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Profit on Construction Contracts

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          800,000Initial Contract Sum
Approved Variations          150,000Approved Contract Variations
Unapproved Variations            50,000Estimate of Unapproved Variations that will be accepted
Total Revenue       1,000,000
  
Costs
Costs Incurred to Date          500,000Actual costs incurred to date (materials, sub-contractors and wages)
Forecast Costs to Completion          300,000Estimate of costs to complete, including variations (materials, sub-contractors and wages)
Total Costs          800,000
  
Forecast Profit          200,000
Forecast Profit Margin20.0%Forecast total Profit margin
  
Costs incurred to date          500,000Actual Costs per Profit & Loss Statement (as above)
% Complete62.50%Percentage complete ($500,000 / $800,000 total cost estimate)
  
Total Revenue Expected       1,000,000As shown above
% Complete62.50%As shown above
Target Revenue FY17          625,000This is the revenue which should be recorded in the Profit & Loss, based on being 62.5% complete
  
Actual Amount Invoiced to date          550,000Actual Revenue in the Profit & Loss
Work in Progress (asset)            75,000WIP 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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