New Revenue Recognition Impact on the Construction Industry
What impact will the New Revenue Recognition Accounting standards have on the Construction Industry? The impact of Revenue from contracts with customers (ASC 606) affects virtually all entities who enter into contracts with customers, whether public, private or not-for-profits. ASC 606 will completely replace all revenue guidance under US Generally Accepted Accounting Principles, including the existing guidance for construction-type contracts under SOP 81-1.
This far-reaching revenue recognition framework will impact a construction company’s accounting systems and processes, financial reporting and documentation functions, operating software systems, internal controls, and financial ratios. Construction companies will need to exercise subjective, yet consistent judgement when reviewing and accounting for revenue from contracts with customers under ASC 606.
ALERT: Private construction companies will need to comply with ASC 606 for financial reporting periods beginning after December 15, 2018.
One might say, “Well is this really going to impact my company? I am a small contractor, my costs are my costs, and my revenue recognized is not going to change.” There may be some truth to that comment. However, until the construction company’s management walk a representative sample of its contracts through the new ASC 606 guidance, they cannot be sure of that belief. This assessment is imperative because the accounting can vary significantly depending on the conclusions drawn. Once the assessment is completed, it is possible that the application of ASC 606 may only yield a few adjustments, both at the transition stage and the ongoing application of ASC 606. Nonetheless, the application of the new standard will indeed require more robust financial statement footnotes for revenue recognition.
While ASC 606 retains the current percentage-of-completion method of recognizing revenue on long-term construction-type contracts, there are refinements to the costing inputs that may require a planned and extended effort on the part of the contractor’s management teams. This particularly includes enhanced communication amongst the accounting, project management, and estimating departments. For example, companies now need to identify specific job costs associated with mobilization activities such as costs to move personnel, equipment and materials to the project site in order to account for separately and capitalize in accordance with ASC 606 rather than accelerate costs-to-date entirely upfront. If they haven’t already done so, contractors need to begin identifying the impact to their financial statements, financial performance metrics, financing, and tax planning.
So if I haven’t caught your attention yet, please consider the following advice at a minimum. A construction company should be reviewing at least some of the various ASC 606 articles, summaries and practice aides available and commence ASC 606 planning well ahead of the upcoming year-end. One might ask why? Well, say for example, if a company has a reporting cycle that ends on December 31, 2019 and issues comparative financial statements, then the company will need to choose one of the two available transition methods each having qualitative and quantitative considerations that take careful analysis, a collaborative effort by management and enhanced internal documentation to implement. For these reasons, construction associations across the country are doing everything they can to educate and alert their most valuable members on the urgency to assemble an internal revenue recognition task force, digest the new ASC 606 standard, review all their existing in-place contracts, apply the new five-step process for revenue recognition, determine the transition method they wish to use to adopt the new standard, and communicate with their trusted advisors on any anticipated effects to their company.
Five-Step Recognition Process
The fundamental principle of the new five-step recognition process is to recognize revenue such that it depicts the consideration which the company expects to be entitled to in exchange for the transfer of promised goods or services to its customers. The key to this five-step process is that the steps are to be achieved consecutively, or else proceeding to the next step will not be possible. Those steps are illustrated below:
So again, one may say, “This will probably have little to no impact on my financial statements.” However, to further emphasize the importance, I liken the ASC 606 implementation process to that of injuring one’s ankle. Would one rather run to the urgent care center, receive treatment and be told they have a very bad sprain injury versus not seeking care and finding out after weeks of letting it go that they did in fact break their ankle that now requires more extreme measures and pain to correct it?
Many are saying the implementation process will be a good exercise for companies and a sort of renewal process for clarifying terms within existing and upcoming long-term contracts. Starting the implementation process now before the overwhelming year-end close period will prove to be essential for all companies. The early implementation will enable the improving or enhancing of accounting policies and procedures, the development of significant judgements and estimates, the identification of performance obligations, the assessment of the probability of collection, and the analyzing of contract modifications including change orders, time and material tickets, incentives and/or liquidated damages. Furthermore, a proactive implementation process will allow companies to have time to exchange dialogue with their trusted advisors regarding the anticipated effects to their financial statements and related disclosures, financial performance metrics, financing, and tax planning before the year is out.
Ultimately, construction companies will have to make several new significant judgements and apply several new concepts upon adoption of the new revenue recognition standard – ASC 606. They may reach different conclusions about the number of performance obligations or the amount and timing of variable considerations (i.e. performance awards or claims) to include in the transaction price. Even if the accounting impact is minimal, companies are realizing now that the implementation of the new standard takes more time and effort than originally anticipated. Benjamin Franklin said it concisely, “If you fail to plan, you are planning to fail!”
|Ronald F. Martino, Jr., CPA, CCIFP®, Partner
(732) 842 3113