Miscellaneous Account

CONTRACT ACCOUNT

INTRODUCTION

For many businesses, revenue and costs are easily divisible into 12months accounting period. For example, a retailer will recognize revenue when realized throughout the year, and match costs in accordance with accruals concept. For some businesses, however, traditional revenue recognition method (i.e. ‘show revenue when realised’) are not applicable. Many such organizations are in the construction industry and their business dealings involve contracts that are usually long term in nature or span at least one accounting year end.

For example, a contractor has just won the bid to build a new stadium in Ikorodu. Work will commence on 1 January 2010 and it is anticipated that the stadium will be completed on 31 December 2012. If this type of contract were treated as a normal sale of goods, then revenue and profit will not be recognized until the project will be completed at the end of the third year. This is known as the completed contracts basis and it is an application of prudence, where profit should not be anticipated.

It can be argued that recognizing the revenue at the end of the project would not faithfully present the situation under the construction contract, as in reality the revenue has been earned over the three year period and not just when the stadium is completed. The problem with this type of industry, therefore, is to determine at what point revenue and costs should be t recognized. For these businesses, the difficulties of accounting for both revenue and costs are remedied by SAS 5 (Contract).

Therefore, contract account can be defined as the account of companies engaging in long term construction contract such as building and civil engineering project which has execution period that is more than one year.

FEATURES OF LONG TERM CONTRACT

1. A formal contract is made between the contractee and the contractor.

2. Work is undertaken to customer (contractee) special requirement.

3. The work is frequently site based

4. The jobs carried out is constructional in nature

5. Work is for relatively long duration

6. A contract includes clauses for penalty for delayed completion and bonus for early completion.

DEFINITION OF TERMS

1. CONTRACT PRICE: This is the price agreed between the contractor and contractee on the contract. The price is usually binding until work is certified by the architect / engineer.

2. PROGRESS PAYMENT: The contract normally provides for the client to make payment either at specific stages