IFRS 15 specifies the circumstances under which an entity recognizes revenue as well as requiring companies to provide users of financial statements with more informative and relevant disclosures. The standard provides a principles-based five-step model to be applied to contracts with customers and will apply to the annual reporting period beginning on or after 1 January 2018.
IFRS 15 replaces the following standards and interpretations:
- IAS 11 Construction contracts
- IAS 18 Revenue
- IFRIC 13 Customer Loyalty Programmes
- IFRIC 15 Agreements for the Construction of Real Estate
- IFRIC 18 Transfers of Assets from Customers
- SIC-31 Revenue – Barter Transactions Involving Advertising Services
The impact of IFRS 15 on the Construction Industry:
1. Capitalizing on pre-contract costs
- Under IFRS 15, an entity recognises as an asset the incremental costs of obtaining a contract with a customer only if it expects to recover those costs. However, if the amortization period of the asset is one year or less, the entity is allowed to expense such costs as incurred.
- Incremental costs of obtaining a contract are costs that are incurred only as a result of winning a contract (e.g. a sale commission). Although this focus on purely incremental cost already exists in current IFRS; it is a new approach in contract accounting.
- Costs incurred during the bid process that would have been incurred regardless of whether the contract was won or lost (e.g. due diligence costs) are recognised as an expense when incurred unless they are directly chargeable to the customer. This is regardless of whether the contract is obtained.
- For costs other than the costs of obtaining the contract, a contractor would first consider if such costs can be capitalised under another standard (e.g. as inventory). If these costs cannot be capitalized, the contractor considers if these costs represent ‘fulfilment costs’ under IFRS 15.
2. Identifying contract performance obligations
- IFRS 15 requires an entity to identify the performance obligations in a contract. A performance obligation is a promise to transfer a good or service to a customer. A performance obligation may be identified explicitly in the contract or implied through previous business practices, published policies or specific statements. A good or service is distinct from other goods and services, and so is a performance obligation if, firstly, 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 secondly the promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.
3. Revenue Recognition
- While IFRS 15 was under development, a key concern was whether contractors would continue to recognise revenue as the contract progresses, similar to the stage of completion method under IAS 11.
- Under IFRS 15, revenue is recognised when, or as, performance obligations are satisfied through the transfer of control of a good or service to a customer. An entity recognises revenue over time if one or more of the following criteria are met:
- The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs – for example, routine or recurring services
- The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced – for example, building an asset on a customer’s site
- 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 – for example, building a specialised asset that only the customer can use, or building an asset to a customer order.
- If it cannot be demonstrated that a performance obligation is satisfied over time, then an entity recognises revenue at the point in time when it satisfies the performance obligation by transferring control of the completed good or service to a customer. IFRS 15 defines control as the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. The benefits of an asset are the potential cash flows (inflows or savings in outflows) that can be obtained directly or indirectly.
During the contract life cycle
1. Capitalising of contract costs
- An entity recognises an asset for the costs incurred to fulfil a contract (e.g. work in progress) when the criteria for recognising an asset are met. Costs that qualify for capitalisation under other standards – e.g. property, plant and equipment – continue to be capitalised under the relevant standards. IFRS 15 provides specific guidance on what costs are required to be expensed. The aim is to ensure that only costs that relate to satisfying (or continuing to satisfy) future performance obligations are capitalised with all other costs expensed off to profit or loss.
2. Measuring contract progress
- If performance obligations are satisfied over time, i.e. similar to the current stage of completion accounting, an entity uses a measure of progress that depicts the transfer of goods or services to the customer in order to determine the amount of revenue to be recognized during the period.
- An entity applies a single method of measuring progress for each performance obligation satisfied over time and applies that method consistently to similar performance obligations and in similar circumstances.
- This may be one of the two methods:
- An input method (e.g. contract costs incurred to date as a percentage of total forecast costs); or
- An output method (e.g. surveys of work completed to date).
- A contractor applying an input method excludes the effect of any inputs that do not depict its performance in transferring control of goods or services to the customer. For example, when using a cost-to-cost method, the contractor would exclude unexpected amounts of wasted materials, labour and any uninstalled materials.