IFRS 15 also specifies the accounting treatment for certain costs an entity incurs in obtaining and fulfilling a contract to provide goods and services to customers for both contracts obtained and contracts under negotiation. However, the requirements in IFRS 15 only apply if another standard does not apply to those costs (e.g., IAS 2 Inventories, IAS 16 Property, Plant and Equipment or IAS 38 Intangible Assets). Just a starter: IAS 11 permitted a broader range of pre-contract costs to be capitalised, not just those that are incremental, when it is probable that a contract will be obtained.
Incremental costs of obtaining a contract Engineering and Construction contract costs
Under IFRS 15, incremental costs of obtaining a contract (i.e., costs that would not have been incurred if the contract had not been obtained) are recognised as an asset if the entity expects to recover them. This can mean direct recovery (i.e., through reimbursement under the contract) or indirect recovery (i.e., through the margin inherent in the contract). As a practical expedient, the standard permits immediate expense recognition for a contract acquisition cost when the asset that would have resulted from capitalising such a cost would have had an amortisation period of one year or less.
The standard cites sales commissions that are directly related to sales achieved as an example of an incremental cost that may require capitalisation. In contrast, some bonuses and other compensation that is based on other quantitative or qualitative metrics (e.g., profitability, EPS, performance evaluations) likely will not meet the criteria for capitalisation because they are not directly related to obtaining a contract. [IFRS 15 91 – 94]
Costs to fulfil a contract Engineering and Construction contract costs
IFRS 15 specifies how to account for costs incurred in fulfilling a contract (i.e., costs that relate directly to a contract, such as materials and labour) that are not in the scope of another standard. Costs to fulfil a contract that are accounted for under IFRS 15 are divided into two categories: (1) those that give rise to an asset; and (2) those that are expensed as incurred. Entities will recognise an asset when costs incurred to fulfil a contract meet all of the following criteria (‘Fulfilment costs’):
- The costs relate directly to a contract or to an anticipated contract that the entity can specifically identify (e.g., costs of designing an asset to be transferred under a specific contract that has not yet been approved).
- The costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future.
- The costs are expected to be recovered. [IFRS 15 95]
When determining whether costs may be eligible for capitalisation, an entity must consider its specific facts and circumstances. The standard provides examples of costs that may be eligible for capitalisation (i.e., costs that relate directly to the contract). Such costs include:
- Direct labour (e.g., salaries and wages of employees who provide the promised services directly to the customer)
- Direct materials (e.g., supplies used in providing the promised services to a customer)
- Allocations of costs that relate directly to the contract or to contract activities (e.g., costs of contract management and supervision, insurance, depreciation of tools and equipment used in fulfilling the contract)
- Costs that are explicitly chargeable to the customer under the contract
- Other costs that are only incurred because an entity entered into the contract (e.g., payments to subcontractors) [IFRS 15 97]
For costs to meet the ‘expected to be recovered’ criterion, they need to be either explicitly reimbursable under the contract or reflected through the pricing of the contract and recoverable through the margin. Engineering and Construction contract costs
The Boards noted that only costs that meet the definition of an asset (i.e., meet the criteria described above) are eligible for capitalisation.
Entities are precluded from deferring costs merely to normalise profit margins throughout a contract by allocating revenue and costs evenly over the life of the contract.
IFRS 15 98 specifically excludes the following costs from the definition of fulfilment costs:
- general and administrative costs (unless those costs are explicitly chargeable to the customer under the contract);
- costs of wasted materials, labour or other resources to fulfil the contract that were not reflected in the price of the contract;
- costs that relate to satisfied performance obligations (or partially satisfied performance obligations) in the contract (ie costs that relate to past performance); and
- costs for which an entity cannot distinguish whether the costs relate to unsatisfied performance obligations or to satisfied performance obligations (or partially satisfied performance obligations).
So these types of costs are expensed as incurred (except for under a. costs explicitly chargeable).
Highlights Engineering and Construction contract costs
The definition of ‘incremental costs of obtaining a contract’ implies that only external costs such as commissions and success fees could generally be recognised as an asset. Internal costs are less likely to meet the incremental costs tests and, for example, an allocation of internal bid team staff costs may be unlikely to meet the criteria to be recognised as an asset.
Costs incurred during the contract bid phase may comprise both ‘contract bid costs’ as well as ‘fulfilment costs’, for example, if the bidder is required to complete detailed design work as part of its bid.
Contract bid costs must be incremental costs to be capitalised. Fulfilment costs must meet the criteria discussed above to be capitalised. Engineering and Construction contract costs
Fulfilment costs related to an ‘anticipated’ contract (i.e. not yet awarded) may also be capitalised if these costs are expected to be recovered.