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With the beginning of 2019, the new revenue recognition standard for contracts with customers is effective for all entities, including private businesses. Under the new standard, all entities shall recognize revenue to depict the transfer of goods or services to the customer under contract in an amount that reflects the consideration the entity receives or expects to receive in exchange for those goods or services provided. This is a significant change from the prior method.
The FASB Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, provides for two methods of implementation: the full retrospective approach and the modified retrospective approach. Entities should carefully consider each method of adoption and the impact it could have on its financial position while taking into consideration the concerns of sureties, bankers and other users of the financial statements.
The full retrospective approach requires an entity to restate all prior periods presented in the financial statements as if the period had originally been accounted for using ASC Topic 606. A cumulative adjustment would be made to necessary balance sheet accounts and the opening balance of retained earnings as of Jan. 1, 2018 and all comparative periods would be restated.
The modified retrospective approach allows for a slightly simpler implementation. The entity would only apply the new revenue recognition standard to contracts that are in process as of Dec. 31, 2018 and onward. The cumulative adjustment would be reflected in the opening balance sheet at January 2019 as a change to the prior period’s retained earnings and disclosed in the financial statements. Comparative periods would not need to be restated.
Regardless of the selected implementation method, it is important to identify and document the key changes that could materially impact revenue recognition for contracts in process as of Dec. 31, 2018. For each in process contract you will need to consider the following:
• Is there more than one performance obligation?
Each in-process contract will need to be analyzed to determine whether the nature of the obligation is to provide distinct goods/services or to transfer a combined item. What used to be accounted for as one contract may have to be split up by performance obligations and accounted for separately. Identification of two or more performance obligations in a contract could impact the revenue recognition on open jobs.
• Are there any capitalizable job fulfillment costs?
Under ASC topic 606 certain costs to fulfill contracts should be capitalized on the balance sheet. Did you incur costs for insurance, bonding, mobilization or any other upfront costs that should be considered? These fulfillment costs should be amortized as a capitalized contract fulfillment cost to job costs over the period reflecting the transfer of control to the customer, which in most cases will be the expected duration of the contract for construction contracts.
• Are there any uninstalled materials or inventory?
Are there specific items that you had to order ahead of time to meet the obligation that have not yet been transferred? Projects often require a wide range of goods to be assembled and those items may not immediately transfer into the control of the customer. It is important to have discussions with project managers and job supervisors to determine if any of these items exist as of Dec. 31, 2018, which would result in inventory or uninstalled materials being recorded in the balance sheet rather than job costs.
• Does the contract include variable consideration?
Claims and pending change orders, incentive and penalty provisions within the contract, price concessions, liquidating damages or unit price contracts with variable units? These items must be factored into the transaction price and cannot be ignored pursuant to an internal company policy.
Determining the amount and timing of revenue to recognize under ASC 606 will require significant judgment by the contractor based on the facts and circumstances present in a given contract. If the effect of the 2018 change in revenue recognition resulting from the adoption of ASC 606 is known prior to issuance of 2019 financial statements, then it should be disclosed in your issued 2018 statements. It is recommended that you identify any potential problem items as close to year end as possible and then schedule a time in mid-2019 to meet with your accountant to review and quantify the effect of the change to Topic 606 will have on your financial statements.
If you have any questions or would like more information on Topic 606, Revenue from Contracts with Customers, contact Kaitlyn Hensler, CPA, CFE at 315•472•9127 or email firstname.lastname@example.org.