Engineering and Construction Accounting Considerations for Deferred Contract Costs, Contract Losses, and Uninstalled Materials
Article 2 in a 3 part series
Adopting the new revenue recognition standard, FASB ASC 606 – Revenue from Contracts with Customers, may pose numerous challenges for engineering and construction contractors. Not only is it important to understand the five-step process for determining how and when to recognize revenue, it is also important to be aware of industry specific impacts. Part one in this series, What Construction Contractors Need to Know about FASB ASC 606 – Revenue from Contracts with Customers, briefly touched on its impacts on accounting for combining contracts, contract modifications, and variable consideration. In part two, we take a look at three more areas of impact: (1) deferred contract costs; (2) contract losses; and (3) uninstalled material
Deferred Contract Costs
- These costs are those that an entity incurs to obtain a contract with a customer that would not have been incurred without the presence of a contract and are expected to be recovered.
- The incremental costs of obtaining a contract will generally be recognized on the balance sheet as an asset as long as (1) the costs are directly related to the contract or a specific anticipated contract; (2) the costs generate or enhance resources that will be used to satisfy a performance obligation in the contract; and (3) the costs are expected to be recovered. However, expensing these costs is allowable so long as the amortization period of the contract is one year or less.
- Deferred contract costs should not reduce a contract liability and should be presented separately on the balance sheet. The asset recognized should then be amortized over the period of which the customer obtains control of the asset and analyzed for impairment at the end of each reporting period. Although there is no specific guidance on the amortization method, these costs should be amortized in the same manner the related contract revenue is recognized.
- A contract loss arises if the total estimated costs of obtaining and fulfilling a contract exceed the contract’s transaction price. Guidance on contract losses specifies that the entire loss shall be recognized as soon as the loss becomes evident, determined at the contract level. Therefore, if contracts are combined (see previous article for Combining Contracts) the loss should be treated as a single unit. However, FASB ASC 606 specifies that an accounting policy election can be made to assess the losses at a performance obligation level if this policy is applied consistently to similar contracts.
- The accounting treatment for uninstalled materials under the previous guidance of FASB ASC 605, the costs of materials that are not unique to a specific project, have been purchased or held at the job site, and have not been installed are excluded from costs incurred when calculating percentage of completion.
- FASB has expanded on this in ASC 606, by stating more broadly that calculation inputs should be adjusted to exclude the effect of any inputs (uninstalled materials, etc.) that are not proportionate to the actual progress of the project. If the entity determines that the additional incurred costs of the uninstall materials would overstate the extent of the entity’s measure of performance, then those costs should be excluded from costs incurred and from the transaction price in calculating revenue recognition. Effectively the entity recognizes revenue for the uninstalled materials equal to the costs to procure (i.e. at a zero profit).
As planning for and implementing the new revenue recognition standard continues, these industry specific items are important to consider to ensure GAAP compliance. For more information on all of the significant changes to the revenue recognition process, please contact your Keiter representative or a member of Keiter’s Construction Industry Team | Email | Call: 804.747.0000
Additional Accounting and Tax Resources:
- GAAP Accounting Concerns for Contractors
- Section 199A Proposed Regulations Released
- New Revenue Recognition Standard: Construction Industry Impact
- Construction Blog
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.