How Costs to Fulfill a Contract Are Capitalized under IFRS 15 and ASC 340-40
- Graziano Stefanelli
- 11 minutes ago
- 5 min read
Contract execution often requires up-front spending—engineering design, set-up, customization, mobilization, and site preparation—that doesn’t transfer a promised good or service by itself. IFRS 15 and US GAAP (ASC 340-40) permit capitalization of costs to fulfill a contract when strict criteria are met, with subsequent systematic amortization and impairment tied to the pattern of revenue recognition. Getting this boundary right prevents premature expense recognition and keeps margins comparable across long-cycle projects.
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How costs to fulfill arise
Typical pre-delivery activities include:
Engineering and design specific to the customer’s contract.
Set-up, staging, and mobilization at the customer site.
Contract-specific tooling, molds, dies, or fixtures that are not separately promised.
Data conversion and configuration required to deliver the contracted solution (but not general R&D).
Direct labor and materials consumed in preparing to provide the goods or services.
These costs differ from costs to obtain a contract (e.g., sales commissions), which follow related but distinct rules.
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When capitalization is allowed under IFRS 15
Capitalize only if all of the following are true:
Directly related to a specific contract (or anticipated contract) — e.g., direct labor, materials, allocations that relate to contract activities, explicitly chargeable costs.
Generate or enhance resources that will be used to satisfy performance obligations in the future.
Expected to be recovered — i.e., the contract pricing (including renewals/options the entity expects to exercise) will cover these costs.
Otherwise, expense as incurred. Start-up, wasted materials, general/admin, and training are expensed.
Amortization (IFRS 15.99): Recognize on a systematic basis consistent with the transfer of goods/services to the customer (often proportional to revenue, milestones, or units delivered).
Impairment (IFRS 15.101–104): Carrying amount cannot exceed the remaining consideration expected to be received less the costs that relate to providing those goods/services. Recognize losses in P&L; reversals are permitted up to the carrying amount that would have existed absent the impairment.
Illustrative entries (IFRS):
Capitalize qualifying set-up costs 300,000
Dr Contract Fulfillment Asset 300,000
Cr Cash / Payables 300,000
Amortize with revenue (e.g., 20% completion) 60,000
Dr Cost of Sales / Amortization 60,000
Cr Contract Fulfillment Asset 60,000
Impairment if recoverable ceiling falls below carrying amount 25,000
Dr Impairment Loss – Fulfillment Costs 25,000
Cr Contract Fulfillment Asset 25,000
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When capitalization is allowed under ASC 340-40
US GAAP mirrors IFRS for costs to fulfill within the scope of ASC 606:
Capitalize if directly related, generate/enhance resources for future performance, and are recoverable.
Expense costs related to wasted materials, general overhead not tied to the contract, pre-contract R&D, and training.
Amortization (ASC 340-40-35): Systematic pattern consistent with transfer to the customer (revenue pattern).
Impairment (ASC 340-40-35-4): Compare carrying amount to remaining consideration expected to be received minus the costs directly related to providing the remaining goods/services. No separate fair-value model; losses go to P&L. Reversals are allowed to the extent the new recoverable ceiling increases (i.e., not above what the balance would have been).
Practical expedient: If the amortization period is one year or less, entities may expense the costs as incurred (policy election).
Illustrative entries (US GAAP):
Dr Contract Fulfillment Cost (Asset) 450,000 / Cr Cash 450,000
Amortization (e.g., over 36 months) 12,500 per month
Dr Amortization Expense 12,500
Cr Contract Fulfillment Asset 12,500
Impairment to recoverable ceiling 40,000
Dr Impairment Loss 40,000
Cr Contract Fulfillment Asset 40,000
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What’s in vs out: practical boundary examples
Capitalize (if recoverable):
Customer-specific molds/dies used to manufacture the contracted product where ownership remains with the entity.
Contract-specific software configuration needed to deliver the service (not a promised good on its own).
Site mobilization and scaffolding for a construction contract accounted for over time.
Expense immediately:
Bid/tender costs not directly attributable to a specific contract award.
General training of staff.
Corporate start-up, relocation, and legacy system clean-up not required by the contract.
Rework and abnormal waste.
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Comparative framework — IFRS 15 vs ASC 340-40
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Worked example — multi-year integration project
Facts: 24-month SaaS integration (the SaaS itself is the vendor’s promised service; the integrator is the reporting entity). Non-distinct configuration and data conversion costs of €480,000 qualify as fulfillment. Total transaction price €2,400,000 over 24 months.
Pattern: Straight-line transfer (time-based).
Month 1 capitalization:
Dr Contract Fulfillment Asset 480,000 / Cr Cash 480,000
Monthly amortization (480,000 / 24) = €20,000:
Dr Amortization Expense 20,000 / Cr Contract Fulfillment Asset 20,000
At month 12, scope reduction cuts remaining consideration by €200,000; remaining costs to complete are €60,000.
Carrying amount at month 12 = 480,000 − (20,000 × 12) = €240,000
Ceiling = Remaining consideration (2,400,000 − 1,200,000 − 200,000) €1,000,000 − Remaining costs €60,000 = €940,000
No impairment (carrying €240,000 < ceiling €940,000). Continue amortization.
If instead the scope reduction were severe so that ceiling were €180,000, book €60,000 impairment.
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Disclosure package that satisfies both frameworks
Beginning balance, additions, amortization, impairment, ending balance.
Amortization method and period; linkage to revenue recognition pattern.
Judgment areas (e.g., which costs are directly related, expected recovery assumptions, renewal expectations).
Example roll-forward (USD):
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Journal entries summary
1) Capitalize qualifying fulfillment costs:
Dr Contract Fulfillment Asset xx
Cr Cash / Payables xx
2) Systematic amortization with performance:
Dr Amortization Expense (COGS/OpEx) xx
Cr Contract Fulfillment Asset xx
3) Impairment to recoverable ceiling:
Dr Impairment Loss – Fulfillment Costs xx
Cr Contract Fulfillment Asset xx
4) Reversal (when ceiling increases):
Dr Contract Fulfillment Asset xx
Cr Reversal of Impairment xx
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Impact on financial performance and ratios
Gross margin / EBITDA: Capitalization smooths margins over the contract term; immediate expensing depresses early-period EBITDA.
Working capital: Fulfillment assets increase current/non-current assets; cash flows remain operating unless costs qualify as investing under local policy (generally operating for 340-40/IFRS 15 items).
Covenants: EBITDA-based covenants may improve with capitalization; disclose policy clarity to avoid perception of aggressive accounting.
Volatility: Impairment triggers can create step-downs when pricing, scope, or usage patterns change.
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Operational considerations
Build a chart of accounts that separates qualifying fulfillment costs from expensed items.
Align project accounting (milestones, %-complete) with revenue schedules to drive amortization.
Implement ceiling tests within closing checklists; automate remaining consideration and remaining cost forecasts.
Document judgments on recoverability and direct relation; align with contracting and pricing teams.
Reassess practical expedients annually (US GAAP) and disclose consistently.
A disciplined capitalization, amortization, and impairment process for costs to fulfill produces revenue-aligned margins and transparent disclosures that withstand audit under both IFRS 15 and ASC 340-40.
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