Construction Industry Spotlight: FAQs on Revenue Recognition
The last half of 2019 is bound to be a whirlwind for Denver construction companies. In addition to managing the higher-than-average growth that experts are predicting, management will have to address labor shortages and strategize around recently released tax incentives. As management maneuvers around these tax and economic fluctuations, they cannot – and should not – overlook regulatory changes. ASC 606, Revenue from Contracts with Customers, was first introduced back in 2014 but only recently went into effect. Even those who have already adopted the new standard are likely to have a few lingering questions. To help our clients, prospects and others understand a few of these more difficult questions, Hanson & Co has provided a summary of the ones most commonly asked below.
How are maintenance agreements treated under the new standard?
Many construction agreements include a clause that offers the client ongoing maintenance for a certain period. Many managers wonder: should these maintenance agreements be accounted for as an integrated part of the project, or do they signify separate performance obligations?
For most contractors, maintenance agreements should be considered separate performance obligations. If maintenance is separate and distinct from the construction services, and if the two are not highly integrated with one another, they can be accounted for separately. In the event the maintenance will significantly modify the design of the project, the maintenance agreement should be lumped in with the construction portion of the contract.
How are warranties accounted for?
Warranty clauses (i.e. written guarantees to repair, replace or service the end product) are often written into construction contracts. Warranties will be accounted for differently if they are purchased separately than if they are included as part of the offering.
Many warranties simply assure the customer that the project that’s delivered will function as they expect and will have no latent defects. These assurance warranties are not covered by ASC 606 at all; they are accounted for under ASC 460, Guarantees. Warranties that are purchased separately should be considered as part of the contract’s overall cost but listed as separate performance obligations.
How are mobilization costs accounted for?
Set-up costs (including labor, temporary workspaces and moving equipment) should – first and foremost – be capitalized or expensed as necessary. All remaining costs that relate directly to the contract will fall under the umbrella of ASC 606. Mobilization costs that will help the entity fulfill future obligations (like a temporary work site) can be capitalized and amortized as control transfers to the customer. In many instances, this duration will match the life of the project.
How are bid costs accounted for?
Bid costs are straightforward. Because bids are sunk costs whether or not the entity wins the project, they should be expensed as they are incurred. The only exception to this rule is when the customer is on the hook for the bid whether it is accepted. This scenario is uncommon.
How are subcontracted jobs accounted for?
When a contractor delivers goods or services to their client directly, they are considered the principal contractor. Contractors who subcontract some of their duties will still be considered principals if they are the party responsible for delivering the end product. Principal contractors should record revenues as we have discussed in this article, on a gross basis, for the full amount they are entitled to under ASC 606.
When an entity simply arranges for a third party to deliver the product or a portion of the product, they are acting as an agent. In this instance, they should only recognize revenues in the net amount to which they are entitled. They should not recognize revenues that represent the third party’s contribution.
Almost all these answers should be qualified with the statement that judgement is necessary. ASC 606 is not black and white. It requires significant judgment on the part of management and the entire implementation team. These judgments should be recorded and reported in the disclosures section of the financials. If you have questions about lease accounting or need assistance with a construction tax or accounting issue, Hanson & Co can help! For additional information call us at 303-388-1010 or click here to contact us. We look forward to speaking with you soon.