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Changing Revenue Recognition for Construction Companies

by Ryan Everhart, CPA

The construction industry has long been held to a different standard of accounting for revenue. This is because of the nature of long-term contracts. For years, bankers and accountants have lobbied construction contractors' behalf for exemptions from traditional GAAP for revenue recognition.

However, the Financial Accounting Standards Board (FASB)'s revenue recognition standard originally issued in May 2014 has changed things. It has essentially swept away all pre-existing GAAP in the area of revenue recognition. This includes the separate principles specific to contractors' accounting.

The new GAAP standards are more in line with international accounting standards than before, and they'll be applied similarly across other industries.

That said, changes for contractors may not be uniformly large. In most cases, the traditional percentage of completion method will still be available. Also, you may continue to account for revenue on a contract-by-contract basis.

How Do the New Standards Affect Construction Contractors?

The industry was successful in retaining the principles found in the traditional percentage of completion method. In most cases, you will still be able to account for contracting on a contract-by-contract basis using a cost-to-cost methodology.

However, the new revenue recognition standard will be driven by “performance obligations” rather than by contracts. This will be the critical driver of revenue recognition. Contracts may range from satisfying one to several performance obligations.

A performance obligation is a promise to provide a unique good or service. Often, a contract contains only one performance obligation. In that case, you will be able to continue accounting for the contract as a single item in the revenue calculation.

Under the new standard, companies will:

  • identify performance obligations.
  • determine the consideration (payment) receivable for each performance obligation.
  • recognize the consideration into which revenue as performance obligations are satisfied.

Will I Need to Change My Contracts into Multiple Performance Obligations?

You will be able to combine related obligations under the new revenue recognition rules. For example, if a company had a single contract to build both a structure and the associated parking lot, they would not be two separate performance obligations.

However, what if said company had a single contract to construct buildings at two different addresses? Under current standards, revenue recognition for one part of the project would require you to estimate revenue from the total contract.

With the new guidance, the company will likely have separate performance obligations and need to allocate the total consideration in the contract between the two performance obligations. The allocation amount will be a matter of judgment. It depends on the relative standalone value of each performance obligation.

If our example company had multiple performance obligations with varying completion dates, it could be required to account for them separately. It may seem like extra administrative red tape, but it could better represent the actual performance of the contract.

How Will Contingent Consideration (Incentives and Bonuses) Affect Revenue Recognition?

You may be able to recognize revenue from contingent consideration earlier than in the past. You will be able to make a judgment when estimating what amount of it to include in the consideration for the contract. This is according to your best estimate and change orders will be treated in a similar manner. You will provide your best estimate of the consideration to be received from unsigned change orders and include them in the total contract price.

Can Contractors Continue to Apply the Percentage of Completion Revenue Recognition Method?

In most situations, yes. Customers often receive and consume benefits of company performance over time. Said performance can create or enhance a customer-controlled asset, and you would measure progress over time using whichever method best depicts the transfer of goods and services, e.g. cost-to-cost input methods, etc.

It should be noted that certain costs will be recorded differently. Waste and rework costs that do not end up satisfying performance obligation will be expense as incurred. Upfront job costs and contract fulfillment costs incurred before the start of a contract will be deferred and amortized over the duration of the contract (i.e. sales commissions paid for winning a contract, up front bonding and insurance, preconstruction costs).

There are also new guidelines for accounting for significant uninstalled materials. Companies will be allowed to recognize revenue equal to the cost of the uninstalled materials. These costs should then be excluded from the percent completion calculation for the remainder for the contract. (Note: expect industry-specific guidance in the near future that may allow for uninstalled materials to be subsequently added back to the percent completion calculation as the materials are used under certain circumstances).

When Will the Changes Take Effect?

Nonpublic organizations should apply the new revenue standard to:

  • annual reporting periods beginning after December 15, 2018, and
  • interim reporting periods within annual reporting periods beginning after December 15, 2019. A nonpublic organization is not required to apply the new revenue standard in interim periods within the year of adoption.

What Steps Should I Be Taking Right Now?

It would benefit your company to review your contracts and have discussions with your bank, accountants, and surety and bonding companies. Some additional recommendations are to:

  • evaluate your current contracts. Would it make sense to separate some of them now?
  • evaluate the current costs that are being incurred into your contracts for possible accounting changes after application.
  • start comparing current contracts against new ones to determine their complexity. How many performance obligations are there? Incentives? Any add-on services?
  • investigate how your contracts impact your executive and incentive compensation programs. How might the potential separation of contracts affect them?
  • think about tax issues you might have down the road stemming from changes in revenue recognition timing.
  • talk to your bank and accountant about future reporting requirements including lines of credit, executive compensation, bank covenants, and how reported revenue will change under new GAAP.

Do you have any further questions about the revenue recognition standard? Contact Ryan Everhart, CPA, Director today at 651-255-9312 or reverhart@redpathcpas.com.

Contact Ryan Everhart, CPA, Director at Redpath and Company

Ryan Everhart, CPA

Ryan Everhart, CPA

Ryan Everhart is a director in the commercial audit service area of Redpath and Company. He works with a variety of clients in industries such as manufacturing, distribution, property development, and construction. He is an active member of the Construction, Real Estate, and Engineering Practice Team. He has provided public accounting services since 2005 and has been at Redpath and Company since 2014.