Identify Building Construction performance obligations – These are two examples in a small series for illustrating the concepts in What is a good or service that is distinct?
Construction of a building Identify Building Construction performance obligations
A building contractor (the vendor) enters into a contract to build a new office block for a customer. The vendor is responsible for the entire project, including procuring the construction materials, project management and associated services.
The project involves site clearance, foundations, construction, piping and wiring, equipment installation and finishing. Although the goods or services to be supplied are capable of being distinct (because the customer could, for example, benefit from them on their own by using, consuming or selling the goods or services, and could purchase them from other suppliers), they are not distinct in the context of the vendor’s contract with its customer.
This is because the vendor provides a significant service of integrating all of the inputs into the combined output (the new office block) which it has contracted to deliver to its customer.
Construction of a wall Identify Building Construction performance obligations
A building company contracts with a customer to build a wall. It identifies two activities that are necessary to complete the wall:
- Arrange for raw materials (such as bricks) for the purposes of building a wall to be available at the customer’s premises; and
- Provide construction services to build a wall with the raw materials. Identify Building Construction performance obligations
The sale of raw materials and the provision of services for the construction of a wall are capable of being distinct. Although the failure to purchase construction services would not significantly affect the delivery of bricks (which, by itself, might result in a vendor identifying two distinct performance obligations), the nature of the overall promise is to build the customer a wall. Consequently, the risks associated with each activity are not separable, and hence they are not distinct within the context of the overall contract. This is for the following reasons:
- The raw materials and construction services are both inputs that result in the creation of an output (the wall) that is very different to the two inputs;
- The provision of construction services significantly modifies the nature of the raw materials (i.e. it transforms the raw materials into something that performs a very different function to the raw materials on their own).
The analysis would be the same even if the arrangement was structured as two contracts negotiated at or around the same time (i.e. a legal contract for the sale of bricks and a separate legal contract for construction services) because for accounting purposes there would be a single contract. Although there are two activities that are capable of being distinct, in the context of the single accounting contract, the assessment of whether they would be distinct within the context of that accounting contract remains the same.
The existence of a significant financing component in the construction contract
– Introduction financing component Identify Building Construction performance obligations
The timing of payments specified in a contract may be different from the timing of recognition of the related revenue (and, consequently, the timing of transfer of control of the related goods or services to the customer). If the timing of payments specified in the contract provides the customer or the vendor with a significant benefit of financing the transfer of goods or services, the transaction price is adjusted to reflect this financing component of the contract. Identify Building Construction performance obligations
Again, it is necessary to look more widely than the documented contractual terms. A significant financing component may exist regardless of whether a financing component is explicitly stated in the contract or implied by the payment terms agreed to by the parties to the contract. Identify Building Construction performance obligations
As a practical expedient, adjustments for the effects of a significant financing component are not required if, at contract inception, the vendor expects that the period between when revenue is recognised for the transfer of the goods or services and the date of payment from the customer will be one year or less. Identify Building Construction performance obligations
– Long-term construction contracts Identify Building Construction performance obligations
A vendor may require a customer to pay in advance for a long-term construction contract because the vendor requires funds in order to obtain materials to carry out the contract. In the absence of the advance payment, the vendor would typically need to borrow the funds. The vendor would need to pay finance charges on those borrowings and would therefore be likely to recharge those borrowing costs to the customer by way of a higher transaction price.
However, the fair value of goods and services transferred to the customer would be the same. It is only the party providing the financing to the vendor that changes. Consequently, the amount of the vendor‘s revenue should not vary depending on whether the vendor receives financing from the customer or from a third party.
Factors to consider in assessing whether a contract contains a significant financing component include:
- The difference, if any, between the amount of consideration and the cash selling price of the goods or services;
- The combined effect of: Identify Building Construction performance obligations
- The expected length of time between the point at which the vendor transfers the goods or services to the customer, and the point at which the customer pays for those goods or services; and
- The prevailing interest rates in the relevant market. Identify Building Construction performance obligations
See also: The IFRS Foundation