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RECTIFICATION COSTS
Sometimes mistakes happen and the entity will have to incur costs to put mistakes right. These are referred to as rectification costs and should be written off to the statement of comprehensive income as soon as they are incurred.
Tania Ananda Mahdani (023113004) It is probable that economic benefits will flow to the entity. The contract costs attributable to the contract, whether or not reimbursable, can be identified and measured reliably. Note : all conditions above must be satisfied.
Solution The statement of comprehensive income will include $800 worth of contract
Tania Ananda Mahdani (023113004) revenue. The loss is estimated to be $1,000 so cost of sales will be $1,800 to generate the required loss (i.e. a balancing figure). This method is used because IAS 11 says that losses must be recognised in the statement of comprehensive income as soon as they are foreseen. Worked Example We shall look at a worked example of how IAS 11 works as follows: Leah Inc reports under IFRS and is preparing their financial statements for the year ended 31 March 2009. On 1 October 2008 Leah Inc commenced work on a contract. The price agreed for the contract was a fixed price of $50 million. Leah purchased plant at a cost of $15 million exclusively for use on the contract. The directors of Leah Inc have estimated that the plant will have no residual value at the end of the contract which is due to finish on 30 September 2009. Costs incurred on the contract plus estimated costs to complete are as follows:
All the costs which have been incurred to date have all been debited to the Contract Account in the general ledger. Leah Inc have appointed an agent who has confirmed that at the reporting date (31 March 2009), the contract was 40% complete at which point the customer made a progress payment amounting to $15 million. The finance department have credited this progress payment to the contract account. There have been no other entries made in respect of this contract. Required Show how the contract should be accounted for under the provisions of IAS 11 Construction Contracts in the financial statements of Leah Inc for the year ended 31 March 2009. Solution Step 1 The overall revenue for the contract amounts to $50 million (the fixed price agreed). Step 2 We know that Leah has incurred the following costs and has made estimates of
As costs are less than total revenue we know the contract is going to make a profit of ($50 million less $44 million) = $6 million. Step 3 The agent has confirmed the contract is 40% complete so we take 40% of the total costs to cost of sales in the income statement. We then add 40% of the expected revenue to revenue in the statement of comprehensive income. Financial Statements (extracts) Revenue (40% x $50 million) $20,000 Cost of Sales Construction contract (40% x $44 million) ($17,600) Step 4 We then need to work out how much should be shown in the statement of financial position as Gross Amounts due from Customer. We need a working for this: Working : Gross Amounts Due from Customer
The gross amount due from customer can be shown as an other current asset in the statement of financial position.