Construction companies - and any other business entity affected by revenue recognition rules - must recognize, if they haven’t already, that drastically revised rules now in effect could substantially alter everything they’ve done in the past or will do in the future.
Changes to ASC (Accounting Standards Codification) 606, “Revenue from Contracts with Customers,” were announced in 2014 by the Financial Accounting Standards Board (FASB). Businesses were given years to comply with the sweeping rules changes.
ASC 606 and its accompanying Accounting Standards Update (ASU) 2014-09, are described, among other objectives, as simplifying and clarifying rules on what revenue is recorded, when, how much, to simplify comparisons in revenue reporting, and to remove “inconsistencies and weaknesses,” according to the FASB.
Public companies had a 2018 deadline to adhere to the new standards; private companies must use the new ASC 606 rules beginning in 2019.
For construction companies, the rules create a revenue recognition challenge in that contracts are frequently long term, with items revised or added throughout the agreement’s life. Billing dates and amounts, change orders, deliveries, construction schedule alterations, and more, mean revenue receipts can be…fluid. Revenue recognition under the new rules occurs when control is transferred to the customer, not necessarily at a project’s conclusion.
The process, says FASB, requires several detailed steps for contractors and other businesses:
- Identify the contract(s) with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue when (or as) the entity satisfies a performance obligation.
Each of the five has sub-steps and accompanying sub-guidelines. They delve into detailed accounting actions requiring great attention to detail. For example, Step No. 3, has five sub-steps: variable considerations, constraining estimates of variable considerations, non-cash considerations, and cash payable to the customer.
Construction contractors have unique issues, given that projects can last two weeks or two years, with different revenue recognition rules based on the type of work performed. Contractors must consider how these new guidelines affect revenue recognition timing.
Also, there is a false assumption among some contractors that under the rules, contracts have multiple performance obligations, all of which would affect revenue recognition timing. In reality, most construction contracts will have one performance obligation. In the isolated cases in which contractual multiple performance obligations may exist, contractors must carefully evaluate their contracts along those lines and document their conclusions.
Another erroneous belief in some construction quarters is that percentage completion accounting has been eliminated. While there are changes to the accounting thought process and terminology, revenue is still recognized in terms of the completion percentage and method in use prior to the new rules.
This is serious business. In one revenue recognition case, the Securities and Exchange Commission in 2017 hit Alere, a Massachusetts medical manufacturer with $13.3 million for bribing foreign officials and fraudulently meeting revenue targets through accounting sleight-of-hand.
“The SEC found that the South Korean subsidiary of Alere Inc., which produced and sold diagnostic testing equipment, improperly inflated revenues by prematurely recording sales for products that were still being stored at warehouses or otherwise not yet delivered to the customers or the distributors,” Compliance Week reported in Nov. 2017.
Any company that hasn’t yet recognized the new rules, or acted on them, should do so without delay. If your accounting advisors aren’t fully aware of what it is, and does, find someone who knows. You’re accountable either way. Please, protect yourself and the business you’ve constructed.
Complete information on FASB ASU 2014-09 can be found here.
This article was originally published in the Knoxville News Sentinel.