Deck 21: Accounting for Real Estate Development and Construction Contracts

Question 1

Sustainability Ltd is a property development company.It commenced a new project at the beginning of the year and had spent $5 million on the project by the end of the year.This was the only project on hand during this period and all borrowings were specifically for this project.The interest cost on borrowings was at an annual rate of 15%.Total interest costs incurred for the year were $850 000.Sustainability Ltd should include as part of the costs of the project,borrowing costs of:

A) $375 000
B) $425 000
C) $850 000
D) $ Nil

Answer 1

A

Question 2

During the year ended 30 June 20X0,Endurance Lands Ltd sold seven blocks of land for the following prices:
$$\begin{array}{l}\text { Blocks } 1 \text { and } 2 \quad \$ 50000 \text { each }\\\text { Blocks } 3 \text { to } 5 \quad \$ 56000 \text { each }\\\text { Blocks } 6 \text { and } 7 \quad \$ 62000 \text { each }\end{array}$$
The average cost of each of blocks 1 and 2 was $45 000 and of each of blocks 3 to 7 was $46 000.In early July 20X0,before the financial statements were completed,the purchaser of Block 3 was declared bankrupt and the contract for sale of the land was rescinded.Also in early July,the company agreed that the purchaser of Block 2 would pay half the purchase price immediately but could delay paying the other half until July 20X1.The total profit on the sale of land for the year ended 30 June 20X1 should be recorded as:

A) $62 000
B) $72 000
C) $57 000
D) $52 000

Answer 2

$62 000

Question 3

Under Australian Accounting Standard AASB 123 'Borrowing Costs',interest on borrowings should not be included as part of the cost:

A) of a building intended to be leased for use by others
B) of any asset
C) of land being held for future building purposes
D) of a building constructed for an entity's own use

Answer 3

C

Question 4

The completed-contract method for recognising profit on a construction contract will usually,during the life of a particular contract:

A) shows a higher amount in some years and a lower amount in other years for the asset 'construction-in-progress' than will the percentage-of-completion method
B) shows the same amount for the asset 'construction-in-progress' than will the percentage-of-completion method
C) shows a higher amount for the asset 'construction-in-progress' than will the percentage-of-completion method
D) shows a lower amount for the asset 'construction-in-progress' than will the percentage-of-completion method

Question 5

The 'area' method of allocating the costs of real estate developments to individual lots:

A) should be used where lots with the same area have similar expected values
B) should be used where all lots have the same, or very similar areas
C) is always the preferred method
D) should always be used for industrial land

Question 6

The percentage-of-completion method for recognising profit on a construction contract will usually:

A) show a higher profit in all years than will the completed-contract method
B) show a higher profit in some year(s) and a lower profit in some year(s) than will the completed-contract method
C) show a lower profit in all years than will the completed-contract method
D) show a lower profit in most years than will the completed-contract method

Question 7

Where possible when allocating the costs carried forward to individual components of a property development the following method should be used:

A) specific identification method
B) area method
C) value method
D) none of the above

Question 8

Using the percentage-of-completion method for recognising profit on a construction contract is advisable in situations where:

A) future costs are likely to fluctuate substantially
B) the ability of either party to the contract to satisfy the terms of the contract is unknown
C) the contract price is clearly specified in a non-cancellable contract
D) the percentage-of-completion method is not advisable in any of the above situations

Question 9

A property developer constructing a project for a client at a specified price can recognise revenues and profits:

A) on an instalment basis
B) when the final instalment is paid
C) at the point of sale
D) on a percentage-of-completion basis

Question 10

Real estate assets owned by a business should be classified:

A) as inventories
B) as either inventories or non-current assets depending on the purpose(s) for which they are held
C) in a separate classification for real estate only
D) as non-current assets

Question 11

In what circumstances should borrowing costs incurred in relation to real estate developments not be included as part of the cost of a development? Explain the reason(s)for not including borrowing costs for each of the circumstances you have listed.

Question 12

Justhouses Ltd is a property development company.By the beginning of this year it had already spent $600 000 on a development project and then spent a further $2 million during this year.Justhouses' total borrowing costs for this year were $250 000 on borrowings outstanding during the year of $4 000 000 and the interest rate on its latest borrowings is 10%.Justhouses should include as part of the total costs of the project for the year,borrowing costs of:

A) $ Nil
B) $125 000
C) $100 000
D) $200 000

Question 13

The completed-contract method for recognising profit on a construction contract is a conservative method of profit recognition because:

A) it results in construction costs being written-off as they are incurred
B) it does not anticipate profit
C) it recognises progress billings as revenue when the cash is received
D) all of the above

Question 14

At the end of 20X2 Bob the Builder had incurred costs of $2.5 million out of a total cost of construction estimated at $5 million.The fixed contract price is $7.5 million.Using the percentage of completion method provide the journal entries to record these transactions.Progress claims to date total $800 000.

A) $\begin{array} { l l } \text { A) Dr. Construction expenses } & \$ 2500000 \end{array}$
Dr. Construction in progress $\quad \$ 1000000$
Cr. Construction revenues $\quad\$ 3500000$
B)B) Dr. Construction revenues $\quad\$ 3500000$
$\begin{array} { l l } \text { Cr. Construction expenses } & \$ 2500000 \\ \text { Cr. Construction in progress } & \$ 1000000 \end{array}$
C) $\begin{array} { l l } \text { C) Dr. Cash at bank } & \$ 1000000 \\\text { Dr. Construction expenses } & \$ 2500000\\\text { Dr. Construction revenue } & \$ 3500000\\\end{array}$
D) $\begin{array} { l r l } \text { D) Dr. Cash at bank } & \$ 1800000 & \\\text { Cr. Construction revenue } & & \$ 1800000\end{array}$

Question 15

'To recognise assets and liabilities when a firm construction contract is signed would be inconsistent with the requirements of AASB 111'.Discuss this statement in reference to the framework.

Question 16

Explain the accounting procedure that should apply when a construction contract is expected to be completed at a loss.Use a simple numerical example to illustrate this procedure.How is this procedure affected if the completed-contract method is used for accounting for construction contracts rather than the percentage-of-completion method?

Question 17

AASB 111 'Construction Contracts' requires the use of the percentage of completion method when:

A) the outcome of the construction contract is relevant
B) the outcome of the construction contract can be easily recognised under the fair value method
C) the outcome of the construction contract can be estimated reliably
D) none of the above

Question 18

Under Australian Accounting Standard AASB 123,borrowing costs relating to the construction of an asset should cease to be recognised as part of the cost of that asset when:

A) the asset is substantially ready for its intended use or sale
B) the asset is finally sold
C) there are temporary interruptions to construction work caused by, for example, industrial action or supply shortages
D) any of the above conditions occur

Question 19

Compare and contrast the two types of contract distinguished by AASB 111,and provide an example of each.