Are you ready for the new revenue recognition standard?
It’s been eight years since the Financial Accounting Standards Board (FASB) first proposed an overhaul of its revenue recognition standard and four years since it issued the new standard. Now the standard’s effective date is finally approaching — Jan. 1, 2019, for calendar-year nonpublic companies that comply with Generally Accepted Accounting Principles. Is your company ready?
Although some construction businesses will be required to record revenue differently, many will see little change. But regardless of the new standard’s impact on your company’s revenue, implementing it will take some preparation. You may need to modify systems or processes for tracking and reporting revenues and costs, implement new internal controls, and expand your financial statement disclosures. Plus, applying the new standard’s requirements will require you to exercise considerable judgment.
In a nutshell
The new standard establishes a five-step approach to recognizing revenue:
- Identify the contract. (In some cases, two or more related contracts should be combined into one.)
- Identify the performance obligations. (One contract may contain a single performance obligation or several distinct obligations.)
- Determine the transaction price.
- Allocate the price among the performance obligations.
- Recognize revenue when (or as) a performance obligation is satisfied.
Many construction contracts involve a fixed price for a single performance obligation satisfied over the life of the contract. For these contracts, revenue will be recognized in much the same way as it is under current rules, often using an approach that’s similar to the percentage-of-completion method.
But more complex contracts will demand significant judgment to determine, among other things, whether there are multiple performance obligations that should be accounted for separately, whether performance bonuses or other incentives should be included in the transaction price and how to allocate the price among the performance obligations.
Steps to take
To prepare for the new standard, first take inventory. Review your contracts and identify those that have multiple performance obligations. Examples of contracts with distinct obligations that may need to be accounted for separately include a contract to build a road and a bridge, or a contract to construct a building, as well as to supply and install certain equipment. On the other hand, multiple goods and services may be treated as a single performance obligation if your firm “provides a significant service of integrating the
goods and services.”
Next, identify contracts with variable consideration provisions such as performance or safety bonuses (or penalties) and liquidated damages. Variable consideration may also result from unapproved or unpriced change orders. Under current rules, variable consideration generally isn’t recognized until the contingency is resolved (in other words, the performance standards are met) and the amount can be measured reliably. Significantly, the new standard provides a complex set of rules for estimating the amount of variable consideration if it’s likely to be realized and including it in the transaction price.
Review your systems, policies and procedures, too. Be sure that you have controls in place to evaluate contracts and make the right judgment calls. Evaluate your accounting system to ensure that it can accommodate separate tracking and reporting of multiple performance obligations, if necessary. And consider whether contractual or operational
changes are appropriate to reduce the impact of the new standard.
As mentioned, the new standard may not affect your construction company all that much. Or maybe it will. The only way to know for sure is to be prepared. Your CPA can help you review your situation.