Occasionally, practitioners have questions about how their clients recognize revenue on long-term service or construction contracts. This is an area that requires significant judgment on the part of management and practitioners will wish to carefully document the rationale.
Performance Achieved and Collection Assured
We remind members that CPA Canada Handbook – Accounting paragraph 3400.04 requires revenue from service transactions “be recognized when the requirements as to performance set out in paragraphs 3400.05-.06 are satisfied, provided that at the time of performance ultimate collection is reasonably assured.”
Furthermore, paragraph 3400.07 specifies that “performance would be regarded as being achieved under paragraphs 3400.05-.06 when all of the following criteria have been met:
- persuasive evidence of an arrangement exists;
- delivery has occurred or services have been rendered; and
- the sellers' price to the buyer is fixed or determinable.”
This means revenue can be recognized only when both contract activities have been performed and the collection of the consideration is assured. In assessing whether a construction client has complied with all three criteria in paragraph 3400.07, practitioners might consider reviewing:
- bidding or project proposal documents;
- signed contracts or agreements; and
- contract details such as the type of contract, construction schedule or calendar, pricing structure and payment schedules, and incentives or penalties provisions.
Knowing such details could likely help practitioners evaluate management’s timing of revenue recognized.
Performance of Services and Long-term Contracts
Paragraph 3400.06 states that “in the case of rendering of services and long-term contracts, performance shall be determined using either the percentage of completion method or the completed contract method, whichever relates the revenue to the work accomplished. Such performance shall be regarded as having been achieved when reasonable assurance exists regarding the measurement of the consideration that will be derived from rendering the service or performing the long-term contract.”
Entities recognize revenue from service and long-term contracts as activities are performed, using one of two methods:
- Completed contract is a method of accounting that recognizes revenue only when the sale of goods or the rendering of services under a contract is completed or substantially completed.
- Percentage of completion is a method of accounting that recognizes revenue proportionately with the degree of completion of goods or services under a contract.
Paragraph 3400.18 clearly states that “the completed contract method would only be appropriate when performance consists of the execution of a single act or when the enterprise cannot reasonably estimate the extent of progress toward completion.” This means enterprises must meet either of the stated criteria before they can apply the completed contract method.
As there’s no application guidance in Section 3400 – Revenue, members might wish to consult other parts of the CPA Canada Handbook – Accounting, such as IAS 11 – Construction Contracts and IAS 18 – Revenue in Part I – International Financial Reporting Standards.