When a performance obligation is satisfied over time, the standard provides two types of methods for measuring progress under the contract: input methods or output methods. The standard requires an entity to select a single measurement method for the relevant performance obligations that best depicts the entity’s performance in transferring goods or services and it does not allow a change of method. That is, a performance obligation must be accounted for under the method the entity selects (i.e., either an input or output method) until it has been fully satisfied.
Input methods recognise revenue “on the basis of the entity’s efforts or inputs to satisfy the performance obligation … relative to the total expected inputs to the satisfaction of that performance obligation”. The standard includes resources consumed, labour hours expended, costs incurred and time elapsed as possible input methods. The standard also notes it may be appropriate to recognise evenly expended inputs on a straight-line basis.
Output methods recognise revenue “on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract”. Measurements of output may include surveys of performance completed to date, appraisals of results achieved, milestones reached and time elapsed.
When an entity applies an output method, the standard includes a practical expedient for an entity that has a right to payment from a customer in an amount that corresponds directly with the value of the entity’s performance completed-to-date (e.g., a service contract in which an entity bills a fixed amount for each hour of service provided). This practical expedient allows an entity to recognise revenue in the amount for which it has the right to invoice.
The standard does not say which method (input or output) is preferable, but it says that entities are required to use careful judgement in evaluating the advantages and disadvantages of each method and consider both the nature of the promised goods and services and the entity’s performance. The Boards also said that the selected method is required to be applied to similar arrangements in similar circumstances.
While input methods (e.g., cost incurred), may be appropriate measures of progress, similar to the previous requirements under IAS 11, E&C entities have carefully evaluated the principles of IFRS 15 to determine whether the pattern of revenue recognition from construction arrangements will be affected.
The Boards decided that, if an entity does not have a reasonable basis to measure its progress, too much uncertainty would exist. Therefore, revenue is not recognised until progress can be measured. However, if an entity cannot reasonably measure its progress, but expects to recover costs incurred toward satisfaction of the performance obligation (i.e., a loss will not be incurred), IFRS 15 requires revenue to be recognised to the extent that costs are incurred until the entity is able to reasonably measure its progress. These requirements are consistent with IAS 11, which allows for zero-margin revenue recognition when a final outcome cannot be estimated, but an entity is assured that no loss will be incurred.
Units of delivery
E&C entities should note that the Boards indicated a units-of-delivery or units-of-production method may not be appropriate if the contract provides both design and production services. This is because each item produced may not transfer an equal amount of value to the customer. That is, the items produced earlier likely have a higher value than the ones produced later. However, the Boards noted that units of delivery may be an appropriate method for certain long-term manufacturing contracts of standard items that individually transfer an equal amount of value to the customer.
In addition, the standard states that “output methods based on units produced or units delivered would not faithfully depict an entity’s performance in satisfying a performance obligation if, at the end of the reporting period, the entity’s performance has produced work in progress or finished goods controlled by the customer that are not included in the measurement of output”.
E&C entities applying an input method that uses costs incurred to measure progress towards completion may find that certain costs incurred do not contribute to the entity’s progress in satisfying the performance obligation.
For example, entities would exclude the costs that may be related to wasted materials or other significant inefficiencies. Furthermore, when uninstalled materials meet all of the four criteria in the extract below, an entity will recognise revenue in an amount equal to the cost of the goods (i.e., at zero margin) and adjust its measure of progress to exclude the costs from the costs incurred and from the transaction price (i.e., from both the numerator and the denominator of its percentage complete calculation).
Reference is made to IFRS 15 B19, regarding the four criteria (i, iii, iii, iv in sub-section (b)) to adjust the measure of progress.
The standard provides the following illustration for considering uninstalled materials when applying an input method that uses costs incurred to measure progress towards completion, reference is made to the example in IFRS 15 ‘Uninstalled Materials’ [IFRS 15IE 95 – IFRS 15IE 100].
Control transferred at a point in time
For performance obligations for which control is not transferred over time, control is transferred at a point in time. In many situations, the determination of when that point in time occurs is relatively straightforward. However, in other circumstances, this determination is more complex. Construction contracts – Measuring progress
IFRS 15 provides the following indicators for entities to consider in determining when control of a promised asset has been transferred:
- The entity has a present right to payment for the asset Construction contracts – Measuring progress
- The customer has legal title to the asset Construction contracts – Measuring progress
- The entity has transferred physical possession of the asset Construction contracts – Measuring progress
- The customer has the significant risks and rewards of ownership of the asset Construction contracts – Measuring progress
- The customer has accepted the asset Construction contracts – Measuring progress
None of these indicators are meant to be individually determinative. The Boards also clarified that the indicators are not meant to be a checklist and not all of them must be present for an entity to determine that the customer has gained control. An entity is required to consider all relevant facts and circumstances to determine whether the control has transferred.