Chapter 5: Revenue (IAS 18) and
construction contracts (IAS 11)
Objectives
When you have completed this chapter, you should be able to:
Explain what revenue is and how it relates to net income.
Distinguish between revenue and income.
Explain how to measure revenue.
Determine when revenue from sale of goods and from rendering of services is normally
recognized.
Understand exceptions to these normal revenue-recognition principles.
Determine amounts to be disclosed in financial statements relating to construction
contracts.
Explain how revenue can be misstated by creative accounting.
Explain the impact of the percentage of completion method on financial statements and
ratio analysis.
Contents
Basic principles of IAS 18 – Revenue and IAS
11 – Construction Contracts.
Recognition of revenue from sale of goods.
Recognition of revenue from rendering of services and from construction contracts.
Recognition of revenue from multiple-element transactions.
Basic principles of IAS 18 and IAS 11
1) Definition of revenue and income
• The IASB’s Framework defines ‘income’ as an increase in economic benefits during the
accounting period in the form of inflows or enhancements of assets or decreases of
liabilities that result in increases in equity, other than those relating to contributions
from equity participants. Use of the word ‘policy’ suggests that the entity has made a
choice between alternative accounting treatments.
• Revenue, a subset of income, is defined as the gross inflow of economic benefits during
the period arising during the ordinary activities or an entity when those inflows result in
increases in equity, other than increases relating to contributions from equity
participants.
2) How to identify a transaction to recognize revenue
Revenue from the sale of goods should be recognized when all the following
conditions have been satisfied:
• the entity has transferred to the buyer the significant risks and rewards of
ownership of the goods.
• the entity retains neither continuing managerial involvement to the degree usually
associated with ownership nor effective control over the goods sold.
• the amount of revenue can be measured reliably.
• it is probable that the economic benefits associated with the transaction will flow
to the entity.
• the costs incurred or to be incurred in respect of the transaction can be measured
reliably.
For a transaction involving the rendering of services, when the outcome of the
transaction can be estimated reliably, revenue should be recognized by reference to
the stage of completion of the transaction at the end of the reporting period. The
outcome of a transaction can be estimated reliably when all the following conditions
are satisfied:
• the amount of revenue can be measured reliably.
• it is probable that the economic benefits associated with the transaction will flow
to the entity.
• the stage of completion of the transaction at the end of the reporting period can be
measured reliably.
the costs incurred for the transaction and the costs to complete the transaction can
be measured reliably.
Sale of goods and rendering of services have the following conditions in common:
• reliable measurement of consideration.
• reliable measurement of costs.
• probability that the economic benefits from the transactions will flow to the
entity.
3) Measurement of revenue
Revenue should be measured at the fair value of the consideration received or receivable,
considering the amount of any trade discounts and volume rebates allowed by the entity.
Example 5.2
Recognition of revenue from sale of goods
Recognition of revenue from rendering of services and from construction
contracts
Construction contracts
• Contracts 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.
• Two groups:
• Fixed price contracts are construction contracts in which the contractor
agrees to a fixed contract price, or a fixed rate per unit of output, which in
some cases is subject to cost escalation clauses.
• Cost plus contracts are construction contracts in which the contractor is
reimbursed for allowable or otherwise defined costs, plus a percentage of
these costs or a fixed fee.
• A construction contract may be negotiated for the construction of a single asset such as a
bridge, building, dam, pipeline, road, ship, or tunnel.
• A construction contract may also deal with the construction of a number of assets which
are closely interrelated or interdependent in terms of their design, technology and
function or their ultimate purpose or use; examples of such contracts include those for the
construction of refineries and other complex pieces of plant or equipment.
Combining and segmenting construction contracts
When a contract covers a number of assets, the construction of each asset shall be treated
as a separate construction contract 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.
• the costs and revenues of each asset can be identified.
A group of contracts, whether with a single customer or with several customers, should
be treated as a single construction contract when:
• The group of contracts is negotiated as a single package;
• the contracts are so closely interrelated that they are, in effect, part of a single
project with an overall profit margin;
• the contracts are performed concurrently or in a continuous sequence.
How to determine a stage of completion
• The ‘percentage of completion’ method is used.
• Depending on the nature of the transaction, the methods may include:
– surveys of work performed method;
How to determine a stage of completion
– services/works performed to date as a percentage of total services/work to be
performed (also called units-of-work-performed method);
– the proportion that costs incurred to date bear to the estimated total contract costs
(also referred to as the cost-to-cost method). Only costs that reflect services/work
performed to date are included in costs incurred to date. Only costs that reflect
services/work performed or to be performed are included in the estimated total
costs of the transaction.
Example 5.8
Constru ction contracts: calculation of gross amount due from customers
Example 5.9
Construction contracts: revision of estimates. An example
A construction contractor has a fixed price contract for €23,000. The initial estimate of
costs is €15,000 and the contract is expected to take four years (2006–9). In 2007 the
contractor’s estimate of total costs increases by €1,000 to €16,000. Of the € 1,000
increase, €600 is to be incurred in 2008 and €400 in 2008.
Example 5.10
Construction contracts: inefficiencies
A construction contractor has a fixed price contract for €23,000. The initial estimate of
costs is €15,000 and the contract is expected to take four years (2006–9). In 2007 the
contractor’s estimate of total costs increases by €1,000 to €16,000 as a result of
inefficiencies in 2007.
Figure 5.4 Recognition of revenue from multiple-element transactions
Source: Vodafone Group Plc Annual Report 2008
