Loss-making contract IFRS 15

[marea]

Hello everyone,

The company has a long-term contract with the customer and it recognises revenue over time (the good/ service has no alternative use for the company and there is the enfocable right for payment). At the reporting date the planned costs exceed the planned revenue. However the overall outcome is still uncertain at the reporting date (negotiations still in progress). Could you please confirm that in such case the company does not recognise the total expected loss as a provision, but it recognises the actual costs incurred to date and the revenue to the extent of contract costs. The company uses the cost to cost method to measure the progress of completion. However, since costs are higher than planned revenue, if revenue is recognised at the same amount as the costs incurred, this results in a higher revenue recognition as if the percentage of completion method would have been applied.

[JRSB]

If it's still in negotiation, presumably the project will be declined if expected to be loss making? Or other factors at play, related party?

[marea]

the contract is already in progress. Some additional costs incurred that were not planned initially. The company is negotiating with the customer to increase the transaction price. No related parties are involved.

[Marek Muc]

I guess a renegotiation is in progress? (EDIT: OK I replied just after @marea and didn't see this reply)

I don't think you approach is justifiable, you need to recognise a provision for onerous contract, and stop overstating revenue - all until renegotiations are concluded

[marea]

I see. Thank you for your answers.

[marea]

After reading the publication on IFRS 15 issued by BDO on this topic, I found an interesting issue regarding the assessment whether a contract is onerous. If the contract includes a variable consideration, then this should be considered as well when assessing whether a contract is onerous. This means that according to IAS 37 all expected revenues are included; the revenue constraint is part of IFRS 15 but not IAS 37. In some cases this may make a significant difference in the assessment.

[Marek Muc]

Sure, but this is not applicable to your case, right?

[marea]

I just wanted to emphasise this in case someone encounter this issue in future . Also, I was focused on one PO, but I should have considered the entire contract as a unit of account....

[Marek Muc]

Good point!

[Leo]

Just wanted to double check that, the application of IAS 37, onerous contract provision is under the assumption that the contract cannot be terminated without incurring a penalty, is that correct? I haven't noticed the mention of this point in the original post.

In a case that the contract can be terminated for no penalty, than, even the contract is loss making, an onerous contract provision cannot be justified, do you agree?

[Ketan Marwah]

Hey Leo,

IAS 37 defines an onerous contract as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under the contract. Unavoidable costs are the lower of the costs of fulfilling the contract and any compensation or penalties from the failure to fulfill it. If a contract can be terminated without incurring a penalty, then it is not onerous.

[Leo]

And that is even you know the contract will be loss making, you still can't book a provision is that correct? You have to wait for the losses to occur.

[Ketan Marwah]

Sounds like a theoretical scenario otherwise tough to understand as to why would an entity consciously incur losses unless oblivious about the contract's potential. Anyhow, would agree that provision for onerous contract would not be recognized in such scenario under IAS 37. IFRS 9 would be applied only & if there is a contractual obligation to pay.

[Leo]

Ifrs9 ?

[Ketan Marwah]

financial liability on account of incurred losses..

[Marek Muc]

Leo, this topic dates back over three years, so start a new one please. Make sure to outline the scenario you're dealing with, including why an entity would choose to continue fulfilling a contract it's not obligated to, especially knowing it will result in a loss.