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.
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