Revenue Recognition on a Solar Supply, Installation and Maintenance Contract
Mwangaza Solar Ltd, a Nairobi solar contractor, signed a contract on 1 March 2025 with a private school for KES 12,400,000 covering a 60 kWp rooftop system, its installation and two years of maintenance. Payment terms are 30% on signature, 50% on commissioning and 20% at the end of year one. Mwangaza regularly sells the same hardware without installation for KES 10,000,000, charges KES 1,500,000 to install a system of this size, and sells two-year maintenance plans for KES 2,000,000. The installation does not modify or customise the hardware, and some customers use their own installers. The contract offers a KES 400,000 bonus if commissioning is completed by 31 May 2025. Seven of Mwangaza's last twelve comparable projects were commissioned on time; the delays came from grid-connection approvals controlled by the utility. Commissioning actually took place on 20 June 2025. The finance director wants to recognise the full KES 12,400,000 in March 2025 because "the contract is signed and the cash is committed".
1. Identify the performance obligations in the contract and allocate the KES 12,400,000 transaction price. Show all workings.
Read the worked answer
Step 1 - identify the performance obligations. Three goods or services are promised. The equipment and the installation are capable of being distinct (Mwangaza regularly sells the hardware without installation and customers do use other installers), and the installation does not significantly modify or customise the hardware, so the two are separately identifiable rather than a single combined obligation. The two-year maintenance plan is separately identifiable and is provided over time. Therefore there are three performance obligations.
Step 2 - allocate on relative standalone selling price, because the fixed discount of KES 1,100,000 (12,400,000 vs 13,500,000) cannot be shown to relate to any one obligation:
| Obligation | Standalone price (KES) | Share | Allocation (KES) |
|---|---|---|---|
| Equipment | 10,000,000 | 74.07% | 9,185,185 |
| Installation | 1,500,000 | 11.11% | 1,377,778 |
| Maintenance (2 yrs) | 2,000,000 | 14.81% | 1,837,037 |
| Total | 13,500,000 | 100% | 12,400,000 |
Check: 9,185,185 + 1,377,778 + 1,837,037 = 12,400,000. The discount is spread across all three obligations because there is no observable evidence that it relates only to, say, the maintenance element.
Recognition pattern: equipment at the point control passes to the school (delivery and acceptance on site); installation over the six-week installation period as the work progresses; maintenance straight line over 24 months from acceptance. A single figure cannot be recognised on signature because performance obligations are satisfied at different times.
2. Advise on the treatment of the KES 400,000 completion bonus and on the finance director's proposal to recognise the whole contract price in March 2025.
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The bonus is variable consideration. It must be estimated (expected value or most likely amount) and then constrained so that it is included only to the extent that it is highly probable that a significant reversal will not occur when the uncertainty is resolved.
Using expected value: 7/12 × 400,000 = KES 233,333. But the constraint is the deciding factor. The historical pass rate is only 58%, and the cause of delay - grid-connection approval by the utility - is outside Mwangaza's control. A 58% probability is not "highly probable", so the bonus should be constrained to nil at inception, and reassessed at each reporting date. Because the 31 May deadline has now passed without commissioning, no bonus is expected at all unless the contract provides for an extension. If a bonus later becomes enforceable, the additional KES 400,000 is added to the transaction price and allocated to the obligations to which it relates (equipment and installation), not to maintenance.
On the finance director's proposal: it is wrong. Signing a contract and receiving a deposit create a liability to perform, not revenue. Revenue is recognised when control of each promised good or service transfers to the customer. Recognising KES 12,400,000 in March 2025 would:
- overstate revenue and profit for the period by amounts not yet earned;
- reverse a material portion of revenue in the following period when the correct pattern is applied;
- create a contract liability and a deferred tax position that the financial statements do not show;
- increase the risk of an audit qualification, of an adjusted set of accounts and of reputational damage with the bank that relies on the accounts for the covenant test.
3. Commissioning took place on 20 June 2025 and the year end is 31 December 2025. Assuming the maintenance period is taken as starting 1 July 2025, compute 2025 revenue and explain how the 30% deposit and the year-end balance should be presented.
Read the worked answer
Revenue for the year ended 31 December 2025:
- Equipment: KES 9,185,185, recognised when control passed on commissioning.
- Installation: KES 1,377,778, recognised on completion of commissioning.
- Maintenance: 1,837,037 ÷ 24 months = KES 76,543 per month; 6 months to 31 December 2025 = KES 459,259.
- Total 2025 revenue = KES 11,022,222.
Cash received in 2025: 30% deposit (KES 3,720,000) plus 50% on commissioning (KES 6,200,000) = KES 9,920,000. The final 20% (KES 2,480,000) falls due at the end of year one.
Presentation:
- The 30% deposit is a contract liability - an obligation to transfer goods or services for which consideration has been received - from 1 March until the related performance obligations are satisfied. It is not revenue and not a customer refund payable.
- At 31 December 2025 cumulative revenue recognised (KES 11,022,222) exceeds cumulative amounts billed (KES 9,920,000) by KES 1,102,222. That excess is presented as a contract asset, not as a receivable and not netted against the contract liability, because it represents consideration for work done but not yet billed.
- It becomes a receivable only when the right to the amount becomes unconditional, which happens when the only outstanding event is the passage of time and the entity has an unconditional right to payment. The distinction matters because a contract asset is subject to impairment testing on a different basis and signals unbilled performance to a reader of the accounts.
- Deferred revenue must not be shown net of costs incurred; any directly attributable cost of obtaining or fulfilling the contract is capitalised separately and amortised on a systematic basis consistent with the transfer of the related service.