Learn about four key accounting impacts for engineering and construction companies in adopting the new revenue recognition standard.
Article 3 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. Part Two in this series covered three other areas of impact: (1) deferred contract costs; (2) contract losses; and (3) uninstalled materials.
Lastly, here in Part Three in the series, we will touch on the four key remaining areas of impact: (1) contract assets and liabilities; (2) claims; (3) completed contract method; and (4) financial statement disclosures.
Contract Assets and Liabilities
First, these new terms are defined as:
- Contract assets – an entity’s right to consideration in exchange for goods or services transferred to a customer when that right is conditioned on something other than the passage of time. NOTE: these assets are different from deferred contract costs, as discussed in Part Two.
- Contract liabilities – an entity’s obligation to transfer goods or services to a customer for which the entity has received consideration (or the amount is due) from the customer.
- Differences begin with under the old guidance of FASB ASC 605, a net obligation was presented on the balance sheet as “billings in excess of costs and estimated earnings”; while a net right was presented as either “accounts receivable” or “costs and estimated earnings in excess of billings”. Under FASB ASC 606, any net obligation is recognized as a contract liability on the balance sheet, and a net right is recognized as either a contract asset or a receivable if the right is unconditional. FASB ASC 606 goes further by concluding the terms “contract asset” and “contract liability” can be substituted for so long as the description allows the reader of the financial statements to distinguish between what is a receivable and what is a contract asset. The guidance states the terms “costs and estimated earnings in excess of billings” and “billings in excess of costs and estimated earnings” may still be used as users of the financial statements should have an understanding of these terms.
- Similarly to ASC 605, the new guidance states that a contract asset and contract liability should never both be recorded for the same contract; rather, these should be combined as a net amount at the contract level. For all contracts in progress at year end, all net contract assets should be combined and presented as a single asset on the balance sheet; and all net contract liabilities should be combined and presented as a single liability on the balance sheet.
- According to the former guidance of FASB ASC 605, revenue from claims made by a contractor against the owner should only be recognized if certain conditions were met. Under FASB ASC 606, the process for recognizing claims revenue has changed and could lead to earlier recognition. The guidance states that claims (along with unapproved change orders) be treated as variable consideration – see Part One in this series.
Completed Contract Method
- One change that could be significant for those contractors for whom this is applicable, is that FASB ASC 606 no longer allows for the completed contract method to be applied. In these instances, a change in accounting method is required.
- The application of FASB ASC 606 is going to require significant consideration and planning, but the required disclosures of the new policy will present an equal challenge for contractors. The new required disclosures will not only cover the nature, amount, and timing of revenue, but also quantitative and qualitative characteristics of contracts, significant judgments made by management, and assets recorded in relation to costs incurred to obtain contract. The good news is that there are some disclosure requirements that are optional for private (nonpublic) entities.
- These industry specific items related to the new revenue recognition standard will require significant planning and consideration to ensure proper implementation and disclosures. For more information, please contact your Keiter representative or a member of Keiter’s Construction Industry Team.
Additional Accounting and Tax Resources for Construction Businesses:
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.