By Lim Ju May
Property Developers have reckoned with the accounting for construction contracts for decades.
IAS 11 Construction Contracts was first issued in 1979 to prescribe the accounting treatment of revenue and costs associated with construction contracts. IAS 11 aptly named was the eleventh accounting standard issued by the International Accounting Standards Committee (IASC).
The IASC which was formed in 1973, issued its first accounting standard, IAS 1 Disclosure of Accounting Policies in 1975.
This was followed by four accounting standards in 1976:
- IAS 2 Inventories,
- IAS 3 Consolidated Financial Statements,
- IAS 4 Depreciation Accounting,
- IAS 5 Information to Be Disclosed in Financial Statements.
Two accounting standards in 1977:
- IAS 6 Accounting Responses to Changing Prices,
- IAS 7 Statement of Changes in Financial Position.
Three accounting standards in 1978:
- IAS 8 Unusual and Prior Period Items and Changes in Accounting Policies,
- IAS 9 Accounting for Research and Development Activities,
- IAS 10 Contingencies and Events Occurring After the Balance Sheet Date.
Slight trivia above to share the history of construction contracts accounting, issued three years prior to the issuance of IAS 18 Revenue Recognition in 1982. Both IAS 11 and IAS 18 endured thirty-eight years until 2018 when they were replaced by IFRS 15 Revenue from Contracts with Customers.
Back to present, below extracts of accounting policies from a same property development company, in financial year 2022 and financial year 2017 highlights the transition from IAS 11 to IFRS 15.
Accounting Policy: Inventories – Development properties for sale
[FY 2022] Inventories – Development properties for sale
Development properties are measured at the lower of cost and net realisable value. Cost includes acquisition costs, development expenditure, capitalised borrowing costs (applicable to construction of a development for which revenue is to be recognised at a point in time) and other costs directly attributable to the development activities.
[FY 2017] Inventories – Development properties for sale
Development properties are measured at the lower of cost and net realisable value. Cost includes acquisition costs, development expenditure, capitalised borrowing costs and other costs directly attributable to the development activities. Borrowing costs that are directly attributable to the acquisition and development of the development property are capitalised as part of development property during the period of development.
Properties under development, the sale of which are recognised using the percentage of completion method
The aggregated costs incurred together which attributable profits and net of progress billings are presented as development properties in the statement of financial position. If progress billings exceed costs incurred plus recognised profits, the balance is presented as part of trade and other payables.
From the above comparison of ‘Inventories – Development properties for sale’ accounting policies, the stark difference is the removal of development properties whose revenue is recognised over time (as opposed to point in time/completed contract revenue recognition) from inventories accounting policy. This is a significant change arising from the percentage of completion (“POC”) concept in IAS 11 not carried forward to IFRS 15. Under the POC method in IAS 11, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. It was market practice to defer costs to normalise profit margins throughout a contract by allocating revenue and costs evenly over the life of the contract. This was especially prevalent in situations where the stage of completion was measured via surveys of work performed or completion of a physical proportion of the contract work.
IFRS 15 De-links Contract Revenue from Contract Cost.
To fill the gap arising from the withdrawal of IAS 11, IFRS 15 includes a segment on contract costs which sets up the requirements of when a cost can be recognised as an asset. Clarification on what are contract costs and when these costs are to be recognised as an asset are set out. These requirements ensure that only costs that meet the definition of an asset under the conceptual framework are recognised as such and that an entity is precluded from deferring costs merely to normalise profit margins throughout a contract by allocating revenue and costs evenly over the life of the contract. IFRS 15 however is silent on the presentation of capitalised contract costs.
IAS 11 requires the presentation of ‘The gross amount due from customers for contract work’ which comprises the costs incurred plus recognised profit less progress billings. This is replaced with the presentation of contract asset under IFRS 15. A contract asset is an entity’s right to consideration for work completed but not billed at the reporting date. In other words, unbilled revenue.
Accounting Policy: Income recognition – Sale of development properties
The below comparison of accounting policies for revenue recognition highlights the requirement of IFRS 15 to expense costs incurred when they either do not relate to the contract or do not qualify for recognition as an asset. Hence, whilst the overtime recognition of revenue by reference to progress towards completing the construction of the residential project may appear similar to the POC method under IAS 11, their net profit or loss impact is different.
Also, unlike IAS 11 which generally requires the POC method for all construction contracts, IFRS 15 allows over time revenue recognition only for construction contracts that meet the criteria under paragraph 35 of IFRS 15.
[FY 2022] Income recognition – Sale of development properties
The residential projects have no alternative use for the Group due to contractual restriction, and the Group has enforceable rights to payment arising from the contractual terms. For those contracts, revenue is recognised over time by reference to the Group’s progress towards completing the construction of the residential project. The measure of the progress is determined based on the proportion of contract costs incurred to date to the estimated total contract costs.
Costs incurred that are not related to the contract or that do not contribute towards satisfying a performance obligation are excluded from the measure of progress and instead are expenses as incurred.
The customer is invoiced on a payment schedule and are typically triggered upon achievement of specified construction milestones. If the value of the goods transferred by the Group exceeds the payments, a contract asset is recognised. If the payments exceed the value of the goods transferred, a contract liability is recognised.
For costs incurred in fulfilling the contract, the Group will capitalise these as contracts costs assets only if (a) these cost relate directly to a contract or an anticipated contract which the Group can specifically identify; (b) these costs generate or enhance resources of the Group that will be used in satisfying (or continuing to satisfy) performance obligations in the future; and (c) these costs are expected to be recovered. Otherwise, such costs are recognised as an expense immediately.
Capitalised contract costs are subsequently amortised on a systematic basis as the Group recognises the related revenue over time. An impairment loss is recognised in the profit or loss to the extent that the carrying amount of capitalised contract costs exceeds the expected remaining consideration less any directly related costs not yet recognised as expense.
[FY 2017] Income recognition – Sale of development properties
Revenue from sales of properties under development is recognised by reference to the stage of completion using the percentage of completion method when the Group determines that (a) control and significant risks and rewards of ownership of the work-in-progress transfer to the buyer in its current state as construction progresses, (b) the sales prices is fixed and collectible, (c) the percentage of the completion can be measured reliably, (d) there is no significant uncertainty as to the ability of the Group to complete the development, and (e) costs incurred can be measured reliably.
In all other instances, revenue from sales of development properties is only recognised upon the transfer of control and risks and rewards of ownership of the property to the buyer. No revenue is recognised when there is significant uncertainty as to the collectability of the consideration due or the possible return of units sold.
The percentage of completion is measured by reference to the work performed, based on the ratio of construction costs incurred to date to the estimated total construction costs. Profits are recognised only in respect of finalised sales contracts to the extend such profits relate to the progress of the construction work.
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Lim Ju May is Technical Director, Assurance Principal, CLA Global TS.
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