IFRS for Construction Entities Explained
Published 5 Oct 2024
IFRS plays a key role in helping construction entities present their financial statements in a clear and consistent manner. These standards ensure transparency, comparability, and reliability in industries that handle complex, short- and long-term projects. In this article, we will draw on the expertise of Mr. Sanjayan Thankappan, a certified financial professional, to explain the importance and implications of adopting IFRS 15 for construction entities.
With over 20 years of experience in finance — 18 years in the construction sector — Mr. Thankappan has held key roles such as Chief Accountant, Accounts Manager, and Finance Manager at leading firms. His expertise spans financial planning, management, strategy, finalizing accounts, audits, tax compliance, and internal controls. Using his hands-on experience, he shares insights to help the construction sector navigate IFRS effectively.
With over 20 years of experience in finance — 18 years in the construction sector — Mr. Thankappan has held key roles such as Chief Accountant, Accounts Manager, and Finance Manager at leading firms. His expertise spans financial planning, management, strategy, finalizing accounts, audits, tax compliance, and internal controls. Using his hands-on experience, he shares insights to help the construction sector navigate IFRS effectively.
Contents
A Brief History of IFRS 15
The IFRS Foundation and IASB were established in 2001, replacing the IASC, which was created in 1973. Before IFRS 15, revenue recognition was governed by older standards like IAS 11 and IAS 18. IAS 11 focused on construction contracts, and IAS 18 dealt with revenue recognition. These standards, adopted in April 2001, traced their roots to earlier versions from the 1980s and 1990s. Over time, several interpretations and amendments were made, including SIC 31 (December 2001), IFRIC 13 (June 2007), IFRIC 15 (July 2008), and IFRIC 18 (January 2009).
Understanding IFRS 15
IFRS 15, titled "Revenue from Contracts with Customers," was put into effect by the International Accounting Standards Board (IASB) in 2018 with earlier application permitted[?]. This standard provides a framework for recognizing revenue, focusing on the nature, amount, timing, and uncertainty of revenue and cash flows from contracts with customers.
Under IFRS 15, revenue is recognized when an entity transfers promised goods or services to a customer. The amount reflects the consideration the entity expects to receive in exchange for those goods or services. The standard replaces previous guidelines such as IAS 11, IAS 18, and IFRIC 13, 15, 18, and SC 31.
IFRS 15 applies to all contracts with customers, including construction contracts, and follows a five-step model for revenue recognition:
Identify the contract with the customer.
Identify the performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price to the performance obligations.
Recognize revenue when (or as) a performance obligation is satisfied.
Importance of IFRS 15 for Construction Entities
Since 2018, IFRS 15 has provided a uniform standard for revenue recognition in the construction industry. Its adoption offers several benefits:
Compliance. Ensures entities meet regulatory requirements.
Reliability. Provides stakeholders with trustworthy, standardized financial reports.
Competitive edge. Helps companies meet international expectations and gain access to global capital markets.
Risk management. Enhances internal controls and identifies financial risks, improving overall risk management.
Trust. Builds confidence among investors and stakeholders for economic decision-making.
Implications of IFRS 15 Adoption
Adopting IFRS has a significant impact on financial reporting. It improves comparability across borders, affects financial statements and ratios, and provides more detailed information. It also influences a company’s position in capital markets, taxation, and industry practices.
IFRS 15 and Long-Term Construction Projects
For large construction projects that span several years, professional judgment is essential in determining when to recognize revenue. Under IFRS 15, revenue is recognized as performance obligations are satisfied. The progress can be measured using either output-based or input-based methods.
The output-based method looks at what’s been completed, like reaching key milestones or delivering finished units. The input-based method focuses on the resources used, like costs or hours worked, assuming these show progress. If it’s hard to measure progress reliably, revenue is only recognized up to the costs spent.
IFRS 15 introduces the terms "contract asset" and "contract liability" for reporting deferred revenue and advance liabilities. Contracts with variable transaction prices, such as those involving discounts or performance bonuses, require companies to estimate the amount they are entitled to receive using either the most likely amount or expected value method.
The output-based method looks at what’s been completed, like reaching key milestones or delivering finished units. The input-based method focuses on the resources used, like costs or hours worked, assuming these show progress. If it’s hard to measure progress reliably, revenue is only recognized up to the costs spent.
IFRS 15 introduces the terms "contract asset" and "contract liability" for reporting deferred revenue and advance liabilities. Contracts with variable transaction prices, such as those involving discounts or performance bonuses, require companies to estimate the amount they are entitled to receive using either the most likely amount or expected value method.
IFRS 15’s Impact on Cash Flows
Cash flows are closely linked to invoices generated for customers. Unbilled revenue represents earned income but does not immediately translate into cash. Managing unbilled revenue is essential for cash flow forecasting and liquidity management. Billing schedules should align with revenue recognition practices to ensure sufficient working capital for ongoing projects.
Tax Implications of IFRS 15 in the UAE
Companies in the UAE mainland are subject to VAT and corporate tax. When it comes to corporate tax, IFRS 15 requires that revenue be recognized according to the accruals concept. This means companies report the income they have earned during the year, keeping everything aligned with accrual accounting principles. The tax authority also advises entities to follow IFRS when determining their revenue.
For certain contracts, like long-term service agreements and multi-element arrangements, IFRS 15 might change either the amount or the timing of revenue recognition. However, if there are differences in how much revenue is recognized under IFRS 15 compared to other methods, these are mostly just timing differences. Eventually, the total revenue from the contract will be recognized and taxed.
When it comes to VAT, it’s charged on the value of goods and services provided in each transaction. Remember, VAT is not a cost for businesses. Advance payments are also subject to VAT, and a VAT invoice must be issued right away when payment is received. For VAT, the "time of supply" is determined by the earliest date of payment, invoice issuance, or delivery of the goods or services.
IFRS 15 includes practical expedients to make it easier for companies to transition to the new standard. One helpful option is the right to invoice. This allows businesses to recognize revenue for overtime contracts as invoiced when their right to payment directly matches the value they’ve delivered to the customer so far.
For certain contracts, like long-term service agreements and multi-element arrangements, IFRS 15 might change either the amount or the timing of revenue recognition. However, if there are differences in how much revenue is recognized under IFRS 15 compared to other methods, these are mostly just timing differences. Eventually, the total revenue from the contract will be recognized and taxed.
When it comes to VAT, it’s charged on the value of goods and services provided in each transaction. Remember, VAT is not a cost for businesses. Advance payments are also subject to VAT, and a VAT invoice must be issued right away when payment is received. For VAT, the "time of supply" is determined by the earliest date of payment, invoice issuance, or delivery of the goods or services.
IFRS 15 includes practical expedients to make it easier for companies to transition to the new standard. One helpful option is the right to invoice. This allows businesses to recognize revenue for overtime contracts as invoiced when their right to payment directly matches the value they’ve delivered to the customer so far.
Ensuring Compliance with IFRS 15
To fully comply with IFRS 15, companies should focus on a few key steps:
Set up proper review and monitoring systems. First, it's essential to have a solid review and monitoring system in place. This standard requires a dedicated team to regularly check that systems and controls are working effectively. This step is essential for ongoing compliance with IFRS 15 and helps identify areas that need improvement.
Update policies, systems, and procedures. Once you spot any gaps in compliance, create a clear plan for changes. This plan should detail what needs to be adjusted in your policies, systems, and procedures. Make sure to involve all relevant departments to ensure everyone is on the same page. If your current contracts or business processes aren’t compliant with IFRS 15, you’ll need to revise them. Take the time to review your contracts and make necessary changes to align with the new standard.
Modify ERP systems. Companies also need to update their IT systems. IFRS 15 requires businesses to have systems that can capture and process the necessary data accurately. Your ERP system should be able to generate reports that meet the new disclosure requirements outlined in IFRS 15.
Automated Solutions for IFRS 15
An ERP solution with strong internal controls can automate the processes required for IFRS 15 compliance. Features like revenue recognition rules, workflows for contract management, and reporting tools can reduce manual efforts during month-end closing. Integrated systems ensure data consistency and provide insights for total revenue, deferral balances, and accrual balances.
Automated solutions also allow for efficient management of changes in revenue recognition, especially in long-term contracts, enhancing project management and ensuring error-free financial reporting.
Here’s how an ERP system can help you stay IFRS compliant.
Automated solutions also allow for efficient management of changes in revenue recognition, especially in long-term contracts, enhancing project management and ensuring error-free financial reporting.
Here’s how an ERP system can help you stay IFRS compliant.
Built-in compliance. An ERP system keeps records clear and accurate. This ensures every transaction meets IFRS standards, reducing the risk of non-compliance.
Automatic revenue tracking. The system can track revenue based on project progress. This eliminates the need for complicated calculations and saves time.
Handling multiple currencies. ERP systems can manage payments in different currencies. They track exchange rate changes easily, which is vital for international operations.
Integration capabilities. An ERP solution can connect with existing systems. This integration ensures both transactional and master data flow seamlessly. It maintains data consistency across all systems and reports.
Supportive workflows. The system assists in setting up contracts and defining performance obligations. It streamlines the entire reporting process, making it more efficient.
Comprehensive reporting. ERP systems provide various reports to analyze and validate data. Users can easily see which invoices have come in and understand the impact of IFRS 15 revenue recognition rules on their revenues.
Automatic deferral and accrual calculations. These systems fully automate deferral and accrual calculations, reducing the need for manual intervention.
Contract-to-date calculations. An ERP system can automatically calculate costs incurred to date. This allows for easy reporting on total revenue, deferral balances, and accrual balances.
It’s important to note that IFRS 15 revenue recognition rules are based not only on actual data but also on effective planning. Changes in plans can impact revenue recognition.
By using ERP for revenue planning, all relevant information can be stored in one system. This makes it easy to access through standard reports. Since most IFRS 15 rules depend on the total contract value, effective planning can significantly influence outcomes
By using ERP for revenue planning, all relevant information can be stored in one system. This makes it easy to access through standard reports. Since most IFRS 15 rules depend on the total contract value, effective planning can significantly influence outcomes
Future Outlook
Adopting and implementing IFRS 15 is crucial for construction entities looking to build trust and credibility with stakeholders. The standard helps ensure transparency, improve risk management, and facilitate access to international capital markets. As the UAE construction sector continues to grow, estimated to reach USD 50 billion by 2029, following IFRS 15 will position companies for success in a competitive and regulated market.
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