Contract Assets and Liabilities: What Contractors Need to Know

Construction industry seeks different approach to treatment of conditional retainage amounts

In the realm of construction accounting, discussion has surfaced, wanting the Private Company Council (PCC) under the Financial Accounting Standards Board (FASB) to delve into a unique challenge related to revenue accounting rules. This particular matter revolves around contracts, featuring conditional retainage receivable provisions, that have been overbilled as a result of percentage of completion calculations. Conditional retainage receivable, a security mechanism widely employed in the construction sector, involves customers withholding a portion of payments due until a project reaches completion or specific milestones are achieved.

Under the current framework outlined in Topic 606, Revenue from Contracts with Customers, new provisions govern the treatment of conditional retainage amounts. These provisions mandate that conditional retainage amounts must either be incorporated into the contract asset or offset against the contract liability on a contract-specific basis. However, stakeholders in the construction industry have voiced their preference for a different approach.

Many users of financial statements in the construction sector find it valuable to see amounts under and over billed presented separately, grossed up to resemble the presentation reported under the previous revenue rules.

The core challenge faced by the construction sector doesn’t revolve around the ability to display overbillings and conditional retainage amounts separately on the balance sheet. Rather, it stems from the restriction that allows only one contract asset or one contract liability per job. This constraint has ignited a discussion about the need for possible exceptions or classifications tailored to the construction industry’s unique needs.

Treatment of contract assets and contract liabilities

The guidance stipulates that a company should not present both a contract asset and a contract liability for the same contract. Instead, these amounts should be combined at the contract level and presented as a net figure.

This accounting principle ensures that the financial statements accurately reflect the financial position of the company in relation to its contracts. By presenting net figures, it provides a more transparent view of the company’s overall contractual position, as opposed to showing individual contract assets and liabilities.

Treatment of retentions

This section of the guidance discusses how to classify retention amounts within contracts. Retentions are amounts held back by a customer as a form of security until the contractor fulfills its obligations. The classification of retention amounts as either receivables or contract assets depends on the specific provisions in the contract.

Contract assets for retentions

If the contract includes restrictive provisions related to retention amounts, such as fulfillment guarantees, then these retentions are classified as contract assets. This means the contractor does not have an unconditional right to the retention amounts until certain conditions are met.

Receivables for retentions

If the contractor’s right to the retention amounts is unconditional (subject only to the passage of time), then the retention amounts are classified as receivables. In this case, the contractor can reasonably expect to receive the withheld amounts without any additional performance obligations.

It’s important to note that the classification of retention amounts is done at the contract level. This means that some contracts may have retention amounts classified as contract assets or contract liabilities, while other contracts have retention amounts classified as receivables, depending on the specific terms of each contract.

These guidelines help companies accurately report and disclose retention amounts in their financial statements, based on the contract terms and conditions that apply to them.

If you need further expansion or have specific questions about these concepts for your construction business, please contact your Keiter Opportunity Advisor or Email | Call: 804.747.0000.