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performance bond treatment - dew - 04-22-2010
I would like to know the accounting treatment of cashing in a performance bond based on terms of contract in case of default.
The current contractor has defaulted the contract and has been kicked out therefore the organization has cashed it's performance bond. The contract states that in case of default the contractor is obliged to cover all the costs incurred to complete the project and the organization has the right to appoint a new contractor to complete the project. Therefore should the performance bond be treated as revenue or as reimbursement to the project in order to cover for any deficit?
- ciapk - 04-30-2010
Dear,
As per para 22 of IAS -18 Revenue is recognised only when it is probable that the economic benefits associated with the transaction will flow to the entity. However, when an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible amount, or the amount in respect of which recovery has ceased to be probable, is recognised as an expense, rather than as an adjustment of the amount of revenue originally recognised.
During the early stages of a transaction, it is often the case that the outcome of the transaction cannot be estimated reliably. Nevertheless, it may be probable that the entity will recover the transaction costs incurred. Therefore, revenue is recognised only to the extent of costs incurred that are expected to be recoverable. As the outcome of the transaction cannot be estimated reliably, no profit is recognised.
When the outcome of a transaction cannot be estimated reliably and it is not probable that the costs incurred will be recovered, revenue is not recognised and the costs incurred are recognised as an expense. When the uncertainties that prevented the outcome of the contract being estimated reliably no longer exist, revenue is recognised in accordance with paragraph 20 rather than in accordance with paragraph 26 of IAS-18.
So, recognize it as revenue if amount of performance bond has been held by the company after taking legal opinion that actually the contractor has failed to perform his contract.