LESSON 9 LONG TERM CONSTRUCTION (2

Hours)
Applicability of PFRS 15

PFRS 15 shall be applied to contracts wherein the counterparty is a customer.

• Contract – An agreement between two or more parties that creates

enforceable rights and obligations. A contract can
be written, oral, or implied by an entity’s customary business practice.

• 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.

Core principle

An entity recognizes revenue to depict the transfer of promised goods or

services to customers in an amount that reflects the consideration to which the
entity expects to be entitled in exchange for those goods or services.

Steps in the recognition of revenue

PFRS 15 requires the following steps in recognizing revenue:

• Step 1: Identify the contract with the customer

Requirements before a contract with a customer is accounted for under PFRS

15:

1. The contract must be approved and the contracting parties

are committed to it;
2. rights and payment terms are identifiable;
3. The contract has commercial substance; and
4. The consideration is probable of collection.

No revenue is recognized if the contract does not meet the criteria above. Any
consideration received is recognized as liability.
Definition of Construction contract

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.

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 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; or

c. Some or all of the goods or services promised in the contracts are a single
performance obligation.

• Step 2: Identify the performance obligations in the contract

Each promise in a contract to transfer a distinct good or service is treated as a

separate performance obligation.

A good or service is distinct if:

(a) the customer can benefit from it, either on its own or together with other
resources that are readily available to the customer (e.g., the good or service is
regularly sold separately); and

(b) the good or service is separately identifiable (i.e., not an input to a

combined output, does not significantly modify the other promises, or not
highly interrelated with the other promises).

A good or service that is not distinct shall be combined with the other
promises in the contract. Combined promises are treated as a single
performance obligation.
Satisfaction of performance obligations

At contract inception, the entity shall determine whether the identified

performance obligations will be satisfied either:

1. Over time;

A performance obligation is satisfied over time if one of the following criteria

is met:

1. The customer simultaneously receives and consumes the

benefits provided by the entity’s performance as the entity performs.
2. 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.
3. 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.

2. At a point in time

• If the entity cannot demonstrate that a performance obligation is satisfied

over time, it is presumed that the performance obligation is satisfied at a
point in time.

• Step 3: Determine the transaction price obligations in the contract

The entity shall determine the transaction price because this is the amount at
which revenue will be measured.

Transaction price is “the amount of consideration to which an entity expects

to be entitled in exchange for transferring promised goods or services to a
customer, excluding amounts collected on behalf of third parties (e.g., some
sales taxes).” The consideration may include fixed amounts, variable amounts,
or both.

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

following:

1. The contract price; and

2. 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.
A construction contract may be either:

1. Fixed price contract; or

2. Cost plus contract.

There are two types of cost-plus contracts.

1. Cost-plus-variable-fee contract
2. Cost-plus-fixed-fee contract

Step 4: Allocate the transaction price to the performance obligations

The transaction price shall be allocated to each performance obligation

identified in a contract based on the relative stand-alone prices of the
distinct goods or services promised to be transferred.

The stand-alone selling price is the price at which a promised good or service
can be sold separately to a customer.

• Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation

A performance obligation is satisfied when the control over a promised good

or service is transferred to the customer.

Revenue is measured at the amount of the transaction price allocated to the

satisfied performance obligation.

Measuring progress towards complete satisfaction of a performance

obligation

• For each performance obligation satisfied over time, an entity shall

recognize revenue over time by measuring the progress towards complete
satisfaction of that performance obligation.

• Examples of acceptable measurement methods:

 1. Input methods (e.g., relationship between costs incurred to date and
total expected costs)
2. Output methods (e.g., surveys of work performed)

Inputs method

• Inputs 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:

1. Costs incurred

2. Resources consumed

3. Labor hours expended

4. Machine hours used

5. Time elapsed

Cost-to-cost

Formula #1:

Percentage of Completion = Total costs incurred to date

Estimated total
contract costs

Formula #2: Variation

A variation of the formula above is presented below

Percentage of completion = Total costs incurred to date

Total costs incurred to

date +
 Estimated costs to
complete

Contract costs include the following:

(a) Incremental costs of obtaining a contract – recognized as asset if they are

recoverable and avoidable. As a practical expedient, the costs are recognized
as expense if their expected amortization period is 1 year or less.

(b) Costs to fulfill a contract –if within the scope of PFRS 15, they are
recognized as asset if they are: (a) directly related to a contract, (b) generate or
enhance resources, and (c) recoverable.

Presentation

A contract where either party has performed is presented in the statement of

financial position as a contract liability, contract asset or receivable.

• Contract liability – is an entity’s obligation to transfer goods or services

to a customer for which the entity has received consideration (or the amount is
due) from the customer.

• 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 the passage of time.

• Receivable – is an entity’s right to consideration that is unconditional.

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.
Cost-recovery Approach

• If the outcome of a performance obligation that is satisfied over time

cannot be measured reasonably, revenue shall be recognized only to the
extent of costs incurred that are expected to be recovered (i.e., “zero profit”
method).

Onerous contract

• A construction contract becomes onerous if the expected costs in fulfilling

the performance obligation exceed the transaction price.

• The entity recognizes and measures the present obligation under an

onerous contract as a provision in accordance with PAS 37 Provisions,
Contingent Liabilities and Contingent 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” principle– The

estimated amount of variable consideration will be included in the transaction
price only to the extent that 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.

• Examples of contract stipulations that could make the consideration in a

construction contract to be variable:

Penalties

Incentive payments

Cost escalations
• 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.”

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.

• If the entity has an enforceable right on the claim, the entity shall account
for the claim as a contract modification using the principles in PFRS 15.

Uncertainty in the collectability of contract revenue

• If the uncertainty in the collectability of contract revenue arises at

contact inception, the entity does not recognize any revenue from the
contract. Any consideration received is recognized as a liability.

• If the uncertainty in the collectability of contract revenue

arises subsequent to contract inception, the uncollectability is accounted for
as impairment of trade receivable and/or contract asset.

REVIEW PROBLEMS

Problem 1: AMG Construction Company agreed to build a large office building

for PG Towers. PG Towers will make annual payments to AMG, but the
amounts of these payments cannot exceed the direct costs incurred by AMG.

Contract Price P5,000,000

Total Anticipated costs (at 10/2014) P4,500,000

2014 2015 2016 2017

Cost Incurred each 950,000 1,000,000 1,650,000 400,000
year
Estimated costs to 3,150,000 3,200,000 400,000
complete
Progress Billings each 400,000 1,000,000 1,400,0000 2,200,000
year
Change order (costs) - - 300,000 200,000
Change order 300, 000 100,000
(revenue)

1. What is the realized gross profit for the year 2014, 2015, 2016 and 2017.

2014 2015 2016

Contract Price 5,000,000 5,000,000 5,300,000 5,400
Less: Total Estimated Cost 950,000 1,950,000 3,900,000 4,500

Cost incurred to date 3,150,000 3,200,000 400,000

Add: Estimated Cost to complete

4,100,000 5,150,000 4,300,000 4,500
Estimated Gross Profit: 900,000 (150,000) 1,000,000 900
Multiplied by: 23.17% -- 90.70% 1

Percentage of Completion:

(Cost incurred to date / Total

Estimated costs)
Recognized Gross Profit to date 208,530 (150,000) 907,000 900
Recognized Gross Profit previous year - (208,530) 150,000 (907,
Realized Gross Profit each year 208,530 (358,530) 1,057,000 (7,

What is the balance of CIP account, net of billings in the 2016 Statement of
Financial Position?

Cost Incurred to date ( 2016) 3,900,000

Add: Realized Gross profit to date 907,000

Construction in Progress 4,807,000

Less: Contact Billings to date 2,800,000

CIP net of Contract Billings (asset) 2,007,000

Use zero profit method in answering the questions that follow.

What is the net income in 2015?

Cost Incurred to Date 5,150,000

Contract Price 5,000,000

Realized Gross Profit / loss (150,000)

What is the balance of the CIP account net of contract billings in 2016?

Cost Incurred to date ( 2016) 3,900,000

Less: Realized loss (150,000)

Construction in Progress 3,750,000

Less: Contract Billings (2,800,000)

CIP net of Contract Billings 950,000 (Asset)

What is the realized gross profit in 2017?

Cost Incurred to Date 5,400,000

Less: Contract Price 4,500,000

Realized Gross Profit 900,000

Add: Previously Realized loss 150,000

Gross profit current year 1,050,000

PROBLEM 2: On September 30, 2014, Jaja Company was awarded the contract
to build a 500-room con-dominium for 100 million. The parties agreed to the
following:

1. 3% mobilization fee (deducted from final billing) payable at the day of

signing the contract.

2. Retention of 10% on all billings (payable with the final bill after completion
and acceptance of final bill.

3. Payments of progress billings are to be paid within 7 days after acceptance.

Jaja which uses the percentage of completion method of accounting for
income, estimated 25% of gross margin on all projects. By the end of the year
Jaja had presented progress billings corresponding to 50% completion. Althea
accepted all the bills presented except one for 10% which was accepted on
January 5 of next year. With the exception of the, of 2nd to the last billings for
8% which was due January 3 of next year, all accepted billings were settled.

What is the amount of cash received by Jaja Company?

Mobilization Fee (3,000,000 x 3%) 3,000,000

Contract Billings ((100,000,000 x 32%) x90%) 28,800,000

Cash payment
Received 31,800,000

What is the construction in progress net of progress billings on December

2014?

Construction in Progress 50,000,000

Contract Billings 50,000,000

CIP net of Contract Billings 0

PROBLEM 3: Sin Construction has used the cost to cost percentage of

completion method of recognizing revenue, Marc Sin assumed the presidency
of the company after the death of his father , Vincent. In inter-viewing the
records marc finds the following information regarding the recently completed
building project for which total contract was P2, 000,000.

2014 2015 2016

Gross Profit (loss) 40,000 140,000 (20,000)
Cost incurred each year 360,000 ? 820,000

Marc wants to know how effectively the company operated during the three
years on this project and since the information is not complete, has asked for
answers to the following questions:

How much costs were incurred in 2015?

Contract Price 2,000,000

Cost Incurred (2014, 2016) (1,180,000)

Gross Profit Realized (‘14, ‘15, ‘16) (160,000)

Cost incurred (2015) 660,000

What percentage of the project was completed by the end of 2015?

Revenue recognized to date (2015) 1,200,000

Divide by: Contract Price 2,000,000

Percentage of completion 60%

What was the total estimated gross profit on the project by the end of 2015?

Cost Incurred to Date (2015) 1,020,000

Divide by: % of completion 60%

Total Estimated Costs 1,700,000

Less: Contract Price 2,000,000

Estimated Gross
Profit 300,000

What was the estimated cost to complete the project at the end of 2015?

Cost Incurred to Date (2015) 1,020,000

Divide by: % of completion 60%

Total Estimated Costs 1,700,000

Less : Cost Incurred to date (1,020,000)

Estimated Cost to complete 680,000

TEACHER’S INSIGHTs

· PFRS 15 requires the following steps in recognizing revenue:

· Step 1: Identify the contract with the customer

· Step 2: Identify the performance obligations in the contract

· Step 3: Determine the transaction price

· Step 4: Allocate the transaction price to the performance obligations

in the contract

· Step 5: Recognize revenue when (or as) the entity satisfies a

performance obligation