This method uses revenue accruals, such as accounts receivable, and expense accruals, such as accounts payable, to capture transactions regardless of when money changes hands. The coronavirus continues to impact construction companies in unprecedented and unknown long-term ways, particularly when it comes to revenue recognition of existing and future contracts. In fact, any of the 5 steps laid out in the new standard revenue recognition process can be affected by the pandemic and therefore it may be time to reassess your compliance obligations and financial risks. While these 5 steps are similar in some ways to the old revenue recognition methods used by many contractors, there are some important and nuanced differences in how revenue is recognized that must be accounted for. The objective of the new standard is to establish the principles to report useful information to users of financial statements about the nature, timing, and uncertainty of revenue from contracts with customers.
The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. If the consideration promised in a contract includes a variable amount, an entity must estimate the amount of consideration to which it expects to be entitled in exchange for transferring the promised goods or services to a customer. See Deloitte’s Roadmap Revenue Recognition for a more comprehensive discussion of accounting and financial reporting considerations related to the recognition of revenue from contracts with customers under ASC 606. A company can establish milestones throughout the project’s lifetime and assign percentages of completion for each milestone. The percentage of completion method allows the revenue and expenses to be attributed to each stage of completion. However, both parties involved must be reasonably certain that they can complete their obligation of the contract.
Change orders
A unit-price contract is an arrangement in which the client pays a specific price for each unit of output. This arrangement is rarely used in a large, complex construction project where there are few units of output that are easily replicated. For example, a client is unlikely to demand a unit-price contract for each of a cluster of apartment buildings. However, the general contractor may use this type of contract with its subcontractors for selected work arrangements. For example, a general contractor for the construction of a road could enter into a unit-price contract that pays a certain amount per square foot of sidewalk installed. Even with nearly a decade of warnings, revenue recognition has arrived quickly and is now requiring the attention of construction companies.
When should revenue be recognized on each of the contracts?
When the conditions have been met, if payment has not yet been received, then the revenue should be recognized and an account receivable be should be recorded. If payment is received before product is delivered or services provided, then deferred revenue should be recorded.
The new standard requires a contractor to determine, at contract inception, whether it will transfer control of a promised good or service over time or at a point in time—regardless of the length of contract or other factors. It is presumed that control transfers at a point in time if a contractor is unable to demonstrate that control transfers over time. In this series, we have identified the contract, identified the performance obligations, determined the transaction price and allocated the transaction price to the various performance obligations. The final step is to recognize revenue as performance obligations are satisfied, by transferring a promised good or service to a customer. ASC 606 requires additional consideration and documentation related to the transfer of control, including whether the transfer of control occurs over time or at a point in time. Goods purchased for a project but not yet installed or used on the project are called uninstalled materials.
Application to the Construction Industry
Under the new rules, the key takeaway is that construction businesses need to use ASC guidance to identify each performance obligation and the most appropriate way to account for its revenue as it’s delivered. In some sense, construction bookkeeping prevailing wage payroll is like a minimum wage but more complex. First, prevailing wage payroll may include and sometimes requires non-cash compensation called “fringe benefits,” such as health care or continuing education.
Alternatively, when the customer performs by prepaying its promised consideration the entity has a contract liability. A construction contractor will account for a contract modification if the parties to the contract approve a change in the scope and/or price of a contract. The new guidance will impact all entities that enter into contracts with customers to transfer goods or services or nonfinancial assets unless those contracts are within the scope of other non superseded existing US GAAP . Recognizing income as a project progresses makes more sense for long-term contracts and maintains a steady income flow. Most contractors choose to use this method, known as the percentage of completion method. We’ll take a more detailed look at it, including what it is, how it’s used, and mistakes to avoid.
On the Radar: ASC 606
Revenue recognition and retainage practices track with long-term contracts paid over time. The ASU includes new comprehensive disclosure requirements that are expected to provide users of financial statements with detailed information on an entity’s contracts with customers. The enhanced disclosure requirements will provide more information that enables “users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.” The new standard provides factors that could indicate that an estimate of variable consideration is subject to significant reversal.