In December 2021, several members of Keiter’s Real Estate and Construction Niche Team attended the 2021 American Institute of Certified Public Accountants (AICPA) & Chartered Institute of Management Accountants (CIMA) Construction & Real Estate Conference. The annual conference was attended by a wide variety of construction and real estate professionals including CEOs, CFOs, CPAs, controllers, sureties, finance and banking professionals.
A big takeaway from the conference was the general consensus of consistency for ASC 606 reporting for contractors. In 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09 which defined new guidance over revenue recognition that eliminates all transaction and industry-specific accounting principles and replaces them with a unified, five step approach:
- 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; and
- Recognize revenue when (or as) the entity satisfies a performance obligation.
Now that nearly all privately held companies have adopted ASC 606, the industry has reflected on many variations of financial statement presentation and disclosures. Companies generally have flexibility in reporting as long as certain standard-required disclosures are addressed within the financial statements and the accompanying notes to the financial statements. A shift has focused to best practices in reporting to enhance and promote consistency in contractor financial statement reporting.
Tips for Consistency in ASC 606 Reporting
ASC 606 Terminology Changes
Contractors need to be aware of certain terminology changes that may be presented in financial statements that align with ASC 606. The commonly used terms representing underbillings and overbillings, ‘costs and estimated earnings in excess of billings on uncompleted contracts’ and ‘billings in excess of costs and estimated earnings on uncompleted contracts’, respectively, have undergone a recommended terminology transition to align with the new terminology ‘contract assets’ and ‘contract liabilities.’ These specific terminology changes are only recommended but are present in many contractors reporting. Alternative terminology does exist and is accepted.
Terminology alternatives for ‘contract assets’ may include:
- Contracts in progress
- Work in progress
- Revenue earned in excess of amounts received or receivable
- Unbilled revenues
Terminology alternatives for ‘contract liabilities’ may include:
- Contracts in progress
- Work in progress
- Deferred revenue
- Payments received or receivable in excess of revenues earned
These alternatives acknowledge the changes implemented with ASC 606 regarding revenue recognition measured as a function of progress toward satisfaction of the performance obligation(s) included in the contract.
Contract Presentation as Contract Asset or Contract Liability
When analyzing and determining aggregate performance obligations, it is important to consider contracts individually, or at the contract level. Consideration should be given to the presentation of a contract as either a contract asset or a contract liability, not both. This could result in presentation of certain contract assets and contract liabilities net.
Contract Retention Receivables
A new level of scrutiny is now hovering over the presentation of contract retainage. Companies must analyze whether retainage receivables should be classified as contracts (accounts) receivable or as a contract asset or contract liability. According to the AICPA Construction Contractors Audit and Accounting Guide, “when payment of the retainage is contingent upon the Company fulfilling its obligations under the contract it does not meet the criteria to be included in contracts receivable and remains in the contract’s respective contract asset or contract liability, determined on a contract-by-contract basis. Retainage for which the Company has an unconditional right to payment that is only subject to the passage of time are included in contracts receivable.” In other words, unconditional retainage is classified as contracts receivable and conditional retainage is classified as a contract asset (subject to Netting Principle below).
Netting Principle for Contracts
As stated above, industry consensus and FASB interpretation consider netting of certain contracts with contract assets and contract liabilities. Contract assets and contract liabilities are not determined at the performance obligation level, but at the contract level. For example, depending on performance and customer’s payment, this contract-by-contract analysis approach could net a contract asset (i.e., conditional retainage) and a contract liability (i.e., payments received or receivable in excess of revenues earned), if these elements exist on the same contract.
Source: AICPA Audit and Accounting Guides Construction Contractors Appendix C—Sample Auditor’s Report and Illustrative Financial Statements of ACME Contractors, Inc. and Subsidiaries
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.