Engineering and design industries: What you need to know about the new accounting for revenue recognition
Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (‘ASU 2014-09’). Our present industry-specific guidance will be superseded by ASU 2014-09’s broad principles.
Application of these principles will necessitate greater judgment and advance preparation. This far-reaching standard establishes a uniform revenue recognition model for substantially all industries; however, the extent of the industry-by-industry impact will vary dramatically. The following are some frequently asked questions and answers regarding implementation of ASU 2014-09 in the engineering and design industries.
When is ASU 2014-09 effective?
Nonpublic entities are required to apply the new standard for annual reporting periods beginning on or after December 15, 2017, and interim reporting periods within annual reporting periods beginning after December 15, 2018. Nonpublic entities may elect early adoption no earlier than public entities.
Public entities are required to adopt ASU 2014-09 in reporting periods beginning after December 15, 2016, and interim and annual reporting periods thereafter (for example, January 1, 2017 for public entities with a December 31 year-end). Early adoption of ASU 2014-09 is not permitted for public entities.
While there have been no changes to the transition dates since the initial release of this ASU, the FASB is currently researching a deferral, and plans to discuss it in Q2, 2015. Stay tuned for developments.
What are the basic ideas?
ASU 2014-09 establishes the following core principle: recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This replaces the current focus on recognizing revenue when risks and rewards are transferred, with an emphasis on when a change in control occurs.
To apply that core principle, an entity should follow these steps:
| Step 1 | Identify the contract with a customer. |
|---|
- A ‘contract’ does not mean a legal document; it is essentially an agreement between you and your customer that creates enforceable rights and obligations.
Step 2Identify the performance obligations in the contract.
- The contract may contain more than one distinct good or service.
Step 3Determine the transaction price.
- Variable elements will require up-front estimation and careful consideration.
Step 4Allocate the transaction price to the performance obligations in the contract.
- Allocate using the relative ‘standalone selling price’ of each good or service, or an estimate if that is not available.
Step 5Recognize revenue when or as the entity satisfies a performance obligation.
- This may occur at a point in time, or over a period of time.
While none of the above sounds radically different from how we currently account for revenue, applying the steps in certain industries may be challenging and produce different outcomes than current practices.
ASU 2014-09 is a principles-based standard, requiring judgment in its application. Accordingly, at a minimum, all entities will be subject to more disclosure requirements. However, the amount of enhanced disclosures will vary according to industry, and the extent of management’s judgments.
ASU 2014-09 will amend the Accounting Standards Codification by creating a new Topic 606, Revenue from Contracts with Customers. This will replace almost all existing revenue recognition guidance.
How will ASU 2014-09 affect the engineering and design industries?
Based upon information currently available, we believe the impact on the engineering and design industries will ultimately be moderate. Since the engineering and design industries are governed by legal contracts, it is easy to default to the thinking that the changes will be profound, but when contracts are evaluated in terms of the guidance above it is unlikely that revenue will be recognized in a substantially different manner than it is now.
The “cost-to-cost” method of revenue recognition that largely prevails now will generally continue, only under the auspices of new terminology. Much design work, specifically in the fields of civil, municipal and survey, create value to the customer as a function of time incurred, subject to agreed-upon pricing. This will yield revenue recognition that is very parallel, if not identical, to the current methods.
Some engineering and design entities may have revenue streams that contain variable elements, such as incentive payments, awards, or penalties. For example, a $500,000 contract may contain a penalty of $40,000 if the work is not completed before a specified date. The $40,000 penalty is considered variable consideration under ASU 2014-09. The new standard requires variable consideration to be estimated as part of the transaction price (Step 3) as long as it is probable that a significant revenue reversal will not occur (this is referred to as a constraint). ASU 2014-09 provides guidance on how to estimate this. Further, any estimated variable consideration not subject to the constraint will then be evaluated for when to recognize it as revenue (Step 5). Generally, the revenue will be recognized as the related performance obligation is satisfied, subject to the constraint. Returning to our example, the entity will assess, based upon its experience with similar contracts, whether it is probable that the penalty will be incurred (not subject to a significant revenue reversal). ASU 2014-09 discusses factors to consider in this assessment, such as if the entity has a long history of performing this type of work on time,is it within their control to complete the work on time, and will the uncertainty be resolved within a relatively short period of time.
Given the swing from a risks and rewards approach to an emphasis on change in control, it is possible that engineering and design entities may recognize certain variable revenue streams sooner than they are today.
What should we be doing now? Later?
Companies are concerned about how much internal effort, external help, and time they need to address implementation questions. Therefore, we recommend the following:
- Develop a broad understanding of ASU 2014-09 (now)
- Perform a deeper dive. Identify and evaluate those aspects of ASU 2014-09 that will be different for your business along department lines: accounting, finance, technology, legal, tax, financial covenants, or internal controls. Specifically, select a few representative customer contracts or arrangements, and evaluate them using the new revenue recognition model to identify areas for a further analysis. (now)
- Monitor industry-specific transition resources (see below) (now and ongoing).
- Select a transition method, and plan for how you will retrospectively adopt ASU 2014-09. It would be valuable to evaluate each of your business units separately to ensure a full understanding for each of your core services (now).
- Establish an implementation plan, including a timeline, educational sessions, third-party resources needed, and possibly a transition committee to oversee conversion (later).
- Educate financial statement users and stakeholders about the changes ASU 2014-09 will have on your financial statements (later).
What resources are available to help us?
A broad discussion of ASU 2014-09 can be found at:
A resource for understanding and implementing the new revenue recognition guidance:
AICPA Resource Page: Revenue from Contracts with Customers
The text of the new standard may be accessed as follows:
Need More Information?
For more information on the topics discussed, please contact your local Withum advisor:
Paul Gergel, CPA, Partner, Practice Leader
609.520.1188
[email protected]
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The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals.
