Co-authored by Eric Wurtenberger
After many years and nearly 350 comment letters from the construction industry, the Financial Accounting Standards Board (FASB) issued the new revenue recognition standard on May 28, 2014. The FASB was responsive to many of the concerns raised in the final standard, however, a number of challenges remain. The final standard does provide guidance on items the construction industry was concerned about such as how a performance obligation is defined, clarifying continuous transfer criteria, and no preference for inputs vs. outputs method on measuring progress for revenue recognized over the life of a contract. However, the industry will face new challenges such as accounting for claims and unapproved change orders, estimation of variable consideration, exclusion of inputs that are not reflective of progress such as rework, and definitive guidance on uninstalled materials.
Accounting For Claims
The key to recognizing claims and unapproved change orders is approval by both parties. Many times these changes are made on the go and these changes would be considered approved when the modification creates or changes the enforceable rights and obligations of the parties to the contract. If approved the company may be able to recognize estimated margin on those change orders even if un-priced. Contractors should consider what changes in process are going to be needed in order to obtain “approval” for claims and changes orders so that revenue can be recognized on these items.
In determining the transaction price of the contract variable consideration such as awards, incentives, and liquidated damages need to be looked at and estimated as part of the price based on the expected value or the most likely amount. To recognize these items it has to be probable that a significant revenue reversal will not occur.
Input methods such as labor hours, machine hours, and costs incurred or output methods such as units delivered can be used to measure progress towards completion as well as output methods such as project milestones. If the input method is used items such as owner provided materials, unexpected waste, uninstalled materials need to be excluded if these items do not depict performance in satisfaction of performance obligations.
Other items in the new standard applicable to the construction industry include incremental costs. These are incremental costs to obtain a contract which need to be capitalized if expected to be recovered unless amortization period is one year or less. The recording of losses on contracts is similar to current guidance unless the contract is less than one year in duration where in that case the loss would not be required to be accrued.
The standard covers a variety of other areas that may change practices for contractors including job cost capitalization, minimum standards for a contract in order to recognize revenue, bifurcation of contracts into multiple units of account for multiple distinct services, and extensive financial statement disclosures.
The effective date of the new standard for non-public companies is for annual periods beginning after December 15, 2017.