By Kyla Hansen, CPA
There’s been a lot of talk about the new revenue recognition standard and the effect it could have on the construction industry. Although the standard, known as Accounting Standards Update (ASU) 2014-09, was first issued by the Financial Accounting Standards Board (FASB) in 2014, it goes into effect for privately held companies—for periods beginning after December 15, 2018, to be exact.
This means that if you are a privately held company with a December 31 year-end, this change will impact your 2019 financial statements. The good news is the percentage of completion isn’t going away! However, there are several nuances that will need to be considered.
Here are five changes you should be aware of:
1 – Combination and segregation of jobs will be based upon performance obligations
- Contracts will now be defined and tracked by performance obligations—i.e., the underlying deliverables. This concept may cause certain contracts that have one shared performance obligation to be combined, even if they were previously considered separate. Additionally, this concept may also cause a contract to be segregated into separate pieces based on the number of performance obligations it includes. Going forward, each contract will need to be closely evaluated to identify performance obligations.
- Change orders will also be impacted by this concept. Some change orders may create a new performance obligation, resulting in an additional job that would have to be tracked separately on the contract schedule, while others may not.
2 – Front-loaded costs will no longer recognize early profit
- Significant costs incurred after a contract is obtained but before goods or services are transferred will need to be capitalized and amortized over the life of the contract. These costs include items such as mobilization and bond costs, and do not include bid, proposal, and selling or marketing expenses. This treatment applies only if all of the following criteria are met:
- The cost directly relates to a specific contract
- The cost generates or enhances resources that will be used in satisfying the performance obligation(s) in the future
- The cost is expected to be recovered (directly or indirectly)
3 – The transaction price might not be the stated value on the contract
When determining a transaction price, the new standards leave room for more judgment regarding the circumstances surrounding a contract and also allow for greater reliance on historical experiences. For example, if the contract is for time and material, the transaction price will represent the amount you anticipate the job to require. In addition, contracts will need to be evaluated if there are various items such as contingent income or damage provisions. The new standards allow for several methods to evaluate the contract value. We expect the most commonly used methods to be the following:
- Most likely value method: Used when there are only two possible values. You select the value that is most likely to occur.
- Expected value method: Used when there is a range of possible amounts; each scenario is weighted based upon the probability of occurrence. This determines the transaction price that you will use on your job schedule as the contract amount.
4 – Anticipate changes to your financial statements
- Your balance sheets will include new items and names.
- Contract assets: This will include costs in excess of billings, unbilled receivables, contract adjustments for variable consideration, and capitalization of costs to fulfill a contract such as mobilization and bonds. As I mentioned previously, these costs will be amortized over the life of the contract.
- Contract liabilities: This will include billings in excess of costs, accrued warranty, refundable consideration, and customer deposits.
- Retained earnings adjustment: If you adopt the new standard ahead of time, you will need to adjust your retained earnings to account for open contracts at the end of 2018 or restate your 2017 amounts in order to comply.
- Additional footnote disclosures: There is a considerable amount of additional footnote disclosures that explain your policies and methods for determining contract prices and related revenue recognition.
5 – Understand the impact on your ratios
In light of the new standard, you may need to discuss modifying metrics used to determine items such as loan covenants or bonding capacity. For example, a lending agent might not give credit for a variable consideration contract asset.
Don’t get caught off guard.
The new revenue recognition standard will go into effect in less than two months, which means now is the time to get ready for the changes I’ve listed here—and the others I haven’t. Don’t forget: Team at JAK can help you pinpoint the ways your business will be affected, so you can prepare with efficiency. If you have questions, please contact our St. Paul office today.