Ever heard of a constructing a major new building, large bridge, metro railway or other significant construction project without contract modifications? Especially in the large urban agglomerations in this world….. Well then look at this:
And technology initiatives to avoid it: Artificial intelligence (AI)
How to account for variations and claims under the construction contract?
IFRS 15 does not include explicit guidance on accounting for contract variations and claims. Instead, it includes general guidance on contract modifications and other changes in the transaction price, which applies to all industries. [IFRS 15 18–21] But it works….
Changes in the scope and/or price of a construction contract
IFRS 15 defines a contract modification as a change in the scope or price (or both) of a contract that is approved by the parties to the contract.
If there is a modification to a construction contract, then an entity applies the following steps.
- The entity considers whether the change is approved. A contract modification could be approved in writing, by oral agreement or implied by customary business practices. If the modification is not approved, then the parties continue to account for the existing contract under IFRS 15. If the parties to a contract have approved a change in the scope of the contract but have not yet determined the corresponding change in price (e.g. an unpriced change order), then the entity estimates the change in price in accordance with guidance on variable consideration.
- The entity considers whether a modification should be accounted for as a separate contract. Typically, claims and variations in a traditional construction contract context will not be accounted for as separate contracts. This is because such claims and variations do not add a distinct good or service to the contract, as additional goods or services tend to be highly inter-related with the original contract.
- If this is the case, and the construction contract qualifies for over time revenue recognition, then the entity re-estimates both the total contract price and the stage of the completion of the contract. This may require the entity to adjust the cumulative revenue recognised to date.
- The entity continues to account for the contract, by reference to the stage of completion as modified and the new contract price. Note that if the approved new contract price is variable, then the entity applies the guidance on variable consideration.
Link between construction contract modifications and construction variable consideration
In construction contract modifications in many cases, a change in scope may be approved, but the change in price may not. In these cases, measurement of revenue will be governed by the guidance on variable consideration which means that even where approval for the modification has been obtained, the price change will be included in revenue only when it is ‘highly probable’ that there will be no significant revenue reversal in the future.
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