G Ltd is a company specialising in the construction of sophisticated items of plant and machinery for clients in the engineering industry. Details of two contracts outstanding at 30 September 1995 (the balance sheet date) are as follows:

Contract with H Ltd This contract was started on 1 January 1995 and is expected to be complete by 31 March 1996.

The total contract price was fixed at £20 million and the total costs to be incurred originally estimated at £15 million, occurring evenly over the contract. The contract has been certified by experts as being 60% complete by 30 September 1995. Due to inefficiencies caused by industrial relations difficulties in the summer of 1995, the actual costs incurred on the contract in the period 1 January 1995 to 30 September 1995 were £10 million. However, the management is confident that these problems will not recur and that the remaining costs will be in line with the original estimate. In accordance with the payment terms laid down in the contract, G Ltd invoiced H Ltd for an interim payment of £10 million on 31 August 1995. The interim payment was received from H Ltd on 31 October 1995.

Contract with I Ltd This contract was started on 1 April 1995 and was expected to be complete by 31 December 1995. The total contract price was fixed at £10 million and the total contract costs were originally estimated at £8 million. However, information received on 15 October 1995 suggested that the total contract costs would in fact be £11 million. The contract was certified by experts as being two-thirds complete by the year end and the costs actually incurred by G Ltd in respect of this contract in the period to 30 September 1995 were £7.5 million. No progress payments are yet due under the payment terms specified in the contract with I Ltd.

Requirements

(a) Explain the principles which are used to establish the timing of recognition of profits/losses on long-term contracts.

You should assume that recognition of profits/losses takes place in accordance with the provisions of SSAP 9 Stocks and long-term contracts, and should refer to fundamental accounting concepts, where relevant. (10 marks)

(b) Compute, separately for each of the contracts with H Ltd and I Ltd:

(i) The amount of turnover and cost of sales that will be recognised in the profit and loss account of G Ltd for the year ended 30 September 1995.

(ii) The contract balances (including nil balances, if appropriate) that will be shown at 30 September 1995 on the following accounts:
● long-term contract work-in-progress ● amounts recoverable on contracts ● provision for losses ● trade debtors. (10 marks)
CIMA, Financial Reporting, November 1995 (20 marks)