Heraclitus had it right when he said that the only constant in life is change: Back in 2014, the Financial Accounting Standards Board (FASB) released a new standard on revenue recognition to allow for comparison of revenues across industries. This new standard, Accounting Standards Update (ASU) 606, goes into effect for periods after December 2018 for nonpublic companies. (Public companies began compliance in December 2017.)
If you’re not already familiar with ASU 606, this standard replaces the current transaction and industry-based revenue recognition guidance with a principles-based approach, effectively creating comparability across industries and geographies.
Which is a fairly complex way of saying: A lot is going to change.
Get Ready, Get Set…
The construction industry is no exception to these changes, but you’ll feel the impact beyond finance and accounting. Every construction company that reports financial statements under Generally Accepted Accounting Principles (GAAP) needs to integrate the new standards into the accounting function used for their internal controls, systems, and processes. Because all the new terminology and concepts will affect the way you structure contracts, estimate jobs, track costs, and calculate revenue.
The devil, as they say, is in the details.
Update 606: Revenue from Contracts with Customers
One of the biggest changes is when revenue is recognized. Moving forward, companies must recognize revenue when the promised goods and/or services are transferred to customers in the amount of consideration the company expects to be entitled.
That sounds complicated, but fortunately, FASB created a 5-step process to help you comply.
- Identify the contract with a customer. Contracts are nothing new for construction contractors. Whether written or oral, contracts are now required to be identifiable, have commercial substance, and be probable that consideration will be collected. If your contract includes a termination clause that doesn’t carry termination penalties, what you’re calling a contract may now no longer actually be considered a contract.
- Identify the performance obligation. Here’s where it gets interesting, because this step involves some management judgement calls, and interpretation will vary. Performance obligations are distinct goods or services provided by a contract. Additional promises that are different from others will require further analysis, and multiple performance obligations need to be treated as separate contracts, even if they all fall under one contract with your customer.
- Determine the transaction price. Most contracts have a stated and straightforward price set. But if there are any variable considerations (bonuses, liquidated damages, unapproved change orders, etc.), you’ll need to try to determine the amount to include in the contract when it’s known and likely to occur.
- Allocate the transaction price. This won’t apply if there’s only one performance obligation in the contract. But if you have more, you’ll need to allocate the contract price based on how the contract was bid.
- Recognize the revenue. Even with all those changes, at the end of the day revenue is still recognized using the same cost-to-cost percentage-of-completion method that is consistent with the current GAAP.
Five Things to Do Right Now
Those all sound like some pretty major changes that have the potential to shake up a lot of things. But ASU 606 may not end up being the revenue apocalypse you fear. These changes may end up being just a tiny bump in the road from rules-based GAAP to principles-based.
Either way, the changes bring judgement, subjectivity, and financial reporting risk, all things that management needs to be looking at right now. How many of these things are you already doing?
- Read and inventory contracts. Be on the lookout for different performance obligations and variable consideration arrangements.
- Create procedures for tracking costs separately if multiple performance obligations exist and then make sure your accounting system is capable of accomplishing the tracking.
- Has everyone on your staff who deals with contracts been educated on these new standards? If not, you may want to schedule a Lunch & Learn as soon as possible.
- Make sure you have solid procedures for identifying multiple performance obligations before any work begins so that costs can be tracked separately.
- Have any contracts that will overlap into 2019? Start mapping out the difference in revenue recognition now for budgeting and reporting purposes.
Building Your Reports
If you’ve read through thus far and nodded your head “yes” to all our solutions, then congratulations! You’re ready for ASU 606 this December. Otherwise, there’s not a moment to lose, specifically when it comes to ensuring your accounting systems can track and report on multiple performance obligations. Fortunately, that’s an area of specific insightsoftware expertise.
Find out how insightsoftware can completely rebuild your cost and revenue reporting, making it easier than ever to track and submit for ASU 606.