IFRS 15 for the construction industry – Overview
04 June 2018
Entities in the construction industry have previously followed their own standard (IAS 11 Construction Contracts) that contained specific guidance for the recognition of revenue from construction contracts. This has now been replaced by a generic revenue standard called IFRS 15 Revenue from Contracts with Customers. The new revenue standard will likely bring about additional complexities for accountants who prepare financial reports for construction entities in addition to potentially changing the pattern of revenue recognition.
The new principle
The core principle in IFRS 15 is to recognise revenue in a way that reflects how the goods or services are provided to the customer. It contains a lot more specific and detailed guidance than the current IAS 18 Revenue and IAS 11 standards.
IFRS 15 focuses on the ‘promises’ made to the customer and requires greater separation of the components or ‘promises’ made in the contract. Revenue needs to be allocated to each ‘distinct’ performance obligation in proportion to the standalone selling prices of each ‘promise’.
When is it effective?
The standard is effective for accounting periods commencing on or after 1 January 2018 with early adoption permitted. For many entities in the construction sector there will be significant need for changes to processes and systems, including far greater liaison between those drafting sales contracts and the accountants that will need to ensure compliance with IFRS 15.
Implications for the construction industry
Due to the nature of construction contracts, the new IFRS 15 will likely introduce significant complexity to the accounting processes of construction companies. Typical construction contracts will contain several performance obligations that will be completed at various points in time. This will require accountants to assess whether goods or services are recognised at a point in time or over time, if these goods or services are distinct or need to be combined with other goods or services when recognising revenue, or if discounting needs to be performed in order to account for the time value of money in long-term contracts.
The commercial effects
The adoption of IFRS 15 may lead to significant changes in the pattern of revenue and profit recognition. Careful consideration and planning will be needed for a wide range of issues, including the effect on:
- Compliance with bank covenants
- Performance-based compensation (including share-based payments)
- Internal budgeting processes
- Corporate tax obligations
- Market and investor communications, including compliance with regulatory requirements (which might arise from significant expected future changes to an entity’s reported financial position or performance).
||High Impact - The adoption of IFRS 15 will cause a potential change to the reported revenue in financial statements of construction companies and/or is likely to require changes to current processes and systems.
||Medium Impact - The adoption of IFRS 15 may cause a potential change to the reported revenue in financial statements of construction companies and/or may require changes to current processes and systems.
||Low Impact - The adoption of IFRS 15 will cause a minor or no change to the reported revenue or disclosures in financial statements of construction companies.
The table below summarises the issues in construction contracts that are expected to be most impacted due to the adoption of IFRS 15. These will be covered in articles released over the coming weeks:
The construction industry needs to pay attention to the new revenue standard now. We predict that the new standard will be extremely difficult to apply for the construction industry due to the complex nature of its contracts. It is far more complex than the current accounting standard, and can significantly alter the pattern of revenue recognition and pattern of profit for the construction industry. It will not just be a mere accounting change but will have wide spread implications to other business areas, e.g. significant IT systems changes will be required, sales contracts/terms may need to be modified, and marketing campaigns will need to be reconsidered. The impact on revenue will also have a flow on effect to bonuses, bank covenants, dividend payments, and corporate taxes.