On May 28, 2014 the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued their final standard on revenue from contracts with customers. The standard, issued as ASU 2014-09 by the FASB and as IFRS 15 by the IASB, outlines guidance for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance.
The construction industry, in particular, is going to be impacted by the new standard, and there are a number of special considerations within it for which companies will need to prepare.
Under the new standard, Section 606-10-55-21 states that when a cost incurred is not proportionate to the entity’s progress in satisfying the performance obligation, the best depiction of the entity’s performance may be to adjust the input method to recognize revenue only to the extent of that cost incurred. This is essentially saying uninstalled material or goods must be accounted for at a zero margin until installed or work is performed on them, assuming they meet the following criteria:
In many construction contracts, there is some level of expected waste that is unavoidable as part of the contract. However, the new standard is looking specifically at instances in which an entity experiences significant unexpected levels of wasted labor, resources or other materials.
The standard states that an entity should exclude from an input method the effects of any inputs that, in accordance with the objective of measuring progress, do not depict the entity’s performance in transferring control of goods or services to the customer. For instance, when using a cost-based input method, an adjustment to the measure of progress may be required when a cost incurred does not contribute to an entity’s progress in satisfying the performance obligation. For example, an entity would not recognize revenue on the basis of costs incurred that are attributable to significant inefficiencies in the entity’s performance that were not reflected in the price of the contract (such as the costs of unexpected amounts of wasted materials, labor, or other resources that were incurred to satisfy the performance obligation).
This will be an area of substantial judgement going forward but, at a minimum, any major unexpected significant inefficiencies (ordering the wrong material that is nonrefundable) that do not contribute at all to the completion of the contract should not be included as contract costs.
These are incremental costs in obtaining the contract, and under the new standard can be capitalized under the correct circumstances. Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained (bid costs) are recognized as expenses when incurred, unless explicitly chargeable to the customer regardless of whether the contract is obtained.
However, direct costs of fulfilling a contract are capitalized under the new standard if not within the scope of other standards, and if they meet the following criteria:
A good example of these type of costs would be sales commissions on a large project.
It is important to note that any capitalized costs are amortized as control of the goods or services to which the asset related is transferred to the customer. If this timeframe is expected to be less than one year, the costs may still be expensed rather than capitalized.
The effective date for all non-public entities are annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. So clearly the time is now to begin adjusting to this new standard.