Accounting for inventories and

construction contracts

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Financial reporting
International financial reporting and analysis (essential
reading) Chapter 17
IAS 2 Inventories
IAS 11 Construction contracts
IFRS 15 Revenue from Contracts with Customers

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Financial reporting
What are inventories?

Inventory is a current asset which can be divided into five categories:

goods or other assets purchased for resale
consumable stores
raw materials and components purchased for incorporation into
products for sale
products and services in intermediate stages of completion
finished goods.

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Financial reporting
Main issues with inventory accounting
What method of inventory valuation should be used?

What components are included within cost?

The cost of goods is:

Opening inventory (in the opening balance sheet)
+ Purchases (during the year)
– Closing inventory (in the closing balance sheet).

Commercial companies: the price of goods purchase for resale

Industrial companies: cost of purchase of raw materials + cost of
conversion (direct & indirect overhead costs)

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Financial reporting
Methods of inventory valuation
Actual cost
A specific cost is attached to each item of inventory, resulting in a match of costs
with revenues. Impracticable for industries with many similar items. Suits for
industries with unique items of high value).

First-in-first-out (FIFO)
The cost of the oldest inventory is charged to income first and the most recent
cost of inventory is recorded in the balance sheet. This method is probably often
a close approximation to the physical flow of goods (for example, a company
selling perishable goods would obviously sell the earliest purchased inventory
first).

Last-in-last-out (LIFO)
The cost of the most recent inventory is charged to income first and the oldest
cost of inventory is recorded in the balance sheet. LIFO is appropriate for the
income statement, but it produces an out-of-date cost in the balance sheet.
LIFO is not allowed in IAS 2 since 2003. It is not acceptable in the UK for tax
purposes.

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Financial reporting
Methods of inventory valuation
Weighted average cost
The weighted average cost of all inventory. This is used a great deal by
organisations with high volumes of identical or near-identical inventory. In times
of low inflation and/or where inventory turnover is relatively quick, the result of
employing weighted average cost differs little from FIFO. This method is also
permitted by IAS 2.

Standard cost
A predetermined cost per unit.

Replacement cost
Inventory is recorded at current rather than actual cost.

Current selling price

Inventory is recorded at current selling price rather than actual cost.

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Financial reporting
Example: FIFO, LIFO and weighted average

Spoon Ltd makes the following purchases and sales of kettles during the year:

Purchases:
1 January 100 kettles @ £30
1 February 100 kettles @ £28
1 July 50 kettles @ £27
1 August 100 kettles @ £25

Sales:
1 May 80 kettles
1 June 100 kettles
1 October 90 kettles

Assume there is no opening inventories.

Determine the cost of goods sold and the closing inventory at the end of the year
using FIFO, LIFO and weighted average.

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Financial reporting
Solution: FIFO

FIFO
Purchase 30 100 3 000
Purchase 28 100 2 800
Sale 30 (80) (2 400)
Sale 30 (20) (600)
Sale 28 (80) (2 240)
Purchase 27 50 1 350
Purchase 25 100 2 500
Sale 28 (20) (560)
Sale 27 (50) (1 350)
Sale 25 (20) (500)
80 2 000

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Financial reporting
Solution: LIFO

LIFO
Purchase 30 100 3 000
Purchase 28 100 2 800
Sale 28 (80) (2 240)
Sale 28 (20) (560)
Sale 30 (80) (2 400)
Purchase 27 50 1 350
Purchase 25 100 2 500
Sale 25 (90) (2 250)
80 2 200

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Financial reporting
Solution: weighted average

Weighted
average
Purchase 30 100 3 000
Purchase 28 100 2 800
Sale 29 (80) (2 320)
Sale 29 (100) (2 900)
Purchase 27 50 1 350
Purchase 25 100 2 500
Sale 26 (90) (2 345)
80 2 085

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Financial reporting
 IAS 2 Inventories
The following items are excluded from the scope of the standard:
Work in progress under construction contracts (covered by IAS 11 Construction
contracts)
Financial instruments (shares, bonds)
Biological assets

Certain inventories are exempt from the standard's measurement rules, for
example, those held by:
Producers of agricultural and forest products
Commodity-broker traders

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Financial reporting
IAS 2 definitions
Inventories are assets:
– Held for sale in the ordinary course of business;
– In the process of production for such sale; or
– In the form of materials or supplies to be consumed in the production
process or in the rendering of services.

Net realisable value is the estimated selling price in the ordinary course
of business less the estimated costs of completion and the estimated
costs necessary to make the sale.

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Financial reporting
Measurement of inventories

IAS2.9
Inventories should be measured at the lower of cost and net realisable
value.

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Financial reporting
Cost of inventories

The cost of inventories will consist of all costs of:

Purchase
Costs of conversion
Other costs incurred in bringing the inventories to their present
location and condition

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Financial reporting
Costs of purchase

The standard lists the following as comprising the costs of purchase of

inventories.
Purchase price PLUS
Import duties and other taxes PLUS
Transport, handling and any other cost directly attributable to the
acquisition of finished goods, services and materials LESS
Trade discounts, rebates and other similar amounts

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Financial reporting
Costs of conversion
Costs of conversion of inventories consist of two main parts:
(a) Costs directly related to the units of production, eg direct materials, direct labour
(b) Fixed and variable production overheads that are incurred in converting materials
into finished goods, allocated on a systematic basis.
Fixed production overheads are those indirect costs of production that remain
relatively constant regardless of the volume of production, eg the cost of factory
management and administration.
Variable production overheads are those indirect costs of production that vary
directly, or nearly directly, with the volume of production, eg indirect materials and
labour.

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Financial reporting
Costs of conversion
IAS 2 emphasises that fixed production overheads must be allocated to items of
inventory on the basis of the normal capacity of the production facilities.
(a) Normal capacity is the expected achievable production based on the average
over several periods/seasons, under normal circumstances.
(b) The above figure should take account of the capacity lost through planned
maintenance.
(c) If it approximates to the normal level of activity then the actual level of
production can be used.
(d) Low production or idle plant will not result in a higher fixed overhead allocation
to each unit.
(e) Unallocated overheads must be recognised as an expense in the period in which
they were incurred.
(f) When production is abnormally high, the fixed production overhead allocated to
each unit will be reduced, so avoiding inventories being stated at more than cost.
(g) The allocation of variable production overheads to each unit is based on the
actual use of production facilities.

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Financial reporting
 Other costs
Any other costs should only be recognised if they are incurred in bringing the
inventories to their present location and condition. The standard lists types of cost
which would not be included in cost of inventories:

(a) Abnormal amounts of wasted materials, labour or other production costs

(b) Storage costs (except costs which are necessary in the production process before
a further production stage)
(c) Administrative overheads not incurred to bring inventories to their present
location and conditions
(d) Selling costs

These costs should be recognised as an expense in the period they are incurred.

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Financial reporting
 Techniques for the measurement of cost
Two techniques are mentioned by the standard, both of which produce results which
approximate to cost, and so both of which may be used for convenience.
(a) Standard costs are set up to take account of normal production values: amount of
raw materials used, labour time etc. They are reviewed and revised on a regular basis.
(b) Retail method: this is often used in the retail industry where there is a large
turnover of inventory items, which nevertheless have similar profit margins. The only
practical method of inventory valuation may be to take the total selling price of
inventories and deduct an overall average profit margin, thus reducing the value to an
approximation of cost. The percentage will take account of reduced price lines.
Sometimes different percentages are applied on a department basis.

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Financial reporting
Example: cost of inventories
The following information for cost of inventories of Spoon Ltd is available:
Direct material cost of kettle per unit $1
Direct labour cost of kettle per unit $2
Other direct cost of kettle per unit $1.5
Production overheads per year $500,000
Administration overheads per year $250,000
Selling overheads per year $300,000
Interest payments per year $150,000

There were 200,000 finished kettles at the year-end. The normal annual level of
production is 800,000, but at the year-end only 600,000 were produced due to
the labour dispute.

Required
Calculate the cost of finished kettles.

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Financial reporting
Solution: cost of inventories
Direct costs:
200,000 units at $1 direct material cost $200,000
200,000 units at $2 direct labour cost $400,000
200,000 units at $1.5 other direct cost $300,000
$900,000

Production overheads per unit (normal production capacity is used):

$500,000 / 800,000 = $0.625

200,000 units at $0.625 $125,000

Cost of finished kettles $1,025,000

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Financial reporting
 Quick quiz
Which of the following costs can be included in the cost of inventory according to
IAS 2?
Discounts on purchased price √
Travel expenses of buyers ×
Import duties √
Transport insurance √
Salaries of sales department ×
Research for new products ×
Audit and tax consultation fees ×
Commission and brokerage costs √
Warranty costs ×
Storage costs that are necessary in the production process √
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Financial reporting
 Net realisable value (NRV)
As a general rule assets should not be carried at amounts greater than those expected
to be realised from their sale or use. In the case of inventories this amount could fall
below cost when items are damaged or become obsolete, or where the costs to
completion have increased in order to make the sale.
In fact we can identify the principal situations in which NRV is likely to be less than
cost, ie where there has been:
(a) An increase in costs or a fall in selling price
(b) A physical deterioration in the condition of inventory
(c) Obsolescence of products
(d) A decision as part of the company's marketing strategy to manufacture and sell
products at a loss
(e) Errors in production or purchasing

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Financial reporting
Net realisable value (NRV)
A write down of inventories would normally take place on an item by item basis,
but similar or related items may be grouped together.
The assessment of NRV should take place at the same time as estimates are made
of selling price, using the most reliable information available. Fluctuations of price
or cost should be taken into account if they relate directly to events after the
reporting period, which confirm conditions existing at the end of the period.
Net realisable value must be reassessed at the end of each period and compared
again with cost. If the NRV has risen for inventories held over the end of more
than one period, then the previous write down must be reversed to the extent
that the inventory is then valued at the lower of cost and the new NRV.
This may be possible when selling prices have fallen in the past and then risen
again.

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Financial reporting
Recognition as an expense
The following treatment is required when inventories are sold.
(a) The carrying amount is recognised as an expense in the period in which the
related revenue is recognised.
(b) The amount of any write-down of inventories to NRV and all losses of
inventories are recognised as an expense in the period the write-down or loss
occurs.
(c) The amount of any reversal of any write-down of inventories, arising from an
increase in NRV, is recognised as an increase in the amount of inventories and
income in the period in which the reversal occurs.

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Financial reporting
 Question: Inventory valuation
A company has inventory on hand at the end of the reporting period as follows.

Units Raw material Attributable Attributable Expected

cost production selling selling
overheads costs price
Item A 300 160 15 12 185
Item B 250 50 10 10 75

Required

At what amount will inventories be stated in the statement of financial position in

accordance with IAS 2?

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Financial reporting
Solution: Inventory valuation
If item A and item B are separable:

Units Cost NRV Lower Total

Item A 300 175 173 173 51,900
Item B 250 60 65 60 15,000

If item A and item B are not separable:

Units Cost NRV Lower Total

Item A 300 175 173 175 52,500
Item B 250 60 65 60 15,000
Total 235 238 235 67,500

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Financial reporting
Difference in cost formula
IAS 2 provides that an entity should use the same cost formula for all
inventories having similar nature and use to the entity.

For inventories with different nature or use (for example, certain

commodities used in one business segment and the same type of
commodities used in another business segment), different cost formulas
may be justified.

A difference in geographical location of inventories (and in the respective

tax rules), by itself, is not sufficient to justify the use of different cost
formulas.

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Financial reporting
IAS 11 Construction contracts
Suppose that a contract is started on 1 January 2014, with an estimated completion
date of 31 December 2015. The final contract price is $1,500,000. In the first year, to
31 December 2014:
(1) Costs incurred amounted to $600,000.
(2) Half the work on the contract was completed.
(3) Certificates of work completed have been issued, to the value of $750,000.
Progress payments are commonly the amount of valuation on the work certificates
issued, minus a precautionary retention of 10%.
(4) It is estimated with reasonable certainty that further costs to completion in 2015
will be $600,000.

What is the contract profit in 2014, and what entries would be made for the
contract at 31 December 2014 if:
(a) Profits are deferred until the completion of the contract?
(b) A proportion of the estimated revenue and profit is credited to profit or loss in
2014?
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Financial reporting
 Solution
(a) If profits were deferred until the completion of the contract in 2015, the
revenue and profit recognised on the contract in 2014 would be nil, and the value
of work in progress on 31 December 2014 would be $600,000.
IAS 11 takes the view that this policy is unreasonable, because in 2015, the total
profit of $300,000 would be recorded. Since the contract revenues are earned
throughout 2014 and 2015, a profit of nil in 2014 and $300,000 in 2015 would be
contrary to the accruals concept of accounting.
This method is prohibited by IAS11.

(b) It is fairer to recognise revenue and profit throughout the duration of the
contract.
As at 31 December 2014 revenue of $750,000 should be matched with cost of
sales of $600,000 in the statement of profit or loss, leaving an attributable profit
for 2014 of $150,000.
The only entry in the statement of financial position as at 31 December 2014 is a
receivable of $750,000 recognising that the company is owed this amount for
work done to date. No balance remains for work in progress, the whole $600,000
having been recognised in cost of sales.
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Financial reporting
 Types of construction contracts

Fixed price contract. A contract in which the contractor agrees to a fixed

contract price, or a fixed rate per unit of output, which in some cases is
subject to cost escalation clauses.

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.

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Financial reporting
What is a construction contract?
Wrong: A contract which lasts for a period of more than one year.

Right: A contract, in which activity starts in one financial period

and ends in another.
The main problem: to which of two or more periods should contract income and
costs be allocated?

IAS 11 definition:
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 may involve the building of one asset, eg a bridge,
or a series of interrelated assets eg an oil refinery. They may also include
rendering of services (eg architects) or restoring or demolishing an asset.
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Financial reporting
Combining and segmenting construction contracts

The standard lays out the factors which determine whether the construction of a
series of assets under one contract should be treated as several contracts.
Separate proposals are submitted for each asset.
Separate negotiations are undertaken for each asset; the customer can
accept/reject each individually.
Identifiable costs and revenues can be separated for each asset.

There are also circumstances where a group of contracts should be treated as one
single construction contract.
The group of contracts are negotiated as a single package.
Contracts are closely interrelated, with an overall profit margin.
The contracts are performed concurrently or in a single sequence.

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Financial reporting
Contract revenue
Contract revenue will be the amount specified in the contract, subject to
variations in the contract work, incentive payments and claims if these will
probably give rise to revenue and if they can be reliably measured.
The result is that contract revenue is measured at the fair value of received or
receivable revenue.

The standard elaborates on the types of uncertainty, which depend on the

outcome of future events, that affect the measurement of contract revenue.
An agreed variation (increase/decrease)
Cost escalation clauses in a fixed price contract (increase)
Penalties imposed due to delays by the contractor (decrease)
Number of units varies in a contract for fixed prices per unit
(increase/decrease).

In the case of any variation, claim or incentive payment, two factors should be
assessed to determine whether contract revenue should be recognised.
Whether it is probable that the customer will accept the variation/claim, or
that the contract is sufficiently advanced that the performance criteria will be
met
Whether the amount of the revenue can be measured reliably
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Financial reporting
 Contract costs
Contract costs consist of:
Costs relating directly to the contract
Costs attributable to general contract activity which can be allocated to the
contract, such as insurance, cost of design and technical assistance not directly
related to a specific contract and construction overheads
Any other costs which can be charged to the customer under the contract, which
may include general administration costs and development costs

Costs that relate directly to a specific contract include:

Site labour costs, including site supervision
Costs of materials used in construction
Depreciation of plant and equipment used on the contract
Costs of moving plant, equipment and materials to and from the contract site
Costs of hiring plant and equipment
Costs of design and technical assistance that are directly related to the contract
Estimated costs of rectification and guarantee work, including expected warranty
costs
Claims from third parties

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Financial reporting
 Contract costs
General contract activity costs should be allocated systematically and
rationally, and all costs with similar characteristics should be treated
consistently.
The allocation should be based on the normal level of construction
activity. Borrowing costs may be attributed.

Some costs cannot be attributed to contract activity and so the following

should be excluded from construction contract costs:
General administration costs (unless reimbursement is specified in the
contract)
Selling costs
R&D (unless reimbursement is specified in the contract)
Depreciation of idle plant and equipment not used on any particular
contract

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Financial reporting
Recognition of contract revenue and expenses
IAS11.22
Revenue and costs associated with a contract should be recognised
according to the stage of completion of the contract at the end of the
reporting period, but only when the outcome of the activity can be
estimated reliably. This is often known as the percentage of completion
method.
If a loss is predicted on a contract, then it should be recognised
immediately in full.
The percentage of completion method is an application of the accruals
assumption. Contract revenue is matched to the contract costs incurred in
reaching the stage of completion, so revenue, costs and profit are
attributed to the proportion of work completed.

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Financial reporting
 Summarise the treatment
Recognise contract revenue as revenue in the accounting periods in which the
work is performed.
Recognise contract costs as an expense in the accounting period in which the
work to which they relate is performed.
Any expected excess of total contract costs over total contract revenue should be
recognised as an expense immediately.
Any costs incurred which relate to future activity should be recognised as an asset
if it is probable that they will be recovered (such as unused inventories of materials
which can be used on another contract).
Where amounts have been recognised as contract revenue, but their collectability
from the customer becomes doubtful, such amounts should be recognised as an
expense, not a deduction from revenue.

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Financial reporting
 Recognition of expected losses (IAS11.36)
Any loss on a contract should be recognised as soon as it is foreseen. The loss will
be the amount by which total expected contract revenue is exceeded by total
expected contract costs. The loss amount is not affected by whether work has
started on the contract, the stage of completion of the work or profits on other
contracts (unless they are related contracts treated as a single contract).
Example
The following data are available in respect of construction contract:
Costs to date $20m
Revenue expected $20m
Further costs to completion $5m

According to POC method: According to IAS11:

Revenue 20 / 25 * 20 = $16m Revenue 20 / 25 * 20 = $16m
Cost to date $20m Cost to date $20m
Loss $4m Loss $5m
Provision for losses on contracts $1m

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Financial reporting
 Determining the stage of completion

The standard lists several methods.

Proportion of contract costs incurred for work carried out to date
Surveys of work carried out
Physical proportion of the contract work completed

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Financial reporting
Example: stage of completion
Centrepoint Co have a fixed price contract to build a tower block. The initial amount
of revenue agreed is $220m. At the beginning of the contract on 1 January 2014 the
initial estimate of the contract costs is $200m. At the end of 2014 the estimate of the
total costs has risen to $202m.
During 2015 the customer agrees to a variation which increases expected revenue
from the contract by $15m and causes additional costs of $8m. At the end of 2015
there are materials stored on site for use during the following period which cost
$4m.
Centrepoint Co have decided to determine the stage of completion of the contract
by calculating the proportion that contract costs incurred for work to date bear to
the latest estimated total contract costs.
The contract costs incurred at the end of each year were 2014: $50.5m, 2015:
$151m (including materials in store), 2016: $210m.

Required
Calculate the stage of completion for each year of the contract and show how
revenues, costs and profits will be recognised in each year.

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Financial reporting
Solution: stage of completion
We can summarise the financial data for each year end during the construction
period as follows (in million $).
2014 2015 2016
Initial amount of revenue 220 220 220
Variation 15 15
Total contract revenue 220 235 235
Contract costs incurred to date 50.5 151 210
Contract costs to complete 151.5 59 –
Total estimated contract costs 202 210 210
Estimated profit 18 25 25
Stage of completion 25% 70% 100%
The stage of completion has been calculated using the formula:
Contract costs incurred to date
Total estimated contract costs

The stage of completion in 2015 is calculated by deducting the $4m of materials held
for the following period from the costs incurred up to that year end, ie
$151m - $4m = $147m
$147m/$210m = 70%.
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Financial reporting
 Recognised in prior year Recognised in current year

2014 Revenue ($220m * 25%) 55,0 - 55,0

2014 Costs ($202m * 25%) 50,5 - 50,5

4,5 - 4,5

2015 Revenue ($235m * 70%) 164,5 55,0 109,5

2015 Costs ($210m * 70%) 147,0 50,5 96,5

17,5 4,5 13,0

2016 Revenue ($235m * 100%) 235,0 164,5 70,5

2016 Costs ($210m * 100%) 210,0 147,0 63,0

25,0 17,5 7,5

Exclude costs relating to future activity, eg cost of materials delivered but not yet used
Exclude payments made to subcontractors in advance of work performed

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Financial reporting
Outcome of the contract cannot be reliably estimated
When the contract's outcome cannot be reliably estimated the following treatment
should be followed:
Only recognise revenue to the extent of contract costs incurred which are
expected to be recoverable
Recognise contract costs as an expense in the period they are incurred
This no profit/no loss approach reflects the situation near the beginning of a
contract, ie the outcome cannot be reliably estimated, but it is likely that costs will
be recovered.

Contract costs which cannot be recovered should be recognised as an expense

straight away. IAS 11 lists the following situations where this might occur.
The contract is not fully enforceable, ie its validity is seriously questioned.
The completion of the contract is subject to the outcome of pending litigation or
legislation.
The contract relates to properties which will probably be expropriated or
condemned.
The customer is unable to meet its obligations under the contract.
The contractor cannot complete the contract or in any other way meet its
obligations under the contract.
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Financial reporting
Example: contract outcome unreliable
An entity is involved in two construction contracts, the outcome of which cannot be
assessed with reliability, for which the following data are available:
Contract A Contract costs incurred equal to $50m, all probably recoverable
Contract B Contract costs incurred equal to $100m, similar contracts have
shown a loss of 20% of contract sales price due to pending legislation affecting the
construction. Contract sale price is $1,000m.
Required
Identify how these two contracts should be treated in financials.

Contract A
Contract revenue $50m
Contract costs $50m

Contract B
Contract revenue $100m
Contract costs $300m

Note: estimated contract loss is 20% * $1,000m = $200m

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Financial reporting
 Example: construction contract disclosures
A contractor has reached the end of its first year of operations. All its contract costs
incurred have been paid for in cash and all its progress billings and advances have
been received in cash. Contract costs incurred for contracts B, C and E include the
cost of materials that have been purchased for the contract but which have not
been used in contract performance to date. For contracts B, C and E, the customers
have made advances to the contractor for work not yet performed.
A B C D E Total
Contract revenue recognised 145 520 380 200 55 1 300
Contract expenses recognised 110 450 350 250 55 1 215

Contract costs incurred in the period 110 510 450 250 100 1 420

Contract costs relating to future activity - 60 100 - 45 205

Progress billings 100 520 380 180 55 1 235

Advances - 80 20 - 25 125
Unbilled contract revenues 45 - - 20 - 65

Estimated costs to complete 90 290 100 140 50 670

Contract value 250 1 000 600 300 120 2 270

Total contract costs 200 800 550 390 150 2 090
Profit/loss on contract 50 200 50 (90) (30) 180
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Financial reporting
 Solution: construction contract disclosures
Income statement
Contract revenue recognised 145 520 380 200 55 1 300
Contract expenses recognised (110) (450) (350) (250) (55) (1 215)
35 70 30 (50) - 85
Provision for losses on contracts (40) (30) (70)
Gross profit (loss) 35 70 30 (90) (30) 15

Contract costs incurred 110 510 450 250 100 1 420

Recognised profits less recognised
losses 35 70 30 (90) (30) 15
Progress billings (100) (520) (380) (180) (55) (1 235)
45 60 100 (20) 15 200

Statement of financial position

Due from customers 45 60 100 (20) 15 200
Bank balance (10) 90 (50) (70) (20) (60)

Due to customers - 80 20 - 25 125

PL 35 70 30 (90) (30) 15

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Financial reporting
Construction contract: five steps
Step 1 Compare the contract value and the total costs expected to be incurred on
the contract. If a loss is foreseen (that is, if the costs to date plus estimated costs to
completion exceed the contract value) then it must be charged against profits. If a
loss has already been charged in previous years, then only the difference between
the loss as previously and currently estimated need be charged.
Step 2 Using the percentage completed to date (or other formula), calculate sales
revenue attributable to the contract for the period (for example percentage
complete * total contract value, less revenue taken in previous periods).
Step 3 Calculate the cost of sales on the contract for the period.

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Financial reporting
 Construction contract: five steps
Step 4 Deduct the cost of sales for the period as calculated above (including any
foreseeable loss) from the sales revenue calculated at Step 2 to give profit (loss)
recognised for the period.
Step 5 Calculate amounts due to/from customers.

Note. This represents unbilled revenue. Unpaid billed revenue will be included in
trade receivables.

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Financial reporting
You can no more find IAS11 at www.ifrs.org...

From 01 January 2018 you should use IFRS15 instead.

IFRS 15 Revenue from Contracts with Customers is

effective for annual periods beginning on or after 1
January 2018.

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Financial reporting
4 important industries that face the biggest challenges:
Telecommunications
Manufacturers
Real estate and property development
Software development and technology

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Financial reporting
The major change under IFRS 15: the timing of revenue recognition

Much of the accounting treatment is very similar to IAS 11. Under IFRS 15, revenue
should only be recognised when the performance obligation specified in the
contract with the customer is satisfied. This means that the possibility to use
judgment under the percentage completion method for IAS 11 has now been
restricted to more objective criteria such as observable contractual obligations.

So, if the contract stipulations are such that only on full completion is the contract
deemed as a ‘deliverable’, then no revenue may be recognised at all during the
construction phases/periods.

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Financial reporting
IFRS 15 has proposed the following requirements:
1. Revenue only recognised when control of the project passes to the customer.
2. Onerous performance obligation should be accounted for as soon as apparent
so as to be consistent with other standards on asset recognition and impairment.
3. More disclosures in the notes to the accounts to facilitate the assessment of
risks and rewards.

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The criteria for recognition of revenue once control passes is very similar to IAS 11,
with two approaches:
• output method – this is similar to the survey or use of professional judgment to
estimate the amount of completion
• input method – this is similar to using costs incurred to date as a way to estimate
the revenue to be recognised for the period.
The conditions for recognition under onerous contracts is also similar to IAS 11, in
that as soon as there are recognisable losses, some/all of the work in progress
should be written off as an impairment expense.

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Financial reporting
 Thank you for attention!

Home assignment: loaded to ICEF-online

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Financial reporting