new revenue recognition standards … · improve comparability of revenue recognition practices...

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11JANUARY/FEBRUARY 2015 CONSTRUCTION ACCOUNTING AND TAXATION

Af ter nearly 1,000 commentle t ters , w ith 350 le t tersf rom the const ruc t ionindustry alone, the Interna-t iona l Account ing Stan-

dards Board (IASB) and the FinancialAccount ing Standards Board (FASB)published a new joint standard on rev-enue recognition, replacing most of theexist ing guidance and taking a majors tep toward converg ing Account ingPr inciples Genera l ly Accepted in theUnited States (U.S. GAAP) and Interna-

t ional Financia l Repor t ing Standards(IFRS). The new standard, AccountingStandards Update (ASU) No. 2014-09,Revenue from Contracts with Customers,joined the Codification of U.S. GAAP asTopic 606, ef fec t ively replacing Topic605, with a corresponding IASB refer-ence of IFRS 15, Revenue from Contractswith Customers.The overal l goal of the new guidance

is depicted in Exhibit 1.The new requ i rement s w i l l a f fe c t

d i f ferent companies in d i f ferent ways

NEW REVENUERECOGNITION

STANDARDS REQUIRECONTRACTORS TOTHINK DIFFERENTLYRO B E RT S . M E RC A DO A N D JA M E S W. M I L L E R

ROBERT S. MERCADO is a partner in the Marcum assurance services division and serves as the New England regional con-struction leader. He has more than 18 years of experience conducting, reviewing, and analyzing financial information forconstruction contractors, manufacturers, and service corporations. As a certified construction industry financial professional,Mr. Mercado has an expertise in troubleshooting problem job performance for construction projects and recommending prac-tices to enhance profitability. He has considerable experience with construction claims matters and has provided litigationsupport services in this area. In addition, he is knowledgeable with systems analysis and with the tailoring of accountingsoftware to meet clients’ needs. Mr. Mercado is a frequent speaker on accounting and auditing matters for construction com-panies, industry organizations, and professional development courses. He has been acknowledged in several publications ofThe AICPA’s Audit and Accounting Guide — Construct ion Contractors and AICPA’s Audit Risk Aler t — Real Estate andConstruct ion Industr y Developments.

JAMES W. MILLER is an integral member of Marcum’s national construction industry group and is located in the New Havenoffice. He has more than 12 years of experience compiling, reviewing, and analyzing financial statements for constructioncontractors and other allied companies. Mr. Miller has also been involved in high-profile and sensitive engagements regard-ing fraud and litigation support and due diligence projects for business acquisitions. A sought-after speaker on construc-tion accounting and auditing matters, Mr. Miller has conducted internal training seminars and has presented on issues andupdates regarding the construction industry and construction engagements. Mr. Miller has also applied his knowledge andexpertise to the success of two large engagements for universities within Connecticut. Mr. Miller’s specialties include trou-bleshooting problem job performance for construction projects and enhancing profitability. He has considerable experiencewith construction claims matters and in-depth knowledge of systems analysis. Mr. Miller began his career at Marcum whenhe joined the firm in 2002.

The new standard def ines a contract as an agreement between two or more par t ies

that creates enforceable r ights and obl igations and specif ies that enforceabi l i ty is a

matter of law.

but wil l require al l contractors to assessthe ex tent of the impac t — includingextensive new disclosure requirementsa imed to enable f inanc ia l s t atementu s e r s t o u nde r s t a nd t h e n a t u r e ,amount , t im ing , and uncer t a int y o frevenue and cash flows arising from con-t rac t s w i th cus tomers . Addi t iona l ly,cont rac tors w i l l have to assess poten-t ia l changes to sys tems and processesto collect data. The new standard movesaway f rom the indust r y- and t ransac-t ion-speci f ic requirements under U.S.GAAP, which are a l so used by someIFRS preparers in the absence of spe-c i f ic IFRS guidance .Depending on whether cer tain cr i-

ter ia are met , revenue is e ither recog-n i z ed ove r t ime ( i n a manne r t h a tdepic ts the contrac tor’s per formance)or at a point in t ime (when control ofthe goods or ser v ices is t ransfer red tothe customer) . Contrac tors w i l l applya f ive-step model to determine when torecognize revenue, and at what amount.The fol low ing l i s t spec i f ies that rev-enue should be recognized when (or

as) a cont rac tor t rans fers cont rol ofgoods or ser v ices to a customer at theamount to which the contractor expectsto be ent it led:1. Identify the contract with a cus-tomer.

2. Identify performance obligat ions.3. Determine the transact ion price.4. Allocate the transact ion price.5. Recognize revenue.

Step 1: Identify the contractThe new standard defines a contract asan agreement between two or more par-t ies that creates enforceable r ights andobligations and specifies that enforceabilityis a matter of law. Contracts can be writ-ten, oral, or implied by an entity’s cus-tomary business pract ices. A contractwith a customer must meet all of the cri-ter ia l isted in Exhibit 2.If a contract meets al l of the cr iter ia

in Exhibit 2 at contract inception, thecontractor does not reassess those cr i-teria unless there is an indication of a sig-n i f i c ant change in the f ac t s and

12 CONSTRUCTION ACCOUNTING AND TAXATION JANUARY/FEBRUARY 2015 REVENUE RECOGNITION STANDARDS

EXHIBIT 1 New Guidance Goal

Remove inconsistencies and weaknesses in revenue requirements.Provide a more robust framework for addressing revenue issues.Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.Provide more useful information to users of financial statements through improved disclosure requirements.Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.

EXHIBIT 2 Relevant Criteria for Customer Contracts

Commercial substanceApproval by both partiesIdentifiable rights regarding assets to be transferredIdentifiable payment terms (even if amount is uncertain)Probability that you will collect consideration entitled

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circumstances. One of the key dif fer-ences between the new standard and U.S.GAAP relates to col lectabi l ity. One ofthe four revenue recognit ion cr iter iaunder FASB ASC 605 is col lectabi l it y,which must be considered reasonablyassured for revenue to be recognized.Under the new guidance, col lectabilityis a factor when determining whether avalid contract exists.When a contract does not meet the

criteria, the contractor shall continue toassess the contract until such conditionsare met; i f they are not met, the con-tractor shall recognize revenue only whene i ther of the fo l low ing event s hasoccurred:• the contractor has no remainingobligat ions to transfer goods or ser-v ices to the customer, and al l , orsubstantial ly al l , of the considera-t ion promised by the customer hasbeen received by the contractor andis nonrefundable, or• the contract has been terminated,and the considerat ion received fromthe customer is nonrefundable.In the case where the cr iter ia are not

met, the consideration received from thecustomer is recognized as a liability untilone of the preceding events occurs orunti l the contract meets the cr iter ia tobe cons idered a cont rac t w ith a cus-tomer. This l iability represents the con-trac tor’s obl igat ion to e ither t ransfergoods or services in the future or refundthe considerat ion received.Throughout the life of a contract, other

contracts are entered into off the exist-ing contract, or modificat ions are madeto the exist ing contract through changeorders. The new standard clar ifies spe-cific definit ions as to when to combineor segment contracts and the recognitionof revenue when there are contract mod-ificat ions.

Combination of contracts. The guid-ance under ASC 606 on combining con-tracts is similar to the current U.S. GAAPliterature w ith the analys is regardingcontracts that were negotiated as a pack-age or have considerat ion that is l inked.There is one main difference, however :Current U.S. GAAP includes indicatorsfor a contractor to consider in evaluat-

ing whether two or more contracts shouldbe combined, whi le ASC 606 requiresthat an ent it y combine contracts thatwere entered into at or near the sametime if they meet any of the following cri-ter ia:• contracts are negotiated with a sin-gle commercial object ive;• amount of considerat ion in onecontract depends on the other con-tract; or• goods or serv ices are a single per-formance obligat ion.Contract modifications and claims. A

contract modificat ion results when thepart ies to a contract approve a changein the scope and/or the price of a con-t r ac t . S evera l pos s ib i l i t i e s ex i s t forchanges in price or scope. For example,the part ies may agree on scope, but notprice changes, or they may have a disputeregarding the pr ice or scope. Specif icguidance in FASB ASC 605-35 is elimi-nated with the changes in the new stan-dard . There a re d i s t inc t d i f fe rencesbetween the exist ing guidance and thenew standard that may enable contrac-tors to record more change orders thanwere al lowed based on the ASC 605-35.Exhibit 3 shows a few examples of the dis-t inct changes.Simi lar to approval of the or ig ina l

cont rac t , approva l of a modi f icat ioncould be made oral ly or in writ ing, or itcould be implied by customary businessprac t ice. There are two opt ions for acontractor to account for the contract mod-ificat ion.1. The contractor accounts for themodificat ion as a separate contract(dist inct), which only affects futurerevenues and is to be adjustedprospect ively, if the modificat ionresults in both of the fol lowing con-dit ions:• the scope increases to reflect addi-t ional promised goods or serv icesthat are “dist inct” as defined in Step2 and• the addit ional considerat ion to thesel ler reflects the added goods orservices’ stand-alone sel ling pricesand any appropriate adjustmentsbased on the circumstances.

13REVENUE RECOGNITION STANDARDS JANUARY/FEBRUARY 2015 CONSTRUCTION ACCOUNTING AND TAXATION

THERE ARE DISTINCTDIFFERENCESBETWEEN THEEXISTING GUIDANCEAND THE NEWSTANDARD THATMAY ENABLECONTRACTORS TORECORD MORECHANGE ORDERSTHAN WEREALLOWED BASED ONTHE ASC 605-35.

2. The modificat ion is not accountedfor as a separate contract, whichresults in three potential outcomes.This requires the contractor to eval-uate the remaining goods and ser-v ices to be delivered under themodified contract. The threepotential outcomes are as fol lows:• If the remaining goods or serv icesare dist inct from those deliveredbefore the contract was modified,the contractor treats the modifica-t ion as a termination of the originalcontract and the creat ion of a newcontract. As such, the amount ofconsiderat ion al located to theremaining separate performanceobligat ions equals the sum of theest imated transact ion price (includ-ing amounts already received fromthe customer) not yet recognized asrevenue, plus the amount of consid-erat ion arising from the modifica-t ion.• If the remaining goods or serv icesare not dist inct and are part of asingle performance obligat ion thatis par t ial ly sat isfied as of the modi-ficat ion date, the contractor treats

the modificat ion as part of the orig-inal contract by adjust ing the trans-act ion price and remeasuring itsprogress toward complet ion of theperformance obligat ion. The rev-enue recognized to date should beincreased or decreased for theeffects of the contract modificat ionon a cumulat ive catch-up basis.• If the modificat ion represents acombination of the two precedingscenarios, the contractor should usea combination of the two methods.Under the guidance for construct ion

contracts , contract revenue and costsmust be adjusted for approved contractmodifications involving scope and price.More detai led guidance is provided forunpriced change orders, which addressesthe t reatment for cos t s and revenue.Under the new standard, accounting forcontract modifications is heavily focusedon the type of modificat ion and is notindustr y-specific.

Example of contract modifications. Acont rac tor has a s ing le per formanceobligation to construct a school. Duringthe contract there is a change order tochange the electr ical work in one of the


EXHIBIT 3 Distinct Changes

Unpriced/ UnapprovedChange Orders

Claims

Record when recovery isprobable, consideringother factors such as trackrecord of success or fai l -ure in pursing changeorders, reasonableness ofpr ic ing, and evaluat ion ofwhether costs relate towork within or outsidescope of contract.

Record only to extend ofcosts incurred when prob-able of result ing in addi-t ional contract revenueand amount can be rel ia-bi l i ty est imated ( includingspecif ic condit ions met).

May be included in perfor-mance obl igat ion (non-dis-t inct) or a separateperformance obl igat ion(dist inct) before the pr iceof the change order isapproved.

May be included in perfor-mance obl igat ion (non-dis-t inct) or a separateperformance obl igat ion(dist inct) before the pr iceof the change order isapproved when there is achange in legal ly enforce-able r ights and obl igat ionsof the part ies.

Existing Guidance (ASC 605-35)

New Standard (Topic606)

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rooms that is a necessary part of the con-tractor’s service to construct the school.His tor ica l ly, the owner and the con-tractor typically agree on the price shortlyafter the work associated with the changeorder beg ins — and h i s tor ica l ly thechange orders have been approved. Inthis case, the change order is not dis-t inct, it would be added to the contractassuming it was part of the contract sinceincept ion, and a cumulat ive catch-upadjustment would be made.

Step 2: Identifying performanceobligationsOnce the contract has been identified,the contractor must next ident if y theperformance obligations within that con-tract. A performance obligation is definedas a promise to deliver a good or providea serv ice in a contract with a customer.Performance obligat ions are normallyspec i f i ed in a cont rac t but may a l soinclude promises implied by a contrac-tor’s customary business practices, pub-l ished policies, or specif ic statementsthat create a valid customer expectationat contract incept ion. A promise con-

st itutes a performance obligat ion if thepromised good or ser v ice is dis t inct .Examples of promised goods are per-forming contractually agreed-upon tasksfor a customer, including construct ing,manufacturing, or developing an asset onbehalf of a customer. (See Exhibit 4.)Goods or ser v ices that are not dis-

t inc t should be combined w ith otherpromised goods or ser v ices unt i l thecontractor identifies a bundle of goodsor serv ices that are dist inct. For con-struct ion contractors, many long-termconstruction contracts and services con-tracts will most likely be identified as sin-gle performance obligations because theyoften include a significant integrat ionservice.If a good or serv ice is par t of a ser ies

of dist inct goods or ser v ices that aresubstantially the same and have the samepattern of transfer, the ser ies is on per-formance obligation if each distinct goodor serv ice in the ser ies represents a per-formance obligat ion sat isfied over t imeand the same method of progress is usedto measure the transfer of each dist inctgood or serv ice in the ser ies to the cus-tomer. Examples of contracts that fit the


EXHIBIT 4 Criteria for Distinct Promised Goods or Services

The customer can benefi t f rom the goodor service ei ther on i ts own or togetherwith other resources that are readi lyavai lable to the customer. Readi ly avai l -able resources are goods or services thatare sold separately (by the contractor orby another ent i ty) or that the customerhas already obtained (from the contractoror from other events or transact ions).

The promise to transfer a good or serviceis separable from other promises in thecontract. The fol lowing factors indicatethat a good or service is separable fromother goods or services in the contract:• The contractor is not using a singlegood or service as an input to produce ordel iver the combined output specif ied bythe customer.• The good or service does not signif i -cant ly modify or customize otherpromised goods or services in the contract.• The good or service is not highly depen-dent on, or interrelated with, otherpromised goods or services in the con-tract. For example, a good or servicemight not be highly interrelated i f a cus-tomer can decide not to purchase a par-t icular good or service and that decisiondoes not signif icant ly affect otherpromised goods or services under thecontract.

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definit ion of a ser ies of dist inct goodsare eng ineer ing ser v ices and projec tmanagement cont rac ts (const ruc t ionmanagement), where the contracts wouldrange a year and require maintenance ofthose contracts continually throughoutthe year. Rather than having performanceobligat ions for each day, the guidancehas al lowed for the accounting of thesetypes of contracts to be over the periodof t ime ut i l i z ing a measure of input(hours).

Example of identifying performance oblig-

ations. A contractor has a contract todesign and construct a commercial build-ing. The contractor and other vendors reg-ularly and separately provide design andconstruction services. Additionally, boththe design and construction services areprovided together, and the design phaseof the contract w i l l require cont inualalteration during the construction phase.In this case, there would be one perfor-mance obligation representing the valueof both the des ign and cons t ruc t ionphases of the contract. However, if thecontractor determines that the designdoes not require significant alterat ionsduring the construct ion phase, and thedes ign and const ruc t ion ser v ices arehighly inter related, there may be twoper formance obl igat ions (one for thevalue of the design phase and the secondfor the value of the construction phase).

Step 3: Determining the transactionpriceThe transact ion price is the amount ofconsideration to which an entity expectsto be entit led to receive in exchange for

transferring goods or services. The trans-action price may include fixed amounts,variable amounts, or both.To determine the transact ion price, a

contractor should consider the effectsof the fol lowing:1. variable considerat ion;2. constraining est imates of variableconsiderat ion;

3. the existence of a significant financ-ing component;

4. noncash considerat ions; and5. considerat ion payable to the cus-tomer.Variable consideration. The amount of

consideration received under a contractmight var y due to discounts , rebates ,refunds, credits, price concessions, per-formance bonuses, l iquidated damages,penalties, or other similar items. The useof variable considerat ions wil l changethe view of fixed-price construction con-tracts. If f ixed-price construct ion con-t rac t s inc lude a f ixed pr ice p lus anyincentives (bonuses) for completing early(or penalties for completing late), a vari-able considerat ion must be completed.To estimate the variable consideration ina contract, a contractor determines eitherthe expected va lue or the most l ikelyamount of considerat ion to be received,depending on which method better pre-dicts the amount to which the entity willbe entit led. (See Exhibit 5.)The expected value method might be

appropriate in situations where the vari-able outcome is a range of outcomes andan ent it y has exper ience w ith a largenumber of s imilar contracts that pro-vide a reasonable basis to predict futureoutcomes. ASC 606 requires an entity to


EXHIBIT 5 Values and Amounts

Expected Value• sum of the probabi l i ty-weightedamounts in a range of possible outcomes• most predict ive when the transact ionhas a large number of possible outcomes• can be based on a l imited number ofdiscrete outcomes

Most Likely Amount• the single most l ikely amount in arange of possible outcomes• may be appropriate when the transact ion wi l l produce only two out-comes

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use the same method to es t imate thevariable considerat ion throughout thelife of a contract.

Constraining estimates of variable con-

sideration. The objective of the constraintis for a contractor to recognize revenueonly to the extent it is probable that a sig-nificant reversal in cumulat ive revenuerecognized on the contract will not occurwhen the uncer tainty is resolved. The“probable” term is consistent with thecurrent GAAP guidance, which ut i l izesa 70 percent l ikelihood that the futureevents wil l occur. To meet the object ive,a contractor should make an assessmentto determine if it is probable that changesin the contractor’s est imate of variableconsiderat ion w i l l not result in a s ig-nif icant downward adjustment of thecumulat ive amount of revenue recog-nized on the contract. In making thisassessment, a contrac tor should con-sider al l of the facts and circumstancesassociated with both the likelihood and

the magnitude of the reversa l i f thatuncertain event were to occur or fai l tooccur. The fol lowing are indicators thatestimates of variable considerations couldresult in a significant revenue reversal.• The amount of considerat ion ishighly susceptible to factors outsidethe contractor’s influence, such asmarket volat i l ity, third-partyact ions, weather, and obsolescencerisk.• The uncertainty is not expected tobe resolved for a long t ime.• The contractor’s experience withsimilar contracts is l imited.• There are a large number and widerange of possible considerat ionamounts in the contract.There are other variables with the con-

siderat ion (i.e., awards, incentives, l iq-uidated damages, claims, or unpr icedchange orders). In this case, the pr icewould be estimated at the expected value(probability weighted) or the most likely


PAS, Inc. 4c paid ad

amount, w ith the probability that a sig-nificant reversal will not occur. The con-t rac tor should update i t s es t imate ofvar iable considerat ion, including theapplicat ion of the constraint, at the endof each reporting period to reflect changesin facts and circumstances.

Example of identifying variable consid-

erations and constraints. A contractor hasa fixed-price contract for $100, with a $20bonus if f inished a month early. Thereare only two potential outcomes — thecontractor either wil l either receive the$20 if finished early or will receive noth-ing. In this instance, because there areon ly two s cenar ios , the mos t l i ke lymethod will be used. The contractor esti-mates an 80 percent l ikelihood that itwil l receive the performance bonus anda 20 percent likelihood that it will receivenone of the performance bonus. Basedon these facts and probability analysis,the $20 bonus would be included in thetransact ion pr ice of the per formanceobligat ion, totaling $120.If the facts were changed, the perfor-

mance bonus was up to $20 if certain tar-gets were met, and the contractor haddetermined var ious probabi l it ies , theexpected value approach would be used.An example of this is shown in Exhibit 6.In the example in Exhibit 6, the con-

tractor would use $12 (sum of the cal-culated amounts) as the expected valueof the per formance bonus and wouldrecord a t ransact ion pr ice of $112 onthe performance obligat ion.Once the contractor has evaluated the

var iable cons iderat ions , i t must nowidentify any constraints. The probabil-ity that the contractor will receive the per-formance bonus i s 80 percent . Theprobabi l it y is 80 percent (sum of theprobabi l it ies of both the $10 and $20

outcomes) that the contractor will receive$12. Both scenarios are greater than theprobability threshold of 70 percent thatthe contractor will receive a performancebonus — therefore a constraint would notbe considered necessar y against bothoptions.

Significant financing component. In somesituations, contractors are paid up-frontfor contracts. The new standard requirescontracts to consider the t ime value ofmoney and to include f inancing con-siderat ions for any amounts paid aheadof t ime. Discounting for the t ime valueof money is required only if there is a sig-nificant financing component (receiv-able or payable). Considerations include:• the expected length of t ime betweendelivery of goods and services andreceipt of payment and• whether the amount of paymentwould differ substantial ly if cashpayment were received in accor-dance with typical credit terms.The e f fec t s o f f inanc ing ( inte re s t

income or interest expense) should be pre-sented separate ly f rom revenue f romcontracts w ith customers in the state-ment of comprehensive income. Addi-t ional ly, retainage is not considered afinancing component in the new standard;it is st i l l considered par t of the com-plet ion of the project.

Noncash considerations. Noncash con-siderations include customer-furnishedmaterials to facilitate a contractor’s ful-fi l lment of the contract. These noncashconsiderations are measured at fair valueor, if not readily identifiable, referencedto the s t and-a lone s e l l ing pr ice inexchange for the considerat ion.

Consideration payable to a customer.

Considerat ion payable to a customerincludes cash amounts that a cont rac-


EXHIBIT 6 Expected Value Approach

Possible Outcomes$20$10$0

Probability40%40%20%

Calculated Amount$8$4$0

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tor pays , or expec ts to pay, to the cus-tomer. It a lso includes credit or otheri tems that can be appl ied against theamounts owed. The cont rac tor shouldaccount for the cons iderat ion payableto a cu s tomer a s a reduc t ion of t hetransact ion pr ice and therefore of rev-enue, un less the payment to the cus-tomer is in exchange for a dist inct goodor ser v ice that the customer t ransfersto t h e cont r a c to r. I f con s i d e r a t i onpayable to a customer is accounted foras a reduct ion of the t ransact ion pr ice,the cont rac tor shou ld recognize thereduction of revenue when (or as) eitherof the fol low ing events occurs .1. The contractor recognizes revenuefor the transfer of the related goodsor serv ices to the customer.

2. The contractor pays or promises topay the considerat ion (even if thepayment is condit ional on a futureevent).Other considerations. The timing of tax

payments, the ability to pay dividendsin some jurisdictions, and covenant com-pliance may all be affected. Tax changescaused by adjustments to t iming andamounts of revenue, expenses, and cap-ita l ized costs may require rev ised taxplanning strategies.

Step 4: Allocation of transaction priceIn this phase, an allocation is made, con-sisting of the amount a company expectsto receive in exchange for satisfy ing eachseparate performance obligat ion. Usingthe school construction example, if thereis a tennis court associated with the con-tract and the stand-alone sel ling pricesfor the school and the tennis court are$100 mil l ion and $10 mil l ion, respec-t ively, 90 percent of the contract con-s iderat ion would be a l located to theschool and 10 percent would be a l lo-cated to the tennis cour t . The s tand-alone sel ling price is the price at whichan entity would sel l a promised good orser v ice separately to a customer. Thenew guidance will mostly affect the tech-nology industr y, as most of technologycontracts include more than one per-formance obligat ion for which stand-alone selling prices must be determined.

When a stand-alone sel ling price is notobservable, a contractor is required tomaximize the use of observable inputs,and/or apply est imation methods con-sistently in similar circumstances. Forconstruct ion contractors, the var iousitems within this section, including allo-cat ion of discounts, variable consider-at ions , and other s e l l ing pr iceconsiderations, would be attributable tothe transaction price of one performanceobligat ion.After contract incept ion, the trans-

act ion price can change for various rea-sons , inc lud ing the re so lut ion ofuncertain events or other changes in cir-cumstances that alter the amount of con-s iderat ion . Amount s a l lo cated to asatisfied performance obligation shouldbe recognized as revenue, or as a reduc-t ion of revenue, in the period in whichthe transact ion price changes.

Step 5: Revenue recognitionUnder U.S. GAAP, the percentage-of-complet ion method is general ly appliedwhen recognizing revenue for long-termcontracts . Under the new f ramework,revenue is recognized only when or as con-trol of the asset is transferred to the cus-tomer. The new guidance is focused onthe analysis of the contract and the deter-mination of whether a performance oblig-at ion is sat isfied over t ime or at a pointin t ime. The contractor should recog-nize revenue when (or as) the contrac-tor sat isf ies a per formance obligat ionby transferr ing a promised good or ser-v ice to a customer.Revenue would be recognized when a

customer :• receives benefits as ent ity performsservices;• creates or enhances an asset that thecustomer controls; or• does not create an asset with alter-nat ive use and the contractor hasright to payment for work com-pleted to date.Revenue is recognized at a point in

time only if control doesn’t transfer overt ime. Factors to consider include:• whether the entity has present r ightto payment;


THE NEWGUIDANCE ISFOCUSED ONTHE ANALYSISOF THECONTRACT ANDTHEDETERMINATIONOF WHETHER APERFORMANCEOBLIGATION ISSATISFIED OVERTIME OR AT APOINT IN TIME.

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• whether the customer has acceptedthe asset;• whether physical possession of theasset has transferred;• whether the customer has signifi-cant r isk and rewards; and• whether the customer has the legalt it le to the asset.Performance obligat ions wil l be rec-

ognized either using the “gross” or “net”concept. This coincides with the currentguidance on recording construction man-ager contracts in measuring whether thecontractor is “at r isk” or “not at r isk.” Ifthe contractor meets the key indicators( i . e . , the cont rac tor i s not pr imar i lyresponsible for fulfi l l ing the contract, itdoes not have inventory r isk, it does nothave discret ion in establishing prices,considerat ion is in the form of a com-mission, and the contractor is not exposedto credit r isk), that contractor wil l actas an agent and recognize revenue onthe performance obligation utilizing the“net” approach (i .e. , purchase obliga-t ion wil l be the total commission fees).If the previously named indicators are notmet, the contractor wil l recognize rev-enue on the performance obligation uti-lizing the “gross” method (i.e., purchaseobligation will be the total contract valueof the project).

Loss contracts. As w ith the cur rentguidance, contractors would accrue ananticipated loss once identified. The newstandard, however, does not require thatlosses be accrued on contracts of lessthan one year’s durat ion. Addit ionally,the new standard recognizes loss provi-sions on each performance obligat ion,not on the contract level. Gains on oneper formance obl igat ion cannot offsetlosses on another performance obliga-t ion.

So what does this mean?For some ent it ies , there may be l i t t lechange in the t iming and amount of rev-enue recognized. However, arr iv ing atthis conclusion wil l require an under-standing of the new model and an analy-s i s o f i t s appl i c at ion to par t i cu la rtransactions. Contractors currently usingthe percentage of complet ion or pro-

por t iona l per formance methods w i l lneed to reassess whether to recognizerevenue over t ime or at a point in t ime.If they recognize it over t ime, the man-ner in which progress toward completionis measured may change. Other entit iesthat current ly recognize revenue at apoint in time may now need to recognizeit over t ime. To apply the new criter ia,an entity will need to evaluate the natureof its performance obligations and reviewits contract terms, considering what islegal ly enforceable in its jurisdict ion.

Disclosures and more required disclo-

sures. There are many new and potentiallycomplex disclosures for contractors, suchas more disaggregat ion of revenue bycategory, including:• type of good or serv ice;• country or region;• type of customer ; and• type of contract.Additionally, contractors are required

to disclose a reconciliat ion of the con-tract balances and costs.

Training. A significant amount of train-ing wil l be required for everyone fromaccount ing to proj ec t managers onchanges to documenting contracts. Sys-tems modif icat ions w i l l be needed tocapture the add i t iona l in format ionrequired under the new standard, includ-ing disclosures, t racking performanceobligations, and contract balances. Inter-nal control and company policies w il lhave to be revised and in some cases re-written.

Additional audit steps. The new stan-dard will require enhancements of auditrequirements sur rounding the use ofes t imates , unders t anding changes ininternal controls and policies, and ret-rospect ive applicat ion of the new stan-dard where applicable. Addit ional bookto tax differences are likely to result fromimplementing the new revenue recogni-t ion standard.

Third-party financial review. Regulatoryagencies, such as banking and bonding,wil l have to rewrite many of the quali-fy ing metrics as defined in many of thecovenants in the current agreements .Pre-qualification requirements and bond-ing capac i t y measurement s w i l l b eaffected, and policies surrounding the


THE NEWSTANDARD WILL

REQUIREENHANCEMENTS

OF AUDITREQUIREMENTSSURROUNDING

THE USE OFESTIMATES,

UNDERSTANDINGCHANGES IN

INTERNALCONTROLS ANDPOLICIES, AND

RETROSPECTIVEAPPLICATION OF

THE NEWSTANDARD WHERE

APPLICABLE.

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review of such metrics wil l have to bereviewed and in most cases rewritten.

Effective date. For public entit ies, thenew s t andard i s e f fec t ive for annua lreport ing periods beginning on or af terDecember 15, 2016, including inter imper iods w ithin that repor t ing per iod.Early applicat ion is not permitted forpublic ent it ies. In addit ion, SEC StaffAccount ing Bul let in (SAB) 74 (Topic11M) , Di sclosure of the Impa ct tha tRecent ly Issued Account ing Standa rdsWill Have on the Financia l Sta tements ofthe Registrant When Adopted in a FuturePeriod, requires public entit ies to pro-v ide disclosures of new author itat iveguidance that has been issued, but thiswil l not be adopted unt i l some futuredate.For nonpublic entit ies, the standard

is effective for annual periods beginningaf ter December 15, 2017, and inter imper iods w ithin annual per iods begin-ning af ter December 15, 2018. Nonpub-lic entities may elect to adopt the standardearlier.FASB al lows contractors two options

when transitioning to the guidance underthe new standard. Contractors may optfor ful l retrospect ive applicat ion of thenew standard, which requires reflect ingthe cumulat ive effect of the change inal l contracts on the opening retainedearnings of the earliest period presented,along with adjust ing the financial state-ments for each prior period presented toref lec t the ef fec t of apply ing the new

accounting standard. Retrospective appli-cation would be applied to interim peri-ods, as well as annual periods presented.The contractor may elect any of the fol-lowing pract ical expedients.• For completed contracts, a contrac-tor does not need to restate con-tracts that begin and end within thesame annual report ing period.• For completed contracts that havevariable considerat ion, a contractormay use the transact ion price at thedate the contract was completedrather than est imating variable con-siderat ion amounts in the compara-t ive report ing periods.• For al l report ing periods presentedbefore the date of init ial applica-t ion, a contractor does not need todisclose the amount of the transac-t ion price al located to remainingperformance obligat ions and anexplanation of when the contractorexpects to recognize that amount asrevenue.As an a lternat ive , contrac tors may

apply the amendments to the new stan-dard ret rospect ively w ith the cumula-t i ve e f f e c t o f i n i t i a l l y app l y ing t heamendments recognized at the date ofthe init ial applicat ion. When using thismethod, the contractor should prov ideaddit iona l d isc losures in the repor t-ing per iods related to the reasons fors ignif icant changes . n


new revenue recognition standards … · improve comparability of revenue recognition practices...

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