Question

QUESTION 2 (IFRS 15) (10) Part a. A construction company enters into a contract with a customer to supply a new building. Control over the completed building will pass to the customer in two years (the contractor's performance obligation will be satisfied at a point in time). The contract contains two payment options. Either the customer can pay $ 5 million in two years when it obtains control of the building, or the customer can pay $ 4 million on inception of the contract. The customer decides to pay 4 million on inception. The contractor concludes that because of the significant period between the date of payment and the transfer of the asset (the completed building) to the customer, together with the prevailing market rates of interest, that there is a significant financing component. The interest rate implicit in the transaction is 11.8%. However, because the contractor is effectively borrowing from its customer, the contractor is also required to consider its own incremental borrowing rate which is determined to be 6%. Required: Prepare well narrated journal entries to record the above. (5)

Answer 1

Dr Cash $4,000,000 Cr Contract Liability $4,000,000 Recognition of a contract liability for the payment received in advance The following journal is recognized over the two-year construction period: Dr Interest expense $494,400 Cr Contract Liability $494,400 Accretion of the contract liability at a rate of 6% (6% compound interest X $4 million for 2 years) The following journal is recognized at the date of the transfer of the asset to the customer: Dr Contract Liability $4.494,400 $4,494,400 Cr Revenue Recognition of contract revenue after performance obligation has been satisfied

Working Note: 6% X 4.000.000 = 240,000 So at end of year one there is effective borrowing of 4,240,000 6% x 4,240,000 = 254,400 So at end of year two there is effective borrowing of 4,940,000 (4 240.000 = 4,000,000 + 240.000) (4.940,000 = 4,240,000 + 254.000)