New Revenue Recognition Standards Apply to Construction Companies
The way that all companies recognize revenue will soon change and it is time for businesses—including construction companies—to start planning to be in compliance with the new guidelines. For privately held companies, the new revenue recognition standard is effective for the calendar year ending Dec. 31, 2019; the standard’s effective date for publicly traded companies is Jan. 1, 2018.
There are several changes that will affect construction contractors and the way they recognize revenue:
- Identify the performance obligations in the contract: A key factor for construction companies is to determine if there is more than one performance obligation in each contract. The key is to determine if the promised goods or services are distinct, a distinct good or service being one that is separately identifiable and from which the customer can derive benefit on its own or with other readily available resources. An example of a potential performance obligation is the design component of a design build contract.
- As you determine the transaction price, you will need to determine whether your contract contains any variable consideration. Variable consideration examples for the construction industry can include unapproved change orders, claims and early completion bonuses. You will have to analyze the probability of a significant reversal in revenue as you analyze variable consideration to arrive at the transaction price.
- Once you arrive at your transaction price, you will allocate the price to all performance obligations.
- You will recognize revenue as each performance obligation is satisfied. The general expectation is that most performance obligations in construction contracts will be satisfied over time. This measure of progress towards completion of each performance obligation would often be calculated using either an input or output method. Input methods include cost-to-cost percentage of completion. This is the method to which most accountants are accustomed. One of the differences under this method is that it will now be applied at the performance obligation level.
- A key consideration is that the input method requires that inefficiencies are excluded from the calculation. In addition, uninstalled materials may have to be excluded from the input method with revenue recognized equal to the cost of the uninstalled materials. Profit will be recognized as other costs are incurred.
- Contract losses will still be recognized as they become known. The measurement of a loss on a contract, however, can now be determined at either the performance obligation level or the contract level.
These new standards will require more coordination between the accounting department and operations. There will be more judgment required to analyze the accounting for each contract. It is important to begin putting procedures into place to address this new standard soon.