Revenue Recognition: Accounting for Uninstalled Materials

11.13.18

One of the significant changes required by the new accounting guidance under ASU 2014‑09, Revenue from Contracts with Customers (Topic 606) relates to accounting for uninstalled materials. Under current accounting practice, the cost of materials specifically produced, fabricated, or constructed for a project, including those that are not yet installed, are to be included in the inputs used to measure the percentage of completion on the project. This will ultimately drive the revenue recognized to date on the contract.  If not specifically produced, fabricated, or constructed for a project (could be installed on another project), the cost of the materials would be capitalized on the balance sheet and reported as inventory until installed.  Under ASU 2014‑09, the cost of uninstalled materials that are not specific to a contract would be accounted for in a similar manner (accounted for as inventory); however, in most cases the amount of the uninstalled materials will also need to be removed from both the transaction price and estimated project costs before applying the cost‑to‑cost input method for recognizing revenue to date on the contract.

For example, a contractor is engaged in a $26 million fixed‑price contract to construct a new bridge that includes the installation of steel beams.  The estimated total cost of the project to the contractor is $20 million, including $4 million for the steel beams.  As of December 31, 2018, the contractor has incurred $8 million in costs, including the $4 million of steel beams, which have been purchased and delivered on‑site but have yet to be installed.  To calculate the revenue the contractor should recognize to date under the new standard, the calculation using the cost‑to‑cost input method would need to be adjusted by subtracting the $4 million for the uninstalled steel beams from the $8 million in total costs incurred to date and from the $20 million in total estimated costs.  Then divide the two to determine progress toward completion, which is 25% ($4 million divided by $16 million). The contractor would also subtract the $4 million for the steel beams from the $26 million contract price before multiplying it by the progress (25%) and then add the $4 million for the steel beams back in, resulting in a current total of $9.5 million in revenue to be recognized ($22 million times 25%, plus $4 million).  Under current accounting practice, if the $4 million for the steel beams was included in the calculation of progress towards satisfaction of the performance obligation, the measurement of progress would have been overestimated and $10.4 million of revenue would have been recognized.  Therefore, the impact of implementing ASU 2014‑09 is a reduction in revenue recognition of $900,000, which represents the potential gross profit on the uninstalled steel beams.  Under ASU 2014‑09, the profit is deferred and will be recognized once the steel beams are installed.

Another category of costs that will need to be addressed under the new standard are customer‑furnished goods, such as materials or equipment.  Under current accounting practice, the value of goods supplied by the customer is added to contract revenues and costs only if the contractor bears the risk of nature, type, characteristics, specification, or ultimate performance of such goods within the overall project incremental costs.  Under ASU 2014‑09, the fair value of goods furnished by customers shall be considered noncash consideration, estimated and included in the transaction price and estimated costs, with no gross profit recognized.  If the contractor controls customer‑contributed equipment or services, the fair value of such noncash consideration should also be estimated and included in the transaction price.

As you can see, the new standard requires the contractor to account for certain costs differently than current practices, which could significantly affect the amount of revenue to be recognized during progress towards satisfaction of the performance obligation.  With lack of software modifications, contractors will have to find alternative strategies to properly account for and present these costs. We recommend you consider reviewing current contract and job costing practices and identify if any of these matters requiring new accounting methods will apply to your business.

For any questions on accounting for uninstalled materials or the new revenue recognition standards, visit our revenue recognition resource center or contact Joseph Chemotti, CPA, CCIFP, Audit Partner with Dannible & McKee, LLP.