Resources [ Hot Topic]

The New Revenue Recognition Guidance: Key Points to Consider

 

The New Revenue Recognition Guidance: Key Points to Consider

Over three years have passed since the Financial Accounting Standards Board (FASB) issued its landmark revenue recognition guidance. Despite that time lag, many contractors have not yet started to seriously consider implementation steps. While it is true that accounting for revenue under the percentage of completion method is still permissible for most contracts under the new guidance, there are still factors to consider for every contractor who is required to prepare financial statements under U.S. generally accepted accounting principles (GAAP).

 

What are the key points of which all contractors should be aware?

  • • Implementation dates of the new guidance:
    • o Non-public entities: years beginning after December 15, 2018 (calendar year 2019)
    • o Public entities: years beginning after December 15, 2017 (calendar year 2018)

  • • An agreement does not qualify as a contract (and therefore may not be considered for revenue recognition) unless collection of amounts due from the customer is probable. This is different from current GAAP, which requires that collection must be “reasonably assured.” Collection focuses on a customer’s ability and intent to pay, and if there are changes in circumstances during the life of the contract, the contract will have to be reassessed. Such a reassessment could impact recognition of revenue on future goods and services to be transferred.

  • • The new standard introduces the concept of a “performance obligation,” which is a promise to transfer a good or service that is distinct, or a series of distinct goods and services, to the customer. Going forward, the performance obligation – not the contract – is the unit of measurement for revenue recognition.

  • • Distinct performance obligations require separate revenue recognition. Generally, a construction contract will be one performance obligation, as it involves interrelated goods and services provided by the contractor, and the risk of performing under one obligation is inseparable from the risk of performing under others. Said differently, a contract requires multiple inputs (design, coordination, plumbing, electric, etc.) to get the one output (a newly-constructed or renovated manufacturing facility).

  • • The new standard also introduces the concept of “variable consideration,” which includes claims, penalty or incentive provisions, change orders for which pricing hasn’t been determined, etc. Variable consideration may be included in the transaction price (ie: “contract value,” in today’s terms) if it is probable that a significant reversal will not occur upon resolution of the uncertainty. An entity must elect whether to use the expected value or most likely amount methods in determining the amount of variable consideration to consider in calculating revenue. A general rule of thumb is that “probable” means that the outcome has a 70-80% chance of occurring. Variable consideration will need to be assessed at each reporting period.

  • • Revenue that is recognized as an entity satisfies a performance obligation may be calculated based on output methods (for example, cube yards of pavement laid) or input methods (for example, cost to cost percentage of completion). The method selected must align with the terms of the underlying contract, ie: based on when control, as defined, is transferred to the customer.

  • • There are two transition options for implementation:
    • o Full retrospective method, by which an entity adjusts its prior-year financial statement balances in the year of implementation.
    • o Modified retrospective method, by which the cumulative effect of retrospective application is recorded at initial adoption.

 

The above just highlights the various considerations in implementing the revenue recognition guidance. There are many more factors, and each will need to be assessed for your company’s specific contracts. Please give us a call to discuss how the revenue recognition guidance affects your company.




Blue & Co.,LLC - Read more in our Hot Topic Archive! Click Here. Like what you read? Subscribe to our  newsletter. Click Here.