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Earlier this month the Financial Accounting Standards Board (FASB) voted to delay the implementation of new revenue recognition rules for one year. The delay provides an opportunity for California construction companies and contractors to become familiar with the changes and how they will impact their business. Since the changes proved far too comprehensive for most to implement before the deadline, the delay was implemented. The new compliance deadline is December 15th, 2018 for privately-held companies. Although this may not seem significant, several of the mandated changes will impact the accounting practices of companies. To help clients, prospects and others understand how the revenue recognition changes will impact them, JLK Rosenberger has provided a summary below.
One of the key reasons for the change to revenue recognition standards is that companies in different industries had different accounting practices. In other words, there was no conformity. This was a major concern for rule setting agencies. To ensure that all companies are using the same set of standards to report revenue, FASB has clearly stated its approach. It has stated that entities should recognize revenue “to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” To help companies apply this principle, they have outlined a five step process for recognition:
- Identify the contract(s) with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue when (or as) the reporting organization satisfies a performance obligation.
Impact on Construction/Contractors
To most business owners the information above may seem like a foreign language. After all, how will this really impact my business? The truth is that there will be a practical impact on current practices for everyone in the construction industry. Below is just a sample of the impact:
- Change Orders – Using the 5 step process it is possible that a change order may represent a new contract with a customer. The key for determining whether a new contract has been created is whether or not it is distinct from the original contract. For example, if the contract is distinct and has its own price then it’s treated as a new contract and accounted for as such. If a change order uses goods and services, not distinct from the existing contract, then no new contract accounting obligation exists. The rules governing change orders are quite complex but generally speaking these examples allude to the classification process.
- Uninstalled Materials – Under the new guidance, contractors will be able to (in most cases) recognize revenue equal to the cost of the uninstalled materials assuming the customer has taken control. Remember, there are criteria that need to be met for these materials to be recognized as revenue. Determination is based on contract and circumstance specifics.
- Transition Process – Contractors will not be required to recalculate all existing contracts under the new regulations when implemented. To make compliance easier, FASB will allow companies to either restate prior periods on the financial statement or account for contracts in progress and any new contracts that may arise going forward.
The good news is that a one year delay has been granted providing more time to plan and modify systems and processes. Many of the additions and changes are quite complex and will require the assistance of a professional familiar with FASB regulations. For additional information, please contact us at (818) 334-8623, or click here to contact us. We look forward to speaking with you soon.