Shwe Yi Engineering: Variable Consideration and Contract Liability
Shwe Yi Engineering Co. Ltd, a Yangon-based manufacturer, signed a contract in April 2024 to design and install a conveyor system for a customer for USD 1,200,000. The contract provides a USD 100,000 bonus if the system is completed by 31 March 2025 and a penalty of USD 20,000 for each week late. At inception, Shwe Yi assessed a 60% chance of earning the bonus. By the 31 March 2025 reporting date, a technical fault has delayed commissioning; management now assesses an 80% probability of a two-week delay. Costs incurred to date are USD 700,000, and estimated costs to complete are USD 500,000. The customer paid a USD 200,000 advance at inception and has been billed USD 800,000 in progress claims. The contract is expected to take 18 months in total. Shwe Yi uses MFRS 15. The finance director has not adjusted the transaction price for the delay and has recognised revenue based on the original contract price.
1. Determine the transaction price at 31 March 2025 and explain how the bonus and penalty should be treated under MFRS 15.
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Under MFRS 15, the transaction price is the amount of consideration to which the entity expects to be entitled, adjusted for variable consideration. The bonus and penalty are variable consideration. For the bonus, Shwe Yi must apply the constraint: it is included only to the extent that it is highly probable that a significant reversal will not occur. A 60% chance at inception, followed by an 80% chance of a two-week delay at the reporting date, does not meet that threshold, so the bonus is excluded. For the penalty, there is an 80% probability of a two-week delay. Because this is a single contract with a binary outcome, the most likely amount is used. The most likely outcome is a USD 40,000 penalty (2 weeks × USD 20,000), so the transaction price is reduced by USD 40,000. Transaction price = USD 1,200,000 − USD 40,000 = USD 1,160,000. The finance director's use of the original contract price overstates revenue and ignores the constraint.
2. Calculate revenue and the contract asset or liability at 31 March 2025, and explain the treatment of the USD 200,000 advance.
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Progress toward completion = costs incurred ÷ total estimated costs = 700,000 ÷ (700,000 + 500,000) = 58.33%. Revenue to date = 1,160,000 × 58.33% = USD 676,667 (rounded). Because cumulative billings of USD 800,000 exceed revenue recognised, the contract is in a liability position: contract liability = 800,000 − 676,667 = USD 123,333. The USD 200,000 advance is not revenue on receipt; it is a contract liability until the related performance obligation is satisfied. Shwe Yi must also assess whether the advance contains a significant financing component. The contract lasts 18 months, so the practical expedient for payment within one year is not available for the advance. If the advance is primarily a mobilisation payment and not financing, the component may be insignificant; if it is significant, Shwe Yi should discount the advance at its incremental borrowing rate, recognise interest expense over the period, and adjust revenue. The facts do not give enough information to conclude, so the financing assessment should be documented.
3. If the delay penalty is later settled at USD 20,000 instead of USD 40,000, how should the change be accounted for?
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If the penalty is later settled at USD 20,000 instead of USD 40,000, the transaction price changes by USD 20,000. This is a change in estimate, not a contract modification. Under MFRS 15, the change is allocated to the performance obligation and recognised as a cumulative catch-up adjustment at the date of change. Revenue increases by 20,000 × 58.33% = USD 11,667 immediately, with the remaining USD 8,333 recognised as the remaining performance obligation is satisfied. The contract liability decreases accordingly. The entity should not restate prior periods; the effect is recognised in the period the estimate changes.