IFRS 15, modified retrospective method, contracting, policies, paras 110-122, contract assets and liabilities, certain disclosures

SNC-Lavalin Group Inc. – Annual report – 31 December 2018

Industry: contracting

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (extracts)

B) NEW STANDARDS, AMENDMENTS AND AN INTERPRETATION ADOPTED IN 2018 (extract 1)

ADOPTION OF IFRS 15 AND AMENDMENTS TO IFRS 15

IFRS 15 introduces a 5-step model to revenue recognition for contracts with customers. Such model requires an entity to: 1) identify the contract with the customer; 2) identify the performance obligations related to that contract; 3) determine the transaction price of the contract; 4) allocate such transaction price between the performance obligations; and 5) recognize revenue when (or as) performance obligations are satisfied. In addition to recognition and measurement, IFRS 15 also provides new requirements on presentation and disclosures.

Transition

The Company elected to adopt IFRS 15 using the modified retrospective method, with recognition of transitional adjustments in opening retained earnings on the date of initial application (January 1, 2018), without restatement of comparative figures.

IFRS 15 provides for certain optional practical expedients, including those related to the initial adoption of the standard. The Company applied the following practical expedients upon adoption of IFRS 15 on January 1, 2018:

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Change orders and claims

Change orders and claims, referred to as contract modifications, were previously recognized as per guidance provided in IAS 11, Construction Contracts, (“IAS 11”). Under such guidance, revenue could be recognized on contract modifications only when certain conditions were met, including the fact that it was probable the customer will approve the modification and the amount of revenue arising from such contract modifications. IFRS 15 also provides guidance on the recognition of revenue from contract modifications, but such guidance is based, among other factors, on the fact that the contract modification is approved and it is highly probable that a significant reversal in the amount of cumulative revenue recognized on such contract modifications will not occur when the uncertainty is subsequently resolved. Given the higher level of probability to be applied under IFRS 15, some revenue recognized under IAS 11 was reversed as at January 1, 2018, resulting in an approximate $210 million adjustment to equity on that date. Revenue from these contract modifications will be recognized when, and if, IFRS 15 guidance is met.

Measure of anticipated revenues and determination of progress

Under IFRS 15, the amount of anticipated revenue used when determining the amount of revenue to be recognized must be based on contracts with legally enforceable rights and obligations. As a result, certain contracts under which the Company anticipates some volume of work based on discussions with the customer or other indicators, but for which formal purchase orders or work orders need to be issued by the customer in order to formalize the exact scope of work, were assessed to determine when the anticipated revenue should be included in the transaction price, resulting in a decrease in the Company’s cumulative revenues recognized on these contracts as at January 1, 2018 (approximately $105 million adjustment to equity on that date).

Furthermore, for projects having revenue recognized based on the stage of completion method using a cost input method, the Company was accounting for its assurance-type warranty costs the same way as other project costs. As a result, the Company did not carry a provision for such expected warranty costs. Rather, it recognized such costs as they were incurred, which in turn was included in the measure of progress of the project based on the stage of completion method and, as such, generated revenue.

Under IFRS 15, these assurance-type warranty costs are to be excluded from the measure of progress of projects for which revenue is recognized over time using a cost input method. Such costs will rather be recognized as a provision in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets, based on the advancement of the projects, and the provision recognized will then either be used when costs are incurred or reversed if it is no longer needed.

In addition to these warranty-related costs, the Company reviewed its other project costs on contracts for which revenue is recognized over time to determine if each of these costs is contributing to the transfer of control of the goods or services to the customer. Such review resulted in an insignificant impact on the Company’s equity as at January 1, 2018.

Presentation

In accordance with IFRS 15, the Company changed its presentation of contract-related assets and liabilities. As such, the Company now presents its contract balances, on a contract-by-contract basis, in a net contract asset or liability position, separately from its accounts receivable. Contract assets and accounts receivable are both rights to consideration in exchange for goods or services that the Company has transferred to a customer, however the classification depends on whether such right is only conditional on the passage of time (accounts receivable) or if it is also conditional on something else (contract assets), such as the satisfaction of further performance obligations under the contract. A contract liability is the cumulative amount received and contractually receivable by the Company that exceeds the right to consideration resulting from the Company’s performance under a given contract.

The Company’s contract assets and contract liabilities include mainly the balances that were presented as “Contracts in progress”, “Retentions on client contracts” included in “Other current financial assets”, “Deferred revenues” and “Downpayments on contracts” in the Company’s consolidated statement of financial position until December 31, 2017.

Procedures and controls

The Company has updated and implemented revised procedures and controls in order to meet the requirements of IFRS 15, notably the recording of the transition adjustment, the change in presentation, as well as additional disclosures provided in the Company’s 2018 audited annual consolidated financial statements.

2018 impacts of adopting IFRS 15

Since the Company elected to adopt IFRS 15 using the modified retrospective method, the following tables summarize the impacts of adopting IFRS 15 on the Company’s consolidated statement of financial position as at December 31, 2018, its consolidated income statement and its consolidated statement of comprehensive income for the year ended December 31, 2018 for each of the line items affected. There was no material impact on the Company’s consolidated statement of cash flows for the year ended December 31, 2018.

Impact on the consolidated statement of financial position

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Impact on the consolidated income statement and the consolidated statement of other comprehensive income

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a. Under IAS 11, contract-related assets and liabilities were accounted for in separate accounts on the Company’s statement of financial position, namely contracts in progress, downpayments on contracts and certain other balances included in other current financial assets and other current financial liabilities. As such, no amount would have been reported as contract assets and contract liabilities under IAS 11.

b. The deferred income tax impact of the changes between IFRS 15 and IAS 11 is presented as a change in income tax expense, as well as a change in either deferred income tax asset or deferred income tax liabilities, as applicable.

c. Revenues reported under IAS 11 would have been different from revenues reported under IFRS 15 based on mainly three differences:

  • Revenue from certain unsigned change orders and claims recognized under IAS 11 was reversed as at January 1, 2018 given the higher level of probability required by IFRS 15 that such revenue will be realized by the Company once the related uncertainty is subsequently resolved. While the Company recognized a portion of such revenue in 2018 under IFRS 15 upon reaching the required level of probability, revenue from some other change orders and claims was not recognized under IFRS 15 in 2018 because it was not meeting the adequate level of probability, but could have been recognized under IAS 11.
  • Revenue from certain contracts recognized under IAS 11 was reversed as at January 1, 2018 due to the need to obtain formal purchase orders or work orders prior to including anticipated revenue in the amount of transaction price under IFRS 15. While the Company recognized a portion of such revenue in 2018 after obtaining formal purchase orders or work orders, such revenue would not have been recognized again in 2018 under IAS 11.
  • Revenue being recognized over time has been adjusted to consider the way revenue was determined when using the stage of completion method under IAS 11, which was different than under IFRS 15 for certain items, such as for assurance-type warranty costs and certain other project costs that are not contributing to the transfer of control of the goods or services to the customer.

d. The change in direct costs of activities reflects mainly the treatment of assurance-type warranty costs on projects for which revenue is recognized over time. Such costs are recognized as a provision under IFRS 15, while they were recognized as incurred under IAS 11.

e. The amount of impairment loss arising from expected credit losses is derived, in part, from the unreserved balance of trade receivables and contract assets. While the amount of trade receivables remained the same under IFRS 15 and IAS 11, the amount of contract asset did not exist under IAS 11 and, as such, the calculations was based on the amount of contracts in progress and certain other current financial assets for the purpose of comparing IFRS 15 and IAS 11.

B) NEW STANDARDS, AMENDMENTS AND AN INTERPRETATION ADOPTED IN 2018 (extract 2)

IMPACT FROM THE ADOPTION OF IFRS 9, IFRS 15 AND AMENDMENTS TO IFRS 2

The following table presents the impact of adopting IFRS 9, IFRS 15 and amendments to IFRS 2 on the Company’s equity as at January 1, 2018:

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G) REVENUE RECOGNITION

POLICY APPLICABLE FROM JANUARY 1, 2018

REVENUES FROM E&C

Revenue from contracts with customers is recognized, for each performance obligation, either over a period of time or at a point in time, depending on which method reflects the transfer of control of the goods or services underlying the particular performance obligation to the customer.

In most cases, for performance obligations satisfied over time, the Company recognizes revenue over time using an input method, based on costs incurred to date relative to total estimated costs at completion, to measure progress toward satisfying such performance obligations. Under this method, costs that do not contribute to the performance of the Company in transferring control of goods or services to the customer are excluded from the measurement of progress toward satisfying the performance obligation. For certain contracts, notably certain cost-plus contracts or unit-rate contracts, the Company recognizes revenue based on its right to consideration when such amount corresponds directly with the value to the customer of the entity’s performance completed to date. In certain other situations, the Company might recognize revenue at a point in time, when the criteria to recognize revenue over time are not met. In any event, when the total anticipated costs exceed the total anticipated revenues on a contract, such loss is recognized in its entirety in the period it becomes known.

The amount of revenue recognized by the Company is based on the transaction price allocated to each performance obligation. Such transaction price corresponds to the amount of consideration to which the Company expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. The transaction price includes, among other things and when applicable, an estimate of variable consideration only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Variable consideration is usually derived from incentives, performance bonuses, and penalties, and could include claims and unpriced change orders. When a contract includes a significant financing component, the value of such component is excluded from the transaction price and is recognized separately as finance income or expense, as applicable.

SNC-Lavalin may enter into contractual arrangements with a client to deliver services on one project which span more than one performance obligation, such as Engineering, Procurement and Construction (“EPC”) or Engineering, Procurement, and Construction and Management (“EPCM”), Operations and Maintenance (“O&M”) and/or Capital investments. When entering into such arrangements, the Company allocates the transaction price by reference to the stand-alone selling price of each performance obligation. Accordingly, when such arrangements exist on the same project, the value of each performance obligation is based on its stand-alone selling price and recognized according to the respective revenue recognition methods described above.

The Company accounts for a contract modification, which consists of a change in the scope or price (or both) of a contract, as a separate contract when the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification and the price of the contract increases by an amount of consideration that reflects the Company’s stand-alone selling price of the additional promised good or services. When the contract modification is not accounted for as a separate contract, the Company recognizes an adjustment to revenue on a cumulative catch-up basis at the date of contract modification.

The Company recognizes assurance-type warranty costs as a provision in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets, based on the advancement of the projects, and the provision recognized is then either used when costs are incurred or reversed if it is no longer needed.

In all cases, the value of construction activities, material and equipment purchased by SNC-Lavalin, when acting as purchasing agent for a client, is not recorded as revenue.

The Company may apply its revenue recognition policy to a portfolio of contracts or performance obligations with similar characteristics if the effect on its financial statements of applying such policy to the portfolio is not reasonably expected to differ materially from applying its policy to the individual contracts or performance obligations within that portfolio.

The Company presents its contract balances, on a contract-by-contract basis, in a net contract asset or liability position, separately from its trade receivables. Contract assets and trade receivables are both rights to consideration in exchange for goods or services that the Company has transferred to a customer, however the classification depends on whether such right is only conditional on the passage of time (trade receivables) or if it is also conditional on something else (contract assets), such as the satisfaction of further performance obligations under the contract. A contract liability is the cumulative amount received and contractually receivable by the Company that exceeds the right to consideration resulting from the Company’s performance under a given contract.

H) FINANCIAL INSTRUMENTS (extract)

Impairment of assets subsequently measured at amortized cost (extract)

For “Trade receivables” and “Contract assets”, the amount of the loss allowance recognized is the amount equal to lifetime expected credit losses that result from all possible default events over the expected life of a financial instrument.

  1. CRITICAL ACCOUNTING JUDGMENTS AND KEY SOURCES OF ESTIMATION UNCERTAINTY (extract)

Revenue recognition

The identification of revenue-generating contracts with customers, the identification of performance obligations, the determination of the transaction price and its allocation between identified performance obligations, the use of the appropriate revenue recognition method (over time or at a point in time) for each performance obligation and the measure of progress for performance obligation satisfied over time are the main aspects of the revenue recognition process, all of which require the exercise of judgment and the use of assumptions.

The transaction price corresponds to the amount of consideration to which the Company expects to be entitled in exchange for transferring promised goods or services to a customer. Such amount may require the Company to estimate an amount of variable consideration, notably from estimated volume of work, claims and unpriced change orders, incentives or penalties, among others. Furthermore, the Company needs to constraint the transaction price by including only the amount for which it is highly probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. The amount of variable consideration to be included in the transaction price of a given contract is determined by using various estimates and assumptions, which could be based on historical experience with the same customer or other similar contracts, third-party assessments, legal interpretation of relevant contractual clauses and probabilistic methodologies, among others. Due to the uncertain nature of the estimations, the amount of variable consideration may vary significantly over time. Such estimated amount of variable consideration then needs to be updated at the end of each reporting period.

The determination of anticipated costs for completing a contract is based on estimates that can be affected by a variety of factors such as potential variances in scheduling and cost of materials along with the availability and cost of qualified labour and subcontractors, productivity, and possible claims from subcontractors.

9. TRADE RECEIVABLES AND CONTRACT ASSETS (extract)

B) CONTRACT ASSETS

As at December 31, 2018, the Company has contract assets of $1,751.1 million which is net of an allowance for expected credit losses of $11.2 million. The change in the allowance for expected credit losses is detailed below:

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The significant changes in the balances of trade receivables and contract assets are disclosed in Note 10B, while the information about the credit exposures is disclosed in Note 32B.

10. REVENUE

A) DISAGGREGATION OF REVENUE

The adoption of IFRS 15 in 2018 resulted in additional disclosures of financial information related to the disaggregation of revenue from contracts with customers. As such, the Company added details on 2018 revenues by geographic area and type of contracts, with a reconciliation between revenues from contracts with customers under the scope of IFRS 15 and total revenues.

The types of contracts presented are defined as follow:

Reimbursable and engineering service contracts: Under reimbursable contracts, the Company charges the customer for the actual cost incurred plus a mark-up that could take various forms such as a fixed-fee per unit, a percentage of costs incurred or an incentive fee based on achieving certain targets, performance factors or contractual milestones. Reimbursable contracts also include unit-rate contracts for which a fixed amount per quantity is charged to the customer, and reimbursable contracts with a cap. Engineering service contracts include: i) time and material agreements based on hourly rates and fixed-price lump-sum contracts with limited procurement or construction risks; and ii) O&M contracts.

EPC fixed-price contracts: Under EPC fixed-price contracts, the Company completes the work required for the project at a lump-sum price. Before entering into such contracts, the Company estimates the total cost of the project, plus a profit margin. The Company’s actual profit margin may vary based on its ability to achieve the project requirements at above or below the initial estimated costs.

The following table presents revenues by geographic area according to project location:

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The following table presents revenues by type of contracts:

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B) CONTRACT BALANCES

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Trade receivables are rights to consideration in exchange of goods or services that the Company has transferred to a customer when such rights are only conditional on the passage of time. Trade receivables are non-interest bearing and are generally on terms of 30 to 90 days. The acquisition of Linxon in 2018 resulted in an increase of trade receivables of $9.4 million (see Note 6A).

Contract assets are rights to consideration in exchange of goods or services that the Company has transferred to a customer when such rights are not only conditional on passage of time, but on something else, such as the satisfaction of further performance obligations under the contract. Contract assets are initially recognized for revenue earned from E&C activities and are usually derecognized when they become trade receivables. In 2018, the increase of contract assets is mainly due to the adoption of IFRS 15 using the modified retrospective method (see Note 2B) and the acquisition of Linxon, which resulted in an increase of contract assets of $14.2 million as at September 1, 2018 (see Note 6A).

Contracts liabilities arise from E&C activities and represent the cumulative amounts received and contractually receivable from customers by the Company that exceed the right to consideration resulting from the Company’s performance under a given contract. In 2018, the increase of contract liabilities is mainly due to the adoption of IFRS 15 using the modified retrospective method (see Note 2B) and the acquisition of Linxon, which resulted in an increase of contract liabilities of $9.8 million as at September 1, 2018 (see Note 6A).

The following table presents the amount of revenue recognized from:

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As a significant portion the Company’s revenues are recognized over time, the contractual terms which determine when consideration becomes receivable from the customer, such as upon the achievement of certain milestones, the Company’s reaching such milestones earlier or later than anticipated and the ability to obtain downpayments on contracts will influence, among other factors, the balance of trade receivables, contract assets and contract liabilities on a given contract.

C) REMAINING PERFORMANCE OBLIGATIONS

The amount of transaction price allocated to performance obligations that are unsatisfied (or partially satisfied) at December 31, 2018, on all contracts with customers, is expected to be recognized in revenues as follows: 2019 – $5.8 billion, 2020 – $2.3 billion, 2021 – $1.2 billion, and thereafter – $5.6 billion. It should be noted that these amounts exclude any estimated amounts of variable consideration that are excluded from the transaction price.

 

 

 

 

 

 

 

 

 

 

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