Success with long-term contracts

One of the major accounting issues for companies involved in the Construction industry is the basis on which long term contracts are accounted for.

If a contract is to run 18-24 months and have a lead in of 12 months before it actually starts, the revenue has to be calculated over three to four financial accounting periods.

Accounting standard FRS102 (Financial Reporting Standard) defines the basis for the preparation of accounts.

Paragraph 23.14 of the FRS102 report states that “when the outcome of a transaction can be estimated reliably, an entity shall recognise revenue associated with the transaction by revenue, to the stage of completion.”

If you recognise revenue you naturally recognise the associated costs.

There are 4 conditions:

  1. Revenue to be measured reliably
  2. Economic benefits to flow to the entity
  3. The stage of completion can be measured reliably
  4. The costs incurred and the cost to complete can be measured reliably

Measuring performance

The objectives of a Financial Director (FD) and a Project Manager (PM) should be aligned because they both have the common interest in seeing
the successful outturn of a project, on time, and within budget.

Generally, a project will have its unknowns and specific areas of risk – for example, dependence on third parties, the weather, etc.

Making progress

Monthly progress reports prepared by the PM will be valuable data for an FD. These should show:

  • stage of completion
  • costs to complete vs. revenue to complete
  • variation and expected outcome on those not agreed
  • potential upsides vs. potential downsides

This will help FDs to avoid recognising revenue on contracts where variations have not been agreed.

Safeguarding

Additional ways to mitigate potential risks also include:

  • Apply financial rigor to key estimates and judgements throughout the project.
  • Formulate specific project cashflows from the start, and update regularly to allow for true contingencies
  • Form strong delivery teams, where the FD. PM and other professionals work together in a collegial manner.

Read more in Issue 16 of our newsletter Real Estate Matters.

Read Real Estate Matters Issue 16

For further information or advice, please get in touch with a member of our Construction and Real Estate Team on 01903 234094.