Acctran

Engage: Partner, Kaya mo pa

Step 1: Identify the contract with the customer

Requirement A:

Yes, the contract qualifies for accounting under PFRS 15 because all of the

requirements of “Step 1” are met.

a. The contract is approved and the parties are committed to perform their respective

obligations;

b. Each party’s rights regarding the services to be transferred can be identified from

the contract;

c. The payment terms for the services to be transferred can be identified from the

contract;

d. The contract has commercial substance; and

e. The consideration in the contract is probable of collection.

Step 2: Identify the performance obligations in the contract

Analysis: Performance obligations

The contract includes commitments to provide construction services and designs

(architectural, engineering, electrical, plumbing and other necessary designs).

However, these commitments do not differ on their own, but a different service

package for the following reasons:

a. Each promise is not separately identifiable from the other promises in the contract.

This is because:

i. Each service is an input to a combined output specified by the customer.

*The design constitute an integral part of the contract (shown in the ARTICLE 6 of

the contract). 

*The contracting authority cannot subcontract any of the specific works that make up

the contract (shown in the ARTICLE 9 of the contract). 

*The contract does not provide for separate accounting for each of the construction

work specified in the contract (see "bills of materials").

ii. Each good or service significantly modifies another good or service

promised in the contract.

Indicators: 

*If there will be changes in any of the design works it would affect the construction

work.

iii. Each good or service is highly interrelated with the other goods or services

promised in the contract.

Indicators: 

*See indicators in (a.i) above. 

*Since the client cannot subcontract any of the works specified in the contract, the

client's decision not to purchase a particular work from the contractor will affect the

other contractual services. For example if the client does not purchase the company's

designs then Entity Y does not provide any construction work and vice versa.

b. Although the customer can benefit from each of the promised services (Entity Y

regularly sells those services separately), the customer’s ability to benefit from those

services individually is limited because of the reasons stated in (a) above.

Requirement B:

The promises to provide the designs and construction service shall be combined and

treated as a single performance obligation.

Analysis: Satisfaction of performance obligations

A performance obligation is satisfied over time if one of the following criteria is

met: a. The customer simultaneously receives and consumes the benefits provided by

the entity’s performance as the entity performs.

[Link] entity’s performance creates or enhances an asset (e.g., work in progress) that

the customer controls as the asset is created or enhanced. 

Criteria a and b are met because, although Entity Y has the right to supervise

construction activity, the client retains ownership of all structures built on the

property, which is evidenced by the fact that in the event If the contract is terminated,

any advance payment in the contract will be offset in favor of the customer.

c. The entity’s performance does not create an asset with an alternative use to the

entity and the entity has an enforceable right to payment for performance completed

to date. 

Criterion (c) is met because of the following reasons:

a. In the event that the contract is terminated, any structure built will be used for the

benefit of the customer, therefore any asset created will have no alternative use for

Entity Y.

In addition, even if Entity Y retains ownership of any structure, the property

belongs to the customer. Established on the property, Entity Y would incur

significant losses to repurpose the asset if the contract were terminated.

This is evidenced by the following:

i. Subsequent billings are based on Entity Y’s progress on the contract.

ii. i. If the contract is cancelled, Entity Y has the right to payment for any progress

on the contract.

Conclusion:

Requirement C:

The performance obligation is satisfied over time because the criteria above are met.

Step 3: Determine the transaction price

Requirement D:

The transaction price is equal to the fixed fee of ₱8,000,000.

Entity Y does not need to discount the transaction price because the timing of the

agreed payments does not offer the customer or Entity Y a significant financing

advantage; That is, quarterly invoice payments are due in a short period of time.

Step 4: Allocate the transaction price to the performance obligations

Requirement E:

Since commitments are treated as a separate package of deliveries and services, it is

not necessary to assign the transaction price to each of these commitments. Instead,

the transaction price is fully assigned to the one-time performance obligation to

complete the house construction according to the agreed specifications.

Requirement F:

Since the performance obligation will be met over time, revenue will be recognized

during construction based on the progress measured by Entity Y towards fully

meeting the performance obligation. Due to insufficient information on the problem,

it is believed that the appropriate measure of progress is the cost-to-cost method, an

application of the input method.

Requirement G:

Sept. 1, 20x1

Cash (8M x 15%) 1,200,000

Contract liability 1,200,000

Oct. 1 to Dec. 31, 20x1

Construction in progress 2,422,000

Cash (or other appropriate accounts) 2,422,000

The percentage of completion as of December 31, 20x1 is computed as follows: 

Total contract price 8,000,000

(a) Costs incurred to date 2,422,000

Estimated costs to complete (squeeze) 4,498,000

(b) Estimated total contract costs (see ‘bill of materials’) 6,920,000

Expected gross profit from contract 1,080,000

Multiply by: Percentage of completion (a) ÷ (b) 35%

Gross profit earned to date 378,000

Gross profit for the year 378,000 

 The revenue and cost of construction in 20x1 are computed as follows:

Total contract price 8,000,000

Multiply by: Percentage of completion 35%

Revenue to date 2,800,000

Less: Revenue recognized in previous yrs. -

Revenue for the year 2,800,000

Cost of construction (squeezed) (2,422,000)

Gross profit for the year (see computation above) 378,000

 The year-end adjusting entry to recognize revenue is as follows:

Dec. 31, 20x1

Cost of construction 2,422,000

Construction in progress (gross profit) 378,000

Revenue 2,800,000

Dec. 31, 20x1

Contract liability (the mobilization fee) 1,200,000

Receivable (squeeze) 1,600,000

Progress billings (8M x 35%) 2,800,000

Dec. 31, 20x1

Cash [(2.8M – 1.2M) x 90%]* 1,440,000

Receivable 1,440,000
* Total progress billing 2,800,000

Less: Mobilization fee (1,200,000)

Progress billing, net of mobilization fee 1,600,000

Less: 10% retention on subsequent billings (1.6M x 10%) (160,000)

Collection 1,440,000

Requirement H:

Entity Y

Statement of financial position

As of December 31, 20x1

Current assets

Receivable (1,600,000 - 1,440,000) 160,000

Contract asset* -

Total current assets 160,000

Current liabilities

Contract liability* -

Total current liabilities -

*Construction in progress 2,800,000

Progress billing (2,800,000)

Contract asset/ Contract liability -

Entity Y

Statement of profit or loss

For the year ended December 31, 20x1

Cost of construction (2,422,000)

Gross profit 378,000

Other operating expenses -

Profit for the year 378,000