AccountingMore Like This

Reduce the Stress of Implementing ASC 606

There is no time to waste in beginning the implementation process for the Financial Accounting Standards Board’s (FASB) new revenue recognition standard, Accounting Standards Codification (ASC) 606. Companies will find differences in some of the methods of recognizing revenue in the future, so taking a proactive approach to ASC 606 can help reduce the stress of implementation.

The objective of ASC 606 is to create a unified, principles-based standard on accounting for revenue from customers. In doing so, the FASB replaced hundreds of pages of rules-based guidance principally designed for specific industries, including construction. The standard affects virtually every entity that prepares financial statements in accordance with Generally Accepted Accounting Principles. Moreover, the standard impacts what is arguably the most important number in financial statements: revenue.

The standard is effective for years beginning after Dec. 15, 2018, for private companies. However, it most likely impacts Dec. 31, 2018, financial statements because most companies issue comparative statements. Additionally, when comparative statements are issued, the impact on contract work-in-process for Dec. 31, 2017, also might need to be determined and retrospectively applied.

Contractors will find many elements of ASC 606 to be very similar to how they currently recognize revenue, but key differences include:

  • financial statement disclosure updates;
  • new terminology related to contract reporting;
  • more specific and robust internal controls and documentation for the revenue cycle;
  • accounting for change orders, claims, variable consideration and uninstalled materials; and
  • combining and segmenting contracts.

Construction contractors enter into many different types of contracts that contain an infinite number of variables. The different contract terms and clauses will directly impact how contractors ultimately record their revenue. The impact will vary, with some companies having limited impact on most of their contracts to some companies having to totally overhaul the revenue reporting.

ELEMENTS OF ASC 606

ASC 606 provides a structure through which all revenue transactions must be assessed. It consists of the following five elements.

  1. Identify the contract with a customer. Both parties must approve of the contract commitment, and each party’s rights must be identified along with the payment terms. Additionally, contracts must have commercial substance and collection must be probable.
  2. Identify the performance obligations in the contract. The parties promise to transfer to the customer either a good or service that is distinct (e.g. a commercial building) or a series of distinct goods or services that are substantially the same (e.g. maintenance services).
  3. Determine the transaction (contract) price. The parties must agree to the amount they are entitled in exchange for transferring promised goods or services to a customer. Contractors will need to understand specific issues in this arena, such as variable consideration (share savings, penalty and incentive clauses, etc.), estimates of uncertain items (ranges and probabilities of events related to pricing) and potential financing components in the contract for delayed receipts or prepayments.
  4. Allocate the transaction price to the performance obligations. The contract price should be allocated to the performance obligations based on the relative standalone selling price of each. The standalone selling price can be determined by charging the actual selling price for the same product or service, or by taking the adjusted market assessment approach, the expected cost plus margin approach or the residual approach.
  5. Recognize the revenue when (or as) the reporting organization satisfies the performance obligations. The company recognizes revenue when it satisfies a performance obligation by transferring the good or service to the customer. The good or service is transferred when the customer obtains control. Two acceptable methods that contractors use are performance obligations satisfied at a point in time, which is similar to today’s completed contract method, and performance obligations satisfied over time, which is similar to today’s percentage of completion method.

ASSESSMENT AND IMPLEMENTATION 

Companies should approach assessment and implementation like they would any new construction project: by planning a systematic approach, assigning a project manager (in this case a financial person), managing the progress and measuring the results. To start, evaluate the company’s different revenue streams and various types of contracts. Then, take an inventory of the contracts and assess the potential impact to each type of contract. Perform a gap analysis by comparing the current state of the organization’s contract process, internal controls and information systems for compliance with ASC 606. Finally, develop and execute an implementation plan, and then manage and evaluate controls and processes in place to record revenue under ASC 606.

Leave a Reply

Your email address will not be published. Required fields are marked *