SEE ALSO >>> Construction
The way construction companies, contractors and others recognize revenue will soon be changing. This is thanks to a new revenue recognition standard recently issued by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). The new single model, Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, provides specific guidance that incorporate key aspects of both domestic and international accounting standards. These changes which were six years in the making outline a new revenue recognition process which will have a significant impact on construction companies.
Making the Determination
The new standard is based on the assumption that entities must recognize revenue in an amount that reflects the consideration they expect to receive as they transfer goods and services to customers. While this does not sound cutting edge, it does result in an important change that must be considered. Once the existing guidance is phased out, companies will be required to rely on professional judgment when assessing the correct amount of revenue to recognize. This will require additional reliance on documentation such as contract terms, conditions and even customary business practices to make the proper determination. This will be something quite new for many companies.
Revenue Recognition Process
To help companies identify when and how much revenue should be recognized in a given period under the new standard, the following process has been identified.
- Identify the customer contract. The ASU defines a contract as “an agreement between two or more parties that creates enforceable rights and obligations.” In certain cases, you should combine contracts and account for them as a single contract.
- Identify the performance obligation in the contract. The new standard defines a performance obligation as “a promise in a contract with a customer to transfer a good or service to a customer.” For this reason it’s important to clearly identify both the obligation and how it will be satisfied. Under the new revenue recognition guidelines this is critical to determining when revenue should be recognized. So be aware you will need to exercise discretion in determining when a performance obligation has been satisfied.
- Assessing the transaction price. The transaction price is “the amount of consideration to which an entity expects to be entitled in exchange for transferring goods or services to a customer, excluding amounts collected on behalf of third parties.” In determining a transaction price, you should consider the effects of variable consideration and constraining estimates of variable consideration, the existence of a significant financing component, noncash consideration, and consideration payable to the customer.
- Allocate the transaction price to the performance obligations. For contracts with more than one performance obligation, you should allocate the transaction price to each obligation in an amount that reflects the corresponding amount of consideration.
- Recognize revenue when obligations are satisfied. Finally, revenue should be recognized when (or as) goods or services are transferred to the customer. This is defined as “when (or as) the customer obtains control of that good or service.” For services transferred, revenue can be recognized over a period of time, but it must be recognized at a specific point in time for goods that are transferred.
Enhanced Disclosure Requirements
Existing regulations require companies to provide very limited information including a description of the company’s revenue-related accounting policies and impact on revenue. However, the new regulations required expanded requirements that arm investors and others with useful information on how revenue is recognized. This includes a cohesive set of disclosures intended to provide insightful information about the company’s contracts with customers. The disclosures should include information about the nature, amount, timing and uncertainty of revenue and cash flow from customer contracts.
The standard will become effective for public companies beginning on or after December 15, 2016. Non-public companies will be required to follow the new regulations on or after December 15, 2017. If privately-held companies want to adopt the recognition standards prior to the 2017 deadline they are able to make such an election. However, publicly held companies are not provided this option.
Take the Next Steps
It’s important to carefully consider how these changes will impact your company. Although there Is some time before mandatory compliance, it’s important to consider this information when assessing new multiple year contracts. For additional information on the new revenue recognition process, please contact Ken Kathcart, CPA, at 949-860-9902, or click here for email.