Accounting for long term contracts
Construction type companies are subject to a special accounting standard called IAS 11 (see http://www.ifrs.org). This standard specifies how construction companies deal with revenues and costs associated with contracts in their published accounts. What’s the problem you might ask? Why a special standard? The problem is that construction or similar contracts often span multiple accounting periods. If too much revenue is recorded early, profits might be inflated incorrectly. And, if costs are recorded too early, profits might look much lower than they should be. So, IAS 11 says what is allowed and not allowed. In a nutshell, losses must be included in accounts immediately; profits should be reported only when certain and in proportion to the completion of a contract. A recent news article in the Telegraph highlights one UK company (Connaught Group) that may be incorrectly applying the standard – you can read it here – to long term social housing maintenance contracts.
In fact, IAS 11 applies two basic accounting concepts. First is applies the prudence concept, as losses are to be recognised straight away and profits only when reliable estimates are possible. It also applies the accruals concept, which means that revenues and costs should be matched against each other as evenly as possible over time.