and previously IT 2450 withdrawn).

If you feel your construction business could use some advice or assistance, please do not hesitate to get in contact.