CONSTRUCTION

CONTRACTS
Revenue Recognition
Learning Objectives
1. Apply the principles under PFRS 15 to account for revenues from
construction contracts.
2. Account for contract costs on construction contracts.
3. Account for onerous construction contracts.
4. Account for variable consideration, contract modifications, and other
changes in the transaction price of construction contract.
5. Account for construction contracts wherein the collectability of contract
revenue is uncertain or becomes uncertain.
Summary of PFRS 15
Step 1. Identify the contract with the customer.
The contract is with a customer and (among other things) the collectability of the consideration is
probable.
Step 2: Identify the performance obligations in 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; and
b. The promise to transfer the good or service is separately identifiable from other promises in the contract.
Summary of PFRS 15
Step 3: Determine the transaction price.
The transaction price is the amount that the entity expects to be entitled to in exchange for
satisfying a performance obligation.
Step 4: Allocate the transaction price to the performance obligations.
The transaction price is allocated to the performance obligations based on relative stand-alone
prices of the distinct goods or services.
Summary of PFRS 15
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 obligation.
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 transaction 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 the rendering of services which are directly related to the construction of the
asset, for example, those for the services of project managers and architects; and
b. Contracts for the destruction or restoration of assets, and the restoration of the environment
following the demolition of assets.
Application of the Basic
Principles of PFRS 15
Step 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 (in writing, orally or implied in customary business
practices) 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 (i.e the risk, timing or amount of the entity’s future cash flows
is expected to change as a result of the contract); and
e. The consideration in the contract is probable of collection. When assessing collectability, the entity
shall consider only the customer’s ability and intention to pay the consideration on due date.
No revenue is recognized on a contract that does not meet the said criteria. Any consideration
received from such contract is recognized as a liability and recognized 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; or
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 (or related parties of the customer) shall be combined and accounted for as 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 the performance of the other contract, or
c. Some or all of the goods or services promised in the contracts are a single performance obligation.

Negotiating multiple contracts are at the same time is not sufficient evidence to demonstrate that the contracts represent a single
arrangement.
Step 2: Identify the performance obligations in
the contract
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); or
b. A series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer.
A promised good or service is distinct if:
c. 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; and
d. The promise to transfer the goo d or service is separately identifiable from other promises in the contract
Customer can benefit:
A customer can benefit from a good or service if the good or service could be used, consumed, sold for an amount that is greater
than the scrap value or otherwise held in a way that generates economic benefits. The fact that the entity regularly sells a good or
service separately indicates that a customer can benefit from the good or service on its own or with other readily available
resources.

Separately identifiable:
A promise to transfer a good or service is separately identifiable if the good or service:
i. is not an input to a combined output specified by the customer
ii. does not significantly modify another good or service promised in the contract
iii. is not highly interrelated with other with other goods or services promised in the contract.

A promised good or service that is not distinct shall be combined with other promised goods or services until a bundle of goods
or services that is distinct is identified. In some cases, this may result to treating all the promised goods or services in a contract
as a single performance obligation.
Series of distinct goods or services
Goods or 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 for as a single performance obligation if both of the following criteria
are met:
a. Each distinct good or service in the series that the entity promises 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 the performance obligation using the same measure of
progress for each distinct good or service in the series.

Performance obligations include only activities that involve the transfer of good or service to a customer. Performance
obligations do not include administrative tasks to set up a contract.

Satisfaction of performance obligations

At a contract inception, the entity shall determine whether the identified performance obligations will be satisfied either:
c. Overtime
d. 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.
b. The entity’s performance creates or enhances an asset (e.g. work in 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.

For many construction contract, it is likely that the performance obligation is satisfied over time. However,
an entity should consider all available information to determine whether one of the criteria mentioned is
met.
If the entity cannot demonstrate that a performance obligation is satisfied over time, it is presumed that the
performance is satisfied at a point in time.
Step 3: Determine the transaction price
The transaction price is the amount to which an entity expects to be entitled in exchange for transferring promised goods or
services to customer, excluding amounts collected on behalf of third parties (e.g. sales taxes)
In construction contract, the transaction price normally consists of the following:
a. The contract price; and
b. Any subsequent variations in the contract price to the extent that it 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 in the contract is affected by the
following:
c. Variable consideration;
d. Constraining estimates of variable consideration;
e. The existence of a significant financing component in the contract;
f. Non-cash consideration; and
g. Consideration payable to a customer
A construction contract may either be:
1. Fixed price contract – a construction contract in which the contractor agrees to a fixed price, or a fixed rate per unit
of output, which in some cases is subject to cost escalation clauses; or
2. Cost plus contract – a construction contract in which the contractor is reimbursed for allowable or otherwise defined
costs, plus a percentage of these costs or a fixed fee. There are two types of cost-plus contracts.
a. Cost-plus-variable-fee contract - the contractor is reimbursed for agreed costs 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 sum 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.

Cost-plus pricing is used in cases where it is difficult for the contractor to quote the 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 basis for price quotation.
Step 4: Allocate the transaction price to the
performance obligations
The transaction price is allocated tot eh performance obligations based on the relative stand-
alone prices of the distinct goods or services.
The stand-alone selling price is the price at which 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.
Step 5: Recognize revenue when (or as) a
performance obligation is satisfied.
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, the entity
recognizes revenue when the performance obligation is satisfied.
Revenue is measured at the amount of the transaction price allocated to the satisfied
performance obligation.
Performance obligation satisfied over time

◦ The recognition of revenue for this type of performance obligation requires the measurement
of progress.
Methods for measuring progress
The entity shall use a single method of measuring progress consistently for each performance
obligation satisfied over time and shall remeasure its progress at the end of each reporting
period. Appropriate methods of measuring progress include:
a. Output methods
b. Input methods
 Input methods
Input methods recognize revenue on the basis of efforts or inputs expended relative to the total expected inputs needed to fully satisfy
a performance obligation. Examples of efforts or inputs include:
a. Costs incurred
b. Resources consumed
c. Labor hours expanded
d. Machine hours used
e. Time elapsed
Cost to cost is the most common application of the input methods. It refers to the estimation of stage of completion by reference to the
proportion of the contract costs incurred for work performed to date bear to the estimated total contract costs.

Percentage of completion = Total costs incurred to date/ Estimated total contract costs
or Total costs incurred to date/ (Total costs incurred to date + Estimated costs to complete)
Output Methods
◦ 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 elapsed and units produced or units
delivered.

Since the various methods of determining the stage of completion of a contract results to different
amounts of revenue, costs and profit recognized for a period, PFRS 15, requires an entity to apply a
single method of measuring progress consistently fore ach performance obligation satisfied overtime.
Changes in the measure of progress
◦ The measure of progress shall be updated as circumstances change over time to reflect any changes in the
outcome of the performance obligation. Such changes are accounted for prospectively as a change in
accounting estimate in accordance with PAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors.
Reasonable Measures of progress
◦ Revenue for a performance obligation satisfied over time is recognized only if the progress towards
complete satisfaction of the performance obligation can be reasonably measured.
◦ If the outcome of the performance obligation cannot be reasonably measured but the entity expects to
recover the costs incurred in satisfying the performance obligation, revenue shall be recognized only to
the extent of those costs incurred until such time that the outcome of the performance obligation can be
reasonably measured.
◦ Under this, no profit is recognized during the periods in which construction work is performed but he
construction is not yet fully complete because the revenue recognized is equal to the cost of
construction recognized as expense.
Contract Costs
Contract costs include:
a. Incremental costs of obtaining the contract
b. Costs to fulfill the contract

Incremental costs of obtaining 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 been obtained (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 explicitly chargeable to the customer regardless of whether the contract
is obtained.
Costs to fulfill a contract
Costs incurred in fulfilling a contract that are withing the scope of other
standards (e.g. PAS 2 Inventories, PAS 16, PPE or PAS 38 Intangible Assets)
are accounted for in accordance with those standards.
Costs incurred in fulfilling a contract that are outside the scope of other
standards are recognized as asset if all of the following criteria are met:
a. The costs are directly related to a contract or specifically identifiable
anticipated contract.
b. The costs generate or enhance resources that will be used in satisfying
performance obligations in the future; and
c. The costs are expected to be recovered.
Costs that related directly to a contract (or 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:
- Payments to subcontractors
- Costs of moving plant , equipment and materials top and from the contract site
- Costs of hiring plant equipment
- Costs of design and technical assistance that are directly related to the contract

d. Costs 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. Allocations of costs that relate directly to the contract or to contract activities. Examples:
- insurance
- depreciation of plant and equipment used on the contract
- costs of design and technical assistance that are not directly related toa specific contract
- costs of contract management and supervision
- borrowing costs capitalized in accordance with PAS 23 Borrowing Costs
- Other construction overloads
The following costs are recognized as expenses when incurred:
a. General administration costs for which reimbursement is not specified in the contract
b. Costs of wasted materials labor or other resources that were not reflected in the price contract
c. Selling costs
d. Research and development costs for which reimbursement is not specified in the contract
e. Depreciation of idle plant and equipment that is not used on a particular contract;
f. Costs that relate to satisfied or partially satisfied performance obligations in the contract (i.e costs that relate to past
performance); and
g. Costs for which an entity cannot distinguish whether the cost relate to unsatisfied performance obligations or to satisfied or
partially satisfied performance obligations

Any incidental income derived from the construction that is not included in contract revenue shall be accounted for
as reduction of contract costs. For example, income from the sale of excess materials or scrap materials and gain on sale of plant
and equipment at he end of the contract shall be accounted for as reduction of contract costs.
Financial Statement Presentation
◦ When either party to a contract has performed, the contract is presented in the statement of financial
position as a contract liability or a contract asset. An unconditional right to consideration is presented
separately as a receivable.
◦ Contract liability - is an entity’s obligation to transfer goods or services toa customer for which the
entity has received consideration (or the amount is due from the customer.
A contract liability is recognized:
a. The entity receives a consideration before the good or service is transferred to the customer (i.e.
advance payment)
b. The entity has an unconditional right to the consideration before the good or service is transferred to
the customer (e.g., a non-cancellable contract requires payment in advance)
Financial Statement Presentation
◦ Contract asset – is an entity’s right to consideration in exchange for goods or services that the entity has
transferred to a customer when that right is conditioned on something other than passage of time (e.g.,
the entity’s future performance)
A contract asset (excluding amounts recognized as a receivable is recognized when the good or
service is transferred to the customer before the consideration is received or becomes due.
◦ Receivable – is an entity’s right to consideration that is unconditional. A right to consideration is
unconditional if only the passage of time is required before payment of that consideration is due, even if
the amount is subject to refund in the future.
◦ On initial recognition, any difference between that measurement of the receivable in accordance with
PFRS 9 and the corresponding amount of revenue is recognized shall be presented as an expense. (e.g.,
as a impairment loss)
Accounting for Construction Contracts
◦ Construction in Progress is an account used in traditional construction accounting to accumulate contract
costs incurred and recognized profits (less recognized losses) to date.
◦ Progress billings is an account used in traditional construction accounting to record amounts billed for
work performed on a contract whether or not they have been paid by the customer.
◦ Retentions are amounts of progress billings that are not paid until the satisfaction of conditions specified
in the contract for the payment of such amounts or until defects have been rectified.
Onerous Contract
◦ An onerous contract is a “ a contract in which the unavoidable costs of meeting the obligations under the
contract exceed the economic benefits expected to be received under it.” (PAS 27)
◦ The entity recognizes and measure the present obligation under an onerous contract as a provision in
accordance with PAS 37.
◦ The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the
lower of the
a. Cost of fulfilling it; and
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.
Onerous Contract
◦ An onerous contract is a “ a contract in which the unavoidable costs of meeting the obligations under the
contract exceed the economic benefits expected to be received under it.” (PAS 27)
◦ The entity recognizes and measure the present obligation under an onerous contract as a provision in
accordance with PAS 37.
◦ The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the
lower of the
a. Cost of fulfilling it; and
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.
Variable consideration
◦ If the consideration includes a variable amount, the entity shall estimate the amount to which 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.
◦ The amount of consideration can vary because of discounts, rebates, 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 event.
◦ 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 which method is
expected to better predict the amount to which the entity will be entitled:
a. Expected value – the sum of probability-weighted amounts in 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 (fore example, an entity either achieves a performance bonus or does not)
Examples of contract stipulations that could make the consideration in a construction contract to be variable:
1. Penalties
2. Incentive payments
3. Cost escalations
Incentive Payments
◦ Incentive payments are additional amounts paid to the contractor if specified performance standards are met or
exceeded. 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.
◦ Incentive payment may be granted by the customer to the contractor on a cost plus contract as internal control
procedure to encourage cost-efficiency and to discourage intentional bloating of expenses on which the final contract
is determined.
Cost escalations
◦ A cost escalation is contractual provision that stipulates an increase in the contract price in the event of
an increase in certain costs. A cost escalation is included 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.
Contract modifications
◦ A contract modification is a change in the scope and/or price of a contract that is approved by the contracting parties in writing
orally or implied by customary business practices. Similar terms are “change order” “variation” and “amendment”.
◦ If the contract modification is not approved, the entity shall continue to apply PFRS 15 to the existing contract until the
modification is approved.
◦ A contract modification is accounted for as a separate contract if both of the following conditions are met:
a. The scope of the contract increases because of the addition of promised goods or services that are distinct; and
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 is accounted for as follows:
 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 the
creation of a new contract.
Accordingly, the sum of a(a) the consideration from the original contract that is not yet recognized as revenue,
and (b) the consideration from the contract modification shall be allocated to all of the remaining performance
obligations.
 If the additional goods or services are not distinct, they are essentially a part of a single performance obligation that is
only partially satisfied. Therefore, the contract modification is accounted for as if it were a part of the existing contract.
Accordingly, the effect of the contract modification on the transaction price, and on the entity’s measure of
progress towards complete satisfaction of the performance obligation, is recognized as an increase or decrease in
revenue at the date of the contract modification. The adjustment to revenue is made on a cumulative catch-up basis.
Variations on the contract (Change orders)

◦ A variation is an instruction by the customer for a change in the scope of work to be

performed under the contract.
Examples:
1. Changes in the specifications or design
2. Changes in the scope of work
3. Changes in the duration of the contract
4. Renegotiations on the originally agreed contract price
Changes in the transaction price
◦ A subsequent change in the transaction price, arising from other than a contract modification,
shall be allocated tot eh performance obligations based on the relative stand-alone prices of the
distinct goods at contract inception. Accordingly, subsequent changes in stand-alone selling
prices are ignored. Amounts allocated tot a satisfied performance obligation shall be
recognized as revenue, or as a reduction of revenue, in the period in which the transaction
price changes.
◦ A subsequent change in the transaction price shall be allocated to all of the performance
obligations in the contract unless it is clear that it relates only to a specific part of the contract.
A change in in the transaction price after a contract modification is accounted for as follows:
 If the change in the transaction is attributable to a variable consideration that existed before a
modification that was accounted for as a termination of the original contract and the creation
of a new contract, the change in the transaction price is allocated to the performance
obligations in the original contract (before the modification).
 In all other cases in which the modification was not accounted for a s a separate contract, the
change in the transaction price is allocated to the unsatisfied performance obligations in the
modified contract.
Claims for reimbursements on the contract
◦ A claim is an amount that the contractor seeks to collect from the customer or another party as
reimbursement for costs not included in the contract price.
◦ A claim may arise from, for example, customer caused delays, errors in specifications, or design and
disputed variations in contract work. The measurement of the amounts of revenue arising from claims is
subject to a high level of uncertainty and often depends on the outcome of negotiations.
◦ Therefore, the entity shall assess whether it has an enforceable right over the claim. If the entity has an
enforceable right over the claim. If the entity has an enforceable right, it shall account for the claim as a
contract modification using the principles in PFRS 15. If the contract modification results to a change
taking into account the constraint on estimates of variable consideration.
Existence of a significant financing component
in the contract
◦ When determining the transaction price, the promised consideration shall be adjusted for the effects of
time value of money if the timing of agreed payments explicitly or implicitly provides the customer or
the entity with a significant benefit of financing the transfer of goods or services to the customer.
◦ When adjusting the promised consideration, the discount rate used shall be the rate that would reflected
in a separate transaction between the entity and the customer at contract inception.
◦ The difference between the promised consideration and the adjusted consideration is the is the financing
component, which is recognized as interest revenue or interest expense separately from revenue from
contracts with customers. Interest revenue or interest expense is recognized only to the extent that a
contract assess (or receivable) or a contract liability is recognized in accounting for a contract with a
customer.
The customer does not have, a significant financing component if:
a. The customer paid in advance and the transfer of the goods or services is at the customer’s discretion.
b. A substantial amount of the consideration is variable and contingent on the occurrence or non-
occurrence of a future event that is beyond the control of the customer or the entity.
c. The difference between the promised consideration and the cash selling price arises from reasons other
than financing.
The promised consideration need not be adjusted for the effects of a significant financing component if the
consideration is expected to be collected within 1 year from the date of transfer of the goods or services.
Non-cash consideration
◦ In many construction contracts, the customer may choose to provide the entity goods or services to
facilitate the fulfillment of the contract. In other circumstances, the entity may acquire those goods or
services using the customer’s procurement and purchase functions.
◦ The contributed goods or services are treated as non-cash consideration and included in the transaction
price fi the entity obtains control over them.
◦ A non-cash consideration is measured:
a. At fair value; or
b. If fair value is not available, at the selling price of the good or service promised to be transferred to the
customer
Uncertainty in the collectability of contract
revenue
◦ If the uncertainty in the collectability of contract revenue arises at contract inception, the entity does not
recognize any revenue from the contract. Any consideration received is recognized as a liability and
recognized 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 an non-refundable; or
b. The contract has been terminated and the consideration received is non-refundable and the
consideration received is non-refundable.
END OF PRESENTATION