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Hi Mike, I’m confused with how this question (Kaplan revision kit question 75) deals with contract liability
Sugar has entered into a long term contract to build an asset for a customer. Sugar will satisfy the performance obligation over time and has measured the progress towards satisfying the performance obligation at 45% at the year end.
The price of the contract is $8m. Sugar has spent $4.5m to date, but the estimated costs to complete are $5.5m. To date, the customer has paid sugar $3m.What items should appear in sugar’s statement of financial position?
Answer: trade receivables $600,000; provision $1,100,000
Explanation:
“As the contract is loss making, sugar should record the full loss immediately. $5,600,000 should be taken to cost of sales. As only $4,500,000 has been spent on costs to date, this means that a provision of $1,100,000 must be included in the statement of financial position”How did they get $5,600,000? I remember getting this figure a month ago when I attempted this but after attempting questions from BPP revision kit and looking at this question again I get so confused.
My answer was:
Trade receivables $600,000; contract liability $500,000I was using the BPP study text method as I found it easier
To be charged to SOPL:
REVENUE $8000*0.45 = $3,600
Cost of sales $10,000*0.45= $4,500
Losses = ($900)
Expected losses (*) = ($1,100)
Estimated losses ($2,000)In SOFP:
Costs incurred to date $4,500
Full loss $(2,000)
Amounts invoiced $(3,000)
Contract liability $500If the Kaplan answer is right, how should then contract liability be split in the statement of financial position?
Hope you could help me on this, thank you!
Contract liability is the same for both Kaplan and for BPP at $500,000 so I don’t understand your question “How should contract liability be split in the statement of financial position?”
If you had re-read the free course notes, you would have remembered that the cost of sales figure is arrived at normally by applying the percentage completed to the total estimated costs of the contract
However, where a loss is forecast, this loss should be recognised in full in the year it is first foreseen
So, in the scenario of the question, $3,600,000 revenue is recognised (45% x $8,000,000) and the temptation is to calculate costs to date in the same way ie 45% x $10,000,000
But that doesn’t recognise the full amount of the loss
Contract value is $8,000,000. Costs to date ($4,500,000) plus estimated costs to complete ($5,500,000) means that we’re forecasting a loss of $2,000,000
If revenue to be recognised is $3,600,000 and we have a loss to recognise of $2,000,000, that must mean that costs to be recognised (the balancing figure) is $5,600,000
Better?
Should the provision be recorded in the statement of financial position, along with the contract liability of $500,000? The expected loss calculated using the BPP’s method as shown above was $1,100,000 too. Can I do it this way instead?
I first had thought that contract liability was like contract asset, which could be presented as trade receivables and work in progress and so on.
Sorry, I have another question relating to government grants.
Question:
The terms of the grant are that if the company retains the asset for four years or more, then no repayment liability will be incurred. If the asset is sold within four year a repayment on a sliding scale would be applicable.The company is certain that it will keep the asset for up to 10 years.
How should this grant be treated under IASB conceptual framework?
The answer said that the grant would be treated as income for the year on receipt of the grant, because there was no past event to give rise to a liability.
My question is, if there is no repayment then shouldn’t the grant be treated as if it were a “normal” grant related to asset – “present as deferred income and deduct the grant in arriving at the carrying amount of the asset”?
This government grant question does not belong on this thread – the title of your original post is “Contract liability” so a question on government grants needs its own thread
Please re-post
“Should the provision be recorded in the statement of financial position, along with the contract liability of $500,000? The expected loss calculated using the BPP’s method as shown above was $1,100,000 too. Can I do it this way instead?
I first had thought that contract liability was like contract asset, which could be presented as trade receivables and work in progress and so on.”
The provision of $1,100,000 is dealt with automatically within the recognition of $2,000,000 loss
The only figure on the statement of financial position in this question is the $500,000 amounts due to customers
I can understand it a bit better now, but there’s one thing still that I don’t get: if contract liability is indeed $500,000, why can’t the answer be “trade receivables $600,000; contract liability 500,000”?
Where on Earth have you found the possibility of $600,000 trade receivables?
My apologies. The question was a MCQ, I left out receivables because I got that right. The two options were (the other two were quite obviously wrong):
1) Receivables 600,000; contract liability $500,000
2) Receivables $600,000; provisions $1,100,000
The solution gave option 2 as the answer. Nothing else from the question and answer is left out now.. were these two options acceptable in your opinion?
Ok, now I have half of the possible solutions. What about giving me the EXACT question?
I really do love it when I’m given half a task and quarter of an answer and have to puzzle my way through it!
Not!
This is the whole question and answer:
Sugar has entered into a long term contract to build an asset for a customer. Sugar will satisfy the performance obligation over time and has measured the progress towards satisfying the performance obligation at 45% at the year end.
The price of the contract is $8m. Sugar has spent $4.5m to date, but the estimated costs to complete are $5.5m. To date, the customer has paid sugar $3m.What items should appear in sugar’s statement of financial position?
Answer:
There is a trade receivables of $600,000. The amount recorded in revenue will be $3,600,000 (45% x 8,000,000). Hewed has paid $3m, leaving $600,000 in Receivables.
As the contract is loss making, sugar should record the full loss immediately. $5,600,000 should be taken to cost of sales. As only $4,500,000 has been spent on costs to date, this means that a provision of $1,100,000 must be included in the statement of financial position.These were the options for the MCQ question:
Option 1: trade receivables $600,000; contract liability
Option 2: trade receivables $5,000,000; provision $1,100,000
Option 3: no asset; contract liability $500,000
Option 4: trade receivables $600,000; provision $1,100,000Referring to the above answer, option D was the answer. Can option A be chosen as well, since contract liability was found to be $500,000?
Oh dear, you’ve done it again!
“Option 1: trade receivables $600,000; contract liability”
“Can option A be chosen as well, since contract liability was found to be $500,000?”
There’s a bit of a contradiction in your two sentences! (Option 1 / Option A does NOT show a $500,000 contract liability!)
I’ve had another look at IFRS 15 and cannot easily see where it says that the revenue recognition should be debited to a receivables account – the printed solution that you have typed would suggest that this entry has been done
The way that I would have accounted for the revenue recognition would be to have debited the contract account (also the destination for the cost recognition)
The net effect of the revenue receivable ($600,000) and the provision for future loss ($1,100,000) is a net liability of $500,000
So Option 1 / Option A cannot be correct since the $600,000 receivable cannot exist alongside the $500,000 provision
I’m sorry Mike, for not checking for any errors in my previous post.
I finally understand it now, thank you 🙂
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