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Accounting Standards Update on Revenue Recognition

Posted 2:34 PM by
In May of this year, the Financial Accounting Standards Board issued an Accounting Standards Update (ASU) on recognition of revenue from contracts with customers. This ASU is the result of a comprehensive overhaul of revenue recognition for all industries. The research and observations of the project were launched in an exposure draft issued in June 2010.This new standard aims to bring consistency between U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards. All industries, many of which have developed their own industry specific revenue recognition guidance over time, such as the percentage of completion method in the construction industry, will follow the guidance contained in this ASU.
This ASU brings a principles-based approach to revenue recognition, and requires an entity to:
  • Identify its contracts with customers,
  • Identify the separate performance obligations in a contract,
  • Determine the transaction price of the contract,
  • Allocate the transaction price to the separate performance obligations, and
  • Recognize revenue when (or as) the entity satisfies the performance obligations.
Also required by this ASU will be more detailed disclosures for readers of your financial statements about your contracts with customers. This will include both qualitative and quantitative information regarding the amount, timing and uncertainty of revenues, as well as a description of the significant judgments used. However, the new footnote requirements will not be as significant for private entities as they will be for public entities.
Some highlights of note for the construction industry include:
  • Performance Obligations – contracts are to be broken out into separate performance obligations.
  • Cost to Cost – this method will be allowed as an input method in recognizing revenue when performance obligations are satisfied over time.
    • As a contractor satisfies a performance obligation over time, the ability to recognize revenue under cost to cost will allow the contractor to continue to account for revenue under a path similar to the percentage of completion method used today, if it is determined that the contract has only one performance obligation.
  • Uninstalled Materials – there will now be certain situations in which an entity may recognize revenue in an amount equal to the cost of uninstalled materials.
  • Incremental Costs to Acquire a Contract – such as employee commissions, may need to be capitalized and amortized as performance obligations are satisfied.
  • Costs to Fulfill a Contract – such as mobilization costs, may need to be capitalized and amortized as performance obligations are satisfied.
  • Penalties – a contractor must estimate the probability of contract penalties when considering transaction price; penalties may lower revenue until they become probable of not occurring.

As construction owners and executives, now is the time to communicate with your business partners and plan for these changes in your financial reporting. Some considerations include:

  • Bank covenants may need to be re-examined,
  • Bonding capacity formulas may need to be discussed,
  • Tax consequences (book/tax differences and revenue apportionment, etc.) should be understood,
  • Information technology and software solutions may need to be enhanced as to their contract management, accounting and reporting modules.
Further, an entity’s management team will also need tailored education on this ASU to create and follow through on an overall implementation plan, covering the items listed above.
The effective date of this standard on U.S. private entities is Jan. 1, 2018, for calendar year entities. However, if comparative statements are to be presented in 2018, the 2017 financial statements would need to be restated to also follow the new guidance. This means that entities may need to be capable of applying the new standards as of Jan, 1, 2017.
While it seems like the effective date is far off, now is the time to think about the impact of the new revenue recognition standard on your business.