In May, the Financial Accounting Standards Board (FASB) issued new rules for how to recognize revenue from contracts with customers. The rules impact many entities across multiple industries, including the construction industry. Before we get into the “what,” let’s first look at the “why.”
Why Did the FASB Issue a New Standard on Revenue Recognition?
Revenue recognition guidance differed between Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). According to the FASB, “The objective of the new guidance is to establish the principles to report useful information to users of financial statements about the nature, timing, and uncertainty of revenue from contracts with customers.” Basically, the new framework helps to patch fragmented and inconsistent standards that allowed companies across industries to record their revenue differently.
What’s Involved in the New Provisions?
The new provisions include a five-step process for recognizing revenue. The steps are briefly described below, but to get a more in-depth description, click here to read an article that was recently published in Properties magazine.
Step 1: Identify the Contract
Ensure that an agreement is in place before work on a project begins.
Step 2: Identify the Performance Obligations
At the initiation of the contract, all distinct performance obligations should be identified. An obligation is distinct if the customer can benefit from it separately. For example: if a car is sold with a two-year maintenance warranty, that warranty is a distinct performance obligation that must be accounted for separately from the sale of the car.
Step 3: Determine the Transaction Price
This step is pretty straightforward for a lump-sum contract, but gets more complex when you start considering cost-type projects with shared-savings arrangements, incentive compensation for early completion and/or liquidated damages for late completion. The new rules provide two methods for determining the transaction price.
Step 4: Allocate the Transaction Price
Once the transaction price has been determined, it needs to be allocated to the distinct performance obligations (if any). The amount to allocate to each performance obligation should equal its standalone selling price.
Step 5: Recognize Revenue as Performance Obligations Are Satisfied
This step may result in companies reporting revenue earlier or later than under current practice, particularly if a longer contract with lots of variables exists.
To read the full article about these new reporting rules and how they specifically affect the construction industry, click here.
Another post by Aaron on the construction industry:
Construction Growth Outpaces GDP
Another post about accounting methods that you might be interested in:
A Different Set of Accounting Rules for Private Companies