In our last article we addressed the new Revenue Recognition standard effective for reporting periods beginning after December 15, 2017 for public companies and reporting periods beginning after December 15, 2018 for private companies. We discussed the 5-step process for implementing the new standard, find that article here. In this article we’re outlining 7 areas construction contractors need to keep in mind when preparing to implement the new revenue recognition standard.
Implementation – Entities have two options for implementation. They can choose between a full retrospective method which would include a full restatement of all years presented in the financial statements, or a modified retrospective method which would include only a cumulative adjustment to beginning equity in the year of adoption.
Financial Statement Disclosures – Changes to financial statement disclosures as a result of the implementation may be significant. Additional disclosures may be required detailing an entity’s performance obligations, how the performance obligations are satisfied, judgements made in applying the new standard to contracts with customers, methods used to allocate a contract’s transaction price, etc.
Agreements – If your Company has any agreements such as loan, compensation, etc. with covenants or metrics tied to revenue, changes may be necessary to the language and/or terms in these agreements.
Uninstalled and Wasted Materials – Accounting treatment of uninstalled or wasted materials:
- Wasted materials, labor, or other resources are considered costs incurred that do not contribute to a contractor’s progress in satisfying the performance obligation and should be excluded from the calculation of revenue.
- Uninstalled materials are considered cost incurred that are not proportionate to the contractor’s progress in satisfying the performance obligation, therefore: revenue should only be recognized only equial to costs incurred for uninstalled materials.
Incremental Contract and Contract Fulfillment Costs-
- Incremental contract costs incurred to obtain a contract are costs that would not have been incurred had the contract not been obtained and should be recognized as an asset and amortized to contract costs over the performance of the contract, as long as recovery of the costs is expected and the recovery period is more than one year. Examples of these costs include sales commissions, costs incurred during design phase, etc.
- Costs incurred in fulfilling the contract are 1) costs directly related to the contract, 2) costs that enhance/generate contractor’s resources in satisfying the performance obligations, and 3) the costs are expected to be recovered. These costs should also be recognized as an asset and amortized over the performance of the contract, as long as the recovery period is greater than one year, on a systematic basis consistent with the transfer of control of the performance obligation(s). In most cases it is believed that this amortization will be on a straight-line basis. Examples of fulfillment costs are bond and insurance premiums, set-up costs, and mobilization costs.
- The capitalization and amortization of mobilization and other fulfillment costs over the duration of the contract may affect the timing of revenue recognition and in turn affect any financial performance metrics/covenants which are based upon revenues.
Bad Debts – Recognition of bad debts is not changed under ASC 606. Bad debts would continue to be recorded as an operating expense. ASC 606 does include a collectability threshold in the step of determining the transaction price, but since in most cases, it is probable that customers will pay the amounts due in full at the time revenue is recognized, sufficient basis to record revenues net of bad debts doesn’t exist. An allowance for doubt may still be necessary to address amounts deemed uncollectible after the revenue recognition and billing step is completed.
Retainage Receivables – Retainage receivables are generally used as a protection by the customer in the event a contractor should fail to satisfy its performance obligations and usually require additional time and performance to be able to collect them. Under the new standards, retainages would not be considered receivables which are defined as “unconditional rights to consideration” and only require the passage of time in order to be collected. Retainages will instead be classified as “Contract assets”.
Implementation can present some unique challenges that differ from one entity to another. No two entities or contracts are the same and, therefore; implementation will require a significant amount of time to review each contract and document the process described above. It will require management to invest time documenting the interpretation of terms and language in each contract.
Suttle & Stalnaker is always available to help you and your team create an implementation plan and work through the challenging details of this new standard. Please give us a call to discuss how this new standard will apply to you and how we can help you with a successful implementation.