Question

A construction company enters into a contract with a customer to supply a new building. Control over the completed building will pass to the customer in two years (the contractor’s performance obligation will be satisfied at a point in time). The contract contains two payment options. Either the customer can pay $ 5 million in two years when it obtains control of the building, or the customer can pay $ 4 million on inception of the contract.

The customer decides to pay 4 million on inception. The contractor concludes that because of the significant period between the date of payment and the transfer of the asset (the completed building) to the customer, together with the prevailing market rates of interest, that there is a significant financing component. The interest rate implicit in the transaction is 11.8%. However, because the contractor is effectively borrowing from its customer, the contractor is also required to consider its own incremental borrowing rate which is determined to be 6%.

Required: Prepare well narrated journal entries to record the above. (5)

Answer 1