Practical Guide to IFRS Engineering and Construction industry supplement July 2010

Revenue recognition full speed ahead

Engineering and Construction industry supplement Overview
Entities in the engineering and construction (E&C) industry applying IFRS or US GAAP have primarily been following either: IAS 11, Construction contracts or Statement of Position 81-1, Accounting for Performance of ConstructionType and Certain Production-Type Contracts (SOP 81-1, as codified in Topic 605-35) to account for revenue. These standards were developed to address the particular aspects of long-term construction accounting and provide guidance on a wide range of industry-specific considerations, including: defining the contract, such as when to combine or segment contracts, and when and how to account for change orders and other modifications; defining the contract price, including variable consideration, customer-furnished materials and claims; recognition methods, such as the percentage-of-completion method (and in the case of US GAAP, the completed contract method) and input/output methods to measure performance; accounting for contract costs, such as pre-contract costs and costs to fulfil a contract; and accounting for loss-making contracts.

Once the new revenue recognition standard becomes effective, SOP 81-1, IAS 11 and all existing revenue recognition guidance under US GAAP and IFRS will be replaced. This includes the percentage-of-completion method and the related construction-cost accounting guidance as a stand-alone model. The following items common in the E&C industry may be significantly affected by the new revenue recognition standard. This practical guide, examples and the related assessments contained in the industry supplements are based on the Exposure Draft, Revenue from contracts with customers, which was issued on 24 June 2010. These proposals are subject to change at any time until a final standard is issued. For a more comprehensive description of the model, refer to PricewaterhouseCoopers' (PwC) Practical Guide to IFRS Revenue recognition (www.pwc.com/ifrs) or visit www.ifrs.org.

Defining the contract

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

These situations and in particular, contract modifications such as change orders are commonplace in the E&C industry. The proposed standard applies only to contracts with customers when such contracts: have commercial substance; have been approved by the parties to the contract and such parties are committed to satisfying their respective obligations; have enforceable rights that can be identified regarding the goods or services to be transferred; and have terms and manners of payment that can be identified.

We do not expect current practice in the area of contract combinations and segmentation to be significantly affected by the proposed standard. Construction entities currently exercise significant judgement to determine when to include change orders and other contract modifications in contract revenue, and there is diversity in practice. We expect that the use of judgement will continue to be required and do not expect current practice (or existing diversity) in this area to be significantly affected by the proposed standard, including the accounting for unpriced change orders. Proposed standard Combining and segmenting contracts Two or more contracts should be combined and accounted for as one contract if their prices are interdependent. A contract should be segmented into more than one contract and accounted for separately if prices for goods and services within that contract are independent. Contracts with interdependent prices are typically: Entered into at or near the same time. Negotiated as a package with a single commercial objective. Performed either concurrently or continuously. Prices for goods and services within a contract are independent if: The entity (or another entity) sells an identical or similar good or service separately; and The customer does not receive a significant discount for buying a bundle of goods and services. Contract modifications (for example, change orders) Consistent with the contract combination and segmentation principle above, a contract modification is combined with the original contract, recognising the cumulative effect of the contract modification in the period in which the modification occurs, if the prices are interdependent. A contract modification is accounted for as a separate contract if it is priced independently of the original contract (consider the factors above). Current US GAAP Current IFRS

Combining and segmenting contracts is permitted provided certain criteria are met. However, it is not required if the underlying economics of the transaction are fairly reflected.

Combining and segmenting contracts is required when certain criteria are met.

A change order is generally included in contract revenue when it is probable that the change order will be approved by the customer and the amount of revenue can be reliably measured. US GAAP also includes detailed revenue and cost guidance on the accounting for unpriced change orders (or those in which the work to be performed is defined, but the price is not).

A change order (known as a variation) is generally included in contract revenue when it is probable that the change order will be approved by the customer and the amount of revenue can be reliably measured. There is no detailed guidance on the accounting for unpriced change orders.

Example 1 Unpriced change orders

Facts: A contractor has a history of executing unpriced change orders; that is, those change orders where price is not defined until after scope changes are agreed upon. When would these change orders be included in contract revenue? Discussion: An entity would first assess whether the change order meets the definition of a contract as defined above, and next assess whether such change order is priced interdependently with the original contract. Many unpriced change orders do not specify the consideration to be exchanged for goods or services at the time of execution, making it difficult to assess whether the change order is priced interdependently with the original contract. This might result in delayed recognition compared to todays model under both US GAAP and IFRS. There are situations, however, where contractors may be able to identify the amount of consideration to be received using various estimation methods based on historical experience. We believe it is possible in these situations for a contractor to include unpriced change orders in contract revenue, as such modifications would: (a) typically meet the definition of a contract; and (b) are likely to be priced interdependently, as the modifications are often negotiated considering the original contract, with a single commercial objective, and relate to activities that are performed either concurrently or continuously.

Determining the transaction price

The transaction price (or contract revenue, as it is called today in the E&C industry) is the amount of consideration the contractor expects to receive in exchange for satisfying its performance obligations. When the contract price is fixed, this determination is simple. When the contract price is not fixed, however, the determination is more complex. Common considerations in this area for the E&C industry include the accounting for awards/incentive payments, customer-furnished materials, claims and the time value of money. Revenue related to awards/incentive payments might be recognised earlier under the proposed standard. We do not expect a significant change in practice as it relates to customer furnished materials, claims or time value of money (except for contracts where payment terms materially vary from performance). Proposed standard Awards/incentive payments Awards/incentive payments are included in contract revenue using a probability-weighted approach when such payments can be reasonably estimated. Such amounts can be reasonably estimated when the contractor has experience with similar types of contract and that experience has predictive value (that is, experience is relevant to the contract because the entity does not expect significant changes in circumstances). Customer-furnished materials If a customer contributes goods or services (for example, materials, equipment or labour) to facilitate the fulfilment of the contract, the value is included in contract revenue if the entity controls these goods or services. Any non-cash consideration is measured at fair value unless fair value cannot be reasonably Current US GAAP Awards/incentive payments should be included in contract revenue when the specified performance standards are probable of being met or exceeded and the amount can be reliably measured. Current IFRS Awards/incentive payments should be included in contract revenue when the specified performance standards are probable of being met or exceeded and the amount can be reliably measured.

The value of customer-furnished materials is included in contract revenue when the contractor has the associated risk for these materials.

There is no explicit guidance on the accounting for non-cash consideration in the construction contracts standard. Management would follow general principles on non-monetary exchanges, which generally require entities to use the fair value of goods or services received in measuring the amount to be included in contract revenue.

Proposed standard estimated; in which case, it is measured by reference to the selling price of the goods or services transferred. Claims Claims should be included in contract revenue, using a probabilityweighted approach, only when such revenue can be reasonably estimated.

Current US GAAP

Current IFRS

A claim is recorded as contract revenue (to the extent of contract costs incurred) only if it is probable and reliably estimable (determined based on specific criteria). Profits on claims are not recorded until they are realised.

A claim is included in contract revenue only if negotiations have reached an advanced stage such that it is probable the customer will accept the claim and the amount can be reliably measured.

Time value of money Contract revenue should reflect the time value of money whenever the effect is material. Management should use a discount rate that reflects a separate financing transaction between the entity and its customer and factors in credit risk.

Revenue is discounted in only limited situations, including receivables with payment terms greater than one year. When discounting is required, the interest component should be computed based on the stated rate of interest in the instrument, or a market rate of interest if the stated rate is considered unreasonable.

Revenue is discounted when the inflow of cash or cash equivalents is deferred. An imputed interest rate should be used to determine the amount of revenue to be recognised, as well as the separate interest income to be recorded over time.

Example 2 Variable consideration

Facts: A contractor enters into a contract for the expansion of an existing two-lane highway to a three-lane highway in a heavily congested area. The contract price is C65 million plus a C5 million award fee if completed before the holiday travel season. The contract is expected to take one year to complete. The contractor has a long history of performing this type of highway work. The award fee is binary that is, if the job is finished before the holiday travel season, the contractor receives the full award fee. If it not finished before the holiday travel season, the contractor does not receive any award fee. The contractor believes, based on significant past experience, that it is 95 per cent likely that the contract will be completed in advance of the holiday travel season. Discussion: The contractor is likely to conclude that it can reasonably estimate the amount of expected award fee. This is because: The contractor has a long history of performing this type of work; It is largely within the contractor's control to complete the work before the holiday travel season; The uncertainty will be resolved within a relatively short period of time; and The possible outcomes are not highly variable. The contract's transaction price is therefore C69.75 million (the fixed contract price of C65 million, plus C4.75 million award fee (probability-weighted amount of C5 million)). This estimate is continuously revised and adjusted as appropriate, using a cumulative catch-up approach, which is consistent with current practice.

Example 3 Claims
Facts: Assume the same fact pattern as Example 2, except that due to reasons outside of the contractor's control (for example, owner-caused delays), the cost of the contract far exceeds original estimates (but a profit is still expected). The contractor submits a claim against the owner to recover a portion of these costs. The claim process is in its early stages, but the contractor has a long history of successfully negotiating claims with owners. Discussion: Claims are highly susceptible to external factors (such as the judgement of third parties), and the possible outcomes are highly variable. The contractor may have experience in successfully negotiating claims, but it might be challenging to assert that such experience has predictive value in this fact pattern (because of the highly

uncertain variables that warrant consideration). The contractor might therefore conclude that such a claim, in the early stages, cannot be reasonably estimated. The claim is excluded from the transaction price until it can be reasonably estimated (this is likely to be closer to the date when the claim is expected to be resolved).

Accounting for multiple performance obligations

Performance obligations are defined as promises to deliver goods or perform services. Today, contractors often account for each contract at the contract level; that is, contractors account for the macro-promise in the contract to build a road or build a bridge, etc. Current guidance permits this, although a contractor effectively promises to provide a number of different goods or perform a number of different services in delivering such macro-promises. Clearing, grading and paving, for example, may qualify as separate performance obligations within the macro-promise to build a road. Determining when to separately account for these performance obligations under the proposed model is therefore a key determination and will require a significant amount of judgement. Under the proposed model, it is possible to account for the contract at the contract level (for example, macro-promise to build a road), but we expect that contractors might have to separately account for more obligations within each contract compared to current guidance. This is an area that we expect will continue to evolve and that contractors should pay particular attention to. Applying the proposed separation principle will be challenging for many construction entities. We believe the final standard should be clear about how to apply this principle to long-term contracts to ensure it meets the proposed standards objectives of providing consistent, decision-useful information for economically similar contracts. Proposed standard Performance obligations separation An entity should separately account for performance obligations only if they are transferred at different times and are distinct. An entity will otherwise combine goods or services with other promised goods or services until it identifies a bundle of goods or services that are distinct. A good or service is distinct if either: the entity or another entity sells an identical or similar good or service separately; or the entity could sell the good or service separately because it: (a) has a distinct function (utility on its own or together with other goods or services); and (b) has a distinct profit margin (subject to distinct risks and the resources needed can be separately identified). Current US GAAP Current IFRS

The basic presumption is that each contract is the profit centre for revenue recognition, cost accumulation and income measurement. That presumption may be overcome only if a contract or a series of contracts meets the conditions described above for combining or segmenting contracts. There is no further guidance for separately accounting for more than one deliverable in a construction contract.

The basic presumption is that each contract is the profit centre for revenue recognition, cost accumulation and income measurement. That presumption is overcome when a contract or a series of contracts meets the conditions described for combining or segmenting contracts. There is no further guidance around separately accounting for more than one deliverable in a construction contract.

Example 4 Design/build contract

Facts: A contractor enters into a construction contract with an owner to design and build a new runway at a small airport. The build stage primarily includes clearing, excavation, grading and paving activities. The contractor often sells similar design and build services together but also sells them separately. How many performance obligations is the contractor required to account for separately? Discussion: We believe that application of the proposed separation principle remains unclear for many long-term contracts. However, based on the principles described above, it is likely that this design/build contract has at least two performance obligations: that of providing design services and that of building the runway. This is because they are

transferred at different times and are distinct, as the contractor has a history of selling similar design services separate from the build. The build aspect of the contract, however, may require further separation. In making this determination, the contractor may have to assess whether the clearing, excavation, grading and paving activities (or activities at an even lower level than these) are sold (or could be sold) by the contractor or others, such as subcontractors. For example, identical or similar activities that are sold separately by subcontractors may be considered distinct and require separation. Construction contracts to deliver a good often also include a significant construction management service. Assessing whether such management services are distinct from other aspects of the contract (that is, the design service and construction of the good) will require significant judgement.

Example 5 Construction management contract

Facts: A contractor enters into a construction contract with an owner to provide construction management services, overseeing the construction of a new runway at a small airport. How many performance obligations is the contractor required to separately account for? Discussion: The contractor might only have one performance obligation in this example: that of providing the construction management service to supervise and coordinate the construction activity on the project.

Allocating the transaction price to multiple performance obligations

Performance obligations are measured at the amount of consideration the contractor expects to receive (that is, the transaction price as described above). This consideration should then be allocated to the performance obligations in a contract that requires separate accounting. We expect that contractors will have to separately account for more performance obligations than today, so the allocation of the transaction price (that is, contract revenue) will be new to many E&C companies. Of particular interest will be the allocation of variable consideration (for example, award/incentive payments) associated with only one separately accounted for performance obligation, rather than the contract as a whole. This is an area that is currently unclear in the proposed standard and we believe is an important area that requires further consideration. Proposed standard Allocating the transaction price For performance obligations that require separate accounting, contract revenue is allocated to each performance obligation based on relative actual or estimated selling prices. An estimation method will not be prescribed nor will any method be precluded. For example, a contractor might use cost plus a reasonable margin in estimating selling price of a good or service. This initial measurement is not revisited unless performance obligations become onerous. Current US GAAP Except for allocation guidance related to contract segmentation, there is no explicit guidance on allocating contract revenue to multiple deliverables in a construction contract, given the presumption that the contract is the profit centre for determining revenue recognition. Current IFRS Except for allocation guidance related to contract segmentation, there is no explicit guidance on allocating contract revenue to multiple deliverables in a construction contract, given the presumption that the contract is the profit centre for determining revenue recognition.

Example 6 Allocating contract revenue to more than one performance obligation

Facts: A contractor enters into a contract to build both a road and a bridge (assume for this example that there are only two performance obligations: to build the road and to build the bridge). The contractor determines at inception that the contract price is C150 million, which includes a C140 million fixed price and an estimated C10 million of award fees if the contact as a whole is finished 30 days ahead of schedule.

Discussion: In allocating the contract consideration (including both the fixed and variable amounts), a contractor must first assign a selling price to both the road and the bridge. The contractor typically constructs both roads and bridges of a similar type and nature to those required by the contract, on a stand-alone basis. The stand-alone selling price to build this road, based on prior experience, is C140 million. The stand-alone selling price to build this bridge, based on prior experience, is C30 million. There is therefore an inherent discount of C20 million built into the bundled contract. Using a relative allocation model, the C150 million transaction price is allocated as follows: Road Bridge C124m (C150m * (C140m / C170m)) C26m (C150m * (C 30m / C170m))

Example 7 Allocating contract revenue to more than one performance obligation changes in the transaction price
Facts: After contract inception, the amount of variable consideration changes from an expected C10 million to an expected C12 million. Performance obligations are not remeasured after contract inception, so the additional C2 million would be allocated to the road and bridge using the initially developed allocation percentages, as follows: Road Bridge C1.6m (C2m * (C140m / C170m)) C 0.4m (C2m * (C30m / C170m))

Discussion: Such changes are recognised using a cumulative catch-up approach. For example, if the road was completed before the change in estimated variable consideration, the full amount of C1.6m would be recognised as revenue when the estimate was revised.

Recognising revenue
Revenue recognition under existing guidance is based on the activities of the contractor that is, provided reasonable estimates are available, revenue can be recognised as the contractor performs (known as the percentage-ofcompletion method). The boards have proposed that revenue is recognised upon the satisfaction of a contractor's performance obligations, which occurs when control of an asset (good or service) transfers to the customer. Control can transfer either at a point in time or continuously over the contract period. The change to a control transfer model will require careful assessment of when a contractor can recognise revenue. We expect that many construction-type contracts will transfer control of a good or service continuously to the owner over the contract term and might therefore produce similar results compared to today. This should not, however, be assumed. Contractors will not be able to default to the method used today. Cost-to-cost may be used today for example, to measure revenue under an activities based recognition model. It might not be appropriate for the extent to which control has transferred under a continuous transfer model. Proposed standard Recognising revenue Revenue is recognised on the satisfaction of performance obligations, which occurs when control of the good or service transfers to the customer. Control can transfer at a point in time or, perhaps most important for the E&C industry, continuously over the contract period. Factors to consider in assessing control transfer include, but are not limited to: The customer has an unconditional obligation to pay. The customer has legal title. The customer has physical possession. The customer specifies the design or function of the good or Current US GAAP Revenue is recognised using the percentage-of-completion method when reliable estimates are available. In circumstances in which reliable estimates cannot be made, but there is an assurance that no loss will be incurred on a contract (for example, when the scope of the contract is illdefined but the contractor is protected from an overall loss), the percentage-of-completion method based on a zero-profit margin is used until more precise estimates can be made. Where reliable estimates cannot be Current IFRS Revenue is recognised using the percentage-of-completion method when reliable estimates are available. In circumstances in which reliable estimates cannot be made, but there is an assurance that no loss will be incurred on a contract (for example, when the scope of the contract is illdefined but the contractor is protected from an overall loss), the percentage-of-completion method based on a zero-profit margin is used until more precise estimates can be made. The completed-contract method is

Proposed standard service. This list is not intended to be a checklist or all-inclusive. The ability to borrow against the asset, for example, may be another control transfer factor to consider. No one factor is determinative on a standalone basis. Measuring continuous transfer of control For contracts where control transfers continuously, a contractor can use either an input method (for example, cost-to-cost, labour hours, labour cost, machine hours, material quantities), an output method (for example, physical progress, units produced, units delivered, contract milestones) or the passage of time to measure the extent to which control has transferred. The method that best depicts the transfer of goods or services to the customer should be applied consistently throughout the contract and to similar contracts with customers. Once the metric to measure the extent to which control has transferred, it should be applied against contract revenue to determine the amount of revenue to be recognised. This is currently referred to as the revenue method. The use of the gross profit method is prohibited. Estimates used to measure the extent to which control has transferred (for example, estimated cost to complete when using a costto-cost calculation) should be continually evaluated and adjusted using a cumulative catch-up method.

Current US GAAP made, the completed-contract method is required. prohibited.

Current IFRS

A contractor can use either an input method (for example, cost-to-cost, labour hours, labour cost, machine hours, material quantities), an output method (for example, physical progress, units produced, units delivered, contract milestones), or the passage of time to measure progress towards completion. Once a percentage-complete is derived, there are two different approaches for determining revenue, cost of revenue and gross profit: the revenue method and the gross profit method.

A contractor can use either an input method (for example, cost-to-cost, labour hours, labour cost, machine hours, material quantities), an output method (for example, physical progress, units produced, units delivered, contract milestones) or the passage of time to measure progress towards completion. Once a percentage-complete is derived, IFRS requires the use of the revenue method. The gross profit method is prohibited.

Example 8 Recognising revenue

Facts: A contractor enters into a construction contract with an owner to build an oil refinery. The contract has the following characteristics: The oil refinery is highly customised to the owner's specifications; owner changes to these specifications are expected over the contract term. Non-refundable, interim progress payments are required as a mechanism to finance the contract. The owner can cancel the contract at any time (with a termination penalty); any work in process is the property of the owner.

 Physical possession and title do not pass until completion of the contract. How would a contractor recognise revenue in this example (assume only for these examples that there is one performance obligation that of building the refinery)? Discussion: The preponderance of evidence suggests control of the oil refinery is being transferred continuously over the contract term. In such cases, the contractor will have to select either an input or output method (or less likely, passage of time) to measure the extent to which control has transferred.

Example 9 Recognising revenue use of cost-to-cost

Facts: Assume the same fact pattern and assumptions as above. Additional contract characteristics are: Contract duration is three years. Total estimated contract revenue is C300 million. Total estimated contract cost is C200 million. Year one cost is C120 million (including C20 million related to contractor caused inefficiencies).

The contractor has concluded that cost-to-cost is a reasonable proxy for measuring the extent to which control has transferred. How much revenue and cost does the contractor recognise at the end of year one? Discussion: In determining the amount of revenue to be recognised under a cost-to-cost model, the contractor would have to exclude any costs that do not depict the transfer of goods or services; in this case, the costs associated with contractor caused inefficiencies. The amount of contract revenue and cost recognised at the end of year one is: Revenue Contract cost Gross contract margin Contract inefficiencies Net contract margin C150m (C300m * (C100m / C200m) C100m C 50m C 20m C 30m

Example 10 Recognising revenue use of cost-to-cost with changes in estimates

Facts: Assume same fact pattern and assumptions as above, except that total estimated cost to complete increases at the end of year two to C250 million due to an unexpected increase in the cost of materials. Actual cumulative cost incurred at the end of year two (excluding year-one inefficiencies) is C200 million. The contractor has concluded that cost-to-cost is a reasonable proxy for measuring the extent to which control has transferred. How much revenue and cost does the contractor recognise at the end of year two? Discussion: The amount of contract revenue and cost recognised at the end of year two is: Cumulative revenue Revenue recognised year one Revenue recognised year two Cumulative costs (excluding inefficiencies) Costs recognised year one (excluding inefficiencies) Costs recognised year two (excluding inefficiencies) Gross contract margin year two Gross contract margin to date Net contract margin to date C240m (C300m * (C200m / C250m) C150m C90m C200m C100m C100m C (10m) C 40m (C240m - C200m) C 20m (C240m - C200m - C20m)

Other considerations Warranties

The proposed standard draws a distinction between warranties that protect against latent defects and warranties that protect against defects that arise after the product is transferred to the customer, such as normal wear and tear. Many warranties in the E&C industry protect against latent defects. We therefore expect practice could significantly change in this area, resulting in delayed revenue recognition and complex accounting calculations. However, contractors will need to use significant judgement to determine whether a defect is latent or has arisen subsequent to the sale. Proposed standard Warranties Warranties that protect against latent defects do not give rise to a separate performance obligation. They acknowledge the possibility that the contractor has not satisfied its performance obligation. Management will need to determine the likelihood and extent of defects in the products it has sold to customers at each reporting period to determine the extent of unsatisfied performance obligations. A portion of the contract revenue should be deferred at the time of sale for defective products that will be replaced either in part or in their entirety. A warranty that protects against defects that arise after the product is transferred gives rise to a separate performance obligation. A portion of the transaction price is allocated to that separate performance obligation at contract inception. Current US GAAP Contractors typically account for warranties that protect against latent defects outside of the contract and in accordance with existing loss contingency guidance. A contractor recognises revenue and concurrently accrues any expected cost for these warranty repairs. Revenue is deferred for warranties that protect against defects arising through normal usage and recognised over the expected life of the contract. Current IFRS Contractors are required to account for the estimated costs of rectification and guarantee work, including expected warranty costs, as contract costs. However, contractors typically (due to materiality considerations) account for standard warranties outside of the contract and in accordance with existing provisions guidance. A contractor will recognise revenue and concurrently accrue any expected cost for these warranty repairs. Revenue is deferred for warranties that protect against defects arising through normal usage and recognised over the expected life of the contract.

Example 11 Accounting for warranties

Facts: Assume the same fact pattern and assumptions as Example 8. The contractor also provides a 60-day warranty that covers latent defects for certain components of the oil refinery. How would the contractor account for such a warranty? Discussion: The contractor would have to estimate, at contract inception using all available information such as historical experience, the selling price of each of the oil refinery components that will require repair or replacement. Once determined, contract revenue would be allocated at inception on a relative selling price basis to those components and revenue deferred until the owner received control of those components without defects (that is, generally the earlier of when the defects are repaired/replaced and when the warranty period expires).

Contract costs
Existing construction literature contains a substantial amount of cost capitalisation guidance, both related to precontract costs and costs to fulfil a contract. The proposed model includes contract cost guidance, but we expect a significant change from today's practice, in particular around the accounting for pre-contract costs.

Proposed standard Contract costs All costs of obtaining a contract, costs relating to satisfied performance obligations and costs relating to inefficiencies (that is, abnormal costs of materials, labour or other costs to fulfil) should be expensed as incurred. Other direct costs incurred in fulfilling a contract are expensed as incurred unless they are within the scope of other standards (for example, inventory, intangibles, fixed assets) in which case the entity should account for such costs in accordance with those standards. If the costs are not within the scope of other standards, the entity should recognise an asset only if the costs relate directly to a contract, relate to future performance and are probable of recovery under a contract. These costs would then be amortised as control of the goods or services to which the asset relates is transferred to the customer.

Current US GAAP There is a significant amount of detailed guidance relating to the accounting for contract costs. This is particularly true with respect to accounting for pre-contract costs. Pre-contract costs that are incurred for a specific anticipated contract generally may be deferred only if their recoverability from that contract is probable. Other detailed guidance is also prescribed in the standard and should be appropriately considered.

Current IFRS There is a significant amount of detailed guidance relating to the accounting for contract costs. Costs that relate directly to a contract and are incurred in securing the contract are included as part of contract costs if they can be separately identified and measured reliably and it is probable that the contract will be obtained. Other detailed guidance is also prescribed in the standard and should be appropriately considered.

Example 12 Accounting for contract costs

Facts: Assume the same fact pattern and assumptions as Example 9. At the beginning of the contract, the contractor incurs certain mobilisation costs amounting to C1 million. The contractor has concluded that such costs should not be accounted for in accordance with existing asset standards (for example, inventory, fixed assets or intangible assets). How should these costs be accounted for? Discussion: These costs to fulfil a contract would be eligible for capitalisation so long as they: (a) relate to the contract; (b) relate to future performance; and (c) are probable of recovery. Using the fact pattern in Example 9 above, C500,000 would be amortised at the end of year one (coinciding with 50 per cent control transfer using a cost-to-cost method).

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