Construction accounting: the key IFRS issues

Why is construction accounting different?

Construction projects run for months or years, cost far more than any single invoice, and change as they go: clients order variations, ground conditions surprise, and disputes are settled late. Revenue cannot wait until completion without making results meaningless, so it is recognised as the work is done, using estimates that are revisited every period. Errors in those estimates are one of the most common causes of contractor profit warnings.

Which IFRS issues matter most in construction accounting?

When is construction revenue recognised over time?

When the contractor builds on the client's land, the client controls the asset as it is built, so revenue is recognised over time. When it builds on its own premises, such as a specialised vessel or plant, revenue is over time only if the asset has no alternative use and the contractor has an enforceable right to payment for work done, including a margin. Most construction contracts are a single performance obligation, because the contractor integrates design, materials and labour into one asset. See construction revenue over time.

How is progress measured?

Usually by the cost-to-cost method: costs incurred to date divided by total expected costs. Costs that do not reflect progress, such as materials delivered but not yet installed or waste from inefficiencies, are excluded or adjusted. Output methods, such as surveys of work performed, are an alternative where they reflect the work transferred more faithfully.

How are variations and claims treated?

A variation changes the scope or price of the contract. It is a contract modification once approved, which can be before the price is agreed, with the price estimated as variable consideration. Claims for extra costs, such as client-caused delays, are included only to the extent it is highly probable that a significant reversal will not occur, a high bar for disputed amounts. Liquidated damages for late completion reduce the transaction price.

What happens when a contract is loss-making?

IFRS 15 has no rules on onerous contracts, so contractors apply IAS 37: when the unavoidable costs of completing a contract exceed the remaining economic benefits, the expected loss is provided for at once. Since 2022, the costs of fulfilling a contract include both incremental costs and an allocation of other costs directly related to it, such as depreciation of plant used on site.

What are contract assets and liabilities?

When revenue recognised exceeds amounts billed, the contractor has a contract asset; when billings run ahead, a contract liability. Retentions withheld by the client until the defects period ends often remain contract assets until the conditions for release are met. Advance payments from clients are contract liabilities and may include a significant financing component.

What other issues arise?

• Tender and mobilisation costs: bid costs are expensed unless incremental and recoverable; set-up costs may be costs to fulfil a contract.
• Joint ventures: construction consortia are often joint operations under IFRS 11, with each partner recognising its share of revenue and costs.
• Defects liability: usually an assurance warranty, provided for under IAS 37.
• Borrowing costs: a contractor recognising revenue over time rarely has a qualifying asset under IAS 23.

How does US GAAP differ?

Revenue recognition under ASC 606 is essentially the same. US GAAP kept specific guidance for provisions on loss-making construction contracts in ASC 605-35, which contractors use instead of an onerous contract model. See IFRS 15 vs ASC 606.

Where can I read more about each construction issue?

Each issue has its own guide: revenue over time, the cost-to-cost method, variations and claims, loss-making contracts, retentions, contract assets and liabilities, mobilisation and tender costs, liquidated damages and joint ventures. Further guides cover uninstalled materials, defects liability and warranties and borrowing costs on contracts.

This guide is general information. It is not tax or legal advice for your situation.