New Revenue Recognition Model for Contractors
By Courtney Coker, CPA, Partner
As the majority of contractors apply the percentage-of-completion accounting model for revenue recognition, the question arises on how much of a change the new accounting guidance in FASB ASC 606, Revenue from Contracts with Customers will impact their financial statements and bottom line. While the new guidance supersedes virtually all existing accounting guidance related to revenue recognition, the good news is that the change may not have a material effect for many contractors.
Under this new guidance, contractors should recognize revenue from contracts by applying the following five-step process for annual reporting periods beginning after December 15, 2018:
- Identify the contract with the customer.
- Identify the separate performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the separate performance obligations.
- Recognize revenue when (or as) each performance obligation is satisfied
Just like the percentage of completion revenue model, contractors can still recognize revenue over time. The biggest differentiator is that the contract amount, and related estimated costs, must be tracked at the performance obligation level rather than at the contract level. The new guidance specifies that a good or service is distinct, and should be treated as an individual performance obligation, if both of the following criteria are met:
- The good or service is distinct and the customer can benefit from the item alone, or together with other resources readily available to the customer.
- The contractor’s promise to transfer the good or service is separately identifiable from other promises in the contract.
As an example, contractors who enter into single contracts to provide design, build and construction services for a customer need to consider the nature of the services provided and how they relate to each other to determine whether each service is distinct and represents a separate performance obligation. Additionally, some contractors provide maintenance or extended warranty agreements, which may add an additional performance obligation. FASB ASC 606-10-10-4 however, does provide a practical expedient that allows a group of contracts with similar characteristics to be combined and accounted for as a single contract if the result of applying the revenue guidance to the combined contract would not differ materially from applying the revenue guidance to the contracts individually. Therefore, all contracts should be reviewed to determine whether multiple performance obligations exist.
Another consideration of the new revenue recognition model is determining the transaction price, which may need to be allocated to any distinct performance obligations. The transaction price may be fixed or variable based on contract provisions (lump-sum contracts, cost-plus, etc.) or include variable consideration based on the occurrence (or nonoccurrence) of a future event, such as incentives or bonuses for completing a contract early, or penalties for not completing a contract on time. The amount of variable consideration should be estimated and included in the transaction price, but only to the extent that it is probable that the estimate would not result in the significant reversal of the cumulative revenue recognized for the contract.
If you have any questions or would like guidance on implementation of FASB ASC 606 for your Company, please reach out to your accounting service providers.
Courtney Coker Assurance Partner, CPA
Courtney is a partner in our firm’s assurance area with over 20 years of experience in public accounting. Courtney is responsible for all aspects of the audit, review or compilation engagement, including planning, risk assessment, supervision, and reporting. She specializes in assisting clients with the successful implementation of new accounting standards, practical and cost […]