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Topic 606 and Construction Revenue: What CPAs Need to Know

In May 2014, FASB issued an Accounting Standards Update regarding Topic 606: Revenue from Contracts with Customers, along with various amendments, to be implemented in 2017 and 2019. In this post, we’ll talk about exact adoption dates of the new construction revenue recognition standards, the major updates, and how you can help your construction clients update their contracts, accounting policies and financial statements.

Required Adoption Dates

Public entitles were required to adopt the standards as of December 15th, 2017, and the private sector is required to adopt the standards as of December 15th, 2019. Although the adoption date for non-public entities is over a year away, it’s incumbent for CPAs with construction clients to both understand the standards and start helping their clients implement them in their work.

Let’s Talk About the Major Changes

The new revenue standards will replace substantially all of the previous revenue guidance. Past standards provided guidance specific to long-term contracts, such as the definition of a contract, the contract price, recognition methods and accounting for contract costs. The new guidance goes above and beyond the old standards to provide a more in-depth and structured approach over a series of 5 steps. Below, we’ll cover each step and the major changes from the previous standards.

Step 1: Identify the Contract

Major Differences from Previous Standards:

  • Combining Contracts– Two or more contracts are combined and accounted for as one if they are entered into near the same time and meet specific conditions.
  • Contract Modifications– A company will account for a contract modification if the parties to the contract approve a change in either the scope or price of a contract.

Step 2: Identify Performance Obligations

Major Differences from Previous Standards:

  • Identifying Performance Obligations– Companies should assess goods or services promised via the contract and identify as a single performance obligation each promise to transfer a customer either a distinct good or service or a serious of distinct goods or services. A good or service must meet specific criteria to identify it as ‘distinct.’

Step 3: Determine the Transaction Price

The consideration the contractor expects in exchange for satisfying performance obligations is the transaction price or contract revenue.

Major Differences from Previous Standards:

  • Awards, Incentive Payments and Liquidated Damages– Awards and incentive payments are to be treated as variable consideration while liquidated damages should be treated as negative incentive payments.
  • Unpriced Change Orders and Variations– As noted in Step 1, contract modifications are accounted for if the contract parties approve a change in the scope or price of the contract.
  • Customer Furnished Materials– Contract revenue includes the value of goods provided by a customer to fulfill the contract if the seller obtains control of these goods or services.
  • Claims– Overrun claims are accounted for as variable consideration and included in the transaction price.
  • Significant Financing Component– If the contract includes a significant financing component, the transaction price must be adjusted.

Step 4: Allocate the Transaction Price

Major Differences from Previous Standards:

  • Transaction Price Allocation to Performance Obligations– The transaction price is allocated to each separate performance obligation. This price is based on the relative individual selling price of each performance obligation.

Step 5: Recognize Revenue

Major Differences from Previous Standards:

  • Satisfaction of Performance Obligation– Currently, the percentage-of-completion method is used widely by the industry. The new standards recognize revenue when the performance obligation is satisfied, which generally occurs when the control of the goods or services transfers to the customer. While this method will provide similar results to the percentage-of-completion method, contractors will need to identify the performance obligation and the satisfaction of the performance obligation on a contract-by-contract basis. To satisfy the performance obligation, contractors must meet a specific set of criteria.

Other Obligations

  • The new revenue recognition standards also provide guidance for the following: warranties, contract costs, set-up and mobilization costs, contract assets and liabilities, onerous contracts, disclosures, performance obligations, significant judgements and reconciliation of contract balances

Providing for Your Construction Clients

While this summary provides an overview of the major changes to revenue recognition for contractors, it is not all-inclusive and does not provide all of the necessary details regarding the new standards.

In order to help their construction clients understand and implement the new standards, CPAs and accountants need to be both familiar and comfortable with the new standards. Surgent CPE delves into the intricacies of the new standards, and how CPAs can provide for their construction clients in their 2 credit CPE course Industrycast: Preparing for New Topic 606 Construction Revenue Recognition Standards (IDNC). The course covers the methods for implementing the standard, the 5 core principles mentioned above, including the impacts and potential pitfalls of each, examples related to the new standards, and an implementation checklist. By taking the course, CPAs, CFOs, Controllers and construction company owners can get a head start on implementing the new standards and be comfortable reporting revenue when the standards are implemented in 2020.

Megan Bierwirth graduated from the University of Kentucky in 2013 with a Bachelor’s of Science in Accounting and passed the CPA exam within 6 months of graduation. She worked in both public accounting and industry while becoming a CPA and now runs a virtual bookkeeping company focused on preventive, integrative and complementary medicine professionals.

Topic 606 and Construction Revenue: What CPAs Need to Know was last modified: February 23rd, 2022 by Richard Daisley, CPA
Richard Daisley, CPA: