The rule: If the contract arrangements do not permit revenue to be recognised progressively, then revenue is recognised at a specific point in time on transfer of control, which for a construction contract will likely be close to completion.
The explanations: Should a contractor recognise revenue as construction work takes place or on practical completion?
While IFRS 15 was under development, a key concern of the construction industry was whether contractors would continue to recognise revenue as the contract progresses, similar to the stage of completion method under IAS 11. Construction over time or at a point in time? Construction over time or at a point in time?
Under IFRS 15, revenue is recognised when, or as, performance obligations are satisfied through the transfer of control of a good or service to a customer. An entity recognises revenue over time if one or more of the following criteria are met. [IFRS 15 31–37, IFRS 15 IE 67 – IE 90 (Example 13, Example 14, Example 15, Example 16 and Example 17)]
The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
Routine or recurring services.
The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
Building an asset on a customer’s site.
The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
Building a specialised asset that only the customer can use, or building an asset to a customer order.
Two important points should be noted when assessing whether the third criterion is met. Firstly, an activity does not create an asset with alternative use when an entity is either restricted practically or contractually during creation/enhancement, or is limited practically when the asset is complete, from directing the asset to another use (e.g. building an asset to a customer order). This assessment is made at contract inception. Construction over time or at a point in time?
Secondly, the entity has an enforceable right to payment only when it is entitled, at all times, to an amount that at least compensates the entity for performance to date (i.e. cost plus a reasonable profit margin) if the contract is terminated for any reason other than the entity’s failure to perform under the contract. Construction over time or at a point in time?
Recognition of revenue at a point in time
If it cannot be demonstrated that a performance obligation is satisfied over time, then an entity recognises revenue at the point in time when it satisfies the performance obligation by transferring control of the completed good or service to a customer. [IFRS 15 38, IFRS 15 IE 81 – IE 90 Example 17]
IFRS 15 defines control of an asset as the ability to direct the use of, and obtain substantially all of the remaining benefits from the asset. The benefits of an asset are the potential cash flows (inflows or savings in outflows) that can be obtained directly or indirectly. Construction over time or at a point in time?
Although there is no automatic right to progressive revenue recognition, performance obligations to provide construction services will generally be satisfied over time. Customers often control the assets as they are created or enhanced. In addition, contractors will often have contractual and practical limitations on transferring the assets to another customer and will have the right to collect costs incurred and a reasonable profit margin from the customer if the customer cancels the contract for reasons other than the entity’s non-performance.
For transactions currently accounted for using the stage of completion method, it will be necessary for management to evaluate contracts against the new criteria to establish whether it is appropriate to recognise revenue over time or at a point in time.
If the contract arrangements do not permit revenue to be recognised progressively, then revenue is recognised at a specific point in time on transfer of control, which for a construction contract will likely be close to completion.