IFRS 15, the new revenue recognition standard, has brought significant changes to the construction industry. It replaces the complex and differing systems used previously, giving a more consistent and transparent approach to revenue recognition. Construction companies affected by this standard will need to identify their contracts, evaluate variable consideration, and allocate the transaction price to meet the revenue recognition criteria.
Here are some examples of how IFRS 15 impacts construction contracts:
Example 1: A construction company has a contract to build a new office building for a client. The construction will take one year to complete, and the contract price is $10 million. Payment terms are set up to pay based on milestones, with 30% upfront, 35% on completion of the structure, and 35% on the final handover of the building.
Under IFRS 15, the construction company needs to evaluate the variable consideration, which includes milestones. The revenue can be recognized when milestones are achieved and control of the project is passed to the client. For instance, the upfront payment of 30% can be recognized as revenue upon receipt of payment, while the remaining 70% is recognized based on completion of the project. This is because the completion of each milestone represents the delivery of a distinct good to the customer.
Example 2: A construction company agrees to undertake a renovation contract for a client. The contract price is $2 million, and the construction will take six months to complete. The payment terms are set up, with 50% paid upfront and the remaining 50% on project completion.
The construction company needs to allocate the transaction price under IFRS 15. Since the renovation work is a single performance obligation, the entire transaction price of $2 million is allocated to this obligation. Therefore, the company can recognize $1 million as revenue upfront, and the remaining $1 million when the project is completed.
Example 3: A construction company signs a contract to build a warehouse for a client. The contract price is $5 million, and the construction will take two years to complete. At the end of year one, the client requests a change to the construction plan that will cause the project to incur an additional cost of $1 million.
Under IFRS 15, the construction company needs to evaluate the change in the transaction price due to the client`s request. Since the change in price is not a distinct good, it is considered a modification of the existing contract. Therefore, the company needs to evaluate the change in the transaction price and allocate it to the remaining period of the project. This may require the company to adjust the revenue recognized to date.
In conclusion, IFRS 15 has brought significant changes to revenue recognition for construction contracts. The construction industry needs to evaluate their contracts and allocate the transaction price to meet the revenue recognition criteria. By doing so, they can ensure that revenue is recognized accurately, and financial statements are transparent.