Understanding the New Revenue Recognition Standard for Construction

This is Part I of a two-part series. In this article we will outline the basic provisions of the new standard. In Part II, we discuss specific changes to how your company should measure job progress to completion.

Construction accounting standards as we have known them are about to undergo crucial change. After nine years in the making, the required implementation of Accounting Standards Codification ASC 606 – Revenue from Contracts with Customers – is right around the corner and becomes mandatory for annual reporting periods beginning after December 15, 2018. For most entities, this means a calendar year beginning January 1, 2019, and ending December 31, 2019.

Construction contractors are very familiar with contracts; however, the new revenue recognition standard will require management to make additional judgments regarding when to recognize revenue associated with contracts.

What are its basic provisions?

The standard creates a five-step model through which companies will analyze each contract.

The definition of a contract with a customer is defined under five criteria, from which the contractor must first determine whether an actual contract exists. For construction contractors, we find nothing new here that would significantly alter your basic understanding of a contract.  However, facets such as termination clauses and whether contracts can be combined or segregated should be looked at more closely.

A good or service is distinct if:

• The customer can benefit from the good or service on its own (or in conjunction with other readily available resources), and
• The good or service is separately identifiable from other obligations included in the contract.

The performance obligation may be specifically stated in the contract or implied based on the company’s historical practices. The determination of the various performance obligations in contracts with customers requires a great deal of analysis and judgment on the part of a contractor.

A significant change included in the new revenue recognition standard is the treatment of variable consideration. Examples of variable consideration within a contract include claims and pending change orders, unpriced change orders, incentive and penalty provisions within the contract, shared savings, price concessions and liquidating damages. Construction contractors need to consider the following steps in calculating the amount of variable consideration in the contract:

1. Identify all variable considerations associated with a given contract or performance obligation.
2. Determine which items, if any, can be grouped together due to similar characteristics for evaluation.
3. Document the amount of the variable consideration using information that your company typically uses during the bid and proposal process as well as information used in establishing prices for promised goods.

The transaction price is allocated to separate performance obligations in proportion to the stand-alone selling price of the promised goods or services. Various methods can be employed when estimating the standalone selling price.

The amount of revenue recognized when transferring the promised good or service to the customer is equal to the amount allocated to the satisfied performance obligation, which may be satisfied at a point in time or over time. Control of the asset refers to the ability to direct the use of and obtain substantially all the remaining benefits from the asset.

The decades-old percentage of completion method on the cost-to-cost basis of recognizing revenue on all your jobs in progress can no longer be assumed to be a proper reflection of your company’s revenue in accordance with GAAP. This new process will require a systematic approach that cannot be effectively performed at the last minute, so discuss with your team at the earliest opportunity.

To make sure you’re ready, the Aldrich Construction team is here to help!

For more details on incorporating the new revenue recognition standard for construction firms, read on in Part II.