Late last week the Financial Accounting Standards Board (FASB) voted to delay the implementation of new revenue recognition rules for one year.
The new rules which change how construction companies and contractors recognize revenue proved far too comprehensive for companies to make the needed changes by the original deadline. This is good news for Colorado contractors because privately held companies will now have December 15th, 2018 to come into compliance. While there is some time before compliance is required it’s important to start planning now. Many of the mandated changes represent a significant change in accounting practices. To help clients understand how the changes will impact them; Hanson & Co., has provided a brief summary of the standard and impact below.
To ensure that all companies are using the same set of standards to report revenue, FASB has clearly stated its approach to revenue recognition. It has stated that entities should recognize revenue “to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” To help companies apply this principle, they have outlined a five step process for recognition:
- Identify the contract(s) with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue when (or as) the reporting organization satisfies a performance obligation.
Impact on Construction/Contractors
It’s important to note that while the 5 step process seems like “technical talk” its practical impact on current practices is significant. Insights into the changes include:
- Change Orders – Using the 5 step process it is possible that a change order may represent a new contract with a customer. The key for determining whether a new contract has been created is whether or not it is distinct from the original contract. For example, if the contract is distinct and has its own price then it’s treated as a new contract and accounted for as such. If a change order uses goods and services not distinct from the existing contract then no new contract accounting obligation exists. The rules governing change orders are quite complex, but generally speaking these examples allude to the classification process.
- Uninstalled Materials – Under new guidance contractors will be able to (in most cases) recognize revenue equal to the cost of the uninstalled materials assuming the customer has taken control. Remember, there are criteria which need to be met for these materials to be recognized as revenue. Determination is based on contract and circumstance specifics.
- Transition Process – Contractors will not be required to recalculate all existing contracts under the new regulations when implemented. To make compliance easier, FASB will allow companies to either restate prior periods on the financial statement or account for contracts in progress and any new contracts that may arise going forward.
The good news is that a one year delay has been granted providing more time to plan and modify systems and processes. Many of the additions and changes are quite complex and will require the assistance of a professional familiar with FASB regulations. If you have questions on the new revenue recognition standards or contract management processes, contact Hanson & Co., today! For additional information please contact us at (303) 388-1010, or click here to contact us. We look forward to speaking with you soon.