What do the rules say?

IFRS 15 prescribers the 5-step model for the revenue recognition.

You can also check out my IFRS Kit with detailed video tutorials about IFRS 15.
To sum up, here are the 5 steps:
1. Identify contract with the customer;
2. Identify the performance obligations in the contract;
3. Determine the transaction price;
4. Allocate the transaction price to the performance obligations in the contract;
5. Recognize revenue when (or as) an entity satisfy a performance obligation.

If you enter into the construction contracts with your customers and you previously applied IAS
11, then you need to follow exactly these 5 steps under IFRS 15.
Let me show you straight on an example.

Example: Construction contract under IFRS 15

Construction company ABC signs a contract in June 20X1 to refurbish a building and install
new windows with window blinds (let’s call it “windows”). Total contract price is CU 12
million. Total expected contract costs are:
 CU 4 mil. for labor, materials and other costs related to the project.
As of 31 December 20X1:
 ABC handed over windows to the client, although the installation has not been
completed. However, the client obtained control of windows.
 Other costs incurred to 31 December were CU 1 mil.
Just before the year-end, the client paid the first progress payment of CU 8 mil.
How should ABC account for this contract as of 31 December 20X1 in line with IFRS 15?

Let’s follow the 5 steps for the revenue recognition.

Step 1: Identify the contract with a customer
It is very clear now, we have the explicit contractual agreement between ABC and a customer.
Step 2: Identify the performance obligations in the contract
You need to identify not only individual goods and services promised in the contract, but also
determine whether they are distinct or not.If the goods and services are not distinct, they can’t
be provided one without the other one (this is very simplified explanation) and thus they must be
treated as ONE single performance obligation.
According to ABC’s assessment, the reparation services, windows and installation of windows
are ONE single performance obligation.
Most construction contracts will contain just ONE performance obligation, because the contract
would be to build or construct something for the customer and is negotiated as a whole package
where a customer has no choice than to get the full package from the supplier.
Sometimes it’s not true and you will have TWO or more performance obligations there.
In this case you must adjust your accounting accordingly as explained below.
Step 3: Determine the transaction price
The transaction price in ABC’s contract is CU 12 million. This is clear, but in reality, you can
have some variability involved, like progress or performance bonuses. You should take these
estimates into account, too based on their probability.
Step 4: Allocate the transaction price to the individual performance obligations
This is very easy here, because as ABC assessed in the step 2, there is just ONE single
performance obligation and thus the whole transaction price is allocated to this ONE obligation.
If there would had been more than one performance obligations, then ABC would need to
allocate the transaction price to them based on their relative stand-alone selling prices.
You can revise the short example in this article to make it totally clear.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation
You should remember that the performance obligation can be satisfied either:
 At the point of time; or
 Over time.

The standard IFRS 15 lists a few criteria when a performance obligation is satisfied over time:
 receives and consumes as the entity performs;
 Customer controls the asset enhanced or created by the entity;
 Entity does NOT create an asset with an alternative use and has an enforceable right to
payment for performance completed to date.
If you meet just one of these criteria, then the performance obligation is satisfied over time.
In most construction contracts, the performance obligations are satisfied over time and NOT at
the point of time (although exceptions might exist).
In this case, you need to recognize revenue based on the progress towards completion.
How to measure progress towards completion?
You can use either input or output methods to measure the progress towards completion.
ABC uses input method, i.e. based on costs incurred to date. Also, let me warn you about one
significant factor specific especially for construction contracts:
There may be no direct relationship between your inputs and the transfer of control of goods
or services to a customer.
Therefore, you should exclude the effects of any inputs from input method that do not depict
your performance in transferring control of goods or services to the customer (par. B19 of IFRS
15).
Translated to human language and applied to this example:
ABC believes that costs of windows are significant item within total costs and including these
costs to measure the progress to completion would not be appropriate, because it would certainly
overstate ABC’s performance.
The reason is that the windows are purchased from the third party and the transfer of windows to
the customer has no direct relationship with the other ABC’s work.
Therefore, progress towards completion will be measured excluding the cost of windows.
Carefully, because you should apply the resulting percentage of completion to the revenues
excluding windows, too – just for the consistency!
Let’s measure the progress towards completion:
 Total costs excluding windows: CU 4 mil.
 Total incurred costs to date excluding windows: CU 1 mil.
 Progress to completion: CU 1/CU 4 = 25%
 Total contract revenue excluding windows: CU 6 mil. (CU 12 – CU 6)
 Total revenue to 31 December 20X1 excluding windows: CU 6 mil. x 25% = CU 1.5 mil.
Journal entries at 31 December 20X1
As we excluded windows from measuring progress towards completion, we will draft the journal
entries separately for windows and for the remaining services.
Windows:
As ABC handed over windows and excluded them from measurement of progress towards
completion due to potential overstatement, the revenue from sale of windows is recognized at the
time of their delivery.
Purchase of windows by ABC (at the time of delivery from the supplier):
 Debit Inventories: CU 6 mil.
 Credit Suppliers: CU 6 mil.
ABC recognizes the revenue for windows at zero profit margin (equal to their cost – in line with
par. B19 (b) of IFRS 15):
 Debit Contract Asset: CU 6 mil.
 Credit Revenue from construction project***: CU 6 mil.
***Not the revenue from sale of windows – remember, the whole project is one performance
obligation and we recognize the revenue under 1 caption in this case.
Cost of windows:
 Debit Costs of construction in profit or loss: CU 6 mil.
 Credit Inventories: CU 6 mil.
The remaining cost/revenues:
Labor costs, materials, etc. to complete the contracts are accounted for as contract costs (at the
time when they are actually incurred):
 Costs to paint the building:
o Debit Contract costs (asset in balance sheet);
o Credit Employees (or suppliers or whatever is relevant)
 Use of paints:
o Debit Contract costs (asset in balance sheet)
o Credit Inventories
At 31 December 20X1, ABC needs to amortize the contract costs based on progress towards
completion.
As the progress is measured by input method (incurred costs), all costs incurred to date are
amortized.
However if different method is used to measure the progress to completion, then the company
can amortize the cost based on the progress percentage.
In this case, at 31 December 20X1:
 Debit Cost of construction in profit or loss: CU 1 mil.
 Credit Contract costs: CU 1 mil.
Let’s recognize the revenue from “remaining” services (all except for windows).
We measured these revenues at CU 1.5 mil.Using the progress towards completion (please see
above).
Journal entry is:
 Debit Contract asset: CU 1.5 mil.
 Credit Revenue from construction project: CU 1.5 mil.
Finally, we need to account for the progress payment of CU 8 mil made by the customer at the
year-end:
 Debit Trade receivables (bank account, cash…): CU 8 mil.
 Credit Contract assets: 8 mil.
Let’s check the contract asset now. Its balance at 31 December 20X1 is:
 Contract arose at revenue recognition (6+1.5): CU 7.5 mil.
 Less progress payment by the customer: CU 8 mil.
 The balance: CU -0.5 mil..
As the contract asset is negative at the end of 31 December 20X1, it became a contract
liability and it should be presented within liabilities in the statement of financial position.
I personally prefer to see contract liabilities at the year-end, not contract assets, because:
 We have no credit risk as we have no performance completed to date which is not paid by
the customer, and
 We don’t have to calculate expected credit loss and measure the impairment on contract
assets – hurray!

Finally…
This is basically the method you should follow when accounting for your construction contracts.
I tried to make this simple as possible, but I can’t cover every single situation here.
If you have any questions, please ask them in the comments or you can even consider
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