The New Revenue Recognition Standard – and the Potential Impacts on the Construction Industry

By: Billy R. Robinson, CPADirector

brobinson@BEcpas.com(540) 434-6736

Agenda

• Why change the standards?• Facts and Myths• What does it say?• What does it mean?• Transition• What should you do now?• Questions

Why change the standards?• Converge US GAAP and IFRS (although this is now less

important than when the project began)• Standardize revenue recognition reporting across

industries and entities• Condense numerous standards into one complete and

understandable standard – eliminates significant amount of industry-specific guidance in GAAP today▫ Principles vs. rules based

• Better application of the matching principal

Facts and Myth• Percentage completion eliminated▫ False – While the thought process and terminology will

be different, revenue recognized may be similar to the method used today

• Revenue recognition allowed on uninstalled materials▫ True – There is specific language where contractors

may be allowed to recognize revenue equal to the cost of the uninstalled materials if the customer obtains control of the goods

Facts and Myth• All contracts will have multiple performance obligations▫ False – many (not all) contracts will have one performance

obligation. Contractors will still need to evaluate each contract for difference performance obligations and document conclusions

• Contractors will have to recalculate all completed contracts under the new standard when implemented▫ False – can either restate prior periods presented, or

account for contracts in progress and all new contracts going forward

Facts and Myth• Cost to cost can still be used to determine

percentage complete▫ True – new standard allows for the use of input or

output methods to determine percentage complete

• There will be significantly more footnotes in the FS▫ Depends – New disclosures will be required with

some relief for nonpublic entities

What does it say?After over 1,000 comment letters from the original exposure draft of which over 350 was from the construction industry – new standard issued 5/28/14.

Core Principal

Recognize revenue ▫ in a manner that matches the transfer of goods or

services to customers ▫ in an amount that reflects the consideration the

entity expects to receive in exchange for those goods or services

What does it say?

Step 1• Identify the contract(s) with a customer

Step 2• Identify the performance obligations in the contract

Step 3• Determine the transaction price

Step 4• Allocate the transaction price to the performance obligations in the

contract

Step 5• Recognize revenue when (or as) you satisfy a performance

obligation

Five Step Process

What does it say?

• This is very similar to percentage completion method in use today

• You may apply the standard to a group of contracts with similar characteristics rather than to individual contracts if it does not materially change the financial statements

Step 1• Identify the contract(s) with a customer• Contract▫ An agreement with consideration between two or more

parties that creates enforceable rights and obligations▫ Must have: Both parties approval Identified payment terms Substance and enforceable rights Probable collectability

Combination of Contracts• If multiple contracts are entered into with the same

customer at the same time, they should be combined and accounted for together as one contract if one of these is true:▫ They are negotiated as a package with one objective▫ Payment for one contract depends on the price or

performance of another▫ The goods/services in the contracts are a single

performance obligation

Change Orders• Account for as a separate contract if:

▫ Scope increases as the addition of goods/services are distinct and,

▫ Price of contract increases by your standalone selling price of additional goods/services provided

• Account for as termination of current contract and creation of new contract if:

▫ Remaining goods/services are distinct from goods/services transferred before contract modification

• Account for as modification of existing contract if:

▫ Remaining goods/services are not distinct

Change Orders• Unpriced Change Orders▫ If parties have approved a change in the scope, but have

not yet determined the corresponding change in price, the entity should estimate the change to the contract as variable consideration

▫ You will estimate the price based on a probability-weighted or most likely amount approach provided that it is probable.

• Most change orders will not be accounted for as a separate contract due to –▫ Change orders generally don’t provide “distinct” goods or

services as they are usually interrelated to the original contract

▫ Change orders are typically based on the goal of obtaining one commercial objective for the overall contract.

Step 2

• Identify the performance obligations in the contract• Performance Obligations▫ A promise to transfer a good or service

• If there are multiple promises, they should be accounted for as separate performance obligations if they are distinct

Step 2• Distinct▫ The customer is able to obtain a benefit and the promise is

separately identifiable from other promises▫ Nondistinct items should be bundled together until they are

distinct

• Most construction contracts will have just one performance obligation▫ A customer cannot benefit from a partially completed building; not

until the entire package is completed does it provide a benefit to the customer

Step 3

• Determine the transaction price• Transaction Price: The amount of consideration

(payment) to which an entity expects to receive in exchange for transferring the goods or services

• Assume the contract will not be renewed, modified, or cancelled

• More complex when it comes to possible awards or incentive payments – if they are probable, they should be included in the transaction price from the beginning

Variable Consideration• Due to discounts, rebates, refunds, credits, price

concessions, incentives, performance bonuses, penalties, etc.

• Use the most likely value or probability-weight the expected value; whichever is most accurate

• Refund Liability▫ Must be recognized if you expect to refund some (or all)

consideration received from customer

Time Value of Money• Time Value of Money: A dollar today is not the same as a

dollar a year from now (likely not a big impact)▫ Must be considered if the project is to extend beyond one

year and there is a significant financing component to the contract (retainage not considered here)

▫ Adjust for time value of money so that revenue is recognized at an amount that matches what you would have received if consideration had been paid when goods/services were transferred to customer

Other considerations• Noncash Consideration – Customer-furnished materials▫ Measure at fair value and include in contract revenue, or if that is

not possible, at the standalone selling price for the good/service rendered or transferred

• Payments to a customer ▫ Credit, coupons, vouchers; these should reduce the transaction

price• Claims▫ Accounted for as variable consideration using the expected value

or most likely amount approach provided that collection is probable

Step 4

• Allocate the transaction price to the performance obligations in the contract. (will require judgment)

• If there is more than one performance obligation in a contract, allocate in an amount that matches the consideration you would receive for meeting that obligation independently

• Allocate variable consideration or discounts to the related performance obligations rather than to the entire contract

Step 4• It is a separate performance obligation if it is distinct,

meaning –▫ The customer can benefit from the good or service either

on its own or together with other resources that are readily available to them; and,

▫ The entity’s promise to transfer the good or service to the customer is separable from other promises in the contract

• This is more significant if things such as engineering, procurement, construction or design/build are included in contracts

Step 4• Determine/estimate standalone selling price at contract inception for

each performance obligation and allocate revenues based on relative standalone selling price▫ Standalone selling price is price at which good/service would be

sold separately to a customer; this is not necessarily the price stated in the contract

▫ Allocate any subsequent changes in price on the same basis as at inception

▫ If standalone information not available, it should be estimated using a reasonable method. Cost plus normal margin for example

• Amounts allocated to a satisfied performance obligation should be recognized as revenue (or a reduction of revenue) in the period in which the transaction price changes

Allocation Example• Performance Obligation 1▫ Build a power plant▫ Standalone Selling Price: $100m

• Performance Obligation 2▫ Build nearby command center▫ Standalone Selling Price: $50m

• Transaction Price: $125m▫ Allocated to power plant: $83m (2/3rd)▫ Allocated to command center: $42m (1/3rd)

Step 5

• Recognize revenue when (or as) you satisfy a performance obligation

• Performance obligation is satisfied when ▫ The good/service is transferred to the customer▫ The customer obtains control of the good/service

Step 5• If a good/service is transferred over time, recognize

revenue over time▫ If the customer receives and uses benefits from your work

while you perform

▫ You create/enhance an asset (work in process) while the customer controls the asset being created/enhanced

▫ Your performance doesn’t create an asset with an alternative use to you, and you have an enforceable right to payment for performance completed to date

Step 5• If performance obligation is not satisfied over time,

recognize revenue at a point in time when▫ You have a right to payment for the asset,▫ The customer has title, physical possession, and the

risks/rewards of ownership of the asset, AND▫ The customer has accepted risk

Measuring Progress• Output Methods

▫ Recognize revenue on basis direct measurement of value of goods/services transferred to date relative to total goods/services promised

▫ Appraisal of results to date, units delivered, etc.

• Input Methods▫ Recognize revenue on basis of efforts to the completion of a performance

obligation▫ Hours expended, costs incurred, etc.▫ Exclude inputs that do not contribute to entity’s progress in meeting performance

obligation or costs that are not proportionate to progress (uninstalled materials)

• Method must accurately depict true progress and hopefully is contemplated in the contract itself

Costs of obtaining contract

• Costs incurred to obtain contract that would not have been incurred if contract not obtained (e.g. sales commission)

• Recognize as asset if expect to recover costs▫ May expense if amortization is less than a year

• Costs incurred despite whether contract obtained are expensed regardless of whether contract obtained or not

Costs of fulfilling a contract• Recognize costs incurred to fulfill a contract as an asset only

if:▫ Relate directly to a contract that is specifically identifiable

▫ Generate/enhance resources of the entity that will be used in meeting performance obligations in the future

▫ Are expected to be recovered

• If within scope of another topic (e.g. inventory), look to that guidance first

• Should be amortized and evaluated for impairment

Warranties

• If warranty is purchased separately, warranty is distinct and therefore a separate performance obligation

• If not purchased separately, account for using existing guidance on warranties

Disclosures• Contracts with customers▫ Revenue/impairments recognized▫ Disaggregation of revenue▫ No real change in reporting of over/under billings

• Significant judgments and changes in judgments▫ Over time or point in time recognition▫ Used to determine transaction price and allocation

• Assets recognized from the costs to obtain or fulfill a contract• Relief for nonpublic entities

Transition• Public Entities▫ Periods beginning after 12/15/16

• Nonpublic Entities▫ Periods beginning after 12/15/17 – generally calendar year

2018▫ May adopt as early as 12/15/16, but no earlier

• Applies to all contracts with customers▫ Other than those covered by other standards, such as leases,

insurance, financing arrangement, financial instruments, and guarantees

Transition

• Have two options during transition period▫ May restate prior periods (retrospective

application) or▫ May apply new standard only to new contracts

going forward and continue to apply current standards to previous contracts Must show a cumulative effect adjustment and

additional disclosures

What should you do now?• Companies should begin evaluating the impact

on –▫ Current business activities, including contract

negotiations▫ Key metrics (debt covenants, surety, pre-qual)▫ Taxes▫ Budgeting▫ Controls and processes,▫ IT requirements

Q & A

THANK YOU!