IFRS 15 – Contract Assets and Contract Liabilities

Application of IFRS® 15, Revenue from Contracts with Customers became mandatory for annual reporting periods beginning on or after 1 January 2018. For many entities, such as those in the retail trade, the introduction of IFRS 15 has had little effect on how revenue is accounted for. However, some industry sectors have felt a much greater impact. For example, the amount and timing of revenue for entities that deal primarily in contracts with multiple performance obligations (eg telecommunication companies) and those that deal with contracts that span multiple periods (eg construction companies) may be significantly different than in the past.

IFRS 15 is a complex standard and since its introduction, the FR examining team at ACCA has become aware of some confusion regarding the accounting treatment of certain elements of IFRS 15. In particular, how to account for contract assets and contract liabilities

What are contract assets and contract liabilities?

IFRS 15 includes the following definitions:
 

Contract asset An entity’s right to consideration in exchange for goods or services that the entity has transferred to a customer when that right is conditioned on something other than the passage of time (for example, the entity’s future performance).
Contract liability An entity’s obligation to transfer goods or services to a customer for which the entity has received consideration (or the amount is due) from the customer.

In simple terms, this means that a contract asset arises when an entity has done work for a customer that has been recognised as revenue to date but has not yet issued an invoice or received payment for that work. A contract liability arises when an entity has invoiced the customer or received payment from them but has not yet done the work and the invoices and/or payments exceed the revenue recognised to date.

Although IFRS 15 uses the terms ‘contract asset’ and ‘contract liability’, these might also be referred to using different terminology such as ‘accrued income’ and ‘deferred income’ respectively. Whatever terminology is used, entities must make sure that they are accounted for as being distinct from trade receivables which will arise when an invoice has been issued.

What is causing confusion?

ACCA are aware that some candidates and learning providers are still using the accounting requirements of IAS® 11, Construction Contracts rather than the requirements of IFRS 15 when calculating contract assets and contract liabilities. IAS 11 is one of the accounting standards that was superseded by the introduction of IFRS 15.

What is the correct accounting treatment under IFRS 15?

Calculating the contract asset or contract liability under IFRS 15 is very straight forward. It is simply:
 

 

$

Revenue recognised to date

X

Less: Amounts invoiced to date

    (X)    

Contract asset/(liability)

 X/(X)

For contracts where performance obligations are satisfied over a period of time, the stage of completion is required to calculate how much revenue should be recognised to date. However, there is no requirement to calculate the estimated profit/loss on the contract (except to the extent of determining whether the contract is onerous).

For the purposes of the FR exam, any costs incurred to fulfil a contract with a customer should be expensed to the statement of profit or loss as they are incurred.

What was the IAS 11 accounting treatment?

Under IAS 11, where the outcome of a construction contract could be estimated reliably, entities were required to calculate the total expected profits of a contract and multiply this by the stage of completion. This then allowed the entity to recognise revenue, expenses and profit that could be attributed to the proportion of work completed. Although the terms ‘contract asset’ and ‘contract liability’ were not used in IAS 11, the equivalent amounts could be established by the following calculation:
 

 

$

Costs incurred to date

X

Profit/(loss) to date

X/(X)

Less: Amounts invoiced to date

    (X)    

Contract asset/(liability)

X/(X)

It has come to the attention of the FR examining team that the above calculation is often still being used by candidates to determine the contract asset and contract liability. However, this is no longer technically correct and is not in accordance with the IFRS standards.

How are ACCA dealing with any confusion?

The calculation of the contract asset under IFRS 15 outlined above is the technically correct one and the FR examining team would expect candidates to take this approach going forwards. However, we also recognise that a significant portion of candidates may still be using the IAS 11 approach discussed in this article. For the exam periods up to and including June 2022, the FR examining team will award credit for either approach. The importance of showing your workings in Section C (Constructed Response questions) cannot be over emphasised as the marker will be able to award credit based on the workings available.

From September 2022 onwards, credit will only be awarded for the correct IFRS 15 approach.

Written by a member of the FR examining team