The new revenue recognition standard has been discussed extensively for the past few years and while most discussions focus on the technical issues, I like to discuss application of the standard, particularly on how it affects the construction industry. In a previous blog, I discussed the importance of adopting the new standard and how it specifically affects the construction industry.
If you are a contractor, you are most likely reporting revenue using percentage of completion and while the new standard is not percentage of completion, it does have some important similarities that place companies in the construction industry at an advantage. For contractors, the changes are primarily in determining which costs can be used to drive revenue (and profit) under the new standard. 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 (see previous blog)
- Contract fulfillment costs
- Uninstalled materials
- Wasted or unproductive costs
What are contract fulfillment costs?
These are contract costs that are typically incurred shortly after obtaining a contract. For example – set up costs, mobilization, bond and insurance premiums.
How are contract fulfillment costs treated under the new standard?
Under current GAAP, contract fulfillment costs are costed to a job when you get the job (front of the job cost). Under the new standard, that’s not allowed, 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 standard.
So, how does this affect your company?
You may be able to continue to expense these at the front of the job if fulfillment costs are immaterial to your financial statements. However, as a financial manager you must establish internal controls and procedures that demonstrate you have considered fulfillment costs on a contract by contract basis when implementing the new standard. The key concept is that you do not recognize revenues and costs that do not reflect the progress of the contract.
Stay tuned for my upcoming blogs as I discuss the other contract costs outlined above.
Abel Coronel, CPA