Seminar Slides 19

AC2101 – Accounting
Recognition and Measurement
Seminar 19
FRS 115 – Application to
Construction Contracts
Semester 1, AY 2017/2018
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Step 1 - Identify the contract with the
customer
5-step model to determine whether a construction
contract falls within the scope of FRS 115, and also the
timing and quantum of revenue recognition from the
construction contract.
Step 1
Identify whether there is a construction contract with a
customer
5 criteria to be met (FRS 115, para. 9):
a. The parties to the contract have approved the contract
and are committed to perform their respective
obligations.
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Step 1 - Identify the contract with
the customer
b. The entity can identify each party‟s rights regarding the

goods or services to be transferred.
c. The entity can identify the payment terms for the goods
or services to be transferred.
d. The contract has commercial substance.
e. It is probable that the entity will collect the consideration
to which it will be entitled in exchange for the goods or
services that will be transferred to the customer.

Step 2 - Identify the POs in the
contract
Step 2
Identify the performance obligations (POs).
 FRS 115, para. 22 specifies that at contract inception, an
entity shall assess the goods or services promised in a
contract with a customer and shall identify as a PO each
promise to transfer to the customer either:
(a) A good or service (or a bundle of goods or services) that is distinct, or
(b) A series of distinct goods or services that are substantially the
same and that have the same pattern of transfer to the customer.
 FRS 115, para. 26(h) specifies that promised goods or
services may include “constructing, manufacturing or
developing an asset on behalf of a customer”.

contract
FRS 115, para. 27 (a) and (b) prescribes that a good or

service is distinct if:
(a) the customer can benefit from the good or service either
on its own or together with other resources that are
readily available to the customer (the good or service is
capable of being distinct) and,
(b) the entity‟s promise to transfer the good or service is
separately identifiable from other promises in the contract
(the promise to transfer the good or service is distinct
within the context of the contract)

contract
A series of distinct goods or services has the same

pattern of transfer to the customer if both of the
following criteria are met:
(a) each distinct good or service in the series that the
entity promises to transfer to the customer would
meet the criteria to be a PO satisfied over time; and
(b) the same method would be used to measure the
entity’s progress towards complete satisfaction of
the PO to transfer each distinct good or service in the
series to the customer.
FRS 115, para 23

contract
FRS 115, Illustrative Example 10:
A contract to build a hospital for a customer and the contract
identifies various goods and services to be provided. FRS
115, para. 27 (b) is not satisfied as the goods and services
are not distinct within the context of the contract. The
entity has to provide a significant service to integrate the
goods and services (the inputs) into the hospital (the
combined output) for which it was contracted to provide.
Thus, the entity should account for all the goods and services
in the construction contract for the hospital as a single PO.

Step 3 – Determine the transaction
price
Step 3
Determine the transaction price (FRS 115, para. 47).
• Under FRS 115, variable consideration may be
recognised in the transaction price only when it is highly
probable that a significant reversal of the cumulative
revenue recognised will not occur when the uncertainty
associated with the variable consideration is subsequently
resolved (para. 56).
 This may result in delayed recognition of the variable
consideration.
 Must recognise „minimum amount‟ that is highly probable of not
reversing
 Reassessed at the end of each reporting period

Step 3 - Determine the transaction price:
Variable Consideration
Included in the transaction price only if it is highly probable that there
will not be a significant revenue reversal.
Significant reversal can occur if:

Limited Susceptible
Uncertainty experience to factors Broad range
over long with similar outside of outcomes
period of time contracts control
• Variable consideration is estimated either as (a) an

expected value, or (b) the most likely amount
(para. 53).
Adapted from PWC

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Step 4 – Allocate the transaction
price
Step 4
Allocate the transaction price to the separate POs.
• In the event that there are separate POs within the
construction contract, FRS 115 paras. 73 and 74 require
the entity to allocate the transaction price to each PO
identified in the contract on a relative stand-alone selling
price basis.
• In our examples on construction contracts, we rely on the
assumption of a single PO

Step 5 – Recognise revenue when
(or as) a PO is satisfied
Step 5
Determine when revenue is recognized.
• Recognise revenue when (or as) the entity satisfies a
performance obligation by transferring a promised good or
service to a customer, which is when control of the
promised good or service is transferred to the customer
 Can happen either over time or at a point in time.
• FRS 115, para. 35 states that an entity transfers control of
a good or service over time and therefore, satisfies a
performance obligation and recognises revenue over time
if one of the following criteria is met:

Criteria (recognize revenue over time):

a) The customer simultaneously receives and consumes the
benefits provided by the entity‟s performance as the entity performs
(eg. routine or recurring services like cleaning services);
b) The entity‟s performance creates or enhances an asset that the
customer controls as the asset is created or enhanced (eg.
building an asset on a customer’s site).
c) The entity‟s performance does not create an asset with an
alternative use to the entity and the entity has an enforceable
right to payment for performance completed to date (eg. building
a specialized asset that only the customer can use, or building an
asset to a customer order).

For criterion c)
- the “alternative use” argument may be problematic if
customisation of the asset occurs relatively late in the
construction process.
- the cumulative amount of payments must at all times
throughout the contract, at least correspond to the
amount that would be necessary to compensate the
entity for performance completed to date.

When does control transfer over time?
Yes Customer receive benefits as

performed/another would not need to re-
perform e.g. cleaning service, shipping
Point in time
No
Over time
Yes Create/enhance an asset customer

controls
e.g. house on customer land
No
Does not create asset with alternative
use AND
Yes No
Right to payment for work to date
e.g. an ‘audit’ report
Adapted from PWC
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If control not transfer over time, then recognise
revenue when control transfers at point in time.
Indicators that customer has obtained control of a good or service:
Customer has accepted

Right to payment for asset the asset
Legal title to asset
Physical possession of Customer has significant

asset risk and rewards
Adapted from PWC

materials
15
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• When any of the criteria for recognizing revenue over

time is satisfied, the contract revenue is recognised
based on a percentage-of-completion method.
 FRS 115, para. 41 provides 2 broad classifications of
methods to measure percentage-of-completion, that
is, input and output methods.
• Otherwise, the contract revenue would be recognised at
a point in time, that is, on a completed contract basis.

• What happens when the construction contract becomes
loss-making?
• FRS 115 defers to FRS 37 Provisions, Contingent
Liabilities and Contingent Assets (para. 66), whereby if a
contract with a customer under FRS 115 becomes
onerous, a provision is to be recognised.
• Thus, a corresponding loss due to onerous contract is
recognised in the P/L. This approach results in the full
recognition of the estimated overall loss from the
construction project in the year the expected loss is
identified.
Under the superseded FRS 11 Construction Contracts, the expected loss
from the loss-making construction contract is added on to the construction
costs for the year. This approach also results in the full recognition of the
estimated construction loss in the year the expected loss is identified.
Current estimates  Overall Profit
Illustration 1 - Project A
 Contract price = $1m; to be completed in 2 yrs
 At end of Year 20x3
 Current costs incurred for the year = $600k
 Billings for the year = $400k
 Collections for the year = $300k
Journal entries are…

• JE1: Incurrence of costs
Dr Construction-in-progress (CIP) $600k In SFP
Cr Cash/payable/acc depreciation/etc. $600k
Construction-In-Progress
(CIP)
An account (in statement of financial position) to record
a. all construction costs incurred on the project, and

b. progressive gross profit or loss recognized on the
project to-date

 Current costs incurred for the year= $600k
 Progress Billings for the year = $400k
Progress Billings
• JE2: Progress billings
Dr Account receivable $400k In SFP
Cr Progress billings $400k Contra against CIP in SFP
Progress Billings
An account (in statement of financial position) to
record the amounts billed to the customers for work
performed on a contract whether or not they have
been paid by the customers.

 Current costs incurred for the year= $600k
 Progress Billings for the year = $400k
Cash Collection
• JE3: Cash collection
Dr Cash $300k In SFP
Cr Account receivable $300k In SFP
At the end of each reporting
period,
 Step 1: Check the overall profitability of the contract

 Step 2: Compute the percentage of completion
 Step 3: Compute the current construction profit/(loss) for
the current period
 Step 4: Compute the construction revenue earned for
the current period
 Step 5: Compute the construction costs incurred for the
current period

 (STEP 1):
 Current costs incurred to date= $600k
 Estimated additional costs-to-complete = $200k
 Total estimated costs = $800k
 Total Estimated profit on Project = $1,000k – ($600k + $200k) = $200k
 PROFITABLE

 (STEP 2):
 % completed to-date (cost-to-cost basis) = $600k / $800k = 75%
 (STEP 3):
 Current year profit = [75% x ($1,000k - $800k)] = $750k - $600k
= $150k
 (STEP 4):
 Current revenue to be recognized = $1,000k x 75% = $750k
 (STEP 5):
 Current costs to be recognised = $800k x 75% = $600k
Journal entries are…
• JE4: Recognition of revenue & costs at end
of period
Dr Construction costs $600k In P/L
Dr Construction-in-progress(CIP) $150k In SFP
Cr Construction revenue $750k In P/L

Profit and Loss Account
Construction revenue $xxx
Less Construction costs $xxx
Profit (Loss) $xxx
Profit and Loss Account for

20x3
Construction revenue $750k
Less Construction costs $600k
Profit (Loss) $150k
Statement of Financial Position
Construction-in-progress
Costs incurred to date $S
Add/(less) attributable profit/(loss) $T
$X
Less Progress billings $Y
Under (over) billings $Z

Statement of Financial
Position as at 31 Dec 20x3
Costs incurred to date $600k
Add/(less) attributable profit/(loss) $150k
$750k
Less Progress billings $400k
Under (over) billings $350k

CIP versus Progress Billings
 CIP > Progress billings = Gross amount due from

customers, i.e. underbilling
 CIP < Progress billings = Gross amount due to

customers, i.e. overbilling

At the completion of Project A
in 20x4
• There are outstanding balances in the two
statement of financial position accounts:
• Construction-in-progress
• Progress Billings
 JE5: Upon completion of project

Dr Progress billings $1m
All closed out
Cr Construction in progress $1m

Illustration 1 – Project B

 At end of Year 20x1, and Year 20x2
 Overall profitability is positive.
 Same treatment as in Project A
 Fill in the blanks in the illustration for both years
 BUT in the Year 20x3, an overall net loss on the project is

forecasted.

Current estimates  Net Loss
 At the end of Year 20x3
 (STEP 1):
 Cumulative costs incurred = $4,620k
 Estimated additional costs-to-complete = $1,980k
 Total estimated costs = $6,600k
 Total Estimated LOSS on Project = $6,000k – $6,600k = -$600k
 Overall Net Loss!
 Under FRS 115, if a contract with a customer becomes onerous, a
provision is to be recognised (FRS 37 para. 66).

 (STEP 2)
 % completed to-date (cost-to-cost basis)= $4,620k/$6,600k= 70%
 (STEP 3)
 Current year loss = [70%*($6,000k – $6,600k)] - $250k = -$420k - $250k =
-$670k
 (STEP 4):
 Current period revenue = (70% x $6,000k) - $3,000k = $4,200k - $3,000k =
$1,200k
 (STEP 5):
 Current period costs = (70% x $6,600k) – $2,750k = $4,620k - $2,750k =
$1,870k
Note: Cumulative revenue = 70% x $6,000k = $4,200k
Cumulative costs for 70% of project = 70% x $6,600k= $4,620k
Cumulative losses for 70% of project = $4,200k - $4,620k = -$420k
*Provision for onerous contract = 30% x -$600k = -$180k
20x3
Construction revenue $1,200k

Less Construction costs $1,870k
Construction Profit (Loss) ($ 670k)
Loss due to onerous contract ($180k)

Costs incurred to date $4,620k
Add/(less) attributable profit/(loss) ($420k)
$4,200k
Less Progress billings to date $4,500k
Under (over) billings ($ 300k)

 At the end of Year 20x4
 (STEP 1):
 Cumulative costs incurred = $6,500k
 Estimated additional costs-to-complete = $0k
 Total costs = $6,500k
 Total LOSS on Project = $6,000k – $6,500k = -$500k
 Overall net loss!
 End of Project!

 (STEP 2):
 % completed to-date (cost-to-cost basis)=$6,500k/$6,500k= 100%
 (STEP 3):
 Total estimated profit (loss) on entire project = 100% x ($6,000k – $6,500k)
= -$500k. Current period loss = -$500k – (-$420k) = -$80k
 (STEP 4):
 Current period revenue = (100% x $6,000k) - $4,200k = $6,000k - $4,200k
= $1,800k
 (STEP 5):
 Current period costs = (100% x $6,500k) – $4,620k = $1,880k
Note: Cumulative revenue = 100% x $6,000k = $6,000k
Cumulative costs for 100% of project = 100% x $6,500k= $6,500k
Cumulative losses for 100% of project = $6,000k - $6,500k = -$500k
20x4
Construction revenue $1,800k

Less Construction costs $1,880k
Construction Profit (Loss) ($ 80k)
Close out of Provision for $ 180k

Onerous Contract
Costs incurred to date $6,500k
Add/(less) attributable profit/(loss) ($ 500k)
$6,000k
Less Progress billings to date $6,000k
Under (over) billings ($ 0k)

Outcome cannot be estimated reliably 
No profit recognized
(FRS 115, paras. 44 & 45)
Illustration 1 – Project C
Contract price = $15m; to be completed in 3 years
 Current costs incurred = $5,000k
 Additional costs-to-complete  Cannot be estimated reliably
 % completed to-date (cost-to-cost basis) = ?
 Revenue to be recognized = $5,000k
 Current profit = $0

Construction Contract:
Disclosure
 The amount of the transaction price that has not yet been
recognised as revenue;
 An explanation of when the entity expects to recognise that amount

as revenue;
 The explanation can be disclosed either on a quantitative basis

using time bands that are most appropriate for the duration of the
remaining performance obligations or by providing a qualitative
explanation.
(FRS 115, paras IE 220-1)

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AC2101 – Accounting

Recognition and Measurement

Copyright © Nanyang Business School

b. The entity can identify each party‟s rights regarding the

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FRS 115, para. 27 (a) and (b) prescribes that a good or

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A series of distinct goods or services has the same

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Significant reversal can occur if:

• Variable consideration is estimated either as (a) an

Adapted from PWC

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Criteria (recognize revenue over time):

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Yes Customer receive benefits as

Yes Create/enhance an asset customer

Customer has accepted

Legal title to asset

Physical possession of Customer has significant

Adapted from PWC

• When any of the criteria for recognizing revenue over

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Journal entries are…

An account (in statement of financial position) to record

a. all construction costs incurred on the project, and

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 Step 1: Check the overall profitability of the contract

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Dr Construction costs $600k In P/L

Dr Construction-in-progress(CIP) $150k In SFP

Cr Construction revenue $750k In P/L

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Profit and Loss Account for

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 CIP > Progress billings = Gross amount due from

 CIP < Progress billings = Gross amount due to

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 JE5: Upon completion of project

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 Contract price = $6m; to be completed in 4 yrs

 BUT in the Year 20x3, an overall net loss on the project is

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Construction revenue $1,200k

Loss due to onerous contract ($180k)

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Construction revenue $1,800k

Close out of Provision for $ 180k

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 An explanation of when the entity expects to recognise that amount

 The explanation can be disclosed either on a quantitative basis

(FRS 115, paras IE 220-1)