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Interm ch6

The document outlines the revenue recognition framework established by IFRS 15 and ASC 606, which introduces a five-step model for recognizing revenue from contracts with customers. It also discusses long-term construction contracts, their types, benefits, challenges, and the basic terminologies used in construction accounting. Additionally, it explains two methods for revenue recognition in long-term contracts: the percentage-of-completion method and the completed-contract method, highlighting their applications and differences under IFRS and GAAP.

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5 views5 pages

Interm ch6

The document outlines the revenue recognition framework established by IFRS 15 and ASC 606, which introduces a five-step model for recognizing revenue from contracts with customers. It also discusses long-term construction contracts, their types, benefits, challenges, and the basic terminologies used in construction accounting. Additionally, it explains two methods for revenue recognition in long-term contracts: the percentage-of-completion method and the completed-contract method, highlighting their applications and differences under IFRS and GAAP.

Uploaded by

Eliyas Man
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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HARAMBEE UNIVERSITY

FACULTY OF BUSINESS AND ECONOMICS


DEPARTMENT OF ACCOUNTING AND FINANCE
INTERMEDIATE FINANCIAL ACCOUNTING-II
2025/2017 ACADEMIC YEAR
CHAPTER VI-REVENUE RECOGNITION

1. Revenue recognition framework

In May 2014, the FASB and IASB issued new, converged guidance on revenue recognition.
This, guidance, known as IFRS 15, aims to improve consistency in recognizing revenue from
contracts with customers. ASC 606 became effective in 2017 for public companies and 2018 for
private companies.

IFRS 15 (ASC 606) introduces a five-step model for recognizing revenue:

1. Identify the contract: A valid contract exists when the parties are committed, the rights
and payment terms are clear, and the contract has commercial substance.
2. Identify the performance obligations: Determine what goods or services are promised in
the contract.
3. Determine the transaction price: The amount expected in exchange for the promised
goods or services.
4. Allocate the transaction price: Split the transaction price based on the standalone selling
price of each performance obligation.
5. Recognize revenue: Revenue is recognized when control of the goods or services is
transferred to the customer.

This model applies to a wide range of industries, ensuring uniformity in how companies report
revenue.

2. Long-term construction contracts


Definition of a Long-term construction contracts
In construction, a long-term contract is any contract that extends beyond one year. Typically,
these contracts involve complex projects that require extended periods of time to complete.
These contracts are essential for large-scale projects like highways, bridges, and commercial
buildings.
Types of Long-Term Contracts

 Fixed-Price Contracts_ provide for a single price for all work performed by the contractor
 Cost-Plus Contracts_ provide for reimbursement of specified costs incurred by the
contractor plus a fee for the contractor’s service
 Time and Materials Contracts_ provide for a fixed hourly rate for the contractor’s direct
labor hours, plus payment for cost of material and other specified items.
 Unit Price Contracts_ include a fixed price for each unit of output under the contract

Benefits of Long-Term Contracts

 Predictable Cash Flow: Long-term contracts provide a steady flow of income over a
longer period.
 Stronger Relationships: They foster long-term relationships with clients, leading to repeat
business.
 Risk Management: Spread financial risk over multiple months or years.

Challenges of Long-Term Contracts

Challenge Description

Cost Overruns Expenses may exceed initial estimates due to changing material costs or labor rates.

Delays Projects may take longer than planned, affecting the budget and schedule.

Regulatory
Changes in laws or building codes can add unexpected complications and costs.
Changes
3. Basic terminologies in construction contract

The Basics of Construction Accounting

Construction accounting has been developed to aid contractors in monitoring individual projects
and understanding their overall impact on the company.

Here are some key terms that are used within construction accounting:

 Contract Revenue: The revenue generated from the construction contract.


 Contract Costs: Expenses associated with fulfilling contract obligations.
 Gross Profit: Revenue after deducting the costs related to a particular project.
 Work in Progress: Ongoing projects and their accumulated costs.
 Overbilling and Under billing: Charging more or less than the work
 Retention: The amount withheld until the project has been completed satisfactorily.
 Change Orders: Modifications to the original contract, which often impacts costs.
 Progress billing occurs when contractors bill based on how much of the project is
completed at each interval
 Contract price- price agreed upon by the contractor and the client for the construction of a
specific project. It represents the contract revenue.
 Cost incurred to date- the cumulative cost of construction incurred by the contractor from
the time the project started up to a particular financial position date.
 Estimated cost to complete- the additional cost of construction reasonably expected to be
incurred to complete the project.
 Total estimated cost-the sum of the cost incurred to date and the estimated cost to
complete. it is the total estimated cost upon completion of the project.
 Total estimated gross profit- the excess of the contract price over the total estimated cost.
 Total estimated loss- the excess of the total estimated cost over the total contract price.
4. Revenue recognition

Revenue recognition for long-term construction contracts can be accounted for using two
basic methods:

 Percentage-of-completion method: revenue, costs, and profits are recognized each accounting
period as the contract progresses to completion.
 Completed-contract method: revenues, costs, and profits are deferred until the project is
substantially complete.
Under IFRS, companies should use the percentage of completion method to account for long-
term contracts. If costs and revenues are difficult to estimate, companies should only recognize
revenue to the extent of the costs incurred. IFRS 15 changes the way in which revenue is
recognized by redefining the activities that determine the completion of performance obligations
as required by the contract. Contractors should recognize revenue “over time” (incrementally
during the life of the contract) when the customer has control. Alternatively, when contractors
retain control, they should recognize revenue at “a point in time” when control is eventually
transferred to the customer.

4.1 The percentage-of-completion


This way of recognizing revenue works best when you are reasonably able to estimate the stages
of project completion as well as the remaining costs of completing the project.If you are unable
to calculate these two things, then it might be best to use a different method. According to this
method, you would calculate the total expenses for the accounting period as a percentage of the
overall cost to complete the contract, and multiple that by the total revenue created by the
contract

4.2 Completed Contract Method


This method of revenue recognition does not report any income until the contract is finished
because there is uncertainty about the collection of funds from the customer under the terms of
the contract. The completed contract method should be used if it is difficult to estimate costs and
the associated percent of total expenses, and if there are inherent hazards that may interfere with
project completion.
IFRS and GAAP both acknowledge this method, however they differ slightly. If reporting using
IFRS, the company will record a revenue and an expense, which will offset each other, and will
only record a profit once the contract has been completed. Under GAAP, no expense or revenue
is reported until the contract is completed. Instead, an asset will be created and a decrease in
cash will occur equal to the amount of contract-related expenses incurred during the year. When
the contract has been completed revenue and expenses will be realized.

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