Acc 202 Ast Reviewer

GROUP 3
BSA-3B
CONSTRUCTION
CONTRACTS
Leader: John Darwin Pontigon

Members:
Luis Hussein Brillantes
Vyron Galit
Michael Christian Socha
Jhon Kenneth Suratos
Introduction
An entity applies PFRS 15 Revenue from Contracts with Customers to account for
revenues from contracts with customers. PFRS 15 supersedes PAS 11 Construction
Contracts.
• Revenue is "income arising in the course of an entity’s ordinary activities." (PFRS
15. Appendix A)
• Contract is "an agreement between two or more parties that creates enforceable
rights and obligations." (PFRS 15. Appendix A)
• Customer is "a party that has contracted with an entity to obtain goods or
services that are an output of the entity's ordinary activities in exchange for
consideration." (PFRS 15. Appendix A)
Core principle under PFRS 15
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.
Summary of the Revenue Recognition Principles under PFRS 15

Definition of Construction Contracts
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 that are directly related to the construction
of an asset, e.g., those for the services of project managers and architects; and
b. Contracts for the destruction or restoration assets, and the restoration of the
environment following the demolition of assets.
Construction contracts are generally long-term. The date at which the contract is
entered into and the date the contract is completed normally fall on different financial
reporting periods The primary issue in the accounting for construction contracts therefore,
is the timing of recognition of contract revenue and contract costs.
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 considers 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 criteria above. 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)
are 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.
Negotiating multiple contracts 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 that is accounted for
separately:
a. A distinct good or service (or a distinct bundle of goods services); or 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:
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 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 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 goods or services promised in the contract. For
example, the customer's decision of not purchasing a good or service does not affect
the other promised goods or services in the contract.
A promised good or service that is not distinct is 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
A series of distinct goods or services that are substantially the same and have the same
pattern of transfer to the customer are accounted for as a single performance obligation
if each good or service in the series represents a performance obligation that would be
satisfied over time if each was accounted for separately; and the entity would use the
same measure of progress toward the satisfaction of the performance obligation for
each of those goods or services.
Performance obligations include only activities that involve the transfer of a good
or service to a customer. Performance obligations do not include administrative tasks to
set up a contract.
Example: Determining whether goods and services are distinct
Entity A, a contractor, enters into a contract to build a resort hotel for a customer. Entity
A is responsible for the overall development and identifies various goods and services
to be provided, including design, engineering, site preparation, procurement,
construction, piping and wiring, installation of uninterruptible power supply system,
swimming pools and Jacuzzi, and finishing. The entity, and its competitors, regularly
sells many of these goods and services separately to customers.
Analysis:
The promised goods and services are capable of being distinct under criterion (a). The
customer can benefit from the goods and services either on their own or together with
other readily available resources. This is evidenced by the fact that the goods and
services are regularly sold to customers. In addition, the customer could generate
economic benefit from the individual goods and services by using, consuming, selling or
holding them.
However, the goods and services are not distinct under criterion (b) because they
are not separately identifiable from each other. This is evidenced by the fact that the
entity provides a significant service of integrating the goods and services (the inputs)
into the hotel resort (the combined output) for which the customer has contracted.
Conclusion:
Because both criteria are not met, the goods and services are not distinct. The entity
accounts for all the goods and services in the contract not separately but 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:
a. Over time; or
b. At a point in time
A performance obligation is satisfied over time if one of the following criteria is
met:
a. The customer simultaneously receives and consumes the benefits provided by
the entity's performance as the entity performs.
Example: If the contract with the customer is discontinued and the customer
enters into a contract with another entity to fulfill the remaining performance obligation.
the other entity would not need to substantially re-perform the work that the entity has
completed to date.
b. The entity's performance creates or enhances an asset (e-g 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.
Alternative use:
i. An asset does not have an alternative use to the entity if the entity is restricted
contractually from directing the asset for another use during or after the asset's
completion, or in the absence of a contractual restriction, the entity would incur
significant costs of rework before it can direct the asset for another use, or the entity
could only sell the asset at a significant loss.
Enforceable right to payment for performance completed to date:

ii. An entity has an enforceable right to payment for performance completed to date if
the entity is entitled to compensation for the completed performance if the contract is
terminated for reasons other than the entity’s failure to perform as promised, and the
compensation sufficient to cover the costs incurred in satisfying the performance
obligation plus a reasonable profit margin. A reasonable profit margin need not equal
the profit margin expected if the contract was fulfilled as promised.
For many construction contracts, 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 above is met.
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.
Example 1.1: Alternative use

Entity A enters into a contract with a customer to build customized solar panel. Entity A
customizes solar panels for various customers. Each solar panel can differ substantially
basis of each customer's needs. If the customer cancels the contract for reasons other
than Entity A's failure to perform, Entity A shall keep the solar panel. However, due to its
specialized nature, significant modification is needed before the solar panel can be sold
to another customer.
Analysis:
At contract inception, Entity A assesses whether its performance obligation to build the
solar panel is a performance obligation that is satisfied over time using the criteria in (a)
to (c) above.
As part of that assessment, Entity A considers whether the solar panel has an
alternative use to Entity A. (See criterion "c")
Although Entity A is not contractually restricted from directing the solar panel to
another customer, the customer specific design of the solar power limits Entity A's
practical ability to readily direct it to another customer without incurring significant costs
of rework. Consequently, the solar panel has no alternative use to Entity A.
However, before Entity A can conclude that its performance obligation is satisfied over
time, Entity A shall also assess if it has an enforceable right to payment for performance
completed to date. See Example 1.2 below.
Example 1.2: Enforceable right to payment
(Continuation of Example 1.1)
The customer is required to make a 15% advance payment at contract inception.
Subsequent payments are based on Entity A's progress on the contract, after
proportionate deductions for the advance payment and 10% retention. The 10%
retention is due when the solar panel is completed and has passed the prescribed
performance tests. The payments are non-refundable unless Entity A fails to perform as
promised. If the customer cancels the contract, Entity A retains any payments received
but has no right to further compensation.
Analysis:
Entity A considers whether it has an enforceable right to payment for performance
completed to date if the customer were to terminate the contract for reasons other than
Entity A's failure to perform as promised. (See criterion 'c’)
Entity A has an enforceable right to payment for performance completed to date
because the payments are non-refundable and are based on Entity A's progress on the
contract. The cumulative amount of the payments is expected, at all times throughout
the contract, to sufficiently cover Entity A's costs plus a reasonable profit margin.
Accordingly, in Examples 1.1 and 1.2, Entity A can conclude that its performance
obligation to build the solar panel is a performance obligation that is satisfied over time.
(Continuation of Example 1.1 and Variation of Example 1.2)
The customer is required to make a 15% advance payment at contract inception,
periodic payments equal to 40% throughout the estimated construction period, and the
remaining 45% when the solar panel is completed and has passed the prescribed
performance tests. The payments are non-refundable unless Entity A fails to perform as
promised. If the customer cancels the contract, Entity A retains any payments received
but has no right to further compensation.
Analysis:
Entity A does not have an enforceable right to payment for performance completed to
date because even though the payments are non-refundable, the cumulative amount of
those payments is not expected, at all times throughout the contract, to compensate
Entity A's performance completed to date.
For example, if the customer cancels the contract upon 100% completion, Entity
A would only be entitled to 55% payment (15% advance 40% periodic payments) and
that would be insufficient to cover Entity A's costs plus a reasonable profit margin.
Accordingly, in Examples 1.1 and 1.3, Entity A's performance obligation to build
the solar panel is a performance obligation that is satisfied at a point in time.

(Continuation of Example 1.1 and Variations of Examples 1.2 & 1.3)
The customer is required to make a 15% advance payment at contract inception. The
balance is payable when the solar panel is completed and has passed the prescribed
performance tests. The payment is refundable only when Entity A fails to perform as
promised.
Analysis:
Entity does not have an enforceable right to payment for performance completed to
date (same reason as with Ex. 1.3).
Step 3: Determine the transaction price

The 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)." (PFRS
15. Appdx. A)
In a 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 any of the following:
a. Variable consideration;
b. Constraining estimates of variable consideration;
c. The existence of a significant financing component in the contract;
d. Non-cash consideration; or
e. Consideration payable to a customer.
A construction contract may be either:

1. Fixed price contract - a construction 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.
2. Cost plus contract - a construction contract in which the contractor is reimbursed for
allowable or defined costs, plus a fee. The two types of cost-plus contracts are:
a. Cost-plus-variable-fee contract - the contractor is reimbursed for the costs
plus a percentage of those costs. The contract price is the sum of the costs and the
variable fee.
b. Cost-plus-fixed-fee contract - the contractor is reimbursed for the costs plus
a fixed amount. The contract price is the sum of the costs and the fixed fee.
Some construction contracts may contain characteristics of both a fixed price
contract and a cost-plus contract, such as in the case of a cost plus contract with a
ceiling price.
Example:
You contracted Mr. Architect Engineer Contractor to build a house for you.
Case 1: The contract states a price of P6M for the house.
Analysis: The contract is a fixed price contract. The transaction price is P6M.
Case 2: The contract states that you shall reimburse Mr. Contractor the total
construction costs plus 15% thereof.
Analysis: The contract is a cost-plus-a-variable-fee contract. The transaction
price is equal to the reimbursable costs plus 15% thereof.
Case 3: The contract states that you shall reimburse Mr. Contractor the total
construction costs plus P2M.
Analysis: The contract is a cost-plus-a-fixed-fee contract. The transaction price
is equal to the reimbursable costs plus P2M.
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; or
b. there have been no precedent similar projects that can be used as basis for price
quotation.
The cost-plus-variable-fee, which is common in government contracts, has the following

disadvantages:
a. Disadvantage to the contractor: The contractor's recovery of overhead costs
depends on the cost of materials, which can be affected by significant price
fluctuations. There can be a risk that the agreed percentage may prove to be too
low for the contractor to recover overhead costs and earn a profit.
b. Disadvantage to contractee: There is no incentive for the contractor to be cost-
efficient. Instead, the contractor is tempted to increase the cost because the greater the
cost, the greater will be the profit. Accordingly, the contractee may end up paying an
outrageously overstated contract price.
Step 4: Allocate the transaction price to the performance obligations

The transaction price is allocated to the performance obligations based on the relative
stand-alone prices of the distinct goods 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 is
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 obligations satisfied over time

An entity recognizes revenue from a performance obligation that is satisfied over time
based on the entity's measurement of its progress towards the complete satisfaction of
the obligation in the contract. For example, if the performance obligation is 70%
completed, revenue is recognized equal to 70% of the transaction price.
Methods of measuring progress
An 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
Inputs methods recognize revenue on the basis of efforts or impuls 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 expended d. Machine hours sed
e. Time elapsed
Cost-to-cost
The most common application of the input methods is the "cost-lo cost" method. Cost-
to-cost method refers to the estimation of stage of completion by reference to the
proportion that contract costs incurred for work performed to date bear to the estimated
total contract costs.
In other words, the percentage of completion is determined as the ratio of total costs
incurred to date over the estimated total contract costs.
Formula #1:
Percentage of completion = Total costs incurred to date
Estimated total contract costs
➢ Total costs incurred to date represent the cumulative costs incurred from contract
inception up to the current reporting date.
➢ Estimated total contract costs (Estimated total costs at completion pertain to the
forecasted total costs of completing the contract This can also be determined as
the sum of total costs incurred to date and estimated costs to complete.
➢ Estimated costs to complete pertain to the anticipated additional costs required to
fully complete the contract.
Formula #2: Variation

A variation of the formula above is presented below:
Illustration 1: Cost-to-cost
In 20x1, ABC Construction Co, enters into contact to construct a building for a
customer. The contract price of P6M will be billed to the customer periodically based on
ABC's progress on the construction.
Case 1: Estimated total contract costs

The estimated total contract costs are P4M. The actual costs incurred in
20x1 are P1.2M.
Requirement: How much revenue is recognized in 20x1?

Solution:
Step 1: Identify the contract with the customer The contract is a construction
contract, Le, a contract specifically negotiated for the construction of an asset.
Step 2: Identify the performance obligations in the contract The performance
obligation is to construct a building. This is satisfied over time because:
a. The entity's performance creates an asset (e.g., work in progress) that the customer
controls as the asset is created.
b. The entity's performance does not create an asset with an alternative use to the entity
Step 3: Determine the transaction price The transaction price is the contract price
of P6M.
Step 4: Allocate the transaction
The whole of the P6M transaction price is allocated to the single performance obligation
of constructing a building.
Step 5: Recognize revenue when (or as) a performance obligation is satisfied
Because the performance obligation is satisfied over time, ABC shall recognize revenue
over time as it progresses towards the complete construction of the building.
ABC shall measure its progress by, in this case, using the cost-to-cost method,
an application of the input method.
Revenue in 20x1 is computed as follows:
Percentage of completion = 1.2M / 4M

Percentage of completion = 30%
Revenue in 20x1 = Contract price x Percentage of completion

Revenue in 20x1=6M x 30%
Revenue in 20x1- P1,800,000
Case 2: Estimated costs to complete

The actual costs incurred in 20x1 are P1.2M. The estimated costs to
complete as of Dec. 31, 20x1 are P2.8M
Requirement: How much revenue is recognized in 20x1?
Solution:
Percentage of completion - 1.2M / (1.2M + 2.8M)

Percentage of completion - 1.2M / 4M
Percentage of completion - 30%
Revenue in 20x1 - Contract price x Percentage of completion

Revenue in 20x1=6M x 30%
Revenue in 20x1= P1,800,000
Illustration 2: Estimated costs to complete - Subsequent period
Information on an entity's contract costs is as follows:
Requirement: Compute for the following:

a. Percentage of completion as of Dec. 31, 20x1
b. Percentage of completion as of Dec. 31, 20x2
c. Percentage completed in 20x2.
Solutions:
Requirement (a): Percentage of completion as of Dec. 31, 20x1

Percentage of completion - 400,000 / (400,000 + 1,600,000)
Percentage of completion = 400,000 / 2,000,000
Percentage of completion as at Dec. 31, 20x1= 20%
Requirement (b): Percentage of completion as of Dec. 31, 20x2

Percentage of completion - 1,500,000 / (1,500,000 +375,000)
Percentage of completion = 1,500,000 / 1,875,000
Percentage of completion as at Dec. 31, 20x2 = 80%
Requirement (c): Percentage of progress made in 20x2 The computed percentages

above are the cumulative percentages of completion at the end of each year. Meaning,
the 80% completion as at Dec. 31, 20x2 includes the 20% completed in 20x1.
Therefore, the percentage completed in 20x2 is 60% (80% minus 20%
Efforts-expended (labor hours-based) method
Another application of the input’s method is the efforts-expended (labor hours-based)
method. Under this method, the percentage of completion is based on "forts expended"
in completing the contract - normally in direct labor hours, rather than on costs. This
method is most commonly used by general contractors whose profits are directly related
on how they manage subcontractors rather than from the value of the subcontracts
themselves.
Requirement: Compute for the percentages of completion as of Dec 31, 20x1 and 20x2
Solution:
20x1
Percentage of completion - 400+ (400 + 1,600)
Percentage of completion - 400 +2,000
Percentage of completion as at Dec. 31, 20x1 - 20%
20x2
Percentage of completion=1,500+ (1.500 +375)
Percentage of completion 1,500 + 1,875
Percentage of completion as at Dec. 31, 20x2 - 80%
➢ The percentage completed in 20x2 is 60% (80% minus 20%).

Contract costs
Contract costs include:
a. Incremental costs of obtaining a contract
b. Costs to fulfill a contract
Incremental costs of obtaining a contract

Incremental costs of obtaining a contract - are costs incurred in obtaining a contract with
a customer that the entity would not have incurred had the contract not been 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.
As a practical expedient, incremental costs of obtaining a contract are recognized as

expense when incurred if the expected amortization period of the asset is one year or
less.
Costs to fulfill a contract
Costs incurred in fulfilling a contract that are within 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.
Examples of costs that are directly related to a contract:

a. Direct materials (e.g., costs of materials used in construction).
b. Direct labor (e.g., site labor costs, including site supervision).
c. Other costs that are incurred only because the entity entered into the contract.
Examples:
i. Payments to subcontractors
ii. Costs of moving plant, equipment and materials to and from the contract site
iii. Costs of hiring plant and equipment
iv. Costs of design and technical assistance that are directly related to the contract
d. Costs that are explicitly chargeable to the customer under the contract (eg. 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 contract activities
Examples:
i. Insurance
ii. Depreciation of plant and equipment used on the contract
iii. Costs of design and technical assistance that are not directly related to a specific
contract
iv. Costs of contract management and supervision
v. Borrowing costs capitalized in accordance with PAS 23 Borrowing Costs
vi. Other construction overheads
The following costs are expensed 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 of the contract
c. Selling costs
d. Research and development costs for which reimbursement is not specified in the
contract
e. Depreciation of idle plant or 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)
g. Costs for which an entity cannot distinguish whether the costs 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 is accounted for as reduction of contract costs, e.g., income from the
sale of excess/scrap materials.
Amortization and impairment
Contract costs recognized as asset are amortized on a systematic basis that is
consistent with the transfer of the related goods or services to the customer.
Impairment loss is recognized to the extent that the carrying amount of the asset
exceeds:
a. the remaining amount of consideration that the entity expects to receive in exchange
for the goods or services to which the asset relates; less
b. the costs that relate directly to providing those goods or services and that have not
been recognized as expenses.
(PERS 15.101)
Percentage of completion -4,500,000 / 10,000,000
Adjustments to the measure of progress

A weakness of the input methods is that there may not be a direct relationship between
the inputs and the transfer of control of the asset to the customer. In such cases, the
inputs used in measuring the entity's progress are adjusted.
When using the "cost-to-cost" method, an entity excludes the following when
measuring its progress on a contract:
a. Costs that do not contribute to the entity's progress in satisfying the performance
obligation, e.g., costs of significant inefficiencies, such as wasted materials, labor and
other resources that were not reflected in the contract price.
b. Costs incurred that are not proportionate to the entity's progress in satisfying the
Examples:
i. Advance payments to subcontractors for which the subcontracted work has not
yet been started.
ii. Materials acquired but not yet used on the contract
However, the entity may adjust the input method to recognize revenue only to the extent
of that cost incurred if the entity expects at contract inception that all of the following
conditions would be met:
1. The good is not distinct;
2. The customer is expected to obtain control of the good significantly before receiving
services related to the good;
3. The cost of the transferred good is significant relative to the total expected costs to
completely satisfy the performance obligation; and
4. The entity procures the good from a third party and is not significantly involved in
designing and manufacturing the rights belongs to respective authors good (but the
entity is acting as a principal).
Illustration 1: Revenue to the extent of cost incurred

On Sept. 1, 20x1, ABC Co. enters into a contract with a customer to remodel a plant's
electrical wirings and install a new generator for a total consideration of P12M. The
remodeling and the installation
are treated as a single performance obligation satisfied over time.
Additional information:
• ABC Co. uses the cost-to-cost method in measuring its progress.
• ABC Co. incurs total costs of P6,000,000 in 20x1, including the cost of the
generator.
• The customer obtains control of the generator when it is delivered to the site in
December 20x1. However, the generator will not be installed until March 20x2.
• ABC Co. regards the cost of the generator as significant in relation to the expected
total contract costs (ie. 4M/9M = 44.44%)
• Although ABC Co. acted as a principal in procuring the generator, ABC Co. is not
involved in designing of
• manufacturing the generator.
Requirements:
a. How much revenue is recognized in 20x1?
b. How much profit is recognized from the contract in 20x1?
Solutions:
Analysis:
➢ The costs incurred to date include the cost of an uninstalled material, I.e., generator.
➢ Because all the conditions listed above (#'s 1 to 4) are met, the uninstalled cost of
the generator is excluded from when computing and applying the percentage of
completion. Instead, the cost of the generator is recognized both as revenue and
cost of goods sold. Consequently, no profit is recognized from the generator in 20x1.
= (6M total costs incurred – 4M cost of generator) / (9M expected total contract costs –
4M cost of generator)
= 2M / 5M
Illustration 2: Adjustments to the input method
ABC Co. uses the "cost-to-cost" method in measuring its progress on a construction
contract. The estimated total contract cost is PIOM. Actual costs incurred during the
year totaled P6M, including P2M advance payment to a subcontractor (the
subcontracted work is not yet started) and P200,000 cost of materials not yet installed.
The unused materials are not significant in relation to the expected total contract costs.
Moreover, ABC Co. retains control over the unused materials because it can use them
on contracts with other customers.
Requirement: Compute for the percentage of completion in 20x1.
Solution:
Because the conditions listed above (i.e., #'s 1 to 4) are not met, the P2M advance
payment to the subcontractor and the P200K unused materials are simply eliminated
when measuring ABC's progress.
Percentage of completion = (6M-2M-200K) / 10M

Percentage of completion = (3.8M / 10M) = 38%
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 of services to a customer

for which the entity has received consideration (or the amount is due) from the
customer." (PFRS 15 Appendix A)
A contract liability is recognized at the earlier of the date:

a. The entity receives 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),
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 (e.g., the entity's future performance)." (PFRS 15.
Appendix A)
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 the measurement of the receivable in
accordance with PFRS 9 and the corresponding amount of revenue recognized is
presented as an expense (e.g., as an impairment loss).
Illustration 1: Contract liability and Receivable

On Jan. 1, 20x1, ABC Co. enters into a contract to install a gate for a customer. The
gate will be fabricated in ABC's place of business and will be assembled and installed in
the customer's premises on
Mar. 31, 20x1. The contract requires the customer to pay a consideration of P1,000 in
advance on Jan. 31, 20x1. The customer pays the consideration on Mar. 1, 20x1. ABC
installs the gate on Mar. 31, 20x1.
Requirement: Provide the journal entries under each of the following scenarios: (a) the
contract is cancellable and (b) the contact is non-cancellable. (Ignore contract costs)
Solutions:
Scenario A: Cancellable Scenario B: Non-cancellable
Jan 1, 20x1 Jan 2
No Entry No Entry
➢ No entry because neither party has performed its obligation.

Jan 31, 20x1 Jan 31, 20x1
No Entry Receivable…………….1,.000
Contract Liability…………..1,000
➢ A receivable is recognized under Scenario B because ABC Co has an unconditional

right to consideration (i.e., the contract is non-cancellable and it requires payment on
this date). ABC Co. is entitled to the consideration whether the customer pursues or
cancels the contract. A corresponding contract liability is recognized for ABC's
obligation to install the gate.
➢ No receivable is recognized under Scenario A because ABC Co. does not have an
unconditional right to consideration (i.e., the contract is cancellable).
Mar. 1, 20x1 Mar. 1, 20x1
Cash……………………………….1,000 Cash…………….1,.000
Contract Receivable…………..1,000
liability……………………………..1,000
➢ Under Scenario A, contract liability is credited when the advanced payment is

received.
➢ Under Scenario B, receivable is credited. The contract liability is recognized on Jan.
31, the earlier of the date the unconditional right to the consideration is obtained
(Jan. 31) and the date the advanced payment is received (Mar. 1).
Mar. 31, 20x1 Mar. 31, 20x1
Contract liability ………….1,000 Contract liability ………….1,.000
Revenue……………………………..1,000 Revenue…………………..…………..1,000
➢ Revenue is recognized only on Mar. 31 when the performance obligation is satisfied

(i.e., the gate is installed)
Illustration 2: Contract asset

On Dec. 1, 20x1, ABC Co. enters into a contract with a customer for the installation of
roof tiles. The expected number of roof tiles to be installed is 1,000 units. The contract
price is P100 per roof tile installed. However, the customer pays the total consideration
only when all of the 1,000 roof tiles have been installed.
ABC assesses its performance obligation to be satisfied over time because the
customer simultaneously receives and consumes the benefits provided by ABC's
performance as ABC performs; and ABC's performance enhances an asset that the
customer controls as it is enhanced.
As of Dec. 31, 20x1, 800 roof tiles have been installed. The remaining 200 tiles have
been installed on Jan. 7, 20x2. The customer pays the consideration on Jan. 9, 20x1.
Requirement: Provide the journal entries. Ignore contract costs.
Solution:
Dec. 1, No Entry
20x1
Dec. 31, Contract Asset (800units x P100) 80,000
20x1 Revenue 80,000
Jan. 7, Receivable (1,000 units x P100) 100,000
20x1 Contract asset 80,000
Revenue (200 units x P10) 20,000
Jan 9, Cash 100,000
20x1 Receivable 100,000
Notes:
➢ Contract asset is recognized on Dec. 31 (rather than 'receivable') because ABC

Co.'s right to consideration is conditioned upon the full installation of the 1,000 roof
tiles.
➢ Revenue is recognized as ABC Co. progresses towards the complete satisfaction of
the performance obligation (i.e., as the roof tiles are installed).
➢ Receivable is recognized on Jan. 7 because ABC Co. obtains an unconditional right
to consideration as all the roof tiles have been installed.
Remember the following:
Scenario Accounting
➢ Consideration is received or becomes ➢ Recognize a contract liability
due before goods or services are
transferred to the customer.
➢ Goods or services are transferred to ➢ Recognize a contract asset.
the customer before consideration is
received: ➢ Recognize a receivable.
a. Right to consideration is conditional.
b. Right to consideration is
unconditional.
PFRS 15 does not prohibit the use of alternative terms for "Contract asset" and
"contract liability" so long as sufficient information is provided to enable users of the
financial statements to distinguish between "receivables" and "contract assets."
For example, the "Advances from customers" account may be used in lieu of contract
liability when the consideration is received in advance. However, this account cannot be
used if the consideration becomes due (rather than received) before the goods or
services are transferred to the customer (see Illustration 1: Scenario B: Jan 31, 20x1
above).
Accounting for Construction Contracts
A summary of the old and current accounting is provided below:
PAS 11 (old standard) PFRS 15 (current standard)
An asset is recognized for “unbilled” Contract asset is recognized when the
accounts receivable when the entity entity performs but its right to
recognizes revenue that is not yet billed. consideration is still conditional. Once the
Once the customer is invoiced, the entity’s right to consideration becomes
unbilled receivable is reclassified as a unconditional (such as when none but the
“billed” accounts receivable. On the other passage of time is required before
hand, billings in excess of costs are payment is due), the contract asset is
recognized as liabilities reclassified as receivable.
More specifically, PAS 11 requires the Contract liability is recognized if the

entity to present: consideration is received or becomes due
a. the gross amount due from customers before the entity performs.
for contract work as an asset; and
b. the gross amount due to customer for
contract work as a liability.
The excess of (1) costs incurred and

recognized profits, net of losses, over (2)
progress billings represent gross amount
due from customers. The excess of (2)
over (1) represents gross amount due to
customers.
Illustration: Percentage of completion

On Jan 1, 20x1, ABC enters into a contract to construct a building for a customer. ABC
identifies its performance obligation to be satisfied over time. ABC uses the input method
based on costs to measure its progress on the contract. The contract price is P9M.
Information on the construction is provided below:
20x1 20x2 20x3
a. Contract costs incurred per year 2,760,000 3,540,000 500,000
b. Billings per year (1) 50% 30% 20%
c. Collections on billings per year (2) 90% 90% balance
d. Estimated costs to complete (at each 4,140,000 700,000 -
yr.-end)
(1)
The billings per year are stated as percentages of the contract price. The contract is
non-cancellable.
(2) The
collections on billings in 20x1 and 20x2 are net of 10% retention. “Retention” is an
amount withheld by the contractee and payable to the contractor at the end of the contract
when the project is completed and accepted.
Requirements:
a. Compute for the gross profits, revenues and costs of construction in 20x1, 20x2, 20x3,
respectively.
b. Provide the journal entries.
c. Determine the amounts presented in the financial statements.
Solutions:
Requirement (a):
➢ Gross Profits
20x1 20x2 20x3
Total contract price 9,000,000 9,000,000 9,000,000
(a) Costs incurred to date* 2,760,000 6,300,000 6,800,000
Estimated costs to complete 4,140,000 700,000 -
(b) Estimated total contract costs 6,900,000 7,000,000 6,800,000
Expected gross profit 2,100,000 2,000,000 2,200,000
Multiply by: % completion (a)+(b) 40% 90% 100%
Gross profit earned to date 840,000 1,800,000 2,200,000
Less: Gross profit in prior years - (840,000) (1,800,000)
Gross profit for the year 840,000 960,000 400,000
* Costs incurred to date’ is the sum of costs incurred in the current year and previous
years. In 20X2, the costs incurred to date is computed as (2.76m costs in 20X1 + 3.54M
costs in 20X2) = 6.3M.
➢ Revenues
20x1 20x2 20x3
Multiply by: % completion 40% 90% 100%
Revenue to date 3,600,000 8,100,000 9,000,000
Less: Revenue recognized in prior - (3,600,000) (8,100,000)
years
Revenue for the year 3,600,000 4,500,000 900,000
Cost of construction ** (2,760,000) (3,540,000) (500,000)
**Under the 'cost-to-cost' method, the 'cost of construction'(contract costs amortized

to expense) is equal to the contract costs incurred in that period. Alternatively, this can
also be 'squeezed' after computing the revenue and gross profit for the year.
Notice that billings and collections do not affect revenue, cost of construction and
gross profit.
Requirement (b): Journal Entries
➢ 20x1
a) Incurrence of cost
Traditional Accounting PFRS 15
Construction in progress 2.76M Contract costs 2.76M
Cash (or other accounts) 2.76M Cash (or other accounts) 2.76M
"Construction in progress" is an account used to accumulate contract costs

incurred and profits (less losses) recognized to date.
b) Billing
Accounts receivable 4.5M Receivable 2.76M
Progress billings (9M x 50%) 4.5M Contract liability 2.76M
"Progress billings" is an account used to record amounts billed for work performed
on a contract.
c) Collection
Cash (4.5M x 90%) 4.05M Cash 2.76M
d) Revenue recognition
Cost of construction 2.76M Contract liability 3.6M
Construction in progress 840K (1) Revenue 3.6M
Revenue 3.6M
Cost of construction 2.76M (2)
Contract costs 2.76M
(1) equal to gross profit

(2)
As the progress is measured using the 'cost to cost' method, all costs incurred are
amortized.
➢ 20x2
Traditional accounting PFRS 15
Cash (2.7M x 90%) 2.43M Cash 2.43M
Construction in progress 960K Revenue 4.5M
Revenue 4.5M
Cost of construction 3.54M
➢ 20x3
Construction in progress .5M Contract costs .5M
Cash (or other accounts) .5M Cash (or other accounts) .5M
Cash 2.52M (a) Cash 2.52M (a)
Cost of construction 500K Contract liability 900K
Construction in progress 400K Revenue 900K
Revenue 900K
Progress billing 9M Cost of construction 500K
Construction in progress 9M Contract costs 500k
To eliminate the accounts
(a)
(10% of 4.5M billing in 20x1) + (10% of 2.7M billing in 20x2) + 1.8M billing in 20x3
= 2.52M
Requirement (c): Financial Statements
Traditional PFRS 15
Accounting
Construction in Contract costs
Progress
2,760,000 2,760,000
840,000 2,760,000
12/31/x1 3,600,000 12/31/x1 -
3,540,000 3,540,000 3,540,000
960,000 12/31/x2 -
12/31/x2 8,100,000 500,000 500,000
500,000 - 12/31/x3
400,000
9,000,000 9,000,000 Contract Liability
- 12/31/x3 4,500,000
3,600,000
Progress Billing 900,000 12/31/x1
4,500,000 12/31/x1 4,500,000 2,700,000
2,700,000 12/31/x2 900,000
7,200,000 12/31/x2 900,000 1,800,000
1,800,000 12/31/x2 -
9,000,000 9,000,000
12/31/x3 -
Accounts Receivable
Receivable
4,500,000 4,500,000
4,050,000 4,050,000
12/31/x1 450,000 12/31/x1 450,000
2,700,000 2,430,000 2,700,000 2,430,000
12/31/x2 720,000 12/31/x2 720,000
1,800,000 2,520,000 1,800,000 2,520,000
- 12/31/x3 - 12/31/x3
- See 'Requirement (a)’ for revenues and costs of construction
- The debit balance in the contract liability account on 12/31/x2 is presented as asset.
The year-end adjusting entry is as follows:
Contract Asset 900k
Contract Liability 900k
- A reversing entry would be made to simplify the recording in 20x3

- Alternatively, the revenue in 20x2 may also be recorded as follows:
Contract Asset 3.6M
Contract Liability 900k
Revenue 4.5M
ABC Co.
Statement of financial position
Current Assets: 20x1 20x2 20x Current 20x1 20x2 20x
3 Assets: 3
Accounts receivable 450,000 720,000 - Receivable 450,000 720,000 -
Construction in - 8,100,00 - Contract asset - 900,000 -
progress 0
Less: Progress - 7,200,00 -
billings 0
Gross amt. due from - 900,000 -
customer
Total 450,000 1,620,00 - Total 450,000 1,620,00 -
0 0
Current liabilities: Current

liabilities:
Construction in 3,600,00 - - Contract liability 900,000 - -
progress 0
Less: Progress 4,500,00 - -
billings 0
Gross amt. due to 900,000 - -
customer
Total 900,000 - - Total 900,000 - -
ABC Co.
Statement of profit or loss
20x1 20x2 20x3 20x1 20x2 20x3
Revenue 3,600,00 4,500,00 900,00 Revenue 3,600,000 4,500,00 900,00
0 0 0 0 0
Cost of (2,760,00 (3,540,00 (500,00 Cost of (2,760,000 (3,540,00 (500,00
construction 0) 0) 0) const. ) 0) 0)
Gross profit 840,000 960,000 400,00 Gross 840,000 960,000 400,00
0 profit 0
Shortcut: Under the 'cost-to-cost' method, the balance of the CIP account is equal to
the revenue recognized to date.
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. Examples of output methods:
a. Surveys of performance completed to date
b. Appraisals of results achieved, milestones reached, time elapsed and units
produced or units delivered
The disadvantages of output methods are that the outputs used to measure
progress may not be directly observable and the information required to apply them
may be costly.
The 'cost-to-cost' method (input method) of estimating stage of completion is the
most commonly tested method in the past CPA board examination. However, in
practice, many entities use the output methods. This is normally the case in the
construction of "high-rise" buildings*, dams, bridges, and other structures wherein the
incurrence of costs is not necessarily proportionate to the entity's progress on the
contract. The input method is more commonly used for non-complex structures, such
as roads.
*Generally, a "high-rise" building is one that is taller than the maximum height which
people are willing to walk up; it normally requires an elevator. The threshold for
distinguishing a high rise building (e.g., number of floors and vertical measurement)
varies from country to country. A building taller than a high-rise building is called a
"skyscraper".
Making the direct measurements under some output methods require a
considerable degree of expertise. In practice, these are generally determined by
experts (e.g., engineers and architects). A CPA is not expected to be proficient in
making those measurements. A CPA applying an output method would rely on the
expert's direct measurements.
The different methods of measuring progress result to different amounts of
revenue, costs and profit. Accordingly, PFRS 15 requires the consistent application of
a single method for each performance obligation satisfied over time.
Illustration 1: Output method - Survey of work
Information on an ongoing construction contract with a fixed contract price of P1M is
shown below:
Cost of construction (contract costs recognized as expense)
P500,000
Percent complete (based on a survey by a professional)
80%
Requirement: Compute for the gross profit for the year.

Solution:
Total Contract price 1,000,000
Multiply by: Percentage of completion 80%
Revenue to date 800,000
Less: Revenue recognized in prior years -
Revenue for the year 800,000
Cost of construction for the year (given) (500,000)
Gross profit for the year 300,000
Illustration 2: Physical proportion of the contract work

In 20x1, ABC Co. was subcontracted to construct the first portion of a 94.5-kilometer,
four-lane expressway. Construction started in 20x1 and it was expected that the
expressway will be opened to the public in three years' time.
Per house resolution, the total contract price for the first portion of the expressway
consisting of 41 kilometers is P13B. ABC uses the output method based on physical
proportion of contract work in estimating the stage of completion of a project.
Additional information on the project is shown below:
Year Cost incurred Estimated costs to No. of kilometers
each year complete completed during the
year
20x1 2.3B 7.7B 10.25
20x2 5.5B 2.4B 22.55
Requirement: Compute for the revenue and the cost of construction recognized as
expense in 20x2, respectively.
Solution:
20x1 20x2
No. of kilometers completed to date 10.25 32.80
Divide by: Total kilometers to be completed 41 41
Percentage of completion to date 25% 80%
➢ Profits:
20x1 20x2
Total contract price 13B 13B
Estimated total contract costs (10B) (10.2B)
Expected total profit from 3B 2.8B
construction
Multiply by: % of completion 25% 80%
Profit to date 0.75B 2.24B
Profit recognized in prior years - (0.75B)
Profit for the year 0.75B 1.49B
*Estimated total contract costs are equal to the costs incurred to date plus estimated
costs to complete at each year-end. These are computed as follows:
- 20x1: (2.3B + 7.7B) = 10B
- 20x2: (2.3B + 5.5B + 2.4B) = 10.2B
➢ Revenues and costs of construction:

20x1 20x2
Total Contract price 13B 13B
Contract revenue to date 3.25B 10.4B
Contract revenue recognized in prior - (3.25B)
years
Contract revenue for the year 3.25B 7.15B
Cost of construction (squeeze) (2.5B) (5.66B)
Profit for the year 0.75B 1.49B
- Unlike the cost-to-cost method, under the output method, the cost of construction
is not equal to the actual costs incurred in that period.
Changes in the measure of progress

The measure of progress is updated as circumstances change over time to reflect any
changes in the outcome of the performance obligation. Changes are accounted for
prospectively as changes 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 the complete satisfaction of the performance obligation can be
reasonably measured
If the outcome of a performance, obligation cannot be reasonably measured,
revenue is recognized only to the extent of cost incurred that are expected to be
recovered.
This accounting method is traditionally called the "zero-profit" method. There is
zero profit because the revenue recognized is equal to the costs incurred.
Illustration: Zero-profit method

Information on a construction contract with a contract price of P9M is provided below:
20x1 20x2 20x3
a. Contract costs incurred per yr. 2,760,000 3,540,000 500,000
b. Estimated costs to complete (at each Not Not -
yr.-end) measurable measurable
Requirements:
a. Compute for the 20x1, 20x2, and 20x3 revenues
b. Provide the journal entries in 20x1 assuming billings were 50% of the contract price
and collections were 90% of the billings.
Solutions:
Requirement (a):
20x1 20x2 20x3
Revenue 2,760,000 3,540,000 2,700,000
Contract costs incurred per year (2,760,000) (3,540,000) (500,000)
Gross profit for the year - - 2,200,000
Notes:
- Prior to completion (i.e., 20x1 and 20x2), the revenues recognized are equal to the
contract costs incurred. Accordingly, no gross profits are recognized during these
years.
- On completion (i.e., 20x3), the revenues recognized is the excess of the contract
price over the revenues recognized in prior years: (9M contract price - 2.76M revenue
in 20x1 - 3.54M revenue in 20x2 = 2.7M).
- Gross profit is recognized only in the year of completion.
Requirement (b): Journal Entries - 20x1 only
Cash (4.5M x 90%) 4.05M Cash 4.05M
Revenue 2.76M Revenue 2.76M
Cost of construction 2.76M
The 20x1 financial statements will show the following:

Statement of financial position
Current assets: 20x1 Current assets: 20x1
Accounts receivable 450,000 Receivable 450,000
Total 450,000 Total 450,000
Current liabilities: Current liabilities:

Construction in progress 2,760,000 Contract liability 1,740,000
Less: Progress billings 4,500,000
Gross amt. due to customer 1,740,000
Total 1,740,000 Total 1,740,000
Statement of profit or loss

20x1 20x1
Revenue 2,760,000 Revenue 2,760,000
Cost of (2,760,000) Cost construction (2,760,000)
construction
Gross profit - Gross profit -
Onerous Contract (Expected Losses)
PAS 11 (old standard) PFRS 15 (current standard)
When it is probable that the total costs As soon as a contact becomes onerous,
will exceed total contract revenue, the an entity recognizes a provision for the
expected loss is recognized immediately loss it expects to incur on the contract in
as expense. accordance with PAS 37 Provisions,
Contingent Liabilities and Contingent
Assets.
An onerous contract is a contract in

which the unavoidable costs of meeting
the obligations under the contract exceed
the economic benefits expected to be
received under it.
The loss recognized in 20x2 is determined as follows:

20x1 – To determine the percentage of completion = 200,000 costs incurred to date
divided by 800,000 estimated total contract costs = 25%
20x2 – N/A because the progress in 20x2 is ignored so that the 100,000 loss is
recognized in full.
The 50,000-profit recognized in 20x1 not restated. Thus, to reflect the expected total
loss on the contract of 100,000, will be 150,000 and will be recognized in 20x2. (50,000
profit in 20x1 – 150,000 losses in 20x2 = 100,000 loss to date)
Solution:
The contract is analyzed as follows:
20x1 20x2 20x3
Contract price 1,000,000 1,000,000 1,000,000
Costs incurred to date 200,000 825,000 1,020,000
Estimated costs to complete 600,000 275,000 -
Estimated total contract costs 800,000 1,100,000 1,020,000
Expected total profits (loss) on 200,000 (100,000) (20,000)
completion
The profit recognized in 20x3 is determined as follows:
Journal Entries: (Billing and Collections are ignored)

20x3
Construction in progress 195,000 Contract costs 195,000
Cash (or other accounts) 195,000 Cash (or other accounts) 195,000
Cost of construction 195,000 Contract asset 250,000
Construction in progress 80,000 Revenue 250,000
Revenue 250,000
Gain on completed contract 25,000
Cost of construction 195,000
Contract costs 195,000
Provision 25,000
Gain on reversal of provision 25,000
The profits (losses) are determined as follows:
20x1 20x2 20x3
Revenue 200,000 625,000 175,000
Contract cost incurred per yr. (200,000) (625,000) (195,000)
Gross profit for the yr - - (20,000)
Loss on onerous contract (100,000)
Gain on reversal of provision 100,000
Profit (loss) for the year - (100,000) 80,000
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.
The amount of consideration can vary because of discounts, rebates, refunds, credits,
price concessions, penalties, incentives, performance bonuses, 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 is estimated using either of the following
methods, depending on which method is expected to be better predict the amount to
which the entity will be entitled:
a. Expected value - the sum of probability-weighted amounts in a range of possible

amounts. This may be appropriate when the entity has a large number of contracts with
similar characteristics.
b. Most likely amount - the single most likely amount in a range of possible amounts.
This may be appropriate when there are only two possible outcomes.
Constraining estimates of variable consideration
The estimated amount of variable consideration is 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.
Example 1: Penalty
A construction contract states a price of 1,000,000. However, a penalty of 100,000 will

be charged if the construction is not completed within two months from the agreed date
of completion.
Analysis:
The consideration includes a fixed amount of 900,000 and a variable amount of
100,000.
Constraining estimates of variable consideration:

The entity determines the probability of the penalty being charged and includes the
variable consideration (and thus a transaction price of 1,000,000) only if it is highly
probable that the penalty will not be charged.
Example 2: Estimating variable consideration
A construction contract states a price of 1,000,000. However, for each day that
completion is delayed after the deadline, the contract price decreases by 1,000,
whereas for each day that the completion is earlier than the deadline, the contract price
increases by 1,000.
In addition, upon completion, a third party will inspect the asset and assign a rating
based on metrics defined in contract. If a specified rating is met, the entity will receive a
bonus of 20,000.
Analysis:
The consideration includes a fixed amount of 1,000,000 and a variable amount, which
the entity needs to estimate using the methods described earlier. The entity makes
separate estimates for each of the components of the variable amount. For example the
entity uses:
a. the expected value method to estimate the variable consideration associated with the
daily penalty or incentive because there can be a range of possible amounts.
b. the most likely amount to estimate the variable consideration associated with the
incentive bonus because there can only be two possible outcomes.
Incentive payments
Incentive payments are additional amounts paid to the contractor if specified

performance standards are met or exceeded.
Incentives payments are included in the transaction price, and consequently to the
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.
Illustration: Incentive payment
ABC Co. started work on a construction contract in 20x1. The contract provides for a
400,000 bonus if the building is completed within 4 years. ABC Co. uses the ‘cost-
to-cost’ method in measuring its progress on the contract. Information on the project is
as follows:
20x1 20x2 20x3

Costs incurred to date 1,000,000 1,960,000 4,160,000
Estimated costs to complete 4,000,000 2,940,000 1,040,000
• In 20x1 and 20x2, it is not highly probable that the construction will be completed
within the 4-year limit.
• In 20x3, ABC Co. acquired new equipment and employed additional personnel.
This has fast-tracked construction work. ABC Co. now believes it is highly
probable that the construction will be completed within the 4-year limit.
To compute for the revenues:
20x1 20x2 20x3
Multiply by: % of completion 20% 40% 80%
Revenue to date 1,200,000 2,400,000 5,120,000
Less: revenue in prior yrs. - (1,200,000) (2,400,000)
Revenue for the year 1,200,000 1,200,000 2,720,000
Cost of construction (squeeze) (1,000,000) (960,000) (2,200,000)
Optional reconciliation:
20x1 20x2 20x3
Fixed fee 1,000,000 1,000,000 1,000,000
Incentive payment 400,000
Estimated total gross profit 1,000,000 1,000,000 1,400,000
Multiply by: % of completion 20% 40% 80%
Gross profit to date 200,000 400,000 1,120,000
Less: Gross profit in prior yrs. (200,000) (400,000)
Cost of construction 1,000,000 960,000 2,200,000
Revenue for the year 1,200,000 1,160,000 2,920,000
Cost escalations
A cost escalation is a contractual provision that stipulates an increase in the contract

price in the event of an increase in certain costs. Escalation clauses are normally
expressed as a percentage of an originally contracted amount. The opposite of an
escalation clause is de-escalation clause.
An escalation is included in (or a 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.
Solution:
20x1 20x2
Total contract price 1,000,000 1,050,000
(a) Costs incurred to date 224,000 518,000
Estimated costs to complete 476,000 222,000
(b) Estimated total contract costs 700,000 740,000
Expected gross profit (loss) 300,000 310,000
Gross profit (loss) to date 96,000 217,000
Gross profit in prior yrs. - (96,000)
Gross profit (loss) for the year 96,000 121,000
Changes in the transaction price
After contract inception, the transaction price can change for various reasons, including
the resolution of uncertain events.
A subsequent change in the transaction price, arising from other than a contract
modification, shall be allocated to the 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 to 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 the transaction price after a contract modification is accounted for as
follows:
• If the change in the transaction price 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 is not accounted for as a separate
contract, the change in the transaction price is allocated to the unsatisfied
performance obligations in the modified contract.
Illustration: Change in the transaction price

On July 1, 20x1, ABC Construction Co. enters into contact with a customer for the
construction of a building. The contract price is P6M. However, ABC is entitled to a
bonus of P500,000 if the building is completed within,3 years. ABC Co. uses the 'cost-to
cost' method in measuring its progress on the contract. At contract inception, ABC Co.
estimates a total contract cost of P4M.
In 20x1, ABC Co. incurs total costs of P1,350,000. On December 31, 20x1, ABC Co.
does not expect that it can finish the building on time for it to be entitled to the bonus.
The estimated costs to complete as of the end of 20x1 are P2.4M.
On January 28, 20x2, ABC Co. and the customer agree to modify the contract to
change the design and the location of the staircase. The modification increased the
contract price to P6.8M and the estimated total contract costs to P4.5M. ABC plans to
increase its manpower in 20x2 and thus now expects to finish the building on time and
receive the bonus.
In assessing the contract modification, ABC Co. concludes that the remaining goods
and services to be provided under the modified contract are not distinct from the goods
and services transferred on or before the date of contract modification; that is, the
contract remains a single performance obligation.
Requirement: Compute for the revenue in 20x1 and the cumulative catch-up
adjustment to revenue recognized on Jan. 28, 20x2 (the contract modification date).
Solutions:
Analysis:
Since the additional goods or services to be provided in the modified contract 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.
Claims for reimbursements on the contract
The transaction price may also change due to claims for reimbursements.
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, it shall account for the claim as a contract modification using
the principles in PFRS 15. If the contract modification results to a change in the
transaction price, the entity shall estimate the change considering the constraint on
estimates of variable consideration.
Illustration 1: Unapproved change in scope and price

ABC Co. entered into a contract to construct a building on a customer-owned land. The
contract requires the customer to provide ABC access to the land within 30 days after
contract inception. However, ABC was provided access only after 120 days due to
storm damage to the site. The contract states compensation for costs incurred resulting
from delay, including force majeure. ABC prepared a claim for the costs incurred on the
delay but the customer disagreed. ABC assessed its legal claim and determined that it
has enforceable rights.
Accounting:
Because ABC Co. has an enforceable right, it shall account for the claim as a
contract modification by updating the transaction price and the measure of progress
towards the complete satisfaction of the performance obligation. ABC considers the
constraint on estimates of variable consideration when estimating the transaction price.
Illustration 2: Change order (Variation) - w/ reimbursable claims
In 20x1, ABC Co. entered into a fixed price contract with XYZ, Inc. to construct a
building for P10M. In 20x2, the design of the building was changed. As a result, the
initial price is decreased by P2M. The construction was started in 20x1 and was
completed in 20x3. ABC Co. uses the 'cost-to-cost method in measuring its progress on
the contract. Information on the construction is provided below:
20x1 20x2 20x3
Contract costs 2,000,000 4,500,000 1,600,000

incurred each year
Estimated total 10,100,000 8,150,000

contract costs
The costs incurred in 20x3 Include costs of variations in contract work amounting to
P50,000. The costs were due to XYZ's fault and ABC is claiming for reimbursement.
ABC assessed that it has an enforceable right over the claim. Negotiations have
reached an advanced stage such that it is highly probable that the reimbursement will
be received.
Requirement: Compute for the profits/losses under (a) percentage of completion and
(b) zero-profit.
Solutions:
Illustration 3: Output measures-with non-reimbursement claims
In 20x1, ABC Co. was contracted to construct a subway. The contract price is P60M
and the total estimated costs are P30M. Information on the project is as follows:
20x1 20x2
Output measure of value of 15M 52.2M

work completed to date
Costs incurred to date 8M 22.5M
(excluding rectification
costs)
Progress billings to date 10M 48M
• In Jan. 2 20x2, ABC Co. agreed to a contract variation that involves an additional
fee of P10M with associated additional estimated costs of P4M. In assessing the
contract modification, ABC Co. concludes that the contract remains a single
• In 20x2, ABC incurred additional P3M rectification costs for substandard work.
These [costs were not included in the original estimates, and although ABC Co.
does not have an enforceable right to reimbursement, ABC is hoping to recover
the costs.
• ABC uses the percentage of completion based on the value of the work certified
to date compared to the total contract price.
Requirement: Compute for the amounts presented in profit or loss in 20x1 and
20x2.
Significant financing component in a contract
When determining the transaction price, the promised consideration is
discounted if the timing of the agreed payments provides the customer or the entity with
a significant benefit of financing the transfer of goods or services. The difference
between the promised consideration and the present value is recognized separately as
interest revenue or interest expense.
A contract 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. The consideration is variable and contingent on a future event that is beyond the
customer's or the entity's control; or
c. The difference between the promised consideration and the cash selling price arises
from reasons other than financing.
The promised consideration need not be discounted if it is collectible within 1 year from
the date of transfer of the goods or services.
Illustration: Withheld payments on a long-term contract

A 3-year construction contract provides for a 10% retention by the customer on all
progress billings throughout the contract duration. The amount retained is payable to
contractor at contract completion when the customer accepts the completed asset.
Analysis: The contract does not include a significant financing component because the
retention is intended to protect the customer from the contractor's failure to satisfy its
contractual obligation rather than financing. Accordingly, the retentions need not be
discounted.
Non-cash consideration
In many construction contracts, the customer may choose to provide the entity goods or
services (e.g., materials, equipment or labor) 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 if the entity obtains control over them.
The 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 in
exchange for the consideration
Uncertainty in the collectability of contract revenue
Contract inception
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 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.
The entity shall continue to assess the contract to determine if the criteria in PFRS 15
are subsequently met.
Subsequent period
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. The impairment is accounted for under PFRS 9 Financial Instruments,
presented in accordance with PAS 1 Presentation of Financial Statements, and
disclosed in accordance with PFRS 7 Financial Instruments: Disclosures. However,
PFRS 15 makes it clear that such amounts are disclosed separately from impairment
losses on other contracts.
Illustration 1- Uncollectability at contract inception
ABC Co. enters into contract to construct a hotel for a customer for P50M. The
customer pays a non-refundable deposit of P2.5M at contract inception and enters into
a long-term financing agreement with ABC for the balance. The financing is on a non-
recourse basis, which means that if the customer defaults, ABC can repossess the hotel
but cannot seek further payment. The customer intends to repay the balance primarily
from the income it will derive from the hotel. The hotel is located in an area where new
hotels face high levels of competition and the customer has little experience in the hotel
industry.
Analysis: At contact inception, there is an uncertainty in the collectability of the
consideration as evidenced by the following:
a. the customer intends to repay the loan (which has a significant balance) primarily
from income on the hotel (which faces significant risks because of high competition in
the and the customer has limited experience); and industry
b. the customer's liability is limited because the loan is non-recourse.
Accounting:
ABC Co. does not recognize any revenue from the contract. ABC treats the P2.5M
nonrefundable deposit and any subsequent collections as liability. ABC Co. recognizes
revenue only when the collectability of the consideration becomes probable or when
either of the following occurs:
a. ABC 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 is terminated and the consideration received is non-refundable.
Illustration 2: Impairment of receivable

ABC Co. started work on a construction contract in 20x1. The contract price is P10M.
Additional information follows:
20x1 20x2
Costs incurred to date 2,400,000 4,500,000
Estimated costs to complete 3,600,000 1,500,000
Progress billings to date 4,000,000 7,500,000
Collections 3,000,000 -
In 20x2, ABC assessed that it cannot collect 10% of the total contract price.
Requirement: Compute for the profit in 20x2.
Solutions:
20x1 20x2
Total contract price 10,000 10,000,000
(a) Costs incurred to 2,400,000 4,500,000

date
Estimated costs to complete 3,600,000 1,500,000
Estimated total costs 6,000,000 6,000,000
Expected profit (loss) 4,000,000 4,000,000

(a) / (b)
Profit (loss) to date 1,600,000 3,000,000
Profit recognized in prior (1,600,000)

years
Total 1,600,000 1,400,000
Impairment loss on (1,000,000)

receivable
Profit for year 1,600,000 400,000
Case 2: No reasonable measure of progress-zero-profit method'
At contract inception, ABC Co. concludes that it has a single performance
obligation that is satisfied over time. However, ABC cannot reasonably measure the
outcome of the performance obligation, but expects to recover all contract costs
incurred.
Requirement: Compute for the revenue, cost of construction, and gross profit
recognized in 20x1, 20x2 and 20x3, respectively.
Case 3: Performance obligation satisfied at a point in time
At contract inception, ABC Co. identifies that, during the construction period, ABC
retains control over the asset created in the contract. This precludes the customer from
simultaneously receiving and consuming the benefits provided by ABC's performance
as ABC performs. Moreover, the asset created in the contract has an alternative use to
ABC because, in case the contract is cancelled, ABC retains ownership over the asset
and can direct it for another use without significant modification or cost. Accordingly,
ABC concludes that the performance obligation is satisfied at a point in time, which is
when the construction is completed and control over the promised good is transferred to
the customer.
Requirement: Compute for the revenue, cost of construction and gross profit recognized
in 20x1, 20x2 and 20x3, respectively.
Illustration 3: Progress billings ABC Co. uses the percentage of completion method to
account for its fixed price construction contracts and makes progress billings as follows:
• 20% down payment upon signing of contract.
• The balance is billed based on percentage of completion minus an application of
the down payment which is also based on the percentage of completion.
Information on ongoing construction contracts is shown below:
Project Contract Price Percent complete
A 1,000,000 25%
B 2,000,000 75%
Requirement: Compute for (a) total progress billings made and (b) total construction
revenue.
Solution:
Requirement (a): Progress billings
Project A
Down Payment 200,000
Subsequent billing:
Billing on balance (1M x 80% x 25%) 200,000
Deduction from down payment (200k x 25%) (50,000) 150,000
350,000
Project B
Down Payment 400,000
Subsequent billing:
Billing on balance (2M x 80% x 75%) 1,200,000
Deduction from down payment (400k x 75%) (300,000) 90,000
1,300,000
Total progress billings (350k +1.3M) 1,650,000
Requirement (b): Construction revenue
Project A: Total contract price x % of completion (1M x 25%) 250,000
Project B: Total contract price x % of completion (2Mx 75%) 1,500,000
Total construction revenue 1,750,000
Illustration 4: Collections
ABC Co. makes progress billings and collections on its fixed price. construction
contracts as follows:
• 15% mobilization fee is due at contract inception, to be deducted from the final
billing.
• Subsequent progress billings are due within 2 weeks upon customer acceptance,
net of 10% customer retention.
ABC made the following three subsequent progress billings on a project with a contract
price of PIM:
• 20% on Nov. 1, 20x1. The customer accepted the billing on Nov. 4, 20x1.
• 10% on Dec. 22, 20x1. The customer disputed the billing.
• 7% on Dec. 26, 20x1. The customer accepted the revised billing on Dec. 30,
20x1. Requirement: Compute for the amount of collections from the project
during 20x1.
Requirement: Compute for the amount of collections from the project during 20x1.
Solution:
Mobilization fee 150,000
Collection from the 20% progress billing (1M x 20% x 90%*) 180,000
Total collections 330,000
Notes:
• The subsequent progress billings are not adjusted for the mobilization fee
because the problem states that the mobilization fee will be "deducted from the
final billing."
• No collection was made on the 10% billing because it was not accepted by the
customer.
• No collection was also made on the 7% billing because it is due 2 weeks from
Dec. 30, 20x1 (the date of acceptance).
Illustration 5: Gross profit rate

ABC Co. uses the percentage of completion to account for its fixed price construction
contracts. ABC requires 15% mobilization fee on contracts signed and collects progress
billings 2 weeks upon acceptance by the contractee.
During the year, ABC started work on a project with a total contract price of P1M on
which ABC expects to earn a gross profit of 30%. By year-end, ABC had presented
progress billings to the contractee corresponding to 60% completion. The contractee
accepted and paid all progress billings except for a 10% progress billing which was
accepted on January 5 of next year and a 5% billing which was due January 9 of next
year.
Requirement: Compute for the profit from construction to be recognized for the year.
Solution:
Total contract price 1,000,000

Multiply by: Expected gross profit rate 30%
Expected total profit from the contract 300,000
Multiply by: Percentage of completion 60%
Profit for the year 180,000
Notice: the mobilization fee and the progress billing not accepted as of year-end do not affect
the computation of profit. This is because progress payments and advances received from
customers often do not reflect the work performed.
Illustration 6: Reconstruction of contract information
ABC Co. uses the percentage of completion to account for its fixed price construction
contracts. On December 31, 20x2, ABC has the following information regarding one of
its construction works in progress which was started 20x1:
20x1 20x2
Percentage of completion 25% 75%
Estimated total contract 1,500,000 1,800,000
costs
Profit of the year 125,000 25,000
Requirements: Compute for the following:

a. Contract revenue and Cost construction in 20x2
b. Estimated costs to complete as of December 31, 20x2.
Solutions:
“Costs incurred to date” is equal of the sum of costs construction recognized in the current year
and in previous years. The costs incurred to date in 20x2 is computed as (375 costs of
construction in 20x1 + 975k costs construction in 20x2= 1,350,000)

ABC Co. uses the traditional accounting and the percentage of completion method to
account for its fixed price construction contracts. On December 31, 20x2, ABC has the
following information regarding one of its construction works in progress which was
started in 20x1
20x1 20x2
Percentage of completion 25% 75%
Profit of the year 125,000 25,000
Construction in progress 500,000 1,500,000
account
Requirement: Compute for the Contract price and the Revenues and Costs or
Construction recognized in 20x1 and 20x2.
Solutions:
Step 2: The CIP account

Concept: The Construction in progress (CIP) account accumulates costs incurred to
date and recognized profits and losses. Accordingly, the balance of the CIP account
represents the revenue recognized to date (i.e., costs of construction + profit =
revenue), except in cases of onerous contracts.
ABC Co. uses the percentage of completion method to account for its construction
contracts. Information on a recently completed contract with a fixed contract price of
P9M is shown below:
20x1 20x2 20x3
Costs incurred to 2,000,000 630,000 ?
date
Profit recognized 250,000 1,550,000 400,000

each year
Requirement: Compute for the (a) costs incurred during 20x3 and (b) estimated costs
to complete as of December 31, 20x2.
Solutions:
Requirement (a):
Contract price 9,000,000
Total costs incurred on the contract (squeeze) (6,800,000)
Total profit recognized on the contract (250k+1.55M+400k) 2,200,000
Total costs incurred on the contract 6,800,000

Costs incurred to date- 20x2 (6,300,000)
Costs incurred during 20x3 500,000
Requirement (b):
Revenue to date – 20x2 (squeeze) 8,100,000
Costs incurred to date – 20x2 (6,300,000)
Profit to date – 20x2 (250k+1.55M) 1,800,000
Revenue to date – 20x2 8,100,000

Divide by: Contract price 9,000,000
Percentage of completion to date= 20x2 90%
Alternative Solution:
Costs incurred to date – 20x2 6,300,000
Divide by: Percentage of completion – 20x2 90%
Estimated total contract costs – 20x2 7,000,000
Costs incurred to date – 20x2 (6,300,000)
Estimated costs to complete – 20x2 700,000
Illustration 9: Contract costs

During the year, ABC Co. started work on a P2M fixed price construction contract and
incurred the following related costs:
Cost of material, labor and construction overhead 1,300,000
Rectification work not expected to be recovered 130,000
Administrative costs 50,000
Selling costs 30,000
• Incidental income from sale of surplus materials amounted to P20,000.
• ABC Co. obtained general borrowings of P6M (with 12% interest) and P2M (with
8% interest) to finance the construction of its various projects. Both loans were
outstanding all throughout the construction period.
• Expenditures on the contract costs were made evenly.
• ABC uses "cost-to-cost" method in measuring its progress on the contract. The
estimated costs to complete as of year-end are P149,600. The estimate includes
an adjustment for capitalizable borrowing costs but does not include expected
warranty costs of P100,000 that are explicitly chargeable to the customer under
the contract
Requirement: Compute for the profit from the contract, net of all related expenses.
Solutions:
Costs of material, labor and construction overhead 1,300,000
Incidental income (20,000)
Contract costs before capitalizable borrowing costs 1,280,000
Capitalize borrowing costs 70,400
Contract costs incurred during the year 1,350,400
Interest on general borrowing (6M x 12%) (2M x 8%) 880,000
Divide by: General borrowing (6M+2M) 8,000,000
Capitalization rate 11%
Multiply by: Average expenditure 640,000
Capitalizable borrowing costs 70,400
Total contract price 2,000,000

Costs incurred to date (a) 1,350,400
Estimated: costs to complete (149,600 + 100,000 warrant costs) 249,600
Estimated total contract costs (b) 1,600,000
Expected gross profit 400,000
Multiply by: % completion (a) / (b) 84.40%
Gross profit earned to date 337,600
Less: Gross profit in prior yr. ___
Gross profit of the year 337,600
Rectification work not expected to be recovered (130,000)
Administrative costs (50,000)
Selling costs (30,000)
Profit of the year 127,600
Notes:
• Incidental income not included in contract revenue is accounted for as reduction
of contract costs.
• Contract costs exclude non-reimbursable costs not included in the contract.
These are outright expenses.
• Contract costs include costs that are explicitly chargeable to the customer under
the contract (e.g., the expected warranty costs above).
Accounting for
Franchise Operations
– Franchisor
Group 4
Leader: Alvez, Ronalyn Q.
Members:
Abing, Liame R.
Alabat, Jane
Andal, Geraldine G.
Destriza, Glenda A.
Miguel, Rey-Ann Grace S.
Chapter 8: Accounting for Franchise Operations – Franchisor
Related standard: PFRS 15 Revenue from Contracts with Customers
Learning Objectives
1. Define a franchise contract.
2. Apply the general and specific principles of recognizing revenue from franchise
contracts.
Core principle under PFRS 15

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.
Summary of the Revenue recognition Principles under PFRS 15:

Step 1: Identify the contract with the The contract is with a customer and
customer. (among others) the collectability of the
consideration is probable.
Step 2: Identify the performance Each promise to deliver a distinct good or
obligations in the contract. service in the contract is treated as a
separate performance obligation.
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 transaction price is allocated to the
the performance obligations performance obligations based on the
relative stand-alone prices of the distinct
goods or services.
Step 5: Recognize revenue when (or as) a - For a performance obligation
performance obligation is satisfied satisfied over time, revenue is
recognized as the entity progresses
towards the complete satisfaction
of the performance obligation.
- For a performance obligation
satisfied at a point in time, revenue
is recognized when the entity
completely satisfies the
Revenue is measured at the amount of
transaction price allocated to the
performance obligation satisfied.
Licensing
The "licensing" section of PFRS 15 (par.B52-B63) provides specific principles that relate
directly to the accounting for franchises. The specific principles are to be applied in
addition to the general principles.
PFRS 15 defines a license as one that "establishes a customer's rights to the intellectual
property of an entity. Examples of licenses of intellectual property include:
a. Software and technology;

b. Motion pictures, music and other forms of media and entertainment;
c. Franchises; and
d. Patents, trademarks, and copyrights.
Franchise
A franchise is a contractual arrangement under which the franchisor grants the franchisee
the right to sell certain products or services, to use certain trademarks or trade names, or
to perform certain functions, usually within a designated geographical area.
We deal with franchises everyday: a Jollibee fast-food restaurant, a 711 convenience store,
an FM radio station, and a public utility vehicle are all examples of franchises.
Franchises are of two types:

1. Contractual arrangement between two private entities or individuals.
• Between two private entities or individuals

The franchisor, having developed a unique concept or product, protects that
concept or product through a patent, copyright, or trademark or trade name.
The franchisee acquires the right to exploit the franchisor's idea or product by
signing a franchise agreement.
2. Contractual arrangement between a private entity or an individual and the government.
• Between a private entity or an individual and the government
In another type of franchise arrangement, a municipality (or other
governmental body) allows a private entity to use public property in
performing its services. Examples: the use of public waterways for a ferry
service, use of public land for telephone or electric lines, use of phone lines for
cable TV, use of city streets for a bus line, or use of the airwaves for radio or TV
broadcasting. Such operating rights, obtained through agreements with
governmental units, are frequently referred to as licenses or permits.
Franchises and licenses may be for a definite period of time or for an indefinite
period of time or perpetual.
Application of the 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 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; 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 criteria above. 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.
The entity need not reassess the criteria above if they have been met on contract
inception unless there is an indication of a significant change in facts and circumstances,
for example, when the customer's ability to pay subsequently deteriorates significantly.
Example: Reassessment of the criteria for identifying a contract
ABC Co. Licenses its proprietary processes to XYZ, Inc. in exchange for usage-based
royalty. At a contract inception, criteria ‘a’ to ‘e’ above are met.
Accounting: ABC accounts for the contract in accordance with PFRS 15 and recognizes
revenue when XYZ's subsequent usage occurs.
In Year 2, XYZ continues to use ABC's processes but XYZ's financial condition declines.
XYZ pays only a portion of the year's billings. XYZ's current access to financing is
limited.
Accounting: ABC continues to recognize revenue based on XYZ's usage but accounts for
any impairment of the existing receivable in accordance with PFRS 9 Financial
Instruments.
In Year 3, XYZ continues to use ABC's processes but XYZ has lost major customers and
access to financing. Thus, XYZ's ability to pay significantly deteriorates.
As a result of this significant change in facts and circumstances, ABC reassesses criteria
'a' to 'e' above and determines that it is no longer probable that ABC will collect the
consideration to which it will be entitled.
Accounting: ABC stops recognizing further revenue from XYZ's future usage of the
processes and accounts for any impairment of the existing receivable in accordance with
PFRS 9.

General principles:
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:

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.
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 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 goods or services promised in the contract.
Satisfaction of performance obligations

At contract inception, the entity shall determine whether the identified performance
obligations will be satisfied either:
a. Over time; or
b. At a point in time
A performance obligation is satisfied over time if one of the following criteria is met:
a. The customer simultaneously receives and consumes the benefits provided by the
entity's performance as the entity performs.
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
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.
Specific principles: ('Licensing' section)

A contract to grant a license to a customer may include other promises to provide
additional goods or services to the customer, whether explicitly stated in the contract or
implied by the entity's customary business practices.
Just like with other types of contracts, the entity shall apply the general principles
in "Step 2" above to identify each of the performance obligations in the contract.
Promise to grant license is not distinct

If the promise to grant a license is not distinct from the other promises in the
contract, all of the promises are accounted for together as a single performance obligation.
The entity determines whether the performance obligation will be satisfied over time or
at a point in time using the general principles above.
Examples of licenses that are not distinct from other goods or services
promised in the contract:
a. A license that is integral to the functionality of a tangible good (e.g., software
embedded to a machine); and
b. A license that the customer can benefit from only in conjunction with a related
service (e.g., software with web hosting arrangement).
Promise to grant license is distinct

If the promise to grant the license is distinct from the other promises in the
contract, the promise to grant the license is treated as a separate performance
obligation.
The entity determines whether the separate promise to grant the license will be
satisfied over time or at a point in time by determining whether the license provides the
customer with either:
a. A right to access the entity's intellectual property as it exists throughout the license
period; or
b. A right to use the entity's intellectual property as it exists at the point in time at which
the license is granted.
➢ If the customer has the right to access the intellectual property as it exists
throughout the license period, the performance obligation is satisfied over time.
Therefore, the amount of consideration allocated to the promise to grant the
license is recognized as revenue over the license period.
➢ If the customer has the right to use the intellectual property as it exists at the point
in time at which the license is granted, the performance obligation is satisfied at a
point in time. Therefore, revenue is recognized at the time when the license is
provided.
Right to access
The customer has the right to access the entity's intellectual property as it exists
throughout the license period if the customer cannot direct the use of, and obtain
substantially all of the remaining benefits from, the license at the point in time at which
the license is granted. This is the case if the intellectual property to which the customer
has rights changes throughout the license period.
The intellectual property changes throughout the license period if:

a. The entity continues to be involved with its intellectual property; and
b. The entity undertakes activities that significantly affect the intellectual property to
which the customer has rights.
The customer has the right to access the entity's intellectual property if all of the following
criteria are met:
a. The contract requires, or the customer reasonably expects, that the entity will
undertake activities that significantly affect the intellectual property to which the
customer has rights;
b. The rights granted by the license directly expose the customer to any positive or
negative effects of the entity's activities identified in (a) above; and
c. Those activities do not result in the transfer of a good or a service to the customer
as those activities occur.
Right to use
The customer has the right to use the entity's intellectual property as it exists at
the point in time at which the license is granted if the customer can direct the use of, and
obtain substantially all of the remaining benefits from, the license at the point in time at
which the license is granted. This is the case if the intellectual property to which the
customer has rights will not change.
Any activities undertaken by the entity merely change its own asset (i.e., the
underlying intellectual property), which may affect the entity's ability to provide future
licenses; however, those activities would not affect the determination of what the license
provides or what the customer controls.
If the customer has the right to use the intellectual property, the promise to grant
a license is a performance obligation satisfied at a point in time.
The entity shall consider the following indicators of transfer of control when
determining the point in time at which the license transfers to the customer:
a. The entity has a present right to payment for the asset.
b. The customer has legal title to the asset.
c. The entity has transferred physical possession of the asset.
d. The customer has the significant risks and rewards of ownership of the asset.
e. The customer has accepted the asset.
However, revenue shall not be recognized before the point in time where the customer
is able to use the license. For example. if a software license period begins before an entity
provides to the customer a code that enables it to use the software, no revenue is
recognized before that code is provided.
The following factors are disregarded when determining whether a license

provides a 'right to access' or a 'right to use:
a. Time, geographical or use restrictions - these define the attributes of the promised
license rather than whether the performance obligation is satisfied at a point in
time or over time.
b. Guarantee that the entity will defend a patent from unauthorized use this is not a
performance obligation but serves only as protection of the intellectual property.
Sales-based or usage-based royalties
Whether a license is distinct or not, and whether a distinct license provides a 'right
to access' or 'right to use, revenue from a sales-based or usage-based royalty is recognized
only when (or as) the later of the following events occurs:
a. The subsequent sale or usage occurs; and
b. The performance obligation to which the sales-based or usage-based royalty has been
allocated has been satisfied (or partially satisfied).
PROMISE TO GRANT LICENSE IS:

Not Distinct Distinct
➢ Treat all promises in the contract as ➢ Treat the promise to grant the
a single performance obligation. license as a separate performance
obligation.
➢ Use general principles to determine ➢ Use specific principles to determine
whether the performance if the promise provides the
obligation is satisfied over time or customer a:
at a point in time.
a. Right to access - performance
obligation is satisfied over time. Revenue
is recognized over the license period.
b. Right to use-performance obligation
is satisfied at a paint in time. Revenue is
recognized at the time when the license is
provided.
PROMISE TO GRANT LICENSE IS DISTINCT:

Right to Access Right to use
The customer cannot direct the use of, and ➢ The customer can direct the use of,
obtain all the remaining benefits from, the and obtain all the remaining
license at the time it was granted. benefits from, the license at the
time it was granted.
➢ Intellectual property (IP) changes ➢ Intellectual property (IP) does not
throughout the license period. change throughout the license
period.
a. The entity continues to be involved with
the IP; and
b. The entity undertakes activities that
significantly affect the IP.
➢ May be evidenced by a sales-
based royalty agreement
between the entity and the
customer.
Illustration: Identifying a distinct license (Based on IFRS 15.IE281-288)

An entity, a pharmaceutical company, licenses to a customer its patent rights to an
approved drug compound for 10 years and also promises to manufacture the drug for the
customer. The drug is a mature product; therefore, the entity will not undertake any
activities to support the drug, which is consistent with its customary business practices.
Case 1: License is not distinct

No other entity can manufacture this drug because of the highly specialized nature
of the manufacturing process. As a result, the license cannot be purchased separately from
the manufacturing services.

Application of the General Principles:
Concept Analysis
Each promised good or service that is The promises are not individually distinct
distinct is treated as a separate because:
performance obligation. A good or service a. the customer cannot benefit from the
is distinct if: license without the manufacturing
a. the customer can benefit from it on its service
own; and b. the promises are highly interrelated,
b. it is separately identifiable from the and thus not separately identifiable.
other promises contract.
❖ Conclusion: The promises are treated as a single performance obligation.
Case 2: License is distinct

The manufacturing process used to produce the drug is not unique or specialized
and several other entities can also manufacture the drug for the customer.
Application of the General principles:
The promises to provide the license and the manufacturing service are distinct
because the customer can benefit from the license without the manufacturing service and
the promises are separately identifiable from each other.
Conclusion:
There are two separate performance obligations in the contract, namely: (1)
License of patent rights and (2) Manufacturing service
The entity determines whether each of the performance obligations is satisfied over
time or at a point in time.
Since the license is distinct, the entity applies the specific principles to
determine whether the customer has the right to access or right to use the entity's
intellectual property.
Application of the Specific Principles:

Concept Analysis
Right to access
✓ Customer cannot direct the use of,
and obtain all the benefits from, the
license at grant date.
✓ Intellectual property changes
throughout the license period.
✓ May be evidenced by a sales-based
royalty agreement.
Right to use The license qualifies with this one the use
✓ Customer can direct the use of, and of, because of the following statement:
obtain all the benefits from, the "The drug is a mature product; therefore,
license at grant date. the entity will not undertake any activities
✓ Intellectual property does not to support the drug…”
change throughout the license ✓ From the statement above, it can be
period. inferred that the intellectual
property does not change
throughout the license period.
Conclusion: The customer has the right to use the entity's intellectual property as it
exists at a point in time. Accordingly, the performance obligation to provide the
license is satisfied at a point in time.
STEP 3 : DETERMINE THE TRANSACTION PRICE
TRANSACTION PRICE – the amount of consideration 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.
The transaction price is normally the contract price. However, the transaction price may
not be equal to the contract price if the consideration in the contract is affected by any of
the following:
a. Variable consideration;
b. Constraining estimates of variable consideration (an entity is exempt from applying
this principle on sales-based or usage-based royalty);
c. The existence of a significant financing component in the contract;
d. Non-cash consideration; or
e. Consideration payable to a customer.
Franchise fees - refer to the fees that the franchisee agrees to pay to the franchisor in
a franchise agreement. The fees may cover the supply of know-how, initial and
subsequent services, and equipment and other tangible assets.
Franchise fees come in the form of:

1. Initial franchise fee - this is the one-off payment made by the franchisee to the
franchisor to obtain the franchise right. Initial franchise fees are normally paid at the
signing of the franchise agreement and are normally non-refundable.
Aside from consideration for the supply of know-how, initial franchise fees may also
cover for the franchisor's initial services in assisting the franchisee in establishing the
new business. Examples of initial services include the following:
a. Assistance in site selection, lease negotiations, financing, fitting-out of the premises,
and supervision of the construction activity
b. Initial training in operating the business
c. Assistance with staff recruitment and training
d. Access to preferential purchasing arrangements the franchisor has put in place
e. Provision of systems (e.g., accounting, information, and quality control)
f. Advertisement and promotion
g. Preparations for, and execution of, the grand opening
h. Initial presence of a trouble-shooter for the first few days after the opening
2. Continuing franchise fees - these are the periodic payments made by the
franchisee to the franchisor for the ongoing franchisee support. Continuing franchise
fees are also referred to as royalty fees and are usually based on a certain percentage
of the franchisee's sales, but can also be set up as a fixed amount or on a sliding scale,
and are payable periodically.
In some cases, continuing franchise fees may be charged separately for the following:
a. Management fees -these pay primarily for ongoing franchisee support and are usually
calculated as percentage of franchisee's sales.
b. Training and conference fees
c. Accounting and other special services fees - in some franchises, the franchisor
provides bookkeeping services or maintains the information system of franchisees.
Separate fees may be charged for these services.
d. Marketing services fund - additional fee may be charged as contribution to the
national product advertising and marketing activities of the franchisor.
e. Renewal fund - a fund may be established to cover for the renewal fee of the franchise
when it expires.
3. Sale of equipment and other tangible assets - in most franchise agreements,

the franchisor provides equipment and other tangible assets to the franchisee for a
separate fee. Also, the franchisor may purchase goods centrally and supplies directly to
franchisees.
Step 4: Allocate the transaction price to the performance obligations

The transaction price is allocated to the performance obligations based on the relative
stand-alone prices of the distinct goods or services.
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) a performance obligation is

satisfied
A performance obligation is satisfied when the control over a promised good or service
is transferred to the customer.
• 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
Illustration 1: Accounting for franchise fees

On January 1, 20x1, ABC Co. grants a franchisee the right to operate a restaurant
in a specific location using ABC's trade name, concept and menu over a 10-year period.
The franchise agreement states an upfront fee of P1,200,000, which includes P200,000
for kitchen equipment that ABC will purchase for the franchisee, plus 10% royalty based
on the franchisee's sales. The P200,000 amount reflects the stand-alone selling price of
the equipment.
ABC regularly undertakes activities such as marketing research, product
development, advertising campaigns, and implementing operational efficiencies and
pricing strategies to support the franchise name.
ABC delivers the equipment on February 1, 20x1. The restaurant opens on April 1,
20x1, at which date the license period starts to run. The franchisee reports sales of
P9,000,000 for the year.
Requirement: Provide the journal entries.
Analysis:
The promises to grant the franchise license and to transfer the kitchen equipment are
distinct because:
a. The customer can benefit from each promise on their own of together with other
resources that are readily available
b. The franchise license and equipment are separately identifiable.
The supporting activities (i.e., marketing research, etc.) are not performance obligations
because these do not directly transfer goods or services to the franchisee. Rather, these
are part of ABC's promise to grant the license and, in effect, change the intellectual
property to which the franchisee has rights.
❖ Conclusion: There are two separate obligations in the contract, namely: (1)
Franchise license; and (2) Equipment.
The entity determines whether each performance obligation is satisfied over time or at a
point in time:
1) Franchise license:
Since the license is distinct, ABC applies the specific principles to determine whether
the franchisee has the right to access or right to use ABC's intellectual property.
❖ Conclusion: The customer has the right to access, and thus the performance
obligation is satisfied over time.
2) Equipment:
The entity applies the general principles to determine whether the performance
obligation to transfer the equipment is satisfied over time or at a point in time.
Since control over the equipment transfers to the customer upon delivery, the
performance obligation is satisfied at a point in time.
Step 3: Determine the transaction price

The transaction price includes a fixed consideration of P1.2M and a variable
consideration for the sales-based royalty.
Step 4: Allocate the transaction price to the obligations

✓ The P1.2M upfront fee is allocated as follows:
▪ P200K to the equipment (because this reflects the stand. alone selling
price); and
▪ P1M balance to the franchise license.
✓ The 10% sales-based royalty is allocated entirely to the franchise license
Step 5: Recognize revenue when (or as) an obligation is satisfied

✓ The P200K is recognized as revenue when the equipment is transferred to the
franchisee.
✓ For the P1M, ABC applies the general principles to determine a measure of
progress that best depict its performance.
Because the contract provides the franchisee with unlimited use of ABC's
intellectual property for a fixed term, an appropriate measure of progress may be
a time-based method. ABC starts to amortize the P1M on April 1, 20x1 because it is
on this date that the franchisee is able to use and obtain the economic benefits from the
license.
✓ The sales-based royalty is recognized as the sales occur.
Journal entries:
Date Account name Debit Credit

Jan 1, Cash
20x1 1,200,000
Contract Liability
1,200,000
to record the receipt of the initial franchise fee
Feb 1, Contract Liability
20x1 200,000
Revenue
200,000
to recognize revenue from the initial franchise fee
allocated to the kitchen equipment
Dec Contract Liability
31, 75,000
20x1
Revenue [1M/10yrs (9/12)]
75,000
to recognize revenue from the initial franchise fee
allocated to the franchise license
Dec Cash
31, 900,000
20x1
Revenue (9M x 10%)
900,000
to recognize revenue from the sales-based royalty
Illustration 2: Initial services

On Dec. 1, 20x1, ABC Co. granted a customer a franchise license to use ABC's trade name
and sell ABC's products for 5 years. The contract requires an upfront fee of P120,000 and
monthly royalty fees of 3% of sales. The upfront fee is non-refundable
ABC Co., as a franchisor, has developed a customary business practice to undertake the
following pre-opening/setup activities:
a. Assistance in site selection and fitting-out of the premises
b. Management and staff training
c. Advertisement and promotion
d. Preparations for, and execution of, the grand opening
ABC Co. does not provide the pre-opening/setup activities separately from the granting
of franchise rights and the franchise agreement does not state separate fees for these
activities. ABC regularly conducts national advertising campaigns to promote the trade
name.
The franchisee started operations in December and as of December 31, 20x1, ABC has no
remaining obligation or intent to refund any of the cash received. All the initial services
(i.e., the pre-opening activities) have been performed. The customer reported sales of
P2,000,000 in December 20x1.
Requirement: Provide the journal entries.
Analysis:
❖ Step 2: The only performance obligation in the contract is the promise to grant
the franchise license.
The pre-opening/setup activities associated with the franchise license are
not performance obligations because these do not directly transfer a good or
service to the customer. Rather, these are part of the entity's promise to grant the
license.
PFRS 15.26 provides the following examples of promised goods or services:
a. Sale of goods produced by a manufacturing entity;

b. Resale of goods purchased by a trading entity (e.g., a retailer);
c. Resale of rights to goods or services purchased by an entity;
d. Performing a contractually agreed-upon task is by a service-oriented entity;
e. Constructing, manufacturing or developing an asset on behalf of a customer;
f. Providing a service of standing ready to provide goods or services (eg. unspecified
updates to software that are provided on a when-and-if-available basis) or of making
goods or services available for a customer to use as and when the customer decides;
g. Providing a service of arranging for another party to transfer goods or services a
customer (e.g., acting as an agent of another party);
h. Granting rights to goods or services to be provided in the future that a customer can
resell or provide to its customer;
i. Granting licenses; and
j. Granting options to purchase additional goods or services (when those options
provide a customer with a material right).
Notice that granting of license is included in the list (i.e.. par. "i"); however, pre-opening
activities (initial services) associated with the granting of a license are not included. Pre-
opening activities are, in nature, administrative tasks to set up a contract and
performance obligations do not include such tasks.
The existence of a shared economic interest (i.e., the sales-based royalty) and
regular advertising campaigns indicate that ABC will continue to be involved with the
intellectual property, and thus the customer has the right to access ABC's intellectual
property. Accordingly, the performance obligation is satisfied over time.
❖ Step 3: The transaction price includes a fixed consideration of P120,000 (the

initial franchise fee) and a variable consideration of 3% of customer sales (the
continuing franchise fee).
❖ Step 4: Both the fixed and variable considerations are allocated to the sole
performance obligation of granting the license.
❖ Step 5: Revenue recognition:
a. The P120,000 is recognized over the 5-year license period using a straight-
line method (see discussion in preceding illustration).
b. The sales-based royalty is recognized as the sales occur.
Old accounting (US GAAP) PFRS 15
Under the old accounting (based on U.S. The '5-step' revenue recognition,
GAAP FAS No. 45, par. 5), the initial including the 'specific principles'
franchise fee is recognized as revenue applicable to licensing.
when:
a. The franchisor has no remaining
obligation or intent (by agreement,
trade practice, or law) to refund
any cash received or forgive any
unpaid notes or receivables;
b. Substantially all of the initial
services of the franchisor required
by the franchise agreement have
been performed; and
c. No other material conditions or the
obligations determination related
to substantial performance exist.
Application of old and new accounting to ‘Illustration 2’ above:
➢ The P120,000 initial franchise fee ➢ The P120,000 initial franchise fee
is recognized in full in December is deferred and amortized over the
20x1 when criteria (a) to (c) above 5 year license period using a
are met, i.e., the initial franchise straight line method.
fee is nonrefundable, all the initial
services have been performed, and
the franchisee has started
operations.
Journal entries:
Dec. 1, 20x1 Dec. 1, 20x1

Cash 120K Cash 120K
Unearned franchise fee 120K Contract liability 120K
To record the receipt of the initial fee To record the receipt of the initial fee
Dec. 31, 20x1 Dec. 31, 20x1

Unearned franchise fee 120K Contract liability 120K
Franchise fee revenue 120K Revenue(120k/5YRS) x 1/12 2K
To recognize the revenue from the initial fee To recognize the revenue from the initial fee
Dec. 31, 20x1 Dec. 31, 20x1
Cash or Receivables 60K Cash or Receivables 60K
Franchise fee revenue (2M x 3%) 60K Revenue (2M x 3%) 60K
To recognize the revenue from the To recognize the revenue from the
continuing fee continuing fee
Financial statement presentation:
Statement of financial position Statement of financial position

Contract liability 118K
Statement of profit or loss Statement of profit or loss

Revenue from initial franchise fee 120K Revenue from initial franchise fee 2K
Revenue from contract franchise fee 60K Revenue from contract franchise fee 60K
Variation 1: Initial fee represents a fair measure of services rendered

The franchisee has not yet started operations by Dec. 31, 20x1. However, ABC has
performed all the initial services and the P120,000 upfront fee, which is non-
refundable, "represents a fair measure of the services rendered."
Old accounting PFRS 15
Under the old accounting (as an exception) "In many cases, even though a non
despite the commencement of non the refundable upfront fee relates to an
franchisee's operations, an upfront fee is activity that the entity is required to
recognized as revenue if it is non- undertake at or near contract inception to
refundable and represents a fair fulfill the contract, that activity does not
measure of the services already result in the transfer of a promised good or
rendered. service to the customer. Instead, the
upfront fee is an advance payment for
future goods or services and, therefore,
would be recognized as revenue when
those future goods or services are
provided." (PFRS 15.849)
The P120,000 upfront fee is recognized as The P120,000 initial franchise fee is
revenue in 20x1. deferred and amortized starting from the
date the franchisee is able to use and
obtain the economic benefits from the
license until contract expiration.
Notice that unlike PFRS 15, the old GAAP does not distinguish initial services as
administrative tasks to set up a contract.
Variation 2: Initial services are distinct

The franchise contract explicitly states that the P120,000 upfront fee is
consideration for the initial services and the sales-based royalty is consideration
for the grant of license. ABC assesses its performance obligations in the contract and
determines that it has two separate performance obligations - (1) the initial services;
and (2) granting of license. ABC concludes that the initial services are distinct because
the customer can benefit from the services on their own and the services are separately
identifiable. ABC further concludes that the performance obligation for the initial
services is satisfied at a point in time, while the performance obligation for the granting
of license is satisfied over time.
The franchisee has not yet started operations by Dec. 31, 20x1. However, ABC has
performed all the initial services and the P120,000 upfront fee, which is non-
refundable, represents the stand-alone selling price of the initial services.
Old accounting (US GAAP) PFRS 15
The P120,000 upfront fee is recognized as The P120,000 upfront fee is recognized
revenue in 20x1. as revenue in 20x1 because in this case
the initial services are distinct and
therefore form a separate performance
obligation.
Exception under PFRS 15:

PFRS 15.851 states the following: "An entity may charge a non-refundable fee in part
compensation for costs incurred in setting up a contract (or other administrative tasks).
If those setup activities do not satisfy a performance obligation, the entity shall
disregard those activities (and related costs) when measuring progress. That is because
the costs of setup activities do not depict the transfer of services to the customer. The
entity shall assess whether costs incurred in setting up a contract have resulted in an
asset that shall be recognized (as 'costs to fulfill a contract')."
Comments on the exception:
➢ The use of the term "may" suggests that the exception above is just an option and
not a requirement.
➢ It is not clear whether the amount from the non-refundable upfront fee to be
charged as compensation for the initial services to set up a contract is the actual
cost of those services, the fair value or stand-alone selling price of those services,
or the amount of the non-refundable upfront fee. Until clarification guidance is
issued, this would be open to different interpretations.
2GO, a Philippine company and logistics provider (similar to LBC and JRS Express),
grants franchise licenses for an upfront fee of P200,000 (P50,000 as cash bond and
P150,000 for the license). The P150,000 fee is inclusive of two management trainings,
a hands-on training for the staff, signage, and promotional posters and pamphlets.
However, a separate fee of P2,000 is charged for the training on 2GO's travel business
segment. In addition, the franchisee will remit to 2GO 80% of its sales.
Analysis (using PFRS 15):

► 2GO would treat the initial services (except the training on the travel segment) as
administrative tasks to setup the contract. Accordingly, the P150,000 fee will be allocated
solely to the performance obligation of granting the license.
► 2GO would recognize the separate fee of P2,000 as revenue when the training on the
travel segment is provided.
► 2GO will recognize the "80% of sales" as revenue as the sales occur.
► The cash bond is a deposit liability because it is returnable to the franchisee at the
expiration or cancellation of the contract.
Illustration 3: Allocation of variable consideration (FRS 15.JE178-1E187)

An entity enters into a contract with a customer for two intellectual property licenses
(Licenses X and Y), which the entity determines to represent two performance obligations
each satisfied at a point in time. The stand-alone selling prices of Licenses X and Y are
P800 and P1,000, respectively.
Case 1: Variable consideration allocated entirely to one performance
obligation
The contract states a fixed consideration of P800 for License X and a 3% sales-based
royalty for License Y. For purposes of allocation, the entity estimates its sales-based
royalties to be P1,000.
Analysis:
The P800 fixed consideration for License X and the P1,000 'estimated' variable
consideration for License Y reflect the stand-alone selling prices. Therefore, the
entity shall allocate the P800 fixed consideration entirely to License X and the sales-
based royalty entirely to License Y. The entity shall recognize the P800 fixed
consideration as revenue when License X is transferred to the customer and the sales-
based royalty when the subsequent sales occur.
Illustration 3: Allocation of variable consideration
An entity enters into a contract with a customer for two intellectual property licenses
(Licenses X and Y), which the entity determines to represent two performance obligations
each satisfied at a point in time. The stand-alone selling prices of Licenses X and Y are
P800 and P1,000, respectively.
Case 1: Variable consideration allocated entirely to one performance

obligation
royalties to be P1,000.
Analysis:
consideration for License Y reflect the stand-alone selling prices. Therefore, the
entity shall allocate the P800 fixed consideration entirely to License X and the sales-
based royalty entirely to License Y. The entity shall recognize the P800 fixed
consideration as revenue when License X is transferred to the customer and the sales-
based royalty when the subsequent sales occur.
Case 2: Variable consideration allocated on the basis of stand-alone selling
prices
royalties to be P1,500. License Y is transferred to the customer at contract inception and
License X is transferred 3 months later.
Analysis:
consideration for License Y do not reflect the stand-alone selling prices P800 and
P1,000, respectively. Therefore, the entity shall:
a) allocate the P300 fixed consideration to License X and License Y on the basis of
their stand-alone selling prices; and
b) allocate the sales-based royalty to License X and License Y also on the basis of
their stand-alone selling prices.
The allocations are done separately because the performance obligations in the
licenses are satisfied at different points in time, and therefore, the timing of revenue
recognition differs between the two licenses and between the two considerations.
➢ The P133 allocated to License X is recognized as revenue 3 months after contract

inception.
➢ The P167 allocated to License Y is recognized as revenue at contract inception.
Additional fact:
In the first month, the customer made total sales of P4,000. Therefore, the royalty due
is P200 (4,000 x 5%).
➢ The P89 allocated to License X is initially recognized as a contract liability and will
be recognized as revenue when License X is transferred to the customer (i.e., 3
mos. after contract inception).
➢ The P111 allocated to License Y is recognized as revenue.
CONTRACT COSTS
Contract costs include:
a. Incremental costs of obtaining a contract
b. Costs to fulfill a contract
Incremental costs of obtaining a contract

Incremental costs (Avoidable costs) are costs that would not have been incurred had the
contract not been obtained (e.g., sales commissions). Incremental costs of obtaining a
contract are recognized as asset if the entity expects to recover them. As a practical
expedient, the costs may be expensed outright if the amortization period of the asset is
one year or less.
Costs that would have been incurred regardless of whether the contract was
obtained (i.e., non-incremental or non-avoidable) are recognized as expense, unless
those costs are explicitly chargeable to the customer even if the contract is not obtained.
Costs to fulfill a contract

Costs incurred in fulfilling a contract that are within the scope of other standards are
accounted for using those standards.
Costs incurred in fulfilling a contract that are outside the scope of other standards
are recognized as asset if they are directly related to a contract, generate or enhance
resources that will be used in satisfying performance obligations in the future, and
expected to be recovered.
Indirect costs and non-reimbursable costs are expensed when incurred (e.g.
general and administrative costs not explicitly chargeable to the customer under the
contract).
Amortization and impairment

Contract costs recognized as asset are amortized on a systematic basis that is consistent
with the transfer to the customer of the goods or services to which the asset relates. This
means that, if revenue is recognized on a straight-line basis, the deferred contract costs
are also amortized on a straight-line basis.
The amortization is updated to reflect any significant change in the expected
timing of transfer of the related goods or services to the customer. Such a change is
accounted for as a change in accounting estimate in accordance with PAS 8.
Illustration: Revenues and Costs

On Dec. 1, 20x1, ABC Co. grants a customer a license to use ABC's patented technology
over a 4-year period. The contract price is P1,000,000, payable in full at contract
inception. During Dec. 20x1, ABC Co. incurs direct contract costs of P120,000 and
indirect costs of P30,000. The customer obtains control of the license on Jan. 2. 20x2
Case 1: Right to use

The license provides the customer the right to use ABC's intellectual property as it
exists at the time the license is granted.
Case 2: Right to access
The license provides the customer the right to access ABC's intellectual property as it
exists throughout the license period. ABC uses a time-based method in measuring its
progress towards the complete satisfaction of the performance obligation.
Journal entries:
20x1 - same as above.
20x2
Jan 2, 20x2 No entry
No revenue is recognized on Jan. 2, 20x2 because the performance obligation is satisfied

over time. ABC will start recognizing revenue (and amortizing the related deferred
costs) on Jan. 31, 20x2 onwards.
20x2
Contract liability (1M / 4 yrs.) x
Jan 31, 20x2
1/12 20,833.33
20,833.33
Revenue
Cost of license (120K / 4 yrs) x

Jan. 31, 20x2 2,500
1/12
2,500
Deferred contract costs
SIGNIFICANT FINANCING COMPONENT IN A CONTRACT

When determining the transaction price, the promised consideration is discounted if
the timing of the agreed payments provides the customer (or the entity) with a
significant benefit of financing the transfer of goods or services.
The discount rate used shall reflect the cash selling price (i.e., the price that the
customer would have paid had he purchased the license outright in cash). After contract
inception, the discount rate shall not be updated for changes in interest rates or other
circumstances.
The difference between the undiscounted and discounted amounts of the
promised consideration is recognized separately as interest revenue (or interest
expense) using the effective interest method.
The promised consideration need not be discounted if it is collectible within 1
year from the date the license was granted.
Illustration: Interest revenue and Profit for the year

On Jan. 1, 20x1, ABC Co. enters into a contract with a customer to transfer a license for a
fixed fee of P100,000 payable as follows:
• 20% upon signing of contract.
• Balance due in 4 equal annual installments starting Dec. 31. 20x1. The discount
rate is 12%.
ABC incurs direct contract costs of P20,000 in 20x1. ABC transfers the license to the
customer on Jan. 3, 20x2. The license provides the customer with the right to use ABC's
intellectual property as it exists at grant date.
Requirement: Compute for the profits in 20x1 and 20x2, respectively.
Solution:
➢ Step 2: The single performance obligation in the contract to transfer the license is
satisfied at a point in time.
➢ Step 3: The transaction price is computed as follows

Down payment (100k x 20%) 20,000
PV of note: [(100k x 80%)/4 ] x PV of ord annuity @12%, n=4 60,747
Transaction price 80,747
➢ Step 4: The transaction price is allocated to the sole performance obligation of

granting the license.
➢ Step 5: The transaction price is recognized as revenue (in full) on Jan. 3, 20x2
when the license is transferred to the customer.
The difference between the contract price of P100,000 and the
transaction price of P80,747 is amortized as interest revenue over the term of the
note using the effective interest method.
No revenue from the license is recognized in 20x1 because the license is not yet
transferred to the customer. Consequently, no cost of franchise is also recognized as
expense. However, interest income is nonetheless recognized because there is passage of
time.
Uncertainty in the collectability of contract revenue

If the uncertainty in the collectability of contract revenue arises at contract
inception, the contract would not qualify under 'Step 1' and thus no revenue is recognized.
Any consideration received is recognized as liability. The contract is continued to be
reassessed if it subsequently meets the criteria.
If the uncertainty arises subsequent to contract inception, the uncollectability is
accounted for as impairment of receivable and/or contract asset.
Illustration: Uncertainty in the collectability of contract revenue

ABC Co. uses a standard contract for the granting of a license to customers. The
standard contract contains the following:
- Fixed fee of P100,000 payable as follows: P20,000 down payment and balance
due in 4 equal annual installments to start a year after the signing of contract.
- The license provides the customer the right to use ABC's intellectual property
as it exists at grant date.
On Jan. 1, 20x1, ABC Co. signs three contracts. The licenses are also transferred to the
customers on this date. The discount rate is 12%. Accordingly, the present value of the
note in each contract is P60,747. ABC assesses the collectability of the note from each
customer and concludes the following:
Collectability of Note
Customer 1 Probable
Customer 2 Doubtful
Customer 3 Significabtly uncertain
- The receivable from Customer 2 is doubtful of collection because the region where
Customer 2 operates is undergoing economic difficulty. However, ABC believes that the
region's economy will recover in the near term and that the license will help Customer 2
increase its sales. Accordingly, ABC expects to provide Customer 2 with a price
concession and estimates that it is probable that ABC will collect only half of the note.
ABC constrains its estimate of the variable consideration and determines an adjusted
transaction price of P50,373 (ie, P20,000 down payment+ P30,373 PV of the note). The
discount rate is 12%.
Analysis:
Step 1: Contracts 1 and 2 meet the criteria, while the Contract 3 does not.
Step 2: All the contracts are satisfied at a point in time.
Step 3: The transaction price is determined as follows:
Customer 1 P80,747 (P20K down payment + P60,747 PV of note)
Customer 2 P50,373 (P20K down payment + P30,373 adjusted PV of note)
Customer 3 P80,747 (P20K down payment +P60,747 PV of note)
Step 4: The transaction price in each contract is allocated to the performance obligation
to transfer the license.
Step 5: Revenue recognition:
- Contracts 1 & 2: Revenue equal to the transaction price is recognized on Jan. 1,
20x1 when the license is transferred to the customer.
- Contract 3: No revenue is recognized. The down payment (and any subsequent
collection from the note) is recognized as a liability and recognized as revenue only when
either of the following has occurred:
c. ABC has no remaining obligation to transfer the license to the customer and all,
or substantially all, of the consideration has been received and is non-refundable; or
d. The contract has been terminated and the consideration received is non-
refundable.
ABC Co. continues to assess Contract 3 to determine if the criteria are subsequently met.
If the criteria are met, ABC Co. accounts for the contract prospectively. For example, if
the collectability subsequently becomes probable, ABC Co. derecognizes the contract
liability and recognizes revenue.
ABC Co. need not reassess the criteria for Contracts 1 and 2 unless there is an
indication of a significant change in facts and circumstances, e.g., when the customer's
ability to pay subsequently deteriorates significantly. (See previous example in 'Step 1.)
Commentary on old accounting

The accounting for Contract 3 above differs from the old accounting treatments under
PAS 18 (superseded by PFRS 15) and FAS No. 45 (US GAAP). These are summarized
below:
PFRS 15 allows the recognition of revenue equal to the costs incurred which the entity
expects to recover (i.e., the 'zero-profit' method discussed in the previous chapter).
However, this differs from the "cost recovery method" under the old U.S. GAAP as follows:
Repossessed franchises
A franchisor may recover franchise rights through repossession if a franchisee
decides not to pursue the franchise agreement. Such an event is accounted for
prospectively as contract cancellation.
Illustration:
A franchisor grants a franchisee the right to operate a restaurant over a 10-year
period using the franchisor's trademark and proprietary processes in exchange for a
P100,000 upfront fee and 10% sales-based royalty. The only performance obligation in
the contract is the promise to grant the license, and this is satisfied over time.
Case 1: Termination before commencement

The contract gives the franchisee 180 days from the signing of the contract to
commence operations. Failure to do so would result to the termination of the contract.
Upon termination, the franchisor refunds 20% of the upfront fee.
The franchisee fails to commence operations within the time frame and thus the
franchisor terminates the contract.
Case 2: Termination after commencement

The franchisor reserves its right to terminate the contract after the restaurant's
commencement of operations for any of the following reasons: abandonment, insolvency,
foreclosure, criminal conviction, failure to make payments, misuse of trademark,
unauthorized disclosure of secret processes, repeated noncompliance with franchise
policies, and unauthorized transfer of the license. Upon such termination, none of the
upfront is refundable and the franchisor reserves its legal right to collect any amount due
from royalty earned and for any legal damages.
At the beginning of Year 3, the franchisee violates one of the covenants above and
thus the franchisor terminates the contract.
Notes:
- The royalties are ignored to simplify the illustration.
- On contract termination, the franchisor may need to test any receivable
recognized on the sales-based royalty for impairment.
- The PFRSs are not clear whether the P80,000 balance of contract liability is
recognized as "revenue" or as "gain." decided to use "revenue" as this parallels the old
accounting treatment under US GAAP FAS No. 45. In 'Case 1' above. "gain" would be more
appropriate because the contract is terminated before the franchisee is able to use and
obtain the economic benefits from the license.
Consignment Sales &
Installment Sales Method.
Group 5 - BSA 3B
Topic Overview.
01 - Consignment 02 - Principal vs. 03 - Installment Sales

Arrangement Agent Considerations Method
04 - Accounting 05 - Additional
06 - Repossession
Procedures Illustrations
07 - Trade Ins 08 - Allocation of 09 - Cost Recovery

COGS Method
01 Consignment
Arrangements
Reporter: Hernandez, Flowny
An entity applies PFRS 15 Revenue from Contracts with
Customers to account for revenues from contracts with
customers. PFRS 15 supersedes PAS 18 Revenue.
Under a consignment arrangement, an entity, called the
“consignor”, delivers goods to another party, “consignee”, who
undertakes to sell the goods to end customers on behalf of the
consignor.
The consignor recognizes revenue only when the consignee
sells the consigned goods to end customers because it is only at
this point that the consignor relinquishes control over the goods.
Accordingly, the consigned goods remain in the consignor’s
inventory until they are sold to end customers. The Consignee
records the consigned goods only through memo entries.
Freight and other incidental costs that the consignor incurs in
transferring the consigned goods to the consignee (e.g, transportation and
insurance) are capitalized as cost of the consigned goods. Repair costs for
damages during shipment and storage and other maintenance costs are
charged as expenses. If the consignee shoulders the freight and other
incidental costs, the consignee treats the costs as receivable costs are
reimbursable; if not, the consignee recognizes them as expense.
In a typical consignment, the consignee is entitled to a commission

based on the consignor’s sales price. In order arrangements, the consignee
purchases the goods from the consignor simultaneously with the sale to the
end customer. In the latter case, the consignee earns income by making a
mark-up on the final selling price. In some other arrangements, the
consignee earns both a commission and a mark-up.
Commission is recognized as expense by the consignor and as income by
the consignee.
Normally, the consignee deducts its commission from the amount remitted
to the consignor. In cases where the commission is paid in advance to the
consignee, the consignor records the advance commission as receivable and
not cost of inventory. When the related goods are sold to the end customer, the
consignor derecognizes the receivable and recognizes commission expense.
When the consigned goods are sold to end customers,
● The consignor recognizes revenue at the gross amount of consideration, i.e,

the sale price agreed with the consignee.
● The consignee recognizes revenue at the commission or fee to which it is
entitled.
Illustration: Revenue recognition from consignment sales
ABC Co. consigns goods costing P220,000 and with a total sales price of P390,000
to XYZ, Inc. XYZ will be entitled to a 20% commission based on its sales.
ABC Co. - Consignor XYZ, Inc. - Consignee

Memo entry Memo entry
XYZ, Inc. sells No entry Cash 100,000

consigned goods Commission income 20,000
costing P55,000 for (100,000 x 20%)
P100,000. ABC Co. is not Payable to ABC Co. 80,000
notified of the sale
No entry is made because ABC Co. was not notified of the sale. In case ABC Co. is notified,
ABC would recognize revenue on this date as follows:
Receivable from XYZ 80,000
Commission expense 20,000
Revenue 100,000
In practice, it is uncommon that the consignor is notified of each sale as those sales
occur. More commonly, the consignor receives notice of the consignee's sales on
scheduled dates, such as weekly, monthly or quarterly, depending on the arrangement.
XYZ, Inc. makes the weekly remittance of sale proceeds, net of commission, to ABC Co.
Cash 80,000 Payable to ABC Co. 80,000
Commission expense 20,000 Cash 80,000
Revenue 100,000
Cost of goods sold 55,000
Inventory 55,000
02 Principal vs. Agent
Considerations
PFRS 15 provides the following additional guidance in accounting for consignment
arrangements:
When another party is involved in providing goods or services to a customer, the
entity shall determine whether it is acting as a principal or an agent.
The entity is a principal if it controls the good or service before the good or service
is transferred to the customer. However, the entity is not necessarily a principal if it
obtains the legal title of a product only momentarily before legal title is transferred to
the customer.
The entity is an agent if its performance obligation is to arrange the provision of
goods or services by another party. When the performance obligation is satisfied, the
agent recognizes revenue at the commission or fee to which it is entitled.
The following are indicators that an entity is an agent (and therefore
does not control the good or service before it is provided to a customer):
a. Another party is primarily responsible for fulfilling the contract;
b. The entity does not have inventory risk before or after the goods
have been ordered by a customer, during shipping or on return;
c. The entity does not have discretion in establishing prices for the
other party's goods or services and, therefore, the benefit that the entity
can receive from those goods or services is limited;
d. The entity's consideration is in the form of a commission; and
e. The entity is not exposed to credit risk for the amount receivable
from a customer in exchange for the other party's goods or services.
Illustration 1:
Analysis: (Based on IFRS 15.1E231 to IE233)
Chopee is an agent because it
does not control the goods or service Chopee Co. operates a website that
before it is provided to the customer enables customers to purchase goods
(i.e., indicators 'a' to 'e' above are from a range of suppliers who deliver the
goods directly to the customers. When a
present). Chopee's performance
good is purchased via the website,
obligation is to arrange the transfer
Chopee is entitled to a 10% commission
of goods from the supplier to the based on the sales price. Chopee's
customer. When this performance website facilitates payment between the
obligation is satisfied, Chopee supplier and the customer at the price
recognizes revenue equal to the set by the supplier. Chopee has no
agreed commission. further obligation to the customer after
arranging a sale.
Illustration 2: X Co. installs CCTV (closed circuit television) for customers. X
Co. does not maintain inventory of CCTVs. Instead, when a customer contracts
X Co., X Co. purchases the CCTV from a supplier and installs it at the customer's
premises. X Co. chooses the supplier; however, the CCTV purchased must meet
the customer's specifications, otherwise the customer can reject it. X Co.
negotiates the contract price with the customer.
Therefore, X Co.'s profit is based on the difference between the contract

price and the purchase price of the CCTV less the labor and other materials
and overheads relating to the installation. Half of the contract price is due upon
signing of contract and the balance is due after installation is complete. In case
of factory defects, the customer can seek remedy from the supplier under the
supplier's warranty. However, X Co. is responsible for any faults relating to the
configuration and installation of the CCTV.
Analysis:
X Co. is a principal because it controls the CCTV before it is provided
to the customer. This is evidenced by the following:
a. X Co. is primarily responsible for fulfilling the contract because,
although the CCTV is purchased from a supplier, X Co. is ultimately
responsible for ensuring that the CCTV functions in accordance with the
customer's specifications.
b. X Co. has inventory risk because of its responsibility in correcting
errors in specifications.
c. X Co. has discretion in establishing the selling price with the
customer.
d. X Co.'s consideration is not in the form of a commission.
e. X Co. has credit risk for the amount receivable from the customer.
When the performance obligation is satisfied, X Co. recognizes revenue
at the gross amount of the contract price negotiated with the customer.
● A consignor recognizes revenue only when the
consigned goods are sold to end customers.
The revenue recognized is the gross amount of
the sale price agreed with the consignee.
Summary
● Consigned goods are included in the
consignor's inventory.
● Freight and other incidental costs of
transferring consigned goods to the consignee
form part of the cost of the consigned goods.
03 Installment
Sales Method
Reporter: Busaing, Ma. Christina
Applicability Brief History
The "installment sales method" has
The "installment sales method" is a
originated from the traditional U.S.
special case of revenue recognition
GAAP and was applied typically by
that deviates from the revenue
entities providing financing through
recognition principles of PFRS 15. This
long-term installment sales of real
method may be used for taxation
property (e.g, land) and other
purposes or when the entity is a "micro
assets with relatively high value (eg,
entity" and has opted to use the
heavy equipment) when there is
income tax basis " of accounting
uncertainty in the collectability of
the consideration.
04 Accounting
Procedures
Under the "installment sales method," the gross profit from
an installment sale is initially deferred and subsequently
realized on a piecemeal basis as the installment
payments are received using the formula below:
Realized gross profit = Collection on sale x Gross profit

rate
*Gross profit rate based on sales Gross profit + Sales*

Illustration 1: Journal entries
ABC Co. uses the "installment sales method." On Jan. 1, 20x1, ABC Co.
sold a bulldozer costing P600,000 for P1,000,000 payable as follows: 20%
down payment and balance due in 4 equal annual installments every
Dec. 31.
Journal Entries:
Jan. 1, 20x1 Cash 200,000
Installment Accounts Receivable 800,000
Sales 1,000,000
Jan. 1, 20x1 Cost of Sales 600,000
Inventory 600,000
Dec. 31, 20x1 Cash (800k / 4) 200,000
Installment Accounts Receivable 200,000
The realized gross profit in 20x1 is computed as follows:
Down Payment - Jan. 1, 20x1 200,000
1st Installment - Dec. 31, 20x1 200,000
Total Collections - 20x1 400,000
Multiply by: Gross profit rate based on sales [(1M - 600k) /1m] 40%
Realized Gross Profit - 20x1 160,000
The adjusting entry to record the deferred gross profit is as follows:
Dec. 31, 20x1 Income Summary 240,000

Deferred Gross Profit 240,000
Sales 1,000,000
Cost of Sales (600,000)
Deferred Gross Profit - beg. 400,000
Less: Realized Gross Profit (160,000)
Deferred Gross Profit - end 240,000
ABC’s Dec. 31, 20x1 financial statements will report the following:
Income Statement Balance Sheet
Installment Sales 1,000,000 ASSETS

Cost of Sales (600,000) Installment Accounts Receivable 600,000
Gross Profit 400,000
Less: Deferred Gross Profit (240,000) Liabilities
Realized Gross Profit 160,000 Deferred Gross Profit 240,000
*The deferred gross profit, being an unearned income, is classified in the balance sheet as liability.
➢ The gross profit rate based on sales can also be computed using the formula below:
Gross Profit Rate = Deferred Gross Profit/Installment Account Receivable
Gross Profit Rate = 240,000/600,000
Gross Profit Rate = 40%
Illustration 2: Two Periods
ABC Co. uses the “installment sales method”. Information on ABC’s transactions during
20x1 and 20x2 is shown below
20x1 20x2
Installment Sales 1,000,000 1,200,000
Cost of Sales 600,000 600,000
Gross Profit 400,000 540,000
Cash Collections from:
20x1 Sales 400,00 200,000
20x2 Sales 480,000
Requirement: Compute for the total realized gross profit in 20x2

Solution:
Prices and costs change over time, so an empty may have different gross profit rates
each year. When computing for the realized gross profit, the original gross profit rate
in a particular year of sale is applied to the subsequent collections.
The gross profit rates based on sales are computed as follows:
20x1 20x2
Gross Profit 400,000 540,000
Installment Sales 1,000,000 1,200,000
Gross Profit Rates based on sales 40% 45%
The realized gross profit based on sales are computed as follows:

Collections in 20x2 from:
20x1 sales: (200,000 * 40%) 80,000
20x2 sales: (480,000 * 45%) 216,000
Total realized gross profit in 20x2 296,000
Additional
05 Illustrations
Reporter: Galam, Marlyn
Most board exam problems on installment sales method are designed to test the
examinee’s skills in using formulas and their variations and in reconstructing
missing information. Use the illustrations below to develop those skills.
Illustration 1: Computation of gross profit rate

ABC Co. uses the “installment sales method.” On January 1, 20x3, ABC Co.’s
records the following balances:
Installment receivable - 20x1 320,000
Deferred gross profit - 20x1 70,400
Deferred gross profit - 20x2 230,400
On December 31, 20x3, ABC Co.’s records show the following:
Installment receivable - 20x1 -
Installment receivable - 20x3 1,200,000
Deferred gross profit - 20x1 (before adjustment) 70,400
Installment sales in 20x3 were made at 33 ⅓ % above cost.
Requirements:
a. Compute for the installment sale in 20x3.
b. Compute for the cash collections in 20x3.
c. Compute for the total realized gross profit in 20x3.
Solutions:
Requirement (a): Installment sale in 20x3
Basic formula: GPR based on sales = Gross Profit
Sales
Variation: Sales = Gross Profit

GPR based on sales

Divide by: Gross profit rate based on sales (1) 25%
Installment sale in 20x3 3,000,000
(1) 33 ⅓ % GPR based on cost / (100% cost + 33 ⅓ % GPR on cost) = 25%

GPR based on sales
Alternative solution 1: 750K x (33 ⅓ % / 133 ⅓ %) = 3,000,000
Alternative solution 2: 750K / (133 ⅓ % / 33 ⅓ %) = 3,000,000
Requirement (b): Cash Collections
Installment receivable - 20x1, Jan. 1, 20x3 320,000

Less: Installment receivable - 20x1, Dec. 31, 20x3 -
Cash Collection in 20x3 320,000
Installment receivable - 20x2, Jan. 1, 20x3 960,000
Less: Installment receivable - 20x2, Dec. 31, 20x3 (384,000)
Cash Collection in 20x3 576,000
Sale in 20x3 (see previous solution) 3,000,000
Less: Installment receivable - 20x1, Dec. 31, 20x3 (1,200,000)
Cash collection in 20x3 1,800,000
Total collections in 20x3 2,696,000
Alternatively, the cash collections may be squeezed using T-accounts:
Installment receivable - 20x1

1/1/x3 320,000
320,000 Collections
- 12/31/x3
1/1/x3
Sales 3,000,000 1,800,000 Collections
1,200,000 12/31/x3
1/1/x3 960,000
576,000 Collections
384,000 12/31/x3
Requirement (c): Total realized gross profit
Formula: Gross profit rate = Deferred gross profit

Installment account receivable
20x1 20x2
Deferred gross profit - 1/1/x3 70,400 230,400
Divide by: Installment receivable - 1/1/x3 320,000 960,000
Gross profit rate based on sales 22% 24%
The gross profit rate based on sales in 20x3 is 25% (see previous solution).
20x1 sales: (320,000 x 22%) 70,400
20x2 sales: (576,000 x 24%) 138,240
20x3 sales: (1.8M x 25%) or [1.8M x (33 ⅓ % / 133 ⅓ %)] 450,000
Illustration 2: Realized gross profit
On Dec. 31, 20x3, ABC Co.’s records show the following:
Deferred gross profit (before year-end adjustments) 1,050,800

Installment receivable - 20x3 1,200,000
Gross profit rate in 20x2 is 24% based on sales, while gross profit
rate in 20x3 is 33 ⅓ % based on cost.
Requirement: Compute for the realized gross profit in 20x3.

Solution:
Variation: Installment account receivable x Gross profit rate = DGP
Formula: DGP, beg. - Realized gross profit = DGP, end.

Variation: DGP, beg. - DGP, end. = Realized gross profit
DGP (before year-end adjustments) 1,050,800

Less: DGP (after year-end adjustments):
Installment receivable, 20x2 x GPR (384K x 24%) 92,160
Installment receivable, 20x3 x GPR
[1.2M x (33 ⅓ % / 133 ⅓ %) or (1.2M x 25%) 300,000 392,160
Decrease in DGP - Realized gross profit in 20x3 658,640
Illustration 3: reconstruction of information
ABC Co. has the following information:
20x1 20x2
Installment sales ? ?
Cost of sales 1,560,000 1,824,000
Installment receivable - 20x1 800,000 320,000
Gross profit rates based on sales 22% 24%
Requirement: Compute for the total realized gross profit in 20x2.

Solution:
Installment receivable - 20x1 Installment receivable - 20x2

1/1/x2 800,000
480,000 Collections Sales 2,400,000 1,440,000 Collections
320,000 12/31/x2 960,000 12/31/x2
*(1,824,000 COS in 20x2 / 76% cost ratio) = 2,400,000 sales in 20x2

76% cost ratio = 100% less 24% gross profit rate

20x1 sales: (480,00 x 22%) 105,600
20x2 sales: (1,440,000 x 24%) 345,600
Illustration 4: Reconstruction of information
ABC Co.’s records show the following information:
20x1 20x2
Deferred gross profit (adjusted ending balances):
From 20x1 sale 176,000 70,400
From 20x2 sale 230,400
Gross profit rates based on sales 22% 24%
Cash collections form:
20x1 sales 1,200,000 480,000
20x2 sales 1,440,000

a. Balances of installment receivables on December 31, 20x2.
b. Installment sales in 20x1 and 20x2.
Solutions:
Variation: Installment accounts receivable = DGP / Gross profit rate
Deferred gross profit - 20x1 sale, Dec. 31, 20x2 70,400

Divide by: Gross profit rate in 20x1 22%
Installment receivable - 20x1, Dec. 31, 20x2 - Requirement (a) 320,000
Add back: Collections (1,200,000 in 20x1 + 480,000 in 20x2) 1,680,000
Installment sale - 20x1 - Requirement (b) 2,000,000
Deferred gross profit - 20x2 sale, Dec. 31, 20x2 230,400

Divide by: Gross profit rate in 20x2 24%
Installment receivable - 20x1, Dec. 31, 20x2 - Requirement (a) 960,000
Add back: Collections from 20x2 sales 1,440,000
Installment sale - 20x2 - Requirement (b) 2,400,000
Illustration 5: Deferred gross profit
ABC Co.’s records show the following:
20x1 20x2
Installment sales 2,000,000 2,400,000
Cost of sales 1,560,000 1,824,000
Cash collections from:
20x1 sales 1,200,000 480,000
20x2 sales 1,440,000
Requirement: Compute for the total deferred gross profit on Dec. 31, 20x2.
Solution:
Variation: Installment account receivable x Gross profit rate = DGP
Gross profit rate in 20x1: [(2M - 1.56M) / 2M] 22%

Gross profit rate in 20x2: [(2.4M - 1.824M) / 2.4M] 24%
Installment sale - 20x1 2,000,000
Cash collections (1,200,000 + 480,000) (1,680,000)
Installment receivable - 20x1, Dec. 31, 20x2 320,000
Multiply by: Gross profit rate in 20x1 22%
Deferred gross profit - 20x1, Dec. 31, 20x2 70,400
Installment sale - 20x2 2,400,000

Cash collections (1,440,000)
Installment receivable - 20x2, Dec. 31, 20x2 960,000
Multiply by: Gross profit rate in 20x2 24%
Deferred gross profit - 20x2, Dec. 31, 20x2 230,400
Total deferred gross profit - Dec. 31, 20x2 300,800
Illustration 6: Cash collection
ABC Co. has the following collection policy on its installment
sales:
● 20% down payment
● Balance due as follows: 50% in the year of sale, 30% in the
second year, and 20% in the third year.
● Installment sales during 20x1, 20x2, and 20x3 were ₱2,000,000,
₱2,400,000, and ₱3,000,000, respectively.
● Gross profit rates based on sales in 20x1, 20x2, and 20x3 were
22%, 24%, and 25%, respectively.
Requirement: Compute for the total realized gross profits in

each of years 20x1, 20x2, and 20x3.
Solution:
20x1 20x2 20x3

20x1 sale:
Down payment (2M x 20%) x 22% 88,000
20x1: [(2M x 80%*) x 50%] x 22% 176,000
20x2: [(2M x 80%) x 30%] x 22% 105,600
20x3: [(2M x 80%) x 20%] x 22% 70,400
20x2 sale:
Down payment (2.4M x 20%) x 24% 115,200
20x2: [(2.4M x 80%) x 50%] x 24% 230,400
20x3: [2.4M x 80%*) x 30%] x 24% 138,240
20x3 sale:
Down payment (3M x 20%) x 25% 150,000
20x3: [(3M x 80%) x 50%] x 25% 300,000
Realized gross profits 264,000 451,200 658,640
*100% less 20% down payment = 80% balance

Illustration 7: Reconstruction of information
ABC Co.’s incomplete records show the following:
20x1 20x2 20x3
Installment sales 2,000,000 2,400,000 ?
Cost of sales ? ? 2,250,000
Gross profit ? ? ?
Gross profit rates ? ? 25%
Collections:
From 20x1 sales 1,200,000 480,000 320,000
From 20x2 sales 1,440,000 576,000
From 20x3 sales 1,800,000
Realized gross profit 264,000 ? 658,640
Requirement: Compute for the cost of sales in 20x2.
Solution:
Realized gross profit - 20x1 264,000

Divide by: Collections in 20x1 1,200,000
Gross profit rate - 20x1 22%

Realized gross profit in 20x3 from 20x1 sales (320K x 22%) (70,400)
Realized gross profit in 20x3 from 20x3 sales (1.8M x 25%) (450,000)
Realized gross profit in 20x3 from 20x2 sales 138,240
Realized gross profit in 20x3 from 20x2 sales 138,240
Divide by: Collections in 20x3 from 20x2 sales 576,000
Gross profit rate - 20x2 24%
Installment sales - 20x2 2,400,000

Multiply by: Cost ratio in 20x2 (100% - 24%) 76%
Cost of sales - 20x2 1,824,000
● Observe that the previous problems all revolve around two

formulas below (and their variations)
Realized gross profit = Collection on sale x Gross profit rate
Gross profit rate = Deferred gross profit

Stated by the Author of the book:
● Please memorize the formulas and practice applying them. I am presupposing you
are already well acquainted with the gross profit rate computations and the use of
the receivable T-account.
● Also, if you analyze Illustrations 1 to 7 more closely, you will find out that these are
actually just variations to one and the same problem. I have designed it this way so
that you will realize that accounting problems all revolve around the same basic
concepts regardless of how differently they were structured. This is me teaching you
how to fish, because I don’t have a fish to give.
● Before moving one, I would like to suggest that you go back to the previous
illustrations, cover the suggested solutions, re-solve the problems independently,
and then check if you got the correct answer. Also, try figuring out how the other
missing information in Illustration 7 can be solved here is your guide:
20x1 20x2 20x3
Installment sales 2,000,000 2,400,000 3,000,000
Cost of sales 1,560,000 1,824,000 2,250,000
Gross profit 440,000 576,000 750,000
Gross profit rates 22% 24% 25%
Collections:
From 20x1 sales 1,200,000 480,000 320,000
From 20x2 sales 1,440,000 576,000
From 20x3 sales 1,800,000
Realized gross profit 264,000 451,200 658,640
Solutions:
Installment Sales - 20x1 2,000,000

Multiply by: Cost ratio in 20x1 (100% - 22%) 78%
Cost of sales of 20x1 1,560,000

Less: Cost of sales of 20x1 1,560,000
Gross Profit - 20x1 440,000

Collection from 20x1 (480,000 x 22%) 105,600
Collection from 20x2 (1,440,000 x 24%) 345,600
Realized gross profit - 20x2 451,200
Cost of sales - 20x3 2,250,000

Divide by: Cost ratio in 20x3 (100% - 25%) 75%

06 Repossession
Reporter: Lazatin, Rose Ann
The seller may repossess the goods sold in case of default by the buyer. On repossession
date:
a.The repossessed goods are debited to an inventory account at"fair value." For
purposes of applying the installment sales method, "fair value" is either:
i. the appraised value of the repossessed good;
ii. or the estimated resale price of the repossessed good less reconditioning costs
and normal profit margin.
b. The carrying amounts of the related installment receivable and deferred gross
profit are derecognized.
c.The difference between (a) and (b) is recognized as gain or loss on repossession.
Pro-forma entry:
Date Date Inventory (at "fair value"') xx

Deferred gross profit (at carrying amount) xx
Loss on repossession (debit balancing figure) xx
xx
Installment receivable (at carrying amount)
xx
Gain on repossession (credit balancing figure)
Illustration 1: Repossession - Appraised value
ABC Co. repossessed a good that was previously sold to a defaulting buyer.
Relevant information follows:
● Appraised value of the repossessed good -P6,000.
● Balance of installment receivable -P10,000.
● Gross profit rate on the sale - 30%.
Requirement: Compute for the gain or loss on repossession.

Solution:
Date Inventory 6,000
Deferred gross profit (10k x30%) 3,000
Loss on repossession (squeeze) 1,000
10,000
Illustration 2: Repossession - Estimated resale price
Information on ABC Co.'s installment sales is as follows: During 20x2, ABC Co. repossessed
a property that was sold in 20x1
20x1 20x2 for P20,000. Prior to repossession,
Sales 200,000 320,000
P5,000 were collected from the
Cost of sales 160.000 224,000
buyer. The repossessed property
Gross profit rate 20% 30%
is expected to be resold for
Installment receivable - 20x1 90.000 30.000 P17,000 after reconditioning costs
Installment receivable - 20x2 144,000 of P3,000. The normal profit
margin is 30%.
Requirements:
a. Compute for the gain or loss on repossession.
b. Compute for the total realized gross profit in 20x2.
c. Compute for the profit recognized in 20x2.
Solution:
Requirement (a):
Date Inventory (a) 8,900

Deferred gross profit (15k x20%( b)) 3,000
15,000
Installment receivable (20k - 5k)
(a) Estimated resale price 17,000

Reconditioning costs (3,000)
Normal profit margin (17,000 resale price × 30%) (5,100)
"Fair value" of repossessed property 8,900
(b) The gross profit rate in the year the repossessed good was
originally sold is used in computing for the related deferred gross
profit.
Requirements (b) and (c):
The collections in 20x2 are computed as follows:
Installment receivable - 20x1 Installment receivable - 20x2

Beg. 90,000 15,000 Write-off Beg. - - Write-off
45,000 Collections Sale 320,000 176,000 Collections
30,000 End. 144,000 End.
Realized gross profit from:

- 20x1 sale (45K x 20%) 9.000
-20x2 sale (176K x 30%) 52,800
Total realized gross profit in 20x2 - Requirement (b) 61.800
Loss on repossession (3,100)
Profit in 20x2 - Requirement (c) 58,700
Illustration 3: Repossession - Fair value after reconditioning costs
Information on a repossessed good from a defaulting buyer is as
follows:
● The appraised value (fair value) is P6,000 after reconditioning
costs of P500.
● The balance of the installment receivable is P10,000. The gross
profit rate on the sale is 30%.
Requirement: Compute for the following:

a. Gain or loss on repossession.
b. New cost basis of the repossessed inventory.
Solution:
Requirement (a):
Date Date Inventory (excluding reconditioning costs) 5.500
(a)
Deferred gross profit (10k x 30%) 3,000
10,000
On repossession date, the inventory account is debited at the appraised value

of the repossessed good in its present condition without the further
reconditioning (i.e., 6,000 - 500 = 5,500). The reconditioning costs are
subsequently capitalized when incurred as follows:
Date Inventory 500
Cash 500
Requirement (b):
The new cost basis of the repossessed inventory is P6,000 (i.e., the sum of
the debits to the inventory account.)
Illustration 4: Profit on resale of repossessed inventory
ABC Co. uses the "installment sales method." ABC Co. sold
inventory costing P30,000 to a customer for P40,000. After
paying P28,000, the customer defaulted and ABC Co.
repossessed the good. Upon repossession, the good was
appraised at P10,000. ABC Co. subsequently spent P2,000 in
reconditioning the good before selling it to another
customer for P15,000. The second buyer made total
payments of P6,000.

a.Gain or loss on repossession.
b. Realized gross profit from the resale.
Solution:
Requirement (a):
Date Inventory (appraised value) 10,000
Deferred gross profit (12k x 25%*) 3,000
Installment receivable (40k - 28k) 12,000
1,000
Gain on repossession (squeeze)
* (40K - 30K) + 40K] - 25% GPR
Requirement (b) :
Resale price 15,000
Cost of sale (10k appraised value + 2k reconditioning costs) (12,000)
Gross profit 3,000
Gross profit rate 20%
Collections from the resale 6,000

Multiply by: Gross profit rate 20%
Realized gross profit from the resale 1,200
Illustration 5: Repossession - installments with interest
ABC Co. uses the installment sales method. On Jan. 1, 20x1, ABC Co. sold inventory
costing P180,000 for P240,000 payable as follows: down payment of P48,000 and
twelve monthly payments of P16,525 due at the beginning of each succeeding
month. The installments include interest of ½ of 1% per month. After making three
succeeding monthly payments, the customer defaulted and ABC Co.
repossessed the inventory. The fair value of the repossessed inventory is
P180,000.

a. Realized gross profit from the sale.
b.Gain or loss on repossession.
Solutions:
Requirement (a): Realized gross profit from the sale
Date Collections Interest Income Principal Balance

1/1/20x1 240,000
1/1/20x1 48.000 - 48.000 192,000
2/1/20x1 16,525 960 15,565 176,435
3/1/20x1 16,525 882 15,643 160,792
4/1/20x1 16,525 804 15.721 145,071
Collections pertaining to principal 94,929
Collections pertaining to principal 94,929

Multiply by: Gross profit rate ((240,000 - 180,000) + 240,0001)) 25%
Realized gross profit 23.732
Requirement (b): Gain or loss on repossession
Date Inventory (appraised value) 180.000

Deferred gross profit (145,071 x 25%) 36,268
Installment receivable
(see amort. table) 145,071
Gain on repossession (squeeze) 71,197
Illustration 6: Repossession - Error
ABC Co. uses the installment sales method. After its first year of operations, ABC had the
following balances:
Installment sales 37,500
Purchases 25.000
Inventory - new merchandise, Dec. 31, 20x1 2,500
Loss on repossession 4,500
Installment receivable, Dec. 31, 20x1 20.000
During the year, ABC Co. repossessed an inventory sold to a defaulting buyer. The inventory
had an appraised value of P1,500. However, this was not recorded. Instead, the
janitor/bookkeeper of ABC Co. erroneously accounted for the repossession as a debit to "Loss
on repossession" and a credit to "Installment receivable" for the unpaid balance. This came to
light when the security guard made an audit. The janitor and the guard were classmates in
college when they took up BS Accountancy. Sadly, they did not graduate because they only
studied half-heartedly and failed in
Advanced Accounting 1.0
Requirement: Compute for the correct amount of gain or loss on repossession.

Solution:
Date Inventory 1,500

Deferred gross profit (4,500 × 40% (b)) 1,800
Installment receivable (a) 4,500
(a) The balance of the installment receivable is equal to the

unadjusted loss on repossession of P4,500. This is because the
janitor recorded the repossession as a debit to "Loss on
repossession" equal to the balance of the receivable.
(b) Installment sales 37,500
Cost of goods sold:
Inventory, beg. (first your of openations) 0
Purchases 25,000
Repossessed inventory 1,500
Total goods available for sale 26,500
Inventory, end. (new & repossessed) (2,500 + 1,500) (4,000) (22,500)
Gross profit 15,000
Gross profit rate (15,000 + 37,500) 40%
07 Trade Ins
Reporter: Dela Costa, Lorraine Jane
A seller may accept from a buyer a trade-in of old merchandise
as part payment for the sale of new merchandise. Trade-ins under
the "installment sales method" are accounted for as follows:
a. The traded-in merchandise is debited to inventory at "fair
value." For purposes of applying the installment sales method,
"fair value is either:
i. the appraised value of the traded-in merchandise; or
ii. the estimated resale price of the traded-in
merchandise less reconditioning costs and normal profit
margin.
b. The seller gives the buyer a trade-in value for the old merchandise.
The trade-in value is the amount that is treated as part payment of the
new merchandise being sold. There is no accounting problem if the
trade-in value is equal to the fair value in (a) above. If this is not the
case, the seller recognizes either an over allowance or an under
allowance for the difference.
● If the trade-in value is greater than the fair value, the difference is
debited to an "Over allowance" account. The over allowance is
deducted from the sale price when computing for the gross profit
rate.
● If the trade-in value is less than the fair value, the difference is
credited to an "Under allowance" account. The under allowance is
added to the sale price when computing for the gross profit rate.
Pro-forma entry
Date Inventory xx
Over allowance xx
Installment receivable (balancing figure) xx
Installment sale xx
Under allowance xx
Illustration 1: Trade-in value equal to Fair value
ABC Co. uses the “installment sales method.” ABC sells
new merchandise costing ₱12,000 to a customer for ₱20,000.
ABC accepts old merchandise as trade-in. The old
merchandise fair value is ₱5,000.
ABC Co. grants the customer a trade-in value of ₱5,000
for the old merchandise. Subsequent collections during the
year amount to ₱7,000.
Requirement: Compute for the realized gross profit in the year

of sale.
Solution:
Date Inventory - traded-in 5,000

Installment receivable (squeezed) 15,000
Installment sale 20,000
FV of old merchandise traded-in 5,000

Collections 7,000
Total 12,000
Multiply by: Gross profit rate [(20k - 12k) + 20k)] 40%
Realized gross profit in year of sale 4,800
Illustration 2: Trade-in (Over Allowance)
ABC Co. uses the “installment sales method.” ABC sells new
merchandise costing ₱12,000 to a customer for ₱20,000. ABC accepts old
merchandise as trade-in. The old merchandise fair value is ₱5,000.
To induce sale, ABC Co. grants the customer a trade-in value of
₱7,000 for the old merchandise. Subsequent collections during the year
amount to ₱7,000
Requirement: compute for the realized gross profit in the year of sale.
Solution:
Over allowance (7k - 5k) 2,000
Installment receivable 13,000
Collections 7,000
Total 12,000
Multiply by: Gross profit rate 33.33%
Realized gross profit in year of sale 4,000
Gross profit rate computation:

Over allowance (2,000)
Adjusted installment sales 18,000
Cost of sale (12,000)
Adjusted gross profit 6,000
Adjusted gross profit rate (6k/18k) 33.33%
Illustration 3: Trade-in (Under Allowance)
ABC Co. uses the “installment sales method.” ABC
sells new merchandise costing ₱12,000 to a customer
for ₱20,000. ABC accepts old merchandise as trade-in.
The old merchandise fair value is ₱5,000.
To induce sale, ABC Co. grants the customer a
trade-in value of ₱2,500 for the old merchandise.
Subsequent collections during the year amount to
₱7,000.
Requirement: Compute for the realized gross profit in

the year of sale.
Solution:
Installment receivable (squeeze) 17,500
Under allowance 2,500
Gross profit rate computation:

Collections 7,000 Installment sales 20,000
Total 12,000 Under allowance 2,500
Multiply by: Gross profit rate 46.67% Adjusted installment sales 22,500
Realized gross profit in year of Cost of sale (12,000)
sale 5,600
Adjusted gross profit 10,500
Adjusted gross profit rate
(10.5k/22.5k) 46.67%
Allocation of
08 Cost of goods
sold
A seller that makes both “regular” and “installment” sales may need to allocate the
cost of goods sold between the two sales.
Illustration 1: Relative cash price equivalents

ABC Co. recognizes revenue from its regular sales at the point of sale and uses
the “installment sales method” for its installment sales. Information at year-end is
as follows:
Regular sales 1,000,000
Installment sales 2,400,000
Cost of goods sold 1,200,000
The installment price is higher than the regular price by 20%
Requirement: Compute for the allocation of the cost of goods sold.

Solution:
Cash sale fraction Allocation of
prices COGS
Regular sales 1,000,000 1/3 400,000
Installment sales
(2.4M/120%) 2,000,000 2/3 800,000
Total 3,000,000 1,200,000
Illustration 2: Consistent mark-up on regular sale
ABC Co. recognizes revenue from its regular sales at the point of sale
and uses the “installment sales method” for its installment sales. ABC’s
trial balance on Dec. 31, 20x2 is shown below:
Debit Credit
Installment receivable - 20x1 sales 75,000
Installment receivable - 20x2 sales 1,000,000
Inventory, Jan. 1, 20x2 350,000
Purchases 2,775,000
Repossessed inventory (at appraisal 15,000
value)
Deferred gross profit - 20x1 sales, Jan. 1, 270,000
20x2
Installment sales 2,125,000
● Installment receivable - 20x1 sales, Jan. 1, 20x2 600,000
● Inventory, Dec. 31, 20x2 (new and repossessed) 475,000
● Consistent gross profit rate on regular sales 30%
● Installment receivable from 20x1 sales written-off in
20x2. The related inventory was repossessed in 20x2. 38,750

a. Total realized gross profit in 20x2 from regular and
installment sales.
b. Gain or loss on repossession.
Solutions:
Requirement (a): Total realized gross profit in 20x2
Total cost computation:
Inventory - Jan. 1, 20x2 350,000
Purchases 2,775,000
Repossession 15,000
Total goods available for sale 3,140,000
Inventory - dec. 31, 20x2 (new and repossessed) (475,000)
Cost of goods sold - regular and installment 2,665,000
COGS on regular sales are computed as follows:

Purchases multiply by: Cost ratio on regular sales 70%
Cost of goods sold - regular 1,347,000
COGS on installment sales are computed as follows:
Cost of goods sold - regular & installment 2,665,000
Cost of goods sold - regular sales (1,347,000)
Cost of goods sold - installment sales in 20x2 1,317,500
Gross profit rate are computed as follows:

Installment sales in 20x2 2,125,000
Cost of goods sold - installment sales in 20x2 (1,317,500)
Gross profit - installment sales in 20x2 807,500
Gross profit rate - installment sales in 20x2 38%
Gross profit rate on the 20x1 installment sales are computed as follows:
Deferred gross profit - 20x1 sales, Jan. 1, 20x2 270,000
Divided by : Installment receivable - 20x1 sales, Jan. 1, 20x2 600,000
Gross profit rate - installment sales in 20x1 45%
Collections in 20x2 from installment sales in 20x1 & 20x2 are
computed as follows:

1/1/x2 600,000 38,750 written-off
486,250 Collections
75,000 12/31/x2

1/1/x2 Installment 2,125,000 1,125,000 Collections
sales
1,000,000 12/31/x2
Total realized gross profit is computed as follows:
Collections from 20x2
20x1 Installment sales (486,250*45%) 218,813
20x2 Installment sales (1,125,000*38%) 427,500
20x2 Regular sales (1,925,000*30%)(given) 577,500
Total realized gross profit in 20x3 1,223,813
Requirement (b): Gain or loss on repossession

Date Inventory - repossessed 15,000
Deferred gross profit (38,750*45%) 17,438
Installment receivable 38,750
Cost Recovery
09 Method
Under the "cost recovery method"* of traditional US GAAP, no gross
profit or interest income is recognized until the total collections from the
sale exceed the cost of the inventory sold.
Illustration:
Cost recovery method ABC Co. uses the "cost recovery method." On
Jan. 1, 20x1, ABC Co. sold inventory costing P280,000 to a customer for
P500,000 payable as follows: P100,000 down payment and balance due
in 4 equal annual payments every Dec. 31.
Requirement: Compute for the realized gross profit in years 20x1

through 20x4
Solution:
20x1 20x2 20x3 20x4

Cumulative collections 200,000 300,000 400,000 500,000
COGS 280,000 280,000 280,000 280,000
Excess collection - 20,000 120,000 220,000
RGP in previous yrs. - (20,000) (120,000)
RGP in current yr. - 20,000 100,000 100,000
Variation:
What if the installments include imputed interest, can ABC
Co. recognize interest income in 20x1?
Answer:
No, under the “cost recovery method,” neither gross profit
nor interest income is recognized until the collections exceed
the cost of goods sold.
Thank You!
Presented by:
Group 5
Flowny Hernandez
Ma. Christina Busaing
Marlyn Galam
Rose Ann Lazatin
Lorraine Jane Dela Costa

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GROUP 3

Leader: John Darwin Pontigon

Summary of the Revenue Recognition Principles under PFRS 15

Construction contract - is a contract specifically negotiated for the construction of an

Satisfaction of performance obligations

Enforceable right to payment for performance completed to date:

Example 1.1: Alternative use

Example 1.4: Enforceable right to payment

Step 3: Determine the transaction price

A construction contract may be either:

The cost-plus-variable-fee, which is common in government contracts, has the following

Step 4: Allocate the transaction price to the performance obligations

Performance obligations satisfied over time

Formula #2: Variation

Case 1: Estimated total contract costs

Requirement: How much revenue is recognized in 20x1?

Percentage of completion = 1.2M / 4M

Revenue in 20x1 = Contract price x Percentage of completion

Case 2: Estimated costs to complete

Requirement: How much revenue is recognized in 20x1?

Percentage of completion - 1.2M / (1.2M + 2.8M)

Revenue in 20x1 - Contract price x Percentage of completion

Requirement: Compute for the following:

Requirement (a): Percentage of completion as of Dec. 31, 20x1

Requirement (b): Percentage of completion as of Dec. 31, 20x2

Requirement (c): Percentage of progress made in 20x2 The computed percentages

➢ The percentage completed in 20x2 is 60% (80% minus 20%).

Incremental costs of obtaining a contract

As a practical expedient, incremental costs of obtaining a contract are recognized as

Examples of costs that are directly related to a contract:

The following costs are expensed when incurred:

Adjustments to the measure of progress

Illustration 1: Revenue to the extent of cost incurred

Requirement: Compute for the percentage of completion in 20x1.

Percentage of completion = (6M-2M-200K) / 10M

Contract liability - is "an entity's obligation to transfer goods of services to a customer

A contract liability is recognized at the earlier of the date:

Receivable - is an entity's right to consideration that is unconditional. A right to

Illustration 1: Contract liability and Receivable

➢ No entry because neither party has performed its obligation.

➢ A receivable is recognized under Scenario B because ABC Co has an unconditional

➢ Under Scenario A, contract liability is credited when the advanced payment is

➢ Revenue is recognized only on Mar. 31 when the performance obligation is satisfied

Illustration 2: Contract asset

Requirement: Provide the journal entries. Ignore contract costs.

➢ Contract asset is recognized on Dec. 31 (rather than 'receivable') because ABC

More specifically, PAS 11 requires the Contract liability is recognized if the

The excess of (1) costs incurred and

Illustration: Percentage of completion

**Under the 'cost-to-cost' method, the 'cost of construction'(contract costs amortized

"Construction in progress" is an account used to accumulate contract costs

(1) equal to gross profit

12/31/x1 3,600,000 12/31/x1 -

3,540,000 3,540,000 3,540,000

12/31/x2 8,100,000 500,000 500,000

Progress Billing 900,000 12/31/x1

4,500,000 12/31/x1 4,500,000 2,700,000

2,700,000 12/31/x2 900,000

7,200,000 12/31/x2 900,000 1,800,000