BY KATIE KUEHNER-HEBERT
Contractors should prepare for how the Financial Accounting Standards Board’s (FASB) new standard for recognizing revenue might impact them.
The U.S.-based organization joined with the International Accounting Standards Board to create one revenue recognition standard across the globe, says Carl Oliveri, partner, construction practice leader at Grassi & Co., an AGC of New York State LLC and Associated Construction Contractors of New Jersey member.
“As the world has gotten smaller, we’re not dealing with geographical borders as much,” Oliveri says. “The intent was to create transparency and comparability globally among companies of all industries — so investors can more easily compare the revenues of a construction company in the U.S. to a textiles manufacturer in China.”
The new standard takes effect for publicly traded companies on Dec. 15, 2018, and a year later for privately held companies, on Dec. 15, 2019.
According to FASB, the five steps that need to be taken to achieve the core principle of the new standard are identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to each obligation and recognizing revenue when each obligation is satisfied.
Taking these steps could change the nature of how work is bundled for accounting purposes, experts say.
Some contractors have had contracts in which they accounted for two separate jobs, but going forward, they will have to combine those jobs, says Andrea Castle, CPA, partner in audit services at Crowe, a member of multiple AGC chapters.
For example, a company that does both engineering and construction is hired to do engineering work and then a month later wins the contract to do the construction as well, Castle says. Under the new standard, the company will likely combine these services as one overall job.
“The company will still be doing the same overall cost-to-cost calculations; they will just have a different numerator and denominator because the contract value and estimated cost is now bigger,” she says.
There could also be changes to accounting for warranties, says Julian Xavier, managing principal of CliftonLarsonAllen’s Walnut Creek, California office. CliftonLarsonAllen is a member of multiple AGC chapters. If a contractor is offering a warranty or a customer has an option to purchase a warranty separately on a project, under the new standard the warranty might need to be shown as a separate performance obligation. Currently, warranties are typically blended into one contract, but now a contractor might have to show them under a
The biggest challenge with the new standard is that it’s principle-based, which means that judgment is going to have a tremendous impact on how performance obligations are assessed, and that can leave room for different interpretations, Oliveri says.
“A project with a financial loss can be debated if one party would have taken a more conservative approach to recognizing revenue as compared to what was reported,” he says. “In the surety and credit world, different positions on the same job could have deep financial ramifications.”
Upfront costs, such as design costs, insurance premiums, mobilization and other preconstruction costs, might also have to be accounted differently, Xavier says. If upfront costs are significant, the standard requires these costs to be amortized over the duration of the project, but upfront costs on projects that last less than 12 months don’t have to be amortized.
The rules have also changed regarding when contractors can recognize revenue from change orders, bonuses and liquidated damages under the new term, “variable considerations,” says Jim Davidson, a CliftonLarsonAllen principal in Minneapolis. There are now probabilistic ways that contractors can test when they can fully recognize revenue.
“For example, if a contractor has unsigned change orders and if they have a history with that type of job and a history of successfully negotiating those change orders, under the current standard they cannot recognize the full amount of the additional revenue until the change orders are approved,” Davidson says. “However, under the new standard, if they have a history of getting those change orders approved, they might be able to recognize the revenue fully.”
For new customers, if a project is halfway done, a contractor would have to review the history of change orders within that project to date to determine the likelihood of being paid for future change orders and then account for that, Castle says. The particular merits of a pending change order should also be taken into account.
“If they get an email from the customer agreeing to a change and authorizing to proceed, then they’ve received documentation and they have to record it,” she says. However if the customer verbally says ‘yes’ out in the field but hasn’t talked amounts, the contractor is probably not going to be able to record that.”
Performance bonuses are considered all-or-nothing variable considerations, says Chris Gewain, a partner and CPA at Moss Adams, LLP, a member of multiple AGC chapters. “Contractors need to go throughout their processes and documents they estimate that amount, and then evaluate that against a probability constraint, determining the likelihood that a bonus would occur. If there is a good chance that they will get a bonus, they will need to include that in the variable transaction price.”
All variable considerations should be recorded to the extent that it’s not probable the company would have to reverse that revenue in a future period, Castle says.
UNUSED AND UNINSTALLED
There is also a new accounting method for waste, Oliveri says. Say an electrical contractor installs switch boxes but then finds them to be faulty and replaces them. Under the old accounting method, the faulty boxes would be considered a contractor cost, but under the new guidance, contractors have to consider them as waste and break this out as a separate line item on their contract schedules, which ultimately impacts the P&L.
“That means contractors have to start breaking it out and tracking it, to determine what is an acceptable level of waste,” he says. “Overall it’s pretty simple to create a waste line item for tracking purposes, but the key will be how the project and field teams communicate that information so the company can properly report it.”
Another change with the new standard is accounting for uninstalled materials, Oliveri says. In the past, when materials get delivered to the jobsite, they were considered a cost and contractors recognized the appropriate amount of revenue associated with that cost.
“But under the new guidance, it’s not that quick — it may be classified as inventory if the contractor can control the materials by pulling the materials from one jobsite and sending them to another,” he says. “But if they don’t have control, they can consider it as a cost.”
The new accounting for uninstalled materials is actually an area of discussion within the industry, Davidson says. When materials arrive on jobsites, contractors typically absorb them into the job over time.
“However, if a big chunk of material arrives at the same time, it might be confusing how to recognize the revenue,” he says. “Our profession hasn’t completely resolved how to do that — we might consider delaying revenue recognition.”
Even if contractors aren’t going to be impacted when recognizing revenue, their financial statement footnote disclosures now have to be much more robust and focused on the user of the financial statement, Gewain says. For instance, contractors will now need to transparently document more of the significant judgments utilized in determining the estimation and inclusion of the variable consideration in the ultimate determination of the transaction price.
MANAGING THE DATA
Contractors need to work with various IT platforms to make sure they can accumulate the necessary data to populate these footnotes, as required under the new standard, he says.
“One thing I’m seeing is that a lot of IT platforms don’t have their systems updated for the new standard, so contractors need to manually track this data so it will be there when their external auditors are requiring the information to populate the footnote,” Gewain says.
Contractors will also have to disclose how the company aggregates its revenues into various streams, he says. One contractor might think geography is a pertinent way to aggregate information, while another contractor aggregates by end user. Other ways could be by size of work, whether the work is for commercial or residential projects, or by type of contract, such as fixed-price contracts or time and material contracts.
While there are going to be some changes in the terminology and the disclosures, fundamentally how construction companies account for contracting is not going to be changing dramatically, Davidson says.
“A lot of the key concepts that we think are good are staying the same or are similar enough that construction companies can easily deal with them, he says. “That’s a big deal, because the fear from earlier drafts of the new standard was that things would change dramatically or become overly complicated. But in reality, the changes are sensible.”