Practical guide to IFRS

Revenue recognition re-exposed ED – implications for engineering and construction industry
November 2011

Overview
Entities in the engineering and construction (E&C) industry applying US GAAP or IFRS have primarily been following industry guidance for 1 construction contracts to account for revenue. These standards were developed to address particular aspects of long-term construction accounting and provide guidance on a wide range of industry specific considerations including: Defining the contract, such as when to combine or segment contracts, and when and how to account for change orders and other modifications; Defining the contract price, including variable consideration, customer furnished materials, and claims; Recognition methods, such as the percentage-of-completion method (and in the case of US GAAP, the completed contract method) and input/output methods to measure performance; Accounting for contract costs, such as pre-contract costs and costs to fulfil a contract; and Accounting for loss-making contracts. Once the new revenue recognition standard becomes effective, the construction contract guidance and substantially all existing revenue recognition guidance under US GAAP
1

and IFRS will be replaced. This includes the percentage-of-completion method and the related construction cost accounting guidance as a standalone model. This E&C industry supplement discusses the areas in which the proposed standard is expected to have the greatest impact. The examples and the related assessments contained herein are based on a current interpretation of the exposure draft, ‘Revenue from contracts with customers’, issued on 14 November 2011. Any conclusions set forth below are subject to further interpretation and assessment based on the final standard. We have also provided a high-level summary of key changes from the original exposure draft issued on 24 June 2010 (the ‘2010 exposure draft’). References to the ‘proposed model’ or ‘proposed standard’ throughout this document refer to the exposure draft issued in November 2011, unless otherwise indicated. For a more comprehensive description of the proposed standard, refer to PwC’s ‘Practical guide’ or visit www.fasb.org or www.ifrs.org.

Defining the contract
Current guidance covers: When two or more contracts should be combined and accounted for together; When one contract should be segmented and accounted for separately as two or more contracts; and When a contract modification should be recognised.

This guidance is included in ASC Topic 605-35, ‘Construction-Type and Production-Type Contracts’ (US GAAP), and IAS 11, ‘Construction contracts ‘(IFRS).

Current practice is not expected to significantly change in the assessment of whether contracts should be combined. The proposed standard does Proposed model Combining contracts Two or more contracts (including contracts with parties related to the customer) are combined and accounted for as one contract if the contracts are entered into at or near the same time and one or more of the following conditions are met: The contracts are negotiated with a single commercial objective. There is no detailed guidance on the accounting for unpriced change orders. Current US GAAP not contain guidance on segmenting contracts. Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 2 . We expect that the use of judgment will continue to be needed and do not expect current practice (or existing diversity) in this area to be significantly affected by the proposed standard. and Have terms and manners of payment that can be identified. Current IFRS Combining and segmenting contracts is required when certain criteria are met. contract modifications such as change orders. US GAAP also includes detailed revenue and cost guidance on the accounting for unpriced change Combining and segmenting contracts is permitted provided certain criteria are met. Have been approved by the parties to the contract and such parties are committed to satisfying their respective obligations. The amount of consideration in one contract depends on the other contract. unpriced change orders). A change order (known as a variation) is generally included in contract revenue when it is probable that the change order will be approved by the customer and the amount of revenue can be reliably measured. construction companies that segment contracts under current guidance might not be significantly affected because of the requirement in the proposed standard to account for separate performance obligations (refer to ‘Accounting for multiple performance obligations’ below). change orders) An entity should account for a modification when the entity has an expectation that the price of the modification will be approved if the parties to a contract have approved a change in the scope of a contract but have not yet determined the corresponding change in price (for example. however.These situations and. Construction companies currently exercise significant judgment to determine when to include change orders and other contract modifications in contract revenue and therefore. including the accounting for unpriced change orders. there is diversity in practice. are commonplace in the E&C industry. Have enforceable rights that can be identified regarding the goods or services to be transferred. Contract modifications (for example. in particular. but it is not required so long as the underlying economics of the transaction are fairly reflected. A change order is generally included in contract revenue when it is probable that the change order will be approved by the customer and the amount of revenue can be reliably measured. The proposed standard applies only to contracts with customers when such contracts: Have commercial substance. or The goods or services promised are a single performance obligation (refer to ‘Accounting for multiple performance obligations’ below).

The pricing 3 Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 . or A prospective adjustment to contract revenue when the remaining goods or services are a combination of distinct and nondistinct. but the price is not). When would these unpriced change orders be included in contract revenue? Discussion: The contractor might be able to determine that it expects the price of the scope change to be approved based on its historical experience. If so. A modification that is not a separate contract is evaluated and accounted for either as: A termination of the original contract and the creation of a new contract if the goods or services are distinct from those transferred before the modification. orders (or those in which the work to be performed is defined. the contractor would account for the unpriced change order and estimate the transaction price based on a probability-weighted or most likely amount approach (whichever is most predictive). Change orders are typically based on the contractor's goal of obtaining one commercial objective on the overall contract. The contractor would need to then determine whether the unpriced change order should be accounted for as a separate contract.A contract modification is accounted for as a separate contract if: The modification promises distinct goods or services that result in a separate performance obligation. those change orders where price is not defined until after scope changes are agreed upon. A cumulative adjustment to contract revenue if the remaining goods and services are not distinct and part of a single performance obligation that is partially satisfied. It is not uncommon for the contractor to commence work once the parties agree to the scope of the change. This will often not be the case based on the following: Change orders often won’t result in a distinct performance obligation because the underlying good or service is highly interrelated with the original good or service and part of the contractor's service of integrating goods into a combined item for the customer. Example 1 – Unpriced change orders Facts: A contractor has a single performance obligation to build an office building. and The entity has a right to consideration that reflects the standalone selling price of the promised goods or services underlying that performance obligation. The contractor has a history of executing unpriced change orders. but before the price is agreed upon. that is.

This determination is simple when the contract price is fixed. including the change order. which generally require companies to use the fair value of goods or services received in measuring the amount to be included in contract revenue. We do not expect a significant change in practice as it relates to customer furnished materials. as a result. except as it relates to the impact of the time value of money on retainage receivables. materials. Any non-cash consideration is measured at fair value unless fair value cannot be reasonably estimated. liquidated damages. This is generally when the contractor has experience with similar types of contracts and that experience has predictive value (that is. claims. Revenue related to awards or incentive payments might be recognised earlier under the proposed standard.of a change order may. in which case it is measured by reference to the selling price of the goods or services transferred. or the time value of money. Determining the transaction price The transaction price (or contract revenue as it is called today in the E&C industry) is the consideration the contractor expects to be entitled to in Proposed model Awards/incentive payments Awards/incentive payments are included in contract revenue using a probability-weighted or most likely amount approach (whichever is more predictive). Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 4 . These amounts are recognised as revenue as the entity satisfies its related performance obligations. equipment. claims. the experience is relevant to the contract). Awards/incentive payments should be included in contract revenue when the specified performance standards are probable of being met or exceeded and the amount can be reliably measured. provided the entity is reasonably assured of being entitled to the amount allocated to that performance obligation. not represent the standalone selling price of the additional good or service. Common considerations in this area for the E&C industry include the accounting for awards/incentive payments. Management would follow general principles on nonmonetary exchanges. and the time value of money. liquidated damages. or labour) to facilitate the fulfillment of the contract is included in contract revenue if the entity controls these goods or services. It is more complex when the contract price is not fixed. customerfurnished materials. Current US GAAP exchange for satisfying its performance obligations. are part of a single performance obligation that is partially satisfied. The value of customer furnished materials is included in contract revenue when the contractor has the associated risk for these materials. There is no explicit guidance on the accounting for non-cash consideration in the construction contracts standard. Current IFRS Awards/incentive payments should be included in contract revenue when the specified performance standards are probable of being met or exceeded and the amount can be reliably measured. The contractor in this case would update the transaction price and measure of progress towards completion of the contract because the remaining goods or services. Customer furnished materials The value of goods or services contributed by a customer (for example.

if the job is finished before the holiday travel season. retainage receivables). but only to the extent of contract costs incurred.Proposed model Claims Claims are included in contract revenue using a probability-weighted or most likely amount approach (whichever is more predictive). Judgment will be necessary to determine when an entity is ‘reasonably assured’ of being entitled to receive variable consideration based on the conditions described above and thus. Key change from the 2010 exposure draft The original exposure draft required variable consideration to be estimated using the probability-weighted estimate approach. that it is 95 percent likely that the contract will be completed in advance of the holiday travel season. Current US GAAP Current IFRS A claim is recorded as contract revenue when it is probable and can be estimated reliably (determined based on specific criteria). Entities may now use a mostlikely amount approach if it is the most predictive (for example. An imputed interest rate is used to determine the amount of revenue to be recognised as well as the separate interest income to be recorded over time. Profits on claims are not recorded until they are realised. The boards added a constraint on when revenue related to variable consideration (for example. As a practical expedient. when the related revenue should be recognised. based on significant past experience. This change from the original exposure draft reduces the potential impact of the accounting for the time value of money on contract revenues. a contractor does not need to consider the time value of money if the period between payment and the transfer of the promised goods or services is one year or less. Revenue is discounted in only limited situations. The contract is expected to take one year to complete. Example 2 – Variable consideration Facts: A contractor enters into a contract for the expansion of an existing two-lane highway to a threelane highway. The contractor does not receive any award fee if the highway is not finished before the holiday season. including receivables with payment terms greater than one year. The interest component is computed based on the stated rate of interest in the instrument or a market rate of interest if the stated rate is considered unreasonable when discounting is required. Entities might still need to account for the time value of money in more instances under the proposed model as compared to existing practice (for example. The contract price is C65 million plus a C5 million award fee if the expansion is completed before the holiday travel season. This might provide results more similar to today's accounting. and awards) can be recognised. that is. Revenue is discounted when the inflow of cash or cash equivalents is deferred. bonus. An entity is not required to consider the time value of money if the period between payment and the transfer of the promised goods or services is one year or less. The contractor has a long history of performing this type of highway work. as a practical expedient. The contractor believes. the contractor receives the full award fee. provided the entity is reasonably assured of being entitled to such payments (see above). 5 Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 . The award fee is binary. Time value of money Contract revenue should reflect the time value of money whenever the contract includes a significant financing component. claims. A claim is included in contract revenue only if negotiations have reached an advanced stage such that it is probable the customer will accept the claim and the amount can be reliably measured. These amounts are recognised as the entity satisfies its related performance obligations. in situations where variable consideration is binary).

How should the contractor account for the award fee? Discussion: The contractor is likely to conclude. It is largely within the contractor's control to complete the work before the holiday travel season. as appropriate. although a contractor effectively promises to provide a number of different goods or perform a number of different services in delivering such macro-promises. The contractor might therefore conclude that it is not reasonably assured of being entitled to receive such a claim in the early stages. How should the contractor account for the claim? Discussion: Claims are highly susceptible to external factors (such as the judgment of or negotiations with third parties). except that due to reasons outside of the contractor's control (for example. This is likely to occur at a date closer to the date the claim is expected to be resolved. albeit sometimes at a discount from the amount sought. The contractor submits a claim against the owner to recover a portion of these costs. using a cumulative catchup approach. Example 3 – Claims Facts: Assume the same fact pattern as Example 2. the cost of the contract far exceeds original estimates (but a profit is still expected). it is eligible to recognise this amount as revenue when the performance obligation is satisfied). The contract's transaction price is therefore C70 million: the fixed contract price of C65 million plus the C5 million award fee (most-likely amount). and the possible outcomes are highly variable. The amount of the claim is included in the transaction price when initiated using either a probability-weighted approach or most likely outcome amount (whichever is more predictive). Contractors often account for each contract at the contract level today. but the contractor has a long history of successfully negotiating claims with owners. It is possible to account for the contract at the contract level (for example. contractors account for the ‘macro-promise’ in the contract (for example. The contractor may have experience in successfully negotiating claims. and The uncertainty will be resolved within a relatively short period of time. but are not limited to: The contractor has a long history of performing this type of work. Determining when to separately account for these performance obligations under the proposed model is a key determination and will require a significant amount of judgment. which is consistent with current practice. but it cannot be recognised until the contractor is reasonably assured of being entitled to receive the claim. The contractor would likely conclude it is reasonably assured of being entitled to the award fee based on its history with similar contracts that provide predictive experience. given the binary award fee. This should not result in a significant change from today’s accounting for variable consideration in many E&C contracts. the macro-promise to build a road) under the proposed model when the criteria 6 Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 . Current guidance permits this approach. but it might be challenging to assert that such experience has predictive value in this fact pattern (because of the highly uncertain variables). that it is appropriate to use the most likely amount approach in determining the amount of variable consideration to include in the estimate of the transaction price. This estimate is regularly revised and adjusted. Accounting for multiple performance obligations Performance obligations are defined as promises to deliver goods or perform services. Factors to consider include. that is. The contractor will then determine whether it is reasonably assured of being entitled to the award fee (and therefore. The claim process is in its early stages. owner-caused delays). to build a road or build a refinery).

or service separately.for combining a bundle of goods or services into one performance obligation. procurement. There is no further guidance around separately accounting for more than one deliverable in a construction contract. that contractors might have to separately account for more obligations within Proposed model Performance obligations − separation An entity should separately account for performance obligations only if the pattern of transfer is different and they are distinct. That presumption is overcome when a contract or a series of contracts meets the conditions described for combining or segmenting contracts. for example. cost accumulation. in the case of engineering. They have now provided guidance for situations when it may be necessary to account for a promised bundle of goods or services as a single performance obligation in an Current US GAAP each contract compared to current guidance. That presumption may A good or service is distinct if either of be overcome only if a contract or a the following criteria are met: series of contracts meets the The entity regularly sells the good conditions described above for combining or segmenting contracts. Significant judgment will be needed. separately accounting for more than one deliverable in a construction contract under the construction An entity should account for two or contract guidance. and income measurement. and income measurement. We believe contractors might have to separately account for more obligations within each contract compared to current guidance notwithstanding this additional guidance. or The customer can use the good or service on its own or together with There is no further guidance for other readily available resources. however. The basic presumption is that each contract is the profit center for revenue recognition. effort to better reflect the economics of certain long-term contracts. should be combined with other performance obligations until the entity identifies a bundle of goods or services that is distinct. Key change from the 2010 exposure draft The boards have clarified the principle for when to separately account for performance obligations. Goods and services that are not distinct and therefore. not separate performance obligations. more performance obligations as a single performance obligation when the following criteria are met: The goods or services are highly interrelated and transferring them to the customer requires the entity to provide a significant service of integrating the goods or services into the combined item(s) for which the customer has contracted. Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 7 . cost accumulation. and The bundle of goods or services is significantly modified or customised to fulfil the contract. We expect. Current IFRS The basic presumption is that each contract is the profit center for revenue recognition. and construction (EPC) contracts.

An estimation method is not prescribed in the proposed guidance. given the presumption that the contract is the profit center for determining revenue recognition. given the presumption that the contract is the profit center for determining revenue recognition. total transaction price less the standalone selling prices. The best evidence of a standalone selling price is the observable price of a good or service when sold separately. Of particular interest will be the allocation of variable consideration (for example. for example. so the allocation of the transaction price (that is. award or incentive payments) associated with only one separate performance obligation. an entity can allocate the transaction price entirely to one (or more) performance obligations. The boards have proposed that. actual or estimated. This would be relevant. For example. of other goods or Except for allocation guidance related to contract segmentation. a bonus award associated with only the build component of a design/build contract). for contracts that have incentive payments wholly tied to only one performance obligation (for example. a contractor might use cost plus a reasonable margin in estimating the selling price of a good or service. Entities may use a residual technique to estimate the standalone selling price (that is. is allocated to the performance obligations in a contract that require Proposed model Allocating the transaction price The transaction price (and any subsequent changes in estimate) is allocated to each separate performance obligation based on relative standalone selling price. overseeing the construction of a new airport runway. there is no explicit guidance on allocating contract revenue to multiple deliverables in a construction contract. We expect that contractors might have to separately account for more performance obligations than today if the risks of providing two or more goods or services are not largely inseparable (as described above). How many performance obligations is the contractor required to separately account for? Discussion: The contractor is only providing the construction management service to supervise and coordinate the construction activity on the project and might only have one performance obligation in this example. once determined. there is no explicit guidance on allocating contract revenue to multiple deliverables in a construction contract. Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 8 . when certain conditions are met. Current US GAAP separate accounting. The standalone selling price should be estimated if the actual selling price is not directly observable. rather than the contract as a whole. contract revenue) will be new to many E&C companies.Example 4 – Construction management contract Facts: A contractor enters into a construction contract with an owner to provide construction management services. Current IFRS Except for allocation guidance related to contract segmentation. Allocating the transaction price The transaction price. An entity should maximise the use of observable inputs when estimating the standalone selling price.

is C140 million. The contractor determines at inception that the contract price is C150 million. For 9 Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 . is C30 million. the percentage used to allocate based on relative standalone selling prices) is not changed after contract inception. There is an inherent discount of C20 million built into the bundled contract. How should the contractor allocate the contract price to the two separate performance obligations? Discussion: A contractor must first assign a standalone selling price to both the road and the bridge in order to allocate the contract price (including both the fixed and variable amounts).changes in the transaction price Facts: Assume the same fact pattern as Example 5 above. The contractor typically constructs both roads and bridges of a similar type and nature to those required by the contract on a stand-alone basis.4m (C2m * (C 30m / C170m)) Such changes are recognised using a cumulative catch-up approach. based on prior experience. The contractor will receive a base award fee if it finishes the entire project 30 days ahead of schedule. The amount of the award fee is variable depending on how early the contractor finishes the entire project. How should the contractor allocate the change in the estimated contract price? Discussion: The basis for allocating the transaction price to performance obligations (that is. The stand-alone selling price to build this road. An entity may also allocate a discount or an amount of contingent consideration entirely to one (or more) performance obligations if certain conditions are met. The amount of the award fee relates to the contractor's ability to finish the contract as a whole ahead of schedule and not specifically to the completion of either the road or bridge ahead of schedule. The additional C2 million of contract price would be allocated to the road and bridge using the initially developed allocation percentages as follows: Road: C1.6m (C2m * (C140m / C170m)) Bridge: C0. The C150 million transaction price is allocated as follows using a relative allocation model: Road: C124m (C150m * (C140m / C170m)) Bridge: C26m (C150m * (C 30m / C170m)) Example 6 – Allocating contract revenue to more than one performance obligation . which includes a C140 million fixed price and an estimated C10 million of award fees. Current US GAAP Current IFRS Example 5 – Allocating contract revenue to more than one performance obligation Facts: A contractor enters into a contract to build both a road and a bridge (assume for this example that there are only two performance obligations: to build the road and to build the bridge). based on prior experience. The award fee is increased (decreased) by 10% for each day before (after) the 30 days it finishes the project. The contractor has experience with similar contracts and has determined that it is reasonably assured of being entitled to an award fee of C10 million using a probabilityweighted estimate approach.Proposed model services in the contract) if the standalone selling price of a good or service is highly variable or uncertain. The stand-alone selling price to build this bridge. except that the amount of variable consideration changes from an expected C10 million to an expected C12 million after contract inception.

The completedcontract method is prohibited. or The completed-contract method is The entity's performance does not create an asset with alternative use required when reliable estimates to the entity and at least one of the cannot be made. but there is an assurance that no loss will be incurred on a contract A performance obligation is satisfied (for example.4m = C0. Contract costs that are not probable of being recovered are recognised as an expense immediately. following: .56m as the remaining performance obligations related to the road (C0. be assumed. over time. The percentage-of-completion method based on a zero-profit margin is used when reliable estimates cannot be made. but the contractor is protected from an overall loss) until more precise estimates can be made. Recognise revenue Revenue recognition under existing guidance is based on the activities of the contractor.6m x 10%) and bridge (C0. but the following criteria is met: contractor is protected from an overall The entity's performance creates or loss) until more precise estimates can enhances an asset that the customer be made. but there is assurance that no loss will be incurred on a contract (for example. might result in a similar pattern of revenue recognition compared to today’s guidance. The percentage-of-completion method based on a zero-profit margin is used when reliable estimates cannot be made. This should not. Control can transfer at a point in time or. The boards have proposed that revenue is recognised upon the satisfaction of a contractor's performance obligations. Control can transfer either at a point in Proposed model Transfer of control Revenue is recognised upon the satisfaction of performance obligations. that is. if the road was 90% complete and work on the bridge had not yet commenced at the time of the change in estimate. Current IFRS Revenue is recognised using the percentage-of-completion method when reliable estimates are available. Revenue is recognised using the percentage-of-completion method when reliable estimates are available. to measure revenue under an activities-based recognition model.4m x 100%) are satisfied. We expect that many construction-type contracts will transfer control of a good or service over time and therefore. The measure of progress toward satisfaction of a performance obligation under the proposed model should depict the transfer of goods or services to the customer. controls.The customer simultaneously receives and consumes the benefits as the entity performs.16m = C1. Current US GAAP time or over time. however. A cost-tocost input method may be used today. when the scope of the contract is ill-defined. the contractor would recognise revenue of C1. Contractors will not be able to default to the method used today and a careful assessment of when control transfers will need to be performed. perhaps most important for the E&C industry. A cost-to-cost input method might not be the most appropriate measure of the extent to which control has transferred when a performance obligation is satisfied over time under the proposed model.Another entity would not need to substantially reperform the Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 10 . provided reasonable estimates are available.44m (C1.6m x 90%) for the portion of the performance obligation already satisfied for the road. The contractor would recognise additional revenue of C0. .example. which occurs when control of the good or service transfers to the customer. which occurs when control of a good or service transfers to the customer. for example. when the scope of the over time when at least one of the contract is ill-defined. revenue can be recognised as the contractor performs (known as the percentage-of-completion method). The change to a control transfer model will require careful assessment of when a contractor can recognise revenue.

Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 11 . surveys of goods or services transferred to date. or contract milestones). labour hours. A contractor can use either an input method (for example. units produced. or The entity has a right to payment for performance completed to date. units delivered. or the passage of time to measure progress towards completion. The gross profit method is not permitted. cost of revenue. Determining when control transfers will require a significant amount of judgment. physical progress. IFRS requires the use of the revenue method to determine revenue. The customer has the significant risks and rewards of ownership. cost of revenue. No one factor is determinative on a standalone basis. cost-to-cost. units delivered. and Input methods that recognise revenue on the basis of the entity's efforts or inputs to the satisfaction A contractor can use either an input method (for example. and gross profit once a ‘percentage complete’ is derived: the Revenue method and the Gross Profit method. Indicators that might be considered in determining whether the customer has obtained control of an asset at a point in time include: The entity has a present right to payment. There are two different approaches for determining revenue. or contract milestones). and gross profit once a ‘percentage complete’ is derived. Methods for recognising revenue when control transfers over time include: Output methods that recognise revenue on the basis of direct measurement of the value to the customer of the entity's performance to date (for example. Measuring performance obligations satisfied over time A contractor should measure progress towards satisfaction of a performance obligation that is satisfied over time using the method that best depicts the transfer of goods or services to the customer.Proposed model work performed to date if that other entity were required to fulfil the remaining obligation to the customer. machine hours. an output method (for example. an output method (for example. cost-to-cost. units produced. labour cost. Current US GAAP Current IFRS - A performance obligation is satisfied at a point in time if it does not meet the criteria above. This list is not intended to be a checklist or all-inclusive. The customer has legal title. appraisals of results achieved). or material quantities). machine hours. physical progress. labour hours. labour cost. or the passage of time to measure progress towards completion. The customer has physical possession. or material quantities). and The customer has accepted the asset.

it must be applied to total contract revenue to determine the amount of revenue to be recognised. The oil refinery does not have an alternative use to the contractor. cost-to-cost. The boards added the criteria above to determine when a performance obligation is satisfied over time in response to feedback that the original guidance was difficult to apply in certain situations. such as service arrangements. estimated costs to complete when using a cost-to-cost calculation) should be regularly evaluated and adjusted using a cumulative catch-up method. It may be appropriate to measure progress by recognising revenue equal to the costs of the transferred goods if goods are transferred at a significantly different time from the related service (such as materials the customer controls before the entity installs the materials). such as abnormal amounts of wasted materials. Current US GAAP Current IFRS Key change from the 2010 exposure draft The 2010 exposure draft had limited guidance on determining when control transfers over time. labour hours. Once the metric is calculated to measure the extent to which control has transferred. Example 7 – Recognising revenue Facts: A contractor enters into a construction contract with an owner to build an oil refinery. interim progress payments are required as a mechanism to finance the contract. Estimates to measure the extent to which control has transferred (for example. Non-refundable. should be excluded from the measurement of progress. or material quantities). The effects of any inputs that do not represent the transfer of goods or services to the customer. machine hours. The contract has the following characteristics: The oil refinery is highly customised to the owner's specifications and changes to these specifications by the owner are expected over the contract term. The owner can cancel the contract at any time (with a termination 12 Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 .Proposed model of a performance obligation (for example. labour cost. The method selected should be applied consistently to similar contracts with customers.

Physical possession and title do not pass until completion of the contract.C200m) C20m (C240m .C100m) C40m (C240m . any work in process is the property of the owner.penalty).C200m . The contractor will have to select either an input or output method in this case to measure the progress towards satisfying the performance obligation. Additional contract characteristics are: Contract duration is three years. Actual cumulative cost incurred as of the end of the second year (excluding year-one inefficiencies) is C200 million. As a result. except that total estimated cost to complete the contract increases at the end of the second year to C250 million due to an increase in the cost of materials. The costs associated with contractor caused inefficiencies would be excluded in this situation. How should the contractor recognise revenue? Discussion: The preponderance of evidence suggests that the contractor's performance creates an asset that the customer controls and control is being transferred over time. How much revenue and cost should the contractor recognise during the second year? Discussion: The amount of contract revenue and cost recognised during the second year: C240m (C300m * (C200m / C250m) C150m C90m C200m C100m C100m C (10m) (C90m . and Year one cost is C120 million (including C20 million related to contractor caused inefficiencies). The contractor has concluded that costto-cost is a reasonable method for measuring the progress toward satisfying its performance obligation. Total estimated contract cost is C200 million. Cumulative revenue: Revenue recognised year one: Revenue recognised year two: Cumulative costs (excluding inefficiencies): Costs recognised year one (excluding inefficiencies): Costs recognised year two: (excluding inefficiencies): Gross contract margin year two: How much revenue and cost should the contractor recognise during the first year? Discussion: The contractor should exclude any costs that do not depict the transfer of goods or services in determining the amount of revenue to be recognised under a cost-to-cost model. Total estimated contract revenue is C300 million. another entity would not need to reperform the tasks performed to date.C20m) 13 Gross contract margin to-date (excluding inefficiencies): Adjusted contract margin to-date: Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 . The contractor determined that the contract is a single performance obligation to build the refinery. The amounts of contract revenue and cost recognised at the end of year one are: Revenue: C150m (C300m * (C100m / C200m)) Contract cost (excluding inefficiencies): C100m Gross contract margin: C50m Contract inefficiencies: C20m Adjusted contract margin: C30m Example 9 − Recognising revenue − use of cost-to-cost with changes in estimates Facts: Assume the same fact pattern as Examples 7 and 8 above. Example 8 – Recognising revenue − use of cost-to-cost Facts: Assume the same fact pattern as Example 7 above.

resulting in delayed revenue recognition and complex accounting calculations for certain of these warranties. Current IFRS Contractors are required to account for the estimated costs of rectification and guarantee work. The contractor also provides a warranty that covers latent defects for certain components of the oil refinery. Key change from the 2010 exposure draft The boards originally proposed that all types of warranties. extended warranties) and recognised over the expected life of the contract. Contractors who determine that cost-to-cost is an appropriate method to measure transfer of control over time might therefore have to consider these costs in their cost-tocost calculation. maintenance) in addition to a promise that the entity’s past performance was as specified in the contract. which is more aligned with today’s accounting. including those that provide assurance that the good or services is as specified in the contract. An entity might provide a warranty that calls for a service to be provided to the customer (for example. Example 10 – Accounting for warranties Facts: Assume the same fact pattern as Example 7 above. A contractor recognises revenue and concurrently accrues any expected cost for these warranty repairs. Contractors typically account for warranties that protect against latent defects outside of contract accounting and in accordance with existing loss contingency guidance. Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 14 . Revenue is deferred for warranties that protect against defects arising through normal usage (that is. There is currently diversity in the way E&C companies account for these and other types of Proposed model Warranties The warranty is accounted for as a cost accrual if a customer does not have the option to purchase a warranty separately from the entity. This warranty is automatically provided by the contractor and the customer does not have an option to purchase the warranty separately from the contractor. How would the contractor account for such a warranty? Discussion: The contractor would account for this warranty as a cost accrual. We expect practice to become less diverse and potentially change significantly for some entities in this area. However. Current US GAAP warranties. as contract costs. contractors typically (due to materiality considerations) account for standard warranties protecting against latent defects outside of contract accounting and in accordance with existing provisions guidance. The accounting for warranties as a separate performance obligation is now based primarily on whether the customer has the option to purchase the warranty separately and if it provides a service in addition to providing assurance that the entity's past performance was as specified in the contract. The entity will account for the service component of the warranty as a separate performance obligation in these circumstances. including expected warranty costs. A contractor will recognise revenue and concurrently accrue any expected cost for these warranty repairs. Revenue is deferred for warranties that protect against defects arising through normal usage (that is. extended warranties) and recognised over the expected life of the contract.Warranties Most warranties in the construction industry provide coverage against latent defects. be accounted for as a deferral of revenue.

As a Other detailed guidance on costs to practical expedient. or other costs to fulfil) are expensed as incurred. are recognised as an asset if they are probable. the entity otherwise would have recognised is one year or less. Direct costs of fulfilling a contract are capitalised under the proposed standard if not within the scope of other standards if they relate directly to a contract. relate to future performance.Contract costs Existing construction contract guidance contains a substantial amount of cost capitalisation guidance. Direct costs of fulfilling a contract are accounted for in accordance with other standards (for example. abnormal costs of materials. Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained (for example. fixed assets) if they are within the scope of that guidance. Costs that relate directly to a contract and are incurred in securing the contract are included as part of contract Incremental costs of obtaining a Pre-contract costs that are incurred costs if they can be separately contract are costs that the entity for a specific anticipated contract identified. such costs may be Other detailed guidance on costs to fulfil a contract is also prescribed by expensed as incurred if the fulfil a contract is also prescribed by current guidance. unless those costs are explicitly chargeable to the customer regardless of whether the contract is obtained. labour. intangibles. and it is would not have incurred if the generally may be deferred only if their probable that the contract will be contract had not been obtained and recoverability from that contract is obtained. There is a significant amount of detailed guidance relating to the accounting for contract costs within the construction contract guidance. certain bid costs) should be recognised as an expense when incurred. expected to be recovered. Capitalised costs are amortised as control of the goods or services to which the asset relates is transferred Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 15 . measured reliably. and are expected to be recovered under the contract. both related to pre-contract costs and costs to fulfil a contract. The proposed standard also includes contract cost guidance that Proposed model Contract costs All costs related to satisfied performance obligations and costs related to inefficiencies (that is. Current US GAAP could result in a change in the measurement and recognition of contract costs as compared to today (in particular for those contractors that currently use the Gross Profit method for calculating revenue and cost of revenue). This is particularly true with respect to accounting for pre-contract costs. Current IFRS There is a significant amount of detailed guidance relating to the accounting for contract costs. inventory. amortisation period of the asset that current guidance.

How should the mobilisation costs be accounted for? Discussion: These costs to fulfil a contract would be capitalised if they: (a) relate directly to the contract. a performance obligation is onerous under the proposed standard if the lowest cost of settling the performance obligation.Proposed model to the customer. The boards received feedback that certain costs to obtain a contract may meet the definition of an asset and should be capitalised. Onerous performance obligations Existing construction contract guidance requires a loss to be recorded when the expected contract costs exceed the total anticipated contract revenue. E&C entities might need to recognise an onerous loss on an overall profitable contract if that contract contains separate performance obligations (for example. or intangible assets). Second. which may include goods or services to be provided under specific anticipated contracts (for example. E&C entities might be impacted by the proposed guidance in two ways. labour. inventory. Example 11 – Accounting for contract costs Facts: Assume the same fact pattern as Example 8 above. The contractor has concluded that such costs should not be accounted for in accordance with existing asset standards (for example. the proposed standard requires entities to assess performance obligations satisfied over a period of time greater than one year to determine whether they are onerous. the contractor incurs certain mobilisation costs amounting to C1 million. C500. Current US GAAP Current IFRS Key change from the 2010 exposure draft Costs to obtain a contract were to be expensed as incurred under the original exposure draft. (b) relate to future performance. a contract renewal). Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 16 . The boards clarified that costs to fulfil a contract are in the scope of the revenue guidance only if they are not addressed by other standards and that the costs of abnormal amounts of materials. including the cost to exit the performance obligation. The guidance was therefore revised to require recognition of an asset for costs to obtain a contract if they are incremental and expected to be recovered (unless the amortisation period of the asset that the entity otherwise would have recognised is one year or less).000 would be amortised as of the end of year one (coinciding with 50 percent control transfer using a cost-to-cost method) using the fact pattern in Example 8 above. exceeds the amount of transaction price allocated to that performance obligation. At the beginning of the contract. and other resources that were not considered in the price of the contract should be recognised as an expense when incurred. Assuming the mobilisation costs meet these criteria and are capitalised. a design / build contract) and one of the performance obligations is determined to be onerous. Factoring in the cost to exit the performance obligation if lower than the remaining direct cost to fulfil it might result in fewer loss provisions recorded (or a decrease in the amount of a loss recorded in some cases) as compared to existing practice. First. and (c) are expected to be recovered. The determination of anticipated losses will not be assessed at the contract level. fixed assets.

This publication has been prepared for general guidance on matters of interest only. The practical expedients are intended to reduce the burden on preparers by (a) not requiring the restatement of contracts for comparative periods that began and ended in the same accounting period. The expected loss is recognised when it is probable that total contract costs will exceed total contract revenue. the accounting for options to obtain additional goods or services and a significant expansion in disclosure requirements (with certain disclosure exceptions for private companies). in reliance on the information contained in this publication or for any decision based on it. A provision for a loss on a contract is made when the current estimates of total contract revenue and contract cost indicate a loss. All rights reserved. The proposed standard requires retrospective application.Proposed model Onerous performance obligations An entity will recognise a liability and a corresponding expense if a performance obligation that is satisfied over a period of time greater than one year is onerous. while the IASB has proposed to permit early adoption. The effective date of the final standard is likely to be no earlier than 2015 or 2016. budgeting. and does not constitute professional advice. information technology requirements. controls and processes. Key change from the 2010 exposure draft Onerous performance obligations were to be evaluated at the performance obligation level for all performance obligations under the original exposure draft. A performance obligation is onerous if the lower of (a) the costs that relate directly to satisfying the performance obligation by transferring the promised goods or services. for example. PricewaterhouseCoopers LLP. responsibility or duty of care for any consequences of you or anyone else acting. Other potential changes include. and (d) not requiring disclosure of the maturity analysis of remaining performance obligations in the first year of application. including contract negotiations. or refraining to act. key metrics (including debt covenants. surety. and accounting. The FASB has proposed to prohibit early adoption. any recipient should not act upon the information contained in this publication without obtaining independent professional advice. (b) allowing the use of hindsight in estimating variable consideration. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited. but allows for certain practical expedients. Current US GAAP Current IFRS Contracts within the scope of construction contract accounting are evaluated at the contract level. and prequalification capacity calculations). Practical guide to IFRS – Revenue proposals: engineering & construction – November 2011 17 © 2011 PricewaterhouseCoopers. and (b) the amount the entity would pay to exit the performance obligation exceeds the amount of the transaction price allocated to that performance obligation. Final thoughts The above commentary is not all inclusive. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication. each of which is a separate and independent legal entity . Contracts within the scope of construction contract accounting are assessed at the contract level. The boards changed the guidance in response to concerns about the unintended consequences of this provision so that it only applies to performance obligations satisfied over a period of time greater than one year. to the extent permitted by law. Performance obligations satisfied at a point in time are not subject to the onerous test under the revised exposure draft. and. employees and agents do not accept or assume any liability. (c) not requiring the onerous test to be performed in comparative periods unless an onerous contract liability was recognised previously. It does not take into account any objectives. Companies should continue to evaluate how the model might change current business activities. its members. financial situation or needs of any recipient.

Sign up to vote on this title
UsefulNot useful