‘Revenue Recognition’ Changes Construction Financial Statements
Accounting for Revenues and Costs for Each Phase of a Contract
Like most other industries, the construction industry is in the midst of a transition to a new standard of accounting that will make financial statements look very different. Users of financial statements – most often banks and sureties – will now see certain information presented in footnotes rather than the face of the financial statements, and certain contracts that formerly would have been presented as single c jobs now will be presented as separate “performance obligations.” Likewise multiple contracts could be required to be combined and presented as a single performance obligation
Implementation of this new standard of accounting, known as “revenue recognition,” was delayed several times, most recently due to the COVID-19 pandemic. But implementation started for public entities last year, and some private entities have already begun the transition, as well.
Accounting Standards Update (ASC 606), “Revenue from Contracts with Customers,” was issued by the Financial Accounting Standards Board. It is intended to bring uniformity to the methods and timing of reporting revenue derived from customer contracts across professions and industries that previously varied from one industry to another, and sometimes within the same industry.
The core principle of the new standard is that a business should recognize revenue related to the “transfer” of promised goods or services in an amount that reflects the price the business expects to be paid. To achieve that core principle, a business should apply these steps:
- Identify the contract(s) with a customer
- Identify each distinct performance obligation in the contract
- Determine the transaction price
- Allocate the transaction price to the distinct performance obligations in the contract
- Recognize revenue on satisfaction of performance obligations (transfer)
Impact on Construction
In the construction industry, implementation of revenue recognition creates significant changes in the appearance of financial statements, including:
- Transaction prices now are broken down and presented at the performance obligation level. That means a $5 million contract may appear on a financial statement as three smaller performance obligations, with the information aligned to the performance obligations called for in the contract. New guidance related to the accounting standard allows for quicker recording of future revenues in the form of change orders or bonuses for early completion or liquidating damages.
- Job schedules can be more cumbersome because you must present information at the performance obligation level rather than the full contract level. Again, that $5 million contract may be broken out into performance obligation.
- Over/under billings, which used to be presented in the body of the financial statements, will now be presented in footnotes and other supplementary schedules. The contract asset or contract liability related to the over/under billings will appear in the body of the financial statement. So, financial statement users will have to use the footnotes to reconcile all contract assets and liabilities.
As an exclusive member firm of CICPAC, a national association of CPA firms who demonstrate proficiency in and provide high quality services to the construction industry, Adams Brown has worked closely with construction industry professionals to analyze this new standard. We have multiple accounting specialists and guides to help implement this new standard.
If you would like to discuss how to implement sound revenue recognition accounting processes in your construction company, contact your Adams Brown advisor or the head of our construction services team, Mark P. Barnett, Jr.