Revenue Recognition for the AE Industry

Presented by:

M. Scott Hursh, CPA, CCIFP®, CDAManaging Shareholder

AE Industry GroupStambaugh Ness, PC

Brian W. Rosenberg, CPA, MBASenior Manager

Brown, Schultz, Sheridan & Fritz

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Revenue Recognition for the AE Industry

Agenda

Background

Overview of new revenue recognition model

Contract costs

Disclosures

Effective dates and transition

Examples

Questions / Discussion

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Revenue Recognition for the AE Industry

Current Guidance Accounting Standards Codification (ASC) Topic 910-605 Pre-Codification SOP 81-1, “Accounting for Performance of

Construction-Type and Certain Production-Type Contracts” Specific to issues unique to the construction industry

New Guidance Initial Exposure Draft June 2010 – Revised Exposure Draft

November 2011 Intended to apply consistently across all industries Joint project with IASB FASB ASU 2014-09 – Revenue from Contracts with

Customers (Topic 606) -Issued May 2014

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Core Principle

“An entity 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.”

Transfer is based on control – Who has the ability to direct the use of and receive the benefit of the asset? (Work in Process)

Factors to consider when determining whether a transfer exists:

• Unconditional obligation to pay • Legal title• Physical possession• Customer-specific design

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Revenue Recognition - 5 Steps

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 entity satisfies a performance

obligation

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Step 1 – Identify the Contract

Identify the contract(s) with a customer

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Identify the Contract(s) with a Customer

Contracts meet the following criteria:• Approval and commitment of the parties• Identification of the rights of the parties• Identification of the payment terms• Contract has commercial substance• Probable that the entity will collect the consideration

(transaction will be completed) Combining Contracts

• Contracts negotiated as a package with a single commercial objective

• Amount of consideration to be paid in one contract depends on the price or performance of the other

• Goods or services promised in the contracts are a single performance obligation

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Identify the Contract(s) with a Customer - continued

Contract Modifications• Accounted for as separate contract if:

1. addition of distinct good or service and

2. price of the contract increases by an amount equal to standalone selling prices

• If not required to account for as separate contract, accounted for as a change to transaction price

• Approved change in scope, but not price, estimate the change in price

• Adjustment made on a cumulative catch-up basis on date of modification (prospective accounting)

• Claims and change orders (approved and unapproved)b Recognize estimated margin if scope approved, but price not

agreed

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Contract Modifications

May exist even if dispute in price, scope or both

Scope may be approved but price has not been approved

May be written, verbal, or customary business practice

This is a change in current practice

Must determine whether rights and obligations created by the modification are enforceable

Facts and circumstances

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Step 2 – Identify Performance Obligations

Identify the contract(s) with a customer

Identify the performance obligations in the contract

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Identify the Performance Obligations in the Contract

Performance Obligation – Promise in a contract with a customer to transfer a good or service to the customer

Account for each distinct, or series of distinct, goods or services as a separate performance obligation

Distinct 1. Customer can benefit from the good or service either on its

own or together with other resources that are readily available to the customer, and

2. Promise to transfer good or service is separately identifiable from other promises in the contract

Series of distinct goods or services – goods and services that are substantially the same and have the same pattern of transfer

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Identify the Performance Obligations in the Contract - continued

An entire contract can be accounted for as one performance obligation

A good or service is not distinct if:• The goods or services are highly interdependent and

interrelated• The entity provides a significant integration service• The goods or services significantly modify or customize

other goods or services in the contract Assurance-type warranties are not distinct

performance obligations One performance obligation for many, but not

all, AE contracts

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Step 3 – Transaction Price

Identify the contract(s) with a

customer

Identify the performance

obligations in the contract

Determine the transaction price

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Determine the Transaction Price

Transaction Price – Amount of consideration to which an entity expects to be entitled in exchange for transferring goods or services

Variable Consideration• Incentives, penalties, claims, performance bonuses,

liquidated damages• Estimate the expected value or most likely amount

b Sum of probability-weighted amountsb Most likely of two possible outcomes (achieve performance

bonus or not)

• Constraint for estimates – only included to the extent it is probable that a significant reversal of revenue recognized will not occur

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Determine the Transaction Price - continued

Other Considerations:• Time value of money (only if significant financing

component)• Noncash consideration

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Step 4 – Allocate Transaction Price

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

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Allocate Transaction Price to Separate Performance Obligations

The transaction price is allocated to all separate performance obligations in proportion to the stand-alone selling price of each (at contract inception)

If a stand-alone selling price is not directly observable, must be estimated

• When estimating, an entity “shall maximize the use of observable inputs”

• Cost plus margin approach – forecast costs and add anticipated margin

• Adjusted market assessment approach – what a customer would have paid if it were a separate transaction

Subsequent changes to transaction price• Allocate any changes in the transaction price to separate

performance obligations on same basis as at contract inception.

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Step 5 – Recognize Revenue

Identify the

contract(s) with a

customer

Identify the performan

ce 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 entity satisfies a

performance obligation

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Recognition of Revenue – Satisfaction of Performance Obligations

Revenue is recognized when (or as) a performance obligation is satisfied by transferring goods or services to a customer.

Transfer occurs when (or as) the customer obtains control.

• Ability to direct the use and obtain substantially all the benefits

• Point in time or over time

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Recognition of Revenue – Satisfaction of Performance Obligations - continued

Control is transferred over time if one of the following criteria are met:

1. Customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs

2. Entity’s performance creates or enhances an asset (work in process) that the customer controls as the asset is created or enhanced

3. Entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date

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Recognition of Revenue Over Time

Customer simultaneously receives and consumes• This includes cases in which another firm would not need

to substantially reperform the work completed to date to fulfill the remaining performance obligation (aside from practical or contractual limitations)

• This applies to services, not goods Customer controls asset

• Generally applies on customer's land No alternative use, and right to payment

• Drawings, site plans, technical specs1. Firm is restricted from selling to or using for another

customer - customer could enforce rights2. Right to payment for work completed to date at any time

in contract, if terminated without cause - must consider laws and contractual terms

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Recognition of Revenue – Satisfaction of Performance Obligations

Revenue recognized over time - consistently apply a method to measure progress toward completion:

Methods to measure progress:1. Output Methods – basis of units produced or delivered,

contract milestones

2. Input Methods – basis of efforts expended to date relative to total efforts expected to be expended. (cost to cost, labor hours, machine hours, etc.)

b Exclude the effects of inputs that do not depict the transfer of goods or services (material or labor overruns)

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Recognition of Revenue – Satisfaction of Performance Obligations - continued

Updates to measure of progress accounted for as change in accounting estimate in the period the change is determined

Reasonable measure of progress – early stages of a contract, recognize revenue only to the extent of the costs incurred (zero margin)

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Recognition of Revenue – Satisfaction of Performance Obligations - continued

If control not transferred over time, revenue recognized the point in time when performance obligation is satisfied and control is transferred

Indicators of transfer of control include, but not limited to:

• Entity has a present right to payment

• Customer has legal title

• Transfer of physical possession

• Customer has significant risks and rewards of ownership

• Customer has accepted the asset

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Contract Costs

Incremental costs of obtaining a contract• Capitalized as an asset if expect to recover

b can be expensed as incurred if the amortization period is one year or less

b amortized on a systematic basis consistent with the pattern of transfer of the goods or services

• Costs that the entity would not have incurred if the contract had not been obtained

Costs to fulfill a contract• Look to other guidance first (inventories, software

development costs)• Recognize as an asset if costs relate directly to a contract

and are expected to be recovered based on future performance

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Contract Costs - continued

Costs to Fulfill a Contract• Direct labor• Direct materials• Allocations of costs that relate directly to the contract or

contract activitiesb Depreciation of equipment, tools, supervision, insurance, etc.

• Costs explicitly chargeable to the customer under the contract provisions

• Other costs incurred only because the entity entered into the contract

b Subcontract costs Uninstalled materials

• Exclude from measurement of progress• Recognize revenue equal to cost (zero margin)

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Disclosures

Revenue recognized from contracts disclosed separately from other sources of revenues

Impairment losses recognized on any contract receivables or contract assets

Disaggregation of Revenue• Revenue recognized as of point in time and over

time• Qualitative information about how economic

factors (type of customer, geographical location of customers, and type of contracts)

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Disclosures - continued

Opening and closing balances of receivables, contract assets, and contract liabilities

Methods used to recognize revenue (input/output methods), information regarding variable consideration recognition

Contract Asset = Costs in Excess / Contract Liability = Billings in Excess

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Effective Dates and Transition

Effective Dates• Public entities – Annual reporting periods beginning after

12/15/17 (calendar year 2018); early adoption prohibited• Non-public entities – Annual reporting periods beginning

after 12/15/18 (calendar year 2019); early adoption permitted to public entity effective date

Transition• Retrospective application – restate prior periods upon

adoption, or• Apply to existing contracts in progress on the effective date

and new contracts going forwardb Requires cumulative effect adjustment and certain additional

transition disclosures

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Example – Contract Modifications

Example 8 - Contract to design a commercial building for $1 million and a bonus of $200,000 if construction costs are less than $100,000,000.

At contract inception – Transaction price= $1m; est. cost $700K

Exclude $200K bonus from transaction price Input measure – costs incurred, 60% complete after first

year ($420K) Q1, Year 2 – no additional costs incurred; modification to

contract - price increased $150K, costs $120K, modifications not distinct, bonus now probable (Estimates received)

Cumulative catch-up adjustment - 51.2% complete($420/$820) on $1,350,000 transaction price = $91,200 revenue adjustment

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Example – Claims

Example 9 – Disputed claim Customer-caused delays result in additional costs

(Overhead rate and labor costs increased) Contractor has legal basis in claim (included in

contract terms) Does not result in any additional goods or services

provided to customer and all remaining goods or services to be provided after the modification are not distinct

Adjust transaction price for estimated amount of claim (considering constraint concept) – cumulative catch-up adjustment

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Example – Performance Obligation

Example 10 – Goods and Services Are Not Distinct Contract to design a bridge - responsible for design,

engineering, survey, permitting Promised goods and services are capable of being

distinct, but Promise to transfer individual goods and services in

the contract are not separately identifiable from other promises in the contract.

• Provides the service of integrating the goods and services into the bridge

Account for all goods and services in the contact as a single performance obligation

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Example – Revenue Recognized Over Time

Example 14 – Consulting Service Provides professional opinion to customer If contract terminated, successor firm would need to

substantially reperform work in process because no benefit from predecessor

Benefit is only received at delivery of opinion But:

• No alternative use since facts and circumstances specific• Firm has enforceable right to bill for time incurred to date

(including profit) Thus revenue is recognized over time

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Example – Revenue Recognized at Point in Time

Example 16 – Build WWTP for Customer

Contract specifies 10% payment at inception, regular payments over work period of 50%, then final 40% due at completion - payments nonrefundable unless firm fails to perform - if customer terminates contract, firm can only retain progress payments to date

Cumulative payments are not expected at all times to correspond to work done (no right to payment for performance to date)

Thus cannot recognize revenue over time

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Example – Uninstalled Materials

Example 19

Highway construction, including installation of precast bridge. Bridge delivered 3 months prior to being installed.

Exclude cost of bridge from progress measurement (% complete)

Revenue recognized up to cost of bridge (zero margin)

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Example – Variable Consideration / Retainage

Example 20 – Penalty provision = variable consideration

• Must determine amount to include in transaction price

Example 21 - Estimating variable consideration

• Expected value method used for portion including multiple outcomes

• Most likely method when only 2 outcomes

Example 27 – Retainage

• Retainage not determined to be financing component – intended to protect the customer from the contractor failing to complete its obligations

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Questions / Discussion

M. Scott Hursh, CPA, CCIFP®, CDAManaging Partner

AEC Industry GroupStambaugh Ness, PC

Phone: 800.745.8233Email: shursh@stambaughness.com

_____________________

Brian W. Rosenberg, CPA, MBASenior Manager

Brown, Schultz, Sheridan & Fritz

Phone: 717.761.7171Email: brianrosenberg@bssf.com