02 – Revenue Recognition: Long-term Construction Contracts

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:

Step 1: Identify the contract with the customer The contract is with a customer and (among
others) the collectability of the consideration is
probable.

Step 2: Identify the performance obligations in Each promise to deliver a distinct good or
the contract service in the contract is treated as a separate
performance obligation.

A promised good or service is distinct if:

a. The customer can benefit from the good or

service either on its own or together with
other resources that are readily available to
the customer; and
 b. The promise to transfer the good or service is
separately identifiable from other promises
in the contract.

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 The transaction price is allocated to 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 satisfied over
performance obligation is satisfied 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 performance
obligation.

Revenue is measured at the amount of the

transaction price allocated to the performance
obligation satisfied.

Definition of Construction contract

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 of 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.

Performance obligations satisfied over time

In the case of construction contracts, performance obligations are generally satisfied over time. An
entity recognizes the 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

Input methods recognize revenue on the basis of efforts or inputs expended relative to the total
expected inputs needed to fully satisfy a performance obligation. Examples of efforts or inputs include:
a. Cost incurred
b. Resources consumed
c. Labor hours expended
d. Machine hours used
e. Time elapsed

Cost-to-cost

The most common application of the input method is the “cost-to-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:

Total costs incurred to date

Percentage of completion =
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:

Total costs incurred to date

Percentage of completion =
Total costs incurred to date + Estimated costs to complete
Illustration 1: Cost-to-cost
In 2021, Living Hope Construction Co. enters into contract to construct a building for a customer. The
contract price of ₱6M will be billed to the customer periodically based on Living Hope’s progress on
the construction.

Case 1: Estimated total contract costs

The estimated total contract costs are ₱4M. The actual costs incurred in 2021 are ₱1.2M.

Requirement: How much revenue is recognized in 2021?

Solution:

Step 1: Identify the contract with the customer

The contract is a construction contract, i.e., a contract specifically negotiated for the construction of an
asset.

Step 2: Identify the performance of 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 as asset with an alternative use to the entity and the
entity has an enforceable right to payment for performance completed to date.

Step 3: Determine the transaction price

The transaction price is the contract price of ₱6M.

Step 4: Allocate the transaction

The whole of the ₱6M transaction price is allocated to the single performance obligation of
construction a building.

Step 5: Recognize revenue when (or as) a performance obligation is satisfied

Because the performance obligation is satisfied over time, Living Hope shall recognize revenue over
time as it progresses towards the complete construction of the building.

Living Hope shall measure its progress by, in this case, using the ‘cost-to-cost’ method, an application
of the input method.

Revenue in 2021 is computed as follows:

Total costs incurred to date

Percentage of completion =
Estimated total contract costs

Percentage of completion = 1.2M

4M Percentage of completion = 30%

Revenue in 2021 = Contract price x Percentage of completion

Revenue in 2021 = 6M x 30%
Revenue in 2021 = ₱1,800,000
 Case 2: Estimated costs to complete
The actual costs incurred in 2021 are ₱1.2M. The estimated costs to complete as of Dec.
31, 2021 are ₱2.8M.

Requirement: How much revenue is recognized in 2021?

Solution:

Total costs incurred to date

Percentage of completion =
Total costs incurred to date + Estimated costs to complete

Percentage of completion = 1.2M (1.2M +

2.8M) Percentage of completion = 1.2M 4M
Percentage of completion = 30%

Revenue in 2021 = Contract price x Percentage of completion

Revenue in 2021 = 6M x 30%
Revenue in 2021 = ₱1,800,000

Illustration 2: Estimated costs to complete – Subsequent period

Information on an entity’s contract costs is as follows:
2021 2022
Total costs incurred to date 400,000 1,500,000
Estimated costs to complete 1,600,000 375,000

Requirement: Compute for the following:

a. Percentage of completion as of Dec. 31, 2021
b. Percentage of completion as of Dec. 31, 2022
c. Percentage completed in 2022

Solutions:

Total costs incurred to date

Percentage of completion =
Total costs incurred to date + Estimated costs to complete

Requirement (a): Percentage of completion as of Dec. 31, 2021

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, 2021 = 20%

Requirement (b): Percentage of completion as of Dec. 31, 2022

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, 2022 = 80%

Requirement (c): Percentage of progress made in 2022

The computed percentages above are the cumulative percentages of completion at the end of each year.
Meaning, the 80% completion as at Dec. 31, 2022 includes the 20% completed in 2021.
Therefore, the percentage completed in 2022 is 60% (80% minus 20%).
Efforts-expanded (labor hours-based) method

Another application of the input method is the efforts-expanded (labor hours-based) method. Under
this method, the percentage of completion is based on “efforts expanded” 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.

The percentage of completion is computed as follows:

Total labor hours to date

Percentage of completion =
Estimated total contract labor hours

OR

Total labor hours to date

Percentage of completion =
Total labor hrs. to date + Estimated labor hrs. to complete

Illustration: Efforts-expended method

Information on an entity’s labor hours on a contract is as follows:
2021 2022
Total direct labor hours to date 400 1,500
Estimated direct labor hrs. to complete 1,600 375

Requirement: Compute for the percentages of completion as of Dec. 31, 2021 and 2022.

Solution:

Total labor hours to date

Percentage of completion =
Total labor hrs. to date + Estimated labor hrs. to complete

2021
Percentage of completion = 400 (400 +
1,600) Percentage of completion = 400 2,000
Percentage of completion as at Dec. 31, 2021 = 20%

2022
Percentage of completion = 1,500 (1,500 + 375)
Percentage of completion = 1,500 1,875
Percentage of completion as at Dec. 31, 2021 =
80%

The percentage completed in 2022 is 60% (80% minus 20%).

Presentation
When either party to a contract has performed, the contract is presented in the statement of financial
position as a contract liability or a contract asset. An unconditional right to consideration is presented
separately as a receivable.
Contract liability – is “an entity’s obligation to transfer goods or services 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 the 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 as presented as an expense (e.g., as an
impairment loss).

Illustration 1: Contract liability and Receivable

On Jan. 1, 2021, Living Hope Co. enters into a contract to install a gate for a customer. The gate will
be fabricated in Living Hope’s place of business and will be assembled and installed in the customer’s
premises on Mar. 31, 2021. The contract requires the customer to pay a consideration of ₱1,000 in
advance on Jan. 31, 2021. The customer pays the consideration on Mar. 1, 2021. Living Hope installs
the gate on Mar. 31, 2021.

Requirement: Provide the journal entries under each of the following scenarios: (a) the contract is
cancellable and (b) the contract is non-cancellable. (Ignore contract costs)

Solutions:
Scenario A: Cancellable Scenario B: Non-cancellable
Jan. 1, 2021 Jan. 1, 2021
No entry No entry

No entry because neither party has performed its obligation.

Scenario A: Cancellable Scenario B: Non-cancellable

Jan. 31, 2021 Jan. 31, 2021
No entry Receivable 1,000
Contract liability 1,000

A receivable is recognized under Scenario B because Living Hope Co. has an unconditional
right to consideration (i.e., the contract is non-cancellable and it requires payment on this
date). Living Hope Co. is entitled to the consideration whether the customer pursues or
cancels the
 contract. A corresponding contract liability is recognized for Living Hope’s obligation to install
the gate.
No receivable is recognized under Scenario A because Living Hope Co. does not have an
unconditional right to consideration (i.e., the contract is cancellable).

Scenario A: Cancellable Scenario B: Non-cancellable

Mar. 1, 2021 Jan. 31, 2021
Cash 1,000 Cash 1,000
Contract liability 1,000 Receivable 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).

Scenario A: Cancellable Scenario B: Non-cancellable

Mar. 31, 2021 Jan. 31, 2021
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, 2021, Living Hope Co. enters into a contract with a customer for the installation of roof
tiles. The expected numbers of roof tiles to be installed is 1,000 units. The contract price is ₱100 per
roof tile installed. However, the customer pays the total consideration only when all of the 1,000 roof
tiles have been installed.

Living Hope assesses its performance obligation to be satisfied over time because the customer
simultaneously receives and consumes the benefits provided by Living Hope’s performance as Living
Hope performs; and Living Hope’s performance enhances an asset an asset that the customer controls
as it is enhanced.

As of Dec. 31, 2021, 800 roof tiles have been installed. The remaining 200 tiles have been installed on
Jan. 7, 2022. The customer pays the consideration on Jan. 9, 2021.

Requirement: Provide the journal entries. Ignore contract costs.

Solution:
Dec. 1, 2021 No entry
Dec. 31, 2021 Contract asset (800 units x ₱100) 80,000
Revenue 80,000
Jan. 7, 2021 Receivable (1,000 units x ₱100) 100,000
Contract asset 80,000
Revenue (200 units x ₱10) 20,000
Jan. 9, 2021 Cash 100,000
Receivable 100,000
Notes:
Contract asset is recognized on Dec. 31 (rather than ‘receivable’) because Living Hope Co.’s
right to consideration is conditioned upon the full installation of the 1,000 roof tiles. Revenue
is recognized as Living Hope 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 Living Hope 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 the
customer before consideration is
received:
a. Right to consideration is  Recognize a contract asset
conditional.
b. Right to consideration is  Recognize a receivable
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, 2021 above).

Accounting for Construction Contracts

As a brief background, PAS 11 Construction Contracts was the old standard used to account for
construction contracts. PAS 11 was subsequently superseded by PFRS 15 Revenue from Contracts with
Customers effective January 1, 2018.

In this module, only the accounting for construction contracts under PFRS 15 will be discussed.

Under PFRS 15:

Contract asset is recognized when the entity performs but its right to consideration is still
conditional. Once the entity’s right to consideration becomes unconditional (such as when
none but the passage of time is required before payment is due), the contract asset is
reclassified as receivable.
Contract liability is recognized if the consideration is received or becomes due before the
entity performs.

Illustration: Percentage of completion

On Jan. 21, 2021, Living Hope enters into a contract to construct a building for a customer. Living Hope
identifies its performance obligation to be satisfied over time. Living Hope uses the input method
based on costs to measure its progress on the contract. The contract price is ₱9M. Information on the
construction is provided below:
 2021 2022 2023
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 year-end) 4,140,000 700,000 -

(1) The billings per year are stated as percentages of the contract price. The contract is non-cancellable.
(2) The collections on billings in 2021 and 2022 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 2021, 2022 and 2023,
respectively.
b. Provide the journal entries.
c. Determine the amounts presented in the financial statements.

Solutions:

Requirement (a):
 Gross profits
2021 2022 2023
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 yrs. - (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 2022,
the costs incurred to date is computed as (2.76M costs in 2021 +3.54M costs in 2022) = 6.3M.

 Revenues
2021 2022 2023
Total contract price 9,000,000 9,000,000 9,000,000
Multiply by: % completion 40% 90% 100%
Revenue to date 3,600,000 8,100,000 9,000,000
Less: Revenue recognized in prior yrs. - (3,600,000) (8,100,000)
Revenue for the year 3,600,000 4,500,000 900,000
Cost of construction** (2,760,000) (3,540,000) (500,000)
Gross profit for the year 840,000 960,000 400,000

** 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.
Important note: Notice that billings and collections do not affect revenue, cost of construction and
gross profit.

Requirement (b): Journal entries

 2021
a) Incurrence of cost
Contract costs 2.76M
Cash (or other accounts) 2.76M

b) Billing
Receivable 4.5M
Contract liability 4.5M

c) Collection
Cash 4.05M
Receivable 4.05M

d) Revenue recognition
Contract liability 3.6M
Revenue 3.6M
Cost of construction 2.76M*
Contract costs 2.76M

*As the progress is measured using the ‘cost-to-cost’ method, all costs incurred are amortized.

 2022  2023
Contract costs 3.54M Contract costs .5M
Cash (or other accounts) 3.54M Cash (or other accounts) .5M
Receivable 2.7M Receivable 1.8M
Contract liability 2.7M Contract liability 1.8M
Cash 2.43M Cash 2.52M
Receivable 2.43M Receivable 2.52M
Contract liability 4.5M Contract liability 900K
Revenue 4.5M Revenue 900K
Cost of construction 3.54M Cost of construction 500K
Contract costs 3.54M Contract costs 500K

Requirement (c): Financial statements

Contract costs Contract liability

2,760,000 4,500,000
2,760,000 3,600,000
12/31/21 12/31/21
- 900,000
3,540,000 3,540,000 4,500,000 2,700,000
12/31/22 12/31/22
- 900,000
500,000 500,000 12/31/23
12/31/23 900,000 1,800,000
- -
 Receivable
4,500,000
4,050,000
12/31/21 450,000
2,700,000 2,430,000
12/31/22
720,000
1,800,000 2,520,000
12/31/23
-

See ‘Requirement (a)’ for revenues and costs of construction.

The debit balance in the contract liability account on 12/31/22 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 2023.

Alternatively, the revenue in 2022 may also be recorded as follows:

Contract liability (900K + 2.7M)
3.6M Contract asset
900
K
Revenue 4.5M
Living Hope Co.
Statement of Financial
Position
Current assets: 2021 2022 2023
Receivable 450,000 720,000 -
Contract asset - 900,000 -
Total 450,000 1,620,000 -

Current liabilities:
Contract liability 900,000 - -
Total 900,000 - -

Living Hope Co.

Statement of Profit or
Loss
2021 2022 2023
Revenue 3,600,000 4,500,000 900,000
Cost of construction (2,760,000) (3,540,000) (500,000)
Gross profit 840,000 960,000 400,000

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 examinations. 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.

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 ₱1M is shown below:

Cost of construction (contract costs recognized as expense) ₱500,000

Percent complete (based on 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 word

In 2021, Living Hope Co. was subcontracted to construct the first portion of a 94.5-kilometer, four-
lane expressway. Construction started in 2021 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 ₱13B. Living Hope 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:
 Cost incurred Estimated cost to No. of kilometers
Year each complete completed during the year
year
2021 2.3B 7.7B 10.25
2022 5.5B 2.4B 22.55

Requirement: Compute for the revenue and the cost of construction recognized as expense in 2021 and
2022, respectively.

Solution:
2021 2022
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:
2021 2022
Total contract price 13B 13B
Estimated total contract costs* (10B) (10.2B)
Expected total profit from construction 3B 2.8B
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 contracts costs are equal to the costs incurred to date plus estimated costs to complete
at each year-end. These are computed as follows:
- 2021: (2.3B + 7.7B) = 10B
- 2022: (2.3B + 5.5B + 2.4B) = 10.2B

 Revenues and Costs of construction:

2021 2022
Total contract price 13B 13B
Multiply by: % of completion 25% 80%
Contract revenue to date 3.25B 10.4B
Contract revenue recognized in prior years - (3.25B)
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

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 PAS8 Accounting Policies, Changes in Accounting Estimates
and Errors.

Reasonable measure of progress

Revenue for a performance of 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 reasonable measured, revenue is recognized
only to the extent of costs 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 ₱9M is provided below:
2021 2022 2023
a. Contract costs incurred per year 2,760,000 3,540,000 500,000
b. Estimated costs to complete (at each
not measurable not measurable -
year-end)

Requirements:
a. Compute for the 2021, 2022 and 2023 revenues.
b. Provide the journal entries in 2021 assuming billings were 50% of the contract price and collections
were 90% of the billings.

Solutions:
Requirement (a):
2021 2022 2023
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., 2021 and 2022), the revenues recognized are equal to the contract
costs incurred. Accordingly, no gross profits are recognized during these years.
On completion (i.e., 2023), the revenue recognized is the excess of the contract price over the
revenues recognized in prior years: (9M contract price - 2.76M revenue in 2021 - 3.54M
revenue in 2022 = 2.7M).
Gross profit is recognized only in the year of completion.

Requirement (b): Journal entries - 2021 only

Contract costs 2.76M
Cash (or other accounts) 2.76M
Receivable 4.5M
Contract liability 4.5M
Cash 4.05M
Receivable 4.05M
Contract liability 2.76M
Revenue 2.76M
Cost of construction 2.76M
Contract costs 2.76M
The 2021 financial statements will show the following:

Living Hope Co. Living Hope Co.

Statement of Financial Position Statement of Financial Position

Current assets: 2021 2021

Receivable 450,000 Revenue 2,760,000
Total 450,000 Cost of construction (2,760,000)
Gross profit -
Current liabilities:
Contract liability 1,740,000
Total 1,740,000

Onerous contract (Expected losses)

Under PFRS 15, as soon as the contract becomes onerous, an entity recognizes a provision for the loss
it expects to incur on the contract in 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.” (PAS 37.Appdx.A)

The amount of loss is determined irrespective of the entity’s progress on the contract.

Illustration 1: Onerous contract

In 2021, Living Hope Co. started work on a ₱1M fixed price contract. Information on the construction
is shown below:
2021 2022
Costs incurred to date 200,000 825,000
Estimated costs to complete 600,000 275,000

Requirement: Compute for the loss in 2022.

Solution:
The contract is analyzed as follows:
2021 2022
Total contract price 1,000,000 1,000,000
Costs incurred to date 200,000 825,000
Estimated costs to complete 600,000 275,000
Estimated total contract costs 800,000 1,100,000
Expected total profit (loss) on completion 200,000 (100,000)
The contract becomes onerous in 2022 as the estimated total contract costs exceed the contract price.
The loss recognized in 2022 is determined as follows:
2021 2022
Total contract price 1,000,000 1,000,000
Estimated total contract costs (800,000) (1,100,000)
Expected total profit (loss) on completion 200,000 (100,000)
Multiply by: percentage of completion 25% (1) N/A
Profit (loss) to date 50,000 (100,000)
Profit (loss) recognized in prior years - (50,000)
Profit (loss) for the year 50,000 (150,000)

(1) (200K costs incurred to date 800K estimated total contract costs) = 25%

N/A – the progress in 2022 is ignored so that the ₱100,000 loss is recognized in full.
The ₱50,000 profit recognized in 2021 is not restated. Thus, to reflect the expected total loss
on the contract of ₱100,000, ₱150,000 loss is recognized in 2022 (i.e., 50K profit in 2021 -
150K loss in 2022 = 100K loss to date).

The amounts recognized in profit or loss are computed as follows:

2021 2022
Total contract price 1,000,000 1,000,000
Multiply by: percentage of completion 25% 75% (2)
Revenue to date 250,000 750,000
Revenue in prior years - (250,000)
Revenue for the year 250,000 500,000
Costs of construction (200,000) (625,000) (3)
Gross profit (loss) for the year 50,000 (125,000)
Loss on onerous contract - (25,000) (4)
Profit (loss) for the year 50,000 (150,000)

(2) 2022: (825K costs incurred to date 1.1M estimated total contract costs) = 75%
(3)
2023: (825K costs incurred to date - 200K costs incurred in 2021) = 625,000
(4)
‘squeezed’ (150K loss for the year - 125K gross loss) = 25K loss provision

 Journal entries: (Billings and Collections are ignored)

2021
Contract costs 200K
Cash (or other accounts) 200K
Contract asset 250K
Revenue 250K
Cost of construction 200K
Contract costs 200K

2022
Contract costs 625K
Cash (or other accounts) 625K
Contract asset 500K
Revenue 500K
 Cost of construction 625K
Contract costs 625K
Loss on onerous contract 25K
Provision 25K

 Financial statements

Statement of Financial Position

Current assets: 2021 2022

Contract asset 250,000 750,000
Total 250,000 750,000

Current liabilities:
Provision - 25,000
Total - 25,000

Statement of Profit or
Loss
2021 2022
Revenue 250,000 500,000
Cost of construction (200,000) (625,000)
Gross loss 50,000 (125,000)
Loss on onerous contract - (25,000)
Profit (loss) for the year 50,000 (150,000)

Illustration 2: Reversal of provision (Continuation of Illustration 1)

The contract is completed in 2023.
2021 2022 2023
Costs incurred to date 200,000 825,000 1,020,000
Estimated costs to complete 600,000 275,000 -

Requirement: Compute for the profit (loss) in 2023.

Solution:
The contract is analyzed as follows:
2021 2022 2023
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 contracts costs 800,000 1,100,000 1,020,000
Expected total profit (loss) on completion 200,000 (100,000) (20,000)
The actual total loss on the contract is ₱20,000. The profit recognized in 2023 is determined as
follows:
2021 2022 2023
Total contract price 1,000,000 1,000,000 1,000,000
Estimated total contract costs (800,000) (1,100,000) (1,020,000)
Expected total profit (loss) 200,000 (100,000) (20,000)
Multiply by: percentage of completion 25% N/A 100%
Profit (loss) to date 50,000 (100,000) (20,000)
Profit (loss) recognized in prior years - (50,000) 100,000
Profit (loss) for the year 50,000 (150,000) 80,000

The profit and loss recognized in 2021 and 2022 are not restated. Instead, to reflect the total loss on
the contract of ₱20,000, ₱80,000 profit is recognized in 2023 (i.e., 50K profit in 2021 - 150K loss in
2022 + 80K profit in 2023 = 20K total loss on contract).

The amounts recognized in profit or loss are computed as follows:

2021 2022 2023
Total contract price 1,000,000 1,000,000 1,000,000
Multiply by: % of completion 25% 75% 100%
Revenue to date 250,000 750,000 1,000,000
Revenue in prior years - (250,000) (750,000)
Revenue for the year 250,000 500,000 250,000
Costs of construction (200,000) (625,000) (195,000) (1)
Gross profit (loss) for the year 50,000 (125,000) 55,000
Loss on onerous contract - (25,000) -
Gain on reversal of provision 25,000
Profit (loss) for the year 50,000 (150,000) 80,000

(1)
1.02M costs incurred to date in 2023 - 825K costs incurred to date in 2022 = 195K

 Journal entries: (Billings and Collections are ignored)

2023
Contract costs 195K
Cash (or other accounts) 195K
Contract asset 250K
Revenue 250K
Cost of construction 195K
Contract costs 195K
Provision 25K
Gain on reversal of provision 25K

Illustration 3: Onerous contract: Zero-profit method

In 2021, Living Hope Co. started work on a ₱1M fixed price contract. Information on the construction
is shown below:
2021 2022 2023
Costs incurred to date 200,000 825,000 1,020,000

 In 2021, Living Hope Co. cannot reasonably measure the outcome of the performance
obligation but expects to recover all contract costs.
  In 2022, Living Hope estimates the total contract costs to be ₱1,100,000.
 The contract is completed in 2023 for a total cost of ₱1,020,000.

Requirement: Compute for the profit (loss) in 2021, 2022 and 2023, respectively.

Solution:
The contract is analyzed as follows:
2021 2022 2023
Contract price 1,000,000 1,000,000 1,000,000
Contract costs N/A 1,100,000 1,020,000
Expected total profit (loss) N/A (100,000) (20,000)

The contract becomes onerous in 2022. The profits (losses) are determined as follows:
2021 2022 2023
Revenue 200,000 625,000 175,000
Contract costs incurred per year (200,000) (625,000) (195,000)
Gross profit (loss) for the year - - (20,000)
Loss on onerous contract (100,000) (100,000)
Gain on reversal of provision 100,000
Profit (loss) for the year - (100,000) 80,000

Notes:
The revenues recognized in 2021 and 2022 are equal to the contract costs incurred in those
periods.
The revenue recognized in 2023 is computed as: 1M contract price - 200K revenue in 2021 -
625K revenue in 2022 = 175,000.
Reconciliation: 0 profit in 2021 - 100K loss in 2022 + 80K profit in 2023 = 20K total loss on
contract.