Use Cases

  • Use Case 1
  • Use Case 2

A contractor enters into a contract to build both a road and a bridge (assume there are two separate performance obligations: building the road and building the bridge). The contractor determines at inception that the contract price is $151 million, which includes a $140 million fixed fee and a variable award fee depending on how early the contractor finishes the project. The contractor will receive a base award fee of $10 million if it finishes the project 30 days ahead of schedule. The award fee increases (decreases) by 10% for each day before (after) the 30 days it finishes the project.

The contractor has experience with similar contracts. The contractor uses the most likely amount method to estimate the variable consideration associated with the award fee. Based on the contractor’s prior experience and its current estimates, the contractor determines that it will finish the project 31 days ahead of schedule and be entitled to the $10 million award fee. The contractor uses the expected value method to estimate the additional variable consideration associated with the 10% daily penalty or incentive. The contractor believes it will be entitled to an additional 10% award fee, or $1 million, for total variable consideration of $11 million. The contractor concludes that it is probable (US GAAP) or highly probable (IFRS) that a change in estimate would not result in a significant revenue reversal in the future. The standalone selling price of the road, based on prior experience, is $140 million. The standalone selling price of the bridge, based on prior experience, is $30 million. How should the contractor allocate the contract price to the two separate performance obligations?

Analysis

The contractor must first assign a standalone selling price to the construction of the road and the bridge in order to allocate the contract price (including both the fixed and variable amounts). The contractor constructs roads and bridges of a similar type and nature to those required by the contract on a standalone basis. Because the variable fee is based on completion of the overall project rather than either the road or the bridge individually, it would be subject to allocation to both performance obligations.

The $151 million transaction price would be allocated as follows using a relative allocation model: Road: $124.4 million ($151m * ($140m / $170m)) Bridge: $26.6 million ($151m * ($ 30m / $170m))

How Hamilton Helps

Hamilton software solution is especially designed for IFRS compliance needs. In the case of construction industry, the above type of contract is common and the Hamilton system understands this. In the Hamilton Solution, users have flexibility to determine how revenue is to be recognized. This flexibility is possible with dedicated logic for each business process. Using Hamilton, contracts are classified in to different groups and the recognition logic is built against each group. All contracts belonging to that group will have same recognition logic.

A customer engages Construction Co. to provide construction services to build a house (contract price of $500,000) and a garage (contract price of $50,000). There are separate contracts for each of these two activities. They were negotiated together and a discount was given on the garage build as Construction Co. would already have the necessary equipment on site from the house construction, and could also build the foundations simultaneously with the house. However, Construction Co. has agreed with the customer to first build and complete the house and then finish the garage within the next three months.

The standalone selling prices of the house and garage are $500,000 and $80,000 respectively.

The expected cost to construct the land and garage are $400,000 and $64,000 respectively. On 30 June 2019, the entity has incurred costs of $200,000 in relation to the house and $5,000 in relation to the garage.

Analysis

The contracts should be combined and accounted for as one contract for the purposes of IFRS 15. Revenue would be recognized as follows:

Components Contract price SSP Relative SSP Contract costs Estimated Cost incurred till June 2019 Revenue to be recognized in June 2019
House 500,000 500,000 474,137 400,000 200,000 237,068
Garage 50,000 80,000 75863 64,000 5,000 5927
Total 550,000 580,000 550,000 464,000 205,000 242,965
How Hamilton Helps

One of the steps in 5-step model for revenue recognition in IFRS 15 is the allocation of revenue to each performance obligation. Hamilton helps in simplifying this. Also, using its sophisticated processing logic, revenue can be recognized either through a cast-based approach or any other form as required in the new standard, thanks to Hamilton's brain-processing ability.