Question

b) Dollah Construction Berhad agreed to construct a building where the contract price was RM50 million and the estimated total costs were RM46 million. By the end of the first year, 40% of the work was completed. Required: i) Determine the gross profit recognised in the first year. (6 marks) (CLO2:PLO2:C2) ii) If the contract yields a loss of RM5 million, how would the company recognise the total loss? (2 marks) (CLO2:PLO2:C3) iii) What is contract revenue and how Dollah Construction recognised its revenue and profit for the contract? (5 marks) (CLO2:PLO2:03)

Answer 1

(i) If a profit is expected under the contract, revenue and costs (and hence profit) are to be recognized in the income statement based on the Stage of Completion of the contract (also known as Percentage of Completion Basis).

Hence the gross profit for the first year will be RM2.4 million [(50 million-46 million)*40%]

(ii) If a loss is expected in respect of a construction contract, the entire loss is recognized immediately in the income statement.This is an application of the Prudence Concept under which anticipated losses are recognized immediately in the income statement. This accounting treatment is also consistent with GAAP which requires unavoidable losses in respect of onerous contracts to be expensed in the accounting period in which such losses become probable.

If stage of completion is calculated using cost method, then cost incurred to date is recognized in the income statement as contract cost. Entire net loss is recognized immediately in the income statement and revenue is calculated as the difference between costs incurred and net loss. If stage of completion is calculated using value method, then revenue is recognized according to the work certified as complete. Entire net loss is recognized immediately and contract cost is calculated as the difference between revenue and net loss.

Thus, the company would immediately recognize the entire loss of RM 5 Million.

(iii) Contract revenue should include the amount agreed in the initial contract (RM50 million), plus revenue from alternations in the original contract work, plus claims and incentive payments that (a) are expected to be collected and (b) that can be measured reliably

Contract revenue should be recongnized in proportion to the percentage of work completed which should be RM20 million (50 million*40%)

If the outcome of a construction contract can be estimated reliably, revenue and costs should be recognised in proportion to the stage of completion of contract activity. This is known as the percentage of completion method of accounting making the gross profit for the first year to be RM2.4 million [(50 million-46 million)*40%]