On 1 March 2018, Excellent Works Limited signed a contract with Fine Technologies Limited. Excellent Works Limited will construct a new office building for Fine Technologies Limited. Four plots of land were recently acquired by Fine Technologies Limited.
Based on the contract, as the office building is constructed, Excellent Works Limited passes control of the office building to the customer. Hence, the performance obligation is fulfilled over time.
The contract price is ₦250,000. However, the amount will reduce or increase depending on the time that the office building construction is completed.
There are multiple outcomes in the contract:
The promised consideration will increase by ₦2,500 for every day prior to 31 August 2019 that the building is completed.
The promised consideration will reduce by ₦2,500 for every day after 31 August 2019 that the building is incomplete.
Based on a similar project that is currently executed by Excellent Works Limited, it is estimated that the construction firm is 60% likely to complete the office building 18 days before 31 August 2019.
The construction firm is 20% likely to complete the office building on 31 August 2019 and receive no incentive.
The construction firm is 20% likely to complete the office building 10 days after 31 August 2019.
Required:
i. Apply the expected value and most likely amount bases to determine the transaction price amount at contract inception.
ii.Advise Excellent Works Limited on how to estimate the transaction price at the end of 28 February 2019. Assume that on 28 February 2019, Excellent Works Limited asserts that it is 85% likely to complete the office building 18 days before the scheduled date and 15% likely to complete the project on the scheduled date. This assertion is based on the completed work to date and the remaining construction based on the Gant Chart used to keep track of work inventory.
See the suggested solution to practice activity 13.22 here.
Suggested solution to practice activity 13.22
i. Estimation of the transaction price at the contract inception:
Scenario 1:
When the contract to construct the office building commences, Excellent Works Limited determines that the expected value basis better predicts the variable consideration associated with the daily incentive or penalty.
Based on the fact that there are multiple outcomes in the contract, the amount is: ₦250,000 ± ₦2,500 per day.
Scenario 2:
At contract inception, based on experience with a similar construction of an office building, Excellent Works Limited estimates the following:
60% likely to finish the office building construction 18 days before 31 August 2019 and receive an incentive of ₦2,500 * 18 = ₦45,000
20% likely to complete the office building construction he project on time and receive no incentive.
20% likely to finish the office building construction 10 days after schedule and be penalised to the amount of:
₦2,500 * 10 = ₦25,000
The probability-weighted estimate is as follows:
Completion 18 days before scheduled date = ₦45,000 * 60% = ₦27,000
Completion on the scheduled date = 0 * 20% = 0
Completion 10 days after scheduled date = ₦25,000 *20% = ₦5,000
Excellent Works Limited will include N32,000 in the transaction price associated with the amount of provisional consideration.
At the inception of the contract, after the base price, daily incentive or penalty are accounted for, the total transaction price is:
₦250,000 + ₦32,000 = ₦282,000
ii. Estimation of the transaction price as at 28 February 2019
The probability-weighted estimate is as follows:
Completion 18 days before scheduled date = ₦45,000 * 85% = ₦38,250
Completion on the scheduled date = 0 * 15% = 0
Excellent Works Limited is expected to update the estimate of the transaction price as at 28 February 2019.
Excellent Works Limited will update the estimated variable consideration from the daily incentive or penalty to ₦38,250 and add ₦6,250 to the transaction price.
Subtract ₦32,000 from ₦38,250. The result is ₦6,250.
On 28 February 2019, after accounting for the base price, daily incentive or penalty, the transaction price is:
₦250,000 + ₦32,000 = ₦282,000 + ₦6,250 = ₦288,250
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