Long-Term Contracts Under IFRS 15: Over-Time Recognition, Contract Assets and Which Costs You Can Capitalise

Most explanations of IFRS 15 stop at the five-step model, which is fine until you have a contract that runs for three years. At that point the interesting questions are not which step you are on but whether revenue goes over time or at a point in time, how you measure progress, where the resulting balance sits on the face of the statement of financial position, and which of the costs you have incurred are allowed to be an asset.

Those four questions are answered in paragraphs most summaries skip.

Over time or at a point in time: the paragraph 35 test

Revenue is recognised over time if any one of three criteria in paragraph 35 is met. Only one is needed, which is the point most often misread:

• (a) the customer simultaneously receives and consumes the benefits of the entity's performance as the entity performs;
• (b) the entity's performance creates or enhances an asset that the customer controls as it is created or enhanced;
• (c) the performance creates no asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.

Criterion (c) is where construction and bespoke manufacturing contracts usually land, and it has two limbs that must both hold. An asset with no alternative use is not enough on its own: without an enforceable right to payment for work completed to date, the contract falls to point-in-time recognition. That right is a legal question about the contract terms, not an accounting judgement about the asset, and it is the limb most often assumed rather than checked.

Measuring progress

Once a performance obligation is satisfied over time, paragraph 39 sets the objective: the measure of progress must depict the entity's performance in transferring control of the promised goods or services.

Paragraph 40 requires a single method for each performance obligation, applied consistently, and remeasured at each reporting date. Paragraph 41 permits both output methods and input methods, with the choice driven by the nature of the good or service rather than by convenience or by what the system already produces.

Two adjustments follow. Under paragraphs 42 and 43, goods or services that do not transfer control to the customer are excluded from the measure and those that do are included; and changes in the measure of progress are accounted for as changes in accounting estimates under IAS 8, not as corrections.

The provision that governs an uncertain outcome

Paragraphs 44 and 45 handle the case where you cannot yet tell how the contract will turn out, and the rule is more generous than people expect but strictly bounded.

Revenue is recognised only if progress can be reasonably measured. Where the outcome cannot be reasonably measured but the entity expects to recover the costs incurred, revenue is recognised only to the extent of the costs incurred.

That is a zero-margin outcome, not a deferral. It keeps revenue and cost moving together through profit or loss while the uncertainty persists, and the moment progress becomes measurable the normal method resumes. A contract parked entirely out of revenue because "we do not know yet" is usually being accounted for incorrectly.

Contract assets, contract liabilities and receivables

This is the part that causes the most presentation errors, and the distinction is about conditionality rather than timing.

• A receivable is an unconditional right to consideration — only the passage of time is required before payment is due. It is presented separately.
• A contract asset arises where the entity has transferred goods or services before the customer pays or before payment is due. It is a right to consideration that is conditional on something other than the passage of time, and it excludes amounts presented as receivables.
• A contract liability arises where the customer has paid, or the entity has an unconditional right to payment, before the entity transfers the goods or services.

The practical test is the one in the middle. If the only thing standing between you and the cash is the calendar, it is a receivable. If something else must still happen — a milestone certified, an acceptance signed, further performance delivered — it is a contract asset. On a long-term contract both balances can exist simultaneously against the same customer, and netting them without authority is a common error.

Which costs can be capitalised

IFRS 15 deals with contract costs in two separate buckets, and conflating them produces the wrong answer.

Incremental costs of obtaining a contract (paragraphs 91 to 92) are recognised as an asset where the entity expects to recover them. The test is counterfactual: these are costs the entity would not have incurred had it not obtained the contract, with sales commissions the standard example. Paragraph 93 requires costs that would have been incurred regardless to be expensed, unless they are explicitly chargeable to the customer — so a bid team's salaries are an expense, while a success-only commission is an asset.

Paragraph 94 then offers a practical expedient: the entity may expense those incremental costs as incurred if the amortisation period of the resulting asset would be one year or less. For businesses with short contract cycles this removes the question entirely, and it is worth taking deliberately rather than by default.

Costs to fulfil a contract (paragraph 95) are capitalised only where they fall outside the scope of another standard and meet all three conditions: they relate directly to the contract, they generate or enhance resources that will be used in satisfying future performance obligations, and they are expected to be recovered. All three, not any one.

What this replaced, and why old habits persist

Long-term contract accounting used to sit in a dedicated construction contracts standard with its own percentage-of-completion language. IFRS 15 absorbed it into a single revenue model, and some of the vocabulary survived the standard that created it. "Percentage of completion" is still used conversationally, but the standard asks for a measure of progress towards complete satisfaction of a performance obligation — related, and not the same test.

For the underlying five-step model, our guides to IFRS 15 and revenue from contracts with customers and the practical application of the standard set out the framework, while the common practical challenges covers the judgements that recur. Entities reporting under UK and Irish GAAP should read the FRS 102 five-step model instead, which was aligned to a similar structure but is not identical.

Where the accounting meets the project controls

The measure of progress is an accounting number that usually originates in a project control system, which is where the two disciplines collide. A cost-based input method inherits whatever the cost system captures, including inefficiencies and rework that arguably do not depict performance. An output method depends on measurements the project team produces for their own purposes.

This is why the measure of progress deserves a documented rationale rather than a system default. Our guides to earned value management and cost control for project accountants and to project financial management cover the control side that feeds the figure.

Our suggestions

Check the enforceable right to payment before concluding over-time recognition under criterion (c). It is a contract term, it varies by jurisdiction and by counterparty, and it cannot be inferred from the nature of the asset.

Document why you chose an input or output method for each performance obligation, and keep that rationale with the contract file. Paragraph 40 requires consistency, and consistency is only demonstrable if the original reasoning was written down.

And review contract assets separately from receivables at every reporting date. They carry different credit risk, they age differently, and the condition attaching to a contract asset is exactly the sort of thing that quietly fails to be met.