Impact to Construction and Real Estate Entities from Recent Revenue Recognition
Posted on 08.21.14
In May 2014, The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) approved the long anticipated new revenue recognition standard; ASU 2014-09, Revenue from Contracts with Customers. The new standard will affect almost all entities to some extent. However, for construction entities, this new revenue recognition standard will replace construction contract literature and substantially all the existing construction revenue recognition guidance currently in practice; including percentage-of-completion method as a stand-alone method.
The standard excludes certain contracts from its provisions that are considered unique and therefore have separate and specific guidance:
- Lease contracts within the scope of FASB ASC 840 on leases;
- Insurance contracts within the scope of FASB ASC 944 on insurance;
- Financial instruments and other contractual rights or obligations (various ASCs);
- Guarantees (except for product and service warrantees) within scope of FASB ASC 460 on guarantees;
- Nonmonetary exchanges between entities in the same line of business to facilitate sales to existing or potential customers.
The new standard provides a five-step process to determine revenue recognition:
- Step 1: Identify the contract(s) with a customer
- Step 2: Identify the contract's performance obligations
- Step 3: Determine the transaction price
- Step 4: Allocate the transaction price to the contract's performance obligations
- Step 5: Recognize revenue when (or as) a performance obligation is satisfied by the entity
The new standard will require enhanced qualitative and quantitative disclosure information relating to:
- Contracts with customers-including revenue and impairments recognized, disaggregation of revenue, and information about contract balances and performance obligations (including the transaction price allocated to the remaining performance obligations);
- Significant judgments and changes in judgments-determining the timing of satisfaction of performance obligations (over time or at a point in time), and determining the transaction price and amounts allocated to performance obligations;
- Assets recognized from the costs to obtain or fulfill a contract
Companies should consider the impact the new standard will have on current business operations, contract negotiations, debt covenants, and bonding requirements and capacity.
The new standard becomes effective for public companies for annual reporting periods beginning after December 15, 2016; for private companies for annual reporting periods beginning after December 15, 2017, however, privates companies can elect early adoption of the new standard as early as December 15, 2016.
Companies can apply the final standard using one of two methods:
- Retrospectively to each prior period presented;
- Retrospectively with the cumulative effect of initially applying the new standard recognized at the date of the initial application. If a company elects this method, it is required to provide additional disclosures in the reporting period of initial application.
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