Few construction projects are completed as planned. Unanticipated problems can and often do arise like differing site conditions or the need to make changes to the original design. Therefore modifications are often made to the scope and/or the price of the contracts, for example in the form of change orders and claims.
Change orders may be initiated by either the E&C entity or the customer, and they include changes in specifications or design, method or manner of performance, and period for completion of the work.
Claims by an E&C entity represent amounts that it seeks to collect from its customer or another party as reimbursement for costs not included in the contract price. A claim may arise from, for example, customer caused delays, errors in specifications and designs, and disputed variations in contract work.
Under HKAS 11 a contract variation was included in contract revenue when it was probable that the customer would approve the variation and the amount of revenue arising from the variation, and that amount of revenue can be measured reliably.
In contrast, HKFRS 15 includes more detailed requirements than HKAS 11 for contract modifications, which apply to all industries, which may affect the timing of and accounting for contract modifications.
Paragraph 18 of HKFRS 15 defines a contract modification as a change in the scope or price (or both) of a contract that is approved by the parties to the contract. A contract modification creates new or changes existing enforceable rights and obligations of the parties to the contract.
If there is a modification to a contract, then an entity considers whether the change is approved. A contract modification could be approved in writing, by oral agreement or implied by customary business practice. If the modification is not approved, then the parties continue to account for the existing contract under HKFRS 15 until the modification is approved (HKFRS 15.18). If the parties to a contract have approved a change in the scope of the contract but have not yet determined the corresponding change in price (an unpriced change order), then the entity estimates the change in price in accordance with the requirements for variable consideration (HKFRS 15.19) (see Q4 for details).
Under HKFRS 15, an entity accounts for a contract modification using one of the following methods:
(a) as a separate contract if the modification is an additional distinct promised good or service and the increase in price represents its stand-alone selling price (HKFRS 15.20).
(b) as a termination of the existing contract and creation of a new contract if the promised goods or services not yet transferred are distinct from those transferred, with revenue adjusted on a prospective basis (HKFRS 15.21(a)).
(c) as part of the existing contract if the remaining promised goods or services are not distinct from those already transferred, with revenue adjusted on a cumulative catch up basis (i.e. the entity updates the transaction price and the measure of progress towards complete satisfaction of the performance obligation (which now includes the modification), and the corresponding effect is recognised as an adjustment to revenue) (HKFRS 15.21(b)).
(d) if the remaining goods or services are a combination of items (b) and (c), account for the unsatisfied (including partially satisfied) performance obligations in the modified contract consistent with the above requirements (HKFRS 15.21(c)).
HKFRS 15 includes several examples that illustrate how contract modifications are accounted for under different scenarios (HKFRS 15.IE18 to IE43).
