Construction Contract Revenue, Cost Revision and Warranty Deferred Tax
BuildRight Co., Ltd. uses K-IFRS and has one construction contract, signed on 1 January 2024, with a fixed price of 1,000,000,000 KRW. At 31 December 2024 costs incurred were 300,000,000 KRW and the estimated cost to complete was 500,000,000 KRW. Progress is measured using the cost-to-cost method. During 2024 the company billed the customer 350,000,000 KRW and collected 330,000,000 KRW. The contract contains a two-year warranty; the company estimates warranty costs at 2% of recognised revenue and has not yet paid any warranty claims. For tax purposes warranty costs are deductible only when actually paid, and the enacted combined corporate tax rate is 20.9%. In 2025, after incurring a further 240,000,000 KRW of cost, management revises the estimated total cost to 900,000,000 KRW because of steel price increases. No other estimates changed.
1. Compute 2024 revenue, cost of sales, gross profit and the contract asset or liability, and explain the logic.
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Under K-IFRS 1115 the contract is a single performance obligation satisfied over time, so revenue follows progress. Progress under the cost-to-cost method is costs incurred divided by total estimated cost: 300,000,000 / (300,000,000 + 500,000,000) = 37.5%.
- Revenue: 1,000,000,000 x 37.5% = 375,000,000 KRW
- Cost of sales: 300,000,000 KRW (costs incurred)
- Gross profit: 75,000,000 KRW
Billing of 350,000,000 is below revenue recognised of 375,000,000, so the entity has a contract asset of 25,000,000 KRW, presented separately from receivables. The 330,000,000 collected is a separate matter: cash collection reduces the receivable, not the contract asset. If billing had exceeded revenue, a contract liability would be presented. The common error is to recognise revenue equal to billing or cash collected; both would misstate the margin.
2. Compute 2025 revenue, cost of sales and profit, and explain how the change in the estimated total cost is accounted for.
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A revision of the estimated total cost is a change in accounting estimate, so it is applied prospectively through a cumulative catch-up in the current period; prior-year figures are not restated.
At the end of 2025: costs incurred 300,000,000 + 240,000,000 = 540,000,000; total estimated cost 900,000,000; progress = 540/900 = 60%.
- Cumulative revenue: 1,000,000,000 x 60% = 600,000,000 KRW
- Revenue for 2025: 600,000,000 - 375,000,000 = 225,000,000 KRW
- Cumulative cost: 540,000,000; 2025 cost: 540,000,000 - 300,000,000 = 240,000,000 KRW
- 2025 loss: 15,000,000 KRW (cumulative profit 60,000,000 versus 75,000,000 recognised in 2024)
The contract remains profitable overall, so no onerous contract provision arises. The whole effect of the steel price increase is absorbed in 2025, which is exactly what a cumulative catch-up does.
3. How should the warranty provision and its tax effect be recognised at 31 December 2024?
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The warranty is a present obligation arising from past sales, probable to require an outflow, and reliably estimable, so a provision is recognised when revenue is recognised. The amount is 2% of recognised revenue: 375,000,000 x 2% = 7,500,000 KRW, charged to profit or loss.
For tax, the provision is not deductible until claims are actually paid, so the carrying amount is 7,500,000 KRW and the tax base is nil. That is a deductible temporary difference, giving a deferred tax asset of 7,500,000 x 20.9% = 1,567,500 KRW. The asset is recognised only to the extent that future taxable profit is probable; given the contract profit, that test is met, but it must be reassessed each reporting date and reduced if claims experience shows the estimate is overstated. When claims are paid in later years, the provision is used and the deferred tax asset reverses.