ACCOUNTING FOR

CONSTRUCTION
CONTRACTS
Construction Contracts
Related standard: PFRS 15 Revenue from Contracts with Customers

Learning Outcomes
 Discuss the nature of long-term construction contracts.
 Journalize revenue, cost, and gross profit transactions pertaining
to long-term construction contracts.
 Compute for revenue, cost, deferred and realized gross profit.
 Properly present long-term construction contracts accounts in the
financial statements.
 Solve accounting problems and cases involving long-term
construction contracts.
PFRS 15 supersedes the following standards:
• PAS 18 Revenue;
• PAS 11 Construction Contracts;
• IFRIC 13 Customer Loyalty Programmes;
• IFRIC 15 Agreements for the Construction of Real Estate;
• IFRIC 18 Transfers of Assets from Customers; and
• SIC-31 Revenue - Barter Transactions Involving Advertising Services.
Applicability of PFRS 15

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

customer.
• Contract – An agreement between two or more parties that creates
enforceable rights and obligations. A contract can be written, oral, or
implied by an entity’s customary business practice.
• Customer – A party that has contracted with an entity to obtain goods
or services that are an output of the entity’s ordinary activities in
exchange for consideration.
Core principle

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

or services to customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for those goods
or services.
Steps in the recognition of revenue
PFRS 15 requires the following steps in recognizing revenue:
• Step 1: Identify the contract with the customer
• Step 2: Identify the performance obligations in the contract
• Step 3: Determine the transaction price
• Step 4: Allocate the transaction price to the performance
obligations in the contract
• Step 5: Recognize revenue when (or as) the entity satisfies a
performance obligation
 
Step 1: Identify the contract with the customer

Requirements before a contract with a customer is accounted for

under PFRS 15:
a. The contract must be approved and the contracting parties are
committed to it;
b. rights and payment terms are identifiable;
c. The contract has commercial substance; and
d. The consideration is probable of collection.

No revenue is recognized if the contract does not meet the criteria

above. Any consideration received is recognized as liability.
Definition of Construction contract

• 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.
Combination of contracts

• Each contract is accounted for separately. 

• However, two or more contracts entered into at or near the same
time with the same customer (or related parties of the customer)
shall be combined and accounted for as a single contract if:
a. The contracts are negotiated as a package with a single commercial objective;
b. The amount of consideration to be paid in one contract depends on the price or
performance of the other contract; or
c. Some or all of the goods or services promised in the contracts are a single performance
obligation.
Step 2: Identify the performance obligations in the
contract

Each promise in a contract to transfer a distinct good or service

is treated as a separate performance obligation.
 Identifying distinct goods or services

A good or service is distinct if:

(a) the customer can benefit from it, either on its own or together
with other resources that are readily available to the customer
(e.g., the good or service is regularly sold separately); and
(b) the good or service is separately identifiable (i.e., not an input to a
combined output, does not significantly modify the other
promises, or not highly interrelated with the other promises).
A good or service that is not distinct shall be combined with the other
promises in the contract. Combined promises are treated as a single
performance obligation.
Satisfaction of performance obligations

• At contract inception, the entity shall determine whether the

identified performance obligations will be satisfied either:
1. Over time; or
2. At a point in time
Performance obligation satisfied over 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 and the entity has an enforceable right to payment for
performance completed to date.
 Performance obligation satisfied at a point
in time

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

time, it is presumed that the performance obligation is satisfied at a point in time.
Step 3: Determine the transaction price

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

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

expects to be entitled in exchange for transferring promised goods or
services to a customer, excluding amounts collected on behalf of third
parties (e.g., some sales taxes).” The consideration may include fixed
amounts, variable amounts, or both.
Step 3: Determine the transaction price - continuation

• In a construction contract, the transaction price normally consists

of the following:
1. The contract price; and
2. Any subsequent variations in the contract price to the extent that it is
probable that they will result in revenue and they are capable of being
measured reliably.
Step 3: Determine the transaction price - continuation

• A construction contract may be either:

1. Fixed price contract; or
2. Cost plus contract.
There are two types of cost-plus contracts.
a. Cost-plus-variable-fee contract
b. Cost-plus-fixed-fee contract
Step 4: Allocate the transaction price to the performance
obligations

• The transaction price shall be allocated to each performance

obligation identified in a contract based on the relative stand-
alone prices of the distinct goods or services promised to be
transferred.
 
• The stand-alone selling price is the price at which a promised good
or service can be sold separately to a customer.
Step 5: Recognize revenue when (or as) the entity satisfies a
performance obligation

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

service is transferred to the customer.
• Revenue is measured at the amount of the transaction price allocated to the
satisfied performance obligation.
 Measuring progress towards complete satisfaction of a
performance obligation

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

recognize revenue over time by measuring the progress towards
complete satisfaction of that performance obligation.
• Examples of acceptable measurement methods:
1. Input methods (e.g., relationship between costs incurred to date
and total expected costs)
2. Output methods (e.g., surveys of work performed)
Inputs method
• Inputs methods recognize revenue on the basis of efforts or inputs
expended relative to the total expected inputs needed to fully satisfy
a performance obligation. Examples of efforts or inputs include:
1. Costs incurred
2. Resources consumed
3. Labor hours expended
4. Machine hours used
5. Time elapsed
Cost-to-cost
Contract costs

Contract costs include the following:

(a) Incremental costs of obtaining a contract – recognized as
asset if they are recoverable and avoidable. As a practical
expedient, the costs are recognized as expense if their
expected amortization period is 1 year or less.
(b) Costs to fulfill a contract –if within the scope of PFRS 15, they
are recognized as asset if they are: (a) directly related to a
contract, (b) generate or enhance resources, and (c)
recoverable.
Presentation

A contract where either party has performed is presented in the

statement of financial position as a contract liability, contract asset or
receivable.
• Contract liability – is an entity’s obligation to transfer goods or
services to a customer for which the entity has received consideration
(or the amount is due) from the customer.
• Contract asset – is an entity’s right to consideration in exchange for
goods or services that the entity has transferred to a customer when
that right is conditioned on something other than the passage of time.
• Receivable – is an entity’s right to consideration that is unconditional.
Changes in the measure of progress

• The measure of progress shall be updated as circumstances change

over time to reflect any changes in the outcome of the performance
obligation. Such changes are accounted for prospectively as a change
in accounting estimate in accordance with PAS 8 Accounting Policies,
Changes in Accounting Estimates and Errors.
Cost-recovery Approach

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

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

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

performance obligation exceed the transaction price.
• The entity recognizes and measures the present obligation under an onerous
contract as a provision in accordance with PAS 37 Provisions, Contingent
Liabilities and Contingent Assets.
 Variable consideration

• If the consideration includes a variable amount, the entity shall

estimate the amount to which it will be entitled in exchange for
transferring the promised goods or services to the customer.

• “Constraining estimates of variable consideration” principle– The

estimated amount of variable consideration will be included in the
transaction price only to the extent that it is highly probable that
a significant reversal in the amount of cumulative revenue
recognized will not occur when the uncertainty associated with
the variable consideration is subsequently resolved .
Variable consideration - continuation

• Examples of contract stipulations that could make the consideration in

a construction contract to be variable:
1. Penalties
2. Incentive payments
3. Cost escalations
Contract modifications

• A contract modification is a change in the scope and/or price of a

contract that is approved by the contracting parties, in writing,
orally or implied by customary business practices. Similar terms are
“change order,” “variation” and “amendment.”
Contract modifications

AFAR PART 1: Zeus Vernon B. Millan

Claims for reimbursements on the contract

• A claim is an amount that the contractor seeks to collect from the

customer or another party as reimbursement for costs not included in
the contract price.
• If the entity has an enforceable right on the claim, the entity shall
account for the claim as a contract modification using the principles in
PFRS 15.
Uncertainty in the collectability of contract revenue

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

contact inception, the entity does not recognize any revenue from the
contract. Any consideration received is recognized as a liability.
• If the uncertainty in the collectability of contract revenue arises
subsequent to contract inception, the uncollectability is accounted
for as impairment of trade receivable and/or contract asset.