Revenue Recognition Issue 8 – Special Focus: Construction
As the new standards are being rolled out, the construction industry needs to address these standards as well as the unique accounting issues that the construction contractor faces with preparing their annual financial statements.
There are several unique items in construction accounting that need to be broken down by the 5-Step Model as outlined by the new standards.
Step 1: Identify the Contract. This is relatively easy as construction contractors normally have written contracts for their work. Items they will need to be aware of and consider when implementing the new standards include:
- When construction contractors can combine a group of contracts under the new standards. The guidance sets forth the specific conditions as to when contracts are required to be combined and thus analysis needs to be documented by the contractor when implementing these standards.
- The contractor will need to determine proper revenue recognition for contract modifications such as change orders. This will include a determination as to whether these are new separate contracts or a change only to the existing contract and, if so, how to recognize revenue associated with the contract.
- The contractor will need to analyze its lines of businesses and revenue streams to determine whether revenue should be recognized at a point in time or over a period of time.
Step 2: Identify Performance Obligations in the Contract. It is expected most contracts will most likely only have a single performance obligation but such items as warranties, master service contracts, maintenance agreements or change orders can possibly create multiple performance obligations in the contract. The contractor will need to establish internal control procedures to determine whether there are multiple performance obligations.
Step 3: Determine Transaction Price. When determining the transaction price, the contractor has to determine if there is any variable consideration that needs to be included in the transaction price including:
- Claims or pending change orders
- Unprocessed change orders
- Incentive or penalty provisions
- Price concessions
- Liquidating damages
- Unit price contracts with variable units
The contractor will need to assess these items and determine if the variable consideration should be included in the transaction price. The measurement is whether it is “probable” that including the variable consideration has a 70-80% likelihood of not being reversed in a future period. If it is probable that the reversal will not occur than the variable consideration will be part of the transaction price. There are specific methods under the standards to estimate the variable consideration to be included in the transaction price. Again, internal control procedures will need to be in place to ensure variable consideration is being addressed under the standards.
Step 4: Allocate Transaction Price to Performance Obligations. This will require determining if there is standalone pricing for each performance obligation or if not, there are other methods that can be utilized under the standards such as the adjusted market assessment approach, expected cost plus margin or residual which can be used.
Step 5: Recognition of Revenue as Performance Obligations are Satisfied. This will include selecting a method based on inputs (such as costs incurred, labor hours, resources consumed) or outputs (such as milestones, units delivered, time elapsed, survey). It is expected most contractors will continue to use cost to cost as a preferred method. In the utilization of the cost to cost method, the new standards address how certain costs are treated; those costs include uninstalled materials, fulfillment costs, wasted materials or labor and mobilization costs. Internal control procedures will need to be implemented around identifying these types of costs, documenting their treatment for Revenue Recognition purposes, and educating accounting and non-accounting personnel in identifying and reporting these costs types in the job cost system.
Please contact your BMF Advisor for additional information regarding the new standards.
Tax Accounting Method Considerations
The impact of this change hits more than just the financial statements – significant tax changes could also lie ahead. The new standard presents a unique opportunity for companies to revisit their tax methods for revenue recognition. Not only do they need to ensure compliance with the tax rules, but they can also take advantage of tax opportunities and planning around revenue recognition. Companies will need to determine whether the new book methods will be permissible for tax purposes.
In instances where the new methods are permissible, the company could file a Form 3115 to implement the new methods on its tax return. If the new methods are not permissible or if the company chooses to continue using their current tax methods, the new financial accounting changes could affect or create new book-tax differences and deferred taxes related to revenue recognition. Companies will need to consider the information needed to compute these book-tax differences, and whether the information will be available after the changes for financial statement purposes.
It is important to plan ahead to make sure that tax considerations are considered upfront and not an afterthought. Companies should thoroughly assess all their revenue streams and the proper tax methods for each to plan the appropriate actions for successful implementation.
Dale A. Ruther?>
CPA, CIT, CDS, CCIFP
Joseph W. Blaha?>
About the Authors
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