Question 13.A.5: A building has now been under construction for three years. ...
A building has now been under construction for three years. It is expected to be completed in two years’ time. The agreed contract price is £500,000. The costs to date are £300 000 and it is expected that another £100 000 will be spent on the building before it is completed.
What profit would you include in the profit and loss account for Year 3?
The expected profit on the contract is now £100 000 [£500 000 – (300 000 +100 000)].
Depending upon a review of the expected outcome, it might be appropriate to claim some profit on account. One way would be to apporption the expected profit on the basis of costs incurred to date as a proportion of the total cost. This would give a profit of £75 000 for Year 3 (£100 000 × 300 000/400 000). However, as the contract is only 60% through it life, some accountant might reduce this by an arbitrary factor of 2/3.
The profit taken would then be £50 000 (£75 000 × 2/3). This is a normal accounting approach to the problem of revenue/profit recognition on contract work. But notice how judgemental the whole exercise appears to be.