IFRIC 15, also known as International Financial Reporting Interpretations Committee (IFRIC) Interpretation 15, provides guidance on how to account for agreements for the construction of real estate.
Definition of Agreements for the Construction of Real Estate:
Agreements for the construction of real estate are contracts that involve the construction or development of real estate, such as residential or commercial properties, by one party for another. These agreements typically specify the rights and obligations of the parties involved, including the transfer of control and risks related to the real estate being constructed. IFRIC 15 provides guidance on how to account for such agreements in the financial statements.
Explanation of IFRIC 15:
IFRIC 15 provides guidance on how to determine when revenue from agreements for the construction of real estate should be recognized and how the associated costs should be accounted for. The key principle of IFRIC 15 is that revenue and costs should be recognized based on the transfer of control of the real estate to the customer.
According to IFRIC 15, control of the real estate is transferred to the customer when the customer has the ability to direct the use and obtain the benefits from the real estate. This typically occurs over time as the construction progresses, rather than at a single point in time. To determine the point at which control is transferred, the following criteria must be met:
The customer has the ability to direct the use of the real estate during its construction.
The customer receives benefits from the real estate as it is being constructed.
The customer can sell, lease, or otherwise dispose of its interest in the real estate to another party.
If these criteria are met, revenue and costs should be recognized over time as the construction progresses using a method that reflects the progress of completion. One common method used to measure progress is the percentage of completion method, where revenue and costs are recognized based on the percentage of work completed relative to the total expected work.
However, if the criteria for over time recognition are not met, revenue should be recognized at a single point in time when control is transferred, which is typically when the construction is completed, and the real estate is ready for use by the customer.
Examples of Agreements for the Construction of Real Estate:
Let’s consider some examples to illustrate the application of IFRIC 15:
Example 1:
ABC Construction enters into a contract with XYZ Corporation to construct a commercial building. The contract specifies that the customer has the ability to direct the use of the building during its construction, and the customer receives benefits from the building as it is being constructed, such as being able to make design changes. The customer also has the right to sell or lease the building to another party. In this case, ABC Construction would recognize revenue and costs over time as the construction progresses, using a method that reflects the progress of completion, such as the percentage of completion method.
Example 2:
DEF Builders enters into a contract with LMN Developers to construct a residential complex. The contract specifies that the customer does not have the ability to direct the use of the residential complex during its construction, and the customer does not receive benefits from the complex until it is completed. The customer also does not have the right to sell or lease the complex to another party until it is completed. In this case, DEF Builders would recognize revenue and costs at a single point in time when the construction is completed and the residential complex is ready for use by the customer.
Case Studies related to IFRIC 15:
Several real-life case studies have demonstrated the application of IFRIC 15. One notable case is the case of a real estate developer who enters into a long-term construction contract for a commercial building. The contract spans over multiple accounting periods and includes various stages of construction, such as foundation, framing, electrical, plumbing, and finishing.
Under IFRIC 15, the developer assesses whether the criteria for over time recognition are met. The developer determines that the customer has the ability to direct the use of the building during its construction, as the customer is actively involved in making design changes and decisions throughout the construction process. The customer also receives benefits from the building as it is being constructed, such as being able to monitor the progress and provide feedback. Additionally, the customer has the right to sell or lease the building to another party.
Based on these assessments, the developer determines that control of the building is transferred to the customer over time. The developer chooses to use the percentage of completion method to measure the progress of completion. The total expected costs of the contract are $10 million, and at the end of the accounting period, the costs incurred to date are $3 million. Therefore, the developer recognizes 30% ($3 million/$10 million) of the total expected revenue from the contract as revenue in the current accounting period, along with the corresponding costs incurred.
In another case, a real estate developer enters into a construction contract for a residential complex. The contract specifies that the customer does not have the ability to direct the use of the complex during its construction and does not receive benefits from the complex until it is completed. The customer also does not have the right to sell or lease the complex to another party until it is completed.
In this case, the developer determines that the criteria for over time recognition are not met, and revenue should be recognized at a single point in time when the construction is completed. The developer completes the construction of the residential complex and obtains the certificate of occupancy, indicating that it is ready for use by the customer. At this point, the developer recognizes the total expected revenue from the contract as revenue, along with the corresponding costs incurred.
Conclusion:
IFRIC 15 provides guidance on how to account for agreements for the construction of real estate in the financial statements. It emphasizes the transfer of control as the key principle for revenue recognition, and provides criteria for determining when control is transferred over time or at a single point in time. Examples and case studies help illustrate the application of IFRIC 15 in real-life scenarios. It is important for entities engaged in the construction of real estate to carefully assess their contracts and apply the guidance provided by IFRIC 15 to ensure accurate and consistent financial reporting.