engineering and construction 21 march 2017€¦ · • introduction • the 5 step model with...

1© 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation.

Document Classification: KPMG Confidential

Engineering and construction21 March 2017


Document Classification: KPMG Public

Kim Heng Kristen Haines

Brandon DaltonAnita Pozo-JonesEtienne Gouws

• Introduction• The 5 step model with practical examples• Other contract considerations with practical

examples• Implementation considerations



1 Jan 20171 April 20171 July 2017 1 Oct 2017

31 Dec 201731 March 201830 June 201830 Sept 2018

31 Dec 2018 31 March 201930 June 2019 30 Sept 2019

Comparative period* First year

Applicable years beginning on or after 1 Jan 2018

Disclosures around standards issued but not yet effective

* If a retrospective transition method applied



Identify the contract(s) with a customer

Identify the performance obligations in the contract

Determine the transaction price

Allocate the transaction price to performance obligations in the contract

Recognise revenue when (or as) the entity satisfies a performance obligation

Core principleRecognise revenue to

depict transfer of promised goods or

services to customers in amount that reflects

consideration to which entity expects to be

entitled in exchange for those goods or service

1

2

3

4

5



1

... it has commercial substance.

... rights to products or services and payment

terms can be identified.

... collection of consideration is considered probable.

... it is approved and the parties are committed to their obligations.

A contract exists if...



Contracts are combined if entered into at or near the same time with the same customer and one or more of the following criteria are met.

Contracts may be combined and accounted for as a single contract.

Contract 1

Contract 2

AASB 15

Negotiated as package with a

single commercial objective.

Consideration in one contract

depends on the other contract.

Products and services are a

single performance obligation.

1



Capable of being distinct

Can the customer benefit from promise on its own or together with other resources that are

readily available?

Distinct within the context of the contract

Is it separately identifiable from other promises in the contract?

+A promise to transfer to the customer a distinct good or service

2



Are we providing a significant service of integration?

Are we customising or modifying the goods significantly?

Is the good or service highly dependent on or highly interrelated with other goods or services in the contract?

1 2 3

If the answer is yes to any of these questions, not separately identifiable

2



• Contractor G enters into contract with customer M to set up a metro system for a new transport line.

• Scope of work to include design, manufacture, delivery and installation of metro and electrical system.

• Contract includes milestone payments as follows:

• Customer will keep all copyrights for drawings/designs with no restrictions on use.

Please respond to polling question 3 that will appear on your screen shortly

Milestone Amount ($M)Design 200

Manufacture 200

Delivery 100

Installation 50

Total contract 550

2



Milestone Criterion 1 – Capable of being distinct

Criterion 2 – Distinct within context of contract

Design

Manufacture

Delivery

Installation

ü

ü

ü

ü

2

Contract includes two performance obligations: (1) Design, and (2) Manufacture, delivery and installation services

ü



Significant financing component

Non-cash considerationVariable consideration

Consideration payable to customer

Transaction price

3



Variable consideration can be:

Variable consideration is estimated using most appropriate method of either:

Expected Value(Sum of probability-weighted

amounts in a range of possible outcomes)

Most Likely Amount(Single most likely outcome, when

the transaction amount has a limited number of possible outcomes)

Capped at an amount for which it is ‘highly probable’ that a significant reversal will not occur.

Credits IncentivesDiscounts Performance bonuses Many more...

3



• Entity C is contracted to build a new power plant at a mine site. Transaction price includes:– Fixed amount: $300m – Performance bonus: $50m – For each week power plant completion is late, performance bonus decreases by 10%.

• C has significant past experience in constructing similar power plants for similar customers, all within the required deadlines.

• C estimates that there is a:– 70% probability project will be completed on time, – 20% probability project will be up to 1 week late, and – 10% probability project will be up to 2 weeks late.

Q: At commencement of contract how much of performance bonus would be included in transaction price?

3



Component AmountFixed amount $300m

Performance bonus – on time (70% x $50m) $35m

Performance bonus – 1 week late (20% x $45m) $9m

Performance bonus – 2 weeks late (10% x $40m) $4m

Transaction price (estimate at inception) $348m

Constrain the variable

consideration

?

3



• Entity X is contracted to construct a road bridge for a customer. Contract states transaction price includes:

– Fixed amount: $50m– Penalty: $10m penalty if bridge is not completed by an agreed date

• Management have determined that most likely outcome is that they will not incur $10m.

• X has significant past experience in constructing similar bridges for similar customers, all within required deadlines.

• X expects bridge will take 1 year to complete.

Q: At contract inception, how much penalty would be included in transaction price?

3



Likelihood Magnitude

Susceptibility to factors outside entity’s

influence?

Uncertainty not resolved

for long time?

Entity’s experience with similar contracts is

limited?

Practice of price

concessions / changing terms for similar

contracts?

Large number / broad range

of possibilities?

Consider the following :

Entire $50m will be included in transaction price at contract inception.

+

3



Allocate based on relative stand-alone selling prices

Performance obligation 1



Determine stand-alone selling prices

Observable price Estimate price

Adjusted market assessment approach

Expected cost plus a margin approach

Residual approach only if selling price is highly variable or uncertain

Fair value measurement

û

4



Q: How is transaction price allocated to performance obligations?

4

• Following on from Example 1

• Contractor G enters into a $550m contract with customer M to set up a metro system for a new transport line.

• Scope of work is for two performance obligations 1) design and 2) manufacture, delivery and installation of metro and electrical system.

• Competitors of G sell designs of metros systems for $230m and the manufacture, delivery and installation for $385m:



4

Stand-alone price$230

$385$615

Selling price ratio

Priceallocation

37.4% $205.7 ($550 X 37.4%)

62.6% $344.3 ($550 X 62.6%)$550

Performance obligation

DesignManufacture, delivery & installation



A performance obligation is satisfied over-time if:

Customer simultaneously receives and consumes the benefits as the entity performs.

The customer controls the asset as the entity creates or enhances it.

The entity’s performance does not create an asset for which the entity has an alternative use and there is a right to payment for performance to date.

Routine or recurring services, e.g. maintenance

services

Asset built on customer’s site, e.g.

power plant on customer’s land

Asset built to order

1 2 3

OR OR

5



… a present obligation to

pay… physical possession … legal title

… risks and rewards of ownership

… accepted the asset

Indicators that control has passed include a customer having…

5



• Ship Builder A enters into a contract with Customer F to design and build a ship, which is a single performance obligation.

• Contract prohibits A from transferring ship to another customer.

• Under contract, F pays A for ship on delivery.

• Contract is a fixed price contract containing a profit margin of 30%.

• If F cancels contract for convenience, then F must pay A for costs incurred to date plus a 20% profit margin.

Q: Should revenue be recognised over-time or at a point-in-time?

5



Criteria for recognising revenue over-time Met?Customer simultaneously receives and consumes benefit as entity performs; or

Customer controls asset as entity creates or enhances it; or

Entity’s performance(a) does not create an asset with alternative use, and(b) right to payment for performance to date

Revenue on construction of ship recognised over-time

üü

5



Input method

Based on entity’s efforts or inputs towards satisfying performance obligation, relative to total expected inputs to satisfy performance obligation in full, e.g.

• Costs incurred• Time elapsed• Labour/machine hours used

Output method

Based on direct measurements of value to customer transferred to date, relative to remaining goods/services promised under the contract, e.g.

• Surveys of work performed• Milestones achieved• Units of production• Time elapsed

5



• Constructor Z agrees to refurbish an office tower for a customer for $15m.

• Total estimated costs to complete are $10m which covers refurbishment of all 7 floors of building.

• Overall gross margin on contract is 33%.

• Costs incurred at end of year 1 are $2m and at this date, a survey of work completed has been performed noting 18% completion.

Q: How much revenue is recognised under each measurement method - (1) input and (2) output?

5



Watch out – Milestone method may not reflect performance!

Output methodSurvey

$15m*18% complete$2.7m$2m

$0.7m26%

Input methodCosts incurred to date

$15m*$2m/$10m$3m$2m$1m33%

Measure of progressCalculation – end of year 1Revenue recognisedCostsGM $GM %

5



Is the contract modification approved?

Do not account for contract modification until approved

Does it add distinct goods or services

that are priced commensurate

with stand-alone selling prices?

Are remaining goods or services distinct from those

already transferred?

Account for as separate contract

(prospective)

Account for as termination of existing contract and creation

of new contract (prospective)

Account for as part of the original contract

(cumulative catch-up)

No

No

No

Yes

Yes Yes



• Construction company G enters into a contract with customer M to build a road for a contract price of $50m. G concludes revenue will be recognised over-time using cost-to-cost method and estimates total costs will be $45m.

• Construction on road starts on 1 July 2018.

• Customer submits a change order on 1 January 2019 requesting a section of road be widened to include two additional lanes. G estimates road widening would increase costs by another $8m.

• On 1 February 2019, change order is approved by G. At this time, G estimates that contract price will be increased by $11m. Costs incurred to date on original road build was $30m and widening was $2m.

• However, G and M only agree contract price on 1 May 2019 at which time, G’s estimate of $11m for the contract modification was confirmed by M.

• At the date of contract modification, stand-alone selling price for road widening is $13m. Stand-alone selling price for remaining work on road build is $25m.

Q: When should G start accounting for contract modification?



1 July 2018 (construction

commencement date)

1 January 2019 (change order receipt date)

1 February 2019 (change order approval date)OR OR

Modification accounting effective from change order approval date, with change order price treated as variable consideration until 1 May 2019.

1 May 2019 (price agreement

date)OR

Q: How should G account for contract modification?




Is road widening distinct from

construction of road and is $11m commensurate

with stand-alone selling price?

Is road widening distinct from

construction of the road?

Modification accounted for separately, as if it was a

separate contract.$35.8m (50*30/45 +

11*2/8)

Unrecognised consideration on original

contract allocated to unsatisfied POs including

those in modification$35.4m (a)

Road widening becomes part of single PO that is

partially satisfied at modification date.$36.8m (61*32/53)

No

No Yes Yes

SSP % allocated

Allocated amount

Revenue

Remaining road build

Widening

25 65.8% 18.2 33 = (33 + 18.2 * (0/15))

13 34.2% 9.5 2.4 = (9.5 * 2/8)

38 27.7 35.4

(a)



Would costs be incurred regardless of whether contract is obtained?

Do costs fall in scope of other guidance?OR

Do they meet criteria to be capitalised as fulfillment costs? (1) Relate to existing contract or specific anticipated contract;

and (2) Will generate or enhance resources of entity that will be

used to satisfy POs in future; and (3) Costs are expected to be recovered

Expense costs as they are incurred

Are incremental costs expected to be recovered?

Capitalise costs

No

No

No

Yes Yes

Yes

As a practical expedient, capitalisation of contract acquisition costs not required if amortisation period would be one year or less.



An entity wins a contract to build an infrastructure asset for a customer over 5years. Following costs were incurred during bidding process (design cost isrecoverable by preferred/winning bidder):


Bid and proposal costs $20,000

Travel costs to deliver proposal $15,000

External legal costs $15,000

Design cost $50,000

Sales commission $10,000



Not incremental costs of obtaining contract. Expensed when incurred.

Capitalise if meets fulfilment costs criteria. Amortise to reflect performance.

Bid and proposal costs $20,000

Travel costs to deliver proposal$15,000

External legal costs$15,000

Design cost$50,000 ?

Sales commission$10,000

Incremental costs of obtaining contract. Capitalise and amortiseover contract term.



Issue DiscussionOver-time criteria met part way through construction

• Does this rule out over-time revenue recognition? • If over-time is still appropriate, what happens with “inventory” that is built prior

to over-time criteria being met? Uninstalled materials • Revenue only to extent of costs incurred.

• Excluded from measure of progress.• When should margin on uninstalled materials be recognised.

Warranties Assurance (provision) vs. service (separate PO) type warranty.

Loss-making contracts No specific rules in AASB 15. Account as an onerous contract under AASB 137 and consider only unavoidable costs of fulfilling an obligation.

Significant financingcomponent

• Transaction price adjusted for significant financing (increase revenue, interest expense for advance payments and decrease revenue and interest income for deferred payments).

• Consider practical expedient of < 1 year.• Quantitative and qualitative considerations.



Issue DiscussionReasonable measure of progress

Not able to reasonably measure the outcome of a performance obligation, but expects to recover costs => recognise revenue only to the extent of costs incurred until such time that it can reasonably measure the outcome

Capitalisation of borrowing costs

When revenue is recognised over-time and there is no (or only minimal WIP), is there a qualifying asset for purposes of capitalising borrowing costs

Learning curve costs • Determine if one or multiple performance obligations• If multiple performance obligations, learning curve costs may result in

losses/lower margins on earlier performance obligations• Consider application of series guidance multiple performance obligations



Financial and operational system changes

‒ Existing systems may not capture required data‒ Inventory of incremental information ‒ Processes re-designed‒ Update systems vs new systems‒ Dual systems for certain transition options‒ Processing changes to contracts

Governance and change

‒ Impact on internal resources‒ Revenue change management team‒ Change to contract practices‒ Training (accounting, sales, etc)‒ Multi-national locations‒ Effect on management compensation metrics‒ Impact on forecasting and budgeting processes

Internal control assessment

‒ Effect on internal control environment‒ New controls vs modify existing controls‒ Identify new risk points‒ Management review controls‒ IT controls‒ Process level controls

Communication with stakeholders

‒ Key to successful implementation‒ Identify relevant stakeholders‒ Messaging‒ Timing of communication‒ Comparability of data communicated‒ Expected impact of change

Revenue Recognition



2017 2018Contract analysis

Accounting guidelines Preparation of the transition

Analysis of processes/IT

Solution development Roll-out of new solutions

Training concept Performance of trainings

Sales conceptsBusiness model Stakeholder and capital markets communication

Analysis Design Implementation Stabilisation

Accounting and

Reporting

Systems and processes

People and change

Business



Assessing the impact to your organisation is a critical first step. The following activities may help position you to plan an effective implementation:

Establish project team and governance1

Involve tax resources6

Determine impacts to your accounting policies and disclosures2

Identify new information requirements3

Identify system and process gaps4

Consider impact to internal controls5



Identify other parties that need to be involved7

Involve your external auditor throughout the process12

Develop initial thoughts regarding transition approach8

Build a project plan9

Determine the resource needs10

Communicate with stakeholders and those charged with governance11


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© 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The KPMG name and logo are registered trademarks or trademarks of KPMG International.

Liability limited by a scheme approved under Professional Standards Legislation.

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engineering and construction 21 march 2017€¦ · • introduction • the 5 step model with...

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