Changes to revenue recognition rules have gained a lot of attention over the past few years.
Regulatory bodies have been looking for a way to bring conformity to how and when companies across multiple industries recognize revenue. Under existing guidelines, companies can apply the rules differently, resulting in a lack of consistency in its application. But that is all about to change with the approval of a new revenue recognition standard (ASC 606) by the Financial Accounting Standards Board (FASB). While companies across all industries will be required to comply with the changes, fewer will be more impacted than construction companies and contractors. Because of the project nature of the construction business and the length of most projects, changing when revenue is recognized can greatly impact a host of areas, including income tax planning. To help clients, prospects and others understand the changes, Hanson & Co. has a provided the key details below.
Key Elements in the New Standard
Below are the highlights of the standard against which all transactions must be assessed as defined by ASC 606.
Identify the Contract with a Customer – Both the company and the customer must approve the contract commitment. There should be an explanation of each party’s rights along with corresponding payment terms. The rules also state that contracts must have commercial substance and collection of payment should be considered probable.
Identify the Performance Obligation in the Contract – The company must promise to provide a good or service (building or other tangible item) or a series of distinct goods and services (ongoing maintenance services).
Determine the Transaction Price – Each party must agree to the amount they are entitled to in exchange for the promise of delivering goods and services to the customer. This will have a specific impact on construction companies when estimating uncertain items and financing terms of the contract, such as prepayments. For this reason, construction contractors must carefully consider contract contingencies.
Allocate the Transaction Price to Performance Obligations in the Contract – The contract price should be allocated to obligations based on the standalone price of each offering. This number is often determined by charging the actual selling price for a product or service or estimating value by taking the adjusted market assessment approach, the expected cost-plus margin approach or the residual approach.
Recognize Revenue when the Entity Satisfies the Performance Obligation – A company should recognize revenue when it meets each performance obligation in the contract by providing the specified good or service to the customer. This occurs when the customer obtains “control” of the good or service. Performance obligations may be satisfied at any one point in time or satisfied over a period of time. This is very similar to the completed contract method and percentage of completion used today.
The new standard must be implemented no later than December 15, 2018 for non-public companies. This leaves a limited time for companies to prepare for transition. If you have questions about ASC 606 or need assistance with a tax, accounting or audit issue, Hanson & Co. can help. For additional information please call us at (303) 388-1010, or click here to contact us. We look forward to speaking with you soon.