Question

On January 1 2019 Areej entered into a contract with a customer to construct a stadium for consideration of $ 200 million. The contract was expected to take 2 years to complete. At 31 December 2019 Areej had incurred costs of $ 55 million, Costs to complete are estimated at $ 50 million. In addition to these costs, Amir purchased plant to be used on the contract at a cost of $ 30 million. This plant was purchased on 1 January 2019 and will have a residual value of $ 10 million the end of 2-year contract. Depreciation on the plant is to be allocated using a straight line method.

Areej determines the progress on contracts with an output method, based on the value of work certified to date. At 31 December 2019, the value of the work certified was $ 110 million, and the payment received from the was $ 20 million.

Required:

1. How should this transaction be accounted for in the year ended 31 December 2019?

2. When do we know that a performance obligation is satisfied, according to IFRS 15? Explain comprehensively and write 15 to 20 lines.

3. Describe briefly the two methods used to determine the progress of a contract. Don’t write more than 8 lines.

4. List 6 types of direct costs and three types of indirect costs for a contract. Moreover, explain the difference between these direct and indirect costs. Don’t write more than 6 lines.

Answer 1

a).

b).

At the inception of the contract, the entity should assess the goods or services that have been promised to the customer, and identify as a performance obligation: [IFRS 15.22]

• a good or service (or bundle of goods or services) that is distinct; or
• a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

A series of distinct goods or services is transferred to the customer in the same pattern if both of the following criteria are met: [IFRS 15:23]

• each distinct good or service in the series that the entity promises to transfer consecutively to the customer would be a performance obligation that is satisfied over time (see below); and
• a single method of measuring progress would be used to measure the entity’s progress towards complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.

A good or service is distinct if both of the following criteria are met: [IFRS 15:27]

• the customer can benefit from the good or services on its own or in conjunction with other readily available resources; and
• the entity’s promise to transfer the good or service to the customer is separately idenitifable from other promises in the contract.

Factors for consideration as to whether a promise to transfer goods or services to the customer is not separately identifiable include, but are not limited to: [IFRS 15:29]

• the entity does provide a significant service of integrating the goods or services with other goods or services promised in the contract;
• the goods or services significantly modify or customise other goods or services promised in the contract;
• the goods or services are highly interrelated or highly interdependent.

c).

The following are 2 methods used to determine the progress of a contract :

1). Units Completed

The Units Completed lends itself well to tracking tasks that are done repeatedly, where each iteration can easily be measured. Usually a task that is done repeatedly tends to take about the same amount of time, resources and effort, so tracking the units completed works well here. A simple example could be installing standard light fixtures. Each fixture takes roughly the same amount of time. If we had 100 fixtures to install then we can simply count the units installed. In this case, there are no subjective experience-based judgement involved.

2). Cost Ratio

The Cost Ratio method is usually implemented on a project that has tasks that tend to occur over a long phase or the entire project. Often used for Overhead costs, this technique is measured based on the budgeted allocation of dollars vs. the labour hours of production. This method gives the contractor the ability to earn value that is equal to the overall percent of project completion.

d).

Direct Costs:

Direct Material cost
Direct Labour cost
Direct machine working costs
Wages for workers specifically taken for a contract
Amounts paid to obtain the contract
Electricity and Water charges payable for completion of contract

Indirect Costs:

• Job site costs, home office costs and general conditions
  • Project Managers, Superintendents and other Support Staff
  • Office Trailers, Equipment and Supplies
  • Insurance, Office Salaries and other Miscellaneous Costs
• Equipment – Owned equipment and small tools
  • Depreciation
  • Repairs and Maintenance
  • Taxes and Insurance
• Labor Burden
  • FICA Taxes
  • Workers Compensation
  • Federal and State Unemployment
  • Vacation and other Fringe Benefits