Authored by Erik Schuchardt
The new accounting standard related to Revenue Recognition from Contracts with Customers – Accounting Standards Update 2014-09; Accounting Standards Codification 606 (ASC 606) took effect on January 1, 2019 for private companies with a calendar year-end and will take effect on other dates throughout 2019 for private companies with a fiscal year-end. At the time the standard becomes effective for a company, and at each reporting period thereafter, time-sensitive data needs to be gathered to accurately transition to ASC 606.
Regardless of whether or not a company has started or finished assessing and implementing ASC 606, the data that needs to be gathered is not easily found in accounting software or year-end financial information.
Specifically, construction companies will need to identify, quantify and understand the impact that uninstalled materials will have on the transition to ASC 606. This information is not only needed for each reporting period after the new standard becomes effective, but, for companies electing the modified retrospective transition to ASC 606, this information will need to be gathered on the last day of their calendar or fiscal year prior (i.e., December 31, 2018 for calendar year-ends).
ASC 606 emphasizes that recognizing revenue over time, under the input method, will be adjusted when a cost is incurred that does not contribute to a contractor’s progress in satisfying the performance obligation. Costs incurred related to rework, wasted materials or uninstalled materials should be excluded from the measurement of progress towards the fulfillment of a contractor’s performance obligations.
While uninstalled materials are excluded from the measurement of progress, a contractor may be permitted under the new accounting standard—subject to certain criteria—to recognize revenue equal to the cost of the uninstalled materials (excluding gross profit). A faithful depiction of a contractor’s performance may allow a contractor to recognize revenue at an amount equal to the cost of a good used to satisfy a performance obligation if the contractor expects at contract inception that all of the following conditions would be met:
- The good is not distinct.
- The customer is expected to obtain control of the good significantly before receiving services related to the good.
- The cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation.
- The contractor procures the good from a third party and is not significantly involved in designing and manufacturing the good (but the contractor is acting as a principal in accordance with paragraphs 606-10-55-36 through 55-40).
Based on the above criteria, a contractor should always exclude costs related to wasted materials, rework or other significant inefficiencies from its measurement of progress. In contrast, when uninstalled materials meet the above criteria, a contractor is allowed to recognize revenue in an amount equal to the cost of the goods and adjust its measure of progress to exclude such costs from the costs incurred and from the transaction price (i.e., from both the numerator and the denominator of its percentage of completion calculation).
Both qualitative and quantitative accounting data on uninstalled materials may not be preserved at a point in time, to be able to go back to at a later date. Therefore, as part of the reporting period close process, companies should quantify the uninstalled materials on all contracts in process. In addition to quantifying the uninstalled materials at each reporting period, a contractor should document the following qualitative factors:
- Where the goods are stored (on a customer controlled job-site, with a third party, in the contractor’s warehouse, etc.),
- Whether the goods are distinct,
- When the customer will obtain control of the goods, and
- Is the contractor acting as the principal or agent in procuring the uninstalled materials?
With proper planning and assessment, the transition to and implementation of ASC 606 will be easier for businesses and their accountants.
For more information on this topic, or to learn how Baker Tilly accounting and assurance specialists can help, contact our team.