April 26, 2019
Revenue Recognition is Upon Us – How is the Construction Industry Faring?
The construction industry was dealt a difficult hand when the new revenue recognition standard was first introduced in 2014. As contract-based businesses, they had to take a close look at almost all their revenues streams and challenge some long-held assumptions in order to comply with the new accounting standard. Since many construction contracts span multiple reporting years, the process was especially daunting. Now that the revenue recognition standard is in effect, we wanted to take a step back and see how construction companies have been faring under this new accounting system. To help clients, prospects and others in the Atlanta construction industry with compliance, Wilson Lewis has compiled a list of key areas of concern.
Revenue Recognition Challenges
Although the standard is currently in effect for both public and private entities, the Atlanta construction industry is constantly pivoting their strategies and making changes to overcome challenges. In the implementation process there have been a few challenges, including:
- How to account for performance inefficiencies. According to the revenue recognition principles, only the true costs of the contract can be reported alongside contract revenues. This means that significant performance inefficiencies will have to be removed and expensed as they are incurred rather than expensed alongside the recognition of revenue. This ostensible mismatch of revenues and expenses can have a big impact on the income statement.
- How to account for uninstalled materials costs. Often, construction companies hold sizable values of uninstalled building materials. As per the new guidance, these costs cannot be expensed until control has been transferred to the customer – that is, until they have been used in the project. Until the materials are used, these substantial costs will have to be accounted for as inventory on the balance sheet.
- How to account for costs that are misaligned with the contract’s progress. When project costs grow at the same rate the contract progresses, the revenue recognition rules are fairly straightforward. When input costs do not correlate with progress on the project, the construction entity will have more difficulty recognizing revenues. How can you measure progress toward completion of the contract if your costs are not a good representation of your progress? Counter intuitively, under the right conditions, the construction company may be in the right to recognize revenues to the extent those non-proportionate costs were incurred. They must be able to prove, among other things, that those costs are significant compared to the total anticipated costs of the contract.
- How to account for performance obligations once you determine they are not profitable. Construction companies have a couple options to choose from. If it becomes apparent that all performance obligations (i.e. the entire contract) is in a loss position, the entity should record the entire loss immediately. However, if only one of the performance obligations is expected to produce a loss, they have options. They can either (1) record that performance obligation on the same timeline they would have otherwise, or (2) record the loss for that performance obligation immediately.
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While the items listed above are the most common challenges faced there are several others to monitor including accounting for contract modification, estimating variable considerations and assessing the ability to collect for a multi-year contract. Revenue recognition can be a challenge to implement but with the right professionals and resources on your side, it doesn’t have to be. If you have questions about revenue recognition, a specific construction tax or accounting issue, Wilson Lewis can help! For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.
