JUDY ANN F.
GAZZINGAN
1. What is construction contract? Discuss
A construction contract is a mutual or legally binding agreement between two parties based on
policies and conditions recorded in document form. The two parties involved are one or more
property owners and one or more contractors. The owner, often referred to as the 'employer' or the
'client',[1] has full authority to decide what type of contract should be used for a specific
development to be constructed and to set out the legally-binding terms and conditions in a
contractual agreement.[2] A construction contract is an important document as it outlines the scope
of work, risks, duties and legal rights of both the contractor and the owner.
2. Give the steps in recognizing revenue from construction contracts? Discuss.
Step one: Identify the contract with a customer
Identifying the contract or contracts with a customer is the first step in the new framework for
determining revenue recognition. Under existing guidance, persuasive evidence of an arrangement
typically does not exist until both parties have signed a contract. The new standard indicates that
contracts may be written, oral, or implied by an entity’s customary business practices as long as
the contracts are enforceable by law.
Step two: Identify each performance obligation in the contract
Identifying performance obligations in a contract, the second step in the new framework, is a
significant change for companies. A performance obligation is a concept created by this new
standard and is defined as a promise in a contract with a customer to transfer to the customer a
distinct good or service or a series of distinct goods or services that are substantially the same and
have the same pattern of transfer. However, companies will need to carefully review their
contracts with customers to identify which promises meet the new standard’s definition of
distinct.
Step three: Determine the transaction price
The change in how the transaction price is determined could be significant for companies that
have variable payment arrangements.
Under the new standard, an entity will be required to determine the transaction price based on the
amount of consideration to which it expects to be entitled, which may differ from the contract
price.
The transaction price also may include variable consideration, such as contingent consideration
due from the customer, consideration payable to the customer, and the time value of money for
significant financing components. Under some contracts, the transaction price includes variable
consideration such as rebates, price concessions, or discounts based on future actions. The new
standard requires that any variable consideration be estimated at contract inception and that the
amount of the consideration be included in the transaction price.
A limited exception to this variable consideration guidance under the new standard is that variable
consideration related to sales or usage-based royalties on licenses of intellectual property should
not be included in the estimate of the transaction price.
Step four: Allocate the transaction price to each performance obligation
Some arrangements typically include various performance obligations. As a result, the allocation
of the transaction price to these separate performance obligations is important. The new standard
changes the transaction price allocation process and indicates that the transaction price should be
allocated to each separate performance obligation, generally in proportion to its stand-alone
selling price – the price at which an entity would sell a good or service on a stand-alone basis at
contract inception. Companies will need to take into account variable consideration, discussed in
step three, and allocate any variable consideration to one or more of the performance obligations.
The new standard requires entities to use observable information, if available, to determine stand-
alone selling prices. It discusses three estimation methods that entities will be able to use when
stand-alone selling prices are not readily observable: 1) an adjusted market assessment approach,
2) an expected cost plus a margin approach, and 3) a residual approach.
Step five: Recognize revenue when or as each performance obligation is satisfied
Satisfying the performance obligations is the final step in the new revenue recognition framework.
Under the new standard, revenue is recognized when an entity satisfies a performance obligation
by transferring a promised good or service to the customer – that is, when the customer obtains
control. The new standard also provides specific guidance to determine when control of distinct
licenses of intellectual property transfer to customers.
