A deep dive into recognizing revenue for long-term contracts and installment sales under IFRS 15 and ASC 606, featuring practical insights and analysis tips.
Introduction
Let’s be honest, the notion of recognizing revenue for a contract that stretches months or even years can feel daunting—like reading an epic novel where twists and turns keep popping up. In my own experience analyzing long-term engineering projects, there’s a whole mix of excitement and anxiety. Will the project stay on budget? Will cash flows arrive on time? Will the revenue recognized match the actual economic reality? These questions are precisely why long-term contract accounting is such a big deal in financial analysis.
Revenue from large construction or engineering projects can span multiple reporting periods, and an analyst’s job is to ensure that the revenue on the financial statements actually reflects performance delivered to the client. That’s where IFRS 15 (Revenue from Contracts with Customers) and FASB ASC 606 come in, providing frameworks that clarify the criteria and timing for revenue recognition. And when you add installment sales to the mix, you realize how critical it is to grasp the nuances around collectibility, payment schedules, and variable considerations. This discussion explains those frameworks, highlights best practices, points out pitfalls, and even offers a few personal reflections along the way.
Long-term contracts typically span more than one accounting period. Classic examples include building a bridge, developing specialized software, or constructing a piece of heavy machinery. Under older standards, there were distinct methods like the percentage-of-completion and completed contract approaches. However, IFRS 15 and ASC 606 introduced a principles-based model that focuses on performance obligations, progress measurement, and the nature of control transfer. If the customer obtains benefits as the project is built, the revenue often gets recognized “over time.” Conversely, if the customer only gains access to the finished asset on completion, it’s recognized at a point in time.
Installment sales occur when a buyer purchases a product or service but pays over an extended period. Think about real estate transactions financed directly by the seller or big-ticket durable goods with partial payments. While IFRS 15 and ASC 606 have largely standardized revenue recognition rules, older statements or specialized markets may still show legacy methods like the installment method or the cost recovery method. Analysts need to closely review these situations to understand when and how revenue is booked.
Under IFRS 15 and ASC 606, the main question is: Does the seller transfer control of goods or services to the customer over time, or all at once?
Over Time Recognition:
This applies if any one of these conditions is met:
• The customer simultaneously receives and consumes the benefits as the entity performs.
• The entity’s performance creates or enhances an asset that the customer controls as it’s created.
• The entity’s performance doesn’t create an asset with alternative use, and the entity has an enforceable right to payment for performance completed to date.
In over-time scenarios (like many construction projects), revenue is recognized in proportion to the progress made. That can be based on inputs (e.g., proportion of costs incurred to total costs) or outputs (e.g., units delivered, milestones achieved).
Point-in-Time Recognition:
If none of the above conditions apply (say, the seller is providing a specialized machine but retains control until the entire unit is finished), revenue is recognized at a discrete point when control passes—often signaled by title transfer, acceptance, or the right to invoice.
From an exam perspective, it’s important to correctly identify which scenario applies. A question might provide background on the project (such as partial acceptance or monthly billing) and ask you how to compute revenue using the appropriate approach.
Before IFRS 15 and ASC 606, the percentage-of-completion method was standard for many industries. It still conceptually aligns with “over time” revenue recognition. Under the legacy approach:
Or we might see output-based measures like the proportion of physical progress. While IFRS 15 doesn’t always use the exact term “percentage-of-completion,” the principle remains. If the contract meets over-time criteria, managers typically use a measure of progress to gauge how much revenue to record. So, the mechanics might look quite similar to the old approach—even though the official guidance is framed in more general terms about “performance obligations.”
A personal anecdote: I once analyzed a contractor that recognized revenue based on labor hours alone. Problems arose when the cost of materials and subcontracts ballooned unexpectedly, distorting how much progress was really made. This mismatch triggered a huge revision to total estimated costs during the year, leading to a big catch-up adjustment. So, watch out for biases in progress measures: Using only input-based measures might be too narrow if big cost items or external dependencies exist.
Contracts often include performance bonuses (like early completion rewards) or penalties (like liquidated damages for being late). Under IFRS 15 and ASC 606, these are forms of variable consideration that must be estimated and included in the transaction price, as long as it’s “highly probable” (IFRS) or not “probable” of a significant reversal (FASB).
Analysts should keep an eye out for unrealistic assumptions about achievements of performance bonuses and the potential for revenue reversals if deadlines aren’t met. If the financial statements show a big chunk of revenue from variable consideration, but the actual cash receipts lag or are in dispute, it can be a red flag pointing to potential over-aggressive revenue recognition.
A practical tip for any analyst is to compare the revenue recognized over time with the contractor’s cash receipts (i.e., from progress billings). If the contract is truly on track, you expect a reasonable correlation between recognized revenue and invoiced amounts (adjusted for normal payment lags). A significant mismatch can indicate one of two things:
On the CFA exam, you might see a scenario in which a firm’s reported revenue from long-term contracts has grown quickly, yet cash flow from operations lags or goes negative. They might expect you to explain the discrepancy or evaluate the risk of uncollectible payments.
Let’s pivot to installment sales. When a property developer sells a large piece of real estate, it might allow the buyer to pay in monthly installments over five years. Older guidance recognized revenue in tandem with the cash collections (the installment method), or recognized no profit until all costs were recovered (the cost recovery method) if collectibility was uncertain.
Under IFRS 15 / ASC 606, the basic premise still revolves around performance obligations and transfer of control. In practice:
Despite the modern standards, some local regulations or older financial statements may show installment or cost recovery methods. For example, in certain regulatory frameworks or specialized real estate transactions, those legacy methods remain. An analyst’s role is to verify if the approach is consistent with actual risk. If collectibility is highly questionable, the cost recovery method leads to a more conservative approach: no profit recognized until total costs have been recouped.
Imagine Atlas Builders, a company that signs a $100 million contract to construct a highway over four years. The arrangement includes milestone-based payments and a potential $3 million bonus if completed six months ahead of schedule. Here’s how IFRS 15 or ASC 606 would apply:
At the end of each year, Atlas updates estimates. Changes in the total project cost or the likelihood of achieving the bonus get accounted for as adjustments to revenue in the period of change. That might cause big year-to-year swings, so as an analyst, you’d watch closely to see whether these changes are well justified.
Below is a Mermaid flowchart summarizing key steps in over-time revenue recognition:
flowchart LR
A["Contract Signed"]
B["Identify Performance Obligations"]
C["Measure Progress <br/> (Input or Output Methods)"]
D["Recognize Revenue <br/> Over Time"]
E["Record & Adjust <br/> Revenue and Costs"]
F["Cash Collected <br/> (Progress Billings)"]
A --> B
B --> C
C --> D
D --> E
E --> F
This flow is simplified. In reality, each step ties back to IFRS 15 or ASC 606 guidelines about variable consideration, transaction prices, and contract modifications.
In both constructed-response and item-set questions on the CFA exam, you might be asked to:
A strong approach is to:
Suppose Titan Infrastructure has a $50 million contract with $5 million possible in variable consideration if they complete early. They expect total costs of $40 million. After year one, they’ve incurred $10 million of costs and expect an additional $30 million in costs, for a total of $40 million. They also believe they’ve hit certain project milestones that make a 75% chance of earning the $5 million bonus.
Any year-end adjustments would shift these numbers. For instance, if next year the engineers realize they will definitely not meet the bonus schedule, Titan must remove the variable portion from the transaction price and revise the recognized revenue accordingly.
Imagine you sell real estate for $2 million but allow the buyer to pay $200,000 per year over ten years. Under IFRS 15 / ASC 606:
Under older approaches like the installment method, you might only recognize each installment’s share of total profit each year. Or with the cost recovery method, you might not recognize any profit until you’ve recovered the cost basis. While these methods are less common under modern standards, they’re still out there in legacy statements and specialized jurisdictions.
Long-term contract revenue recognition is about faithfully representing the economic reality of multi-period projects. IFRS 15 and ASC 606 are designed to accomplish that by focusing on performance obligations and the transfer of control. But that doesn’t mean complexities (like variable consideration, modifications, or uncertain collectibility) just go away. Installment sales add another layer of intrigue, particularly in older or specialized environments where you still see installment or cost recovery methods.
As a candidate preparing for the CFA exam—or a finance professional verifying real-world statements—you want to understand where the rubber meets the road. Watch how management measures progress, incorporates potential bonuses or penalties, and addresses collectibility. Don’t just accept top-line revenue as a done deal; cross-check it with cash flows, contract assets, and any disclaimers in the footnotes. Doing so can be the difference between a robust, reality-based analysis and a superficial read that misses brewing trouble.
Important Notice: FinancialAnalystGuide.com provides supplemental CFA study materials, including mock exams, sample exam questions, and other practice resources to aid your exam preparation. These resources are not affiliated with or endorsed by the CFA Institute. CFA® and Chartered Financial Analyst® are registered trademarks owned exclusively by CFA Institute. Our content is independent, and we do not guarantee exam success. CFA Institute does not endorse, promote, or warrant the accuracy or quality of our products.