Chapter 7

Construction Contracts

PROBLEM 7-1: TRUE OR FALSE

1. FALSE 6. TRUE
2. FALSE 7. TRUE
3. FALSE 8. FALSE
4. TRUE 9. FALSE
5. TRUE 10. TRUE

PROBLEM 7-2: THEORY & COMPUTATIONAL

1. D

2. D

3. A

4. C

5. D

6. C

7. D

8. C

9. D

10. C

11. C

12. Solutions:
Requirement (a):

July 1 to Construction in progress 120,000

Dec. 31, 120,000
Cash (or other appropriate accounts)
20x1
to record the contract costs

The percentage of completion as of December 31, 20x1 is computed as

follows:

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 The gross profit earned in 20x1 is computed as follows:

Total contract price 600,000

(a) Costs incurred to date 120,000
Estimated costs to complete 240,000
(b) Estimated total contract costs (see ‘bill of materials’) 360,000
Expected gross profit from contract 240,000
Multiply by: Percentage of completion (a) ÷ (b) 33 1/3%
Gross profit earned to date 80,000
Less: Gross profit earned in previous years -
Gross profit for the year 80,000

 The revenue and cost of construction in 20x1 are computed as

follows:

Total contract price 600,000

Multiply by: Percentage of completion 33 1/3%
Revenue to date 200,000
Less: Revenue recognized in previous yrs. -
Revenue for the year 200,000
Cost of construction (squeezed) (120,000)
Gross profit for the year (see computation above) 80,000

The year-end adjusting entry to recognize revenue is as follows:

Dec. 31, Cost of construction 120,000
20x1 Construction in progress (gross profit) 80,000
Revenue 200,000

Dec. Receivable (600K x 33 1/3%) 200,000

31, 180,000
Progress billings (given)
20x1
Contract liability 20,000

to record the billing to the customer

“Receivable” is debited instead of “Contract asset” because Contractor Co.

has an unconditional right to consideration for progress made on the
contract.

The excess of the receivable (i.e., unconditional right to consideration) over

the amount invoiced to the customer (i.e., progress billing) is recognized as a
contract liability.

Contract liability – is an entity’s obligation to transfer goods or services to a

customer for which the entity has received consideration (or the amount is
due) from the customer.

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Dec. Cash 60,000
31,
Receivable 60,000
20x1
to record the collection on the billing

Requirement (b):
Contractor Co.
Statement of financial position
As of December 31, 20x1

Current assets
Receivable (200,000 - 60,000) 140,000
Contract asset* 20,000
Total current assets 160,000

Current liabilities
Contract liability (see journal entries above) 20,000
Total current liabilities 20,000

*Construction in progress (120,000 + 80,000) 200,000

Progress billing (180,000)
Contract asset 20,000

Contractor Co.
Statement of profit or loss
For the year ended December 31, 20x1

Revenue 200,000
Cost of construction (120,000)
Gross profit 80,000
Other operating expenses -
Profit for the year 80,000

13. Solutions:
20x1 20x2
Total contract price 9,000,000 9,000,000
(a) Costs incurred to date 3,900,000 6,300,000
Estimated costs to complete (squeeze) 3,900,000 1,800,000
(b) Estimated total contract costs 7,800,000 8,100,000
Expected profit (loss) 1,200,000 900,000
Multiply by: % of completion (a) ÷ (b) 50% 77.7778%
Profit (loss) to date 600,000 700,000
Profit recognized in prior years - (600,000)

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 Profit (loss) for the year 600,000 100,000

20x1 20x2
Total contract price 9,000,000 9,000,000
Multiply by: % of completion 50% 77.7778%
Contract revenue to date 4,500,000 7,000,000
Contract revenue in prior years - (4,500,000)
Contract revenue for the year 4,500,000 2,500,000
Cost of construction (squeeze) (3,900,000) (2,400,000)
Profit (loss) for the year 600,000 100,000

14. Solutions:
20x1 20x2
Contract revenue to date (a) 3,900,000 6,300,000
Contract revenue in prior years - (3,900,000)
Contract revenue for the year 3,900,000 2,400,000
Cost of construction (b) (3,900,000) (2,400,000)
Profit (loss) for the year - -

(a) Equal
to the “Cumulative contract costs incurred.”
(b)
Equal to the costs incurred during the year. The cost incurred in 20x2 is
computed as follows: (6,300,000 – 3,900,000) = 2,400,000.

15. Solution:
No revenue shall be recognized during the course of construction. Revenue
(and cost of construction) will be recognized only when the construction is
complete and legal title over the constructed building is transferred to the
customer.

16. Solutions:
 The costs incurred to date include the cost of an uninstalled materials
(i.e., elevators).
 Because all the conditions under PFRS 15 are met, the entity shall adjust
its measure of progress to recognize revenue only to the extent of the
costs of the uninstalled elevators. The cost of goods sold recognized
in 20x1 will also include this cost. Consequently, the entity recognizes
zero profit from the elevators in 20x1.

Percentage of Total costs incurred to date

=
completion Estimated total contract costs
= (500,000 costs incurred, excluding cost of elevator) ÷ (2.5M ‘other costs’
only, excluding cost of elevator)
Percentage of completion = 20%

Requirement (a): Revenue in 20X2

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[(5M transaction price – 1.5M cost of elevator) x 20%] + 1.5M cost of elevator
= ₱2,200,000 revenue in 20X2

Requirement (b): Profit in 20X2

Cost of goods sold in 20X2
[(2.5M ‘other costs’ only, excluding cost of elevator) x 20%] + 1.5M cost of
elevator = ₱2,000,000 cost of goods sold in 20X2

Profit in 20X2 = 2.2M – 2M = ₱200,000

17. Solutions:

Analysis:
Since the additional goods or services to be provided in the modified contract
are not distinct, they are essentially a part of a single performance obligation
that is only partially satisfied. Therefore, the contract modification is
accounted for as if it were a part of the existing contract.

Accordingly, the effect of the contract modification on the transaction price,

and on the entity’s measure of progress towards complete satisfaction of the
performance obligation, is recognized as an increase or decrease in revenue
at the date of the contract modification. The adjustment to revenue is
made on a cumulative catch-up basis.

The percentage of completion is computed as follows:

Contract
modification date
20x1 in 20x2
(a) Costs incurred to date 420,000 420,000
Estimated costs to complete ignored ignored
(b) Estimated total contract costs (given) 700,000 820,000 (1)
Percentage of completion (a) ÷ (b) 60% 51.2%

(1)
The revised estimated total contract costs as of the date of contract
modification in 20x2 is computed as (700K original estimate of total contract
costs + 120K increase due to the contract modification in 20x2) = 820K.

The revenue in 20x1 and the cumulative catch-up adjustment to

revenue in 20x2 are computed as follows:
Contract
modification
20x1 date in 20x2
Total contract price 1,000,000 1,350,000 (2)
Multiply by: % of completion 60% 51.2%
Revenue to date 600,000 691,200
Less: Revenue recognized in prior yrs. - (600,000)

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Revenue in 20x1 /
Cumulative catch-up adjustment to
revenue in 20x2 600,000 91,200
Cost of construction (420,000) ( - )
Gross profit for the year /
Cumulative catch-up adjustment to gross
profit in 20x2 180,000 91,200

(2)
The bonus is included in the transaction price only in 20x2 when it became
highly probable that the entity will receive the bonus. The revised
transaction price on contract modification date in 20x2 is computed as (1M
contract price + 150,000 contract modification + 200,000 bonus =
1,350,000).

PROBLEM 7-3: EXERCISES: COMPUTATIONAL

1. Solutions:
Total contract price 20,000,000
(a) Costs incurred to date 2,000,000
Estimated costs to complete (squeeze) 14,000,000
(b) Estimated total contract costs 16,000,000
Expected profit (loss) 4,000,000
Multiply by: % of completion (a) ÷ (b) 12.50%
Profit (loss) to date 500,000
Profit recognized in prior years -
Profit (loss) for the year 500,000

Total contract price 20,000,000

Multiply by: % of completion 12.50%
Contract revenue to date 2,500,000
Contract revenue in prior years -
Contract revenue for the year 2,500,000
Cost of construction (squeeze) (2,000,000)
Profit (loss) for the year 500,000

2. Solutions:
Total contract price 4,500,000
(a) Costs incurred to date 1,350,000
Estimated costs to complete (given) 2,700,000
(b) Estimated total contract costs 4,050,000
Expected profit (loss) 450,000
Multiply by: % of completion (a) ÷ (b) 33 1/3%
Profit (loss) to date 150,000
Profit recognized in prior years -
Profit (loss) for the year 150,000

Total contract price 4,500,000

Multiply by: % of completion 33 1/3%
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 Contract revenue to date 1,500,000
Contract revenue in prior years -
Contract revenue for the year 1,500,000
Cost of construction (squeeze) (1,350,000)
Profit (loss) for the year 150,000

3. Solutions:
Requirement (a):
Total contract price 1,200,000
(a) Costs incurred to date 590,000
Estimated costs to complete (given) 410,000
(b) Estimated total contract costs 1,000,000
Expected profit (loss) 200,000
Multiply by: % of completion (a) ÷ (b) 59%
Profit (loss) to date 118,000
Profit recognized in prior years -
Profit (loss) for the year 118,000

Total contract price 1,200,000

Multiply by: % of completion 59%
Contract revenue to date 708,000
Contract revenue in prior years -
Contract revenue for the year 708,000
Cost of construction (squeeze) (590,000)
Profit (loss) for the year 118,000

Requirement (b):
Costs incurred 590,000
Profit recognized 118,000
Construction in progress 708,000

4. Solutions:
Requirement (a):

Contract revenue for the year (equal to cost incurred) 590,000

Cost of construction (squeeze) (590,000)
Profit (loss) for the year -

Requirement (b):
Costs incurred 590,000
Profit recognized -
Construction in progress 590,000

5. Solutions:
Requirement (a):
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 Contract revenue for the year -
Cost of construction -
Profit (loss) for the year -

Requirement (b):
Costs incurred 590,000
Profit recognized -
Construction in progress 590,000

6. Solutions:
20x1 20x2
Total contract price 6,000,000 6,000,000
(a) Costs incurred to date 2,250,000 4,800,000
Estimated costs to complete 2,250,000 -
(b) Estimated total contract costs 4,500,000 4,800,000
Expected profit (loss) 1,500,000 1,200,000
Multiply by: % of completion (a) ÷ (b) 50% 100%
Profit (loss) to date 750,000 1,200,000
Profit recognized in prior years - (750,000)
Profit (loss) for the year 750,000 450,000

20x1 20x2
Total contract price 6,000,000 6,000,000
Multiply by: % of completion 50% 100%
Contract revenue to date 3,000,000 6,000,000
Contract revenue in prior years - (3,000,000)
Contract revenue for the year 3,000,000 3,000,000
Cost of construction (squeeze) (2,250,000) (2,550,000)
Profit (loss) for the year 750,000 450,000

7. Solutions:
20x1 20x2
Contract revenue to date (a) 2,250,000 6,000,000
Contract revenue in prior years - (2,250,000)
Contract revenue for the year 2,250,000 3,750,000
Cost of construction (b) (2,250,000) (2,550,000)
Profit (loss) for the year - 1,200,000

(a)The contract revenue to date in 20x1 is equal to the ₱2,250,000 costs

incurred during that year. The contract revenue to date in 20x2 is equal to the
₱6,000,000 contract price because the construction is 100% complete.

(b) Equal to the costs incurred during the year.

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8. Solutions:
20x1 20x2
Contract revenue to date (a) - 6,000,000
Contract revenue in prior years - -
Contract revenue for the year - 6,000,000
Cost of construction (b) - (4,800,000)
Profit (loss) for the year - 1,200,000

(a) No revenue is recognized during the construction period because the

performance obligation is satisfied at a point in time. The whole of the
transaction price is recognized as revenue only in 20x2 when the construction
is completed.

(b)The costs incurred during the construction period are deferred and
recognized in full only in 20x2 when the related revenue is recognized.

9. Solutions:
20x1 20x2
Construction in progress, ending balances 122,000 364,000
Contract costs incurred to date (a) (105,000) (297,000)
Profit to date 17,000 67,000
Profit in previous years - (17,000)
Profit for the year 17,000 50,000

(a)
The contract costs incurred to date in 20x2 is computed as follows: (105,000 +
192,000 = 297,000).

20x1 20x2
Revenue for the year (squeeze) 122,000 242,000
Cost of construction (equal to costs incurred each yr.) (b) (105,000) (192,000)
Profit for the year 17,000 50,000

Under the ‘cost-to-cost’ method of measuring progress, the “cost of

(b)

construction” each year is equal to the contract cost incurred during the year.

Requirement (b):
Solution:
Progress billings, 20x2 420,000
Receivable, 20x2 (300,000)
Total collections 120,000

10. Solution:
The costs incurred to date are computed as follows:
20x1 20x2
(a) Costs incurred to date (squeeze) 978,750 4,524,000
Estimated costs to complete ignored ignored
(b) Estimated cost at completion (given) 6,525,000 6,960,000
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 (a) ÷ (b) Percentage of completion (given) 15% 65%

The costs of construction are computed as follows:

20x1 20x2
Costs incurred to date 978,750 4,524,000
Costs incurred in previous years - (978,750)
Costs incurred during the year 978,750 3,545,250

The profits are computed as follows:

20x1 20x2
Total contract price (given) 8,700,000 8,700,000
(a) Costs incurred to date (ignored)
Estimated costs to complete (ignored)
(b) Estimated cost at completion (given) 6,525,000 6,960,000
Expected profit (loss) 2,175,000 1,740,000
Multiply by: % of completion (given) 15% 65%
Profit (loss) to date 326,250 1,131,000
Profit recognized in prior years - (326,250)
Profit (loss) for the year 326,250 804,750

11. Solution:
Contract 1 Contract 2
Contract price 420,000 300,000
Costs incurred during the year 240,000 280,000
Estimated costs to complete 120,000 40,000
Total expected contract costs 360,000 320,000
Expected loss - (20,000)

Answer: Red Hot Co. recognizes a loss of ₱20,000 in 20x1. The loss is
recognized as a provision for onerous contract in accordance with PAS 37.

12. Solution:
Contract 1 Contract 2
Total contract price 420,000 300,000
(a) Costs incurred to date 240,000 280,000
Estimated costs to complete 120,000 40,000
(b) Estimated total contract costs 360,000 320,000
Expected profit (loss) 60,000 (20,000)
Multiply by: % of completion (a) ÷ (b) 66.67% N/A
Profit (loss) to date 40,000 (20,000)
Profit recognized in prior years - -
Profit (loss) for the year 40,000 (20,000)

Answer: Red Hot Co. recognizes a net profit of ₱20,000 (40,000 profit –
20,000 loss) in 20x1. The loss is recognized as a provision for onerous
contract in accordance with PAS 37.
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13. Solution:
Contract 1 Contract 2
Contract price 420,000 300,000
Costs incurred during the year 240,000 280,000
Estimated costs to complete 120,000 40,000
Total expected contract costs 360,000 320,000
Expected loss - (20,000)

Answer: Red Hot Co. recognizes a loss of ₱20,000 in 20x1. The loss is
recognized as a provision for onerous contract in accordance with PAS 37.

14. Solutions:
Requirement (a):
Contract Contract Contract
Total
1 2 3
Total contract price 500,000 700,000 250,000
Costs incurred to date (a) 375,000 100,000 100,000
Estd. costs to complete - 400,000 100,000
Estd. total contract costs
375,000 500,000 200,000
(b)
Expected profit (loss) 125,000 200,000 50,000
% of completion (a) ÷ (b) 100% 20% 50%
Profit (loss) to date 125,000 40,000 25,000
Profit in prior years - - -
Profit (loss) for the yr. 125,000 40,000 25,000 190,000

Contract Contract Contract

Totals
1 2 3
Total contract price 500,000 700,000 250,000
Multiply by: % of completion 100% 20% 50%
Contract revenue to date 500,000 140,000 125,000
Revenue in prior years - - -
Revenue for the yr. 500,000 140,000 125,000 765,000
Costs incurred (squeeze) (375,000) (100,000) (100,000) (575,000)
Profit (loss) for the year 125,000 40,000 25,000 190,000

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Requirement (b):
Contract 1 Contract 2 Contract 3 Totals
Costs incurred 375,000 100,000 100,000
Profit (loss) for the year 125,000 40,000 25,000
Total 500,000 140,000 125,000
Closing entry (a) (500,000) - -
Balance - 140,000 125,000 265,000

(a)
The CIP balance of Contract 1 is zeroed out because it is already
complete.

15. Solution:
Contract Contract Contract
Totals
1 2 3
Revenue for the yr. 500,000 - - 500,000
Costs incurred (squeeze) (375,000) - - (375,000)
Profit (loss) for the year 125,000 - - 125,000

16. Solution:
Contract Contract Contract
Totals
1 2 3
Revenue for the yr. 500,000 100,000 100,000 700,000
Costs incurred (squeeze) (375,000) (100,000) (100,000) (575,000)
Profit (loss) for the year 125,000 - - 125,000

The revenues recognized in contracts 2 and 3 are equal to the costs incurred
on those contracts during the year.

17. Solutions:

Requirement (a):
20x1 20x2
Contract revenue for the year (squeeze) 3,000,000 3,000,000
Cost of construction (2,250,000) (2,550,000) (a)
Profit (loss) for the year 750,000 450,000 (b)

(a) (4.8M – 2.250M = 2.550M)

(b) (1.2M – .750M = .450M)

Requirement (b):
Since the contract is 100% complete in 20x2, the transaction price is equal to
the sum of the revenues recognized in 20x1 and 20x2, i.e., 6,000,000 (3M +
3M).

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18. Solution:
20x1 20x2
Total contract price 3,000,000 3,000,000
Multiply by: % of completion 20% 60%
Contract revenue to date 600,000 1,800,000
Contract revenue in prior years - (600,000)
Contract revenue for the year 600,000 1,200,000
Cost of construction (squeeze) (450,000) (990,000)
Profit (loss) for the year 150,000 210,000(a)

(a) (360,000 -150,000) = 210,000

19. Solutions:
Requirement (a): Profit in 20x2

20x1 20x2
Total contract price 3,000,000 3,000,000
(a) Costs incurred to date 1,800,000
Estimated costs to complete, Dec. 31, 20x2 600,000
(b) Estimated total contract costs 2,250,000 2,400,000
Expected profit (loss) 750,000 600,000
Multiply by: % of completion (a) ÷ (b) 40% 75%
Profit (loss) to date 300,000 450,000
Profit recognized in prior years (given) - (300,000)
Profit (loss) for the year 300,000 150,000

Requirement (b): Estimated costs to complete – Dec. 31, 20x1

20x1
(a) Costs incurred to date (3rd step) – (2.250M x 40%) 900,000
Estimated costs to complete (Last step) – (squeeze) 1,350,000
(b) Estimated cost at completion (2nd step) – (given) 2,250,000
(a) ÷ (b) Percentage of completion (1st step) – (given) 40%

Requirement (c): Contract costs incurred in 20x2

Costs incurred to date, Dec. 31, 20x2 (given) 1,800,000

Costs incurred in 20x1 (see solution in 'b' above) (900,000)
Costs incurred in 20x2 900,000

Requirement (d): Revenues and Costs of construction – 20x1 & 20x2

20x1 20x2

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 Total contract price 3,000,000 3,000,000
Multiply by: % of completion (see ‘a’ above) 40% 75%
Contract revenue to date 1,200,000 2,250,000
Contract revenue in prior years - (1,200,000)
Contract revenue for the year 1,200,000 1,050,000
Cost of construction (see ‘b’ and ‘c’ above) (900,000) (900,000)
Profit (loss) for the year 300,000 150,000

20. Solutions:
Requirement (a):
Transaction price 20,000,000
Costs incurred to date, Dec. 31, 20x3 (squeeze) (18,400,000)
Profit to date, Dec. 31, 20x3 (400K + 1.4M - 200K) 1,600,000

Costs incurred to date, Dec. 31, 20x3 18,400,000

Costs incurred in 20x1 & 20x3 (3.6M + 8.2M) (11,800,000)
Costs incurred in 20x2 6,600,000

Requirement (b):
20x1 20x2
Total contract price (given) - Step 6 20,000,000
% of completion - (12M ÷ 20M) - Last step 60%
Contract revenue to date (squeeze) - Step 4 4,000,000 12,000,000
Contract revenue in prior years - Step 5 - (4,000,000)
Contract revenue for the year (squeeze) - Step 3 4,000,000 8,000,000
Costs incurred each year (see 'a' above) - Step 2 (3,600,000) (6,600,000)
Profit for the year (given) - Step 1 400,000 1,400,000

Requirement (c):
20x1
(a) Costs incurred to date (3.6M + 6.6M) (2nd step) 10,200,000
Estimated costs to complete (squeeze) - (Last step) 6,800,000
(b) Estimated cost at completion (10.2M ÷ 60%) (3rd step) 17,000,000
(a) ÷ (b) Percentage of completion (see ‘b’ above) - (1st step) 60%

21. Solution:
20x1 20x2 20x3
Total contract price 10,000,000 9,500,000 9,500,000
Costs incurred to date (a) 3,000,000 6,500,000 8,200,000
Estimated costs to complete 5,000,000 1,600,000 -
Estimated total contract costs (b) 8,000,000 8,100,000 8,200,000

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Expected profit (loss) 2,000,000 1,400,000 1,300,000
% of completion (a) ÷ (b) 37.50% 80.25% 100.00%
Profit (loss) to date 750,000 1,123,500 1,300,000
Profit recognized in prior years - (750,000) (1,123,500)
Profit (loss) for the year 750,000 373,500 176,500

20x1 20x2 20x3

Total contract price 10,000,000 9,500,000 9,500,000
Multiply by: % of completion 37.50% 80.25% 100%
Contract revenue to date 3,750,000 7,623,750 9,500,000
Contract revenue in prior years - (3,750,000) (7,623,750)
Contract revenue for the year 3,750,000 3,873,750 1,876,250
Costs incurred each year (given) (3,000,000) (3,500,000) (1,700,000)
Profit (loss) for the year 750,000 373,750 176,250

The differences in the profits (20x2 and 20x3) are due to the
rounding-off of the percentage of completion in 20x2.

22. Solution:
Requirement (a):
20x1
Expected gross profit (given) 5,000,000
Multiply by: % of completion (given) 50.00%
Profit to date 2,500,000
Profit in previous years -
Profit for the year 2,500,000

Requirement (b):
Collection from mobilization fee (20M x 5%) 1,000,000

Unadjusted progress billings (20M x 50%) 10,000,000

Billing accepted in the following yr. (20M x 10%) (2,000,000)
Billing due in the following year (20M x 8%) (1,600,000)
Adjusted progress billings 6,400,000
Multiply by: (100% - 10% retention) 90%
Collections from progress billings 5,760,000
Total collections in 20x1 6,760,000

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PROBLEM 7-4: CLASSROOM ACTIVITIES

ACTIVITY #1:

Solutions:

Step 1: Identify the contract with the customer

Requirement (a): YES, the contract qualifies for accounting under PFRS 15
because all of the requirements of “Step 1” are met.

a. The contract is approved and the parties are committed to perform their
respective obligations;
b. Each party’s rights regarding the goods or services to be transferred can
be identified from the contract;
c. The payment terms for the goods or services to be transferred can be
identified from the contract;
d. The contract has commercial substance; and
e. The consideration in the contract is probable of collection.

Step 2: Identify the performance obligations in the contract

Analysis: Performance obligations

There are three (3) promises in the contract: the promise to transfer the lot, to
provide the house design, and to construct the house.

However, these promises are not distinct on their own but rather a distinct
bundle of goods and services because of the following reasons:
a. The customer cannot benefit from the lot, the house design, and the
house separately because the contract requires the customer to
purchase those goods and services as a bundle. Moreover, Entity X
does not regularly sell those goods and services separately.
b. Each promise is not separately identifiable from the other promises in
the contract. This is because:
i. Each good or service is an input to a combined output specified by
the customer.
ii. Each good or service significantly modifies another good or service
promised in the contract.
iii. Each good or service is highly interrelated with the other goods or
services promised in the contract. For example, the customer’s
decision of not purchasing the house affects its ability to purchase
the lot.

Conclusion:
Requirement (b):
The promises to transfer the lot, the house design and the house shall be
combined and treated as a single performance obligation.

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Analysis: Satisfaction of performance obligations

A performance obligation is satisfied over time if one of the following criteria

is met:
a. The customer simultaneously receives and consumes the benefits
provided by the entity’s performance as the entity performs.

b. The entity’s performance creates or enhances an asset (e.g., work in

progress) that the customer controls as the asset is created or
enhanced.

 Criteria (a) and (b) are not met because the following reasons:
a. Entity X retains control of the lot, the design, and the house
during the construction period. This precludes the customer
from simultaneously receiving and consuming the benefits
provided by the entity’s performance as the entity performs.
b. In case of default, Entity X forfeits the properties in its favor.

c. The entity’s performance does not create an asset with an alternative

use to the entity and the entity has an enforceable right to payment for
performance completed to date.

 Criterion (c) is not met because the following reasons:

a. The entity’s performance creates an asset with an alternative
use. This is evidenced by the fact that Entity X can resell
forfeited properties without much modification because the
design is standard and not unique to the customer.
b. Entity X’s right to payment is not directly correlated with
performance completed to date, i.e., the monthly payments are
due irrespective of the stage of completion of the house.

Conclusion:
Requirement (c):
The performance obligation is satisfied at a point in time.

Step 3: Determine the transaction price

Analysis:
The transaction price includes a variable consideration because of the
stipulated penalty (i.e., a reduction of 2% of contract price for every month of
delay in the completion of the construction). However, since Entity X does not
expect any delays on the construction, Entity X is not required to estimate the
variable consideration. This holds true until there is a subsequent change in
circumstances, in which case Entity X will be required to estimate the variable
consideration.

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Conclusion:
Requirement (d):
The transaction price is ₱6,000,000. Using the practical expedient allowed
under PFRS 15, Entity X need not discount the installment payments
because they are due within 1 year.

Step 4: Allocate the transaction price to the performance obligations

Requirement (e):
Since the promises are treated as a distinct bundle of goods and services,
there is no need to allocate the transaction price to each of those promises.
Instead, the transaction price is allocated in its entirety to the single
performance obligation of transferring the lot together with the house
design and the house.

Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation

Requirement (d):
Since the performance obligation is satisfied at a point in time, revenue shall
be recognized at the point in time when control over the property (i.e., lot,
house design, and house) is transferred to the customer and the customer
accepts the property (i.e., the constructed house meets the specifications in
the contract).

Requirement (e):
Apr. Cash (6M x 20%) 1,200,000
1,
Receivable (6M x 80%) 4,800,000
20x1
Contract liability 6,000,000

“Receivable” is debited instead of “Contract asset” because Entity X has an

unconditional right to the consideration. This is because:
a. The contract is non-cancellable and the installment payments are
not dependent on performance completed to date.
b. The installment payments are conditioned only on the passage of
time (i.e., the installment payments are due at each month-end).
PFRS 15 states that, “A right to consideration is unconditional if only
the passage of time is required before payment of that consideration
is due, even if the amount is subject to refund in the future.”

Month-end entries:
Every Cash (6M x 80%) ÷ 18 months 266,666.67
end of 266,666.67
the
Receivable
month

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Apr. Contract liability 6,000,000
1, 6,000,000
20x2
Revenue

ACTIVITY #2:

Solutions:

Step 1: Identify the contract with the customer

Requirement (a): YES, the contract qualifies for accounting under PFRS 15
because all of the requirements of “Step 1” are met.

a. The contract is approved and the parties are committed to perform their
respective obligations;
b. Each party’s rights regarding the services to be transferred can be
identified from the contract;
c. The payment terms for the services to be transferred can be identified
from the contract;
d. The contract has commercial substance; and
e. The consideration in the contract is probable of collection.

Step 2: Identify the performance obligations in the contract

Analysis: Performance obligations

The contract includes the promises to provide the construction services and
the designs (architectural, engineering, electrical, plumbing and other
necessary designs).

However, these promises are not distinct on their own but rather a distinct
bundle of services because of the following reasons:
a. Each promise is not separately identifiable from the other promises in
the contract. This is because:
i. Each service is an input to a combined output specified by the
customer.

Indicators:
 The designs constitute an integral part of the contract (see
ARTICLE 6 of the contract).
 The customer is precluded from subcontracting any of the
specific works that constitute the contract (see ARTICLE 9 of
the contract).
 The contract does not indicate separate billings for each of the
design works stated in the contract (see ‘bill of materials’).

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 ii. Each good or service significantly modifies another good or service
promised in the contract.

Indicator:
 A change in any of the design works would affect the
construction work.

iii. Each good or service is highly interrelated with the other goods or
services promised in the contract.

Indicators:
 See indicators in (a.i) above.
 Since the customer is precluded from subcontracting any of the
works specified in the contract, the customer’s decision of not
acquiring a specific work from the contractor affects the other
services covered in the contract. For example, if the customer
does not acquire the designs from Entity Y, Entity Y will not
perform the construction services, and vice-versa.

b. Although the customer can benefit from each of the promised services
(Entity Y regularly sells those services separately), the customer’s ability
to benefit from those services individually is limited because of the
reasons stated in (a) above.

Conclusion:
Requirement (b):
The promises to provide the designs and construction service shall be
combined and treated as a single performance obligation.

Analysis: Satisfaction of performance obligations

A performance obligation is satisfied over time if one of the following criteria

is met:
a. The customer simultaneously receives and consumes the benefits
provided by the entity’s performance as the entity performs.

b. The entity’s performance creates or enhances an asset (e.g., work in

progress) that the customer controls as the asset is created or
enhanced.

 Criteria (a) and (b) are met because, although Entity Y has the right
to supervise the construction activity, the customer retains
ownership over any structure built on the lot. This is evidenced by
the fact that, in case the contract is cancelled, any progress on the
contract inures to the benefit of the customer.

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c. The entity’s performance does not create an asset with an alternative
use to the entity and the entity has an enforceable right to payment for
performance completed to date.

 Criterion (c) is met because of the following reasons:

a. In case the contract is cancelled, any structure built inures to
the benefit of the customer. Therefore, any asset created has
no alternative use to Entity Y.

Moreover, the lot belongs to the customer. Even if Entity Y

retains ownership over any structure built on the lot, Entity Y
would incur significant losses to direct the asset for another use
in case the contract is cancelled.

b. Entity Y has an enforceable right to payment for performance

completed to date. This is evidenced by the following:
i. Subsequent billings are based on Entity Y’s progress on
the contract.
ii. If the contract is cancelled, Entity Y has the right to
payment for any progress on the contract.

Conclusion:
Requirement (c):
The performance obligation is satisfied over time because the criteria above
are met.

Step 3: Determine the transaction price

Requirement (d):
The transaction price is equal to the fixed fee of ₱8,000,000.

Entity Y does not need to discount the transaction price because the timing of
agreed payments do not provide either the customer or Entity Y with a
significant benefit of financing, i.e., the payments on quarterly billings are due
within a short period of time.

Step 4: Allocate the transaction price to the performance obligations

Requirement (e):
Since the promises are treated as a distinct bundle of goods and services,
there is no need to allocate the transaction price to each of those promises.
Instead, the transaction price is allocated in its entirety to the single
performance obligation of completing the construction of the house in
accordance with the agreed specifications.

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Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation

Requirement (f):
Since the performance obligation is satisfied over time, revenue shall be
recognized over the construction period based on Entity Y’s measure of its
progress towards the complete satisfaction of the performance obligation.

Entity Y shall determine an appropriate method for measuring its progress on

the contract. Because of insufficient information given in the problem, the
appropriate measure of progress is presumed to be the “cost-to-cost”
method, an application of the inputs method.

Requirement (g):
Sept. Cash (8M x 15%) 1,200,000
1, 1,200,000
20x1
Contract liability
to record the mobilization fee

Oct. 1 to Construction in progress 2,422,000

Dec. 31, 2,422,000
Cash (or other appropriate accounts)
20x1
to record the contract costs

The percentage of completion as of December 31, 20x1 is computed as

follows:

 The gross profit earned in 20x1 is computed as follows:

Total contract price 8,000,000

(a) Costs incurred to date 2,422,000
Estimated costs to complete (squeeze) 4,498,000
(b) Estimated total contract costs (see ‘bill of materials’) 6,920,000
Expected gross profit from contract 1,080,000
Multiply by: Percentage of completion (a) ÷ (b) 35%
Gross profit earned to date 378,000
Less: Gross profit earned in previous years -
Gross profit for the year 378,000

 The revenue and cost of construction in 20x1 are computed as

follows:

Total contract price 8,000,000

Multiply by: Percentage of completion 35%
Revenue to date 2,800,000
Less: Revenue recognized in previous yrs. -
Revenue for the year 2,800,000

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Cost of construction (squeezed) (2,422,000)
Gross profit for the year (see computation above) 378,000

The year-end adjusting entry to recognize revenue is as follows:

Dec. Cost of construction 2,422,000
31, Construction in progress (gross profit) 378,000
20x1
Revenue 2,800,000

Dec. Contract liability (the mobilization fee) 1,200,000

31,
20x1
Receivable (squeeze) 1,600,000
Progress billings (8M x 35%) 2,800,000
to record the first quarterly progress billing

“Receivable” is debited instead of “Contract asset” because Entity Y has an

unconditional right to consideration for progress made on the contract (see
discussion in ‘Step 2’ above).

Dec. Cash [(2.8M – 1.2M) x 90%]* 1,440,000

31,
20x1
Receivable 1,440,000
to record the collection on the first quarterly
progress billing

* Total progress billing 2,800,000

Less: Mobilization fee (1,200,000)
Progress billing, net of mobilization fee 1,600,000
Less: 10% retention on subsequent billings (1.6M x 10%) (160,000)
Collection 1,440,000

Requirement (h):
Entity Y
Statement of financial position
As of December 31, 20x1

Current assets
Receivable (1,600,000 - 1,440,000) 160,000
Contract asset* -
Total current assets 160,000

Current liabilities
Contract liability* -
Total current liabilities -

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*Construction in progress 2,800,000
Progress billing (2,800,000)
Contract asset/ Contract liability -

Entity Y
Statement of profit or loss
For the year ended December 31, 20x1

Revenue 2,800,000
Cost of construction (2,422,000)
Gross profit 378,000
Other operating expenses -
Profit for the year 378,000

PROBLEM 7-5: MULTIPLE CHOICE - THEORY

1. B 6. C 11. D
2. A 7. A 12. A
3. B 8. D 13. D
4. D 9. A 14. D
5. A 10. B 15. D

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