Long-term contract

What it means

A long-term contract is a job that starts in one accounting period and finishes in another. Typical examples are construction, bespoke machinery, large software projects and refurbishments. The accounting question is when to recognise revenue and profit from work lasting more than a year.

If revenue were booked only at handover, the company would show nothing but costs and a loss in the first year and the whole profit in the second. That would distort both the result and taxes. Under the accrual principle, revenue and costs are therefore assigned to the periods in which the work actually took place.

Slovak accounting procedures allow work in progress to be carried either as work in progress at cost or, according to the stage of completion, with a proportionate share of revenue recognised as well. If a contract is heading for a loss, the expected loss should be recognised as soon as it is known, for example through a provision.

How it works in practice

The foundation is job costing: each contract has its own number, and all costs, hours and invoices are assigned to it. Without that, the stage of completion cannot be determined sensibly and at year end work in progress is guessed.

Contracts for work on long-term jobs often include partial deliveries and advances. For VAT it matters that tax arises both on receipt of payment and on handover of an agreed stage, so we issue advance invoices and tax documents for advances as the law requires.

At year end we go through every open contract with the client: how much has been invoiced, what costs have been incurred, the estimate to complete and whether the margin holds. Differences between invoicing and actual progress are handled through accruals and deferrals so the result reflects reality.

What to watch out for

The most common mistake is invoicing on the customer’s schedule and treating everything invoiced as revenue. If invoices run ahead of the work, the company shows profit it has not yet earned, and problems at the end of the job bring an unpleasant surprise.

The second mistake is ignoring an expected loss. If it is clear a contract will end in a loss, for example because material prices have risen, the prudence principle requires recognising it in the current year, not at handover.