Partial Topics

1. Partnership Formation

a. Characteristics of a partnership

b. Accounting for partnership

ADVACC1
c. Formation

d. Valuation of contributions of partners

1. Partnership Operation

Accounting for Special

2. Partnership dissolution

3. Partnership Liquidation

Transactions
(Advanced Accounting 1)
 Topic – 5
Construction Contracts
Related standard : PFRS 15 Revenue from Contracts with Customer
PFRS 15 establishes a comprehensive framework for recognition of revenue form contracts with customer
based on a core principle that an entity should recognize revenue representing the transfer of promised goods or
services
to customer in an amount that reflects the consideration to w/c the entity expects to be entitled in exchange for those
goods or services.

An entity shall apply the principles set forth under PFRS 15 Revenue form Contracts with Customer in
accounting for revenues from contracts with customers, regardless of the nature of the contract entered into
with a customer, except the following:
1. Lease contracts (PAS 17 Lease)
2. Insurance contracts (PFRS 4 Insurance Contracts)
3. Financial Instruments and
4. Non-monetary exchanges between entities in the same line of business to facilitate sales to customers.

Example : Non-monetary exchanges

PFRS does not apply to a contract between two oil companies that agree to an exchange of oil to
fulfill demand from their customers in different specified location.
 PFRS 15 introduces a five-step model for revenue recognition that focuses on the transfer of
control rather that the

transfer of risks and rewards.

The five-step model is as follows:

STEP I STEP II STEP III STEP IV STEP V

Allocate the Recognize
Identify the Identify the Determine transaction revenue
contract with performance the price to the when (or as)
a customer obligation in transaction performance the entity
the contract price obligation in satisfies a
Definitions: the contract performance
a. Revenue – income arising in the course of an entity’s ordinary activities
b. Contract – An agreement between two or more parties that obligation
creates enforceable
rights
and obligations . A contract can be written oral, or implied by an
entity’s customary
business practice.
c. Customer – a party that has contracted with an entity to obtain goods or
services that are
an output of the entity’s ordinary activities in exchange for
consideration.
PFRS 15 supersedes PAS 11 Construction Contracts
Summary of the Revenue recognition Principles under PFRS 15 :
Step 1- Identify the contract with the customer - The contract is with a customer and the collectability of the
consideration is probable.
Step 2 – Identify the performance obligation in the contract – Each promise to deliver a distinct good or service
in the contract is treated as a separate performance obligation.
A promised 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.
b. The promise to transfer the good or service is separate identifiable from other promises in the contract.
Step 3 – Determine the transaction price – The transaction price is the amount that the entity expects to be entitled to in

exchange for a satisfying performance obligation.

Step 4 – Allocate the transaction price to the performance obligations – The transaction price is allocated to
the performance obligations based on the relative stand alone prices of the distinct goods and services.
Step 5 - Recognize revenue when (or as) a performance obligation is satisfied – For performance obligations satisfied
over time, revenue is recognized as the entity progresses towards the complete satisfaction of the
performance.
For performance obligations satisfied at a point in time , revenue is recognized when the entity completely
satisfies the performance obligation.
Revenue is measured at the amount of satisfaction price allocated to the performance obligation satisfied.
 Construction contract – is a contract specifically negotiated for the construction of an asset or a combination of
assets that are closely interrelated or interdependent in terms of their design, technology
and function or their ultimate purpose or use.

Construction contracts include:

a. Contracts for rendering of services which are directly related to the construction of the asset, for
example,
those for the services of project managers and architects.
b. Contracts for the distraction or restoration of assets and the restoration of the environment following
the
demolition of assets.

Application of the Basic Principles of PFRS 15

Sept 1 - Identify the contract with the customer

A contract with a customer is accounted for only when all of the following criteria are met:
a. The contracting parties have approved the contract and are committed to perform their respective
obligations.
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. The consideration in the contract is probable of collection .
Collectability criteria (e) step 1 - Identify the contract with a customer
The inclusion of a collectability requirement in the identification of a contract incorporates an evaluation of the
customer’s credit risk in determining whether a contract is, in fact valid. When performing the collectability
assessment, an entity only consider the customer’s ability and intention to pay the expected consideration when due.
No revenue is recognized on a contract that does not meet the criteria above.

An example of this scenario is included in the standard relating the significant deterioration in a customer’s ability
to pay the consideration when due. Entities in this situation will need to determine whether it is still probable that they
will be able to collect the amount of consideration to w/c they are entitled , or the contract may no longer be a contract
under PFRS 15.
 Any consideration received from the contract is recognize as a liability and recognize as revenue only when
either
of the following has occurred:
a. The entity has no remaining obligation to transfer goods or services to the customer and all, or
substantially
all, of the consideration has been received and is non-refundable
b. The contract has been terminated and the consideration received is non-refundable

Combination of contracts
Each contract is accounted for separately. However, two or more contracts entered into at or near the
same
time with the same customer shall be combined and accounted for as a single contract if:
a. The contracts are negotiated as a package with a single commercial objective
b. The amount of consideration to be paid in one contract depends on the price or performance of
the other
contract
c. Some or all of the goods or services promised in the contracts are single performance obligation
 Step 2 - Identify the performance obligation in the contract
Once an entity has identified the contract w/ a customer, it evaluates the contract terms and its customary
business practices to identify all the promised goods or services within the contract and determine w/c of those promised
goods or services will be treated as separate performance obligations.
A contract includes both explicitly and implicitly promised goods or services.
Each promise to transfer the following is a performance obligation to be accounted for separately :
a. A distinct good or service (or a distinct bundle of goods or services)
b. A series of distinct goods or services that are substantially the same and have the same
pattern of transfer to the customer
A promise 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.
b. The promise to transfer the good or service is separately identifiable from other promises
in the contract.
Separate identifiable:
A promise to transfer a good or service is separately identifiable if the good and service:
a. is not an input to a combined output specified by the customer.
b. does not significantly modify another good or service promised in the contract.
c. is not highly interrelated with other goods or services promised in the contract.
Example : Identifying Distinct Goods

A bus manufacturer offers for sale both fully manufactured buses and spare parts. When a customer purchases a
fully
manufacture bus, it is made up of many inputs(e.g., engine, tires, frame, etc.); however, the customer is not receiving
these individual inputs (e.g., the engine in isolation). Rather, these inputs are used to produce a combined output to the
customer(i.e., a bus). Although engines may be sold separately as a spare part, w/c would indicate that it meets the first
criterion of being a distinct goods (i.e., capable of being distinct) in the context of a contract for a fully manufactured bus
the engine is not considered distinct because it is an output and the entity is proving a significant service by integrating
the engine with other goods and services in the contract (i.e., the engine is not distinct within the context of the contract).

Therefore in this type of contract, the engine is not considered to be a distinct good or service, and is not a
separate performance obligation.
Series of distinct goods or services
Goods and services that are part of a series of distinct goods or services that are substantially the
same and have the same pattern of transfer to the customer shall be accounted as a single
performance obligation if both of the following criteria are met:
a. Each distinct good or service in the series that entity promise to transfer represents a
performance obligation that would be satisfied over time if it were accounted for
separately.
b. The entity would measure its progress toward satisfaction of performance obligation
using the same measure of progress for each distinct good or service in the series.
Example – Goods and services are not distinct
An entity, a contractor, enters into a contract to build a hospital for a customer. The
entity is responsible for the overall management of the project and identifies various
goods or services to be provided , including engineering, site clearance , foundation,
procurement, construction of the structure, piping and wiring installation of equipment
and finishing.
Satisfaction of performance obligations
At the contract inception, the entity shall determine whether the identified performance obligations
will be satisfied either:
a. Over time; or
b. At a point in time
A performance obligation is satisfied over time if one of the following criteria is met:
a. The customer simultaneously receives and consumes the benefits provided by the entity’s
performance as the entity performs.
Ex. If the contract with the customer is discontinued and the customer enters into a contract with
another entity to fulfill the remaining performance obligation, the other entity would not need
to substantially re-perform the work that the entity has completed to date.
b. The entity’s performance creates or enhances an asset (e.g., working progress) that the
customer controls as the asset is created or enhanced.
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.
Alternative use
i. An asset does not have alternative use to the entity if the entity is restricted contractually from
directing the asset for another use during or after the asset’s completion. In the absence of a
contractual restriction, the entity is still restricted from directing the asset for another use if the entity
would incur significant losses to direct the asset for another use because it need to rework the
asset at a significant cost or the asset can only be sold at a significant loss (e.g., the asset has design
specifications that are unique to the customer or is located in a remote area).

Enforceable right to payment for performance completed to date

ii. An entity has enforceable right to payment for performance completed to date if the entity is entitled
to
an amount that compensates the entity for any performance completed in the event that the customer or
another party terminates the contract for reason other than the entity’s failure to perform as promised.
iii. The amount referred to in (ii) above shall be sufficient for the entity to recover the cost incurred in
satisfying the performance obligation plus a reasonable profit margin. The compensation for a
reasonable
profit margin need not equal the profit margin expected if the contract was fulfilled as promised.
Example : Assert has no alternative use to the entity.

An entity enters into a contract with a customer, a government agency, to build a specialized
satellite. The entity builds satellite for various customers, such a government and commercial entities.
The design and construction of each satellite differ substantially, on the basis, on the basis of each
customer’s needs and the type of that is incorporated into the satellite.

At contract inception, the entity assesses whether its performance obligation satisfies over time. 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.
Example : Enforceable right to payment for performance completed to date
An entity enters into a contract with a customer to build an item of equipment. The payment schedule in the contract
specifies that the customer must make an advance payment at the contact inception of 10% of the contract price , regular
payments throughout the construction (amounting to 50% of the contract price) and a final payment of 40% of the
contract price after construction is completed and the equipment has passed the prescribe performance test. The
payment are non-refundable unless the entity fails to perform as promised. If the customer terminates the contract, the
entity is entitled only to retain any progress payment received from the customer. The entity has no further rights to
compensation from the customer.

Because the entity does not have a right to payment for performance completed to date, the entity’s performance
obligation is not satisfied over time. The entity accounts for the construction of the equipment as a performance
obligation satisfied at a point in time.
Ex. Assessing whether a performance obligation is satisfied at a point in time or over time .

An entity is developing a multi-unit residential complex. A customer enters into a binding sales contract with the entity
for a specified unit that is under construction. Each unit has similar floor plan and is of a similar size, but other attributes
of the units are different (for ex. The location of the unit within the complex ).

Case A – Entity does not have enforceable right to payment for performance completed to date

The customer pays a deposit upon entering into the contract and the deposit is refundable only if the entity
fails to complete construction of the unit in accordance with the contract . The remainder of the contract price is payable
on completion of the contract when the customer obtains physical possession of the unit. If the customer defaults on
the contract before completion of the unit, the entity only has the right to retain the deposit.

The entity does not have an enforceable right to payment for performance completed to date because, until
construction of the unit is complete, entity only has the right to deposit paid by the customer. Therefore , the entity’s
performance obligation is not satisfied over time but rather satisfied at a point in time.
Case B - Entity has an enforceable right to payment for performance completed to date
The customer pays a non-refundable deposit upon entering into the contract and will make
progress payments during construction of the unit . The contract has substantive terms that preclude
the entity from being able to direct the unit to another customer. In addition, the customer does not have
the right to terminate the contract unless the entity fails to perform as promised progress payments as
and when they are due the entity would have right to all of the consideration promised in the contract
if it completes the construction of the unit. The courts have previously upheld similar rights that entitle
developers to require the costumer to perform, subject to the entity meeting obligation under the contract.

Conclusion: Entity performance does not have an alternative use because contract precludes the transferring
specified unit to another customer. No contract termination, performance obligation is satisfied
over time. Revenue recognition is over time by reference to the measure of its progress towards
the complete satisfaction of the performance obligation.

Step 3 – Determine the transaction price

The transaction price is the amount of consideration to w/c an entity expects to be entitled in exchange for
transferring promised goods or services to a customer, excluding amounts collected on behalf of third party
(e.g., some sales taxes).

This amount is meant to reflect the amount to w/c the entity has rights under the present contract, which may
differ from the contractual price (e.g., if the entity intends to offer a price concession.

In a construction contract, the transaction price normally consists of the ff:

a. The contract price; and
b. Any subsequent variations in the contract price to the extent that is probable that they will
result in revenue and they are capable of being measured reliably.
However, the transaction price may not be equal to the contract price if the consideration is affected by any of the ff:

a. Variable consideration

b. Constraining estimates of variable consideration

c. The existence of a significant financing component in the contract

d. Non-cash consideration; and

e. Consideration payable to a customer

a. Variable Consideration encompasses any amount that is variable under a contract, including , for example,
performance bonus penalties, discounts, rebates’ price concession, incentives and the customer’s right to return
products.

In addition, consideration may be contingent on the occurrence or non-occurrence of a future event (e.g., a
performance bonus).
An entity is required to estimate each type of variable consideration using either the ‘expected value(i.e., the sum
of probability –weighted amounts) or the most likely amount (i.e., the single most likely outcome.
b. Constraining estimates of variable
To include variable consideration in the estimated transaction price, the entity has to first conclude that it is
highly probable that a significant revenue reversal will occur when the uncertainties related to the variability are resolved.

Factors that may indicate that revenue will be subject to a significant reversal:
a. The amount of consideration is highly susceptible to factors outside the entity’s influence(e.g.,
market volatility, judgement or actions of third parties, weather conditions).
b. The uncertainty about the amount of consideration is not expected to be resolved for a long period of time.
c. The entity’s experience (or other evidence) with similar types of contract is limited or that experience
has limited predictive value.
d. The entity has a practice of either offering a broad range of price concessions or changing the payment
terms and conditions of similar contract in similar circumstances.
e. The contract has a large number and broad range of possible consideration amounts.

c. Existence of a significant financing component

The objective when adjusting the promised amount of consideration for a significant financing component Is that revenue

recognized should reflect the “cash selling price” of the particular good or service at the time the good or service is transferred.

A significant financing component may exist when the receipt of consideration does not much the timing of the transfer of

goods or services to the customer (i.e., the consideration is prepaid or is paid well the after the goods or services are provided).
 Non-cash consideration
The customer may choose to procure and provide to the contractor certain materials that are necessary for the entity to
complete a project. In other circumstances, the contractor may purchase and pay for the required materials using the
customer’s procurement and purchase functions.

The standard states that a customer’s contribution of goods or services (e.g., materials, equipment labor) that are
used in the fulfilment of a contract is a form of non-cash consideration if the contractor obtains control of the goods or
services.
When an entity receives, or expects to receive, non-cash consideration, the fair value of the non-cash consideration
is included in the transaction price. The fair value of non-cash consideration, it required to measure the non-cash
consideration indirectly by reference to the estimated stand-alone selling price of the promised goods or services.
Ex. A technology company has recently encountered some cash flow difficulty. However, the company believes
a new division of operations will fix this issue. In order to commence operations in this new division, the company
requires certain software license, w/c its regular software vendor agrees to provide. However, rather than receiving a
cash consideration for the licenses . The software vendor agrees to receive 1,000 shares of the common stock
of the technology company, w/c they receive in 60days when payment is due.
e. Consideration payable to the customer
This may constitute a payment for distinct goods or services , or payment of a discount or refund . Some ,
common examples include coupons, vouchers, slotting and listing fees, etc. This type of consideration must
be accounted for as a reduction of the transaction price.
A construction contract may be either:

1. Fixed price contract – a construction contract in w/c the contractor agrees to a fixed contract price, or a
fixed rate per unit of out put, w/c in some cases is subject to cost escalation clauses; or

2. Cost plus contract – a construction contract in w/c the contractor is reimbursed for allowable or
otherwise defined cost, plus a percentage of these costs or affixed fee.

There are two types of cost-plus contracts.

a. Cost-plus-variable-fee contract – the contractor is reimbursed for agree cost with no provision
for a fixed fee. Instead the fee is determined by applying an agreed percentage to the total
reimbursable costs. The total contract price is the sum of reimbursable costs and the
percentage based on these costs.

b. Cost-plus-fixed fee contract – The contractor is reimbursed for agreed costs plus a provision
for a fixed fee. The contract price is the sun of reimbursable costs and the fixed fee.

Some construction contracts may contain characteristics of both a fixed price contract and a cost plus contract,
for example in the case of a cost plus contract with an agreed maximum price.
Example: You want to put up a house so you contracted Mr. Architect Engineer Contractor to build a house for you.

1. Your contract with Mr. Contractor states a price of P6M for the house. What type of contract is this, fixed
price contract or Cost plus contract and how much is the transaction price?
Ans. Fixed price contract, transaction price is P6M.

2. Your contract with Mr. Contractor states that you shall reimburse Mr. Contractor the total construction
costs plus 15% thereof. What type of contract fixed price or cost-plus contract and what is the transaction price?
Ans. Contract is a cost-plus-a- variable –fee contract, transaction price is equal to the reimbursable costs
plus 15% thereof.

Cost-plus pricing is used in cases where it is difficult for the contractor to quote the contract price
because contract price because either:
a. It is not possible to accurately estimate the scope of the project
b. there have been no precedent similar projects that can be used as a basis for price quotation.

The cost-plus method, particularly the cost-plus-variable-fee is generally used for contracts with the government.
Step 4 - Allocate the transaction price to the performance obligations
Once the performance obligation is identified and the transaction price has been determine, an entity is
required to allocate the transaction price to the performance obligations in proportion to their stand-alone selling
price (i.e., on a relative stand-alone selling price basis).
The transaction price is allocated to the performance obligation based on the relative stand-alone prices of the
distinct goods or services
The stand-alone selling price is the price at w/c a promised good or service can be sold separately to
a customer.
If there is only one performance obligation in a contract, the transaction price shall be allocated only
to that single performance obligation.
Example: Allocating the transaction price
A retailer sells a customer a computer- and – printer package for P90,000. The retailer has determine
that these are two separate performance obligations and regularly sells the printer for P30,000 and
the computer for P70,000.
Required : Allocate P90,000 total transaction price.
Solution : Printer : 30,000/100,000 x 90,000 = 27,000
Computer : 70,000/100,000 x 90,000 = 63,000

In this transaction, there is an inherent discount of P10,000 w/c does not relate to a specific performance obligation and is
therefore allocated to all performance obligation on a relative stand-alone selling price basis.
Step 5 – Recognized revenue when (or as ) a performance obligation is satisfied

A good or service is considered to be transferred when the customer obtains control. Control of the good
or service refers to the ability to direct its use and to obtain substantially all of its remaining benefits
(i.e., right to cash inflows or reduction of cash outflows generated by the good or service).

Control also means the ability to prevent other entities from directing the use of and receiving the benefit
from, a good or service.
If the performance obligation in the contract is satisfied over time, revenue is recognized over time as the
entity progresses towards the complete satisfaction of the obligation.
If the performance obligation in the contract is satisfied at a point in time, recognize revenue when
the performance obligation is satisfied.
Revenue is measured at the amount of the transaction price allocated to the satisfied performance obligation.

Ex. If the performance obligation is 70% completed, revenue is recognized equal to 70% of the transaction

price.
Revenue recognized at a point in time
When recognizing revenue at a point in time, entities need to consider when the customer obtains the ability to direct the
use of, and obtain substantially all of the remaining benefits from, the asset. 
IFRS 15 provides a list of indicators that control has passed, including if the customer has:

• A present obligation to pay

• Physical possession of the asset(s)
• Legal title
• Risks and rewards of ownership
• Accepted the asset(s).
Revenue recognized at over time
In practice, it is not always straightforward to determine which of the ‘over time’ criteria, if any, are relevant and
Whether they are satisfied. For example, in the case of a professional services engagement:

• Does the customer receive a service or goods? Payroll processing services could be services that the customer
receives and benefits
• from throughout the contract and may qualify for over time revenue recognition under the criteria
• Is the objective of the engagement to produce a report? The customer is unlikely to benefit until the report is
delivered. In such cases,
• the entity needs to consider the criteria or revenue might need to be recognized at a point in time when the report
is completed.
• A careful review of the contract terms, and the legal frameworks that govern the transaction, is required.  There is
often considerable judgement involved in assessing:
• Whether the asset can be sold to another customer, and
• Whether there is a right to payment for both costs incurred to date and a reasonable profit margin at all times
throughout the contract.
 
 
 
 

      
 Methods for measuring progress
The entity shall use a single method of measuring progress consistently for each for each performance obligation
satisfied over time and shall measure its progress at the end of each reporting period. Appropriate methods of
measuring
progress include :
a. Output methods
b. Input methods

Input methods
These methods recognize revenue on the basis of efforts or inputs expended relative to the total expected
inputs needed to fully satisfy a performance obligation, example of efforts or inputs include:
a. Cost incurred
b. Resources consumed
c. Labor hours expended
d. Machine hours used
e. Time elapsed
The most common application of the input methods is the cost-to-cost method. Cost – to - cost - method refers

to the estimation of stage of completion by reference to the proportion that contract costs incurred for wok

perform to date bear to the estimated total contract cost.

In other words, the percentage of completion is determined as the ratio of total cost incurred to date

over the estimated total contract costs.

Total costs incurred to date

Formula: Percentage of completion =
Estimated total contract costs

Total cost incurred to date

or =
Total cost incurred to date + Estimated to complete
 Total cost incurred to date include the cumulative costs incurred on the contract from inception of construction up to

the end of the current reporting period.

 Estimated total contract costs pertain to the forecasted total cost of completing the construction contract. Total

estimated contract cost may also be determined as the sum of total costs incurred to date plus the estimated costs to

complete.

 Estimated costs to complete pertain to the anticipated additional contract costs required to fully complete the contract
at

a schedule time.
Illustration 1 – Input method – estimated total contract price costs
On July 1, 2019, ABC Const. Co. enters into contract with a customer for the construction of a
building. The contract price is P6M , w/c is to be billed to the customer periodically based on
ABC’s progress on the construction. The estimated total contract cost is P4M . The actual cost
incurred in 2019 amounts to P1.2M

Requirement: Identify the customer, performance obligation, transaction price and allocate the transaction price. How
much revenue is recognized in 2019?

Solution:

Step 1 – Identify the contract with the customer:

The contract is a construction contract, i.e., a contract specifically negotiated for the construction of

an asset.

2 - Identify the performance obligation in the contract:

Performance obligation is to construct a building. The performance obligation is satisfied over time.

3 – Determine the transaction price:

Transaction price is the contract price of P6M

4 - Allocate the transaction
The whole of P6M transaction price is allocated to the single performance obligation of constructing a

building.

5 – Recognize revenue when a performance obligation is satisfied

Performance obligation is satisfied over time, as it progresses towards the complete construction of

building. ABC shall measure progress using cost-to-cost , an application of the input method.

Computation for revenues :

Revenue in 2019 = Percentage of completion = total costs incurred to date / estimated total contract
cost
= 1.2M / 4M

= 30%

Revenue in 2019 = contract price x percentage of completion

= 6M x 30%

= P1,800,000
Illustration 2 – Input method – Estimated costs to complete

On July 1, 2019, ABC Const. Co. enters into contract with a customer for the construction of a building. The contract price is
P6M. The actual costs incurred in 2019 amounts to P1.2M. As of December 31,2019, the estimated costs to complete is P2.8M.
Requirement: How much revenue is recognized in 2019?
Solution:
Percentage of completion = Total costs incurred to date / total costs incurred to date + estimated costs to complete
= 1.2M / (1.2M + 2.8M)
= 30%
Revenue for 2019 = Contract price x Percentage of completion
= 6M x 30%
= P1,880,000
Illustration : Effort-expended method
ABC CO. is contracted to construct an amusement park for XYZ, Inc. ABC subcontracted a large portion of the contract. ABC
uses the effort- expended method in determining the stage of completion of the contract. Information on efforts expended on the
contract is:
20x1 20x2
Total direct labor hour to date 400 1,500
Estimated direct labor hours to complete 1,600 375
Requirement: Compute for the percentage of completion of the contract as of December 31,20x1 and 20x2.

Solution:
Percentage of completion = Total labor hours to date / Total labor hours to date + Estimated labor hours to complete

20x1 : Percentage of completion = 400 / (400 +1,600)

= 20%

20x2 : = 1,500 / (1,500 + 375)

= 80%
The percentage completed in 20x2 is 60% (80% - 20%)
 Contract costs
Contract costs include:
a. Incremental costs of obtaining a contract
b. Costs to fulfill a contract

Incremental costs of obtaining a contract – are costs incurred in obtaining a contract with a customer that the entity
would not have incurred had the contract not been obtain (e.g. Sales commission)
 Such costs are recognized as asset if the entity expects to recover them.
 Costs that would have been incurred regardless of whether the contract was obtained are recognized as expense , unless
those costs are explicit chargeable to the customer regardless of whether the contract is obtained.

As a practical expedient , incremental cost of obtaining a contract are recognized as expense when incurred if the expected
amortization period of the these asset is one year or less.
Costs that relate directly to a contract (for a specific anticipated contract) include any of the following:
a. Direct materials (e.g., cost of materials used in construction).
b. Direct labor (e.g., site labor costs, including site supervision).
c. Other costs that are incurred only because the entity entered into the contract. Examples:
i. Payments to subcontractor
ii. Cost of removing plant, equipment and materials to and from the contract site
iii. Costs of hiring plant and equipment
iv. Costs of design and technical assistance that are directly related to the contract
d. Cost that are explicitly chargeable to the customer under the contract (e.g., estimated costs of rectification and
guarantee work, including expected warranty costs, and claims from third parties.

e. Allocation of costs that relate directly to the contract or to contract activities. Examples:

i. Insurance

ii. Depreciation of plant and equipment used on the contract

iii. Costs of design and technical; assistance that are not directly related to a specific contract

iv. Costs of contract management and supervision

v. Borrowing costs capitalized in accordance with PASS 23 Borrowing Costs

Accounting for Construction Contracts
Illustration : On January 1,2019 , ABC Co. enters into a contract with a customer for the construction of a building. The contract
price is P1M.
a. At the inception , the customer makes an advance payment of P100,000 as facilitation fee.

Journal entry : Cash 100,000

Contract liability 100,000

b. ABC CO. incurs total contract costs of P300,000 during the period.

Journal entry : Construction in progress 300,000

Cash 300,000

c. The estimated costs to complete as of year end is P500,000 , Year –end adjusting entry to recognize revenue

Journal entry: Cost of construction 300,000

Construction in progress (gross profit) 75,000
Revenue 375,000
Gross profit computation: Total contract price 1,000,000
(a) Cost incurred to date 300,000
Estimated costs to complete 500,000
(b) Estimated total contract costs 800,000
Expected gross profit from contract 200,000
Multiply by : Percentage of completion (a) / (b) 37.50%
Gross profit earned to date 75,000

d. ABC, C. bills the customer for work performed on the contract

Journal entry: Receivable 275,000

Contract liability 100,000

Progress billing (1M x 37.50%) 375,000

Output methods - recognize revenue on the basis of direct measurements of the value to the customer of the goods

or services transferred to date relative to the remaining goods or services promised under the contract.

Output methods include the following :

a. Surveys of performance completed to date

b. Appraisals of results achieved, milestones reached, time elapse and units produce or

units delivered.

The disadvantage of output methods are that outputs used to measure progress not directly observable and

the information required to apply them may be costly.

This normally the case for construction of high-rise building, dams, bridges and other structures where in the

incurrence of cost is not necessarily proportionate to the entity’s progress on the contract.
Onerous contract

When it is probable that total contract costs will exceed total contract revenue, the expected loss shall be
recognized immediately as expense. This shall be treated as a change in accounting estimate accounted for prospectively.

Onerous contract is a contract in w/c the unavoidable costs of meeting the obligations under the contract exceed the economic
benefits to be received under it.

Example – a construction contract becomes onerous if the expected costs in fulfilling the performance obligation
exceed the transaction price.

The unavoidable costs under a contract reflect the lease net cost of exiting from the contract, w/c is the lower of the:
a. Cost of fulfilling it
b. Any compensation or penalties arising from failure to fulfill it .

Before a separate provision for an onerous contract is established, an entity recognizes any impairment loss that has occurred on
assets dedicated to that contract in accordance with PAS 36 Impairment of assets.
Example – Measurement of provision – Onerous contract
On July 1, 2019, ABC Const. Co. enters into contract with a customer for the construction of a building. ABC Co. uses the cost-
to-cost method in measuring its progress on the contract.
The contractual agreement stipulates the ff:
 The contract price is P6M. The bill of materials, labor and other costs states an expected total contract cost of P4M
 In the event that ABC Co. cancels the contract, ABC Co. shall pay the customer a penalty of 15% of the contract price. The customer
retains any asset created in the contract and any unused materials acquired for the contract.
ABC Co. Incurs total costs of P1,860,00 in 2019. On December 31, 2019,ABC Co. revises its estimates of total contract cost to P6.2M.
Requirement: Compute for the provision for onerous contact on the December 31,2019.
Solution:
The net cost from fulfilling the contract is computed as follows:
Contract price 6.0 M
Revised estimated total contract cost 6.2 M
Net cost of fulfilling the contract (.2 M)
Penalty from failure to fulfill the contract is computed as follows:
Contract price 6.0 M
Multiply by penalty percentage 15%
Penalty from failure to fulfill the contract 0.9 M

The loss recognized in 2019 is P0.2 M, the lower amount.

The amount recognized in 2019 profit and loss are computed as follows:

Total contract price 6,000,000

Multiplied by percentage of completion:
Costs incurred to date 1,860,000
Divide by estimated total contract costs 6,200,000 30%
Revenue to date 1,800,000
Cost of construction (actual cost incurred ) (1,860,000)
Gross loss for the year (60,000)
Provision for onerous contract( 200,000- 60,000) (140,000)
Loss for the year (200,000)
Variable consideration

If the consideration includes a variable amount, the entity shall estimate the amount to w/c it will be entitled in exchange
for transferring the promised goods or services to the customer.

Constraining estimates of variable consideration

The estimated amount of variable consideration will be included in the transaction price only to the extent that is highly
probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty
associated with the variable consideration is subsequently resolved.

As used in the standards:

Probable – means more likely not (i.e., there is more than 50% chance that an event will occur;
Highly probable – means significantly more likely than probable

The amount of consideration can vary because of discounts, refunds, credits, price concessions, incentives, performance ,
bonuses, penalties or other similar items.

It can also vary if the entity’s entitlement to the consideration is contingent on the occurrence or non-occurrence of a future
events.

The variability of consideration may be explicitly stated in the contract or implied by the entity’s customary business
practices ,published policies, specific statements, or by other facts and circumstances.
The amount of variable consideration shall be estimated using either of the following methods, depending on w/c method
is expected to better predict the amount to w/c the entity will be entitled:

a. Expected value – the sum of profitability-weighted amounts in a range of possible amounts. This may be
appropriate when the entity has a large number of contracts with similar characteristics.

b. Most likely amount – the single most likely amount in a range of possible amounts. This may be appropriate
when there are only two possible outcomes (for example, an entity either achieves
a performance bonus or does not).

Examples of contract stipulation that could make the consideration in a construction contract variable:

1. Penalties
2. Incentive payments
3. Cost of escalations
Example – Penalty gives rise to variable consideration
An entity enters into a contract with a customer to build an asset for CU 1million. In addition , the terms of the
contract include a penalty of CU 100,000 if the construction is not completed within three months of a date specified in
the contract.
Conclusion : The consideration promised in the contract includes a fixed amount of CU 900,000 and a variable amount of
CU 100,000 (arising from the penalty).
Example – Estimating variable consideration
An entity enters into a contract with a customer to build a customized asset. The promise to transfer the
assets a performance obligation that is satisfied over time. The promised consideration is CU 2.5 million,
but the amount will be reduced or increased depending on the timing of completion of the asset.
Specifically, for each day after 31 March 20x7 that the asset is incomplete, the promised consideration
is reduce by CU 10,000. For each day before 31 March 20x7 the asset is complete, the promised
consideration increase by CU 10,000.
In addition, upon completion of the asset, a third party will inspect the asset and assign a rating based
on metrics that are defined in the contract. If the asset receives a specific rating, the entity be entitled
to an incentive bonus of CU 150,000.
Expected value method is used, CU 2.5million plus or minus CU 10,000per day
Most likely amount to estimate variable consideration, two possible outcomes CU 150,000 or CU 0)
In determining the transaction price, the entity prepares a separate estimate for each element of variable consideration to w/c the
entity will be entitled using the estimation methods described above:
a. The entity decides to use the expected value method to estimate the variable consideration associated with the daily
penalty or incentive (i.e., CU 2.5 million , plus or minus CU 10,000 per day). This is because it is the method that the entity expects to
better predict the amount of consideration to w/c it will be entitled.
b. The entity decides to use the most likely amount to estimate the variable consideration associated with the incentives
bonus. This is because there are only two possible outcomes ( CU 150,000 or CU 0 ) and it is the method that the entity expects to
better predict the amount of consideration to w/c it will be entitled.

Incentive payments
Incentive payments are additional amounts paid to the contractor if specified performance standards are met or exceeded.
For example, a contract may allow for an incentive payment to the contractor for early completion of the contract.
Incentive payments are included in the transaction price and consequently to contract revenue when, in applying the
constraining estimates of variable consideration principle, it is highly probable that a significant reversal in the amount of cumulative
revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
Cost escalations
A cost escalation is contractual provision that stipulates an increase in the contract price in the event of an increase in certain cost. For
example, an escalation clause may specify that the contract price will increase with inflation to provide safeguard to the contractor against
changes in the prices of material and labor.
Cost escalation clauses are normally expressed as a percentage of an originally contracted amount. The opposite of an escalation clause is
de-escalation clause. It include in (or a cost de-escalation is excluded from) the transaction price when, in applying the constraining estimates of
variable consideration principle, it is highly probable that a significant reversal in the amount of cumulative revenue recognized will not occur
when the uncertainty associated with the variable consideration is subsequently resolved.
Illustration : ABC Co. started work on a construction contract in 20x1. The contract price is P10 Million . However, the contract agreement
stipulates that if the cumulative inflation reaches or exceeds 26%, the contract price shall be adjusted upward by 10%. Additional information on
the contract is shown below:
20x1 20x2
Costs incurred to date 2,400,000 4,500,000
Estimated costs to complete 3,600,000 1,500,000
Cumulative inflation rate 18% 27%
Requirement: Compute for the profit to be recognized in 20x2.
Solution: 20x1 20x2
Total contract price 10,000,000 11,000,000
a) Costs incurred to date 2,400,000 4,500,000
Estimated costs to complete 3,600,000 1,500,000
b) Estimated total contract costs 6,000,000 6,000,000
Expected profit (loss) 4,000,000 5,000,000
Multiply by % of completion (a) / (b) 40% 75%
Profit (loss) to date 1,600,000 3,750,000
Profit recognized in prior years - (1,600,000)
Profit (loss) for the year 1,600,000 2,150,000
(10 million x 110% = 11 Million
Contract modification
A contract modification is a change in the scope and / or price of a contract that is approve by the contracting parties , inwriting,
orally or implied by customary business practices . Similar terms are change order, variation and amendments.
If the contract modification is not approved , the entity shall continue to apply PFRS 15 to the existing contract until the medication
is approved.
A contract modification is accounted for as a separate contract ( meaning that the original contract is left as it is), if both
of the following conditions are met:
a. The scope of the contract increase because of addition of promised goods or services that are distinct
b. The contract price increases by an amount that reflects the stand-alone selling prices of the additional
promised goods or services
A contract modification that is not accounted for as a separate contract (or one of them is not met above), is accounted for
as follows:
a. If the additional goods or services are distinct but the increase in the contract price does not reflect the stand-alone
selling price, The contract modification is accounted for as if it were a termination of the existing contract and a
creation
of a new contract.
b. If the additional goods or services are not distinct, they are essentially a part of a single obligation that is only
partially satisfied. Therefore the contract modification is accounted for as if it were a part of the existing contract.

Variation on the contract (Change orders)

A variation is an instruction by the consumers for a change in the scope of the work to be performed under the contract.
Examples of variations:
1. Changes in the specifications or design
2. Changes in the scope of work
3. Changes in duration of the contract
4. Renegotiations on the originally agreed contract price
Revenue under IFRS 15
Here, the additional contract represents typical contract modification, as the amount of computers changes and the
total transaction price changes, too.
IFRS 15 precisely specifies how to account for contract modifications, based on the terms of modification.
There are 2 basic types of contract modification:
Changes in the transaction price

After contract inception, the transaction price can change for various reasons, including the resolution of
uncertain events
A subsequent change in transaction price, arising from other than a contract modification, shall be allocated
to the Shall be allocated for the performance obligations based on the relative stand-alone prices of the
distinct goods at contract inception.
Amounts allocated to a satisfied performance obligation shall be recognize as revenue or as a reduction of
revenue in the period in w/c the transaction changes.

A change in the transaction price after a contract modification is accounted for as follows:
a. If the change in the transaction price is attributable to a variable consideration that existed
before a modification that was accounted for as s termination of the original contract and the
creation of a new contract, the change in the transition price is allocated to the performance
obligations in the original contract (before the modification).

b. In all cases in w/c the modification was not accounted for as a separate contract, the
change in the transaction price is allocated to the unsatisfied performance obligations in the
modified contract.
Illustration : Change in the transaction price
On July 1,20x1, ABC construction Co. enters into contract with a customer for the construction of a building. The contract price is
P6 Million. However, ABC is entitled to a bonus of P500,000 if the building is completed within 3 years. ABC CO. uses the cost-to
cost method in measuring its progress on the contract. At contract inception, ABC CO. estimates a total contract cost of P4
Million.
In 20x1 ABC CO. incurs total costs of P1,350,000. On December 31, 20x1. Due to bad weather conditions, ABC CO. Does not
expect that it can finish the building on time for it to be entitled to the bonus. The estimated costs to complete as of the end of
20x1 are P2.4 Million.
On January 28, 20x2, ABC Co. and the customer agree to modify the contract to change the design and location of the staircase.
The modification increase the contract price and the estimated total contract costs of P6.8 Million and P4.5 Million, respectively.
On this date, due to improvements in weather conditions, ABC Co. now expects that it is highly probable that it can finish the
building on time for it to be entitled to the bonus.
In assessing the contract modification, ABC Co. concludes that the remaining goods and services to be provided using the
modified contract are not distinct from the goods and services transferred on or before the date of contract modification; that is,
the contract remains a single performance obligation.
Requirement : Compute for the revenue in 20x1 and the cumulative catch–up adjustments to revenue to be recognized on contract
modification date on Jan 28, 20x2, respectively.
Solutions :
20x1 Jan. 28, 20x2
(a) Costs incurred to date 1,350,000 1,350,000
Estimated to complete 2,400,000 -
(b) Estimated total contract costs 3,750,000 4,500,000 (revised estimated total contract
costs)
Percentage of completion (a) / (b) 36% 30%
The revenue in 20x1 and the cumulative catch-up adjustment revenue in 20x2;
20x1 Jan. 28, 20x2
Total contract price 6,000,000 7,300,000
Multiply by % of completion 36% 30%
Revenue to date 2,160,000 2.190,000
Less: Revenue recognize in previously year - (2,160,000)
Revenue in 20x1 catch-up to adjustments
to revenue 20x2 2,160,000 30,000
Cost of construction (1,350,000) -
Gross profit for the year/ Cumulative catch-up
adjustment to gross profit in 20x2 810,000 30,000

* End of Presentation *