Professional Documents
Culture Documents
Audit of Construction Industry: (Standard Industrial Classification)
Audit of Construction Industry: (Standard Industrial Classification)
Definition
Construction Industry pertains to the branch of manufacture and trade based on the building,
maintaining, and repairing structures which includes drilling and solid mineral exploration
(Standard Industrial Classification).
Categories
Building Construction Industry: All general contractors and operative builders primarily
engaged in the construction of residential, farm, industrial, commercial, or other buildings.
Heavy Construction Industry: All general contractors primarily engaged in heavy construction
other than building, such as highways and streets, bridges, sewers, railroads, irrigation
projects, and flood control projects and marine construction. This includes special trade
contractors primarily engaged in activities not normally performed on buildings, such as highway
grading or underwater rock removal. This does not include special trade contractors primarily
engaged activities performed on buildings.
Special Trade Construction Industry: All special trade contractors who undertake activities of
a type that are specialized either to building construction, including work on mobile homes, or
to both building and nonbuilding projects. This includes projects such as painting, electrical
work, plumbing, etc. This does not include activities specialized for heavy construction.
If a contract covers two or more assets, the construction of each asset should be accounted for
separately if (a) separate proposals were submitted for each asset, (b) portions of the contract
relating to each asset were negotiated separately, and (c) costs and revenues of each asset can
be measured. Otherwise, the contract should be accounted for in its entirety. (IAS 11.8)
Two or more contracts should be accounted for as a single contract if they were negotiated
together and the work is interrelated. (IAS 11.9)
If a contract gives the customer an option to order one or more additional assets, construction
of each additional asset should be accounted for as a separate contract if either (a) the additional
asset differs significantly from the original asset(s) or (b) the price of the additional asset is
separately negotiated. (IAS 11.10)
Application of Audit Risk Model to a Construction Contractor
Do all
Do all costs
modifications
reported for this job
included by the
Have contracts been represent
Existence client meet the N/A
properly segmented? capitalizable costs
GAAP
for this job and not
recognition
some other job?
criteria?
Has the client Have all elements
Have all
recognized all of future cost
capitalizable costs
Have contracts been modifications that been included in
Completeness associated with the
properly combined? meet the GAAP the estimate of
job been allocated
recognition costs to
to the job?
criteria? complete?
Audit planning is performed at two general levels. First, assess risk at the overall entity level.
Understand the contractor’s estimating process and how significant estimates are to the financial
statements. On a second level, assess risk at the individual contract level.
Audit of a Contractor’s Ability to Estimate
Control Environment
General audit manuals and the professional literature (in particular AU section 319) provide
broad guidance on assessing the control environment. The following are some considerations that
are unique for construction contractors:
Revenue Recognition
Allowed if contracts:
Are negotiated as package in same economic environment with an overall profit margin objective.
Constitute in essence an agreement to do a single project.
Require closely interrelated construction activities with substantial common costs that cannot be
separately identified with, or reasonably allocated to, the elements, phases, or units of output.
Are performed concurrently or in a continuous sequence under the same project management at
the same location or at different locations in the same general vicinity.
Constitute in substance an agreement with a single customer.
Segmentation of Project
Allowed if following steps are taken and are documented and verifiable
Contractor submitted bona fide proposals on separate components of project and on the entire
project.
Customer had the right to accept the proposals on either basis.
Aggregate amount of the proposals on the separate components approximated the amount of the
proposal on the entire project.
Several approaches to measuring progress on a contract can be grouped into input and output
measures. Input measures are made in terms of efforts devoted to a contract. They include
the methods based on costs and on efforts expended. Output measures are made in terms
of results achieved. They include methods based on units produced, units delivered,
contract milestones, and value added.
Acceptability of the results of input or output measures deemed to be appropriate to the
circumstances should be periodically reviewed and confirmed by alternative measures that
involve observation and inspection.
Estimated revenue from a contract is the total amount that a contractor expects to realize from
the contract. It is determined primarily by the terms of the contract and the basic contract price.
Contract price may be relatively fixed or highly variable and subject to a great deal of
uncertainty, depending on the type of contract involved.
Accounting for change orders depends on underlying circumstances, which may differ for each
change order depending on the customer, contract, and nature of the change. Change orders should
therefore be evaluated according to their characteristics and the circumstances in which they occur.
Practices in estimating total contract costs vary, and guidance is needed in this area because of
the impact of those practices on accounting. The following practices should be followed:
a. Systematic and consistent procedures that are correlated with the cost accounting system should
be used to provide a basis for periodically comparing actual and estimated costs.
b. In estimating total contract costs, the quantities and prices of all significant elements of cost
should be identified.
c. The estimating procedures should provide that estimated cost to complete includes the same
elements of cost that are included in actual accumulated costs; also, those elements should reflect
expected price increases.
d. The effects of future wage and price escalations should be taken into account in cost estimates,
especially when the contract performance will be carried out over a significant period of time.
Escalation provisions should not be blanket overall provisions but should cover labor,
materials, and indirect costs based on percentages or amounts that take into consideration
experience and other pertinent data.
e. Estimates of cost to complete should be reviewed periodically and revised as appropriate to
reflect new information.
The computation of income earned for Revisions in revenue, cost, and profit estimates
a period involves a determination of the or in measurements of the extent of progress toward
portion of total estimated contract completion are changes in accounting estimates
revenue that has been earned to date and, as such, should be accounted for in accordance
(earned revenue) and the portion of total with FASB Statement No. 154, Accounting Changes
estimated contract cost related to that and Error Corrections—a replacement of APB
revenue (cost of earned revenue). Opinion No. 20 and FASB Statement No. 3.
Transition
Questions
1. What are the methods of measuring extent of progress towards completion of a project?
a. cost-to-price, variations of cost-to-price, efforts expended, units of delivery, units of work
performed
b. cost-to-cost, variations of cost-to-cost, efforts expended, units of delivery, units of work
performed
c. cost-to-cost, efforts expended, units of delivery, units of work performed
d. cost-to-cost, variations of cost-to-cost, efforts expended, units of completion, units of work
performed
2. The completed-contract method is preferable when which of the following conditions exists?
I. The results would not vary materially from use of the percentage of completion method
II. Lack of dependable estimates or the existence of inherent hazards cause forecasts to be doubtful
a. I only
b. II only
c. Either I or II
d. Both I and II
4. For long-term construction contracts, what journal entry records construction costs?
a. Work in Progress xx
Cash (and/or Accounts Payable) xx
b. Cost of Construction xx
Construction in Progress xx
c. Construction in Progress xx
Cash (and/or Accounts Payable) xx
d. Construction Expenses xx
Cash (and/or Accounts Payable) xx
Accounting in the construction industry is unlike most other industries. Accounting for
construction industry uses “Construction in progress” account to keep track of construction costs.
The CIP account is basically just an account (with a normal debit balance) for recording all the
different expenditures that will occur during a construction project.
5. The PoC method is best practice when which of the following conditions exist:
I. Reasonably dependable estimates can be made
II. The contract clearly specifies the enforceable rights of both the contractor and the buyer, the
consideration to be exchanged, and the manner and terms of settlement
III. The buyer can be expected to satisfy its obligations under the contract
IV. The contractor can be expected to perform its contractual obligations
a. I & II only
b. I, II, III
c. I, II, IV
d. I, II, III, IV
The Accounting Standards Executive Committee believes that in general when estimates of
costs to complete and extent of progress toward completion of long-term contracts are reasonably
dependable, the percentage-of-completion method is preferable. When lack of dependable
estimates or inherent hazards cause forecasts to be doubtful, the completed-contract method is
preferable. Disclosure of the method followed should be made. While the rest of the statements are
conditions for both methods.