BY RYAN INLOW, CPA
MAULDIN & JENKINS
AN AGC GEORGIA MEMBER
Revenue recognition has always represented a challenge for the construction sector. In May 2014, the FASB in partnership with the International Accounting Standards Board released a much-anticipated update to GAAP standards for this complex area. Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), as the guidance is titled, makes sweeping changes to revenue recognition in accounting and related reporting. As a result, contractors can expect their revenue recognition to vary dramatically in amount and timing from current patterns.
In a series of updates since ASU 2014-09 was first issued, FASB has amended the guidance further. Topic 606 can now be considered final (to the degree any GAAP standards are truly final). For affected companies that have not yet adopted the guidance, however, the necessary changes are just beginning.
FASB’s core principle in the updated standard was ensuring that entities “recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” To that end, the guidance creates a five-step process:
- Identify the contract.
- Identify the performance obligations contained in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue as each performance obligation is met or satisfied.
Topic 606 details a great many tests and rules for implementing each of the five steps, too comprehensive for treatment in this article. There are a number of important concepts though that construction professionals should bear in mind as they begin delving into a serious study of the revised regulations.
Despite the detailed nature of the guidance, applying the five-step process it outlines will demand some amount of estimation. In addition, company representatives should be prepared to make reasonable interpretations and judgement calls based on the intent of the standard and the terms of a particular contract.
Whereas older guidance offered contractors a choice between percentage of completion or completed contract accounting methods, the new standard applies specific criteria that govern whether to recognize revenue at a single point or over time. Some methods of measuring relative completion status when recognizing contract revenue over time may render the cost-to-cost method unsuitable.
If the results will be essentially the same, it is acceptable for contractors to apply ASC 606 to a portfolio of contracts rather than individually accounting for each. Companies should be able to provide documentation supporting the assumption that the portfolio method of accounting will not lead to materially different results when electing this option. Estimates and judgments used in applying the portfolio method must be appropriate for the nature and total amount of revenue in the portfolio.
To help users more readily understand the contents of financial statements, contractors are required under ASC 606 to make additional disclosures, both quantitative and qualitative. For many contractors, the new disclosure requirements will necessitate changes to internal systems and processes. Balance sheet presentation of contract assets and liabilities will demand complex analysis as well in order to provide adequate transparency. Company leaders should not underestimate the difficulty and time needed for meeting new disclosure and balance sheet requirements; to remain in compliance, entities must undertake a serious effort now.
Other important considerations:
- ASC 606 does not apply to certain types of contracts that include leases; insurance contracts covered under ASC 944; guarantees other than those tied to product or service warrantees; and some nonfinancial exchanges.
- Some types of obligations and contractual rights are similarly excluded.
- Nonfinancial transfers between contractors and non-customers may in some circumstances merit the same treatment as that described in ASC 606 guidance for customer contracts.
TAKE ACTION NOW
Given the scope of the changes, a sense of urgency in regard to understanding and transitioning to the new regulations is fully warranted. Companies that haven’t yet addressed the issue are likely to discover multiple questions as they begin the process of adapting to ASU 2014-09, some of which may be answered in the FASB’s Topical Reference Guide. However, it is important that all organizations impacted by the updated revenue recognition standards seek qualified professional help in interpreting and applying the regulations.
Ryan Inlow, CPA, specializes in audit and tax services for closely held entities, non-profit organizations and employee benefit plans. Inlow has a wide variety of industry experience with current and former clients in the construction industry. He serves as the partner in charge of the Albany Office, chair of the firm’s Executive Committee, and as the practice leader for the Entrepreneurial Services practice firm-wide. For more information, visit www.mjcpa.com.