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Revenue recognition: costs of obtaining contracts

contracts, revenue recognition, accounting, constructionBy now most of us are experiencing information overload on the new revenue recognition standard and are contemplating to jump ship before the standard comes into effect. The Accounting Standard Codification introduces Topic 606 (too close to triple-six if you ask me), Revenue from Contracts with Customers, and it is effective to all nonpublic companies for annual reporting periods beginning on or after December 15, 2018. Therefore, if this is the first time you are hearing about this, I advise that you become familiar with the standard as it will have an impact across all industries, no exceptions.

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However, if you are a contractor, you are ahead of the curve compared to most other industries. Why? Because the new guidance introduces the concept of contracts (sounds familiar?) and the principle of recognizing revenue over time (like percentage of completion) or at a point in time (like completed contract accounting). For the most part, revenue recognition for commercial construction under the new guidance will be like these current methods and the “cost to cost” measurement method used in current percentage of completion will still be used – with some modifications.

This does not mean that if you are a contractor you are exempt from any changes (similar does not mean the same). For contractors, the changes are primarily in determining which costs can be used to drive revenue (and profit) under Topic 606. Specifically, some costs, which are now commonly charged to jobs, need to be excluded from the cost to cost calculation because they don’t contribute to the contractor’s progress in completing the project. These costs, under the new standard are:

  • Incremental costs of obtaining a contract
  • Contract fulfillment costs
  • Uninstalled materials
  • Wasted or unproductive costs

What are incremental costs of obtaining a contract?

Those costs that the company would not have incurred if the contract had not been obtained. These are costs that are incurred only as a result of obtaining a contract (for example, proposal costs, commissions, etc.). This does not include costs such as salaries related to personnel working on a proposal. Such costs would not be incremental since the costs would be incurred even if the contract was not obtained.

How are these costs treated under the new standard?

Under current GAAP, the costs of obtaining a contract are currently costed to a job when you get the job (front of the job cost). Under the new standard, that will still be permitted unless the contract is longer than one year, in which case they are required to be amortized over the life of the job. There are no other differences on how these costs will be treated under the new revenue recognition standard.

So, how does this affect your company?

If your contracts are typically under one year, you are probably thinking you don’t have to worry about this. However, as a financial manager you must establish internal controls and procedures that show you have considered this on a contract by contact basis when implementing the new standard.

Stay tuned for my upcoming blogs as I discuss the other contract costs outlined above. In the meantime, you can download our revenue recognition e-Book for more information, including industry specific guidance for construction.

Abel Coronel, CPA