Construction businesses that follow Generally Accepted Accounting Principles (GAAP) will face an important change in about one year. That’s when Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, begins to take effect for private companies. Let’s take a look at what’s changing.
To be precise, for private companies the new rules take effect with annual reporting periods beginning after December 15, 2018. They’ll affect contractors with significant dollar value contracts that span considerable lengths of time. The big change, in a nutshell, is a move away from a strict percentage-of-completion method to recognizing revenue under a revenue recognition model.
Your primary objective under ASU 2014-09 will be to separate contracts into “performance obligations.” The issuer of the new rules, the Financial Accounting Standards Board (FASB), defines these as “promised goods or services that are distinct and should be accounted for separately.” What makes them recognizable as revenue is that the customer “can benefit from the good or service” by itself as a standalone, or use the delivered good or service by itself with other resources the customer already has, without needing to receive any future goods or services to use it.
ASU 2014-09 will have the most impact on new construction. The FASB notes that many common line items are tempting to treat as separately recognizable revenue because construction companies typically sell these goods and services separately. Examples include:
- Site clearance,
- Foundation work,
- Construction of a structure,
- Piping and wiring, and
- Installation of equipment and finishing.
What’s more, “… customers could generate economic benefit from the individual goods and services by using, consuming, selling or holding those goods or services,” stated the FASB in a webcast last year.
But a significant level of service by the contractor is required to integrate these components into a usable whole for the customer. Therefore, electrical wiring and foundation work in new construction, for example, aren’t separately recognized as revenue under the new rules. They’re merely components of revenue that will be reported later. You may be able to bill for them separately, but you can’t account for them separately as revenue when these line items are billed or paid.
Bundle of goods/services
To recognize revenue, the contractor must aggregate the building components “… until it identifies a bundle of goods or services that is [separately deliverable and usable as stand-alone and] distinct,” states the FASB in ASU 2016-10 (an update on ASU 2014-09). “In some cases, that would result in … accounting for all the goods or services … in a contract as a single performance obligation.”
So, for new construction, this means your construction company may have to account for all of the goods and services as a single performance obligation. ASU 2014-09 will delay revenue, which may cause your initial year under the new standard to show much less income than you have in previous years.
Impact on other jobs
Recording revenue on installation and renovation projects will be different. The major question is whether the revenue from materials or equipment can be recognized separately from the installation work.
To figure this out, you’ll need to determine whether the equipment has a standalone value to the customer. This won’t be the case if you’re performing specialized integration services that transform the materials into usable form, as is true of most renovation projects. However, revenue is recorded separately if:
- The equipment could be installed (without customization) by other contractors, and
- It has retail sales value to the customer in its own right.
Then there’s the question of project phases. The nature of contracting is to provide materials and services that combine to create a whole that equals more than the sum of its parts. Thus, in most cases, completion of that whole project (or phase) is going to be the revenue recognition point.
A construction project consisting of renovating or installing components (when those components are interrelated) will have those installations or renovation activities aggregated and recognized as revenue only when the bundle of services is complete. Typically, this is going to delay revenue recognition for construction companies that are used to recognizing revenue throughout the course of a project under the percentage-of-completion method.
While following the new revenue recognition rules might sound onerous, standardized accounting clarifies reporting of earnings and financial assets and improves comparability with other construction companies. To better understand how ASU 2014-09 will affect revenue recognition for your construction company please contact Paul Atkinson who can help your company have the right processes in place when the new rules take effect.