Revenue Recognition on a Long-Term Construction Contract
Bouwgroep Noord BV has a fixed-price construction contract with a total price of €12,000,000. The contract started on 1 March 2024 and is expected to finish in August 2026. At 31 December 2024 the company has incurred costs of €3,600,000. The estimated total costs to complete the contract are €8,400,000, so total expected costs are €12,000,000 and the expected margin is zero. During 2024 the company invoiced the client €4,000,000 and received €3,500,000. The project manager believes the contract will be profitable because 'we always make money on these jobs'. The finance director wants to recognise revenue equal to the amounts invoiced, arguing that this is simpler and matches cash collection. The company reports under Title 9 Book 2 of the Dutch Civil Code and applies RJ 221 for construction contracts.
1. Determine the revenue and profit to be recognised in 2024 under the percentage-of-completion method and evaluate the finance director's proposal.
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Under RJ 221, revenue on a fixed-price construction contract is recognised by reference to the stage of completion. The stage of completion can be measured by costs incurred relative to total expected costs: €3,600,000 / €12,000,000 = 30%. Revenue for 2024 is 30% × €12,000,000 = €3,600,000. Costs incurred are €3,600,000, so the gross profit is zero. Because total expected costs equal the contract price, the contract has no expected margin, and no profit should be recognised. If there were an expected loss, it would be recognised immediately in full. The finance director's proposal to recognise revenue equal to amounts invoiced (€4,000,000) is not acceptable: invoicing is not a measure of performance, and cash collection is irrelevant to revenue recognition. Recognising €4,000,000 against €3,600,000 of costs would overstate profit by €400,000 and overstate revenue by €400,000. The contract asset or liability should be presented as the difference between revenue recognised and amounts invoiced. Here revenue of €3,600,000 versus invoiced €4,000,000 gives a contract liability of €400,000. Disclose the method and the stage of completion.
2. The project manager insists the contract will be profitable. Explain how you would handle this and the effect on the 2024 accounts.
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The project manager's assertion is not sufficient evidence. Under RJ 221, expected profits are recognised only when the outcome of the contract can be estimated reliably. Reliable estimation requires a documented budget, a cost-to-complete estimate, and evidence that the estimate is achievable. If the best estimate of total costs is €12,000,000, the expected margin is zero and no profit is recognised. If the project manager believes costs will be lower, obtain a revised cost-to-complete estimate supported by contracts, quotes, and historical data. If the revised total cost is, for example, €11,400,000, the expected margin is €600,000, and 30% of that (€180,000) could be recognised in 2024, subject to the reliability criteria. If the estimate cannot be supported, recognise zero profit and consider whether a loss provision is needed. The finance director should not override the accounting estimate without evidence. Document the assessment, the revised budget, and the rationale. The 2024 accounts should reflect the best estimate at the balance sheet date, with disclosure of the contract position and any uncertainty.