PwC
Revenue from contracts with customers
The standard is final – A comprehensive look at the
new revenue model
What’s inside:
Overview .........................1
Defining the contract ..... 2
Determining the
transaction price............ 4
Accounting for multiple
performance obligations.7
Allocating the transaction
price ..............................10
Recognising revenue ..... 11
Other considerations.....16
Final thoughts ...............19
Engineering and construction industry
supplement
At a glance
On 28 May 2014, the IASB and FASB issued their long-awaited converged standard on
revenue recognition. Almost all entities will be affected to some extent by the
significant increase in required disclosures. But the changes extend beyond
disclosures, and the effect on entities will vary depending on industry and current
accounting practices.
This supplement highlights some of the areas that could create the most significant
challenges for engineering and construction entities as they transition to the new
standard.
Overview
Entities in the engineering and construction (E&C) industry applying IFRS or US GAAP
have primarily been following industry guidance for construction contracts
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to account
for revenue. These standards were developed to address particular aspects of long-term
construction accounting and provide guidance on a wide range of industry-specific
considerations including:
• Defining the contract, such as when to combine contracts, and when and how to
account for change orders and other modifications.
• Defining the contract price, including variable consideration, customer-furnished
materials, and claims.
• Recognition methods, such as the percentage-of-completion method (and, in the case
of US GAAP, the completed contract method) and input/output methods to measure
performance.
• Accounting for contract costs, such as pre-contract costs and costs to fulfil a contract.
• Accounting for loss-making contracts.
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The new revenue standard will replace the construction contract guidance and substantially all existing revenue
recognition guidance under IFRS and US GAAP. This includes the percentage-of-completion method and the related
construction cost accounting guidance as a stand-alone model.
Defining the contract
Current guidance covers:
• When two or more contracts should be combined and accounted for together.
• When one contract should be segmented and accounted for separately as two or more contracts.
• When a contract modification should be recognised.
These situations and, in particular, contract modifications such as change orders, are commonplace in the E&C
industry. The new standard applies only to contracts with customers that meet the following criteria:
• The contract has commercial substance.
• The contract has been approved by the parties to the contract and such parties are committed to satisfying their
perspective obligations.
• It is probable that the entity will collect the consideration to be received in exchange for the goods or services to be
transferred to the customer.
• The contract has enforceable rights that can be identified regarding the goods or services to be transferred.
• The payment terms can be identified.
Current practice is not expected to significantly change in the assessment of whether contracts should be combined.
The standard does not contain guidance on segmenting contracts; however, construction companies that segment
contracts under current guidance might not be significantly affected because of the requirement to account for
separate performance obligations (refer to ‘Accounting for multiple performance obligations’ below). Construction
companies currently exercise significant judgement to determine when to include change orders and other contract
modifications in contract revenue and therefore there is diversity in practice. We expect that the use of judgement will
continue to be needed and do not expect current practice (or existing diversity) in this area to be significantly affected
by the new standard, including the accounting for unpriced change orders.
New standard Current US GAAP Current IFRS
Combining contracts
Two or more contracts (including
contracts with parties related to the
customer) are combined and
accounted for as one contract if the
contracts are entered into at or near
the same time and one or more of the
following conditions are met:
• The contracts are negotiated with
a single commercial objective.
Combining and segmenting contracts
is permitted provided certain criteria
are met, but it is not required so long
as the underlying economics of the
transaction are fairly reflected.
Combining and segmenting contracts
is required when certain criteria are
met.
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New standard Current US GAAP Current IFRS
• The amount of consideration in
one contract depends on the other
contract.
• The goods or services promised are
a single performance obligation
(refer to ‘Accounting for multiple
performance obligations’ below).
Contract modifications (for
example, change orders)
An entity will account for a
modification if the parties to a
contract approve a change in the scope
and/or price of a contract. If the
parties have approved a change in the
scope, but have not yet determined the
corresponding change in price (for
example, unpriced change orders), the
entity should estimate the change to
the contract price as variable
consideration.
A contract modification is accounted for
as a separate contract if:
• the modification promises distinct
goods or services that result in a
separate performance obligation;
and
• the entity has a right to
consideration that reflects the
stand-alone selling price of the
additional goods or services.
A modification that is not a separate
contract is accounted for either as:
• A prospective adjustment if the
goods or services in the
modification are distinct from those
transferred before the modification.
The remaining consideration in the
original contract is combined with
the consideration promised in the
modification to create a new
transaction price that is then
allocated to all remaining
performance obligations.
A change order is generally included in
contract revenue when it is probable
that the change order will be approved
by the customer and the amount of
revenue can be reliably measured.
US GAAP also includes detailed
revenue and cost guidance on the
accounting for unpriced change orders
(or those in which the work to be
performed is defined, but the price is
not).
A change order (known as a variation)
is generally included in contract
revenue when it is probable that the
change order will be approved by the
customer and the amount of revenue
can be reliably measured.
There is no detailed guidance on the
accounting for unpriced change
orders.
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New standard Current US GAAP Current IFRS
• A cumulative adjustment to
contract revenue if the remaining
goods and services are not distinct
and are part of a single
performance obligation that is
partially satisfied.
Example 1 - Unpriced change orders
Facts: A contractor has a single performance obligation to build an office building. The contractor has a history of
executing unpriced change orders; that is, those change orders where price is not defined until after scope changes
are agreed upon. It is not uncommon for the contractor to commence work once the parties agree to the scope of the
change, but before the parties agree on the price.
When would these unpriced change orders be included in contract revenue?
Discussion: The contractor might be able to determine that it expects the price of the scope change to be approved
based on its historical experience. If so, after the scope changes are approved, the contractor will account for the
unpriced change order as variable consideration. The contractor will estimate the transaction price based on a
probability-weighted or most likely amount approach (whichever is more predictive) provided that it is highly
probable (IFRS) or probable (US GAAP) that a significant reversal in the amount of cumulative revenue recognised
will not occur when the price of the change order is approved.
The contractor will need to determine whether the unpriced change order is accounted for as a separate contract. This
will often not be the case based on the following:
• Change orders often don’t provide distinct goods or services because they are highly interrelated with the goods or
services in the original contract, and are part of the contractor’s service of integrating goods and services into a
combined item for the customer.
• Change orders are typically based on the contractor’s goal of obtaining one commercial objective for the overall
contract. The pricing of a change order may, as a result, not represent the stand-alone selling price of the
additional goods or services.
The contractor in this case will update the transaction price and measure of progress toward completion of the
contract (that is, a cumulative catch-up adjustment) because the remaining goods or services, including the change
order, are not distinct and are part of a single performance obligation that is partially satisfied.
Determining the transaction price
The transaction price (or contract revenue) is the consideration the contractor expects to be entitled to in exchange
for satisfying its performance obligations. This determination is more complex when the contract price is variable.
Common considerations in this area for E&C include the accounting for awards or incentive payments,
customerfurnished materials, claims, liquidated damages, and the time value of money. Revenue related to awards or
incentive payments might be recognised earlier under the new standard in some situations. A significant change in
practice as it relates to customer-furnished materials, claims, liquidated damages, and the time value of money is not
expected.
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New standard Current US GAAP Current IFRS
Awards/incentive payments
Awards/incentive payments are accounted for
as variable consideration. They are included in
contract revenue using the expected value or
most likely amount approach (whichever is
more predictive of the amount the entity
expects to be entitled to receive). These
amounts are included in the transaction price
only if it is highly probable (IFRS) or probable
(US GAAP) that a significant reversal in the
amount of cumulative revenue recognised will
not occur in the future.
An entity should assess its experience with
similar types of performance obligations and
determine whether, based on that experience,
the entity expects a significant reversal in
future periods in the cumulative amount of
revenue recognised.
Awards/icentive payments should
be included in contract revenue
when the specified performance
standards are probable of being met
or exceeded and the amount can be
reliably measured.
Awards/incentive payments
should be included in contract
revenue when the specified
performance standards are
probable of being met or exceeded
and the amount can be reliably
measured.
Customer-furnished materials
The value of goods or services contributed by
a customer (for example, materials,
equipment, or labour) to facilitate the
fulfilment of the contract is included in
contract revenue (as non-cash consideration)
if the entity controls these goods or services
after they are provided. Noncash
consideration is measured at fair value unless
fair value cannot be reasonably estimated, in
which case it is measured by reference to the
selling price of the goods or services
transferred.
The value of customer-furnished
materials is included in contract
revenue when the contractor has the
associated risk for these materials.
There is no explicit guidance on
the accounting for non-cash
consideration in the construction
contracts standard. Management
follows general principles on non-
monetary exchanges, which
generally require companies to use
the fair value of goods or services
received in measuring the amount
to be included in contract revenue.
Claims
Claims are accounted for as variable
consideration. They are included in contract
revenue using the expected value or most
likely amount approach (whichever is more
predictive of the amount the entity expects to
be entitled to receive) provided that it is highly
probable (IFRS) or probable (US GAAP) that a
significant reversal in the amount of
cumulative revenue recognised will not occur
when the uncertainty associated with the
claim is subsequently resolved.
A claim is recorded as contract
revenue when it is probable and can
be estimated reliably (determined
based on specific criteria), but only
to the extent of contract costs
incurred. Profits on claims are not
recorded until they are realised.
A claim is included in contract
revenue only if negotiations have
reached an advanced stage such
that it is probable the customer
will accept the claim and the
amount can be reliably measured.
6
New standard Current US GAAP Current IFRS
Time value of money
Contract revenue should reflect the time value
of money whenever the contract includes a
significant financing component. An entity is
not required to consider the time value of
money if the period between payment and the
transfer of the promised goods or services is
one year or less, as a practical expedient.
All relevant facts and circumstances should be
considered when assessing if a contract
contains a significant financing component.
Revenue is discounted in only
limited situations, including
receivables with payment terms
greater than one year.
The interest component is
computed based on the stated rate
of interest in the instrument or a
market rate of interest if the stated
rate is considered unreasonable
when discounting is required.
Revenue is discounted when the
inflow of cash or cash equivalents
is deferred. An imputed interest
rate is used to determine the
amount of revenue to be
recognised as well as the separate
interest income to be recorded
over time.
Example 2 - Variable consideration
Facts: A contractor enters into a contract for the expansion of an existing two-lane highway to a three-lane highway.
The contract price is C65 million plus a C5 million award fee if the expansion is complete before the holiday travel
season. The contract is expected to take one year to complete. The contractor has a long history of performing this
type of highway work. The award fee is binary; that is, if the job is finished before the holiday travel season, the
contractor receives the full award fee. The contractor does not receive any award fee if the highway is not finished
before the holiday season. The contractor believes, based on its significant past experience, that it is 95 percent likely
that the contract will be completed in advance of the holiday travel season.
How should the contractor account for the award fee?
Discussion: The contractor is likely to conclude, given the binary award fee, that it is appropriate to use the most
likely amount approach to determine the amount of variable consideration to include in the estimate of the
transaction price. The contract’s transaction price is therefore C70 million: the fixed contract price of C65 million
plus the C5 million award fee (the most-likely amount). This estimate is regularly revised and adjusted, as
appropriate, using a cumulative catch-up approach, which is consistent with current practice.
The contractor will then assess, based on its experience with similar types of performance obligations, whether it is
highly probable (IFRS) or probable (US GAAP) that the award fee included in the transaction price will not be subject
to a significant reversal when the contract is completed. Factors to consider in making this assessment include, but
are not limited to:
• The contractor has a long history of performing this type of work.
• It is largely within the contractor’s control to complete the work before the holiday travel season.
• The uncertainty will be resolved within a relatively short period of time.
• There are only two possible final consideration amounts.
This assessment will determine whether the award fee is eligible to recognise as revenue when the performance
obligation is satisfied (that is, as the construction occurs).
Example 3 - Claims
Facts: Assume the same fact pattern as Example 2, except that due to reasons outside of the contractor’s control (for
example, customer-caused delays), the cost of the contract far exceeds original estimates, but a profit is still expected.
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The contractor submits a claim against the customer to recover a portion of these costs. The claim process is in its
early stages, but the contractor has a long history of successfully negotiating claims with customers, albeit sometimes
at a discount from the amount sought.
How should the contractor account for the claim?
Discussion: Claims are highly susceptible to external factors (such as the judgement of, or negotiations with, third
parties), and the possible outcomes are highly variable. The contractor might have experience in successfully
negotiating claims, but it might be challenging to assert that such experience has predictive value in this fact pattern
(because of the highly uncertain variables). The contractor might therefore conclude that it is highly probable (IFRS)
or probable (US GAAP) that the amount of the claim, if recognised, could be subject to significant reversal in future
periods.
The amount of the claim is excluded from the transaction price (contract revenue) until the contractor determines it
is highly probable (IFRS) or probable (US GAAP) it will not be subject to significant reversal in future periods. The
contractor will then estimate the amount of the claim using the expected value method (which is more predictive in
this fact pattern) and include the amount not subject to significant reversal in the transaction price.
It could be highly probable (IFRS) or probable (US GAAP) that some portion of the claim will not result in a
significant revenue reversal, such as when a contractor can demonstrate that specific direct costs were incurred as a
result of the customer-caused delay. Based on the underlying contractual terms, the contractor might determine that
it has an enforceable right to receive payment from its customer. If the contractor has a history of successful
negotiations it might therefore conclude that it is highly probable (IFRS) or probable (US GAAP) that a portion (that
is, a minimum amount) of the claim will not be subject to significant reversal in the future periods. The contractor
will need to reassess the estimates of the claim amount at each reporting date until the uncertainty is resolved.
Example 4 - Time value of money
Facts: A contractor enters into a contract for the construction of a hospital that includes scheduled milestone
payments. The performance obligation will be satisfied over time and the contractual milestone payments are
estimated to coincide with the revenue to be earned. The contract specifies that the customer will retain 5% of each
milestone payment and the retainage will be paid to the contractor only when the hospital is complete.
Does the contract include a significant financing component?
Discussion: The contractor will likely conclude that the contract does not include a significant financing component
and therefore will not reflect the time value of money in the transaction price. The milestone payments are estimated
to coincide with the contract revenue to be earned. Further, the contract requires amounts to be retained for reasons
other than to provide financing; that is, retainage is intended to protect the customer from the contractor failing to
adequately complete some or all of its obligations under the contract.
Accounting for multiple performance obligations
Performance obligations are promises to deliver goods or perform services. Contractors often account for each
contract at the contract level today; that is, contractors account for the ‘macro-promise’ in the contract (for example,
to build a road or build a refinery). Current guidance permits this approach, although a contractor effectively
promises to provide a number of different goods or services in delivering such macro-promises. Determining when to
separately account for these performance obligations under the new standard will require judgement.
It is possible to account for a contract at the contract level (for example, the macro-promise to build a road) under the
new standard when the criteria for combining a bundle of goods or services into one performance obligation are met.
Judgement will be needed in many situations to determine if all of the promises in the contract should be bundled
together, particularly when assessing contracts such as engineering, procurement, and construction (EPC) or design /
build contracts.
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New standard Current US GAAP Current IFRS
An entity should assess the goods or
services promised in a contract and
identify as a performance obligation
each promise to transfer to a customer
either:
(a) A good or service (or bundle of
goods or services) that is distinct.
(b) A series of distinct goods or
services that are homogenous and
meet both of the following criteria:
• Each distinct good or service that is
transferred consecutively is a
performance obligation satisfied
over time.
• The same method would be used to
measure the entity’s progress
toward satisfying the performance
obligation for each distinct good or
service.
A good or service is distinct if both of
the following criteria are met:
• 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.
• The entity’s promise to transfer the
good or service to the customer is
separable from other promises in
the contract.
Factors that indicate a performance
obligation is separable from other
promises in the contract include, but
are not limited to:
• The goods or services are not highly
dependent on or interrelated with
other goods or services in the
contract.
• The entity does not provide a
significant service of integrating
The basic presumption is that each
contract is the profit centre for revenue
recognition, cost accumulation, and
income measurement. That
presumption may be overcome only if
a contract or a series of contracts
meets the conditions described above
for combining or segmenting
contracts.
There is no further guidance for
separately accounting for more than
one deliverable in a construction
contract under the construction
contract guidance.
The basic presumption is that each
contract is the profit centre for revenue
recognition, cost accumulation, and
income measurement. That
presumption is overcome when a
contract or a series of contracts meets
the conditions described for combining
or segmenting contracts.
There is no further guidance for
separately accounting for more than
one deliverable in a construction
contract.
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New standard Current US GAAP Current IFRS
the
goods or services into the
combined item(s) for which the
customer has contracted.
• The goods or services do not
significantly modify or customise
another good or service in the
contract.
Goods and services that are not
distinct and therefore not separate
performance obligations should be
combined with other goods or services
until the entity identifies a bundle of
goods or services that is distinct.
Example 5 - Design and build contract
Facts: A contractor enters into a contract to design and build an airport terminal. The contractor is responsible for
the design and overall management of the project build, including engineering, site clearance, foundation,
procurement, construction of terminal space, gates with loading bridges, customs and immigration, airline office
space, distribution systems required for its operations, and installation of equipment and finishing.
How many distinct performance obligations are in the contract?
Discussion: The contractor will likely account for the design and build contract as a single performance obligation
because these goods and services are not distinct. The goods and services are highly interrelated and the contract
includes a significant service of integrating the goods and services into the combined item the customer contracted
for; that is, the airport terminal. Revenue is recognised over time by selecting an appropriate measure of progress
toward satisfaction of the single performance obligation.
Example 6 - Procurement of specialised equipment
Facts: Assume the same fact pattern as Example 5 above, except the contract requires the contractor to procure
specialised equipment from a subcontractor and integrate the equipment into the airport terminal. The contractor
expects to transfer control of the equipment approximately one year from the contract inception. The installation and
integration of the equipment continue throughout the contract.
How many distinct performance obligations are in the contract?
Discussion: The contractor will likely account for the design and build contract as well as the procurement of
specialised equipment as a single performance obligation. The goods and services in the bundle are highly
interrelated and providing them to the customer requires the contractor also provide significant services of
integrating the services into the combined item the customer has contracted to receive (the airport terminal).
Revenue is recognised over time by selecting an appropriate measure of progress toward satisfaction of the
performance obligation. (See discussion of accounting for uninstalled materials in Example 12 below.)
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Allocating the transaction price
The transaction price is allocated to the performance obligations in a contract that require separate accounting. Of
particular interest will be the allocation of variable consideration (for example, award or incentive payments)
associated with only one performance obligation, rather than the contract as a whole. An entity can allocate the
transaction price entirely to one (or more) performance obligations when certain conditions are met.
New standard Current US GAAP Current IFRS
The transaction price (and any
subsequent changes in estimate of the
transaction price) is allocated to each
separate performance obligation based
on the relative stand-
alone selling price
of each performance obligation. The
best evidence of a stand-alone selling
price is the observable price of a good
or service when sold separately.
The stand-alone selling price should
be estimated if the actual selling price
is not directly observable. The
standard does not prescribe a specific
estimation method. For example, a
contractor might use cost plus a
reasonable margin to estimate the
selling price of a good or service. An
entity should maximise the use of
observable inputs when estimating the
stand-alone selling price.
Entities may use a residual approach
to estimate the stand-alone selling
price if the stand-alone selling price of
a good or service is highly variable or
uncertain.
An entity may also allocate a discount
or an amount of contingent
consideration entirely to one (or more)
performance obligations if certain
conditions are met.
Except for allocation guidance related
to contract segmentation, there is no
explicit guidance on allocating contract
revenue to multiple deliverables in a
construction contract, given the
presumption that the contract is the
profit centre for determining revenue
recognition.
Except for allocation guidance related
to contract segmentation, there is no
explicit guidance on allocating contract
revenue to multiple deliverables in a
construction contract, given the
presumption that the contract is the
profit centre for determining revenue
recognition.
Example 7 - Allocating contract revenue to more than one performance obligation
Facts: A contractor enters into a contract to build both a road and a bridge (assume there are two separate
performance obligations: building the road and building the bridge). The contractor determines at inception that the
contract price is C151 million, which includes a C140 million fixed price and an estimated C11 million award fee. The
amount of the award fee is variable depending on how early the contractor finishes the project. The contractor will
receive a base award fee of C10 million if it finishes the project 30 days ahead of schedule. The award fee increases
(decreases) by 10% for each day before (after) the 30 days it finishes the project. The contractor has experience with
similar contracts. The contractor uses the most likely amount to estimate the variable consideration associated with
the incentive bonus of C10 million. Based on the contractor’s prior experience and its current estimates, the
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contractor determines that it will finish the project 30 days ahead of schedule and be entitled to the C10 million
award fee. The contractor uses the expected value method to estimate the additional variable consideration associated
with the 10% daily penalty or incentive and determines it will be entitled to a 10% increase or C1 million. The
contractor concludes that it is highly probable (IFRS) or probable (US GAAP) that a change in estimate would not
result in a significant revenue reversal in the future.
How should the contractor allocate the contract price to the two separate performance obligations?
Discussion: The contractor must first assign a stand-alone selling price to each of the road and the bridge in order to
allocate the contract price (including both the fixed and variable amounts). The contractor constructs roads and
bridges of a similar type and nature to those required by the contract on a stand-alone basis. The stand-alone selling
price of the road, based on prior experience, is C140 million. The stand-alone selling price of the bridge, based on
prior experience, is C30 million. There is an inherent discount of C19 million built into the bundled contract. The
C151 million transaction price is allocated as follows using a relative allocation model:
Road:
C124.4m (C151m * (C140m / C170m))
Bridge: C 26.6m (C151m * (C 30m / C170m))
Example 8 - Allocating contract revenue – changes in the transaction price
Facts: Assume the same fact pattern as Example 7 above, except that the amount of variable consideration changes
from an expected C11 million to an expected C13 million after contract inception. The changes are due to improved
weather conditions during the construction period and therefore an expectation that the contractor will complete the
entire project earlier than expected.
How should the contractor allocate the change in the estimated contract price?
Discussion: The basis for allocating the transaction price to performance obligations (that is, the percentage used to
allocate based on relative stand-alone selling prices) does not change after contract inception. The additional C2
million of transaction price is allocated to the road and bridge using the initially developed allocation percentages as
follows:
Road: C1.6m (C2m * (C140m / C170m))
Bridge: C0.4m (C2m * (C 30m / C170m))
The change in estimate is recognised using a cumulative catch-up approach. For example, if the road is 90% complete
and work on the bridge has not yet commenced when the estimate changes, the contractor will recognise cumulative
revenue of C113.4 million (C124.4 million x 90% +C1.6 million x 90%) for the portion of the performance obligation
already satisfied for the road. The contractor will recognise additional revenue of C12.6 million (C124.4 million x 10%
+ C1.6 million x 10%) as the remaining performance obligations related to the road are satisfied and C27 million
((C26.6 million + C0.4 million) x 100%) as the bridge is completed.
Assume the same fact pattern as above, except that the bridge is completed and the amount of the award fee only
relates to the completion of the road. In this situation, the contractor will allocate the entire change in the estimated
contract price of C2 million to the road. The contractor will recognise additional revenue of C1.8 million (C2 million x
90%) in the period of the change of estimate for the portion of the performance obligation already satisfied for the
road. The contractor will recognise the remaining revenue of C12.6 million (C124.4 million x 10% + C2 million x 10%)
as the remaining performance obligations related to the road are satisfied.
Recognising revenue
Revenue recognition under existing guidance is based on the activities of the contractor; that is, provided reasonable
estimates are available, revenue can be recognised as the contractor performs (known as the percentage-of-
completion method). Revenue is recognised under the new standard when a performance obligation is satisfied,
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which occurs when control of a good or service transfers to the customer. Control can transfer either at a point in time
or over time. The change to a control transfer model requires careful assessment of when a contractor can recognise
revenue. Many construction-type contracts will transfer control of a good or service over time and therefore might
result in a similar pattern of revenue recognition as today’s guidance. This should not, however, be assumed.
Contractors will not be able to default to the method used today, and will need to perform a careful assessment of
when control transfers.
New standard Current US GAAP Current IFRS
Transfer of control
Revenue is recognised upon the satisfaction of
performance obligations, which occurs when
control of the good or service transfers to the
customer. Control can transfer at a point in
time or, perhaps more common for the E&C
industry, over time.
A performance obligation is satisfied over time
when at least one of the following criteria is
met:
• The customer receives and consumes the
benefits of the entity’s performance as the
entity performs.
• The entity’s performance creates or
enhances a customer-controlled asset.
• An asset with an alternative use to the entity
is not created but the entity has a right to
payment for performance completed to
date.
A performance obligation is satisfied at a point
in time if it does not meet the criteria above.
Determining when control transfers will
require a significant amount of judgement.
Indicators that might be considered in
determining whether the customer has
obtained control of an asset at a point in time
include:
• The entity has a present right to payment.
• The customer has legal title.
• The customer has physical possession.
• The customer has the significant risks and
rewards of ownership.
• The customer has accepted the asset.
Revenue is recognised using the
percentage-of-completion method
when reliable estimates are
available. The percentage-of-
completion method based on a
zero-profit margin is used when
reliable estimates cannot be made,
but there is an assurance that no
loss will be incurred on a contract
(for example, when the scope of
the contract is ill-defined, but the
contractor is protected from an
overall loss) until more precise
estimates can be made.
The completed-contract method is
required when reliable estimates
cannot be made.
Revenue is recognised using the
percentage-of-completion method
when reliable estimates are
available.
The percentage-of-completion
method based on a zero-profit
margin is used when reliable
estimates cannot be made, but
there is assurance that no loss will
be incurred on a contract (for
example, when the scope of the
contract is ill-defined, but the
contractor is protected from an
overall loss) until more precise
estimates can be made.
Contract costs that are not probable
of being recovered are recognised
as an expense immediately. The
completed contract method is
prohibited.
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New standard Current US GAAP Current IFRS
This list is not intended to be a checklist
or all-inclusive. No one factor is
determinative on a stand-alone basis.
Measuring performance
obligations satisfied over time
A contractor should measure progress
toward satisfaction of a performance
obligation that is satisfied over time
using the method that best depicts the
transfer of goods or services to the
customer. Methods for recognising
revenue when control transfers over time
include:
• Output methods that recognise
revenue on the basis of direct
measurement of the value to the
customer of the entity’s performance
to date (for example, surveys of goods
or services transferred to date,
appraisals of results achieved).
• Input methods that recognise revenue
on the basis of the entity’s efforts or
inputs to the satisfaction of a
performance obligation (for example,
cost-to-cost, labour hours, labour
cost, machine hours, or material
quantities).
The method selected should be applied
consistently to similar contracts with
customers. Once the metric is calculated
to measure the extent to which control
has transferred, it must be applied to
total contract revenue to determine the
amount of revenue to be recognised.
The effects of any inputs that do not
represent the transfer of goods or
services to the customer, such as
abnormal amounts of wasted materials,
should be excluded from the
measurement of progress.
It may be appropriate to measure
progress by recognising revenue equal to
the costs of the transferred goods if goods
are transferred at a significantly different
time from the related service
A contractor can use either an input
method (for example, cost-to-cost,
labour hours, labour cost, machine
hours, or material quantities), an
output method (for example,
physical progress, units produced,
units delivered, or contract
milestones), or the passage of time
to measure progress toward
completion.
There are two different approaches
for determining revenue, cost of
revenue, and gross profit once a
‘percentage complete’ is derived: the
Revenue method and the Gross
Profit method.
A contractor can use either an input
method (for example, cost-to-cost,
labour hours, labour cost, machine
hours, or material quantities), an
output method (for example, physical
progress, units produced, units
delivered, or contract milestones), or
the passage of time to measure
progress toward completion.
IFRS requires the use of the Revenue
method to determine revenue, cost of
revenue, and gross profit once a
‘percentage complete’ is derived. The
Gross Profit method is not permitted.
14
New standard Current US GAAP Current IFRS
(such
as materials the customer controls
before the entity installs the materials).
Estimates to measure the extent to which
control has transferred (for example,
estimated costs to complete when using a
cost-to-cost calculation) should be
regularly evaluated and adjusted using a
cumulative catch-up method.
Example 9 - Recognising revenue
Facts: A contractor enters into a construction contract with an owner to build an oil refinery. The contract has the
following characteristics:
• The oil refinery is highly customised to the owner’s specifications and changes to these specifications by the owner
are expected over the contract term.
• The oil refinery does not have an alternative use to the contractor.
• Non-refundable, interim progress payments are required as a mechanism to finance the contract.
• The owner can cancel the contract at any time (with a termination penalty); any work in process is the property of
the owner. As a result, another entity would not need to re-perform the tasks performed to date.
• Physical possession and title do not pass until completion of the contract.
The contractor determines that the contract has a single performance obligation to build the refinery.
How should the contractor recognise revenue?
Discussion: The preponderance of evidence suggests that the contractor’s performance creates an asset that the
customer controls and control is being transferred over time. The contractor will have to select either an input or
output method to measure the progress toward satisfying the performance obligation.
Example 10 - Recognising revenue - use of cost-to-cost
Facts: Assume the same fact pattern as Example 9 above. Additional contract characteristics are:
• Contract duration is three years.
• Total estimated contract revenue is C300 million.
• Total estimated contract cost is C200 million.
• Year one cost is C120 million (including C20 million related to contractor-caused inefficiencies).
The contractor concludes that cost-to-cost is a reasonable method for measuring the progress toward satisfying its
performance obligation.
How much revenue and cost should the contractor recognise during the first year?
15
Discussion: The contractor should exclude any costs that do not depict the transfer of goods or services to determine
the amount of revenue to recognise under a cost-to-cost model. The costs associated with contractor-caused
inefficiencies should be excluded in this situation. The amounts of contract revenue and cost recognised at the end of
year one are:
Revenue: C150m (C300m * (C100m / C200m))
Contract cost (excluding inefficiencies): C100m
Gross contract margin: C 50m
Contract inefficiencies: C 20m
Adjusted contract margin: C 30m
Example 11 - Recognising revenue - use of cost-to-cost with changes in estimates
Facts: Assume the same fact pattern as Examples 9 and 10 above, except that the total estimated cost to complete the
contract increases at the end of the second year to C250 million due to an increase in the cost of materials. Actual
cumulative costs incurred as of the end of the second year (excluding year-one inefficiencies) is C200 million.
How much revenue and cost should the contractor recognise during the second year?
Discussion: The amount of contract revenue and cost recognised during the second year:
Cumulative revenue:
C240m (C300m * (C200m / C250m)
Revenue recognised year one: C150m
Revenue recognised year two: C 90m
Cumulative costs (excluding inefficiencies): C200m
Costs recognised year one (excluding inefficiencies): C100m
Costs recognised year two: (excluding inefficiencies):
C100m
Gross contract margin year two: C (10m) (C90m - C100m)
Gross contract margin to-date (excluding inefficiencies): C 40m (C240m - C200m)
Adjusted contract margin to
-date: C 20m (C240m - C200m - C20m)
Example 12 - Recognising revenue – uninstalled materials
Facts: Assume the same fact pattern as Example 6 above and at contract inception the contractor estimates the
following:
Contract price: C100 million
Contract costs: C50 million
Cost of the specialised equipment: C20 million
Discussion: The contractor concludes that including the costs to procure the specialised equipment in measuring
progress would overstate the extent of the contractor’s performance. Therefore, revenue should be recognised for the
specialised equipment in an amount equal to the cost of the specialised equipment upon the transfer of control to the
customer. As such, the contractor excludes the cost of the specialised equipment from its measure of progress toward
complete satisfaction of the performance obligation on a cost-to-cost basis. During the first six months, the contractor
incurs C25 million of costs compared to the total of C50 million of expected costs to complete (excluding the C20
million cost of the specialised equipment). Therefore, the contractor estimates that the performance obligation is 50
percent complete (C25 million ÷ C50 million) and recognises revenue of C40 million (50% × (C100 million total
transaction price – C20 million revenue for the specialised equipment)). Upon transfer of control of the specialised
16
equipment, the contractor recognises revenue and costs of C20 million. Subsequently, the contractor continues to
recognise revenue on the basis of costs incurred relative to total expected costs (excluding the revenue and cost of the
specialised equipment).
Other considerations
Warranties
Most warranties in the construction industry provide coverage against latent defects. There is currently diversity in
the way E&C companies account for these and other types of warranties. Warranty costs are either accounted for
within contract accounting (for example, as a contract cost) or outside of contract accounting in accordance with the
existing loss contingency guidance. We expect practice to become less diverse and potentially change significantly for
some entities that utilise a cost-to-cost input method for measuring progress and do not currently include warranty as
a contract cost.
New standard Current US GAAP Current IFRS
Warranties that the customer has the option
to purchase separately give rise to a separate
performance obligation. A portion of the
transaction price is allocated to that separate
performance obligation at contract inception.
The warranty is accounted
for as a cost accrual
if a customer does not have the option to
purchase a warranty separately from the
entity.
An entity might provide a warranty that calls
for a service to be provided to the customer
(for example, maintenance) in addition to a
promise that the entity’s past performance
was as specified in the contract. The entity
will account for the service component of the
warranty as a separate performance obligation
in these circumstances. An entity that cannot
reasonably account for an assurance warranty
separately from services also provided under
the warranty should account for both
warranties together as a single performance
obligation.
Contractors typically account for
warranties that protect against latent
defects outside of contract
accounting and in accordance with
existing loss contingency guidance. A
contractor recognises revenue and
concurrently accrues any expected
cost for these warranty repairs.
Revenue is deferred for warranties
that protect against defects arising
through normal usage (that is,
extended warranties) and recognised
over the expected life of the contract.
Contractors are required to
account for the estimated costs of
rectification and guarantee work,
including expected warranty
costs, as contract costs. However,
contractors typically account for
standard warranties protecting
against latent defects outside of
contract accounting and in
accordance with existing
provisions guidance. A
contractor will recognise revenue
and concurrently accrue any
expected cost for these warranty
repairs.
Revenue is deferred for
warranties that protect against
defects arising through normal
usage (that is, extended
warranties) and recognised over
the expected life of the contract.
Example 13 - Accounting for warranties
Facts: Assume the same fact pattern as Example 9 above. The contractor also provides a warranty that covers latent
defects for certain components of the oil refinery. This warranty is automatically provided by the contractor and the
customer does not have an option to purchase the warranty separately from the contractor.
How should the contractor account for such a warranty?
Discussion: The contractor should account for this warranty as a cost accrual. Contractors who determine that cost-to
cost is an appropriate method to measure transfer of control over time might therefore have to consider these costs in
their cost-to-cost calculation.
17
Contract costs
Existing construction contract guidance contains a substantial amount of cost capitalisation guidance, both related to
pre-contract costs and costs to fulfil a contract. The new standard also includes contract cost guidance that could
result in a change in the measurement and recognition of contract costs as compared to today. In particular,
measurement and recognition could change for those contractors that currently use the Gross Profit method for
calculating revenue and cost of revenue.
New standard Current US GAAP Current IFRS
All costs related to satisfied performance
obligations and costs related to
inefficiencies (that is, abnormal costs of
materials, labour, or other costs to fulfil)
are expensed as incurred.
Incremental costs of obtaining a contract
are costs that the entity would not have
incurred if the contract had not been
obtained and are recognised as an asset if
they are expected to be recovered. As a
practical expedient, such costs may be
expensed as incurred if the amortisation
period of the asset that the entity otherwise
would have recognised is one year or less.
Costs to obtain a contract that would have
been incurred regardless of whether the
contract was obtained (for example, certain
bid costs) are recognised as an expense
when incurred, unless those costs are
explicitly chargeable to the customer
regardless of whether the contract is
obtained.
Direct costs of fulfilling a contract are
accounted for in accordance with other
standards (for example, inventory,
intangibles, fixed assets) if they are within
the scope of that guidance.
Direct costs of fulfilling a contract are
capitalised under the new standard if not
within the scope of other standards and if
they relate directly to a contract, relate to
future performance, and are expected to be
recovered under the contract.
Capitalised costs are amortised as control
of the goods or services to which the asset
relates is transferred to the customer,
which may include goods or services to be
provided under specific anticipated
contracts (for example, a contract
renewal).
There is a significant amount of
detailed guidance relating to the
accounting for contract costs within
the construction contract guidance.
This is particularly true with respect
to accounting for pre-contract costs.
Pre-contract costs that are incurred
for a specific anticipated contract
generally may be deferred only if
their recoverability from that
contract is probable.
Other detailed guidance on costs to
fulfil a contract is also prescribed by
current guidance.
There is a significant amount of
detailed guidance relating to the
accounting for contract costs.
Costs that relate directly to a contract
and are incurred in securing the
contract are included as part of
contract costs if they can be separately
identified, measured reliably, and it is
probable that the contract will be
obtained.
Other detailed guidance on costs to
fulfil a contract is also prescribed by
current guidance.
18
Example 14 - Accounting for contract costs
Facts: Assume the same fact pattern as Examples 9 and 10 above. At the beginning of the contract, the contractor
incurs certain mobilisation costs amounting to C1 million. The contractor has concluded that such costs should not be
accounted for in accordance with existing asset standards (for example, inventory, fixed assets, or intangible assets).
How should the contractor account for the mobilisation costs?
Discussion: These costs to fulfil a contract would be capitalised if they: (a) relate directly to the contract; (b) relate to
future performance; and (c) are expected to be recovered. Assuming the mobilisation costs meet these criteria and are
capitalised, C500,000 would be amortised as of the end of year one (coinciding with 50 percent control transfer using
a cost-to-cost method) using the fact pattern in Examples 9 and 10 above. Amortisation of capitalised mobilisation
costs would be included in the measurement of the contractor’s satisfaction of its performance obligation.
Contract assets and liabilities
Existing construction contract guidance requires a contractor to record an asset for unbilled accounts receivable when
revenue is recognised but not billed. The unbilled accounts receivable is transferred to a billed accounts receivable
when the invoice is submitted to the customer. Under the new standard, if a contractor delivers services to a customer
before the customer pays consideration, the contractor should record either a contract asset or a receivable depending
on the nature of the contractor’s right to consideration for its performance. The transfer from a contract asset to an
accounts receivable balance (when the contractor has a right to payment) may not coincide with the timing of the
invoice as is required under the existing guidance. Cost in excess of billings and billings in excess of cost initially
recognised on the balance sheet under current GAAP should be similar to the contract asset and contract liability
recognised under the new standard.
New standard Current US GAAP Current IFRS
The entity should present either a contract
asset or a receivable depending on the nature
of the entity’s right for its performance, if an
entity recognises revenue before the
customer pays consideration.
(a) A contract asset is an entity’s right to
payment 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 (for example,
the entity’s future performance).
(b) A receivable is an entity’s right to
payment that is unconditional.
If a customer makes a payment or an amount
of payment is due before an entity satisfied
its performance obligations, the entity should
present that amount as a contract liability. A
contract liability is an entity’s obligation to
transfer goods or services to a customer for
which the entity has received payment from
the customer.
Unbilled receivables arise when
revenues have been recognised
as the performance of contract
work is being performed, but the
amount cannot be billed under
the terms of the contract until a
later date.
Billings in excess of costs and
estimated earnings represent
obligations for work to be
performed with the exception of
when billings exceed total
estimated costs at completion of
the contract plus contract profits
earned to date.
A contractor may have incurred
contract costs that relate to future
activities on the contract. Such
contract costs are recognised as an
asset provided it is probable that they
will be recovered. Such costs represent
an amount due from the customer and
are often classified as contract work in
process.
Advances received before the related
work has been performed are
recognised as a liability.
19
Onerous performance obligations
Existing construction contract guidance requires a loss to be recorded when the expected contract costs exceed the
total anticipated contract revenue. Existing guidance related to the recognition of losses arising from contracts with
customers will be retained for entities within the scope of that guidance.
Final thoughts
The above discussion does not address all aspects of the new standard. Companies should continue to evaluate how
the new standard might change current business activities, including contract negotiations, key metrics (including
debt covenants, surety, and prequalification capacity calculations), taxes, budgeting, controls and processes,
information technology requirements, and accounting.
Entities can adopt the final standard retrospectively or use a simplified approach. Entities using the simplified
approach will: (a) apply the revenue standard to all existing contracts as of the effective date and to contracts entered
into subsequently; (b) recognise the cumulative effect of applying the new standard in the opening balance of retained
earnings on the effective date; and (c) disclose, for existing and new contracts accounted for under the new revenue
standard, the impact of adopting the standard on all affected financial statement line items in the period the standard
is adopted. An entity that uses this approach must disclose this fact in its financial statements.
Contact us
Questions?
To have a deeper discussion, please contact:
Name
E
-
mail
Designation
Telephone
Steven Drake
s.drake
@ae.pwc.com
Partner
–
Accounting
Advisory Services
+971 4 3043 421
Gavin Steel
Partner
–
Accounting
Advisory Services
+971 4 3043 308
Mohamed Ashraf
Kashef
mohamed.ashraf.kashef
@ae.pwc.com
Director
–
Accounting
Advisory Services
+
971 4 3043 187
Mahjid Malik
mahjid.mali[email protected]
Senior Manager
–
Accounting Advisory
Services
+971 4 3043 379
This content is for general information purposes only, and should not be used as a substitute for consultation
with professional advisors.
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