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ASR 2 – REVENUE AND CONSTRUCTION CONTRACTS CONCEPTUAL FRAMEWORK & AASB15 Note the new AASB15 supersedes AASB118 (REVENUE) & AASB 111 (CONSTRUCTION CONTRACTS) I strongly recommend you review the standard from AASB website and the illustrative examples posted to UTSonline under this week’s tab. The examples are the best way to understand the new standard. Refer to Conceptual Framework paras 70-75 for definitions of income, revenue, gains, expenses etc The new standard calls for a 5-step process 1. Identify the contract. Refer to paras 9-21. Need to meet all of the following: Parties have approved the contract and are committed to perform their obligations, can identify each party’s rights, can identify the payment terms, has commercial substance, it is probable that the entity will collect the consideration due to it from exchange of goods and services. Para 17 combining contracts & Para 18 modifying contracts. If a client can cancel the order without penalty, the contract is not recognised as revenue. Only if the sale goes ahead and goods are delivered does the contract exist. See lecture e.g. 2. Identify performance obligations Para 22-45. Para 22 – at the outset, identify whether the terms of the contract provide a distinct G&S or a series of G&S which can be combined. To be distinct, the customer must be able to benefit from the G&S on its own and the entity’s promise to transfer the G&S is separately identifiable in the contract (e.g. textbook example of buying different items of furniture versus buying wood that it to be used in the building process) 3. Determine the transaction price: Appendix A defines the transaction price as “the amount of consideration to which the entity expects to be entitled for transferring promised G&S.., excluding amounts collected on behalf of third parties (e.g. GST). If the entity is acting as an agent it simply records the commission to which it is entitled as its revenue. Variable consideration – include rebates for larger orders, discounts, price concessions and performance bonuses. If variable consideration arises, the entity estimates the transaction price using either the expected value (sum of probability-weighted amounts) or most likely amount (used if there are only 2 possible outcomes i.e. achieves a performance bonus or does not) and then applies this consistently throughout the contract. Deferred consideration – Sometimes the amount to be paid is deferred and may take the form of interestfree credit or acceptance of a note receivable at below-market interest rate. If so, the fair value will be less than the nominal amount of the receivable. See example 15.1 in online chapter and lecture examples about drones. Exchanges or swaps – When the customer is paying in something other than cash, the entity needs to measure the non-cash consideration at FV adjusted for any cash received. If this cannot be reliably estimated, the entity uses the value of the G&S they are promising to the customer. See text example 15.2 re milk/milk & milk/cream 4. Allocate the transaction price: When multiple performance obligations exist (eg mobile phone and service) the entity must allocate the transaction price to each performance obligation by reference to their stand-alone selling price (para 74). Example 15.3 from textbook and revisiting lecture example about mobile phones:

Example: On July 1, Telstra sells a Samsung mobile phone with a 1-year capped service contract for $2,000, payable in advance. The stand-alone prices of the phone & service contract are $500 & $2,000 respectively. Therefore, revised pricing is phone $400 (i.e. 500/2,500 x 2,000) & Service is $1,600 (i.e.2000/2,500 x 2,000) July 1 Dr Cash 2000, Cr Revenue 400, Cr unearned revenue 1600 June 30 Dr Unearned revenue 1600, Cr revenue 1600

5. Recognise revenue: Para 31 – An entity shall recognise revenue when the performance obligation has been met by the transfer of control of the asset to the client. Para 33 defines control as “the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. This control can pass over time (construction contract, mobile phone service) or at a point in time (goods delivered, flight taken) (para 35-38). Progress can be measured in terms of inputs (e.g. costs incurred, labour or machine hours) and outputs (results achieved, performance completed to date) (B14-19). Note also conditions attached to the sale such as installation which, if major, can delay the point of recognition. If goods are simply consigned to a party for onsale to their clients, this is not considered revenue until they actually sell it to their clients. Paragraph 83 of the CF requires that revenue can only be recognised when it is probable that any future economic benefit will flow to the entity and the item has a cost or value that can be measured reliably. Disclosure of accounting policies relating to revenue (para 110) See Appendix for advice on sale of goods with right of return, warranties, non-refundable upfront fees etc ------------------------------------------------------------------------------------AASB111 Construction contracts has been superseded by the new AASB15 Revenue. Construction contracts are complex because they usually run over a number of reporting periods. There are fixed price and cost plus margin contracts but we focus on fixed cost contracts. Each construction site must be looked at individually. Progress can be measured in terms of output (performance completed to date, units delivered) or input (costs incurred, labour or machine hours expended). We focus on costs incurred to date as a % of total expected costs of contract. Recognition – if outcome can be reliably estimated, revenue & expense are recognised by reference to the stage of completion test but if they can’t be, revenue is limited to costs incurred to date. (para 44-45) As before, customer must have control of the asset throughout the construction, for revenue to be recognised. Journals: Construction costs plus gross profit are accumulated in an asset account (Work in Progress) and progress billings are accumulated in a contra account (progress billings) i.e.

Work in progress (asset) less Progress Billings (contra)

which is built up through: Dr WIP Cr Cash/payables

asset recognition/ costs incurred

Dr WIP (gross profit) (if it can be reliably estimated) Dr COGS Income Cr Revenue Dr A/c receivable Cr Progress Billings

billings

Dr Cash

cash received

Annually

Cr A/c receivable

Dr Progress Billings Cr WIP

Approval and acceptance

On completion

Notes: If contract is profitable, the CIP (asset) and revenue will both equal total costs plus gross profit i.e value of fixed contract. BUT, if costs escalate under a fixed contract, leaving the contractor incurring a loss overall, revenue is limited to the agreed fixed contract amount and will be exceeded by expenses. Any profit already booked must be reversed. This will bring the WIP account back to the value of the fixed contract. Recognition of expected loss – must be recognised immediately contractor becomes aware that a loss will occur (conservatism) Revenues always equal the fixed contract amount. Work out expenses and profit/loss to determine revenue amount. DO NOT attempt to work out revenue first. Make sure you only recognise additional profit for this year, noting previous % already taken into account. If you make a loss, you must eradicate any previously booked profit and then create a loss so that the overall project profit/loss is correct. Be careful, sometimes questions are expressed as costs to date or costs this year. Recommended Process: Always draw up a table as below before doing journals. Note, all figures except contract price (which is fixed) may change over life of project. I have just assumed builder and client have agreed on the payment plan as indicated in the journals for a/c rec. Contract price (fixed) $ mln Costs to date $mln Estimated costs to complete $mln Estimated total costs $mln Estimated total gross profit $mln % complete (costs to date/est total costs) Profit recognized to date $mln Period profit $mln Period expenses $mln Period revenue $mln

10 2 6 8 2 25% 0.5 0.5 2 2.5

10 7 1 8 2 87.5% 1.75 1.25 5 6.25

10 8 0 8 2 100% 2 0.25 1 1.25

YEAR 2 5 5

YEAR 3 1 1

TOTAL 8 8

Dr Cr

Work in Progress Cash/payables

YEAR 1 2 2

Dr Dr Cr

Construction expenses Work in Progress Revenue

2 0.5 2.5

5 1.25 6.25

1 .25 1.25

8

Dr Cr

Accounts receivable Progress Billings

3 3

3 3

4 4

10 10

Dr Cr

Cash Accounts receivable

3 3

3 3

4 4

10 10

Dr Cr

Progress Billings Work in Progress

See also self-study question 15.7

10 10

2 10...