8 Revenue Recognition Questions for Contractors (article)
At long last, private contractors will be making the change to their new revenue recognition model. The construction sector is uniquely affected by the guidance in ASC Topic 606, Revenue from Contracts with Customers because the new revenue recognition standard supersedes previous industry-specific guidance and will affect nearly every contract with a customer.
To ready themselves for the potential impact on Dec. 31, 2019 financial statements, contractors may want to review the following questions. Considering these unique risk factors can help illustrate your company’s implementation preparedness.
Have I Combined the Appropriate Contracts?
The new revenue recognition standard makes contract combinations mandatory in certain situations. Contractors will combine contracts with the same customer that begin around the same time when:
- The contracts are negotiated as a package with a single commercial objective
- The amount of consideration to be paid in one contract depends on the price or performance of the other contracts
- The goods or services promised are a single performance obligation
Contracts with different customers cannot be combined, even if they are economically linked.
Are Change Order Requests Captured Correctly?
Contractors face new guidance when it comes to change orders. Depending on what the change order includes, it may be accounted for as a separate contract. The key consideration is whether the change order adds additional distinct goods or services at their standalone selling prices.
Have Maintenance Agreements Been Evaluated?
In some circumstances, maintenance contracts and other related, ongoing services will be treated as separate performance obligations from the sale or installation of the asset. Maintenance agreements will need to be evaluated to determine whether they meet the separate performance obligation criteria.
Does the Transaction Price Reflect Any Incentives or Penalties?
Contracts in the construction sector often reflect variable pricing based on the completion of certain milestones. Awards and incentive payments, penalties, change orders, customer furnished materials, claims and liquidated damages, and any other elements entail variable pricing. The timing of when to recognize variable consideration will need to be considered when determining the transaction price and may differ than when recognized under current GAAP.
How Is Retainage Treated?
The unconditional right to receive payment represents receivables under the new guidance and these receivables are to be classified separately from other contract assets. Traditionally, retainage amounts have been classified as receivables and disclosed in the footnotes. Thus, going forward, retainage will be classified as a component of contract assets. Industry disclosures practices are sure to continue.
Have Customer-Controlled Goods Been Correctly Factored Into the Transaction?
Customers may provide contractors with goods to fulfill the contract. If the customer transfers control of the goods it provides to the seller, then the value of those goods must be considered noncash revenue on the fair value of those goods when it comes time to determine the transaction price.
Will My Number of Contracts Change in the New Guidance?
Nine times out of 10, arrangements that met the definition of contracts under legacy GAAP will meet the contract definition in ASC Topic 606. The vast majority of construction contracts are written agreements. However, job orders and MSAs may omit to the scope of work. Instead, the purchase or task provided in the arrangement may be a general description of the type of work that may be performed at agreed-upon pricing for a pre-authorized maximum. In this situation, contractors will not have a contract under ASC Topic 606 until a purchase or tax order is issued.
Have I Appropriately Accounted for Uninstalled Materials?
Contractors may have materials acquired to satisfy the performance obligation to the customer, but the control of the materials does not transfer to the customer. The cost incurred in acquiring those uninstalled materials does not depict the transfer of control to the customer, therefore, any uninstalled materials should be excluded from measuring the progress towards completion of a contract.
For More Information
For a deeper dive into your organization’s preparedness for revenue recognition, please contact us.
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