Article:

IFRS 15 for the construction industry – Tender costs

06 June 2018

In addition to the substantially more detailed guidance for revenue recognition, IFRS 15 contains prescriptive criteria to be applied when determining whether costs associated with the acquisition of a contract should be recognised as an asset, or expensed as incurred.  This extends to cover all contract acquisition costs, such as bid costs incurred prior to the award of a contract.

IFRS 15 is restrictive in that it permits only incremental costs of obtaining a contract to be considered for capitalisation.  Therefore, only those costs which would not have been incurred if the contract had not been obtained are eligible to be considered.  An example is a sales commission which is only payable in the event that a contract is awarded.  In contrast, ongoing costs of running the business, such as a legal department, are not eligible to be considered because these costs would have been incurred regardless of whether a specific contract had been obtained.  Although it might be argued that the legal department would not exist unless an entity was involved in obtaining sales contracts, IFRS 15 does not permit those contracts to be analysed on a portfolio basis.  Instead, the focus is on whether costs attributable to each individual contract are incremental.

Once incremental costs have been identified, these are recognised as an asset if there is an expectation that they will be recovered, typically through profits to be generated from the related contract.  This asset is then amortised on a basis that is consistent with the transfer of the goods or services specified in the contract.  It will be necessary for judgement to be applied in determining an appropriate amortisation period and profile.

Example – Tender costs

Background
Construction Co wins a competitive tender to construct a warehouse for a customer. They incur the following costs to obtain the contract:

  • External legal fees for due diligence: $35,000
  • Travel costs to deliver proposal: $5,000
  • Commission to sales employee if tender is successful: $10,000
  • External consulting costs incurred to assist Construction Co preparing the tender documentation: $10,000
  • Administrative costs incurred in preparing the tender document: $15,000.

The completion of this construction project is expected to take 2 years.

Question
How does Construction Co account for the tender costs incurred?

Answer

Cost Amount
$
Treatment Justification
Due diligence legal fees 35,000 Expense Expensed as incurred because these would have been incurred whether or not the tender was successful.
Travel costs to deliver proposal 5,000 Expense Expensed as incurred because these would have been incurred whether or not the tender was successful.
Commission to sales employee 10,000 Capitalise Recognise as an asset because these are incremental costs of obtaining the contract and the company expects to recover them through future construction fees.
External consulting costs incurred to assist Construction Co preparing the tender documentation 10,000 Expense Expensed as incurred because these would have been incurred whether or not the tender was successful.
Administrative costs 15,000 Expense Expensed as incurred because these would have been incurred whether or not the tender was successful.
Total 75,000    

Journal entries

Dr Tender costs (contract asset) $10,000  
Dr Tender expenses $65,000  
Cr Trade Payables   $75,000

Current practice under IAS 11

There is very little guidance in the current accounting standards about which types of costs are allowed to be capitalised but in practice most entities will capitalise the majority of costs associated with winning a tender if the tender is successful. IFRS 15 will be a lot more restrictive in what costs are allowed to be capitalised.

Practical implications on systems and processes  

Some of the practical implications on systems and processes for Construction Co include:

  • Systems to capture tender costs
  • Processes to identify which costs are able to be capitalised
  • Systems to recognise capitalised costs
  • Systems to amortise capitalised costs
  • Processes to assess for impairment of capitalised costs.