IFRS U.S. GAAP
Relevant guidance: IAS 11; IFRIC 15 Relevant guidance: ASC 605-35
Introduction
IAS 11 applies to the accounting for construction contracts for a single asset (such as a building, bridge, ship, or tunnel) or combination of related assets (such as the construction of refineries and other complex pieces of plant or equipment) in the financial statements of contractors. Contracts are classified as fixed-price contracts and cost-plus contracts for purposes of IAS 11 (IAS 11.1-.6).
A construction contract is defined as “a contract
specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.” (IAS 11.3). According to IAS 11:
If the outcome of a construction contract can be estimated reliably, contract revenue and costs are recognised by reference to the stage of completion (IAS 11.22). If the outcome of a contract cannot be estimated reliably, contract revenue is recognised to the extent of recoverable contract costs and contract costs are recognised as an expense in the period incurred (IAS 11.32).
Unlike U.S. GAAP, the completed-contract method is not permitted.
Probable losses are recognised as an expense immediately (IAS 11.36).
As noted in Section 6.1, “Revenue ‒ general”, revenue recognition guidance is included in ASC 605 and other topics in the Codification, as well as SEC guidance. Industry specific guidance, such as for real estate, is included in other ASC topics.
ASC 605-35 applies to construction-type and production- type contracts. The guidance in ASC 605-35 applies to performance contracts where a customer provides specifications for the construction of a facility, production of goods, or provision of certain related services. (ASC 605-35-15-2 through 15-6).
According to ASC 605-35:
Percentage-of-completion is the preferred method in situations in which reasonably dependable
estimates can be made and the conditions in ASC 605-35-25-57 exist
(ASC 605-35-25-56 and 25-57).
If a precise estimate is not practical and the contract is not expected to result in a loss, the percentage-of- completion method based on a zero profit margin is recommended until results can be estimated more precisely (ASC 605-35-25-67 through 25-69).
If reasonable estimates cannot be made, the completed-contract method is used
(ASC 605-35-25-61).
IFRS U.S. GAAP
is recognized as soon as it becomes evident (ASC 605-35-25-45 and 25-50).
An agreement for the construction of real estate may be within the scope of IAS 11 or 18. The determination is a matter of judgement that depends on the terms of the agreement and the specific facts and circumstances of the arrangement. IFRIC 15 provides guidance to assess whether an agreement for the construction of real estate is within the scope of IAS 11 or 18 and when revenue from the construction of real estate is recognised.
ASC 605-35-15-6(j) states that entities do not apply the guidance in ASC 605-35 to service contracts that are not within its scope (ASC 605-35-15-2, 15-3, and 15-6).
IAS 11 applies to each construction contract separately. However, in some situations IAS 11 is applied to separate components of a single contract or to a group of contracts together (IAS 11.7).
Contracts are combined when they are negotiated as a single package, they are closely interrelated and they are performed concurrently or in a continuous sequence (IAS 11.9).
Contracts are segmented when separate proposals have been submitted for each asset, each asset has been subject to separate negotiation and the contractor and customer have been able to accept or reject that part of the contract relating to each asset, and costs and revenues of each asset can be identified (IAS 11.8).
ASC 605-35 permits, but does not require, the combining and segmenting of contracts provided certain criteria are met (ASC 605-35-25-5 through 25-14). IFRS requires combining and segmenting contracts when certain criteria are met.
Recognition guidance
IAS 11.22 provides that when the outcome of a
construction contract can be reliably estimated, contract revenue and contract costs are recognised by reference to the stage of completion of the contract at the end of the reporting period. IAS 11.23 and .24 list the conditions that must be met for the outcome of a fixed price or cost plus contract, respectively, to be reliably estimated. An expected loss on a contract is recognised as an expense immediately (IAS 11.22 and .36).
If the outcome of a contract cannot be estimated reliably, contract revenue and contract costs are recognised as follows (IAS 11.32):
Revenue is recognised only to the extent of contract costs incurred that it is probable will be recoverable
Contract costs are recognised as an expense in the period incurred
According to IAS 11.33, during the early stages of a contract it is possible that the outcome of the contract cannot be estimated reliably; however, it may be probable that the entity will recover contract costs. In this situation, contract revenue is recognised only to the extent of costs incurred that are expected to be
The ability to produce reasonably reliable estimates is essential for the use of the percentage-of-completion method. In a situation in which a precise estimate is not practical and the contract is not expected to result in a loss, the percentage-of-completion method based on a zero profit margin is recommended until results can be estimated more precisely (ASC 605-35-25-56 and 25-67 through 25-69). If reasonable estimates cannot be made, the completed contract method is used
IFRS U.S. GAAP
recoverable.
Contract revenue includes (IAS 11.11):
Initial amount of revenue agreed in the contract
Contract variations and claims to extent that they are probable of resulting in revenue and capable of being reliably measured
The amount of claims that can be included in contract revenues is subject to a high level of uncertainty. Therefore, IAS 11.14 provides that claims are included in contract revenue only when both of the following
conditions are met:
Customer negotiations have reached an advanced stage such that it is probable that the customer will accept the claim
The probable amount acceptable to the customer can be measurable reliably
Similar to IFRS, contract revenues include the basic contract amount and other contract variations and claims if certain criteria are met. For example:
Contract revenue and costs are adjusted to reflect change orders when their scope and price have been approved by the customer and contractor. ASC 605-35-25-28 includes guidance for unpriced change orders (ASC 605-35-25-25 through 25-28).
Generally, recognition of additional contract revenue resulting from claims is appropriate only if it is probable that the claim will result in additional revenue and the amount can be reliably estimated, which generally requires specific criteria to be met. Revenue is recognized only to the extent that contract costs relating to the claim have been incurred (ASC 605-35-25-30 through 25-31).