New Revenue Recognition Rules for 2019 Will Create Significant End-of-Year Reporting Challenges for Contractors
Effective for 2019 calendar year-end reporting, private company revenue recognition practices for contracts with customers (FASB ASC Topic 606) under accounting standards generally accepted in the United States (US GAAP) have changed. We have been talking about this change for the past five years hoping that it could be avoided, but the deadline for implementation has now come and there is no way around it. Several new requirements under the new standard could mean a significant amount of effort on the part of contractors to ensure compliance.
The new standard requires a five-step approach to be taken on each and every contract with customers.
- Identify the contract.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations.
- Recognize revenue when (or as) the entity has satisfied a performance obligation.
The most challenging issues for contractors to implement and account for the new standard will include the following matters:
- Determining when to recognize revenue on contracts at a specific point in time vs. over time.
- Determining when combination of multiple contracts into one, or segregation of one contract into multiple performance obligations is appropriate.
- Accounting for variable consideration (such as performance bonuses) and contract modifications (such as change orders).
- Allocation of contract price to multiple performance obligations (design-build-operate-maintain contracts, for example).
- Identification of upfront fulfilment “contract” costs, that must be deferred and amortized over the life of the contract.
- Accounting for purchased materials that are not yet installed.
If you currently have financial statements prepared under generally accepted accounting principles (GAAP), you are likely used to seeing certain specific contract disclosures and financial statement presentation. Under the new revenue recognition standards, there are broad-sweeping modifications to financial statement presentation as well as several new and enhanced disclosures that come along with it. Among the changes to disclosures and reporting are new requirements to describe the company’s accounting policies for compliance with the many complex facets of FASB ASC Topic 606, including how the company identifies and segregates performance obligations, the company’s transaction price allocation methods, when and how revenue is being recognized, and how the company accounts for variable consideration, contract modifications, uninstalled materials and upfront costs and warranties.
Private companies are also required to report revenue disaggregated by timing of revenue recognition. For instance, revenue should be broken down and reported separately for revenue recognized on contracts at completion (point-in-time method) and revenue that has been recognized over time (such as a cost-to-cost method similar to percentage of completion, or straight line recognition models). Further disaggregation of revenue into meaningful categories, such as geographic market, types of customers or product lines/services, is encouraged, but not required.
FASB ASC Topic 606 provides for two optional methods for transitioning from the old accounting method to the new: the full retrospective approach and the modified retrospective (simplified) approach. The full retrospective approach requires an entity to restate all prior periods presented in the financial statements as if the period had originally been accounted for using FASB ASC Topic 606. A cumulative adjustment will be made to necessary balance sheet accounts and the opening balance of retained earnings as January 1 of the earliest year being reported on, and all comparative period information would be restated. The modified retrospective (simplified) approach allows the reporting entity to only apply the new revenue recognition standard to contracts that are in process as of December 31, 2018 and onward. The cumulative adjustment would be reflected in the opening balance sheet at January 2019 through a change to the opening balance of retained earnings. Comparative periods would not need to be restated under this method of adoption. Entities should carefully consider each method of adoption and the impact it could have on its financial position while taking into consideration the concerns of sureties, bankers and other users of the ﬁnancial statements.
Implementation of the new standard will create some serious implementation challenges for contractors on both the internal accounting and external financial reporting fronts. Internal policies and procedures will need be modified to ensure compliance with FASB ASC Topic 606. Further. we strongly recommend meeting now with your CPA, bonding agents and bankers to discuss how the changes to your company’s accounting could impact external decisions that are being made.
Contributing author: Benjamin A. Sumner, CPA, is an audit partner with over nine years of experience providing auditing, accounting and consulting services to a wide variety of privately-held businesses. For more information on the revenue recognition standard and practical ways to make the transition easier, contact Ben at 315-472-9127 or firstname.lastname@example.org. Visit our Revenue Recognition Resource Center for additional guides and articles on the new standard.