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Q: Valuing Contracts on a Company's Balance Sheet ( Answered,   0 Comments )
Question  
Subject: Valuing Contracts on a Company's Balance Sheet
Category: Business and Money > Accounting
Asked by: esher-ga
List Price: $200.00
Posted: 01 Feb 2006 04:48 PST
Expires: 03 Mar 2006 04:48 PST
Question ID: 440015
I am looking for examples of UK public companies that place the value
of long term contracts (I.e. more than 12mths) on their balance sheet
as a long term asset. i.e. if a company knows it is going to make 5m
absolute minimum from a contract it should under uk accounting
principals recognise this on the balance sheet as a long term asset.
Can you proivide me some real world examples of this (direct link  to
the annual report and if possible note that handles it)  ideally 5.
The sector they are in is not important.

Request for Question Clarification by pafalafa-ga on 01 Feb 2006 09:19 PST
esher-ga,

I have been able to find UK company annual reports that make mention
of the value of long-term contracts.

But it's much harder (especially given my familiarity with US, but not
UK, financial reporting) to actually pinpoint the places in the
balance sheets that actually include the value of the contracts as an
asset.


For instance, here are a few excerpts from the most recent annual
report of Balfour Beatty:

--b) On 6 August 2004 the Group acquired from the Skanska Group its 50%
shareholdings in each of Gammon China Ltd, Gammon Asia Ltd and
Gammon Construction Holdings Ltd (the ?Gammon Skanska Group?)
for a total consideration of HK$475m (33m) in cash and costs of 1m.
The Group?s share of the book value of net assets acquired was 27m.
Provisional fair value adjustments amounting to 14m have been made to
harmonise accounting policies for income and profit recognition on long-term
contracts and the cost of pension obligations...


--Reliable earnings growth is underpinned by long-term alliance
contracts. We already have many such contracts and have won more
in 2004, including a 400m, five-year project to manage and maintain
motorways and trunk roads in south-west England and a five-year
contract likely to be worth approximately 500m for rail renewals on
the mainline network. Early in 2005, we secured a 380m contract
to work with National Grid Transco in replacing the gas mains in
Greater Manchester over the next eight years.

--g) Profit recognition on contracting activities
Profit on individual contracts is taken only when their outcome can be foreseen
with reasonable certainty, based on the lower of the percentage margin earned
to date and that prudently forecast at completion, taking account of agreed
claims. Full provision is made for all known or expected losses on individual
contracts, taking a prudent view of future claims income, immediately such
losses are foreseen. Profit for the year includes the benefit of
claims settled on contracts completed in prior years.


--Pre-contract costs are expensed as incurred until it is virtually
certain that a contract will be awarded, from which time further
pre-contract costs are
recognised as an asset and charged as an expense over the period of the
contract. Amounts recovered in respect of costs that have been written off
are deferred and amortised over the life of the contract.


--Stocks and unbilled contract work in progress are valued at the lower of
cost and net realisable value. Cost, where appropriate, includes a proportion
of manufacturing overheads. Applications for progress payments are
deducted from cost, with any excess included in other creditors as advance
progress applications.




Some balance sheets entries appear to have relvant information, but
I'm not especially well-versed in interpreting them.  For instance,

==========

                           Group   Group  Company  Company
                           2004    2003   2004     2003
                                   (millions of )

Contract work in progress   189     174    ?        ?
Progress applications      (116)    (96)   ?        ?

==========


Please let me know, a bit more precisely, which (if any) of the above
information is useful to you, and I'll see if I can find a five
companies to meet your needs.

Cheers,

pafalafa-ga

Clarification of Question by esher-ga on 01 Feb 2006 10:52 PST
the extract "g" is fairly useful. I'd suggest looking at Uk hotel and
airport companies as these are close to our business and are dependent
upon contracts for long periods i.e. 10-100years. For instrance does a
hotel company which MANAGES (as opposed owns directly) a hotel on
behalf of another (property/investment) company typically place the
minimum expected annual earnings and liabilities  of the contract on
the balance sheet at the point of winning it? If so presumeably these
future cash flows will be discounted to present value by a suitable
risk factor.

hope that helps

Request for Question Clarification by pafalafa-ga on 01 Feb 2006 19:42 PST
esher-ga,

I've continued looking into this, and now have a bit more context for
the question (and hopefully, for the answer as well).

In the course of my work, I've come across some sources of information
that -- while not annual reports -- are certainly germane to the topic
at hand.  I wonder if they might be of interest as well?

Here is one example of what I mean:


http://www.pkf.co.uk/web/pkf800.nsf/pagesbyID/ID3C50F2C623F7572F80256F01004A9D6B?OpenDocument
Who's afraid of Application Note G ? Revenue and profit recognition
for professional firms



What do the accounting rules require?

Historically, revenue recognition by professional firms has been
governed by SSAP 9 'Stocks and long-term contracts' which sets out how
to account for long-term contracts. These are defined as contracts
which span a year-end and are sufficiently material that not to record
turnover and attributable profit would lead to a distortion of the
accounts.

Where a professional service contract is determined to be long-term,
the activity within the year, measured by reference to the time costs
incurred, should be recognised as revenue at its estimated net sales
value. Note that this may include equity partner time. Where the
outcome can be assessed with reasonable certainty, prudently
calculated profit should also be recognised in the profit and loss
account as the difference between the reported turnover and related
costs charged. On the balance sheet, the amount by which the turnover
exceeds the amount billed at the year-end should be shown as a debtor.

...These rules are summarised in the decision tree shown in figure 1.

==========


Let me know if this sort of document is of interest at all.


Thanks,

paf

Clarification of Question by esher-ga on 02 Feb 2006 03:05 PST
that article nails it perfectly! please submit as an answer. nice job.
Answer  
Subject: Re: Valuing Contracts on a Company's Balance Sheet
Answered By: pafalafa-ga on 02 Feb 2006 04:25 PST
 
esher-ga,

It's always great to hear that word, 'perfectly!'...Thanks a lot.


Just to make it formal, here again is the material from above:



==========

http://www.pkf.co.uk/web/pkf800.nsf/pagesbyID/ID3C50F2C623F7572F80256F01004A9D6B?OpenDocument
Who's afraid of Application Note G ? Revenue and profit recognition
for professional firms



What do the accounting rules require?

Historically, revenue recognition by professional firms has been
governed by SSAP 9 'Stocks and long-term contracts' which sets out how
to account for long-term contracts. These are defined as contracts
which span a year-end and are sufficiently material that not to record
turnover and attributable profit would lead to a distortion of the
accounts.

Where a professional service contract is determined to be long-term,
the activity within the year, measured by reference to the time costs
incurred, should be recognised as revenue at its estimated net sales
value. Note that this may include equity partner time. Where the
outcome can be assessed with reasonable certainty, prudently
calculated profit should also be recognised in the profit and loss
account as the difference between the reported turnover and related
costs charged. On the balance sheet, the amount by which the turnover
exceeds the amount billed at the year-end should be shown as a debtor.

...These rules are summarised in the decision tree shown in figure 1.

==========

Let me know if there's anything else I can do for you on this one.


paf



search strategy -- Searched UK company annual reports for terms
related to [ long term contracts ], and also searched Google for [
"profit recognition" site:uk ]
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