Construction contract: bonus, penalty and contract asset
LankaBuild (Pvt) Ltd has a single construction contract with a customer to build a warehouse for a fixed price of LKR 240 million. The contract started on 1 July 2024 and is expected to run 18 months. At 31 March 2025, LankaBuild has incurred costs of LKR 96 million and reliably estimates that total costs to complete will be LKR 192 million. The contract includes an early-completion bonus of LKR 20 million, but the project manager reports that a key supplier has delayed steel deliveries and completion on time is now unlikely. A penalty of LKR 10 million applies if handover is late, and the project manager considers a delay probable. The customer has been billed LKR 100 million. Costs incurred are recorded in contract work-in-progress. The finance director wants to recognise the bonus because the customer has praised progress, and wants to spread the penalty evenly over the contract. The company reports under SLFRS.
1. Determine the transaction price at 31 March 2025, the percentage of completion, and the revenue and gross profit to recognise. Explain the treatment of the bonus and the penalty.
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Start with the fixed consideration of LKR 240 million. The LKR 20 million bonus is variable consideration. It is constrained to nil because the supplier delay makes early completion unlikely; general customer praise is not sufficient evidence that the bonus is highly probable. The LKR 10 million penalty is also variable consideration. Because delay is probable, the most likely amount is that the penalty will be incurred, so include it as a reduction. Transaction price = 240 - 10 = LKR 230 million.
Progress = costs incurred / total expected costs = 96 / 192 = 50%. Revenue = 50% x 230 = LKR 115 million. Cost = LKR 96 million. Gross profit = LKR 19 million. The penalty should not be spread evenly over the contract; it is part of variable consideration and must be re-estimated at each reporting date. If delay later becomes unlikely, the penalty estimate would be revised.
2. Show the journal entries to recognise revenue and cost, and explain how the contract balance should be presented.
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Assume the billing of LKR 100 million was already recorded as Dr receivable LKR 100 million / Cr contract liability LKR 100 million. At the reporting date, recognise cumulative revenue and remove the contract liability:
Dr contract liability LKR 100 million Dr contract asset LKR 15 million Cr revenue LKR 115 million
Recognise the cost already incurred in contract work-in-progress:
Dr cost of sales LKR 96 million Cr contract work-in-progress LKR 96 million
The net contract position is a contract asset of LKR 15 million (revenue recognised LKR 115 million less billed LKR 100 million). Present it as a contract asset, not as a receivable, because the right to consideration is conditional on further performance. Do not offset a contract asset and contract liability from different contracts; within the same contract, present the net position.
3. After the reporting date but before the financial statements are approved, the customer agrees to extend the deadline and waives the late penalty. Advise whether this changes the 31 March 2025 revenue.
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The waiver and extension are agreed after the reporting date. Under LKAS 10, they are normally non-adjusting events because they do not change the condition that existed at 31 March 2025: at that date, delay was probable and the penalty was expected. The transaction price at 31 March should therefore still include the LKR 10 million penalty. No adjustment to revenue is made.
Disclose the waiver and extension if material, because it affects the expected cash flows and the penalty in the next period. If the facts showed that the penalty was never enforceable at 31 March, the conclusion would differ, but that is not the case here. Re-estimate variable consideration in the next reporting period.