Major projects can take many forms. An organisation might enter a long-term contract for the construction of new buildings or major improvements, or it might be like a large-scale technology or computer software project.
When governments or private sector bodies enter into long-term contracts it is often a moment of great financial risk. Particularly when the provision of an asset is involved as the required output from the contract, it may be a number of years before the final product is delivered. There is an inherent risk that costs will increase over and above the initial estimate. There are various reasons for this:
Inflation
One practical reason is that inflation will often increase costs especially if there is a gap of a number of years between the time that the contract is put in place and when the required outputs are delivered.
Under-estimation
A much more significant factor is that initial costs may be under-estimated. This may happen for various reasons. One is political (which in this case may be politics with either a small or a big "P"). In this scenario, the sponsors of a particular project may want it to proceed regardless of its true cost and therefore underestimate the costs involved knowing that if they were not to do so then the project might not go ahead as it would appear to be too expensive. Another is that there are of course inherent difficulties in adequately specifying the full extent of the work to be undertaken or understanding all of the costs involved particularly when looking into our crystal ball many years into the future.
Relevant IFRS Standards
As far as the assets themselves are concerned several Standards are relevant. If the contract is for delivery of a building for example then IAS 16 Property, Plant and Equipment would apply to the asset itself. However, long-term contracts can also be for intangible items such as major computer software projects. These too have their own Standard, in this case IAS 38 Intangible Assets.
There are two other Standards though which are particularly relevant to the contracts themselves which this module will explore in more detail. One of them is IAS 37 Provisions, Contingent Liabilities and Contingent Assets and the other is IFRS 15 Accounting for Revenue from Contracts with Customers. How applicable IAS 37 and IFRS 15 are will depend to a significant extent on the nature of the contract and the fine detail within it. The key question to consider is which of them applies in a particular situation. We will look in more depth at this potentially hugely material issue. Deciding on whether IAS 37 or IFRS 15 applies can have a dramatic effect on the bottom line of the parties involved. This is a useful reminder that when we talk about IFRS Standards we sometimes cannot look at issues in isolation but may have to consider two or more Standards and their interdependence before coming up with the definitive accounting answer for how to treat such transactions.
Although our major focus will be on longer-term projects which by definition are more likely to be major in nature, it is also possible that shorter-term contracts may still be material if they involve a significant sum of money or a high degree of financial risk.
Collectability
We will also look briefly at the guidance regarding collectability (or possible non-collectability) of any monies due from both short and longer-term projects. This is covered by IFRS 9 Financial Instruments. This and the other Standards discussed may have particular relevance given the onset of the recent COVID-19 pandemic and the potential financial fallout which may accrue from that particular situation where the risk of corporate failures and consequent non-payment of amounts due from customers has generically increased.
Wayne Bartlett is an author for accountingcpd. To see his courses, click here.
You need to sign in or register before you can add a contribution.