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moreŁucja PADRAK
Audit Manager at RSM Poland
We have recently devoted a lot of attention to the IFRS 15 standard which has introduced uniform principles for determining the time of recognising revenue irrespective of the service performed or the goods supplied (with certain exceptions). Today we are going to discuss the impact of these changes on reporting in companies on the example of recognising revenue from the performance of construction services.
IFRS15 defines two ways of recognising revenue, i.e.:
- over time;
- at a point in time.
In order to make the right choice of one of the above methods, one must analyse the three conditions (listed below) that determine recognising revenue by the entity over time. If none of these conditions is met, the entity recognises revenue at a point in time.
1. The customer simultaneously receives and consumes benefits provided by the entity as the entity performs.
According to the interpretations issued by the International Accounting Standards Board, this criterion pertains to goods and services that can be consumed on an ongoing basis. Therefore, this condition should not be considered in the case of construction services[1].
2. The entity’s performance creates or enhances as asset (e.g. work in progress) that the customer controls as the asset is created or enhanced.
In line with the regulations, the control shall be understood as the ability to directly use and to obtain substantially all of the remaining benefits from the asset. In the case of assets, it means that the customer has control over the asset at each stage of production. An example of such a situation is the construction of real estate on land being owned by the customer[2].
If it proves problematic to determine whether the customer has control over the asset as the construction service is being performed, the second condition must be analysed.
3. The entity’s performance does not create as asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
When checking if a given construction service meets the above criterion, it must be analysed whether the two conditions discussed below are met.
An asset with an alternative use to the entity is not created.
At this point it should be recalled that the basic principle defining when to recognise revenue is the moment in which the control over the asset is transferred. If the created asset can have an alternative use, e.g. free sale to another customer, it means that the control over the asset has not been transferred to the customer, thus there are no grounds for recognising the revenue. It should be noted that, apart from the product universality, legal restrictions that are often involved in the case of construction services, play a key role here. In a situation in which the contract for a construction service provides that the created asset can only be sold to a predefined customer, it must be stated that this customer controls the asset the moment it is created, thus the revenue should be recognised over time.
The entity has an enforceable right to payment for performance completed to date.
In accordance with IFRS 15 B9, the entity has the right to payment for performance completed to date if the entity would be entitled to an amount that at least compensates the entity for its performance completed to date in the event that the customer or another party terminates the contract for reasons other than the entity’s failure to perform as promised.
And what if you are entitled, under the contract, to payment only once a certain milestone is reached?
In accordance with the regulations, when assessing whether the entity has the right to payment for performance completed to date one must consider whether in the event that the contract is terminated for reasons other than the entity’s failure to perform as promised before the end of performance, the entity would have an enforceable right to demand or keep payment for the services performed to date.
Looking at the above conditions it can be assumed that a majority of the concluded construction contracts would meet at least one of them, which means that the revenue should be recognized over time. To do this, one of the methods below should be selected to define the progress towards a complete satisfaction of a performance obligation by the entity.
1.Output methods.
They involve recognising revenue on the basis of a direct measurement of the value of the goods and services transferred to the customer to date relative to the remaining goods and services promised under the contract. These methods include, but are not limited to, the survey of performance completed to date, the appraisal of results achieved, milestones reached, time elapsed and the units produced or delivered.
2. Input methods.
Input methods recognise revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labour hours expended, costs incurred, time lapsed or machine hours used) relative to the total expected inputs necessary for the satisfaction of the performance obligation. If the entity’s efforts or inputs are expended evenly throughout the performance period, the entity may recognise revenue on a straight-line basis.
It should be remembered that when choosing the method, one must decide which of them would provide a reliable reflection of the progress towards the satisfaction of the performance obligation by the entity.
Summing up, the changes in IFRS 15 provisions will primarily require companies from the construction industry to analyse the concluded contracts in terms of the criteria for recognising revenue over time.
And what does the situation look like in other industries? This will be discussed in the next article.