Are You Ready for the New Revenue Recognition Standard?

If your company gets revenue from contracts with customers, as construction companies do, you’d better be ready for ASC 606, the new revenue recognition standard issued by the Financial Accounting Standards Board (FASB). That’s because it goes into effect this year for privately held businesses.

The principle of the new standard is that a business should recognize revenue in the amount that it would expect to receive under the contract for the promised goods and services transferred to the customer (performance obligation met) in a given period. This poses special issues for construction companies, because the long-term nature of many construction contracts generally requires use of the percentage of completion (PC) method of accounting to report partial contract revenues and costs over several accounting periods. That can complicate complying with the new revenue recognition standard, because most rules-based revenue guidance is eliminated and new judgments, estimates and disclosures are required.  

What you must do

The issues your construction company may have to deal with stem from the five-step approach the new standard uses to analyze contracts and recognize revenue:

 

  1. Identify the contract. Fortunately, most construction contracts are readily identifiable, in that they are written and contain specific details about deliverables, deadlines and price. But oral contracts, or contracts that allow the construction company leeway on such services as design-build, may need to be clarified with much greater detail to conform to the new standard.

  2. Identify the performance obligation. This refers to a distinct good or service provided under an identifiable contract. But to the extent that a single contract with a single customer contains multiple performance obligations, it may be viewed as multiple contracts. This can impact the accounting for the contract. Also, change orders may constitute separate contracts, each requiring separate accounting and separate tracking of costs and revenues.

  3. Determine the transaction price. Most construction contracts include unambiguous language about the transaction price. However, they also may include performance bonuses, safety bonuses and/or consideration for change orders. If there are any variable elements to the transaction price in a contract, you will need to determine the probability of each part of it being earned or forfeited.

  4. Allocate the transaction price to the distinct performance obligations in the contract. This becomes an issue if there are multiple performance obligations. If so, allocation will be easier if the contract is written with clarity and detail. If a contract has only one clearly identifiable performance obligation, allocation is simple.

  5. Recognize revenue on satisfaction of performance obligations (transfer). Utilizing the PC accounting method, revenue will be recognized in each separate accounting period based on the percentage of the performance obligation that was fulfilled during that period.
  • While cost is often the most reliable measure of contract fulfillment, careful consideration should be given to certain contract costs that are not accurate indicators of fulfillment and should be excluded from the PC measurement. Mobilization, bonding, materials not yet used or installed, and certain other costs required to fulfill the performance obligation do not have value to the customer. Under the new standard, these costs are not immediately included in the PC cost measure. Instead, they are capitalized and recognized as the performance obligation is fulfilled.
  • For certain contracts, non-cost measurements of completion may be more appropriate, such as units produced or milestones achieved. 

 

How you can prepare

Implementing this five-step approach can require more time, effort and people than you might think. In addition, the new standard has more extensive disclosure requirements regarding how decisions about revenue recognition were made. So if you are not already taking steps to implement the new standard, the time to start is now! Here are three things to begin with:

  1. Take inventory of your contracts and analyze them to determine distinct performance obligations, as well as variable price terms.
  2. Evaluate the standard language in your contracts and determine if it should be changed to add greater detail and clarity.
  3. Create new procedures to identify multiple performance obligations before work begins, and to track costs separately for each one.

AT ARB, we would welcome the opportunity to help you comply with the new standard. For more information on revenue recognition, or for help in review of your current contracts and procedures, please call David V. Jean, CPA, CCIFP, CExP at 207-772-1981.