Obayashi : Non-consolidated Financial Statements (Year Ended March 31, 2026) with Independent Auditor's Report

Estimation of total construction revenue and total construction costs under the method to recognize revenue by satisfying performance obligations over a certain period of time

Description of Key Audit Matter

Auditor's Response

As described in "(1) Application of the method to recognize revenue by satisfying performance obligations over a certain period of time" under "4. Significant Accounting Estimates" in the notes

to the consolidated financial statements,

We mainly performed the following procedures to evaluate the estimates of total construction revenue and total construction costs in applying the method to recognize revenue by satisfying

OBAYASHI CORPORATION and its

consolidated subsidiaries (the "Group") apply the method to recognize revenue by satisfying performance obligations over a certain period of time for construction contracts based on estimates of total construction revenue, total construction costs, and progress of satisfaction of performance obligations, with the exception of construction contracts having very short construction periods. The method of estimating the degree of progress of satisfaction of performance obligations is calculated as the ratio of the costs incurred to the estimated total cost of construction (input method). If it is likely that total construction costs associated with construction contracts will exceed total construction revenue, and if the amount of the excess can be reasonably estimated, then the amount resulting from deducting the profit or loss already recorded for such construction contracts from the expected amount of the excess of costs over revenue ("loss on construction contracts") is accounted for as a loss in the period in which loss on construction contracts is expected. In addition, a provision for loss on construction contracts is recorded. The Company recognized revenues from construction contracts using the method to recognize revenue by satisfying performance obligations over a certain period of time of 1,378,528 million yen, accounting for 57.2% of consolidated revenues from construction contracts of 2,409,378 million yen for the consolidated fiscal year ended March 31, 2026 ("the current consolidated fiscal year"). The Company also recorded a provision for loss on construction contracts of 6,840 million yen, accounting for 80.0% of the provision for loss on construction contracts of 8,575 million yen as at the end of the current consolidated fiscal year.

In applying the method of recognizing revenue as performance obligations are satisfied over time, revenues from construction contracts are determined by multiplying total construction revenue by progress of satisfaction of performance obligations, which is based on total construction costs and corresponds to costs

actually incurred up until the end of the fiscal year.

performance obligations over a certain period of time.

(1) Evaluation of internal controls

We evaluated the design and operating effectiveness of the following internal controls relating to estimates of total construction revenue and total construction costs.

・We evaluated controls to ensure reliability by requiring that operating budgets, on which estimates of total construction costs are based, are prepared by individuals in charge of construction work who possess specialized knowledge. In addition, necessary approvals for these operating budgets must be obtained from construction and other departments involved in functions such as construction management, progress management, and logistics support.

・We evaluated controls to confirm that each of the elements of total construction costs is accumulated and calculated in detail based on objective prices such as internally-approved standard unit prices and third party quotations.

・We evaluated controls for revising estimates of total construction costs in a timely manner in accordance with factors, such as the status of construction and the amount of costs actually incurred, or changes in specifications instructed by customers, and controls to confirm that revisions are made in a timely and appropriate manner.

・We evaluated controls to ensure reliability by requiring that estimates of total construction revenue are calculated by accumulating information from materials such as construction instructions and quotations, and that the necessary approval for such calculations is obtained.

・We evaluated controls for revising estimates of total construction revenue in a timely manner in accordance with factors such as the status of discussions with ordering parties, and controls to confirm that revisions are made in a timely and appropriate manner.

Accordingly, it is necessary to reasonably estimate total construction revenue, total construction costs, and progress of satisfaction of performance obligations as of the end of the fiscal year. In addition to the fact that the construction contracts undertaken by the Group are individual in nature (varying in specifications and construction periods by project) many of these contracts span long construction periods. This makes it likely that total construction revenue and total construction costs will change during the course of construction due to additions and changes to construction details instructed by ordering parties, and changes to construction details caused by certain facts coming to light and conditions at construction sites changing after the start of construction.

(Total construction revenue)

Although total construction revenue, which serves as the basis for revenue recognition, is based on construction contract amounts, construction details and contracts often undergo modifications while construction is still in progress due to new agreements between counterparties. This makes estimates of additional contract amounts arising from changes in construction details uncertain until a final agreement is reached with the ordering party. (Total construction costs)

Although total construction costs are based on operating budgets for each construction contract and are estimated in line with revisions resulting from changes in construction details and fluctuations in building material and labor prices, they also rely on certain assumptions or the judgment of individuals directly or indirectly responsible for cost and progress management over construction contracts. This is because there is no uniform rule for determining estimates of work details, working hours, and the costs of building materials and labor necessary to complete construction, nor for assessing the feasibility of cost reduction activities, especially since many contracts span long construction periods.

1. Evaluation of estimates of total construction revenue

   We identified construction contracts in which there was either material or qualitative uncertainty over the estimate of total construction revenue in light of factors such as construction contract amount, profit (loss) on construction, construction details, and the status of construction, and performed the following procedures. We also identified construction contracts subject to consideration that meet certain conditions set by us (including construction profit margin levels and fluctuations). In addition, to complement the identification of the aforementioned construction contracts, we utilized the Project Progress Anomaly Detector. This tool detects unusual progress in construction contracts where revenue is recognized by satisfying performance obligations over a certain period of time, based on forecasts of progress toward completion using machine learning. It also forecasts situations where total construction costs exceed total construction revenue. (The same applies to (3) below).

   • We compared the construction contract amounts, which are incorporated into estimates of total construction revenue, to construction contracts.

   • Regarding additional construction contract amounts incorporated into estimates of total construction revenue, we compared the portion in existing contracts to the relevant construction contracts. We also compared the portion in contracts not in effect to supporting materials, such as construction instructions and quotations submitted to ordering parties. This was done after making inquiries with individuals, such as on-site construction managers, about the details and basis for these amounts, and by inspecting the minutes of discussions with ordering parties.

(3) Evaluation of estimates of total construction costs

We identified construction contracts in which there was either material or qualitative uncertainty

In the current consolidated fiscal year, under the business environment characterized by persistently high construction material prices and further increases in labor costs, certain construction projects experienced an increase in level of profit (loss) on construction compared with initial estimates, reflecting increases in estimated contract considerations and reductions in construction costs. Furthermore, for large-scale construction in the domestic building construction segment where a provision for loss on construction contracts had been recorded in previous fiscal years, the balance of the provision for loss on construction contracts at the end of the current consolidated fiscal year declined compared to the end of the previous consolidated fiscal year, as a result of progress in construction and improvements in construction profit.

Based on the above, we have determined that estimates of total construction revenue and total construction costs, as they relate to the application of the method to recognize revenue by satisfying performance obligations over a certain period, are particularly significant for the current consolidated fiscal year. Accordingly, we consider this a key audit matter.

over the estimate of total construction costs in light of factors such as construction contract amount, profit (loss) on construction, construction details, and the status of construction, and performed the following procedures.

・We compared estimates of total construction costs to operating budgets, which serve as the basis for these estimates. We assessed whether the details of the estimated costs were consistent with construction deliverables, whether the estimated costs were calculated by aggregating amounts by type of construction, and whether the operating budgets included significant cost reduction initiatives.

・We compared the most recent estimates of total construction costs for each quarter with the corresponding estimates from the preceding quarter. We evaluated whether the details of significant quarter-to-quarter changes were reflected in these estimates in a timely manner by inquiring with on-site construction managers about these changes and reconciling them with revised supporting materials prepared by on-site construction personnel.

・We inspected operating budgets and compared the estimated costs for each type of work to the underlying materials, such as quotations, from which costs are accumulated to serve as the basis for these estimated costs. We also compared the actual costs incurred relative to the estimated costs for each type of work and determined whether actual costs exceeded estimated costs while also assessing consistency with construction progress. To evaluate the feasibility of the significant cost reduction initiatives included in the operating budgets, we assessed the consistency of these initiatives with construction progress by discussing scenarios for their implementation with on-site construction managers.

・We performed on-site observations for a portion of construction projects to determine whether the status of construction progress was consistent with the progress reported by the

construction departments or on-site construction managers, as well as with the